MALACHITE INNOVATIONS, INC. - Quarter Report: 2016 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2016

For the transition period from __________ to __________

Commission File Number: 000-53832

VITALITY BIOPHARMA, INC.

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

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

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

As of February 13, 2017, there were 17,786,515 shares of the registrant’s common stock outstanding.

VITALITY BIOPHARMA, INC.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended

December 31, 2016

INDEX

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

VITALITY BIOPHARMA, INC.

CONDENSED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED DECEMBER 31, 2016 AND 2015

(Unaudited)

VITALITY BIOPHARMA, INC.

CONDENSED BALANCE SHEETS

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

VITALITY BIOPHARMA, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

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

VITALITY BIOPHARMA, INC.

CONDENSED STATEMENT OF STOCKHOLDERS’ DEFICIT

NINE MONTHS ENDED DECEMBER 31, 2016

(Unaudited)

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

VITALITY BIOPHARMA, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

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

VITALITY BIOPHARMA, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED DECEMBER 31, 2016 and 2015

(Unaudited)

1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Vitality Biopharma, Inc. (the “Company”, “we”, “us” or “our”) was incorporated under the laws of the State of Nevada on June 29, 2007. In December 2015, we discovered novel pharmaceutical applications of our glycosylation technology for producing cannabinoid prodrugs and we have recently changed our operational focus towards pharmaceutical development of the cannabinoid prodrugs. On July 15, 2016, the holders of a majority of our outstanding common stock and our Board of Directors approved 1) a name change whereby our name changed from Stevia First Corp. to Vitality Biopharma, Inc., 2) a reverse split of our outstanding common shares whereby each 10 shares of common stock were exchanged for 1 share of common stock and 3) an increase in the number of shares of authorized common stock from 525,000,000 to 1,000,000,000. These changes became effective on July 20, 2016. All share and per share information contained in this Quarterly Report, including these unaudited condensed financial statements, has been adjusted to reflect these changes as if it had occurred in the earliest period presented.

Going Concern

These financial statements have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying financial statements, for the nine months ended December 31, 2016, the Company incurred a net loss of $4,105,232 and utilized $883,627 of cash in operations, and at December 31, 2016, had a stockholders’ deficit of $681,198. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. In addition, the Company’s independent registered public accounting firm, in their report on the Company’s March 31, 2016 audited financial statements, raised substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

The ability to continue as a going concern is dependent on the Company attaining and maintaining profitable operations in the future and/or raising additional capital to meet its obligations and repay its liabilities arising from normal business operations when they come due. We estimate that we will have sufficient funds to operate the Company through June 30, 2017. These estimates could differ if we encounter unanticipated difficulties, in which case our current funds may not be sufficient to operate our business for that period. In addition, our estimates of the amount of cash necessary to operate our business may prove to be wrong, and we could spend our available financial resources much faster than we currently expect.

We do not have any firm commitments for future capital. We will need to raise additional funds in order to continue operating our business and pursue and execute our planned research and development and commercial operations. We do not presently have, nor do we expect in the near future to have, sufficient or consistent revenue to fund our business from our operations, and will need to obtain significant funding from external sources. Since inception, we have funded our operations primarily through equity and debt financings, and we expect to continue to rely on these sources of capital in the future. However, if we raise additional funds by issuing equity or convertible debt securities, our existing stockholders’ ownership will be diluted, and obtaining commercial loans would increase our liabilities and future cash commitments. If we pursue capital through alternative sources, such as collaborations or other similar arrangements, we may be forced to relinquish rights to our proprietary technology or other intellectual property that could result in our receipt of only a portion of any revenue that may be generated from a partnered product or business. Further, these or other sources of capital may not be available on commercially reasonable or acceptable terms when needed, or at all. If we cannot raise the money that we need in order to continue to operate and develop our business, we will be forced to delay, scale back or eliminate some or all of our operations. If any of these were to occur, there is a substantial risk that our business would fail and our stockholders could lose all of their investment.

Basis of Presentation of Unaudited Condensed Financial Information

The unaudited condensed financial statements of the Company for the nine months ended December 31, 2016 and 2015 have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, applied on a consistent basis, and pursuant to the requirements for reporting on Form 10-Q and the requirements of Regulation S-K and Regulation S-X promulgated under the Securities Act of 1933, as amended (the “Securities Act”). Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete audited financial statements. However, the information included in these financial statements reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for the fair presentation of the Company’s financial position and the results of operations. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full fiscal year or any future annual or interim period. The balance sheet information as of March 31, 2016 was derived from the audited financial statements as of and for the year ended March 31, 2016 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on June 24, 2016. These financial statements should be read in conjunction with that report.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The more significant estimates and assumptions by management include, among others, the fair value of equity instruments issued for services, and assumptions used in the valuation of our outstanding derivative liabilities.

Accounts Receivable

The Company evaluates the collectability of its trade accounts receivable based on a number of factors. In circumstances where the Company becomes aware of a specific customer’s inability to meet its financial obligations to the Company, a specific reserve for bad debts is estimated and recorded, which reduces the recognized receivable to the estimated amount the Company believes will ultimately be collected. In addition to specific customer identification of potential bad debts, bad debt charges are recorded based on the Company’s historical losses and an overall assessment of past due trade accounts receivable outstanding.

The allowance for doubtful accounts and returns and discounts is established through a provision reducing the carrying value of receivables. At December 31, 2016, and March 31, 2016, the allowance for doubtful accounts and returns and discounts was approximately $35,500 and $17,517, respectively.

Financial Assets and Liabilities Measured at Fair Value

The Company accounts for the fair value of financial instruments in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (ASC) topic 820, “Fair Value Measurements and Disclosures” (ASC 820). ASC 820 defines “fair value” as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

Authoritative guidance provided by the FASB defines the following levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these financial assets:

The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts payable and accrued liabilities, each qualify as financial instruments and are a reasonable estimate of their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest.

The Company uses Level 2 inputs for its valuation methodology for the warrant derivative liabilities as their fair values were determined by using a probability weighted average Black-Scholes-Merton pricing model based on various assumptions. The Company’s derivative liabilities are adjusted to reflect fair value at each period end, with any increase or decrease in the fair value being recorded in results of operations as adjustments to fair value of derivatives.

At December 31, 2016 and March 31, 2016, the Company’s balance sheet includes the fair value of derivative liabilities of $474,562 and $401,127, respectively, that were measured using level 2 measurements. The Company did not identify any other non-recurring assets and liabilities that are required to be presented in the balance sheets at fair value in accordance with ASC 815.

Derivative Financial Instruments

The Company evaluates its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations. For stock-based derivative financial instruments, the Company uses a probability weighted average Black-Scholes-Merton model to value the derivative instruments at inception and on subsequent valuation dates through the December 31, 2016 reporting date. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Revenue Recognition

Revenue is measured at the fair value of the consideration received or receivable and represents amounts receivable for products and/or services that have been delivered in the normal course of business, title has passed, the selling price is both fixed and determinable, and collectability is reasonably assured, all of which generally occurs upon shipment of the Company’s product or delivery of the product to the destination specified by the customer.

The Company determines whether delivery has occurred based on when title transfers and the risks and rewards of ownership have transferred to the buyer, which usually occurs when the Company ships the products. The Company regularly reviews its customers’ financial positions to ensure that collectability is reasonably assured. Except for warranties, the Company has no post-sales obligations.

Stock-Based Compensation

The Company periodically issues stock options and warrants to employees and non-employees in non-capital raising transactions, for services and for financing costs. The Company accounts for share-based payments under the guidance of the FASB, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, officers, directors, and consultants, including employee stock options, based on estimated fair values. The Company estimates the fair value of share-based payment awards to employees and directors on the date of grant using an option-pricing model, and the value of the portion of the award that is ultimately expected to vest is recognized as expense over the required service period in the Company’s statements of operations. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with the authoritative guidance whereas the value of the stock compensation is based upon the measurement date as determined at either (a) the date at which a performance commitment is reached, or (b) the date at which the necessary performance to earn the equity instruments is complete. Stock-based compensation is based on awards ultimately expected to vest and is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, as necessary, in subsequent periods if actual forfeitures differ from those estimates.

Basic and Diluted Loss Per Share

The Company’s computation of earnings (loss) per share (EPS) includes basic and diluted EPS. Basic EPS is calculated by dividing the Company’s net income (loss) available to common stockholders by the weighted average number of common shares during the period. Shares of restricted stock subject to vesting are included in basic weighted average common shares outstanding from the time they vest. Diluted EPS reflects the potential dilution, using the treasury stock method that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income (loss) of the Company. In computing diluted EPS, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period.

As of December 31, 2016 potentially dilutive securities include options to acquire 2,427,488 shares of common stock and warrants to acquire 4,045,163 shares of common stock. As of December 31, 2015 potentially dilutive securities include options to acquire 899,167 shares of common stock and warrants to acquire 2,502,714 shares of common stock. The basic and fully diluted shares for the three and nine months ended December 31, 2016 are the same because the inclusion of the potential shares would have had an anti-dilutive effect. The basic and fully diluted shares for the three and nine months ended December 31, 2015 are the same because (i) for the three months ended December 31, 2015, the inclusion of the potential shares would have had an anti-dilutive effect and (ii) for the nine months ended December 31, 2015, there were no instruments that would result in issuance of additional shares using the treasury stock method

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers.  ASU 2014-09 is a comprehensive revenue recognition standard that will supersede nearly all existing revenue recognition guidance under current U.S. GAAP and replace it with a principle based approach for determining revenue recognition.  Under ASU 2014-09, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.  In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  The FASB has recently issued ASU 2016-08, ASU 2016-10, ASU 2016-11, ASU 2016-12, and ASU 2016-20 all of which clarify certain implementation guidance within ASU 2014-09.    ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017.   Early adoption is permitted only in annual reporting periods beginning after December 15, 2016, including interim periods therein.  The standard can be adopted either retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method).  The Company is currently in the process of analyzing the information necessary to determine the impact of adopting this new guidance on its financial position, results of operations, and cash flows.  The Company will adopt the provisions of this statement in the quarter beginning April 1, 2018. 

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods thereafter. Early adoption is permitted. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases. ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

In March 2016, the FASB issued the ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The amendments in this ASU require, among other things, that all income tax effects of awards be recognized in the income statement when the awards vest or are settled. The ASU also allows for an employer to repurchase more of an employee's shares than it can today for tax withholding purposes without triggering liability accounting and allows for a policy election to account for forfeitures as they occur. The amendments in this ASU are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted for any entity in any interim or annual period. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

Other recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.

2. DERIVATIVE LIABILITY

Under authoritative guidance by the FASB on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock, instruments which do not have fixed settlement provisions are deemed to be derivative instruments. The warrants issued to purchasers and placement agent in June 2013 and September 2014, and the warrants issued to investors in May 2015, do not have fixed settlement provisions because their exercise prices will be lowered if the Company issues securities at lower prices in the future or have other variable provisions. The Company was required to include the reset provisions in order to protect the holders of the warrants from the potential dilution associated with future financings, and a fundamental transaction provision, which require a revaluation of the liabilities. In accordance with the FASB authoritative guidance, the warrants have been characterized as derivative liabilities to be re-measured at the end of every reporting period with the change in value reported in the statement of operations.

As of March 31, 2016 and December 31, 2016, the derivative liabilities were valued using a probability weighted average Black-Scholes-Merton pricing model with the following assumptions:

Warrants:

The risk-free interest rate was based on rates established by the Federal Reserve Bank. The Company uses the historical volatility of its common stock to estimate the future volatility for its common stock. The expected life of the warrants was determined by the expiration dates of the warrants. The expected dividend yield was based on the fact that the Company has not paid dividends to its common stockholders in the past and does not expect to pay dividends to its common stockholders in the future.

At March 31, 2016, the fair value of the derivative liabilities was $401,127. During the nine months ended December 31, 2016, the Company recorded an increase in fair value of the derivative liabilities of $1,980,592. In addition, derivative liabilities of $80,278 were extinguished that were related to warrants that expired and $1,826,882 was extinguished upon the cashless exercise of warrants. At December 31, 2016, the fair value of the derivative liabilities was $474,562.

3. EQUITY

Equity Financing

In May 2016, the Company entered into a securities purchase agreement providing for the issuance and sale by the Company, in a private placement, of units including 2,650,000 shares of the Company’s common stock (the “Shares”) and Warrants to purchase 7,950,000 shares of the Company’s common stock (the “Warrants”), at a price of $0.10 per Share. The Warrants have an exercise price of $0.17 per share and expire February 4, 2017. The offering closed on May 4, 2016, and aggregate proceeds to the Company from the sale of the Shares and Warrants was $265,000. $165,030 of the proceeds was received in the current period and $99,970 was received prior to April 1, 2016 and had been reflected as common stock issuable at March 31, 2016.

Common stock issued to employees for services with vesting terms

The Company has issued shares of common stock to employees and directors that vest over time. The fair value of these stock awards were based on the market price of the Company’s common stock at the dates granted, and are amortized over vesting terms ranging up to three years.

During the nine months ended December 31, 2016, the Company issued an aggregate of 1,436,170 shares of its common stock to one officer and one director. The aggregate fair value of these awards was approximately $718,000, which will amortized over the 1.75 year vesting term of the awards.

At March 31, 2016, the accumulated vested balance of stock awards was $611,216. During the nine months ended December 31, 2016, the fair value of stock awards that vested was $235,499. At December 31, 2016, the accumulated vested balance of the stock awards $846,715. At December 31, 2016, the amount of unvested compensation related to these awards is approximately $513,000, and will be recorded as expense over 1.25 years as the shares vest.

Shares of restricted stock granted above are subject to forfeiture to the Company or other restrictions that will lapse in accordance with a vesting schedule determined by our Board. In the event a recipient’s employment or service with the Company terminates, any or all of the shares of common stock held by such recipient that have not vested as of the date of termination under the terms of the restricted stock agreement are forfeited to the Company in accordance with such restricted grant agreement.

The following table summarizes restricted common stock activity:

4. STOCK OPTIONS

During the nine months ended December 31, 2016, the Company granted to employees options to purchase an aggregate of 1,618,262 shares of the Company’s common stock with exercise price of $0.50 per share, that expire ten years from the date of grant, and all have vesting period of 24 months. The fair value of each option award was estimated on the date of grant using the Black-Scholes option pricing model based on the following assumptions: (i) volatility rate of 126.34%, (ii) discount rate of 1.60 %, (iii) zero expected dividend yield, and (iv) expected life of 6 years, which is the average of the term of the options and their vesting periods. The total fair value of the option grants to employees at their grant dates was approximately $775,000. For the nine months ended December 31, 2016, amortization of approximately $179,000 was recorded related to these options.

During the nine months ended December 31, 2016, the Company also granted to two consultants options to purchase 142,559 shares of the Company’s common stock with exercise prices of per share $0.50 and $0.96, respectively, both option grants expire in ten years from date of grant, and both have vesting period of 24 months. The fair value of these options granted to the consultants was estimated using the Black-Scholes option pricing model based on the following assumptions: (i) volatility rate between 126.34%, (ii) discount rate of 1.36%, (iii) zero expected dividend yield, and (iv) expected life of 10 years. The total fair value of the option grants to the consultants at their grant dates was approximately $146,000. The Company re-measures any non-vested options to non-employees to fair value at the end of each reporting period. At December 31, 2016, the fair value of the 142,559 options was $417,000. During the nine months ended December 31, 2016, amortization of $85,880 was recorded on these options.

Pursuant to the terms of the 2012 Stock Incentive Plan, the exercise price for all equity awards issued under the 2012 Stock Incentive Plan is based on the market price per share of the Company’s common stock on the date of grant of the applicable award.

A summary of the Company’s stock option activity for the nine months ended December 31, 2016 is presented below:

At December 31, 2016, options to purchase common shares were outstanding as follows:

During the nine months ended December 31, 2016 and 2015, we expensed total stock-based compensation related to vesting stock options of $581,510 and $186,447, respectively, and the remaining unamortized cost of the outstanding stock options at December 31, 2016 was $1,145,699. This cost will be amortized over a weighted average remaining vesting period of 2 years and will be adjusted for subsequent changes in estimated forfeitures. Future option grants will increase the amount of compensation expense that will be recorded.

The intrinsic values of all outstanding and exercisable stock options at December 31, 2016 were approximately $5,000,000 and $450,000, respectively.

5. WARRANTS

At December 31, 2016, warrants to purchase common shares were outstanding as follows:

Warrants issued in equity financing (see Note 3)

In May 2016, the Company issued warrants to purchase up to an aggregate of 7,950,000 shares of the Company’s common stock in conjunction with a securities purchase agreement for the sale of shares of the Company’s common stock and warrants. The warrants have an exercise price of $0.17 per share and expired on February 4, 2017. All of these warrants were exercised prior to expiration.

Warrants issued to employees

On August 25, 2014, we entered into employment agreements with two employees, pursuant to which these employees received warrants to purchase an aggregate of 440,000 shares of the Company’s common stock with a fair value of $705,880. The warrants have an exercise price of $3.00, and a term of ten years from issue date. Warrants to purchase 80,000 shares of common stock vested immediately and warrants to purchase 200,000 shares of common stock were amortized over their vesting terms of one year to three years. The balance of 160,000 warrants vest upon the achievement of certain milestones, as defined, none of which have been met through December 31, 2016. At March 31, 2016, the accumulated amortization of the vested fair value for these warrants was $614,846. During the nine months ended December 31, 2016, amortization of vested warrants was $0, and at December 31, 2016, the accumulated amortization for vested warrants was $649,860. Beginning September 1, 2016, there is no further amortization of fair value being recorded for the warrants (see Note 7).

During the nine months ended December 31, 2016, the Company received $777,000 of proceeds from holders of warrants to acquire 4,750,590 shares of common stock. In addition, warrant holders exchanged 1,086,965 warrants on a cashless basis for 454,364 shares of common stock.

The aggregate intrinsic value of all of the outstanding and exercisable warrants at December 31, 2016 and March 31, 2016 was approximately $9,750,000 and $0, respectively.

6. RELATED PARTY TRANSACTIONS AND LEASE OBLIGATIONS

Related party lease obligations

On April 23, 2012, the Company entered into a lease agreement (the “Carlson Lease”) with One World Ranches, LLC (“One World Ranches”), which is jointly-owned by Dr. Avtar Dhillon, the Chairman of the Board of Directors of the Company, and his wife, Diljit Bains, pursuant to which the Company has agreed to lease from One World Ranches certain office and laboratory space located at 5225 Carlson Road, Yuba City, California. The Carlson Lease began on May 1, 2012 and expires on May 1, 2017, and the Company’s rent payments thereunder are $2,300 per month. The Company has paid $1,500 as a refundable security deposit under the Carlson Lease.

Aggregate payments under the above lease for the nine months ended December 31, 2016 and 2015 were $0 and $15,800, respectively.

7. DISTRIBUTION AND LICENSE AGREEMENTS

In August 2014, the Company entered into distribution and license agreements with Qualipride International and certain individuals to provide stevia products to the Company. In connection with these agreements, the Company issued 1,400,000 shares of common stock with a total fair value of $420,000 that was being amortized over a three year vesting term (see Note 3). At December 31, 2016, the accumulated amortization for these shares was $395,000. Also in connection with these agreements, the Company issued warrants to purchase 440,000 shares of common stock with a total fair value of $705,880 (See Note 5). At December 31, 2016, the accumulated amortization for these warrants was $649,860. The distribution and license agreements terminated in August 2016 and beginning September 1, 2016, there is no further amortization of fair value being recorded for the common stock or warrants.

8. SUBSEQUENT EVENTS

In January and February 2017, holders of warrants to purchase 1,056,038 shares of the Company’s common stock were exercised on a cashless basis. In February 2017 the Company issued 37,500 shares of common stock valued at $87,750 in exchange for services. In January and February 2017, the Company issued options to purchase a total of 400,000 shares of the Company’s common stock to one employee and three consultants with a fair value of approximately $948,000 which will be amortized over 24 months as the options vest. These options have an exercise price of between $2.34 and $2.79 per share and expire ten years form the date of issuance.

 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

As used in this discussion and analysis and elsewhere in this Quarterly Report, the “Company”, “we”, “us” or “our” refer to Vitality Biopharma, Inc., a Nevada corporation.

Cautionary Statement

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Unaudited Condensed Financial Statements and the related notes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q (this “Quarterly Report”). The information contained in this Quarterly Report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Quarterly Report and in our other reports filed with the Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the fiscal year ended March 31, 2016 filed on June 24, 2016, and the related audited financial statements and notes included therein.

Certain statements made in this Quarterly Report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are projections in respect of future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, which may cause our or our industry’s actual results, levels of activity or performance to be materially different from any future results, levels of activity or performance expressed or implied by these forward-looking statements. These risks and uncertainties include: general economic and financial market conditions; our ability to obtain additional financing as necessary; our ability to continue operating as a going concern; any adverse occurrence with respect to our business or; results of our research and development activities that are less positive than we expect ; our ability to bring our intended products to market; market demand for our intended products; shifts in industry capacity; product development or other initiatives by our competitors; fluctuations in the availability of raw materials and costs associated with growing raw materials for our intended products; poor growing conditions for the stevia plant; other factors beyond our control; and the other risks described under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on June 24, 2016.

Although we believe that the expectations and assumptions reflected in the forward-looking statements we make are reasonable, we cannot guarantee future results, levels of activity or performance. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those expressed by any forward-looking statements. As a result, readers should not place undue reliance on any of the forward-looking statements we make in this report. Forward-looking statements speak only as of the date on which they are made. Except as required by law, we undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Company Overview

We were incorporated in the State of Nevada on June 29, 2007 under the name Legend Mining Inc. On October 10, 2011, we completed a merger with our wholly-owned subsidiary, Stevia First Corp., whereby we changed our name from “Legend Mining Inc.” to “Stevia First Corp.” Also on October 10, 2011, we effected a seven for one forward stock split of authorized, issued and outstanding common stock. As a result, our authorized capital was increased from 75,000,000 shares of common stock with a par value of $0.001 to 525,000,000 shares of common stock with a par value of $0.001, and issued and outstanding shares of common stock increased from 7,350,000 to 51,450,000. In February 2012, we substantially changed our management team and added other key personnel. In December 2015, we discovered novel pharmaceutical applications of our glycosylation technology for producing cannabinoid prodrugs and we have recently changed our operational focus towards pharmaceutical development of the cannabinoid prodrugs. On July 15, 2016, the holders of a majority of our outstanding common stock and our Board of Directors approved 1) a name change whereby our name changed from Stevia First Corp. to Vitality Biopharma, Inc., 2) a reverse split of our outstanding common shares whereby each 10 shares of common stock will be exchanged for 1 share of common stock and 3) an increase in the number of shares of authorized common stock from 525,000,000 to 1,000,000,000. These changes became effective on July 20, 2016.

Plan of Operations

Business Overview

Vitality Biopharma is unlocking the power of cannabinoids for the treatment of serious neurological and inflammatory disorders, such as inflammatory bowel disease and narcotic bowel syndrome, a form of severe opiate-induced bowel dysfunction.

Vitality Biopharma has developed a new class of cannabinoids known as cannabosides, which were discovered in 2015 through application of the company’s proprietary enzymatic bioprocessing technologies originally developed for stevia sweeteners. In 2016, Vitality received approvals from the U.S. Drug Enforcement Administration (the “DEA”) and the State of California to initiate studies and manufacturing scale-up at its research and development facilities in order to develop cannabosides as a new class of cannabinoid pharmaceuticals.

Cannabosides are cannabinoid glycoside “prodrugs,” which means that they are medications or compounds that, after administration, are converted within the body into a pharmacologically active drug, which already has a long history of clinical investigation and use. A classic prodrug example is Aspirin, acetylsalicylic acid, which was first made by Felix Hoffmann at Bayer in 1897 and is a synthetic prodrug of salicylic acid. Because there already exists independent verification of the active drug’s safety and efficacy, prodrugs may receive marketing approval more quickly than others, and in some cases may receive drug approvals through completion of small clinical studies evaluating bioequivalence or bioavailability. At the same time, a prodrug can have many commercial advantages, including that they can be proprietary and patentable compositions of matter, unlike cannabinoids themselves, or older pharmaceutical formulations where patent protection has already expired.

Cannabosides are more stable and soluble than cannabinoids, and upon oral delivery, have been documented to pass through the digestive tract and release within the large intestine or colon. This enables targeted delivery of cannabinoids for the treatment of gastrointestinal disorders. Cannabosides enable the reduction or elimination of systemic delivery of tetrahydrocannibinol (THC) into the bloodstream and brain, reducing psychoactive side effects, and enabling higher concentrations of compounds to be used for treatment of pain and inflammation. Because passage of cannabosides through the digestive tract is likely to occur over several hours or longer, there is a sustained or delayed release of cannabinoids, which can also provide patients with long-lasting or overnight relief, a desirable attribute that is unavailable with medical marijuana or with current cannabinoid pharmaceutical formulations.

We have produced more than 25 novel cannabosides so far and have patent applications that include composition of matter claims for prodrugs of cannabinoids that have been studied extensively in clinical trials worldwide, including THC, cannabidiol (CBD), cannabidivarin (CBDV), and other phytocannabinoids and endocannabinoids. Upon successful patent prosecution, protection would extend until 2035 and be available in all major markets worldwide. In addition, we have filed composition of matter claims on vanilloid glycoside compounds that target the TRPV receptors, which mediate pain relief. We aim to develop and approve these proprietary molecules as pharmaceuticals using a low-risk regulatory strategy that is available for prodrugs, and to amplify the benefits that have been evidenced through use of cannabinoids or medical marijuana for treatment of neurological and inflammatory conditions.

A key part of our strategy will be to take advantage of a more efficient FDA review and approval process that is available for prodrugs, which reduces the need for large and expensive clinical trials. Expedited regulatory processes may be available for our cannabosides because in the U.S. and internationally there have already been many independent preclinical and clinical studies completed using the reference cannabinoid drugs we are studying, and so existing clinical data may be submitted to drug regulatory agencies as supporting evidence of our compounds’ safety and efficacy.

We are initially developing our cannabosides drug formulations for treatment of inflammatory bowel disease as well as narcotic bowel syndrome, a severe form of opiate-induced abdominal pain.

For inflammatory bowel disease (IBD), there have been independently-conducted preclinical and clinical studies that have demonstrated the benefit of cannabinoids, and many U.S. states now permit the use of medical marijuana for IBD, including for treatment of Crohn’s disease or ulcerative colitis patients. Independently-run retrospective clinical studies have found that in 56 patients who used cannabinoids with IBD that 83.9% of patients reported improvement in abdominal pain and 76.8% of patients reported improvement in abdominal cramping. In addition, in a prospective trial that was independently-managed and placebo-controlled, it was found that 45% of Crohn’s disease patients achieved remission through only 8 weeks of treatment. Patients reported improvements in sleep and appetite with no significant side effects, and some patients were able to eliminate use of corticosteroids and opiate pain medications. Patients experienced benefits with cannabis treatment despite being non-responders to traditional front-line therapies, such as corticosteroids, immunomodulators, and biologic TNF-alpha inhibitors.

Narcotic bowel syndrome (NBS) is a severe form of opiate-induced abdominal pain. In studies, more than half (58%) of opiate users have reported chronic abdominal pain. When opiate-induced abdominal pain is overlooked or misdiagnosed, potentially due to common gastrointestinal side effects like opiate-induced constipation, it may lead to a vicious cycle of dose escalation. While seeking pain relief, increasing the dose of opiate medications could lead both to worsening abdominal pain and to more severe drug addiction. Studies have reported that approximately 6% of opiate users have NBS, and that patients afflicted with this disorder report a quality-of-life that is worse than patients with quadriplegia. Independent preclinical studies have reported that endogenous opioid peptides may play a role within the intestinal tract in the development of inflammation, and that they act in a synergistic manner to opiates for pain relief, meaning that cannabinoids could enable opiate dose reduction without sacrificing pain relief. Independent clinical studies have confirmed this effect, where it was reported that cannabis provides additional pain relief to patients taking stable doses of opiates for chronic pain management, and that they also were reported to reduce the severity of common opiate withdrawal symptoms, such as nausea. Independent clinical studies have also found an inadequacy in current treatments for narcotic bowel syndrome, showing that 45.8% of patients had returned to using narcotics within only three months.

We plan to complete preclinical studies necessary to commence clinical trials in 2017, which will focus initially on evaluating the clinical pharmacokinetics and safety of cannabosides, as well as then evaluating their utility for treatment of inflammatory bowel disease and narcotic bowel syndrome. We plan to conduct additional preclinical studies also, which will evaluate the utility of cannabosides for providing symptomatic relief of chronic conditions such as neuropathic pain, irritable bowel syndrome, muscle spasticity in multiple sclerosis, and opiate-induced bowel dysfunction.

Our primary operations are based in Yuba City, California, where we originally developed our proprietary bioprocessing methods. The Company’s research and development facilities include laboratories and a manufacturing suite that will be used for pharmaceutical-grade production of cannabosides for clinical trials. These facilities have been registered with and approved by the DEA as well as the State of California.

Our Operations

Product Development Plans

For each of the pharmaceutical products in our pipeline, the active cannabinoid pharmaceutical agents have either been independently approved by regulatory bodies, or are now in late-stage clinical trials, and there is extensive clinical data already available related to drug safety and effectiveness. Because of this, the Company will in general benefit from the increased familiarity of clinical investigators and regulators with these compounds, which may enable abbreviated paths towards clinical testing and eventual approval of its pharmaceutical products.

Cannabinoids are known to be effective anti-inflammatory and neuroprotective agents, and as of 2015, more than 20 U.S. states have enacted medical marijuana laws to permit access to cannabis for treatment of a variety of conditions. The approved disease indications include ones directly related to the drug indications we are targeting, as well as many others. The list includes chronic pain, inflammatory bowel disease, epilepsy, wasting disorders, multiple sclerosis and muscle spasticity disorders, glaucoma, cirrhosis, Alzheimer’s disease, nausea, traumatic brain injury, Parkinson’s disease, HIV/AIDS, Huntington’s disease, and more. Cannabinoid pharmaceuticals are increasingly being approved as well, including primarily synthetic and botanical extracts of the two major constituents of Cannabis sativa, which are THC and CBD. Dronabinol is a synthetic THC drug that has been approved for treating nausea and for stimulating appetite. Nabiximols is a blend of two cannabinoids, THC and CBD, which has been approved in more than 20 countries for treatment of muscle spasticity in multiple sclerosis, and also for treatment of cancer pain in certain countries.

CBD is not psychoactive, has established antianxiety and antipsychotic effects, and beyond its inclusion in nabiximols, has also been investigated independently by clinical researchers as a stand-alone agent for epilepsy, schizophrenia, inflammatory bowel disease, opiate dependence, and a variety of other neurological and inflammatory conditions. We intend to obtain marketing authorizations in one or more of these disease indications, while focusing initially on inflammatory bowel disease and narcotic bowel syndrome.

Short Term Development Targets

We believe that our long-term commercial success and profit potential depends in large part on our ability to develop and advance proprietary cannabinoid prodrugs that are strongly differentiated from both medical marijuana and existing cannabinoid pharmaceuticals, and to do this more quickly, efficiently and effectively than our competitors. Another critical factor that will determine our success is our ability to obtain and enforce patents, maintain protection of trade secrets, and operate our business without infringing the proprietary rights of third parties. As a result, we are dedicated to the continued development and protection of our intellectual property portfolio. See “Intellectual Property” in this report for a further discussion.

Product Pipeline

Our pipeline includes pharmaceutical formulations of cannabosides, which are cannabinoid glycoside prodrugs. Prodrugs are medications or compounds metabolized by the body into a pharmacologically active drug. We have patents pending for more than 25 of these novel pharmaceutical compositions including prodrugs of THC, CBD, and CBDV, which are cannabinoids that are either marketed and approved as pharmaceutical products today, or that are under investigation in independently-managed clinical trials currently. Prodrugs can optimize the marketability of a drug because they can be patented and proprietary, and yet still be approved through an abbreviated regulatory pathway.

VITA-100 is an oral cannabinoid formulation containing cannabosides that is being developed for acute treatment of inflammatory bowel disease and narcotic bowel syndrome. VITA-210 is an oral cannabinoid formulation containing cannabosides being investigated in preclinical studies for chronic treatment of neuropathic pain, irritable bowel syndrome, muscle spasticity in multiple sclerosis, and opioid-induced bowel dysfunction.

Through a process called glycosylation, the solubility and stability of a drug can be significantly improved. Cannabinoid glycoside prodrugs and their use in drug formulations that are currently under development at Vitality Biopharma are designed to enable significant benefits, including:

We also have licensed intellectual property that seeks to protect methods of use of certain FDA-approved drugs for treatment of multiple sclerosis and demyelinating disorders. These drugs are being tested in combination with our cannaboside drug formulations in order to establish treatment regimens that provide regenerative effects for patients with serious neurological and inflammatory conditions.

Additional Operations

Our glycosylation technology in the past was applied primarily to production of better tasting varieties of stevia through enzyme bioprocessing, which was developed in concert with additional technologies designed to improve the taste and yield of stevia sweetener derived from the stevia plant. The company has an intellectual property portfolio related to stevia, as well as commercial operations related to the manufacture and sale of research products that commenced in 2014. The Company intends to sustain these operations and technologies in a manner that is cash-flow neutral or better, through a combination of restructuring of existing agreements and entering into new licensing arrangements or strategic partnerships.

In May 2014, we purchased the assets of a Percipio Biosciences, Inc., which produced and sold these products, and which we continue to sell under their existing brand names. These products are sold primarily to research universities and companies in the United States and through a network of research product distributors internationally. The tests enable measurement by life science researchers of biomarkers of inflammation and oxidative signaling and stress. The kits and products include antibodies, enzymes, as well as specialty chemicals.

Results of Operations

Three Months Ended December 31, 2016 and December 31, 2015

Our net loss during the three months ended December 31, 2016 was $2,450,167 compared to a net loss of $83,636 for the three months ended December 31, 2015. During the three months ended December 31, 2016, we generated $39,682 in revenue and $19,752 in gross profit, compared to $80,818 in revenue and $50,147 in gross profit for the 2015 period. Our revenue in each of the periods presented is earned from the sale of research diagnostic testing kits and chemicals. We expect such sales to continue at approximately this rate.

During the three months ended December 31, 2016, we incurred general and administrative expenses in the aggregate amount of $669,574 compared to $535,389 incurred during the three months ended December 31, 2015 (an increase of $134,185). General and administrative expenses generally include corporate overhead, salaries and other compensation costs, financial and administrative contracted services, marketing, consulting costs and travel expenses. A significant portion of these costs are related to the development of our organizational capabilities as a biotechnology company, including costs such as legal and advisory fees related to intellectual property development. The majority of the increase in general and administrative costs in the period relates to stock-based compensation costs which increased to $294,646 in the period ending December 31, 2016, as compared to $166,677 in the period ending December 31, 2015 (an increase of $127,969).

In addition, during the three months ended December 31, 2016, we incurred research and development costs of $255,334, compared to $161,144 during the three months ended December 31, 2015 (an increase of $94,190).

During the three months ended December 31, 2016, we incurred related party rent and other costs totaling $6,900 compared to $7,900 incurred during the three months ended December 31, 2015 (a decrease of $1,000). This decrease resulted from a one-time additional charge incurred during the 2015 period.

This resulted in a loss from operations of $912,056 during the three months ended December 31, 2016 compared to a loss from operations of $654,286 during the three months ended December 31, 2015.

During the three months ended December 31, 2016, we recorded total net other income (expenses) in the amount of $(1,538,111), compared to total net other income (expenses) recorded during the three months ended December 31, 2015 in the amount of $570,650. During the three months ended December 31, 2016, we recorded a loss related to the change in fair value of derivatives of $1,538,047, compared to a gain of $570,797 during the 2015 quarter. This resulted in a net loss of $2,450,167 during the three months ended December 31, 2016, compared to a net loss of $83,636 during the three months ended December 31, 2015.

The net loss during the three months ended December 31, 2015 compared to the net loss for the three months ended December 31, 2016 is attributable primarily to the loss related to the change in the fair value of derivatives in the 2016 period compared to the gain recorded during the 2015 period.

Nine Months Ended December 31, 2016 and December 31, 2015

Our net loss during the nine months ended December 31, 2016 was $4,055,425 compared to net income of $636,284 for the nine months ended December 31, 2015. During the nine months ended December 31, 2016, we generated $131,947 in revenue and $66,005 in gross profit from sales of certain research products, compared to $194,430 in revenue and $98,527 in gross profit from sales of certain research products. Our revenue in each of the periods presented is earned from the sale of research diagnostic testing kits and chemicals. We expect such sales to continue at approximately this rate.

During the nine months ended December 31, 2016, we incurred general and administrative expenses in the aggregate amount of $1,685,527 compared to $1,833,930 incurred during the nine months ended December 31, 2015 (a decrease of $148,403). General and administrative expenses generally include corporate overhead, salaries and other compensation costs, costs of financial and administrative contracted services, marketing and consulting costs and travel expenses. A significant portion of these costs are related to the development of our organizational capabilities as a biotechnology company, including costs such as legal and advisory fees related to intellectual property development. The general and administrative expenses included stock-based compensation of $659,611 during the nine months ended December 31, 2016, as compared to stock-based compensation of $396,776 during the nine months ended December 31, 2015 (an increase of $262,835).

In addition, during the nine months ended December 31, 2016, we incurred research and development costs of $483,638, compared to research and development costs of $487,802 during the nine months ended December 31, 2015 (a decrease of $4,164). The decrease resulted primarily from changes in our research and development activities, including lower equipment costs included in the 2016 period.

During the nine months ended December 31, 2016, we incurred related party rent and other costs totaling $20,700 compared to $23,700 incurred during the nine months ended December 31, 2015 (an increase of $3,000). This increase resulted from a one-time additional charge incurred during the 2015 period.

This resulted in a loss from operations of $2,123,860 during the nine months ended December 31, 2016 compared to a loss from operations of $2,246,905 during the nine months ended December 31, 2015.

During the nine months ended December 31, 2016, we recorded total other income (expense) in the amount of $(1,931,565), compared to total other income (expense) recorded during the nine months ended December 31, 2015 in the amount of $2,883,189. During the nine months ended December 31, 2015, we recorded a loss related to the change in fair value of derivative liabilities of $1,930,785, compared to a gain of $2,883,189 during the nine months ended December 31, 2015.

Liquidity and Capital Resources

As of December 31, 2016, we had total current assets of $195,551, which was comprised mainly of cash of $153,836. Our total current liabilities as of December 31, 2016 were $876,749 and consisted of accounts payable and accrued liabilities of $374,587, and derivative liability of $424,755. The derivative liability is a non-cash item related to certain of our outstanding warrants as of December 31, 2016. As a result, on December 31, 2016, we had working capital deficit of $631,391.

These financial statements have been prepared on a going concern basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying financial statements, for the nine months ended December 31, 2016, the Company incurred a net loss of $2,123,860 and had a stockholders’ deficit of $631,391 at December 31, 2016. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern. In addition, the Company’s independent registered public accounting firm, in their report on the Company’s March 31, 2016 audited financial statements, raised substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

The ability to continue as a going concern is dependent on the Company attaining and maintaining profitable operations in the future and/or raising additional capital to meet its obligations and repay its liabilities arising from normal business operations when they come due. We estimate that we will have sufficient funds to operate the Company through June 30, 2017. These estimates could differ if we encounter unanticipated difficulties, in which case our current funds may not be sufficient to operate our business for that period. In addition, our estimates of the amount of cash necessary to operate our business may prove to be wrong, and we could spend our available financial resources much faster than we currently expect.

We do not have any firm commitments for future capital. Significant additional financing will be required to fund our planned operations in future periods, including research and development activities relating to our principal product candidate, seeking regulatory approval of that or any other product candidate we may choose to develop, commercializing any product candidate for which we are able to obtain regulatory approval or certification, seeking to license or acquire new assets or businesses, and maintaining our intellectual property rights and pursuing rights to new technologies. We do not presently have, nor do we expect in the near future to have, significant revenue to fund our business from our operations, and will need to obtain funding from external sources. We may seek to raise such funding from a variety of sources. If we raise additional funds by issuing equity or convertible debt securities, our existing stockholders’ ownership will be diluted, and obtaining commercial loans would increase our liabilities and future cash commitments. If we pursue capital through alternative sources, such as collaborations or other similar arrangements, we may be forced to relinquish rights to our proprietary technology or other intellectual property that could result in our receipt of only a portion of any revenue that may be generated from a partnered product or business. Further, we may not be able to obtain additional financing from any of these sources on commercially reasonable or acceptable terms when needed, or at all. If we cannot raise the money that we need in order to continue to operate and develop our business, we will be forced to delay, scale back or eliminate some or all of our operations. If any of these were to occur, there is a substantial risk that our business would fail and our stockholders could lose all of their investment.

Net Cash Used in Operating Activities

We have not generated positive cash flows from operating activities. For the nine months ended December 31, 2016, net cash used in operating activities was $883,628 compared to net cash used in operating activities of $1,473,226 for the nine months ended December 31, 2015. This decrease was primarily attributable to a loss related to the change in fair value of derivative liability. Net cash used in operating activities during the nine months ended December 31, 2016 consisted primarily of a net loss of $4,055,425 offset by a change in fair value of derivative liability of $1,930,785, $581,510 related to stock-based compensation for vested stock options and $276,000 for stock issued in exchange for services. For the nine months ended December 31, 2015, net cash used in operating activities was $1,473,226 compared to net cash used in operating activities of $1,837,920 for the nine months ended December 31, 2014. Net cash used in operating activities during the nine months ended December 31, 2015 consisted primarily of net income of $636,284 and change in fair value of derivative liability of $2,883,552, offset by $186,447 related to stock-based compensation for vested stock options and $147,059 for stock-based compensation for vested warrants granted to employees.

Net Cash Used in Investing Activities

During the nine months ended December 31, 2016 and December 31, 2015, no net cash was used in or provided by investing activities.

Net Cash Provided By Financing Activities

During the nine months ended December 31, 2016, net cash provided by financing activities was $942,031 compared to net cash provided by financing activities of $0 for the nine months ended December 31, 2015. Net cash provided by financing activities during the nine months ended December 31, 2016 was attributable to $165,030 from the sale of common stock and warrants and $777,001 provided by the exercise of warrants. No net cash was used in or provided by financing activities during the nine months ended December 31, 2015.

Off-Balance Sheet Arrangements

We have no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that would be material to stockholders.

Critical Accounting Policies

Our financial statements and accompanying notes included in this report have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) applied on a consistent basis. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

We regularly evaluate the accounting policies and estimates that we use to prepare our financial statements. In general, management’s estimates are based on historical experience, on information from third party professionals, and on various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from the estimates made by management. There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” included in our Annual Report on Form 10-K filed with the SEC on June 24, 2016.

Recent Accounting Pronouncements

Please refer to Footnote 1 of the accompanying financial statements for management’s discussion of recent accounting pronouncements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not Applicable.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive and financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on this evaluation, our principal executive and financial officer concluded that as of December 31, 2016, these disclosure controls and procedures were not effective to ensure that the information required to be disclosed by our Company in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (“SEC”), including that such information is accumulated and communicated to our management, including our principal executive and financial officer, as appropriate to allow timely decisions regarding required disclosures .. The conclusion that our disclosure controls and procedures were not effective was due to the presence of material weaknesses in our internal control over financial reporting, as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, as previously disclosed in Item 9A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2016. In light of the material weaknesses identified by management, we performed additional analyses and procedures in order to conclude that our condensed financial statements for the interim period ended December 31, 2016 are fairly presented, in all material respects, in accordance with GAAP.

Description of Material Weaknesses and Management’s Remediation Initiatives

As of the date of this report, our remediation efforts continue related to each of the material weaknesses that we have identified in our internal control over financial reporting and additional time and resources will be required in order to fully address these material weaknesses. We have not been able to complete all actions necessary and test the remediated controls in a manner that would enable us to conclude that such controls are effective. We are committed to implementing the necessary controls to remediate the material weaknesses described below, as and when resources permit. These material weaknesses will not be considered remediated until (1) the new processes are designed, appropriately controlled and implemented for a sufficient period of time and (2) we have sufficient evidence that the new processes and related controls are operating effectively. The following is a list of the material weaknesses identified by management as of December 31, 2016:

(1) Insufficient segregation of duties in our finance and accounting functions due to limited personnel. During the nine months ended December 31, 2016, we internally performed all aspects of our financial reporting process, including, but not limited to, access to the underlying accounting records and systems, the ability to post and record journal entries and responsibility for the preparation of the financial statements. Due to the fact that these duties were often performed by the same person, there was a lack of review over the financial reporting process that might result in a failure to detect errors in spreadsheets, calculations, or assumptions used to compile the financial statements and related disclosures as filed with the SEC. This could result in a material misstatement to our interim or annual financial statements that would not be prevented or detected.

(2) Insufficient corporate governance policies. We do not have a majority of independent directors on our board of directors, resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures.

Changes in Internal Control over Financial Reporting

We are currently considering adding additional independent members to our board of directors and adding accounting personnel to our staff in connection with the ongoing efforts to remediate the material weaknesses described above, but no specific progress has been made on these goals or other remediation efforts during the nine months ended December 31, 2016. As a result, there were no changes in our internal control over financial reporting during the nine months ended December 31, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Internal Control

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. In addition, projections of any evaluation of effectiveness to future periods are subject to risks that controls that are effective at one date may subsequently become inadequate because of changes in conditions or because the degree of compliance with the policies or procedures may deteriorate.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. The impact and outcome of litigation, if any, is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business. We are not currently a party to and our properties are not currently the subject of any material pending legal proceedings the adverse outcome of which, individually or in the aggregate, would be expected to have a material adverse effect on our financial position or results of operations.

Item 1A. Risk Factors

Please refer to the risks described under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on June 24, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 6. Exhibits

* Filed herewith.

† Furnished 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.

VITALITY BIOPHARMA, INC.

EXHIBIT INDEX

* Filed herewith.

† Furnished herewith.