SideChannel, Inc. - Annual Report: 2016 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

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

EXCHANGE ACT OF 1934

For the Fiscal Year Ended September 30, 2016

OR

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

EXCHANGE ACT OF 1934

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

Commission File Number: 000-28745

Cipherloc Corporation

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

825 Main Street, Suite 100

Buda, TX 78610

(Address of principal executive offices)

(512) 772-4237

(Issuer’s telephone number)

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

None

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

Common Stock, $0.01 par value per share

(Title of Class)

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

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

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

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

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

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

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

Aggregate market value of the voting stock held by non-affiliates: $15,617,469 as based on the closing price of the stock on January 26, 2017. The voting stock held by non-affiliates on that date consisted of 4,579,903 shares of common stock.

As of February 2, 2017, there were 5,877,673 shares of common stock, par value $0.01, and 10,000,000 shares of preferred stock, par value $0.01, issued and outstanding.

Documents Incorporated by Reference: None

Cipherloc Corporation

FORM 10-K ANNUAL REPORT

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2016 and 2015

TABLE OF CONTENTS

Special Note Regarding Forward-Looking Statements

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

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

PART I

ITEM 1. BUSINESS.

General

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

Our Company

Cipherloc Corporation (the “Company”) was incorporated in Texas on June 22, 1953 as American Mortgage Company. On March 15, 2015, the Company changed its name to Cipherloc Corporation. The name change became effective by the Amended Certificate as of March 23, 2015. The name change and the 1-100 reverse split were announced March 20, 2015 in the Daily List and became effective on March 23, 2015. The financial statements as to shares and earnings per share are restated as if the reverse split occurred on the first day of the first period being reported.

In the year ended September 30, 2011, the Company introduced Cloud-MD. On September 29, 2015, the Company decided to sell Cloud-MD. It was sold to an employee for $250,000 as set out in an Asset Purchase Agreement and Promissory Note attached to this report as an exhibit. The sale of Cloud MD closed on October 1, 2015. As of this time, the Company has not received a payment from the purchaser, and a full allowance has been recorded.

Item 1. Description of Business

Products and Services

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

CipherLoc Marketing

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

Personnel

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

WHERE YOU CAN FIND MORE INFORMATION

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

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

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

ITEM 2. RISK FACTORS

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

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

The independent auditor’s report on our financial statements for the year ended September 30, 2016 contains explanatory language that substantial doubt exists about our ability to continue as a going concern. We have an accumulated deficit at September 30, 2016 of $45,780,569 and need additional cash flows to maintain our operations. We depend upon equity financing provided by our active Private Placement Memorandum (PPM) and product sales to finance our operations and need to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of our products and business. If we are unable to obtain sufficient financing in the near term or achieve profitability, then we would, in all likelihood, experience severe liquidity problems and may have to curtail or cease our operations altogether. If we curtail our operations or cease our operations, we may be placed into bankruptcy or undergo liquidation, the result of which will adversely affect the value of our common shares.

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

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

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

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

Our common stock is subject to penny stock regulation.

Our shares are subject to the provisions of Section 15(g) and Rule 15g-9 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), commonly referred to as the “penny stock” rule. Section 15(g) sets forth certain requirements for transactions in penny stocks and Rule 15g-9(d)(1) incorporates the definition of penny stock as that used in Rule 3a51-1 of the Exchange Act. The Commission generally defines penny stock to be any equity security that has a market price less than $5.00 per share, subject to certain exceptions. Rule 3a51-1 provides that any equity security is considered to be penny stock unless that security is: registered and traded on a national securities exchange meeting specified criteria set by the Commission; authorized for quotation on the NASDAQ Stock Market; issued by a registered investment company; excluded from the definition on the basis of price (at least $5.00 per share) or the registrant’s net tangible assets; or exempted from the definition by the Commission. Since our shares are deemed to be “penny stock”, trading in the shares will be subject to additional sales practice requirements on broker/dealers who sell penny stock to persons other than established customers and accredited investors.

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

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

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

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

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

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

Risks Relating To Our Industry

We face intense competition.

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

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

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

Delays in product development schedules may adversely affect our revenues.

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

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

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

Risks Related to our Securities

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

ITEM 1B. UNRESOLVED STAFF COMMENTS

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

ITEM 2. PROPERTIES

Starting in August 2016, the Company setup a new office at 825 Main Street, Suite 100, Buda, Texas 78610. The Company still maintains a shared office with a shareholder at 1291 Galleria Drive, Suite 200, Henderson, Nevada 89014. The office is of no cost to the Company.

ITEM 3. LITIGATION

As of September 30, 2016, the Company is not involved in any material litigation.

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

ITEM 4. NOT APPLICABLE

PART II

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

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

At September 30, 2016, there were 5,268,859 shares of common stock of the Company outstanding and there were 963 shareholders of the Company’s common stock.

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

Dividends

We did not declare any dividends for the year ended September 30, 2016. Our Board of Directors does not intend to declare dividends in the near future. The declaration, payment and amount of any future dividends will be made at the discretion of the Board of Directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors as the Board of Directors considers relevant. There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend.

Transfer Agent

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

Recent sales of Unregistered Securities

Fiscal Year Ended September 30, 2016

Stock Issued for Cash

During the year ended September 30, 2016, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 513,500 shares of common stock for $946,320 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act of 1933, as amended (the “Act”), afforded by Rule 506 of Regulation D.

Stock Issued in Connection with acquisition of Software

During the year ended September 30, 2016, the Company issued 5,000 shares of common stock valued at $27,500 based on the market price on the date of grant for the acquisition of software. The software was expensed as there was not technical feasibility for use of the software.

Stock Issued for Services

During the year ended September 30, 2016, the Company issued 75,000 shares of common stock for legal services with a fair value of $210,000 and was recorded on the date of grant. The Company issued 28,000 shares of common stock to BrokerBank Securities having a market value of $56,000 as the stock portion of the fees due pursuant to the fee agreement. BrokerBank Securities is a registered broker dealer in connection with sales of securities. The Company issued 10,677 shares of common stock with a fair value of $32,138 at date of grant to Michael Salas as a quarterly bonus. The Company also issued 800 shares of common stock to Pamela Kafka to design a company logo which had a fair value of $1,600 at date of grant.

Preferred Stock

The Company has authorized 10,000,000 shares of Series A Preferred Stock, at $0.01 par value and all are issued and outstanding as of September 30, 2016. Each share of the preferred stock has 150 votes on all matters presented to be voted by the holders of our common stock. The CEO has been granted 9,000,000 shares of the preferred stock. The holders of the Preferred A shares can only convert the shares if agreed upon by 50.1% vote of all preferred shareholders.

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

Common Stock

On April 11, 2011, the Company amended its articles of incorporation to increase the authorized shares to 650,000,000 shares, at $0.01 par value. On March 23, 2015, the common stock was reverse split on a 1 for 100 basis. There were 5,268,859 shares issued and outstanding as of September 30, 2016. The holders of our common stock are entitled to receive such dividends, if any, as may be declared by our board of directors from time to time out of legally available funds. The dividend rights of our common stock are junior to any preferential dividend rights of any outstanding shares of preferred stock. The holders of our common stock also are entitled to receive distributions upon our liquidation, dissolution or winding up of our assets that are legally available for distribution, after payment of all debt and other liabilities and distribution in full of preferential amounts, if any, to be distributed to holders of our preferred stock.

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

Fiscal Year Ended September 30, 2015

During the year ended September 30, 2015, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 1,147,500 shares of common stock for $2,283,000 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act of 1933, as amended (the “Act”), afforded by Rule 506 of Regulation D.

Stock Issued in Connection with acquisition of Software Licensing

During the year ended September 30, 2015, the Company issued 50,000 shares of common stock valued at $194,500 based on the market price on the date of grant in regards to the purchase of a software license known as XPSS in accordance with the Software Licensing Agreement. Each of the two owners received 25,000 shares.

Stock Issued for Services

During the year ended September 30, 2015, the Company issued 161,654 shares of common stock as compensation, which includes a performance bonus of 2,084 shares to Dr. Carlson. The fair value of the shares was $994,665 including stock that vested immediately and a performance base grant valued at $10,733, and was recorded at the market price on the date of grant.

Stock Issued for Performance

Dr. Carlson shall be entitled to a performance bonus of 50,000 shares of Cipherloc stock to be paid at such time as the CipherLoc Polymorphic Hardware Engine can be demonstrated to function as a working, complete, product capable of being manufactured in facilities that would normally produce standard Field Programmable Gate Array chips. Management had determined that it was probable that the award will vest. Accordingly, the Company recognized 2,084 shares during 2015 and compensation expense of $10,733 during the year ended September 30, 2015. The unvested portion of the award was to be recognized over the implied service period of twenty-four months. During the year ended September 20, 2016, it was determined that technological feasibility had not yet been reached and no additional expense was recognized during the year.

Stock Issued for Services Related Party

On September 18, 2015, the Company granted 140,000 common shares to its President/CEO, Michael De La Garza. The fair value of the shares was $838,600 and was recorded at the market price on the date of grant. During the fiscal year, Mr. De La Garza was issued 6 million shares of preferred stock. These 6 million shares were valued at $9,900,000.

Warrants and Options

There are no issued and outstanding options or warrants to purchase common stock or any other security.

ITEM 6. SELECTED FINANCIAL DATA

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

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

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

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

Our Business

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

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

Critical Accounting Policies

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

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

Software Revenue Recognition

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

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

Stock issued to employees and non-employees

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

RESULTS OF OPERATIONS

Fiscal Year Ended September 30, 2016, Compared to Fiscal Year Ended September 30, 2015 (as restated)

Revenue is $341,478 for the year ended September 30, 2016; no revenues were realized in 2015. The revenues in 2016 are related a five-year license agreement for certain source code which we will support over the contract. Delivery occurred in late December 2015, so we are recording revenues over the remaining term of the agreement of 30 months from the delivery date. Cost of revenue was $90,900 for the year ended September 30, 2016. We include certain salaries of technical support staff and related costs.

General and administrative expenses decreased to $1,167,466 the year ended September 30, 2016 from $12,842,678 for the year ended September 30, 2015. The decrease in our general and administrative expenses is largely due to the $10.7 million in stock-based compensation to our Chief Executive Officer during the year ended September 30, 2015.

We incurred settlement expenses of $763,469 to settle litigation and for the termination of software licenses related to seven separate licenses in that the software usage would possibly interfere with the Company’s future software development. The software license settlements were satisfied through the issuance of 327,500 shares of common stock at fair value on date of grant, which are presented net of 20,359 shares returned in the litigation settlement.

Sales and marketing expenses were $218,722 for the year ended September 30, 2016 and $43,524 for the year ended September 30, 2015. We hired Mike Salas as VP of Sales and Marketing during the current year to lead our sales and marketing efforts. We also updated and re-launched our company website to more accurately show our enhanced business focus.

Research and development costs increased to $755,159 from $227,650 for the years ended September 30, 2016 and 2015, respectively. Our research and development costs increase is related to an increase in research and development payroll. Our research and development staff is working on the utilization of our software on multiple platforms with varying specifications.

Interest expense, net of interest income, increased to $47,117 in 2016 from $2,722 in 2015 for the years ended September 30, 2016 and 2015, respectively. Our interest expense increased as a result of interest expensed towards unpaid accrued benefits and salaries related to the former Chief Financial Officer of the Company in accordance with the employment agreement.

Net Loss

The net loss in the year ended September 30, 2016 was $2,641,743 compared to net loss during the year ended September 30, 2015 of $13,758,100. The decrease in the net loss is primarily due to a decrease in our general and administrative expenses. The net loss will continue to be reduced in that our research and developments will be less and anticipated revenues will be realized in the year ending September 30, 2017.

Liquidity and Capital Resources

We have an accumulated deficit at September 30, 2016 of ($45,780,569). We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. At September 30, 2016, the Company had cash of $344,138. We believe that our existing cash balances are insufficient to fund future operations for the next 12 months. These factors raise doubt about the Company’s ability to continue as a going concern.

We depend upon the continued participation of our active Private Placement Memorandum (PPM) to finance our operations and need to obtain additional funding sources to explore potential strategic relationships and to provide capital and other resources for the further development and marketing of our products and business. The Company has raised money in the form of a private placement memorandum total $946,320. In addition, subsequent to September 30, 2016, the Company has raised $784,520 in equity financing, net of offering costs.

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

Cash Flow

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

Operating Activities

Our cash used in operating activities was $2,567,341 and $749,050 for the years ended September 30, 2016 and 2015, respectively. The increase in cash used in operations was primarily attributable to an increase in legal costs, salaries, marketing and office costs.

Investing Activities

Our cash used in investing activities was $28,247 and $0 for the years ended September 30, 2016 and 2015. Our increase in cash used in investing activities is related to equipment, leasehold improvements, and lease deposit.

Financing Activities

Cash provided by financing activities was $946,320 and $2,229,388 for the years ended September 30, 2016 and 2015, respectively. We received cash net of offering costs from the sale of our common stock of $946,320 and $2,283,000 for the years ended September 30, 2016 and 2015, respectively. During the year ended September 30, 2015, we repaid our lines of credit of $53,612.

Off-Balance Sheet Arrangements

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 8. FINANCIAL STATEMENTS

CIPHERLOC CORPORATION

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Cipherloc Corporation

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

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

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

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As more fully explained in Note 2 to the financial statements, the Company has incurred losses and has a working capital deficit as of September 30, 2016. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with respect to these factors are also described on Note 2. The Company’s financial statements do not include any adjustments that might result from the outcome of these uncertainties should the Company be unable to continue as a going concern.

dbbmckennon

Newport Beach, California

February 2, 2017

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Cipherloc Corporation

Buda, Texas

We have audited the accompanying balance sheet of Cipherloc Corporation (the “Company”) as of September 30, 2015, and the related statements of operations, stockholders’ deficit and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2015, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has a working capital deficit and has incurred recurring losses, which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to this matter are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

CIPHERLOC CORPORATION

BALANCE SHEETS

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

CIPHERLOC CORPORATION

STATEMENTS OF OPERATIONS

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

CIPHERLOC CORPORATION

STATEMENTS OF STOCKHOLDERS’ DEFICIT

FOR THE YEARS ENDED SEPTEMBER 30, 2016 AND 2015

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

CIPHERLOC CORPORATION

STATEMENTS OF CASH FLOWS

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

CIPHERLOC CORPORATION

NOTES TO FINANCIAL STATEMENTS

FOR THE YEARS ENDED SEPTEMBER 30, 2016 AND 2015

NOTE 1- DESCRIPTION OF BUSINESS

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

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

On September 30, 2015, the Company decided to sell Cloud MD. Cloud MD was a business segment that provided cloud based medical software and services, designed for healthcare providers. The details of the sale were finalized in October 2015. By selling Cloud MD, the Company will allocate all resources towards the Cipherloc encryption development. The Cloud MD component is presented as a discontinued operation as more fully described in Note 3.

NOTE 2 - GOING CONCERN

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has incurred losses from operations, has an accumulated deficit at September 30, 2016 of ($45,780,569) and needs additional cash to maintain its operations.

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

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES

The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are as follows:

Use of Estimates and Assumptions

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

Legal

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

Consolidation of Financial Statements

The Company is presenting the years ended September 30, 2016 and 2015 without consolidation of financial activity, as there has been no activity in any subsidiaries.

Reclassifications

Certain reclassifications have been made to conform the 2015 amounts to the 2016 classifications for comparative purposes.

Cash and Cash Equivalents and Concentration of Credit Risk

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. At September 30, 2016 and 2015, cash and cash equivalents include cash on hand and cash in the bank. The Company maintains its cash in accounts held by large, globally recognized banks which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures these deposits up to $250,000. At September 30, 2016, approximately $94,138 of the Company’s cash balance was uninsured. The Company has not experienced any losses in such accounts.

Website and Software Costs

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

Fixed Assets

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

Long-Lived Assets

Long-lived assets are evaluated for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the undiscounted future cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value. The Company impaired software in the amount of $347,477 associated with discontinued operations during the year ended September 30, 2015.

Fair Value of Financial Instruments

The Company's financial instruments consisted primarily of cash, accounts payable and accrued expenses, and debt. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments.  

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

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

Customer Concentration

During the year ended September 30, 2016, one customer accounted for 100% of revenues.

Revenue Recognition

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

Deferred Revenue

Deferred revenue result from fees billed to customers for which revenue has not yet been recognized.

The Company has deferred revenue of $783,522 and $1,125,000 as of September 30, 2016 and 2015, respectively.

Research and Development and Software Development Costs

Capitalization of certain software development costs are recorded after the determination of technological feasibility. Based on our product development process, technological feasibility is determined upon the completion of a working model. To date, costs incurred by us from the completion of the working model to the point at which the product is ready for general release do not have technological feasibility. Accordingly, we have charged all such costs to research and development expense in the period incurred. Our research and development costs incurred in our continuing operations for the years ended September 30, 2016 and 2015 were $755,159 and $227,650, respectively.

Share-Based Compensation

The Company measures the cost of services provided by employees in exchange for an award of an equity instrument based on the grant-date fair value of the award. Compensation cost is recognized over the vesting or requisite service period. The Black-Scholes option-pricing model is used to estimate the fair value of options or warrants granted. Performance-based grants should be recognized prior to completion if the assessment is that it is probable that the performance condition will be met. There were no options or warrants issued by the Company during the years ended September 30, 2016 and 2015.

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

Income Taxes

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

The Company uses the two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company's tax positions and tax benefits, which may require periodic adjustments. The Company did not record any liabilities for uncertain tax positions for the years ended September 30, 2016 or 2015.

Basic and Diluted Net Loss per Common Share

Basic income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the reporting period. The weighted average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding.  Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest resulting in the issuance of common stock that could share in the earnings of the Company. As of September 30, 2016 and 2015, the Company had 10,000,000 shares of preferred stock outstanding which are convertible into 15,000,000 shares of common stock.

Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss.

Discontinued Operations

Cloud MD Sale

The Company’s Board of Directors believed that it was in the best interest of the Company to discontinue the former business operation Cloud MD. During September 2015, the Cloud MD business segment was discontinued and a plan of sale of the segment was approved. The Cloud MD sale occurred in October 2015 as a $250,000 note payable from the buyer. Accordingly, the assets, which had a net book value of zero as of September 30, 2015, qualified as held for sale and the Company has presented Cloud MD as discontinued operations. As of September 30, 2016, the Company has not received any payments towards the note payable from the buyer, and a full allowance has been recorded.

Details of the classifications for revenues, operating expenses and discontinued operations are shown below.

There were no significant assets of discontinued operations during the periods presented.

Recent Accounting Announcements

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

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

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

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

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

NOTE 4 – SOFTWARE LICENSES 

Gawk

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

GoSecured

The Company signed a license agreement with GoSecured on September 15, 2016 to provide GoSecured with a non-exclusive, non-transferable license to use multiple versions of CipherLoc encryption software. GoSecured is to pay a $10,000 license and maintenance fee, as well a royalty (three to ten percent of gross sales) for each end user agreement, dependent upon the origination of the end user agreement. To date, no amounts have been received or recorded as revenues under this contract.

NOTE 5 – RELATED PARTY TRANSACTIONS

Employment Contracts

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

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

During the years ended September 30, 2016 and 2015, cash compensation amounted to $397,854 and $684,098, including benefits, respectively. During the years ended September 30, 2016 and 2015, stock-based compensation amounted to zero and $10,738,600, respectively. As of September 30, 2015, the Chief Executive Officer was due $778,087, which is included within accrued compensation on the accompanying balance sheet. The Chief Executive Officer was prepaid $44,788 to be offset against 2017 payments. In addition, as of September 30, 2016, payroll taxes of $34,557 were included within accrued liabilities on the accompanying balance sheet. Payments made to the Chief Executive Officer were made on a gross basis with the Chief Executive Officer assuming responsibility for the remittance of the tax to the appropriate tax authorities.

Other than the employment contract with our CEO, we have employment agreements with Michael Salas and Michael Hufnagel (the “Agreements”). The Agreements are for a term of one year, with Mr. Salas’s Agreement commencing on April 25, 2016 and expiring on April 24, 2017, and Mr. Hufnagel’s commencing on June 27, 2016 and expiring on June 26, 2017. Both Agreements have three successive one year extensions. Mr. Salas has an annual salary of $175,000 and quarterly stock issuances equal to $125,000 per year. Mr. Hufnagel has an annual salary of $145,000, an initial sign-on bonus of $10,000 and quarterly stock issuances equal to $60,000 per year. As of September 30, 2016, these individuals were owed $13,333 which is included within accrued compensation on the accompanying balance sheet. As of September 30, 2016, these individuals were owed common shares for services, but for which shares have not yet been issued. An accrual has been recorded to equity totaling $41,456 to accrue the common shares earned.

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

Terminated Employment Agreement

We previously had an employment agreement with our Chief Financial Officer which terminated in 2015. There were amounts that were accrued and unpaid as of September 30, 2016 and 2015, totaling $291,715 and $253,665, respectively, According to the original agreement, the unpaid salaries were to accrue interest at 15%, which has been accrued at each reporting date. Interest expense was $38,050 and $23,915 during the years ended September 30, 2016 and 2015, respectively. Management believes that such amounts were previously satisfied though the issuance of common stock, and does not intend to pay such amounts.

NOTE 6 – COMMITMENTS AND CONTINGENCIES

Litigation

As of September 30, 2016, the Company is not involved in any material litigation.

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

Commission Agreement

The Company entered into an agreement with BrokerBank Securities, Inc. to raise up to $40 million from the issuance of common stock. In connection therewith, the Company agreed to pay a commission of 9%, payable 5% in cash and 4% in common stock. During the year ended September 30, 2016, the Company paid cash commissions of $20,680 and 28,000 shares of common stock. These amounts were netted against the proceeds received as described in Note 7 below. After September 30, 2016, the Company revised the commission to be paid to 8% in cash.

Leases

The Company leased 3,906 square feet of office space Buda, Texas. The lease for the Buda facility began on April 1, 2016 and continues until March 31, 2019. The current rental rate of $7,216 continues until March 31, 2017, and then increases to $7,379 from April 1, 2017 until March 31, 2018. On April 1, 2018, the rent goes to $7,542 and ends on March 31, 2019. The lease shall be automatically renewed for two one-year periods, $7,705 per month through March 31, 2020  and $7,867 per month until March 31, 2021 ) unless either Landlord or Customer (the Company) notifies the other in writing at least 180 days prior to the expiration of the current term.

Future annual minimum lease obligations at September 30, 2016 are as follows:

Line of Credit

The Company does not have any lines of credit. Prior to September 30, 2015, the Company had a line of credit that was unsecured and was paid in full in the amount of $53,612.

NOTE 7 - STOCKHOLDERS’ DEFICIT

Common Stock

As of September 30, 2016 and 2015, the Company had 5,268,859 and 4,356,741 outstanding, respectively, and was authorized to issue 650,000,000 common shares at a par value of $0.01. The Company issued 25,000 shares of stock for a subscription receivable for $50,000 during the year ended September 30, 2015. The subscription receivable was removed during the year ended September 30, 2016 due to non-payment.

Preferred Stock

As of September 30, 2016 and 2015, the Series A Preferred Stock is convertible into the Company’s common stock at a rate of 1 to 1.5 common shares. As of November 11, 2016, there are a total of 10,000,000 shares of the Series A Preferred Stock authorized and outstanding which are convertible into a total of 15,000,000 shares of common stock. Each share of the Preferred Stock has 150 votes on all matters presented to be voted by the holders of common stock. The holders of the Preferred A shares can only convert the shares if agreed upon by 50.1% vote of all preferred shareholders. On February 5, 2015, the Company issued 6,000,000 shares of its Series A Preferred Stock to its CEO. As of September 30, 2015, the Series A Preferred Stock is convertible into the Company’s common stock at a rate of 1 to 1.5 common shares. The Company recorded $9,900,000 as stock compensation based on the market value of the Company’s common stock on the date of grant.

Fiscal Year Ended September 30, 2016

Stock Issued for Cash

During the year ended September 30, 2016, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 513,500 shares of common stock for $946,320, net of offering costs of $80,680.

Stock Issued for Services

During the year ended September 30, 2016, the Company issued 10,677 shares of common stock valued at $32,138 and accrued earned shares of common stock amounting to $41,456 as compensation to certain officers pursuant to their employment agreements. In addition, the Company issued 800 shares for marketing services valued at $1,600, and 5,000 shares issued for software development valued at $27,500. The Company also issued 75,000 shares for legal services valued at $210,000. The shares for these issuances were valued using the closing market price of the Company's common stock on the commitment date.

Stock Issued for Settlements

The Company issued stock to terminate software licenses. The Company incurred settlement expenses of $763,469 for the termination of software licenses related to seven separate licenses in that the software usage would possibly interfere with the Company’s future software development. The settlements were satisfied through the issuance of 307,141 shares of common stock at fair value on date of grant.

Stock Issued for Subscription Receivable

The Company issued stock for an interested Private Placement Memorandum party. The individual’s payment did not clear the bank account, and, the stock was never received by the individual. The Company has not received the money and is in the process of cancelling the issued stock.

Fiscal Year Ended September 30, 2015

Stock Issued for Cash 

During the year ended September 30, 2015, through the utilization of a Private Placement Memorandum and upon receipt of executed Subscription Agreements, the Company issued 1,147,500 shares of common stock for $2,283,000 in net cash proceeds pursuant to the exemption from the registration provisions of the Securities Act of 1933, as amended (the “Act”), afforded by Rule 506 of Regulation D.

Stock Issued in Connection with acquisition of Software Licensing

During the year ended September 30, 2015, the Company issued 50,000 shares of common stock valued at $194,500 based on the market price on the date of grant in regards to the purchase of a software license known as XPSS in accordance with the Software Licensing Agreement. Each of the two owners received 25,000 shares.

Stock Issued for Services

During the year ended September 30, 2015, the Company issued 161,654 shares of common stock as compensation, which includes 2,084 shares issued for performance to Dr. Carlson. The fair value of the shares was $994,665 including stock that vested immediately and a performance base grant valued at $10,733, and was recorded at the market price on the date of grant.

Stock Issued for Performance

Dr. Carlson shall be entitled to a performance bonus of 50,000 shares of Cipherloc stock to be paid at such time as the CipherLoc Polymorphic Hardware Engine can be demonstrated to function as a working, complete, product capable of being manufactured in facilities that would normally produce standard Field Programmable Gate Array chips. Management has determined that it is probable that the award will vest. Accordingly, the Company recognized 2,084 shares during 2015 and compensation expense of $10,733 during the year ended September 30, 2015. The unvested portion of the award will be recognized over the implied service period of 24 months. During the year ended September 20, 2016, it was determined that technological feasibility had not yet been reached and no additional expense was recognized during the year.

Stock Issued for Services Related Party

On September 18, 2015, the Company granted 140,000 common shares to its President/CEO, Michael De La Garza. The fair value of the shares was $838,600 and was recorded at the market price on the date of grant. In addition, on February 5, 2015, the Company issued 6,000,000 shares of its Series A Preferred Stock to its CEO, valued at $9.9 million. The Company recorded $10.7 million as stock compensation for the combined value of all preferred and common stock, based upon the market value of the Company’s common stock on the date of grant.

NOTE 8 - INCOME TAXES

The provision (benefit) for income taxes from continued operations for the years ended September 30, 2016 and 2015 consist of the following:  

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

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