Digipath, Inc. - Quarter Report: 2019 June (Form 10-Q)

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 June 30, 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)

(702) 527-2060

(Registrant’s telephone number, including area code)

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

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.

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).

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.

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).

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 August 9, 2019 was 48,155,550.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to financial statements.

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes to financial statements.

DIGIPATH, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

See accompanying notes to financial statements.

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to financial statements.

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.

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, 2018. 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 June 30, 2019:

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.

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

Effective October 1, 2018, the Company adopted 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., and to a lesser extent, through the sale of advertising through one of our other subsidiaries, TNM News Corp. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition.

There was no impact on the Company’s financial statements as a result of adopting ASC 606 for the nine months ended June 30, 2019, or the twelve months ended September 30, 2018.

Revenue is primarily generated through our subsidiary, Digipath Labs, Inc., which recognizes revenue from the analytical testing of cannabis products to 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.

The Company also recognizes revenue through our subsidiary, TNM News Corp., which primarily recognizes revenue from advertisements through partnered merchants. Payment for ad revenues are received prior to the distribution of the ad campaign, and the revenues are recognized ratably over the campaign. The Company defers any revenue for which the term of the campaign has not yet been realized. To date, these revenues have not been materially significant.

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.

Recent Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-13, Fair Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, which modify the disclosure requirements of Topic 820. The new guidance is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2019, with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires lessees to recognize assets and liabilities for most leases. ASU 2016-02 is effective for public entity financial statements for annual periods beginning after December 15, 2018, and interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. ASU 2016-02 was further clarified and amended within ASU 2018-01, ASU 2018-10, ASU 2018-11 and ASU 2018-20 which included provisions that would provide us with the option to adopt the provisions of the new guidance using a modified retrospective transition approach, without adjusting the comparative periods presented. The Company is currently evaluating ASU 2016-02 and its impact on its consolidated financial statements.

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.

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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 $14,553,595, and as of June 30, 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.

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:

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The following schedule summarizes the valuation of financial instruments at fair value on a recurring basis in the balance sheets as of June 30, 2019 and September 30, 2018, respectively:

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 $500,000 of convertible debentures, net of discounts of $49,747 as of June 30, 2019.

There were no transfers of financial assets or liabilities between Level 1, Level 2 and Level 3 inputs for the nine months ended June 30, 2019 or the year ended September 30, 2018.

Note 4 – Note Receivable

On March 8, 2019 and February 15, 2019, we loaned Big Valley Analytical Labs, Inc. $25,000 and $20,000, respectively. The loans carried interest at an annual rate of 15%, were evidenced by secured demand notes, and were secured by a lien on the borrower’s assets. The principal amount of the loans was subsequently repaid in full on April 1, 2019.

On various dates between December 28, 2018 and June 13, 2019, we loaned Northwest Analytical Labs, Inc. a total of $95,000. The loans bear interest at an annual rate of 10%, are evidenced by secured demand notes, which are secured by a lien on the borrower’s assets. An allowance for doubtful accounts for the full value of the notes was recognized due to the uncertainty of collectability.

Note 5 – Accounts Receivable

Accounts receivable was $185,829 and $167,734 at June 30, 2019 and September 30, 2018, respectively, net of allowance for doubtful accounts of $63,070 and $14,900 at June 30, 2019 and September 30, 2018, respectively.

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 6 – Fixed Assets

Fixed assets consist of the following at June 30, 2019 and September 30, 2018:

Depreciation and amortization expense totaled $194,588 and $213,225 for the nine months ended June 30, 2019 and 2018, respectively.

Note 7 – Convertible Notes Payable

Convertible notes payable consist of the following at June 30, 2019 and September 30, 2018, respectively:

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 nine months ended June 30, 2019. 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. During the nine months ended June 30, 2019, the Company recorded debt amortization expense in the amount of $21,217, attributed to the aforementioned debt discount.

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 $25,742 for the nine months ended June 30, 2019.

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 8 - 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 June 30, 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 June 30, 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.

Preferred Stock Conversions

On December 31, 2018, a total of 100,000 Series A Preferred shares were converted into 500,000 shares of common stock. The stock was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

Common Stock

Common stock consists of $0.001 par value, 250,000,000 shares authorized, of which 48,155,550 shares were issued and outstanding as of June 30, 2019.

Common Stock Sales

On February 7, 2019, the Company sold 1,000,000 shares of its common stock in exchange for proceeds of $200,000.

On February 1, 2019, the Company sold 250,000 shares of its common stock in exchange for proceeds of $50,000.

On January 31, 2019, the Company sold 625,000 shares of its common stock in exchange for proceeds of $125,000.

On January 24, 2019, the Company sold 1,250,000 shares of its common stock in exchange for proceeds of $250,000.

Common Stock Issued for Services

On June 25, 2019, the Company issued 300,000 shares of common stock to a consultant for business development services to be performed from May 1, 2019 through October 31, 2019. The fair value of the common stock was $58,500 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.

On June 25, 2019, the Company issued 41,667 shares of common stock to its President and CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $6,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On June 25, 2019, the Company issued 104,167 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.

On May 25, 2019, a total of 50,000 shares of common stock were issued to a consultant that was engaged to assist the Company with acquisition activities. The fair value of the common stock was $8,030 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

On April 25, 2019, a total of 50,000 shares of common stock were issued to a consultant that was engaged to assist the Company with acquisition activities. The fair value of the common stock was $9,500 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On March 29, 2019, the Company issued 475,000 shares of common stock to the estate of our former CEO in exchange for the cancellation of 4,750,000 common stock options. The aggregate fair value of the options exceeded the fair value of the common stock at issuance, therefore there was no additional expense as a result of the modification of the equity awards.

On March 25, 2019, the Company issued 29,268 shares of common stock to its President and CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $6,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On March 25, 2019, the Company issued 73,171 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.

On March 25, 2019, a total of 50,000 shares of common stock were issued to a consultant that was engaged to assist the Company with acquisition activities. The fair value of the common stock was $10,250 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On February 25, 2019, a total of 50,000 shares of common stock were issued to a consultant that was engaged to assist the Company with acquisition activities. The fair value of the common stock was $12,300 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On January 25, 2019, a total of 50,000 shares of common stock were issued to a consultant that was engaged to assist the Company with acquisition activities. The fair value of the common stock was $10,500 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On December 25, 2018, the Company issued 46,261 shares of common stock to its President and CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $6,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On December 25, 2018, the Company issued 115,652 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.

On December 25, 2018, a total of 150,000 shares of common stock were issued to three consultants that were engaged to assist the Company with acquisition activities. The aggregate fair value of the common stock was $19,455 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On November 25, 2018, a total of 150,000 shares of common stock were issued to three consultants that were engaged to assist the Company with acquisition activities. The aggregate fair value of the common stock was $24,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

On October 30, 2018, the Company issued 400,000 shares of common stock to another consultant for business development services to be performed from November 1, 2018 through April 30, 2019. The fair value of the common stock was $54,120 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.

On October 25, 2018, a total of 150,000 shares of common stock were issued to three consultants that were engaged to assist the Company with acquisition activities. The aggregate fair value of the common stock was $23,250 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period.

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Amortization of Stock-Based Compensation

A total of $22,110 of stock-based compensation expense was recognized during the nine months ended June 30, 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 June 30, 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 $19,500 of stock-based compensation expense was recognized during the nine months ended June 30, 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. As of June 30, 2019, a total of $39,000 of unamortized expenses are expected to be expensed during the remaining requisite service period.

A total of $137,412 of stock-based compensation expense was recognized from the amortization of options over their vesting period during the nine months ended June 30, 2019.

Note 9 – 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 5,105,000 options were outstanding as of June 30, 2019. During the nine months ended June 30, 2019, options to purchase an aggregate total of 27,500 shares of common stock at a weighted average exercise price of $0.26 per share expired.

Options Issued to Officers and Directors for Services

On January 7, 2019, we granted options to purchase 500,000 shares of common stock as compensation for services to our Chief Science Officer. The options vest immediately as to 125,000 shares and as to an additional 125,000 shares on each of April 7, 2019, July 7, 2019, and October 7, 2019, and are exercisable for a ten-year period at an exercise price of $0.13 per share, based on the most recent closing stock price. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 107% and a call option value of $0.1019, was $50,934. The options are being expensed over the vesting period, resulting in $32,463 of stock-based compensation expense during the nine months ended June 30, 2019. As of June 30, 2019, a total of $18,471 of unamortized expenses are expected to be expensed over the vesting period.

On January 7, 2019, we granted options to purchase 500,000 shares of common stock as compensation for services to Bruce Raben, one of our directors. The options vest immediately as to 125,000 shares and as to an additional 125,000 shares on each of April 7, 2019, July 7, 2019, and October 7, 2019, and are exercisable for a ten-year period at an exercise price of $0.13 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 107% and a call option value of $0.1019, was $50,934. The options are being expensed over the vesting period, resulting in $32,463 of stock-based compensation expense during the nine months ended June 30, 2019. As of June 30, 2019, a total of $18,471 of unamortized expenses are expected to be expensed over the vesting period.

Options Exchanged for Common Stock

On March 29, 2019, the Company issued 475,000 shares of common stock to the estate of our former CEO in exchange for the cancellation of 4,750,000 common stock options. The aggregate fair value of the options exceeded the fair value of the common stock at issuance, therefore there was no additional expense as a result of the modification of the equity awards.

Re-Priced Options Issued to Officers and Directors for Services

On January 7, 2019, the board amended the following options to reduce their exercise price to $0.13 per share, based on the most recent closing stock price. All other terms were unchanged. The modification of these equity awards resulted in an additional expense of $36,764.

Options Issued to Employees for Services

On December 25, 2018, we granted fully vested options to purchase an aggregate of 345,000 shares of common stock as compensation for services to a total of fourteen of our employees. The options are exercisable over a ten-year period at an exercise price of $0.13 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 107% and a call option value of $0.1017, was $35,078. The options are being expensed over the vesting period, resulting in $17,971 of stock-based compensation expense during the nine months ended June 30, 2019. As of June 30, 2019, a total of $17,107 of unamortized expenses are expected to be expensed over the vesting period.

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 10 – Common Stock Warrants

Warrants to purchase a total of 3,417,126 shares of common stock were outstanding as of June 30, 2019.

On various dates from December 21, 2018 to May 2, 2019, warrants to purchase an aggregate of 2,933,336 shares of common stock at $0.30 per share expired, and on November 23, 2018, warrants to purchase another 100,000 shares of common stock at $0.40 per share expired.

Note 11 – Other Income

Other income for the nine months ended June 30, 2019 and 2018 consisted of the following:

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.

Note 12 - 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 nine months ended June 30, 2019 and the year ended September 30, 2018, 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 June 30, 2019, the Company had approximately $8,900,000 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 June 30, 2019 and September 30, 2018, respectively.

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

Note 13 – Subsequent Events

There were no subsequent events to report.

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, 2018 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, 2018 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 June 30, 2019 are described below.

Our cannabis testing revenues improved slightly over the previous fiscal quarter, but was substantially lower than our comparative nine month period ending June 30, 2018. This decrease was primarily the result of the temporary suspension by regulators of two of our competitors in the prior year’s quarter, resulting in a significant increase in our sales during that quarter. Our revenues stabilized subsequent to the prior period when these competitors were reinstated. As an ISO 17025:2017 accredited lab, we believe that we are now well positioned to handle future growth in full compliance with Nevada’s regulations applicable to our operations and are actively working to expand to other jurisdictions.

We are currently seeking to expand our lab testing services to Colombia, and to that end have retained Colombian counsel, formed a Colombian subsidiary and hired two local employees. Our goal is to launch a testing lab in Colombia by the end of the fiscal year, although there can be no assurance that we will be successful in that regard.

In January 2019, we entered into an agreement to provide potency testing laboratories for hemp production at sites owned by Hemp, Inc. in North Carolina, Oregon and Arizona. Under the terms of the agreement, we will oversee and manage the construction and build out of a hemp potency-testing laboratory in three of Hemp Inc.’s locations and Hemp. Inc. will provide the space for the testing laboratories at no cost to us.

We are also exploring opportunities to capitalize on the extensive data we have collected from our cannabis testing activities. Through our wholly-owned subsidiary, GroSciences, Inc., we intend to license specific formulations and intellectual property developed from our experience in the cannabis industry. We have not yet commenced operations for this initiative, other than minimal research and development activities and patent filings.

Results of Operations for the Three Months Ended June 30, 2019 and 2018:

The following table summarizes selected items from the statement of operations for the three months ended June 30, 2019 and 2018.

Revenues

Revenues were generated by our cannabis testing lab and to a de minimis extent, from advertising on TNM News’ media outlets. Aggregate revenues for the three months ended June 30, 2019 were $652,920, compared to revenues of $521,772 during the three months ended June 30, 2018, an increase of $131,148, or 25%. The increase in revenue was due to industry growth and expansion to hemp testing during the current period.

Cost of Sales

Cost of sales for the three months ended June 30, 2019 were $424,067, compared to $520,888 during the three months ended June 30, 2018, a decrease of $96,821, or 19%. 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 35%, increased during the three months ended June 30, 2019, compared to gross margins of approximately -0-% during the three months ended June 30, 2018, due primarily to decreased cost of sales in the current quarter and increased costs in the prior quarter when we devoted significant resources to the improvement of operations and compliance with regulations, including the ISO 17025:2017 requirement.

General and Administrative Expenses

General and administrative expenses for the three months ended June 30, 2019 were $431,636, compared to $360,689 during the three months ended June 30, 2018, an increase of $70,947, or 20%. The expenses consisted primarily of marketing, rent, salaries and wages, and travel expenses. General and administrative expense increased during the current period due to increased investor relation expenses.

Professional Fees

Professional fees for the three months ended June 30, 2019 were $195,052, compared to $228,482 during the three months ended June 30, 2018, a decrease of $33,430, or 15%. Professional fees included non-cash, stock-based compensation of $114,018 and $177,472 during the three months ended June 30, 2019 and June 30, 2018, respectively. Professional fees decreased primarily due to decreased stock-based compensation during the current period.

Bad Debts Expense (Recoveries)

Bad debts expense (recoveries) for the three months ended June 30, 2019 was $93,340, compared to recoveries of $(45,200) during the three months ended June 30, 2018, an increase of $138,540, or 307%. Bad debts expense increased during the current period as our allowance for doubtful accounts increased with an allowance of $95,000 for potentially uncollectible notes receivable and the change in allowance for doubtful accounts on our trade receivables during the quarter.

Operating Loss

Our operating loss for the three months ended June 30, 2019 was $491,175, compared to $543,087 during the three months ended June 30, 2018, a decrease of $51,912, or 10%. Our operating loss decreased primarily due to increased margins, as offset in part by increased marketing expenses, during the three months ended June 30, 2019, compared to the three months ended June 30, 2018.

Other Income

Other income for the three months ended June 30, 2019 was $1,547, compared to other income of $43,012 during the three months ended June 30, 2018, a decrease of $41,465, or 96%. Other income consisted of $21,000 of sublease rents, as offset by a $1,250 reversal of interest income and $18,203 of interest expense for the three months ended June 30, 2019. Other income during the three months ended June 30, 2018 consisted of $19,200 of subleased rents and $23,812 of restitution payments received from a former employee.

Net Loss

Net loss for the three months ended June 30, 2019 was $489,628, compared to $500,075 during the three months ended June 30, 2018, a decrease of $10,447, or 2%. The decreased net loss was due primarily to increased gross profits as described above, as offset in part by increased investment relation expenses, increased bad debts expense, and interest on debt financing.

Results of Operations for the Nine Months Ended June 30, 2019 and 2018:

The following table summarizes selected items from the statement of operations for the nine months ended June 30, 2019 and 2018.

Revenues

Revenues were generated by our cannabis testing lab and to a de minimis extent, from advertising on TNM News’ media outlets. Aggregate revenues for the nine months ended June 30, 2019 were $1,946,590, compared to revenues of $2,223,630 during the nine months ended June 30, 2018, a decrease of $277,040, or 12%. The decrease in revenue was due to a spike in revenues in the comparative fiscal period ending June 30, 2018 due to regulators’ temporary suspension of two of our competitors during that period. Our revenues normalized when these competitors were reinstated.

Cost of Sales

Cost of sales for the nine months ended June 30, 2019 were $1,334,217, compared to $1,563,518 during the nine months ended June 30, 2018, a decrease of $229,301, or 15%. 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 31%, increased slightly during the nine months ended June 30, 2019, compared to gross margins of approximately 30% during the nine months ended June 30, 2018.

General and Administrative Expenses

General and administrative expenses for the nine months ended June 30, 2019 were $1,240,612, compared to $1,108,202 during the nine months ended June 30, 2018, an increase of $132,410, or 12%. The expenses consisted primarily of marketing, rent, salaries and wages, and travel expenses. General and administrative expense increased during the current period due to increased investor relation and travel expenses.

Professional Fees

Professional fees for the nine months ended June 30, 2019 were $677,299, compared to $964,269 during the nine months ended June 30, 2018, a decrease of $286,970, or 30%. Professional fees included non-cash, stock-based compensation of $413,427 and $815,887 during the nine months ended June 30, 2019 and June 30, 2018, respectively. Professional fees decreased primarily due to decreased stock-based compensation, as diminished by increased marketing efforts during the current period.

Bad Debts Expense

Bad debts expense for the nine months ended June 30, 2019 was $143,170, compared to $53,041 during the nine months ended June 30, 2018, an increase of $90,129, or 170%. Bad debts expense increased during the current period as our allowance for doubtful accounts increased with an allowance of $95,000 for potentially uncollectible notes receivable was recognized during the current period. Our bad debts expense due to the change in our allowance for doubtful accounts was 2.5% and 2.4% of sales for the nine months ended June 30, 2019 and 2018, respectively.

Operating Loss

Our operating loss for the nine months ended June 30, 2019 was $1,448,708, compared to $1,465,400 during the nine months ended June 30, 2018, a decrease of $16,692, or 1%. Our operating loss decreased primarily due to decreased revenues and an increased change in our allowance for doubtful accounts, as offset in part by decreased stock-based compensation, during the nine months ended June 30, 2019, compared to the nine months ended June 30, 2018.

Other Income

Other income for the nine months ended June 30, 2019 was $45,441, compared to other income of $85,912 during the nine months ended June 30, 2018, a decrease of $40,471, or 47%. Other income consisted of $62,400 of sublease rents and a $30,000 gain on settlement of a previously written off note receivable, as offset by $46,959 of interest expense for the nine months ended June 30, 2019. Other income during the nine months ended June 30, 2018 consisted of $57,600 of subleased rents and $28,312 of restitution payments received from a former employee.

Net Loss

Net loss for the nine months ended June 30, 2019 was $1,403,267, compared to $1,379,488 during the nine months ended June 30, 2018, an increase of $23,779, or 2%. The increased net loss was due primarily to decreased gross profits and increased marketing costs and bad debts expense as described above, as offset in part by decreased stock-based compensation, over the comparative nine month period.

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 nine month periods ended June 30, 2019 and 2018:

Net Cash Used in Operating Activities

During the nine months ended June 30, 2019, net cash used in operating activities was $889,401, compared to net cash used in operating activities of $212,707 for the same period ended June 30, 2018. The increase in cash used in operating activities is primarily attributable to our increased net loss as we didn’t benefit from the decreased competition from the suspension of two competing cannabis testing labs in the current period, as we did in the prior period.

Net Cash Used in Investing Activities

During the nine months ended June 30, 2019, net cash used in investing activities was $125,261, compared to $194,008 for the same period ended June 30, 2018. The decrease is attributable to investments made for cannabis testing equipment in the prior period that was not necessary in the current period, in addition to the advancement of short-term loans during the current period.

Net Cash Provided by Financing Activities

During the nine months ended June 30, 2019, net cash provided by financing activities was $1,125,000, compared to $268,608 for the same period ended June 30, 2018. The current period consisted of $500,000 of proceeds received on fixed convertible debt financing at $0.14 per share and the sale of $625,000 of common stock, while the comparative period consisted of proceeds received from the sale of $268,608 of common stock and warrants.

Ability to Continue as a Going Concern

As of June 30, 2019, our balance of cash on hand was $286,365. 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

Effective October 1, 2018, the Company adopted 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., and to a lesser extent, through the sale of advertising through one of our other subsidiaries, TNM News Corp. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition.

There was no impact on the Company’s financial statements as a result of adopting ASC 606 for the nine months ended June 30, 2019, or the twelve months ended September 30, 2018.

Revenue is primarily generated through our subsidiary, Digipath Labs, Inc., which recognizes revenue from the analytical testing of cannabis products to 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.

The Company also recognizes revenue through our subsidiary, TNM News Corp., which primarily recognizes revenue from advertisements through partnered merchants. Payment for ad revenues are received prior to the distribution of the ad campaign, and the revenues are recognized ratably over the campaign. The Company defers any revenue for which the term of the campaign has not yet been realized. To date, these revenues have not been materially significant.

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 June 30, 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 June 30, 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.

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 June 30, 2019:

On June 25, 2019, we issued 300,000 shares of common stock, restricted in accordance with Rule 144, to another consultant for business development services to be performed from May 1, 2019 through October 31, 2019.

On June 25, 2019, we issued 41,667 shares of common stock, restricted in accordance with Rule 144, to our President and CEO for services rendered pursuant to his employment agreement.

On June 25, 2019, we issued 104,167 shares of common stock, restricted in accordance with Rule 144, to our CFO for services rendered pursuant to his employment agreement.

On May 25, 2019, we issued 50,000 shares of common stock, restricted in accordance with Rule 144, to a consultant that was engaged to assist the Company with acquisition activities.

On April 25, 2019, we issued 50,000 shares of common stock, restricted in accordance with Rule 144, to a consultant that was engaged to assist the Company with acquisition activities.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

* Filed herewith.

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: August 13, 2019