Attached files

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EX-32.2 - Digipath, Inc.ex32-2.htm
EX-32.1 - Digipath, Inc.ex32-1.htm
EX-31.2 - Digipath, Inc.ex31-2.htm
EX-31.1 - Digipath, Inc.ex31-1.htm
EX-10.2 - Digipath, Inc.ex10-2.htm
EX-10.1 - Digipath, Inc.ex10-1.htm
EX-4.4 - Digipath, Inc.ex4-4.htm
EX-4.3 - Digipath, Inc.ex4-3.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For Quarterly Period Ended December 31, 2019

 

or

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission File Number 000-54239

 

 

Digipath, Inc.

(Exact name of registrant issuer as specified in its charter)

 

Nevada   27-3601979

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

     
6450 Cameron St Suite 113 Las Vegas, NV   89118
(Address of principal executive offices)   (zip code)

 

(702) 527-2060

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class  

Trading

Symbol(s)

  Name of each exchange on which registered
N/A   N/A   N/A

 

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 every Interactive Data File required to be submitted 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 such files).

Yes [X] No [  ]

 

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

 

  Large accelerated filer [  ] Accelerated filer [  ]
  Non-accelerated filer (Do not check if a smaller reporting company) [  ] Smaller reporting company [X]
      Emerging growth company [X]

 

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

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

The number of shares of registrant’s common stock outstanding as of February 12, 2020 was 49,657,666.

 

 

 

   
 

 

TABLE OF CONTENTS

 

  Page No.
PART I - FINANCIAL INFORMATION
ITEM 1.   FINANCIAL STATEMENTS (Unaudited) 1
    Condensed Consolidated Balance Sheets as of December 31, 2019 (Unaudited) and September 30, 2019 1
    Condensed Consolidated Statements of Operations for the Three Months Ended December 31, 2019 and 2018 (Unaudited) 2
    Consolidated Statement of Stockholders’ Equity for the Three Months Ended December 31, 2019 and 2018 (Unaudited) 3
    Condensed Consolidated Statements of Cash Flows for the Three Months Ended December 31, 2019 and 2018 (Unaudited) 4
    Notes to the Condensed Consolidated Financial Statements (Unaudited) 5
ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 19
ITEM 4.   CONTROLS AND PROCEDURES 19
PART II - OTHER INFORMATION
ITEM 1.   Legal Proceedings 20
ITEM 1A.   RISK FACTORS 20
ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 20
ITEM 3.   DEFAULTS UPON SENIOR SECURITIES 20
ITEM 4.   MINE SAFETY DISCLOSURES 20
ITEM 5.   OTHER INFORMATION 20
ITEM 6.   EXHIBITS 21
   

SIGNATURES

22

 

   
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   December 31,   September 30, 
   2019   2019 
   (Unaudited)     
Assets          
Current assets:          
Cash  $68,657   $323,739 
Accounts receivable, net   282,068    179,256 
Other current assets   54,957    74,620 
Inventory   37,900    - 
Deposits   25,647    51,704 
Total current assets   469,229    629,319 
           
Right-of-use asset   289,867    - 
Fixed assets, net   1,137,179    726,614 
           
Total Assets  $1,896,275   $1,355,933 
           
Liabilities and Stockholders’ Equity          
           
Current liabilities:          
Accounts payable  $214,454   $136,612 
Accrued expenses   85,934    134,881 
Short term advances   25,000    - 
Current portion of operating lease liabilities   196,069    - 

Current portion of finance lease liabilities

   

29,771

    - 
Current maturities of note payable   52,030    - 
Convertible notes payable, net of discounts of $33,105 and $-0- at December 31, 2019 and September 30, 2019, respectively   666,895    200,000 
Total current liabilities   1,270,153    471,493 
           

Operating lease liabilities

   

94,777

    - 
Finance lease liabilities   43,578    - 
Note payable, equipment financing   239,901    - 
Convertible notes payable, net of discounts of $-0- and $41,426 at December 31, 2019 and September 30, 2019, respectively   -    458,574 
           
Total Liabilities   1,648,409    930,067 
           
Stockholders’ Equity:          
Series A convertible preferred stock, $0.001 par value, 10,000,000 shares authorized; 1,325,942 shares issued and outstanding   1,326    1,326 
Common stock, $0.001 par value, 250,000,000 shares authorized; 48,532,666 and 48,361,433 shares issued and outstanding at December 31, 2019 and September 30, 2019, respectively   48,533    48,361 
Additional paid-in capital   15,374,094    15,331,839 
Accumulated (deficit)   (15,176,087)   (14,955,660)
           
Total Stockholders’ Equity   247,866    425,866 
           
Total Liabilities and Stockholders’ Equity  $1,896,275   $1,355,933 

 

See accompanying notes to financial statements.

 

 1 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

   For the Three Months Ended 
   December 31, 
   2019   2018 
         
Revenues  $808,930   $642,115 
Cost of sales   405,481    482,320 
Gross profit   403,449    159,795 
           
Operating expenses:          
General and administrative   388,432    390,471 
Professional fees   183,633    246,580 
Bad debts expense   43,250    24,565 
Total operating expenses   615,315    661,616 
           
Operating loss   (211,866)   (501,821)
           
Other income (expense):          
Other income   21,000    50,400 
Interest expense   (29,561)   (10,753)
Total other income (expense)   (8,561)   39,647 
           
Net loss  $(220,427)  $(462,174)
           
Weighted average number of common shares outstanding - basic and fully diluted   48,372,600    42,708,641 
           
Net loss per share - basic and fully diluted  $(0.00)  $(0.01)

 

See accompanying notes to financial statements.

 

 2 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

 

   For the Three Months Ended December 31, 2018 
   Series A Convertible           Additional       Total 
   Preferred Stock   Common Stock   Paid-in   Accumulated   Stockholders’ 
   Shares   Amount   Shares   Amount   Capital   (Deficit)   Equity 
                             
Balance, September 30, 2018   1,425,942   $1,426    42,245,364   $42,245   $14,121,236   $(13,150,328)  $  1,014,579 
                                    
Common stock issued for services   -    -    1,011,913    1,012    148,264    -    149,276 
                                    
Common stock options issued for services   -    -    -    -    6,559    -    6,559 
                                    
Conversion of preferred stock to common stock   (100,000)   (100)   500,000    500    (400)   -    - 
                                    
Beneficial conversion feature of convertible debts   -    -    -    -    70,964    -    70,964 
                                    
Net loss for the three months ended December 31, 2018   -    -    -    -    -    (462,174)   (462,174)
                                    
Balance, December 31, 2018   1,325,942   $1,326    43,757,277   $43,757   $14,346,623   $(13,612,502)  $779,204 

 

   For the Three Months Ended December 31, 2019 
   Series A Convertible           Additional       Total 
   Preferred Stock   Common Stock   Paid-in   Accumulated   Stockholders’ 
   Shares   Amount   Shares   Amount   Capital   (Deficit)   Equity 
                             
Balance, September 30, 2019   1,325,942   $1,326    48,361,433   $48,361   $15,331,839   $(14,955,660)  $     425,866 
                                    
Common stock issued for services   -    -    171,233    172    24,578    -    24,750 
                                    
Common stock options issued for services   -    -    -    -    17,677    -    17,677 
                                    
Net loss for the three months ended December 31, 2019   -    -    -    -    -    (220,427)   (220,427)
                                    
Balance, December 31, 2019   1,325,942   $1,326    48,532,666   $48,533   $15,374,094   $(15,176,087)  $247,866 

 

See accompanying notes to financial statements.

 

 3 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   For the Three Months Ended 
   December 31, 
   2019   2018 
Cash flows from operating activities          
Net loss  $(220,427)  $(462,174)
Adjustments to reconcile net loss to net cash used in operating activities:          
Change in allowance for doubtful accounts   43,250    24,565 
Depreciation and amortization expense   70,874    64,381 
Stock issued for services   24,750    149,276 
Options and warrants granted for services   17,677    6,559 
Amortization of debt discounts   8,321    4,846 
Decrease (increase) in assets:          
Accounts receivable   (146,062)   (107,576)
Other current assets   19,663    15,432 
Inventory   (37,900)   - 
Deposits   26,057    - 
Right-of-use assets   47,376    - 
Increase (decrease) in liabilities:          
Accounts payable   77,842    (47,455)
Accrued expenses   (48,947)   (15,316)
Lease liabilities   (46,398)   - 
Deferred revenues   -    1,225 
Net cash used in operating activities   (163,924)   (366,237)
           
Cash flows from investing activities          
Purchase of fixed assets   (90,315)   - 
Advance of note receivable   -    (50,000)
Net cash used in investing activities   (90,315)   (50,000)
           
Cash flows from financing activities          
Proceeds from short term advances   25,000    - 
Principal payments on finance lease   (25,843)   - 
Proceeds from convertible notes   -    500,000 
Net cash provided by (used in) financing activities   (843)   500,000 
           
Net increase (decrease) in cash   (255,082)   83,763 
Cash - beginning   323,739    176,027 
Cash - ending  $68,657   $259,790 
           
Supplemental disclosures:          
Interest paid  $7,125   $- 
Income taxes paid  $-   $- 
           
Non-cash investing and financing activities:          
Fixed assets acquired with capitalized finance lease  $99,193   $- 
Fixed assets acquired with note payable, equipment financing  $291,931   $- 
Value of preferred stock converted to common stock  $-   $100,000 
Beneficial conversion feature of convertible notes payable  $-   $70,964 

 

See accompanying notes to financial statements.

 

 4 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1 – Organization, Basis of Presentation and Significant Accounting Policies

 

Organization

 

Digipath, Inc. was incorporated in Nevada on October 5, 2010. Digipath, Inc. and its subsidiaries (“Digipath,” the “Company,” “we,” “our” or “us”) is a service-oriented independent testing laboratory, data analytics and media firm focused on the developing cannabis and hemp markets, and supports the cannabis industry’s best practices for reliable testing, cannabis education and training. Our business units are described below.

 

  Ø Digipath Labs, Inc. Digipath Labs’ mission is to provide pharmaceutical-grade analysis and testing to the cannabis industry, under ISO-17025:2017 guidelines, to ensure consumers and patients know exactly what is in the cannabis they ingest and to help maximize the quality of our clients’ products through research, development, and standardization. Digipath has been operating a cannabis-testing lab in Nevada since 2015 and has plans to open labs in other states and countries that have legalized the sale of cannabis, beginning with California.
     
  Ø GroSciences, Inc. Launched during the first fiscal quarter of 2019 to capitalize on the extensive data we have collected from cannabis through the testing process. GroSciences plans to develop and license specific formulations to other producers and product makers in the industry, and to market and sell its “Tru-Hemp ID” Kit which distinguishes industrial hemp from drug-type cannabis.

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Intercompany accounts and transactions have been eliminated.

 

The unaudited condensed consolidated financial statements of the Company and the accompanying notes included in this Quarterly Report on Form 10-Q are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the Condensed Consolidated Financial Statements have been included. Such adjustments are of a normal, recurring nature. The Condensed Consolidated Financial Statements, and the accompanying notes, are prepared in accordance with GAAP and do not contain certain information included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019. The interim Condensed Consolidated Financial Statements should be read in conjunction with that Annual Report on Form 10-K. Results for the interim periods presented are not necessarily indicative of the results that might be expected for the entire fiscal year.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of the following entities, all of which were under common control and ownership at December 31, 2019:

 

    Jurisdiction of    
Name of Entity(1)   Incorporation   Relationship
Digipath, Inc.(2)   Nevada   Parent
Digipath Labs, Inc.   Nevada   Subsidiary
TNM News, Inc.   Nevada   Subsidiary
GroSciences, Inc.(3)   Colorado   Subsidiary
Digipath Labs S.A.S. (4)   Colombia   Subsidiary

 

(1) All entities are in the form of a corporation.

(2) Holding company, which owns each of the wholly-owned subsidiaries. All subsidiaries shown above are wholly-owned by Digipath, Inc., the parent company.

(3) Commenced operations during the first fiscal quarter of 2019, but has not incurred income to date.

(4) Formed during the first fiscal quarter of 2019, but has not yet commenced significant operations.

 

The consolidated financial statements herein contain the operations of the wholly-owned subsidiaries listed above. All significant inter-company transactions have been eliminated in the preparation of these financial statements. The parent company and subsidiaries will be collectively referred to herein as the “Company”, “Digipath” or “DIGP”. The Company’s headquarters are located in Las Vegas, Nevada and substantially all of its customers are within the United States.

 

These statements reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary for fair presentation of the information contained therein.

 

 5 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Segment Reporting

 

ASC Topic 280, “Segment Reporting,” requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance. The Company operates as a single segment and will evaluate additional segment disclosure requirements as it expands its operations.

 

Fair Value of Financial Instruments

 

Under FASB ASC 820-10-05, the Financial Accounting Standards Board establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement reaffirms that fair value is the relevant measurement attribute. The adoption of this standard did not have a material effect on the Company’s financial statements as reflected herein. The carrying amounts of cash, accounts receivable, accounts payable and accrued expenses reported on the balance sheets are estimated by management to approximate fair value primarily due to the short-term nature of the instruments.

 

Revenue Recognition

 

The Company recognizes revenue in accordance with ASC 606 — Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue from the sale of lab testing services through our subsidiary Digipath Labs, Inc.

 

Revenue is primarily generated through our subsidiary, Digipath Labs, Inc., which recognizes revenue from the analytical testing of cannabis products for licensed producers and cultivators within the state of Nevada on a determinable fixed fee per test, or panel of tests basis. Revenue from the performance of those services is recognized upon completion of the tests, at which time test results are delivered to the customer, provided collectability of the fee is reasonably assured. We typically require payment within thirty days of the delivery of results. Management estimates an allowance for doubtful accounts based on the aging of its receivables.

 

Inventory

 

Inventories are stated at the lower of cost or market. Cost is determined on a standard cost basis that approximates the first-in, first-out (FIFO) method. Market is determined based on net realizable value. Appropriate consideration is given to obsolescence, excessive levels, deterioration, and other factors in evaluating net realizable value. Our products consist of handheld devices used to test cannabis for THC, CBD and CBG levels under our GroSciences, Inc. subsidiary. We have not yet commenced sales of this product.

 

Stock-Based Compensation

 

The Company accounts for equity instruments issued to employees in accordance with the provisions of ASC 718 Stock Compensation (ASC 718) and Equity-Based Payments to Non-employees pursuant to ASC 505-50 (ASC 505-50). All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the earlier of the date on which the counterparty’s performance is complete or the date at which a commitment for performance by the counterparty to earn the equity instruments is reached because of sufficiently large disincentives for nonperformance.

 

Adoption of New Accounting Standards and Recently Issued Accounting Pronouncements

 

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost (that is, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). The new guidance is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2018, with early adoption permitted. There was no impact on the Company’s financial statements as a result of adopting this ASU for the three-month period ending December 31, 2019 or the year ended September 30, 2019.

 

 6 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In February 2016, the FASB established Topic 842, Leases, by issuing ASU No. 2016-02, which requires lessees to recognize the rights and obligations created by leases on the balance sheet and disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-11, Targeted Improvements, ASU No. 2018-10, Codification Improvements to Topic 842, and ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the statement of operations.

 

The new standard became effective for fiscal years beginning after December 15, 2019, with early adoption permitted. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. An entity may choose to use either (1) its effective date or (2) the beginning of the earliest comparative period presented in the financial statements as its date of initial application. If an entity chooses the second option, the transition requirements for existing leases also apply to leases entered into between the date of initial application and the effective date. The entity must also recast its comparative period financial statements and provide the disclosures required by the new standard for the comparative periods. The Company adopted the new standard on October 1, 2019 using the modified retrospective transition approach as of the effective date of the initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before October 1, 2019. The new standard provides a number of optional practical expedients in transition. The Company elected the “package of practical expedients”, which permits entities not to reassess under the new lease standard prior conclusions about lease identification, lease classification and initial direct costs. The Company does not expect to elect the use-of-hindsight or the practical expedient pertaining to land easements.

 

The most significant effects of the adoption of the new standard relate to the recognition of new ROU assets and lease labilities on our balance sheet for office operating leases and providing significant new disclosures about our leasing activities.

 

The new standard also provides practical expedients for an entity’s ongoing accounting. The Company has also elected the short-term leases recognition exemption for all leases that qualify. This means that the Company will not recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets and lease liabilities, for existing short-term leases of those assets in transition. The Company also currently expects to elect the practical expedient to not separate lease and non-lease components for its leases. The new standard did not have a material impact.

 

There are no other recently issued accounting pronouncements that the Company has yet to adopt that are expected to have a material effect on its financial position, results of operations, or cash flows.

 

Note 2 – Going Concern

 

As shown in the accompanying condensed consolidated financial statements, the Company has incurred recurring losses from operations resulting in an accumulated deficit of $15,176,087, and as of December 31, 2019, the Company’s cash on hand may not be sufficient to sustain operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management is actively pursuing new customers to increase revenues. In addition, the Company is currently seeking additional sources of capital to fund short term operations. Management believes these factors will contribute toward achieving profitability. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

The consolidated financial statements do not include any adjustments that might result from the outcome of any uncertainty as to the Company’s ability to continue as a going concern. These financial statements also do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

Note 3 – Fair Value of Financial Instruments

 

Under FASB ASC 820-10-5, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under GAAP, certain assets and liabilities must be measured at fair value, and FASB ASC 820-10-50 details the disclosures that are required for items measured at fair value.

 

 7 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The Company has certain financial instruments that must be measured under the new fair value standard. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels are as follows:

 

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

 

Level 3 - Unobservable inputs that reflect our assumptions about the assumptions that market participants would use in pricing the asset or liability.

 

The following schedule summarizes the valuation of financial instruments at fair value on a recurring basis in the balance sheets as of December 31, 2019 and September 30, 2019, respectively:

 

   Fair Value Measurements at December 31, 2019 
   Level 1   Level 2   Level 3 
Assets               
Cash  $68,657   $-   $- 
Total assets   68,657    -    - 
Liabilities               
Short term advances   -    25,000    - 
Lease liabilities   -    -    364,195 
Note payable, equipment financing   -    291,931    - 
Convertible notes payable, net of discounts of $33,105   -    -    666,895 
Total liabilities   -    316,931    1,031,090 
   $68,657   $(316,931)  $(1,031,090)

 

   Fair Value Measurements at September 30, 2019 
   Level 1   Level 2   Level 3 
Assets               
Cash  $323,739   $-   $- 
Total assets   323,739    -    - 
Liabilities               
Convertible notes payable, net of discounts of $41,426   -    -    658,574 
Total liabilities   -    -    658,574 
   $323,739   $-   $(658,574)

 

The fair value of our intellectual properties are deemed to approximate book value, and are considered Level 3 inputs as defined by ASC Topic 820-10-35.

 

Level 3 liabilities consist of a total of $700,000 of convertible debentures, net of discounts of $33,105 and $41,426 as of December 31, 2019 and September 30, 2019, respectively.

 

There were no transfers of financial assets or liabilities between Level 1, Level 2 and Level 3 inputs for the three months ended December 31, 2019 or the year ended September 30, 2019.

 

Note 4 – Accounts Receivable

 

Accounts receivable was $282,068 and $179,256 at December 31, 2019 and September 30, 2019, respectively, net of allowance for uncollectible accounts of $93,790 and $50,540 at December 31, 2019 and September 30, 2019, respectively.

 

 8 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 5 – Fixed Assets

 

Fixed assets consist of the following at December 31, 2019 and September 30, 2019:

 

   December 31,   September 30, 
   2019   2019 
Software  $123,492   $123,492 
Office equipment   57,460    55,061 
Furniture and fixtures   29,115    29,115 
Lab equipment   1,498,789    1,118,942 
Leasehold improvements   494,117    494,117 
Lab equipment held under capital leases   99,193    - 
    2,302,166    1,820,727 
Less: accumulated depreciation   (1,164,987)   (1,094,113)
Total  $1,137,179   $726,614 

 

Depreciation and amortization expense totaled $70,874 and $64,381 for the three months ended December 31, 2019 and 2018, respectively.

 

Note 6 – Leases

 

The Company’s leases its operating and office facilities, and sub-leases one of the units, under non-cancelable real property lease agreements that expire on May 31, 2021 and June 30, 2021. The Company also has a financing lease for lab equipment subject to the recently adopted ASU 2016-02. In the locations in which it is economically feasible to continue to operate, management expects to enter into a new lease upon expiration. The operating and office facility leases contain provisions requiring payment of property taxes, utilities, insurance, maintenance and other occupancy costs applicable to the leased premise. As the Company’s leases do not provide implicit discount rates, the Company uses an incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments.

 

The components of lease expense were as follows:

 

   For the Three
Months Ended
December 31,
2019
 
Operating lease cost  $52,002 
Finance lease cost:     
Amortization of assets   4,960 
Interest on lease liabilities   3,306 
Sublease income   (21,000)
Total net lease cost  $39,268 

 

 9 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Supplemental balance sheet information related to leases was as follows:

 

   December 31, 
   2019 
Operating leases:    
Operating lease assets  $289,867 
      
Current portion of operating lease liabilities  $196,069 
Noncurrent operating lease liabilities   94,777 
Total operating lease liabilities  $290,846 
Finance lease:     
Equipment, at cost  $99,193 
Accumulated amortization   (4,960)
Equipment, net  $94,233 
      
Current portion of finance lease liability  $29,771 
Noncurrent finance lease liability   43,578 
Total finance lease liability  $73,349 
      
Weighted average remaining lease term:     
Operating leases   1.5 years 
Finance leases   2.3 years 
      
Weighted average discount rate:     
Operating leases   5.75%
Finance lease   18.41%

 

Supplemental cash flow and other information related to leases was as follows:

 

    For the Three
    Months Ended
    December 31,
    2019
Cash paid for amounts included in the measurement of lease liabilities:      
Operating cash flows provided by sublet operating leases   $ 21,000
Operating cash flows used for operating leases   $ 51,024
Operating cash flows used for finance leases   $ 3,306
Financing cash flows used for finance leases   $ 25,843
       
Leased assets obtained in exchange for lease liabilities:      
Total operating lease liabilities   $ -
Total finance lease liabilities   $ 99,193

 

Future minimum annual lease commitments under non-cancelable operating leases are as follows at December 31, 2019:

 

Fiscal Year Ending   Minimum Lease   Sublease   Net Lease 
September 30,   Commitments   Income   Commitments 
2020*  $155,032   $42,000   $113,032 
2021    148,957    -    148,957 
    $303,989   $42,000   $261,989 

 

* Liability pertains to the remaining nine month period from January 1, 2020 through September 30, 2020.

 

 10 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Future minimum annual lease payments required under the finance lease and the present value of the net minimum lease payments are as follows at December 31, 2019:

 

   Finance 
   Leases 
     
2020*  $30,921 
2021   37,105 
2022   21,644 
Total minimum lease payments   89,670 
Less interest   16,321 
Present value of lease liabilities   73,349 
Less current portion   29,771 
Long-term lease liabilities  $43,578 

 

* Liability pertains to the remaining nine month period from January 1, 2020 through September 30, 2020.

 

Note 7 – Short Term Advances

 

On December 26, 2019, a total of $25,000 was received as a short-term loan from one of our convertible noteholders. The advance was subsequently repaid on February 6, 2020. No interest expense was recognized.

 

Note 8 –Note Payable, Equipment Financing

 

Note payable consists of the following at December 31, 2019 and September 30, 2019, respectively:

 

   December 31,   September 30, 
   2019   2019 
         
On December 26, 2019, the Company financed the purchase of $377,124 of lab equipment, in part, with the proceeds of a bank loan in the amount of $291,931. The loan bears interest at the rate of 5.75% per annum and requires monthly payments of $5,622 over the five-year term of the loan ending on December 26, 2024. The Company’s obligations under this loan are secured by a lien on the purchased equipment.  $291,931   $- 
Less: current maturities   (52,030)   - 
Note payable  $239,901   $- 

 

The Company recorded interest expense pursuant to the stated interest rate and closing costs on the equipment loan in the amount of $3,819 during the three months ended December 31, 2019.

 

Note 9 – Convertible Notes Payable

 

Convertible notes payable consists of the following at December 31, 2019 and September 30, 2019, respectively:

 

   December 31,   September 30, 
   2019   2019 
         
On September 23, 2019, the Company received proceeds of $200,000 on a senior secured convertible note that carries an 8% interest rate, which matures on September 23, 2020. The principal and interest are convertible into shares of common stock at the discretion of the note holder at a fixed conversion price of $0.11 per share. The Company’s obligations under this Note are secured by a lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc.  $200,000   $200,000 
           
On November 8, 2018, the Company received proceeds of $350,000 on a senior secured convertible note that carries an 8% interest rate, which matures on December 31, 2020. The principal and interest are convertible into shares of common stock at the discretion of the note holder at a fixed conversion price of $0.14 per share. The Company’s obligations under this Note is secured by a lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc. A total of $4,066 of interest was repaid during the three months ended June 30, 2019.   350,000    350,000 
           
On November 5, 2018, the Company received proceeds of $150,000 on a senior secured convertible note that carries an 8% interest rate, which matures on December 31, 2020. The principal and interest are convertible into shares of common stock at the discretion of the note holder at a fixed conversion price of $0.14 per share. The Company’s obligations under this Note are secured by a lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc.   150,000    150,000 
           
Total convertible notes payable   700,000    700,000 
Less: unamortized debt discounts   (33,105)   (41,426)
    666,895    658,574 
Less: current maturities   (666,895)   (200,000)
Convertible notes payable  $-   $458,574 

 

 11 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In addition, the Company recognized and measured the embedded beneficial conversion feature present in the convertible notes by allocating a portion of the proceeds equal to the intrinsic value of the feature to additional paid-in-capital. The intrinsic value of the feature was calculated on the commitment date using the effective conversion price of the convertible notes. This intrinsic value is limited to the portion of the proceeds allocated to the convertible debt.

 

The aforementioned accounting treatment resulted in a total debt discount equal to $70,964 during the three months ended December 31, 2018. The discount is amortized on a straight-line basis from the dates of issuance until the earlier of the stated redemption date of the debts, as noted above or the actual settlement date. The Company recorded debt amortization expense on the aforementioned debt discount in the amount of $8,321 and $4,846 during the three months ended December 31, 2019 and 2018, respectively.

 

All of the convertible notes limit the maximum number of shares that can be owned by each note holder as a result of the conversions to common stock to 4.99% of the Company’s issued and outstanding shares.

 

The Company recorded interest expense pursuant to the stated interest rates on the convertible notes in the amount of $14,115 and $5,907 for the three months ended December 31, 2019 and 2018, respectively.

 

The Company recognized interest expense for the three months ended December 31, 2019 and 2018, respectively, as follows:

 

   December 31,   December 31, 
   2019   2018 
         
Interest on capital leases  $3,306   $- 
Interest on notes payable   3,819    - 
Amortization of beneficial conversion features   8,321    4,846 
Interest on convertible notes   14,115    5,907 
Total interest expense  $29,561   $10,753 

 

Note 10 - Changes in Stockholders’ Equity

 

Convertible Preferred Stock

 

The Company is authorized to issue 10,000,000 shares of preferred stock with a par value of $0.001 per share, of which 6,000,000 have been designated as Series A Convertible Preferred Stock (“Series A Preferred”), with the remaining 4,000,000 shares available for designation from time to time by the Board as set forth below. As of December 31, 2019, there were 1,325,942 shares of Series A Preferred issued and outstanding. The Board of Directors is authorized to determine any number of series into which the undesignated shares of preferred stock may be divided and to determine the rights, preferences, privileges and restrictions granted to any series of the preferred stock. Each share of Series A Preferred is currently convertible into five shares of common stock.

 

The conversion price is adjustable in the event of stock splits and other adjustments in the Company’s capitalization, and in the event of certain negative actions undertaken by the Company. At the current conversion price, the 1,325,942 shares of Series A Preferred outstanding at December 31, 2019 are convertible into 6,629,710 shares of the common stock of the Company. No holder is permitted to convert its shares of Series A Preferred if such conversion would cause the holder to beneficially own more than 4.99% of the issued and outstanding common stock of the Company immediately after such conversion, unless waived by such holder by providing at least sixty-five days’ notice.

 

 12 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Common Stock

 

Common stock consists of $0.001 par value, 250,000,000 shares authorized, of which 48,532,666 shares were issued and outstanding as of December 31, 2019.

 

Common Stock Issued for Services

 

On December 25, 2019, the Company issued 171,233 shares of common stock to its CFO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $15,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

 

Amortization of Stock-Based Compensation

 

A total of $22,110 of stock-based compensation expense was recognized during the three months ended December 31, 2019 as a result of the issuance of 200,000 shares of common stock to one of our directors, Bruce Raben, on September 12, 2018, as amortized over the requisite service period. As of December 31, 2019, a total of $7,452 of unamortized expenses are expected to be expensed during the remaining fiscal year ended September 30, 2019.

 

A total of $9,750 of stock-based compensation expense was recognized during the three months ended December 31, 2019 as a result of the issuance of 300,000 shares of common stock to a consultant on June 25, 2019, as amortized over the requisite service period. No further unamortized expenses are to be expensed during the remaining requisite service period.

 

A total of $17,677 of stock-based compensation expense was recognized from the amortization of options over their vesting period during the three months ended December 31, 2019.

 

Note 11 – Common Stock Options

 

Stock Incentive Plan

 

On June 21, 2016, we amended and restated our 2012 Stock Incentive Plan (the “2012 Plan”), which was originally adopted on March 5, 2012 and previously amended on May 20, 2014. As amended, the 2012 Plan provides for the issuance of up to 11,500,000 shares of common stock pursuant to the grant of options or other awards, including stock grants, to employees, officers or directors of, and consultants to, the Company and its subsidiaries. Options granted under the 2012 Plan may either be intended to qualify as incentive stock options under the Internal Revenue Code of 1986, or may be non-qualified options, and are exercisable over periods not exceeding ten years from date of grant.

 

A total of 3,085,000 options were outstanding as of December 31, 2019. During the three months ended December 31, 2019, options to purchase an aggregate total of 3,000,000 shares of common stock at a weighted average exercise price of $0.13 per share expired.

 

Note 12 – Common Stock Warrants

 

Warrants to purchase a total of 3,417,126 shares of common stock were outstanding as of December 31, 2019.

 

Note 13 – Other Income (Expense)

 

Other income (expense) for the three months ended December 31, 2019 and 2018 consisted of the following:

 

   December 31, 
   2019   2018 
Settlement income on note receivable  $-   $30,000 
Rental income on subleases   21,000    20,400 
Interest expense   (29,561)   (10,753)
   $(8,561)  $39,647 

 

On December 1, 2018, we received $30,000 as full settlement of a Note dated December 17, 2014, consisting of $250,000 of principal and approximately $58,125 of unpaid interest that was previously written off as uncollectible.

 

 13 
 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 14 - Income Tax

 

The Company accounts for income taxes under FASB ASC 740-10, which requires use of the liability method. FASB ASC 740-10-25 provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences.

 

For the three months ended December 31, 2019 and the year ended September 30, 2019, the Company incurred a net operating loss and, accordingly, no provision for income taxes has been recorded. In addition, no benefit for income taxes has been recorded due to the uncertainty of the realization of any tax assets. At December 31, 2019, the Company had approximately $9,200,000 of federal net operating losses. The net operating loss carry forwards, if not utilized, will begin to expire in 2031.

 

Based on the available objective evidence, including the Company’s history of its loss, management believes it is more likely than not that the net deferred tax assets will not be fully realizable. Accordingly, the Company provided for a full valuation allowance against its net deferred tax assets at December 31, 2019 and September 30, 2019, respectively.

 

In accordance with FASB ASC 740, the Company has evaluated its tax positions and determined there are no uncertain tax positions.

 

Note 15 – Subsequent Events

 

Common Stock Issuances for Services

 

On January 27, 2020, the Company issued 500,000 shares of common stock to a consultant for investor relations services to be performed from February 1, 2020 through July 31, 2020. The fair value of the common stock was $37,500 based on the closing price of the Company’s common stock on the date of grant, and is being expensed over the requisite service period.

 

Options Issued to Directors for Services

 

On January 29, 2020, Edmond A. DeFrank was appointed to the Company’s Board of Directors, filling the vacancy resulting from the resignation of Dr. Cindy Orser on January 20, 2020. On January 31, 2020, we granted Mr. DeFrank options to purchase 250,000 shares of common stock as compensation for Director services. The options vest immediately as to 62,500 shares and as to an additional 62,500 shares on each of January 31, 2021, January 31, 2022, and January 31, 2023, and are exercisable for a ten-year period at an exercise price of $0.10 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 106% and a call option value of $0.0683, was $17,078. The options are being expensed over the vesting period.

 

On January 31, 2020, we granted options to purchase 250,000 shares of common stock as compensation for Director services to Dennis Hartmann. The options vest immediately as to 62,500 shares and as to an additional 62,500 shares on each of January 31, 2021, January 31, 2022, and January 31, 2023, and are exercisable for a ten-year period at an exercise price of $0.10 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 106% and a call option value of $0.0683, was $17,078. The options are being expensed over the vesting period.

 

Convertible Note Financing

 

On February 11, 2020, the Company completed the sale to an accredited investor of a 9% Secured Convertible Promissory Note in the principal amount of $150,000. The transaction was effected pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended and Rule 506(b) promulgated thereunder. The Note matures on August 11, 2022, bears interest at a rate of 9% per annum, and is convertible into shares of the Company’s common stock at a conversion price of $0.15 per share. The Company’s obligations under the Note are secured by subordinated lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc., pursuant to a Security Agreement between the Company, Digipath Labs, Inc. and the investor.

 

On February 10, 2020, the Company completed the sale to an accredited investor of a 9% Secured Convertible Promissory Note in the principal amount of $350,000. The transaction was effected pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended and Rule 506(b) promulgated thereunder. The Note matures on August 10, 2022, bears interest at a rate of 9% per annum, and is convertible into shares of the Company’s common stock at a conversion price of $0.15 per share. The Company’s obligations under the Note are secured by a lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc., pursuant to a Security Agreement between the Company, Digipath Labs, Inc. and the investor.

 

 14 
 

 

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

 

The information contained in this Form 10-Q is intended to update the information contained in our Annual Report on Form 10-K for the year ended September 30, 2019 and presumes that readers have access to, and will have read, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other information contained in such Form 10-K. The following discussion and analysis also should be read together with our financial statements and the notes to the financial statements included elsewhere in this Form 10-Q.

 

The following discussion contains certain statements that may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements appear in a number of places in this Report, including, without limitation, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements are not guarantees of future performance and involve risks, uncertainties and requirements that are difficult to predict or are beyond our control. Forward-looking statements speak only as of the date of this quarterly report. You should not put undue reliance on any forward-looking statements. We strongly encourage investors to carefully read the factors described in our Annual Report on Form 10-K for the year ended September 30, 2019 in the section entitled “Risk Factors” for a description of certain risks that could, among other things, cause actual results to differ from these forward-looking statements. We assume no responsibility to update the forward-looking statements contained in this quarterly report on Form 10-Q. The following should also be read in conjunction with the unaudited Financial Statements and notes thereto that appear elsewhere in this report.

 

Overview

 

Digipath, Inc. was incorporated in Nevada on October 5, 2010. Digipath, Inc. and its subsidiaries (“Digipath,” the “Company,” “we,” “our” or “us”) is a service-oriented independent testing laboratory, data analytics and media firm focused on the developing cannabis and hemp markets, and supports the cannabis industry’s best practices for reliable testing, cannabis education and training. Our business units as of December 31, 2019 are described below.

 

Ø Digipath Labs, Inc. Digipath Labs’ mission is to provide pharmaceutical-grade analysis and testing to the cannabis industry, under ISO-17025:2017 guidelines, to ensure consumers and patients know exactly what is in the cannabis they ingest and to help maximize the quality of our clients’ products through research, development, and standardization. Digipath has been operating a cannabis testing lab in Nevada since 2015 and has plans to open labs in other states and countries that have legalized the sale of cannabis, beginning with California.
   
Ø GroSciences, Inc. Launched during the first fiscal quarter of 2019 to capitalize on the extensive data we have collected from cannabis through the testing process. GroSciences plans to develop and license specific formulations to other producers and product makers in the industry, and to market and sell its “Tru-Hemp ID” Kit which distinguishes industrial hemp from drug-type cannabis.

 

 15 
 

 

Results of Operations for the Three Months Ended December 31, 2019 and 2018:

 

The following table summarizes selected items from the statement of operations for the three months ended December 31, 2019 and 2018.

 

   Three Months Ended December 31,   Increase / 
   2019   2018   (Decrease) 
Revenues  $808,930   $642,115   $166,815 
Cost of sales   405,481    482,320    (76,839)
Gross profit (loss)   403,449    159,795    243,654 
                
Operating expenses:               
General and administrative   388,432    390,471    (2,039)
Professional fees   183633    246,580    (62,947)
Bad debts expense   43,250    24,565    18,685 
Total operating expenses:   615,315    661,616    (46,301)
                
Operating loss   (211,866)   (501,821)   (289,955)
                
Total other income (expense)   (8,561)   39,647    (48,208)
                
Net loss  $(220,427)  $(462,174)  $(241,747)

 

Revenues

 

Aggregate revenues for the three months ended December 31, 2019 were $808,930, compared to revenues of $642,115 during the three months ended December 31, 2018, an increase of $166,815, or 26%. The increase in revenue was due to industry growth and increased market share attained during the current period.

 

Cost of Sales

 

Cost of sales for the three months ended December 31, 2019 were $405,481, compared to $482,320 during the three months ended December 31, 2018, a decrease of $76,839, or 16%. Cost of sales consists primarily of labor, depreciation, maintenance on lab equipment, and supplies consumed in our testing operations. The decreased cost of sales in the current period was primarily due to better pricing on our consumable supplies, and improved efficiencies with respect to our labor. Our gross margins of approximately 50%, increased during the three months ended December 31, 2019, compared to gross margins of approximately 25% during the three months ended December 31, 2018, which translated to $243,654 of increased gross profit. We intend to continue to automate processes through equipment enhancements to improve our margins, and acquired a new triple quad machine on December 26, 2019 that we expect will help increase our testing volume and considerably decrease our variable costs.

 

General and Administrative Expenses

 

General and administrative expenses for the three months ended December 31, 2019 were $388,432, compared to $390,471 during the three months ended December 31, 2018, a decrease of $2,039, or 1%. The expenses consisted primarily of marketing, rent, salaries and wages, and travel expenses. General and administrative expenses included non-cash, stock-based compensation of $18,400 and $21,000 during the three months ended December 31, 2019 and December 31, 2018, respectively.

 

Professional Fees

 

Professional fees for the three months ended December 31, 2019 were $183,633, compared to $246,580 during the three months ended December 31, 2018, a decrease of $62,947, or 26%. Professional fees included non-cash, stock-based compensation of $24,027 and $134,835 during the three months ended December 31, 2019 and December 31, 2018, respectively. Professional fees decreased primarily due to decreased stock-based compensation, as partially diminished by increased cash-based professional fees, during the current period.

 

 16 
 

 

Bad Debts Expense

 

Bad debts expense for the three months ended December 31, 2019 was $43,250, compared to $24,565 during the three months ended December 31, 2018, an increase of $18,685, or 76%. Bad debts expense increased during the current period as our allowance for doubtful accounts increased to $93,790 during the quarter.

 

Operating Loss

 

Our operating loss for the three months ended December 31, 2019 was $211,866, compared to $501,821 during the three months ended December 31, 2018, a decrease of $289,955, or 58%. Our operating loss decreased primarily due to increased margins, decreased professional fees, as offset in part by increased bad debts expense, during the three months ended December 31, 2019, compared to the three months ended December 31, 2018.

 

Other Income (Expense)

 

Other expense, on a net basis, for the three months ended December 31, 2019 was $8,561, compared to other income, on a net basis, of $39,647 during the three months ended December 31, 2018, a net decrease of $48,208. Other expense consisted of $29,561 of interest expense, as partially offset by other income, consisting of $21,000 of subleased rental income for the three months ended December 31, 2019. Other income during the three months ended December 31, 2018 consisted of $20,400 of subleased rents and a $30,000 gain on settlement of a previously written off note receivable, as offset by $10,753 of interest expense.

 

Net Loss

 

Net loss for the three months ended December 31, 2019 was $220,427, compared to $462,174 during the three months ended December 31, 2018, a decrease of $241,747, or 52%. The decreased net loss was due primarily to increased gross profits as described above, as offset in part by increased bad debts expense, and interest on debt financing.

 

Liquidity and Capital Resources

 

The following is a summary of the Company’s cash flows provided by (used in) operating, investing, and financing activities for the three-month periods ended December 31, 2019 and 2018:

 

   2019   2018 
Operating Activities  $(163,924)  $(366,237)
Investing Activities   (90,315)   (50,000)
Financing Activities   (843)   500,000 
Net Increase (Decrease) in Cash  $(255,082)  $83,763 

 

Net Cash Used in Operating Activities

 

During the three months ended December 31, 2019, net cash used in operating activities was $163,924, compared to net cash used in operating activities of $366,237 for the same period ended December 31, 2018. The decrease in cash used in operating activities was primarily attributable to our decreased net loss.

 

Net Cash Used in Investing Activities

 

During the three months ended December 31, 2019, net cash used in investing activities was $90,315, compared to $50,000 for the same period ended December 31, 2018. The increase is attributable to investments made for cannabis testing equipment in the current period that was not necessary in the prior period, as partially diminished by an advancement of short-term loans during the prior period.

 

Net Cash Provided by Financing Activities

 

During the three months ended December 31, 2019, net cash used in financing activities was $843, compared to net cash provided by financing activities of $500,000 for the same period ended December 31, 2018. The current period consisted of $25,843 of principal finance lease payments on equipment, as offset by, $25,000 of proceeds received on a short term advance that were subsequently repaid on February 6, 2020, compared to $500,000 of proceeds received on fixed convertible debt financing at $0.14 per share in the comparative period.

 

 17 
 

 

Ability to Continue as a Going Concern

 

As of December 31, 2019, our balance of cash on hand was $68,657. We currently may not have sufficient funds to sustain our operations for the next twelve months and we may need to raise additional cash to fund our operations and expand our lab testing business. As we continue to develop our lab testing business and attempt to expand operational activities, we expect to experience net negative cash flows from operations in amounts not now determinable, and will be required to obtain additional financing to fund operations through common stock offerings to the extent necessary to provide working capital. We have and expect to continue to have substantial capital expenditure and working capital needs.

 

The Company has incurred recurring losses from operations resulting in an accumulated deficit, and, as set forth above, the Company’s cash on hand is not sufficient to sustain operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management is actively pursuing new customers to increase revenues. In addition, the Company is currently seeking additional sources of capital to fund short term operations. In the event sales do not materialize at the expected rates, management would seek additional financing or would attempt to conserve cash by further reducing expenses. There can be no assurance that we will be successful in achieving these objectives, becoming profitable or continuing our business without either a temporary interruption or a permanent cessation. In addition, additional financing may result in substantial dilution to existing stockholders.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business. The unaudited consolidated financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

Off-Balance Sheet Arrangements

 

We have no outstanding off-balance sheet guarantees, interest rate swap transactions or foreign currency contracts. We do not engage in trading activities involving non-exchange traded contracts.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported, including the notes thereto, and related disclosures of commitments and contingencies, if any. We have identified certain accounting policies that are significant to the preparation of our financial statements. These accounting policies are important for an understanding of our financial condition and results of operations. Critical accounting policies are those that are most important to the presentation of our financial condition and results of operations and require management’s subjective or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates are particularly sensitive because of their significance to financial statements and because of the possibility that future events affecting the estimate may differ significantly from management’s current judgments.

 

While our significant accounting policies are more fully described in notes to our consolidated financial statements appearing elsewhere in this Form 10-Q, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating our reported financial results and affect the more significant judgments and estimates that we used in the preparation of our financial statements.

 

Revenue Recognition

 

Under ASC 606, the Company recognizes revenue from the commercial sales of products, licensing agreements and contracts to perform pilot studies by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition. Under ASC 605, revenue was recognized when the following criteria had been met: (1) persuasive evidence of an arrangement exists; (2) the performance of service has been rendered to a customer or delivery has occurred; (3) the amount of fee to be paid by a customer is fixed and determinable; and (4) the collectability of the fee is reasonably assured.

 

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Our revenue is primarily generated through our subsidiary, Digipath Labs, Inc., which recognizes revenue from the analytical testing of cannabis products for licensed producers and cultivators within the state of Nevada on a determinable fixed fee per test, or panel of tests basis. Revenue from the performance of those services is recognized upon completion of the tests, at which time test results are delivered to the customer, provided collectability of the fee is reasonably assured. We typically require payment within thirty days of the delivery of results. Management estimates an allowance for doubtful accounts based on the aging of its receivables.

 

Stock-Based Compensation

 

The Company accounts for equity instruments issued to employees in accordance with the provisions of ASC 718 Stock Compensation (ASC 718) and Equity-Based Payments to Non-employees pursuant to ASC 505-50 (ASC 505-50). All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date of the fair value of the equity instrument issued is the earlier of the date on which the counterparty’s performance is complete or the date at which a commitment for performance by the counterparty to earn the equity instruments is reached because of sufficiently large disincentives for nonperformance.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide the information required by this Item

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2019. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 31, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

There have been no significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) or in other factors that occurred during the period of our evaluation or subsequent to the date we carried out our evaluation which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any system of controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

We are not a party to any legal or administrative proceedings that we believe, individually or in the aggregate, would be likely to have a material adverse effect on our financial condition or results of operations.

 

ITEM 1A. RISK FACTORS.

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide the information required by this Item.

 

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

 

The following issuances of equity securities by the Company were exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(a)(2) of the Securities Act of 1933 during the three month period ended December 31, 2019:

 

On December 25, 2019, we issued 171,233 shares of common stock, restricted in accordance with Rule 144, to our CFO for services rendered pursuant to his employment agreement.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

On February 11, 2020, the Company completed the sale to an accredited investor of a 9% Secured Convertible Promissory Note in the principal amount of $150,000. The transaction was effected pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended and Rule 506(b) promulgated thereunder. The Note matures on August 11, 2022, bears interest at a rate of 9% per annum, and is convertible into shares of the Company’s common stock at a conversion price of $0.15 per share. The Company’s obligations under the Note are secured by a subordinated lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc., pursuant to a Security Agreement between the Company, Digipath Labs, Inc. and the investor. The information set forth in this Item 5 is qualified in its entirety by reference to the actual terms of the Secured Convertible Promissory Note and Security Agreement described above, which have been filed as Exhibits 4.4 and 10.2, respectively, and which are incorporated herein by reference.

 

On February 10, 2020, the Company completed the sale to an accredited investor of a 9% Secured Convertible Promissory Note in the principal amount of $350,000. The transaction was effected pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended and Rule 506(b) promulgated thereunder. The Note matures on August 10, 2022, bears interest at a rate of 9% per annum, and is convertible into shares of the Company’s common stock at a conversion price of $0.15 per share. The Company’s obligations under the Note are secured by a lien on the assets of the Company and its wholly-owned subsidiary Digipath Labs, Inc., pursuant to a Security Agreement between the Company, Digipath Labs, Inc. and the investor. The information set forth in this Item 5 is qualified in its entirety by reference to the actual terms of the Secured Convertible Promissory Note and Security Agreement described above, which have been filed as Exhibits 4.3 and 10.1, respectively, and which are incorporated herein by reference.

 

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ITEM 6. EXHIBITS.

 

Exhibit  Description
3.1  Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Form 10 filed with the Securities and Exchange Commission by Digipath, Inc. on July 15, 2011)
3.2  Bylaws (incorporated by reference to Exhibit 3.2 of the Form 10 filed with the Securities and Exchange Commission by Digipath, Inc. on July 15, 2011)
3.3  Certificate of Amendment to Articles of Incorporation dated April 4, 2014 (incorporated by reference to Exhibit 3.1 of the Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on April 10, 2014)
3.4  Certificate of Designations, Preferences, Limitations, Restrictions and Relative Rights of Series A Convertible Preferred Stock dated April 9, 2014 (incorporated by reference to Exhibit 3.2 of the Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on April 10, 2014)
3.5  Certificate of Amendment to Articles of Incorporation dated May 22, 2015 (incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on May 26, 2015)
3.6  Certificate of Amendment to Articles of Incorporation dated May 14, 2019 (incorporated by reference to Exhibit 3.6 of the Current Report on Form 10-Q filed with the Securities and Exchange Commission by Digipath, Inc. on August 13, 2019)
4.1  Form of 8% Senior Secured Convertible Notes due December 31, 2020 (incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on November 21, 2018)
4.2  Form of 8% Senior Secured Convertible Notes due September 23, 2020 (incorporated by reference to Exhibit 4.1 of the Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on September 26, 2019)
4.3*  9% Secured Convertible Note, between Digipath, Inc. and holder, due August 10, 2022

4.4*

 

9% Secured Subordinated Convertible Note, between Digipath, Inc. and holder, due August 11, 2022

10.1*  Security Agreement, between Digipath, Inc., Digipath Labs, Inc., and holder of the 9% Senior Secured Convertible Note due August 10, 2022

10.2*

 

Security Agreement, between Digipath, Inc., Digipath Labs, Inc., and holder of the 9% Senior Secured Convertible Note due August 11, 2022

31.1*  Section 302 Certification of Chief Executive Officer
31.2*  Section 302 Certification of Chief Financial Officer
32.1*  Section 906 Certification of Chief Executive Officer
32.2*  Section 906 Certification of Chief Financial Officer
101.INS* XBRL Instance Document
101.SCH* XBRL Schema Document
101.CAL* XBRL Calculation Linkbase Document
101.DEF* XBRL Definition Linkbase Document
101.LAB* XBRL Labels Linkbase Document
101.PRE* XBRL Presentation Linkbase Document

 

* Filed herewith.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: February 14, 2020

 

DIGIPATH, INC.  
     
By: /s/ Kyle Remenda  
Name: Kyle Remenda  
Title: Chief Executive Officer and Director  
     
By: /s/ Todd Peterson  
Name: Todd Peterson  
Title: Chief Financial Officer and Secretary  

 

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