UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For Quarterly Period Ended June 30, 2018

 

or

 

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

 

For the transition period from __________ to __________

 

Commission File Number 000-54239

 

 

Digipath, Inc.

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

 

Nevada		27-3601979
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
6450 Cameron St Suite 113 Las Vegas, NV		89118
(Address of principal executive offices)		(zip code)

 

(702) 527-2060

(Registrant’s telephone number, including area code)

 

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 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, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

 

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

Yes

[  ]

No

[X]

 

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

 

The number of shares of registrant’s common stock outstanding as of August 13, 2018 was 41,564,235.

 

 

 

TABLE OF CONTENTS

 

			Page
			No.
PART I - FINANCIAL INFORMATION
ITEM 1.		FINANCIAL STATEMENTS (Unaudited)	3
		Condensed Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and September 30, 2017	3
		Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Nine Months Ended June 30, 2018 and 2017 (Unaudited)	4
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2018 and 2017 (Unaudited)	5
		Notes to the Condensed Consolidated Financial Statements (Unaudited)	6
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	15
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	20
ITEM 4.		CONTROLS AND PROCEDURES	21
PART II - OTHER INFORMATION
ITEM 1.		Legal Proceedings	22
ITEM 1A.		RISK FACTORS	22
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	22
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES	22
ITEM 4.		MINE SAFETY DISCLOSURES	22
ITEM 5.		OTHER INFORMATION	22
ITEM 6.		EXHIBITS	23
		SIGNATURES	24

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		June 30,				September 30,
		2018				2017
		(Unaudited)
Assets
Current assets:
Cash		$	40,070			$	178,177
Accounts receivable			200,867				266,613
Prepaid expenses			67,732				73,750
Deposits			25,647				25,647
Total current assets			334,316				544,187
Fixed assets, net			1,007,832				1,027,049
Total Assets		$	1,342,148			$	1,571,236
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	196,234			$	121,994
Accrued expenses			30,894				42,004
Deferred revenues			2,775				—
Total current liabilities			229,903				163,998
Total Liabilities			229,903				163,998
Stockholders’ Equity:
Series A convertible preferred stock, $0.001 par value, 10,000,000 shares authorized; 1,425,942 and 1,897,942 shares issued and outstanding at June 30, 2018 and September 30, 2017, respectively			1,426				1,898
Common stock, $0.001 par value, 90,000,000 shares authorized; 40,897,568 and 35,027,118 shares issued and outstanding at June 30, 2018 and September 30, 2017, respectively			40,898				35,027
Additional paid-in capital			13,946,080				12,866,984
Accumulated (deficit)			(12,876,159	)			(11,496,671	)
Total Stockholders’ Equity			1,112,245				1,407,238
Total Liabilities and Stockholders’ Equity		$	1,342,148			$	1,571,236

 

See accompanying notes to financial statements.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

 

		For the Three Months Ended								For the Nine Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
Revenues		$	521,772			$	389,315			$	2,223,630			$	1,296,115
Cost of sales			520,888				215,729				1,563,518				640,871
Gross profit			884				173,586				660,112				655,244
Operating expenses:
General and administrative			360,689				300,924				1,108,202				907,994
Professional fees			228,482				279,843				964,269				745,437
Bad debts expense (recoveries)			(45,200	)			4,396				53,041				23,150
Total operating expenses			543,971				585,163				2,125,512				1,676,581
Operating loss			(543,087	)			(411,577	)			(1,465,400	)			(1,021,337	)
Other income:
Other income			43,012				3,000				85,912				263,000
Total other income			43,012				3,000				85,912				263,000
Net loss		$	(500,075	)		$	(408,577	)		$	(1,379,488	)		$	(758,337	)
Other comprehensive loss
Available-for-sale investments:
Change in net unrealized loss (net of tax effect)			-				(9,080	)			-				(2,560	)
Comprehensive loss		$	(500,075	)		$	(417,657	)		$	(1,379,488	)		$	(760,897	)
Weighted average number of common shares outstanding - basic and fully diluted			40,374,897				31,542,189				38,237,869				27,849,386
Net loss per share - basic and fully diluted		$	(0.01	)		$	(0.01	)		$	(0.04	)		$	(0.03	)

 

See accompanying notes to financial statements.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		For the Nine Months Ended
		June 30,
		2018				2017
Cash flows from operating activities
Net loss		$	(1,379,488	)		$	(758,337	)
Adjustments to reconcile net loss to net cash used in operating activities:
Bad debts expense			53,041				30,650
Depreciation and amortization expense			213,225				186,922
Stock issued for services			377,204				224,294
Options and warrants granted for services			438,683				299,760
Decrease (increase) in assets:
Accounts receivable			12,705				(96,429	)
Prepaid expenses			6,018				(48,404	)
Deposits			-				14,203
Increase (decrease) in liabilities:
Accounts payable			74,240				(3,239	)
Accrued expenses			(11,110	)			(33,953	)
Deferred revenues			2,775				-
Net cash used in operating activities			(212,707	)			(184,533	)
Cash flows from investing activities
Purchase of fixed assets			(194,008	)			(136,894	)
Net cash used in investing activities			(194,008	)			(136,894	)
Cash flows from financing activities
Proceeds from sale of common stock			268,608				300,000
Net cash provided by financing activities			268,608				300,000
Net decrease in cash			(138,107	)			(21,427	)
Cash - beginning			178,177				135,390
Cash - ending		$	40,070			$	113,963
Supplemental disclosures:
Interest paid		$	-			$	-
Income taxes paid		$	-			$	-
Non-cash investing and financing activities:
Net change in unrealized gain (loss) on available-for-sale securities		$	-			$	(2,560	)
Value of preferred stock converted to common stock		$	472,000			$	1,372,500

 

See accompanying notes to financial statements.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

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

 

Organization

 

Digipath, Inc. was incorporated in Nevada on October 5, 2010. Digipath, Inc. and its subsidiaries (“Digipath,” the “Company,” “we,” “our” or “us”) supports the cannabis industry’s best practices for reliable testing, cannabis education and training, and brings unbiased cannabis news coverage to the cannabis industry. Our business units are described below.

 

		Digipath Labs, Inc. Digipath Labs’ mission is to provide pharmaceutical-grade analysis and testing to the cannabis industry to ensure consumers and patients know exactly what is in the cannabis they ingest and to help maximize the quality of our clients’ products through research, development, and standardization. We have been operating a cannabis testing lab in Nevada since 2015 and have plans to open labs in other states that have legalized the sale of cannabis, beginning with California.
		The National Marijuana News Corp. provides a balanced and unbiased approach to cannabis news, interviews and education with a news/talk radio show, app, national marijuana news website and social media presence focusing on the political, economic, medicinal, scientific, and cultural dimensions of the rapidly evolving—and profoundly controversial—medicinal and recreational marijuana industry.

 

Basis of Presentation

 

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

 

The unaudited condensed consolidated financial statements of the Company and the accompanying notes included in this Quarterly Report on Form 10-Q are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the Condensed Consolidated Financial Statements have been included. Such adjustments are of a normal, recurring nature. The Condensed Consolidated Financial Statements, and the accompanying notes, are prepared in accordance with GAAP and do not contain certain information included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2017. The interim Condensed Consolidated Financial Statements should be read in conjunction with that Annual Report on Form 10-K. Results for the interim periods presented are not necessarily indicative of the results that might be expected for the entire fiscal year.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of the following entities, all of which were under common control and ownership at June 30, 2018:

 

		State of
Name of Entity(1)		Incorporation		Relationship
Digipath, Inc.(2)		Nevada		Parent
Digipath Labs, Inc.		Nevada		Subsidiary
TNM News, Inc.		Nevada		Subsidiary
GroSciences, Inc.(3)		Colorado		Subsidiary

 

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

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

⁽³⁾ Entity formed for prospective purposes, but has not incurred any income or expenses to date.

 

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

 

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

 

Reclassifications

 

Prior period interest income in the amount of $7,500 has been reclassified to net against the related $7,500 of bad debt expense to conform to the current period presentation. These reclassifications had no impact on net earnings, financial position or cash flows.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Segment Reporting

 

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

 

Fair Value of Financial Instruments

 

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

 

Revenue Recognition

 

Effective January 1, 2018, the Company adopted ASC 606 — Revenue from Contracts with Customers. Under ASC 606, the Company recognizes revenue from the commercial sales of products, licensing agreements and contracts to perform pilot studies by applying the following steps: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied. For the comparative periods, revenue has not been adjusted and continues to be reported under ASC 605 — Revenue Recognition. Under ASC 605, revenue is recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the performance of service has been rendered to a customer or delivery has occurred; (3) the amount of fee to be paid by a customer is fixed and determinable; and (4) the collectability of the fee is reasonably assured.

 

There was no impact on the Company’s financial statements as a result of adopting ASC 606 for the nine months ended June 30, 2018 and 2017, or the twelve months ended September 30, 2017.

 

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

 

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

 

Stock-Based Compensation

 

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

 

Recent Accounting Pronouncements

 

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost (that is, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). The new guidance is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendment provides guidance on accounting for the impact of the Tax Cuts and Jobs Act (the “Tax Act”) and allows entities to complete the accounting under ASC 740 within a one-year measurement period from the Tax Act enactment date. This standard is effective upon issuance. The Tax Act has several significant changes that impact all taxpayers, including a transition tax, which is a one-time tax charge on accumulated, undistributed foreign earnings. The calculation of accumulated foreign earnings requires an analysis of each foreign entity’s financial results going back to 1986. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.

 

In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The guidance permits entities to reclassify tax effects stranded in Accumulated Other Comprehensive Income as a result of tax reform to retained earnings. This new guidance is effective for annual and interim periods in fiscal years beginning after December 15, 2018. Early adoption is permitted in annual and interim periods and can be applied retrospectively or in the period of adoption. The Company is currently in the process of evaluating the impact of adoption on its consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies when a change to the terms or conditions of a share-based payment award must be accounted for as a modification. The new guidance requires modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award. The new guidance is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. Since ASU 2014-09 was issued, several additional ASUs have been issued to clarify various elements of the guidance. These standards provide guidance on recognizing revenue, including a five-step model to determine when revenue recognition is appropriate. The standard requires that an entity recognize revenue to depict the transfer of control of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted the new standard to be effective with our first interim reporting period for the three months ended December 31, 2017. We use the modified retrospective method of adoption. We have completed an initial evaluation of the potential impact from adopting the new standard, including a detailed review of performance obligations for all material revenue streams. Based on this initial evaluation, adoption does not have a material impact on our financial position, results of operations, or cash flows. Related disclosures have been expanded in line with the requirements of the standard.

 

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

 

Note 2 – Going Concern

 

As shown in the accompanying condensed consolidated financial statements, the Company has incurred recurring losses from operations resulting in an accumulated deficit of ($12,876,159), and as of June 30, 2018, the Company’s cash on hand may not be sufficient to sustain operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management is actively pursuing new customers to increase revenues. In addition, the Company is currently seeking additional sources of capital to fund short term operations. Management believes these factors will contribute toward achieving profitability. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

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

 

Note 3 – Related Party Transactions

 

Stock Based Compensation for Services

 

On June 25, 2018, the Company issued 118,421 shares of common stock to its then CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $22,500 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

On June 25, 2018, the Company issued 31,579 shares of common stock to its then President and COO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $6,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On June 25, 2018, the Company issued 78,947 shares of common stock to its CFO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $15,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On March 26, 2018, the Company issued 207,852 shares of common stock to its then CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $45,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On March 26, 2018, the Company issued 55,427 shares of common stock to its then President and COO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $12,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On March 26, 2018, the Company issued 138,568 shares of common stock to its CFO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $30,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On December 22, 2017, the Company issued 300,000 shares of common stock to its CFO as a bonus for services rendered. The aggregate fair value of the common stock was $78,828 based on the closing price of the Company’s common stock on the date of grant, and was expensed in full.

 

On December 22, 2017, the Company issued 100,000 shares of common stock to Dr. Alfredo Axtmayer for his service on our Board of Directors. The aggregate fair value of the common stock was $26,276 based on the closing price of the Company’s common stock on the date of grant, and was expensed in full.

 

On December 22, 2017, we granted fully vested options to purchase 500,000 shares of common stock as compensation for services to our President and COO. The options are exercisable over a ten year period at an exercise price of $0.27 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 112% and a call option value of $0.2094, was $104,698. The options were expensed over the vesting period, resulting in $104,698 of stock based compensation expense during the nine months ended June 30, 2018.

 

Note 4 – Fair Value of Financial Instruments

 

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

 

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

 

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

 

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

 

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

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following schedule summarizes the valuation of financial instruments at fair value on a recurring basis in the balance sheets as of June 30, 2018 and September 30, 2017, respectively:

 

		Fair Value Measurements at June 30, 2018
		Level 1				Level 2				Level 3
Assets
Cash		$	40,070			$	-			$	-
Total assets			40,070				-				-
Liabilities
Total liabilities			-				-				-
		$	40,070			$	-			$	-

 

		Fair Value Measurements at September 30, 2017
		Level 1				Level 2				Level 3
Assets
Cash		$	178,177			$	-			$	-
Total assets			178,177				-				-
Liabilities
Total liabilities			-				-				-
		$	178,177			$	-			$	-

 

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

 

There were no transfers of financial assets or liabilities between Level 1, Level 2 and Level 3 inputs for the nine months ended June 30, 2018 or the year ended September 30, 2017.

 

Note 5 – Accounts Receivable

 

Accounts receivable was $200,867 and $266,613 at June 30, 2018 and September 30, 2017, respectively, net of allowance for doubtful accounts of $85,221 and $32,180 at June 30, 2018 and September 30, 2017, respectively.

 

Note 6 – Fixed Assets

 

Fixed assets consist of the following at June 30, 2018 and September 30, 2017:

 

		June 30,				September 30,
		2018				2017
Software		$	123,492			$	121,617
Office equipment			52,520				36,080
Furniture and fixtures			28,486				14,285
Lab equipment			1,099,942				938,450
Leasehold improvements			489,147				489,147
			1,793,587				1,599,579
Less: accumulated depreciation			(785,755	)			(572,530	)
Total		$	1,007,832			$	1,027,049

 

Depreciation and amortization expense totaled $213,225 and $186,922 for the nine months ended June 30, 2018 and 2017, respectively.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 7 - Changes in Stockholders’ Equity

 

Convertible Preferred Stock

 

The Company is authorized to issue 10,000,000 shares of preferred stock with a par value of $0.001 per share, of which 6,000,000 have been designated as Series A Convertible Preferred Stock (“Series A Preferred”), with the remaining 4,000,000 shares available for designation from time to time by the Board as set forth below. As of June 30, 2018, there were 1,425,942 shares of Series A Preferred issued and outstanding. The Board of Directors is authorized to determine any number of series into which the undesignated shares of preferred stock may be divided and to determine the rights, preferences, privileges and restrictions granted to any series of the preferred stock. Shares of Series A Preferred are convertible into common stock at a fixed conversion rate of $0.20 per share.

 

The conversion price is adjustable in the event of stock splits and other adjustments in the Company’s capitalization, and in the event of certain negative actions undertaken by the Company. At the current conversion price, the 1,425,942 shares of Series A Preferred outstanding at June 30, 2018 are convertible into 7,129,710 shares of the common stock of the Company. No holder is permitted to convert its shares of Series A Preferred if such conversion would cause the holder to beneficially own more than 4.99% of the issued and outstanding common stock of the Company immediately after such conversion, unless waived by such holder by providing at least sixty-five days’ notice.

 

Preferred Stock Conversions

 

During the three months ended March 31, 2018, a total of 322,000 Series A Preferred shares were converted into 1,610,000 shares of common stock. The stock was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

During the three months ended December 31, 2017, a total of 150,000 Series A Preferred shares were converted into 750,000 shares of common stock. The stock was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Common Stock

 

Common stock consists of $0.001 par value, 90,000,000 shares authorized, of which 40,897,568 shares were issued and outstanding as of June 30, 2018.

 

Common Stock Sales

 

On April 13, 2018, the Company sold 14 units, consisting of an aggregate of 140,000 shares of its common stock and warrants to purchase 70,000 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $25,200. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

On April 12, 2018, the Company sold 28 units, consisting of an aggregate of 280,000 shares of its common stock and warrants to purchase 140,000 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $50,400. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

On April 10, 2018, the Company sold 27.78 units, consisting of an aggregate of 277,778 shares of its common stock and warrants to purchase 138,889 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $50,000. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

On December 20, 2017, the Company sold 10 units, consisting of an aggregate of 100,000 shares of its common stock and warrants to purchase 50,000 shares of common stock, exercisable at $0.26 per share over a thirty six month period, in exchange for total proceeds of $18,000. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

On December 14, 2017, the Company sold 13.89 units, consisting of an aggregate of 138,889 shares of its common stock and warrants to purchase 69,445 shares of common stock, exercisable at $0.26 per share over a thirty six month period, in exchange for total proceeds of $25,000. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

On December 14, 2017, the Company sold 55.56 units, consisting of an aggregate of 555,600 shares of its common stock and warrants to purchase 277,800 shares of common stock, exercisable at $0.26 per share over a thirty six month period, in exchange for total proceeds of $100,008. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Exercise of Options

 

On January 3, 2018, two option holders exercised options to purchase a total of 500,000 shares of common stock at $0.181 per share on a cashless basis, resulting in the issuance of 317,172 shares of common stock.

 

On January 2, 2018, an option holder exercised options to purchase 37,500 shares of common stock at $0.22 per share on a cashless basis, resulting in the issuance of 21,000 shares of common stock.

 

Exercise of Warrants

 

On January 3, 2018, a warrant holder exercised warrants to purchase 71,428 shares of common stock at $0.26 per share on a cashless basis, resulting in the issuance of 34,285 shares of common stock.

 

Common Stock Issued for Services

 

On June 25, 2018, the Company issued 118,421 shares of common stock to its then CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $22,500 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On June 25, 2018, the Company issued 31,579 shares of common stock to its then President and COO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $6,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On June 25, 2018, the Company issued 78,947 shares of common stock to its CFO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $15,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On June 25, 2018, the Company issued 131,579 shares of common stock to a consultant for business development services. The fair value of the common stock was $25,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On June 25, 2018, the Company issued 100,000 shares of common stock to another consultant for business development services. The fair value of the common stock was $19,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on June 30, 2018.

 

On March 26, 2018, the Company issued 207,852 shares of common stock to its then CEO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $45,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on March 31, 2018.

 

On March 26, 2018, the Company issued 55,427 shares of common stock to its then President and COO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $12,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on March 31, 2018.

 

On March 26, 2018, the Company issued 138,568 shares of common stock to its CFO for services rendered pursuant to his employment agreement. The aggregate fair value of the common stock was $30,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on March 31, 2018.

 

On March 26, 2018, the Company issued 69,284 shares of common stock to a consultant for business development services. The fair value of the common stock was $15,000 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on March 31, 2018.

 

On December 22, 2017, the Company issued 300,000 shares of common stock to its CFO as a bonus for services rendered. The aggregate fair value of the common stock was $78,828 based on the closing price of the Company’s common stock on the date of grant, and was expensed in full.

 

On December 22, 2017, the Company issued 100,000 shares of common stock to Dr. Alfredo Axtmayer for his service on our Board of Directors. The aggregate fair value of the common stock was $26,276 based on the closing price of the Company’s common stock on the date of grant, and was expensed in full.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

On November 29, 2017, a total of 314,069 shares of common stock were issued to three consultants that were engaged to assist the Company with acquisition activities. The aggregate fair value of the common stock was $82,600 based on the closing price of the Company’s common stock on the date of grant, and was expensed over the requisite service period that ended on December 31, 2017.

 

Amortization of Stock Options

 

A total of $438,683 of stock-based compensation expense was recognized from the amortization of options over their vesting period during the nine months ended June 30, 2018.

 

Note 8 – Common Stock Options

 

Stock Incentive Plan

 

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

 

A total of 8,352,500 options were outstanding as of June 30, 2018. During the three months ended June 30, 2018, options to purchase an aggregate total of 40,000 shares of common stock at a weighted average exercise price of $0.27 per share expired, during the three months ended March 31, 2018, options to purchase an aggregate total of 55,000 shares of common stock at a weighted average exercise price of $0.24 per share expired, and during the three months ended December 31, 2017, options to purchase an aggregate total of 1,110,000 shares of common stock at a weighted average exercise price of $0.40 per share also expired.

 

On January 3, 2018, two option holders exercised options to purchase a total of 500,000 shares of common stock at $0.181 per share on a cashless basis, resulting in the issuance of 317,172 shares of common stock.

 

On January 2, 2018, an option holder exercised options to purchase 37,500 shares of common stock at $0.22 per share on a cashless basis, resulting in the issuance of 21,000 shares of common stock.

 

On December 22, 2017, we granted fully vested options to purchase 500,000 shares of common stock as compensation for services to our then President and COO. The options are exercisable over a ten year period at an exercise price of $0.27 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 112% and a call option value of $0.2094, was $104,698. The options were expensed over the vesting period, resulting in $104,698 of stock based compensation expense during the nine months ended June 30, 2018.

 

On November 29, 2017, we granted fully vested options to purchase 100,000 shares of common stock as compensation for services to our Chief Scientist. The options are exercisable over a ten year period at an exercise price of $0.27 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 112% and a call option value of $0.21, was $21,004. The options were expensed over the vesting period, resulting in $21,004 of stock based compensation expense during the nine months ended June 30, 2018.

 

On November 29, 2017, we granted fully vested options to purchase an aggregate of 205,000 shares of common stock as compensation for services to a total of ten of our employees. The options are exercisable over a ten year period at an exercise price of $0.27 per share. The estimated value using the Black-Scholes Pricing Model, based on a volatility rate of 112% and a call option value of $0.21, was $43,057. The options were expensed over the vesting period, resulting in $43,057 of stock based compensation expense during the nine months ended June 30, 2018.

 

Note 9 – Common Stock Warrants

 

Warrants to purchase a total of 6,117,128 shares of common stock were outstanding as of June 30, 2018. On January 3, 2018, a warrant holder exercised warrants to purchase 71,428 shares of common stock at $0.26 per share on a cashless basis, resulting in the issuance of 34,285 shares of common stock.

 

On December 31, 2017, warrants to purchase 200,000 shares of common stock at $0.30 per share expired, and on December 30, 2017, warrants to purchase another 300,000 shares of common stock at $0.45 per share also expired.

 

 

DIGIPATH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Warrants to purchase an aggregate 348,889 shares of common stock at $0.30 per share over a 36 month period were issued at various dates in April of 2018 pursuant to unit offerings for the sale of an aggregate of 697,778 shares of common stock in exchange for total proceeds of $125,600.

 

Warrants to purchase 50,000 shares of common stock at $0.26 per share over a 36 month period were issued on December 20, 2017 pursuant to a unit offering for the sale of 100,000 shares of common stock in exchange for proceeds of $18,000, and warrants to purchase a total of 347,245 shares of common stock at $0.26 per share over a 36 month period were issued on December 14, 2017 pursuant to two unit offerings for the sale of an aggregate 694,489 shares of common stock in exchange for total proceeds of $125,008.

 

Note 10 – Other Income

 

Other income for the nine months ended June 30, 2018 and 2017 consisted of the following:

 

		June 30,
		2018				2017
Settlement income on license agreement		$	-			$	250,000
Rental income on subleases			57,600				3,000
Restitution income			28,312				10,000
		$	85,912			$	263,000

 

Note 11 - Income Tax

 

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

 

For the nine months ended June 30, 2018 and the year ended September 30, 2017, the Company incurred a net operating loss and, accordingly, no provision for income taxes has been recorded. In addition, no benefit for income taxes has been recorded due to the uncertainty of the realization of any tax assets. At June 30, 2018, the Company had approximately $7,787,000 of federal net operating losses. The net operating loss carry forwards, if not utilized, will begin to expire in 2031.

 

Based on the available objective evidence, including the Company’s history of its loss, management believes it is more likely than not that the net deferred tax assets will not be fully realizable. Accordingly, the Company provided for a full valuation allowance against its net deferred tax assets at June 30, 2018 and September 30, 2017, respectively.

 

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

 

Note 12 – Subsequent Events

 

Common Stock Sales

 

On July 11, 2018, the Company sold 66.67 units, consisting of 666,667 shares of its common stock and warrants to purchase 333,334 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $100,000. The proceeds received were allocated between the common stock and warrants on a relative fair value basis.

 

 

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

 

The information contained in this Form 10-Q is intended to update the information contained in our Annual Report on Form 10-K for the year ended September 30, 2017 and presumes that readers have access to, and will have read, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other information contained in such Form 10-K. The following discussion and analysis also should be read together with our financial statements and the notes to the financial statements included elsewhere in this Form 10-Q.

 

The following discussion contains certain statements that may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements appear in a number of places in this Report, including, without limitation, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements are not guarantees of future performance and involve risks, uncertainties and requirements that are difficult to predict or are beyond our control. Forward-looking statements speak only as of the date of this quarterly report. You should not put undue reliance on any forward-looking statements. We strongly encourage investors to carefully read the factors described in our Annual Report on Form 10-K for the year ended September 30, 2017 in the section entitled “Risk Factors” for a description of certain risks that could, among other things, cause actual results to differ from these forward-looking statements. We assume no responsibility to update the forward-looking statements contained in this quarterly report on Form 10-Q. The following should also be read in conjunction with the unaudited Financial Statements and notes thereto that appear elsewhere in this report.

 

Overview

 

Digipath, Inc. was incorporated in Nevada on October 5, 2010. Digipath, Inc. and its subsidiaries (“Digipath,” the “Company,” “we,” “our” or “us”) supports the cannabis industry’s best practices for reliable testing, cannabis education and training, and brings unbiased cannabis news coverage to the cannabis industry. Our business units as of June 30, 2018 are described below.

 

		Digipath Labs, Inc. Digipath Labs’ mission is to provide pharmaceutical-grade analysis and testing to the cannabis industry to ensure consumers and patients know exactly what is in the cannabis they ingest and to help maximize the quality of our clients’ products through research, development, and standardization. We have been operating a cannabis testing lab in Nevada since 2015 and have plans to open labs in other states that have legalized the sale of cannabis, beginning with California.
		The National Marijuana News Corp. provides a balanced and unbiased approach to cannabis news, interviews and education with a news/talk radio show, app, national marijuana news website and social media presence focusing on the political, economic, medicinal, scientific, and cultural dimensions of the rapidly evolving—and profoundly controversial—medicinal and recreational marijuana industry.

 

Our cannabis testing and business licenses were briefly suspended by Nevada regulators for an eight business day period subsequent to the end of the quarter ended December 31, 2017, commencing at the end of business on Friday, January 19, 2018, and were reinstated on January 31, 2018. This significantly affected our financial results for the second and third fiscal quarter due to the lack of revenue for the eight day period, followed by the need to outsource our pesticide analyses to another lab while we re-validated our testing method. In response to the temporary suspension, we accelerated the implementation of ISO 17025:2017 standards and increased our staffing to better support an ISO-accredited laboratory and be able to service the level of demand we experienced during the first fiscal quarter. At the end of June 2018, our pesticide methods were certified by the State of Nevada, which enabled us to end our outsourcing of pesticide testing. We believe that we are now well positioned to handle future growth in full compliance with Nevada’s regulations applicable to our operations and get back to operating at a gross margin consistent with other analytical testing labs in the industry.

 

On July 3, 2018, following the untimely passing of Joseph Bianco, who had served as our Chief Executive Officer, our Board appointed Todd Denkin as Chief Executive Officer and Chairman of the Board, succeeding Mr. Bianco. At the time of such appointment, Mr. Denkin was serving as the Company’s President and Chief Operating Officer, and as the President of the Company’s wholly-owned subsidiaries, Digipath Labs, Inc. and TNM News Corp., and he will continue to serve in such capacities.

 

 

Results of Operations for the Three Months Ended June 30, 2018 and 2017:

 

The following table summarizes selected items from the statement of operations for the three months ended June 30, 2018 and 2017.

 

		Three Months Ended June 30,								Increase /
		2018				2017				(Decrease)
Revenues		$	521,772			$	389,315			$	132,457
Cost of sales			520,888				215,729				305,159
Gross profit			884				173,586				(172,702	)
Operating expenses:
General and administrative			360,689				300,924				59,765
Professional fees			228,482				279,843				(51,361	)
Bad debts expense (recoveries)			(45,200	)			4,396				(49,596	)
Total operating expenses:			543,971				585,163				(41,192	)
Operating loss			(543,087	)			(411,577	)			131,510
Total other income			43,012				3,000				40,012
Net loss		$	(500,075	)		$	(408,577	)		$	91,498

 

Revenues

 

Revenues were generated by our cannabis testing lab and to a de minimis extent, from advertising on TNM News’ media outlets. Aggregate revenues for the three months ended June 30, 2018 were $521,772, compared to revenues of $389,315 during the three months ended June 30, 2017, an increase of $132,457, or 34%. The increase in revenue was due to the continued growth of our testing lab operations in Nevada as our customer base, consisting of production and cultivation facilities, increased their operations, particularly following the implementation of the Nevada law permitting the recreational use of marijuana, which went into effect on July 1, 2017.

 

Cost of Sales

 

Cost of sales for the three months ended June 30, 2018 were $520,888, compared to $215,729 during the three months ended June 30, 2017, an increase of $305,159, or 141%. Cost of sales consists primarily of labor, depreciation, maintenance on lab equipment, and supplies consumed in our testing operations. The increased cost of sales in the current period was primarily due to the cost of outsourcing our pesticide analysis, and increased labor and supplies as we revamped our operations to comply with regulators’ requirements and gear up for increased demand. During the three months ended June 30, 2018, we continued to implement ISO/IEC 17025 standards for the competence of testing and calibration laboratories, and outsourced our pesticide testing to a third party while we repaired and upgraded instrumentation and developed State approved assays. At the end of June, our pesticide methods were certified by the State of Nevada and were able to resume our own pesticide testing, which is expected to significantly reduce our cost of sales in future periods. Our gross margins of approximately 0%, decreased during the three months ended June 30, 2018, compared to gross margins of approximately 45% during the three months ended June 30, 2017, as we devoted significant resources to the improvement of operations in response to the temporary suspension of our Nevada licenses. We expect cost of sales to decrease and gross margins to increase as we continue to grow, and for gross margins to be in the neighborhood of 50% as we now perform our own pesticide tests.

 

General and Administrative Expenses

 

General and administrative expenses for the three months ended June 30, 2018 were $360,689, compared to $300,924 during the three months ended June 30, 2017, an increase of $59,765, or 20%. The expenses consisted primarily of marketing, rent, salaries and wages, and travel expenses.

 

Professional Fees

 

Professional fees for the three months ended June 30, 2018 were $228,482, compared to $279,843 during the three months ended June 30, 2017, a decrease of $51,361, or 18%. Professional fees included non-cash, stock-based compensation of $177,472 and $201,185 during the three months ended June 30, 2018 and June 30, 2017, respectively, including the amortization of $89,972 and $99,920, respectively, of stock options expense that is now fully amortized. Professional fees decreased primarily due to decreased legal and consulting fees during the current period.

 

 

Bad Debts Expense (Recoveries)

 

Bad debts expense (recoveries) for the three months ended June 30, 2018 was $(45,200), compared to $4,396 during the three months ended June 30, 2017, a net decrease of $49,596. Bad debts expense (recoveries) decreased during the current period as our allowance for doubtful accounts decreased with greater resources devoted to collection efforts during the quarter. Our bad debts allowance was 8.7% and 1.1% of sales for the three months ended June 30, 2018 and 2017, respectively.

 

Operating Loss

 

Our operating loss for the three months ended June 30, 2018 was $543,087 compared to $411,577 during the three months ended June 30, 2017, an increase of $131,510, or 32%. Our operating loss increased primarily due to the costs of outsourced pesticide analysis, offset in part by our increased revenues during the three months ended June 30, 2018, compared to the three months ended June 30, 2017.

 

Other Income

 

Other income for the three months ended June 30, 2018 was $43,012, compared to other income of $3,000 during the three months ended June 30, 2017, an increase of $40,012. Other income consisted of $19,200 of subleased storage space and $23,812 related to restitution payments received from a former employee for the three months ended June 30, 2018. Other income during the three months ended June 30, 2017 consisted of $1,500 of subleased storage space and $1,500 of restitution payments received from a former employee.

 

Net Loss

 

Net loss for the three months ended June 30, 2018 was $500,075, compared to $408,577 during the three months ended June 30, 2017, an increase of $91,498, or 22%. The increased net loss was due primarily to increased staffing and outsourced pesticide testing costs over the comparative three month period, as we revamped operations to better position ourselves for anticipated increased demand in the recreational cannabis market and addressed the temporary suspension of our Nevada licenses.

 

Results of Operations for the Nine Months Ended June 30, 2018 and 2017:

 

The following table summarizes selected items from the statement of operations for the nine months ended June 30, 2018 and 2017.

 

		Nine Months Ended June 30,								Increase /
		2018				2017				(Decrease)
Revenues		$	2,223,630			$	1,296,115			$	927,515
Cost of sales			1,563,518				640,871				922,647
Gross profit			660,112				655,244				4,868
Operating expenses:
General and administrative			1,108,202				907,994				200,208
Professional fees			964,269				745,437				218,832
Bad debts expense			53,041				23,150				29,891
Total operating expenses:			2,125,512				1,676,581				448,931
Operating loss			(1,465,400	)			(1,021,337	)			444,063
Total other income			85,912				263,000				(177,088	)
Net loss		$	(1,379,488	)		$	(758,337	)		$	621,151

 

 

Revenues

 

Revenues were generated by our cannabis testing lab and to a de minimis extent, from advertising on TNM News’ media outlets. Aggregate revenues for the nine months ended June 30, 2018 were $2,223,630, compared to revenues of $1,296,115 during the nine months ended June 30, 2017, an increase of $927,515, or 72%. The increase in revenue was due to the continued growth of our testing lab operations in Nevada as our customer base, consisting of production and cultivation facilities, increased their operations, particularly following the implementation of the Nevada law permitting the recreational use of marijuana, which went into effect on July 1, 2017. This was bolstered during the first fiscal quarter of the current period due to the suspensions that were served by Nevada regulators on two of our competitors, as offset in part by our own suspension during the second fiscal quarter of the current period. We believe that these regulatory disruptions are reflective of the early stages of our nascent industry and are not indicative of ordinary operating conditions in Nevada.

 

Cost of Sales

 

Cost of sales for the nine months ended June 30, 2018 were $1,563,518, compared to $640,871 during the nine months ended June 30, 2017, an increase of $922,647, or 144%. Cost of sales consists primarily of labor, depreciation, maintenance on lab equipment, and supplies consumed in our testing operations. The increased cost of sales in the current period was primarily due to the cost of outsourcing our pesticide analysis, and increased labor and supplies as we revamped our operations to comply with regulators’ requirements and gear up for increased demand. During the nine months ended June 30, 2018, we began to implement ISO/IEC 17025 standards for the competence of testing and calibration laboratories, and outsourced our pesticide testing to a third party while we repaired and upgraded instrumentation and developed State approved assays. At the end of June, our pesticide were methods certified by the State of Nevada and were able to resume our own pesticide testing, which is expected to significantly reduce our cost of sales in future periods. Our gross margins of approximately 30%, decreased during the nine months ended June 30, 2018, compared to gross margins of approximately 51% during the nine months ended June 30, 2017. We anticipate our gross margins to be in the neighborhood of 50% as we now perform our own pesticide tests.

 

General and Administrative Expenses

 

General and administrative expenses for the nine months ended June 30, 2018 were $1,108,202, compared to $907,994 during the nine months ended June 30, 2017, an increase of $200,208, or 22%. The expenses consisted primarily of marketing, rent, salaries and wages, and travel expenses.

 

Professional Fees

 

Professional fees for the nine months ended June 30, 2018 were $964,269, compared to $745,437 during the nine months ended June 30, 2017, an increase of $218,832, or 29%. Professional fees included non-cash, stock-based compensation of $815,887 and $524,054 during the three months ended June 30, 2018 and June 30, 2017, respectively, including the amortization of $438,683 and $299,760, respectively, of stock options expense that is now fully amortized. Professional fees increased primarily due to increased stock-based compensation paid to employees and consultants during the current period.

 

Bad Debts Expense

 

Bad debts expense for the nine months ended June 30, 2018 was $53,041, compared to $23,150 during the nine months ended June 30, 2017, an increase of $29,891, or 129%. Bad debts expense increased during the current period as our allowance for doubtful accounts increased with the growth in sales and disruption of operations during the year. Our bad debts allowance was 2.4% and 1.8% of sales for the nine months ended June 30, 2018 and 2017, respectively.

 

Operating Loss

 

Our operating loss for the nine months ended June 30, 2018 was $1,465,400 compared to $1,021,337 during the nine months ended June 30, 2017, an increase of $444,063, or 43%. Our operating loss increased primarily due to increased cost of sales as we reworked our lab processes, in addition to increased stock-based compensation, offset in part by our increased revenues, during the nine months ended June 30, 2018, compared to the nine months ended June 30, 2017.

 

Other Income

 

Other income for the nine months ended June 30, 2018 was $85,912, compared to other income of $263,000 during the nine months ended June 30, 2017, a decrease of $177,088. Other income consisted of $57,600 of subleased rent and $28,312 related to restitution payments received from a former employee for the nine months ended June 30, 2018. Other income during the nine months ended June 30, 2017 consisted of $250,000 received pursuant to the settlement under a license agreement with GB Sciences, Inc., $3,000 of subleased rental income and $10,000 of restitution payments received from a former employee.

 

 

Net Loss

 

Net loss for the nine months ended June 30, 2018 was $1,379,488, compared to $758,337 during the nine months ended June 30, 2017, an increase of $621,151, or 82%. The increased net loss was due primarily to increased staffing and outsourced pesticide testing costs over the comparative nine month period, as we revamped operations to better position ourselves for anticipated increased demand in the recreational cannabis market and addressed the temporary suspension of our Nevada licenses.

 

Liquidity and Capital Resources

 

The following is a summary of the Company’s cash flows provided by (used in) operating, investing, and financing activities for the nine month periods ended June 30, 2018 and 2017:

 

		2018				2017
Operating Activities		$	(212,707	)		$	(184,533	)
Investing Activities			(194,008	)			(136,894	)
Financing Activities			268,608				300,000
Net Increase in Cash		$	(138,107	)		$	(21,427	)

 

Net Cash Provided in Operating Activities

 

During the nine months ended June 30, 2018, net cash used in operating activities was $212,707, compared to net cash used in operating activities of $184,533 for the same period ended June 30, 2017. The increase in cash used in operating activities is primarily attributable to our increased net loss as we continued to develop our cannabis testing lab operations.

 

Net Cash Used in Investing Activities

 

During the nine months ended June 30, 2018, net cash used in investing activities was $194,008, compared to $136,894 for the same period ended June 30, 2017. The increase is attributable to greater investments made for cannabis testing equipment in the current period than was necessary in the comparative period.

 

Net Cash Provided by Financing Activities

 

During the nine months ended June 30, 2018, net cash provided by financing activities was $268,608, compared to $300,000 for the same period ended June 30, 2017.

 

Ability to Continue as a Going Concern

 

As of June 30, 2018, our balance of cash on hand was $40,070. We currently may not have sufficient funds to sustain our operations for the next twelve months and we may need to raise additional cash to fund our operations and expand our lab testing business. As we continue to develop our lab testing business and attempt to expand operational activities, we expect to experience net negative cash flows from operations in amounts not now determinable, and will be required to obtain additional financing to fund operations through common stock offerings to the extent necessary to provide working capital. We have and expect to continue to have substantial capital expenditure and working capital needs.

 

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

 

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

 

 

Off-Balance Sheet Arrangements

 

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

 

Critical Accounting Policies and Estimates

 

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

 

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

 

Revenue Recognition

 

The Company adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) on October 1, 2017. This update provides guidance on recognizing revenue, including a five-step model to determine when revenue recognition is appropriate. The standard requires that an entity recognize revenue from contracts with customers to depict the transfer of control of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new update does not affect how the Company recognizes revenue in accordance with ASC 605, Revenue Recognition. ASC 605 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery of product has met the criteria established in the arrangement or services rendered; (3) the fee is fixed and determinable; and (4) collectability is reasonably assured. With respect to our cannabis lab testing revenues, we sell our services on a determinable fixed fee per test, or panel of tests basis, and offer a discounted price for customers that agree to exclusive or predetermined quantities of tests. We typically require payment within thirty days of the delivery of results. Revenues are recognized upon the substantial completion of the tests when collectability is reasonably assured, which is usually upon delivery of results to the customer.

 

Stock-Based Compensation

 

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

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

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

 

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2018. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2018, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

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

 

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

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

 

ITEM 1A. RISK FACTORS.

 

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

 

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

 

The following issuances of equity securities by the Company were exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(a)(2) of the Securities Act of 1933 during the three month period ended June 30, 2018:

 

On June 25, 2018, we issued 118,421 shares of common stock, restricted in accordance with Rule 144, to Joseph Bianco for his services rendered as our CEO.

 

On June 25, 2018, we issued 31,579 shares of common stock, restricted in accordance with Rule 144, to Todd Denkin for his services rendered as our President and COO.

 

On June 25, 2018, we issued 78,947 shares of common stock, restricted in accordance with Rule 144, to Todd Peterson for his services rendered as our CFO.

  

The following issuances of common stock and warrants during the three month period ended June 30, 2018 are restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuances were exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(a)(2) thereof and/or Rule 506 of Regulation D promulgated thereunder. The purchasers were accredited investors, familiar with our operations, and there was no general solicitation.

 

On April 13, 2018, the Company sold 14 units, consisting of an aggregate of 140,000 shares of its common stock and warrants to purchase 70,000 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $25,200.

 

On April 12, 2018, the Company sold 28 units, consisting of an aggregate of 280,000 shares of its common stock and warrants to purchase 140,000 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $50,400.

 

On April 10, 2018, the Company sold 27.78 units, consisting of an aggregate of 277,778 shares of its common stock and warrants to purchase 138,889 shares of common stock, exercisable at $0.30 per share over a thirty six month period, in exchange for total proceeds of $50,000.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

None.

 

 

ITEM 6. EXHIBITS.

 

Exhibit		Description
3.1		Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Form 10 filed with the Securities and Exchange Commission by Digipath, Inc. on July 15, 2011)
3.2		Bylaws (incorporated by reference to Exhibit 3.2 of the Form 10 filed with the Securities and Exchange Commission by Digipath, Inc. on July 15, 2011)
3.3		Certificate of Amendment to Articles of Incorporation dated April 4, 2014 (incorporated by reference to Exhibit 3.1 of the Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on April 10, 2014)
3.4		Certificate of Designations, Preferences, Limitations, Restrictions and Relative Rights of Series A Convertible Preferred Stock dated April 9, 2014 (incorporated by reference to Exhibit 3.2 of the Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on April 10, 2014)
3.5		Certificate of Amendment to Articles of Incorporation dated May 22, 2015 (incorporated by reference to Exhibit 3.1 of the Report on Form 8-K filed with the Securities and Exchange Commission by Digipath, Inc. on May 26, 2015)
31.1*		Section 302 Certification of Chief Executive Officer
31.2*		Section 302 Certification of Chief Financial Officer
32.1*		Section 906 Certification of Chief Executive Officer
32.2*		Section 906 Certification of Chief Financial Officer
101.INS*		XBRL Instance Document
101.SCH*		XBRL Schema Document
101.CAL*		XBRL Calculation Linkbase Document
101.DEF*		XBRL Definition Linkbase Document
101.LAB*		XBRL Labels Linkbase Document
101.PRE*		XBRL Presentation Linkbase Document

* Filed herewith.

 

 

SIGNATURES

 

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

 

Date: August 14, 2018

 

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