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, 2020 and 2019. 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.
There was no impact on the Company's financial statements from the adoption of
ASC 606 for the years ended September 30, 2020 or 2019.
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 $45,120 and $221,980 for the years ended
September 30, 2020 and 2019, 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, 2020 and
2019, 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.
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,
2020 and 2019.
Years Ended September 30, Increase /
2020 2019 (Decrease)
Revenues $ 2,574,399 $ 2,552,600 $ 21,799
Cost of sales 1,778,564 2,712,788 65,776
Gross profit 795,835 839,812 (43,977 )
Operating expenses:
General and administrative 1,483,253 1,673,785 (190,532 )
Professional fees 782,885 878,525 (95,640 )
Bad debts expense 91,558 130,640 (39,082 )
Impairment expense 630,521 - 630,521
Total operating expenses: 2,988,217 2,682,950 305,267
Operating loss (2,192,382 ) (1,843,138 ) 349,244
Total other income (expense) (117,108 ) 37,806 (154,914 )
Net loss $ (2,309,490 ) $ (1,805,332 ) $ 504,158
Revenues
Aggregate revenues for the year ended September 30, 2020 were $2,574,399,
compared to revenues of $2,552,600 during the year ended September 30, 2019, an
increase of $21,799, or 1%. Revenues increased slightly despite severe
disruptions to the Nevada cannabis market during portions of the year as a
result of the COVID-19 pandemic.
Cost of Sales
Cost of sales for the year ended September 30, 2020 were $1,778,564, compared to
$1,712,788 during the year ended September 30, 2019, an increase of $65,776, or
4%. Cost of sales consists primarily of labor, depreciation and maintenance on
lab equipment, and supplies consumed in our testing operations. The increased
cost of sales in the current year was primarily due to equipment failures that
caused us to have to outsource some of our testing to competitors. Our gross
margins of approximately 31%, decreased during the year ended September 30,
2020, compared to gross margins of approximately 33% during the year ended
September 30, 2019, which translated to $43,977 of decreased gross profit. We
intend to continue to automate processes through equipment enhancements to
improve our margins.
General and Administrative Expenses
General and administrative expenses for the year ended September 30, 2020 were
$1,483,253, compared to $1,673,785 during the year ended September 30, 2019, a
decrease of $190,532, or 11%. 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 $110,473 during
the year ended September 30, 2020, compared to $84,185 during the year ended
September 30, 2019, an increase of $26,288, or 31%. General and administrative
expenses decreased primarily due to decreased advertising and investment
relations expenses during the current year.
Professional Fees
Professional fees for the year ended September 30, 2020 were $782,885, compared
to $878,525 during the year ended September 30, 2019, a decrease of $95,640, or
11%. Professional fees decreased primarily due to decreased business development
and legal fees, and decreased stock-based compensation paid to directors and
consultants, as offset by increased consulting and board fees during the current
period. Stock-based compensation was $253,748 during the year ended September
30, 2020, compared to $436,470 during the year ended September 30, 2019, a
decrease of $182,722, or 42%.
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Bad Debt Expense
Bad debt expense for the year ended September 30, 2020 was $91,558, compared to
$130,640 during the year ended September 30, 2019, a decrease of $39,082. Bad
debts expense decreased during the current year as we recognized $95,000 of
debts in the prior year that we had written off as uncollectible notes
receivable, and our allowance for doubtful accounts increased in the current
year by approximately $78,400. Our allowance for doubtful accounts on trade
receivables was $128,944 and $50,540 at September 30, 2020 and 2019,
respectively, or approximately 5% and 2% of sales for the years ended September
30, 2020 and 2019, respectively.
Impairment Expense
Impairment expense for the year ended September 30, 2020 was $630,521.
Impairment expense consisted of $592,621 of goodwill impairment following our
acquisition of VSSL Enterprises, and $37,900 of impairment expense related to
our investment in the development of handheld devices used to test cannabis for
THC, CBD and CBG levels under our GroSciences, Inc. subsidiary, which has ceased
operations.
Operating Loss
Operating loss for the year ended September 30, 2020 was $2,192,382, compared to
$1,843,138 during the year ended September 30, 2019, an increase of $349,244, or
19%. Operating loss increased primarily due to $630,521 of impairment expense,
and decreased gross profit, as offset in part by decreased general and
administrative, professional fees and bad debts expense during the year ended
September 30, 2020, compared to the year ended September 30, 2019.
Other Income (Expense)
Other expense, on a net basis, for the year ended September 30, 2020 was
$117,108, compared to other income of $37,806 during the year ended September
30, 2019, a decrease of $154,914. Other expense during the year ended September
30, 2020 consisted of rental income of $79,285 on sublease rents and a $1,724
gain on the modification of operating leases, as offset by $148,024 of interest
expense and a loss on disposal of fixed assets of $50,093. Other income during
the year ended September 30, 2019, consisted of rental income of $83,400 on
sublease rents and a $30,000 gain on settlement of a previously written off note
receivable, as offset by $65,670 of interest expense and a loss on disposal of
fixed assets of $9,924.
Net Loss
Net loss for the year ended September 30, 2020 was $2,309,490, compared to
$1,805,332 during the year ended September 30, 2019, an increase of $504,158, or
28%. The increased net loss was primarily due to expenses on impaired assets and
an increased loss on disposal of fixed assets, along with increased interest
expense.
Liquidity and Capital Resources
As of September 30, 2020, the Company had current assets of $397,242, comprising
of cash of $82,749, accounts receivable of $242,145, other assets of $53,673,
and deposits of $18,675. The Company's current liabilities as of September 30,
2020 were $742,678, consisting of $387,946 of accounts payable, $163,152 of
accrued expenses, $20,000 of short term advances, the current portion of
operating lease liabilities in the amount of $84,731, the current portion of
financing lease liabilities in the amount of $32,532, and the current maturities
of notes payable in the amount of $54,317.
The following table summarizes our total current assets, liabilities and working
capital at September 30, 2020 and 2019.
September 30,
2020 2019
Current Assets $ 397,242 $ 629,319
Current Liabilities $ 742,678 $ 471,493
Working Capital $ (345,436 ) $ 157,826
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The following table summarizes our cash flows during the years ended September
30, 2020 and 2019, respectively.
Years Ended
September 30,
2020 2019
Net cash used in operating activities $ (671,605 ) $ (1,042,213 )
Net cash used in investing activities (341,008 ) (135,075 )
Net cash provided by financing activities 771,623 1,325,000
Net change in cash $ (240,990 ) $ 147,712
Net Cash Used in Operating Activities
The decrease in funds used in operating activities for the year ended September
30, 2020, compared to the year ended September 30, 2019, was primarily
attributable to our increased net loss, as we didn't benefit from the decreased
competition from the suspension of two competing cannabis testing labs in the
current period, as we did in the prior period.
Net Cash Used in Investing Activities
The increase in funds used in investing activities for the year ended September
30, 2020, compared to the year ended September 30, 2019, was due primarily to
the $200,000 of cash paid for the purchase of VSSL Enterprises, Ltd. in the
current year.
Net Cash Provided by Financing Activities
The decrease in funds provided by financing activities for the year ended
September 30, 2020, compared to the year ended September 30, 2019, was primarily
due to decreased sales of our securities through private placement offerings and
the sale of convertible notes, in the year ended September 30, 2020.
Satisfaction of our Cash Obligations for the Next 12 Months
As of September 30, 2020, our balance of cash on hand was $82,749. 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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