This discussion summarizes the significant factors affecting the operating results, financial condition, liquidity and cash flows of the Company and its subsidiaries for the fiscal years ended September 30, 2022 and 2021. The discussion and analysis that follows should be read together with the section entitled "Forward Looking Statements" and our consolidated financial statements and the notes to the consolidated financial statements included elsewhere in this annual report on Form 10-K.

Except for historical information, the matters discussed in this section are forward looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond the Company's control. Consequently, and because forward-looking statements are inherently subject to risks and uncertainties, the actual results and outcomes may differ materially from the results and outcomes discussed in the forward-looking statements. You are urged to carefully review and consider the various disclosures made by us 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 mission is to provide pharmaceutical-grade analysis and testing to the cannabis industry, under ISO-17025:2017 guidelines, to ensure consumers and patients know exactly what is in the cannabis they ingest and to help maximize the quality of our clients' products through research, development, and standardization. Digipath has been operating a cannabis-testing lab in Nevada since 2015 and has plans to open labs in other states and countries that have legalized the sale of cannabis, beginning with California.





Critical Accounting Policies

The establishment and consistent application of accounting policies is a vital component of accurately and fairly presenting our financial statements in accordance with generally accepted accounting principles in the United States ("GAAP"), as well as ensuring compliance with applicable laws and regulations governing financial reporting. While there are rarely alternative methods or rules from which to select in establishing accounting and financial reporting policies, proper application often involves significant judgment regarding a given set of facts and circumstances and a complex series of decisions.





Basis of Accounting

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission. Intercompany accounts and transactions have been eliminated. All references to GAAP are in accordance with The FASB Accounting Standards Codification ("ASC") and the Hierarchy of Generally Accepted Accounting Principles.





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

The Company adopted ASC 820, Fair Value Measurements and Disclosures (ASC 820). ASC 820 defines fair value, establishes a three-level valuation hierarchy for disclosures of fair value measurement and enhances disclosure requirements for fair value measures. The three levels are defined as follows:





  - Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for
    identical assets or liabilities in active markets.
  - Level 2 inputs to the valuation methodology include quoted prices for similar
    assets and liabilities in active markets, and inputs that are observable for
    the asset or liability, either directly or indirectly, for substantially the
    full term of the financial instrument.
  - Level 3 inputs to valuation methodology are unobservable and significant to
    the fair measurement.




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The carrying value of cash, accounts receivable, accounts payables and accrued expenses are estimated by management to approximate fair value primarily due to the short term nature of the instruments.





Fixed Assets

Fixed assets are stated at the lower of cost or estimated net recoverable amount. The cost of property, plant and equipment is depreciated using the straight-line method based on the lesser of the estimated useful lives of the assets or the lease term based on the following life expectancy:





Software                         3 years
Office equipment                 5 years
Furniture and fixtures           5 years
Lab equipment                    7 years
Leasehold improvements     Term of lease

Repairs and maintenance expenditures are charged to operations as incurred. Major improvements and replacements, which extend the useful life of an asset, are capitalized and depreciated over the remaining estimated useful life of the asset. When assets are retired or sold, the cost and related accumulated depreciation and amortization are eliminated and any resulting gain or loss is reflected in operations.

Impairment of Long-Lived Assets

Long-lived assets held and used by the Company are reviewed for possible impairment whenever events or circumstances indicate the carrying amount of an asset may not be recoverable or is impaired. Recoverability is assessed using undiscounted cash flows based upon historical results and current projections of earnings before interest and taxes. Impairment is measured using discounted cash flows of future operating results based upon a rate that corresponds to the cost of capital. Impairments are recognized in operating results to the extent that carrying value exceeds discounted cash flows of future operations.

Our intellectual property is comprised of indefinite-lived brand names acquired and have been assigned an indefinite life as we currently anticipate that these brand names will contribute cash flows to the Company perpetually. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired.





Revenue Recognition

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

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





Advertising Costs

The Company expenses the cost of advertising and promotions as incurred. Advertising and promotions expense was $58,739 and $28,066 for the years ended September 30, 2022 and 2021, respectively.





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Basic and Diluted Loss Per Share

The basic net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding. Diluted net loss per common share is computed by dividing the net loss adjusted on an "as if converted" basis, by the weighted average number of common shares outstanding plus potential dilutive securities. For the years ended September 30, 2022 and 2021, potential dilutive securities had an anti-dilutive effect and were not included in the calculation of diluted net loss per common share.





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 2018-07 (ASC 2018-07). All transactions in which the consideration provided in exchange for the purchase of goods or services consists of 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.

The Company accounts for equity-based transactions with non-employees under the provisions of ASC Topic No. 505-50, "Equity-Based Payments to Non-Employees" ("Topic No. 505-50"). Topic No. 505-50 establishes that equity-based payment transactions with non-employees shall be measured at the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.





Income Taxes

The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than not.





Uncertain Tax Positions

In accordance with ASC 740, "Income Taxes" ("ASC 740"), the Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be capable of withstanding examination by the taxing authorities based on the technical merits of the position. These standards prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. These standards also provide guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.

Various taxing authorities periodically audit the Company's income tax returns. These audits include questions regarding the Company's tax filing positions, including the timing and amount of deductions and the allocation of income to various tax jurisdictions. In evaluating the exposures connected with these various tax filing positions, including state and local taxes, the Company records allowances for probable exposures. A number of years may elapse before a particular matter, for which an allowance has been established, is audited and fully resolved. The Company has not yet undergone an examination by any taxing authorities.

The assessment of the Company's tax position relies on the judgment of management to estimate the exposures associated with the Company's various filing positions.

Various taxing authorities periodically audit the Company's income tax returns. These audits include questions regarding the Company's tax filing positions, including the timing and amount of deductions and the allocation of income to various tax jurisdictions. In evaluating the exposures connected with these various tax filing positions, including state and local taxes, the Company records allowances for probable exposures. A number of years may elapse before a particular matter, for which an allowance has been established, is audited and fully resolved. The Company has not yet undergone an examination by any taxing authorities.

The assessment of the Company's tax position relies on the judgment of management to estimate the exposures associated with the Company's various filing positions.





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Results of Operations



The following table shows operating results for the years ended September 30,
2022 and 2021.



                                 Years Ended September 30,         Increase /
                                    2022             2021          (Decrease)
Revenues                       $    2,699,920     $ 2,503,800     $    196,120
Cost of sales                       1,633,972       1,788,635         (154,663 )
Gross profit                        1,065,948         715,165          350,783

Operating expenses:
General and administrative          1,359,005         934,143          424,862
Professional fees                     656,860         581,635           75,225
Bad debts expense (recovery)           64,427         (28,165 )         92,592
Total operating expenses:           2,080,292       1,487,613          592,679

Operating loss                     (1,014,344 )      (772,448 )       (241,896 )

Total other income (expense)       (1,042,774 )        85,945       (1,128,719 )

Net loss                       $   (2,057,118 )   $  (686,503 )   $ (1,370,615 )




Revenues

Aggregate revenues for the year ended September 30, 2022 were $2,699,920, compared to revenues of $2,503,800 during the year ended September 30, 2021, an increase of $196,120, or 8%. The increase in revenue was due to an increase in Nevada tourism and our customers' cash flows during the current period.





Cost of Sales

Cost of sales for the year ended September 30, 2022 were $1,633,972, compared to $1,788,635 during the year ended September 30, 2021, a decrease of $154,663, or 9%. Cost of sales consists primarily of labor, depreciation and maintenance on lab equipment, and supplies consumed in our testing operations. The decreased cost of sales in the current period was primarily due to our decrease in outsourcing to other labs. Our gross margins of approximately 40% and 29% during the years ended September 30, 2022 and 2021, respectively, translated to $350,783 of increased gross profit in the current period.

General and Administrative Expenses

General and administrative expenses for the year ended September 30, 2022 were $1,359,005, compared to $934,143 during the year ended September 30, 2021, an increase of $424,865, or 45%. The expenses consisted primarily of marketing, rent, salaries and wages, and travel expenses. General and administrative expenses included stock-based compensation paid to officers of $454,238 during the year ended September 30, 2022, compared to $50,856 during the year ended September 30, 2021, an increase of $403,382. General and administrative expenses increased due primarily to increased corporate overhead activities offset by the discontinuation of rents on warehouse space that we were previously subleasing.





Professional Fees

Professional fees for the year ended September 30, 2022 were $656,860, compared to $581,635 during the year ended September 30, 2021, an increase of $75,225, or 13%. Professional fees increased primarily due to increased use of corporate consulting services during the current period. Stock-based compensation was $106,994 during the year ended September 30, 2022, compared to $241,582 during the year ended September 30, 2021, a decrease of $134,588.





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Bad Debt Expense

Bad debt expense for the year ended September 30, 2022 was $64,427, compared to bad debt recovery for the year ended September 30, 2021 of $28,165, an increase of $92,592. Our change in allowance for doubtful accounts was a result of collection issues from various customers. Our allowance for doubtful accounts on trade receivables was $139,279 and $87,795 at September 30, 2022 and 2021, respectively, or approximately 5% and 4% of sales for the years ended September 30, 2022 and 2021, respectively.





Operating Loss

Operating loss for the year ended September 30, 2022 was $1,014,344, compared to $772,448 during the year ended September 30, 2021, an increase of $241,896, or 31%. Operating loss increased primarily due to increased general and administrative, professional fees and bad debts expense, during the year ended September 30, 2022, compared to the year ended September 30, 2021.





Other Income (Expense)

Other expense, on a net basis, for the year ended September 30, 2022 was $1,042,774, compared to other income of $85,945 during the year ended September 30, 2021, a decrease of $1,128,719. Other expense during the year ended September 30, 2022 consisted of $260,274 of interest expense and a credit loss of $782,500. Other income during the year ended September 30, 2021 consisted of a $222,393 gain on the settlement of debt, interest income of $929, and settlement of accounts payable of $7,580, as offset by $144,957 of interest expense.





Net Loss

Net loss for the year ended September 30, 2022 was $2,057,118, compared to $686,503 during the year ended September 30, 2021, an increase of $1,370,615, or 200%. The increased net loss was due primarily to larger professional fees and an increase in other expenses.

Liquidity and Capital Resources

As of September 30, 2022, the Company had current assets of $562,104, comprising of cash of $56,168, accounts receivable of $335,085, other assets of $45,710, a note receivable of $100,000 and deposits of $25,141. The Company's current liabilities as of September 30, 2022 were $2,953,909, consisting of $550,467 of accounts payable, $378,368 of accrued expenses, the current portion of operating lease liabilities in the amount of $100,685, the current maturities of convertible notes payable of $1,198,469, and the current maturities of notes payable in the amount of $725,920

The following table summarizes our total current assets, liabilities and working capital at September 30, 2022 and 2021.





                              September 30,
                          2022             2021
Current Assets        $    562,104     $    826,865

Current Liabilities $ 2,953,909 $ 2,014,384



Working Capital       $ (2,391,805 )   $ (1,187,519 )




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The following table summarizes our cash flows during the years ended September 30, 2022 and 2021, respectively.





                                                   Years Ended
                                                  September 30,
                                               2022           2021

Net cash (used) in operating activities $ (184,786 ) $ (135,968 ) Net cash (used) in investing activities (660,371 ) (286,206 ) Net cash provided by financing activities 605,393 635,357



Net change in cash                          $ (239,764 )   $ (135,968 )

Net Cash Used in Operating Activities

The increase in funds used in operating activities for the year ended September 30, 2022, compared to the year ended September 30, 2021, was primarily attributable to our increased net loss, offset by the change in allowance for doubtful accounts and credit losses.

Net Cash Used in Investing Activities

The increase in funds used in investing activities for the year ended September 30, 2022, compared to the year ended September 30, 2021, was due primarily to loans we made in connection with a potential acquisition that we did not close, offset by proceeds received from the sale of equipment held as collateral securing that loan.

Net Cash Provided by Financing Activities

The decrease in funds provided by financing activities for the year ended September 30, 2022, compared to the year ended September 30, 2021, was primarily due to increased payments we made on our outstanding convertible notes in the year ended September 30, 2022.

Satisfaction of our Cash Obligations for the Next 12 Months

As of September 30, 2022, our balance of cash on hand was $56,168. We do not currently have sufficient funds to fund our operations at their current levels for the next twelve months. As we continue to develop our lab testing business and attempt to expand operational activities, we expect to continue to experience net negative cash flows from operations in amounts not now determinable, and will be required to obtain additional financing to fund operations. Our ability to continue as a going concern is dependent upon our ability to raise additional capital and to achieve sustainable revenues and profitable operations. Since inception, we have raised funds primarily through the sale of equity securities. We will need and are currently seeking additional funds to operate our business. No assurance can be given that any future financing will be available or, if available, that it will be on terms that are satisfactory to us. Even if we are able to obtain additional financing, it may contain undue restrictions on our operations or cause substantial dilution for our stockholders. If we are unable to obtain additional funds, our ability to carry out and implement our planned business objectives and strategies will be significantly delayed, limited or may not occur. We cannot guarantee that we will become profitable. Even if we achieve profitability, given the competitive and evolving nature of the industry in which we operate, we may not be able to sustain or increase profitability and our failure to do so would adversely affect our business, including our ability to raise additional funds.

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.

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