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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2011
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to
 Commission File No. 000-53235
 DIGITILITI, INC.
 (Exact name of Registrant as specified in its charter)
 Delaware
    
    26-1408538(State or Other Jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 266 East 7th Street, 4th Floor
St. Paul, Minnesota 55101  (Address of Principal Executive Offices)
 (651) 925-3200  (Registrants telephone number, including area code)
 (Former name, former address and former fiscal year,
 Yes þ No o
 Yes o No o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ(Do not check if smaller reporting company)
 Yes o No þ
   Class
    
    Outstanding at May 23, 2010Common Stock, $.001 par value per share
    
    66,714,481 shares




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PagePART I  Financial InformationItem 1. Financial Statements (unaudited):Consolidated Balance Sheets  As of March 31, 2011 and December 31, 2010
    
    
    3Consolidated Statements of Operations  Three months ended March 31, 2011 and 2010
    
    
    4Consolidated Statements of Cash Flows  Three months ended March 31, 2011 and 2010
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 4. Controls and Procedures
    
    
    17PART II  Other InformationItem 1. Legal Proceedings
    
    
    18Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    18Item 3. Defaults Upon Senior Securities
    
    
    18Item 6. Exhibits
    
    
    18Signatures
    
    
    19EX-10.1EX-10.2EX-10.3EX-10.4EX-10.5EX-31.1EX-31.2EX-32.1
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Item 1.
    
    Financial Statements
 DIGITILITI, INC.
 
 CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 March 31,
    
    
    December 31,2011
    
    
    2010ASSETSCURRENT ASSETSCash
    
    $
    1,654
    
    
    $
    27,557Accounts receivable
    
    
    284,360
    
    
    
    333,687Prepaid and other current assets
    
    
    340,371
    
    
    
    247,970Total current assets
    
    
    626,385
    
    
    
    609,214Property and equipment, net
    
    
    127,649
    
    
    
    158,105Software license, net
    
    
    365,557
    
    
    
    436,608Deferred financing costs
    
    
    139,340
    
    
    
    4,466Other assets
    
    
    6,322
    
    
    
    6,322Total assets
    
    $
    1,265,253
    
    
    $
    1,214,715LIABILITIES AND STOCKHOLDERS DEFICITCURRENT LIABILITIESAccounts payable
    
    $
    735,532
    
    
    $
    692,923Accrued expenses
    
    
    564,325
    
    
    
    554,978Bank overdraft
    
    
    5,472
    
    
    
    Deferred income
    
    
    9,989
    
    
    
    9,989Notes payable
    
    
    
    
    
    
    231,540Note payable  related party
    
    
    16,000
    
    
    
    Current maturities of convertible debt, net of unamortized discounts of
$3,333 and $0
    
    
    539,038
    
    
    
    782,941Current maturities of capital lease obligations
    
    
    13,531
    
    
    
    23,308Total current liabilities
    
    
    1,883,887
    
    
    
    2,295,679Convertible debt, non-current, net of unamortized discounts of $540,179 and $0
    
    
    760,949
    
    
    
    250,000Other liabilities
    
    
    3,607
    
    
    
    3,607Total liabilities
    
    
    2,648,443
    
    
    
    2,549,286STOCKHOLDERS DEFICITSeries A Convertible Preferred Stock, $0.001 par value; 1,200,000 shares
authorized for Series A, 668,720 and 724,187 shares issued and outstanding
    
    
    669
    
    
    
    724Series B Convertible Preferred Stock, $1.00 par value; 2,000,000 shares
authorized for Series B, 420,000 shares issued and outstanding
    
    
    420,000
    
    
    
    420,000Common stock, $.001 par value; 125,000,000 shares authorized, 66,714,481 and
65,699,753 shares issued and outstanding
    
    
    66,714
    
    
    
    65,700Additional paid-in capital
    
    
    25,269,583
    
    
    
    24,409,477Accumulated deficit
    
    
    (27,140,156
    )
    
    
    (26,230,472
    )Total stockholders deficit
    
    
    (1,383,190
    )
    
    
    (1,334,571
    )Total liabilities and stockholders deficit
    
    $
    1,265,253
    
    
    $
    1,214,715
 See accompanying notes to unaudited consolidated financial statements.
  3




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DIGITILITI, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 Three Months EndedMarch 31,2011
    
    
    2010REVENUES
    
    $
    411,029
    
    
    $
    625,127COST OF REVENUES
    
    
    (519,059
    )
    
    
    (301,971
    )GROSS PROFIT (LOSS)
    
    
    (108,030
    )
    
    
    323,156OPERATING EXPENSESSelling and marketing
    
    
    143,065
    
    
    
    214,664General and administrative
    
    
    363,575
    
    
    
    458,631Research and development
    
    
    147,853
    
    
    
    269,742Total Operating Expenses
    
    
    654,493
    
    
    
    943,037LOSS FROM OPERATIONS
    
    
    (762,523
    )
    
    
    (619,881
    )OTHER EXPENSESLoss on extinguishment of debt
    
    
    71,634
    
    
    
    Interest expense
    
    
    75,527
    
    
    
    228,130Total other expenses
    
    
    147,161
    
    
    
    228,130NET LOSS
    
    $
    (909,684
    )
    
    $
    (848,011
    )NET LOSS PER SHARE  BASIC AND DILUTED
    
    $
    (0.01
    )
    
    $
    (0.02
    )WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 
BASIC AND DILUTED
    
    
    66,011,034
    
    
    
    41,318,675
 See accompanying notes to unaudited consolidated financial statements.
  4




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DIGITILITI, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Three Months EndedMarch 31,2011
    
    
    2010OPERATING ACTIVITIESNet loss
    
    $
    (909,684
    )
    
    $
    (848,011
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation expense
    
    
    31,391
    
    
    
    84,258Amortization of software license
    
    
    71,051
    
    
    
    75,195Amortization of deferred financing costs
    
    
    8,861
    
    
    
    19,722Amortization of debt discounts
    
    
    24,787
    
    
    
    64,617Loss on extinguishment of debt
    
    
    71,634
    
    
    
    Warrant expense
    
    
    18,039
    
    
    
    Common shares issued for services
    
    
    10,000
    
    
    
    40,995Employee stock option expense
    
    
    135,593
    
    
    
    59,086Changes in operating assets and liabilities:Accounts receivable
    
    
    49,327
    
    
    
    61,412Prepaid and other current assets
    
    
    (92,401
    )
    
    
    (21,742
    )Accounts payable
    
    
    75,085
    
    
    
    (7,148
    )Accounts payable  related parties
    
    
    
    
    
    
    (7,861
    )Accrued expenses
    
    
    89,588
    
    
    
    170,044Deferred rent
    
    
    (764
    )
    
    
    (2,396
    )Net cash used in operating activities
    
    
    (417,493
    )
    
    
    (311,829
    )INVESTING ACTIVITIESPurchase of property and equipment
    
    
    (935
    )
    
    
    (41,317
    )Purchase of software license
    
    
    
    
    
    
    (3,782
    )Net cash used in investing activities
    
    
    (935
    )
    
    
    (45,099
    )FINANCING ACTIVITIESBank overdraft
    
    
    5,472
    
    
    
    Proceeds from sale of common stock, net of issuance costs
    
    
    
    
    
    
    765,300Payments on capital lease obligations
    
    
    (9,777
    )
    
    
    (10,829
    )Proceeds from notes payable  related parties
    
    
    16,000
    
    
    
    Proceeds from convertible debt
    
    
    760,000
    
    
    
    Payments on notes payable
    
    
    (231,540
    )
    
    
    (364,572
    )Payments on convertible debt
    
    
    (147,630
    )
    
    
    (70,000
    )Net cash provided by financing activities
    
    
    392,525
    
    
    
    319,899NET DECREASE IN CASH
    
    
    (25,903
    )
    
    
    (37,029
    )Cash at beginning of year
    
    
    27,557
    
    
    
    141,086Cash at end of year
    
    $
    1,654
    
    
    $
    104,057SUPPLEMENTAL CASH FLOWS INFORMATIONCash paid for interest
    
    $
    9,746
    
    
    $
    12,842Cash paid for income taxes
    
    
    
    
    
    
    NON-CASH INVESTING AND FINANCING ACTIVITIES:Convertible debt issued for debt issuance costs
    
    
    64,000
    
    
    
    Warrants issued for debt issuance costs
    
    
    79,735
    
    
    
    Accrued interest converted to convertible debt
    
    
    8,844
    
    
    
    Debt discount due to warrants issued with debt
    
    
    316,226
    
    
    
    Debt discount due to beneficial conversion feature
    
    
    126,729
    
    
    
    Debt discount
    
    
    118,284
    
    
    
    Common stock issued for the conversion of Series
A preferred stock
    
    
    277
    
    
    
    Common stock issued for accrued interest
    
    
    103,109
    
    
    
    Notes payable issued for maintenance fees
    
    
    
    
    
    
    56,634Accrued interest converted to debt principal
    
    
    
    
    
    
    24,646
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DIGITILITI, INC.
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
 1. Basis of Presentation
  Software Revenue Recognition
      Correction of a Prior Period
   6




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Three Months Ended March 31, 2010As PreviouslyReported
    
    
    Adjustments
    
    
    As RevisedGeneral and administrative
    
    $
    175,293
    
    
    $
    39,371
    
    
    $
    214,664Total operating expenses
    
    
    903,666
    
    
    
    39,371
    
    
    
    943,037Net loss from operations
    
    
    (580,510
    )
    
    
    (39,371
    )
    
    
    (619,881
    )Net loss
    
    $
    (808,640
    )
    
    $
    (39,371
    )
    
    $
    (848,011
    )Net loss per share  Basic and Diluted
    
    $
    (0.02
    )
    
    $
    
    
    
    $
    (0.02
    )Weighted average shares outstanding  Basic and Diluted
    
    
    41,318,675
    
    
    
    
    
    
    
    41,318,675
  New Accounting Pronouncements
        2. Going Concern
    7




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3. Notes Payable
   4. Convertible Debt
         8




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Convertible debt, net at December 31, 2010
    
    $
    1,032,941Add: Notes issued
    
    
    951,128Less: 10% discount on the Notes
    
    
    (118,284
    )Less: discount due to relative fair value of warrants
    
    
    (316,226
    )Less: discount due to beneficial conversion feature
    
    
    (126,729
    )Less: principal payments
    
    
    (147,630
    )Add: amortization of debt discounts
    
    
    24,787Convertible debt, net at March 31, 2011
    
    $
    1,299,987Less: current maturities, net
    
    
    (539,038
    )Long-term portion of convertible debt, net
    
    $
    760,949
 5. Common Stock
  a)
    
    issued 50,000 common shares for services valued at $10,000,
 b)
    
    issued 687,393 common shares to repay accrued interest of $103,109 (see also Note 4)
and
 c)
    
    issued 277,335 common shares for the conversion of 55,467 Series A preferred shares.
 6. Stock Options
    9




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WeightedWeighted-
    
    
    AverageAverage
    
    
    RemainingOptions
    
    
    Exercise Price
    
    
    Life (yrs)Outstanding at December 31, 2010
    
    
    2,990,000
    
    
    $
    0.34Granted
    
    
    1,650,707
    
    
    
    0.19Canceled
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding at March 31,2010
    
    
    4,640,707
    
    
    $
    0.28
    
    
    
    3.6Exercisable at March 31, 2010
    
    
    2,431,917
    
    
    $
    0.33
    
    
    
    3.0
   7. Stock Warrants
      10




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WeightedWeighted-
    
    
    AverageAverage
    
    
    RemainingWarrants
    
    
    Exercise Price
    
    
    Life (yrs)Outstanding at December 31, 2010
    
    
    8,683,348
    
    
    $
    0.64Granted
    
    
    3,995,821
    
    
    
    0.29Forfeited
    
    
    
    
    
    
    Outstanding at March 31, 2011
    
    
    12,679,169
    
    
    $
    0.53
    
    
    
    3.85Exercisable at March 31, 2011
    
    
    12,679,169
    
    
    $
    0.53
    
    
    
    3.85
   8. Commitments and Contingencies
   9. Subsequent Events
    11




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Item 2.
    
    Managements Discussions and Analysis of Financial Condition and Results of Operations.
 Forward-looking Statements
     The Business
     12




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Growing both Business Segments:
  (i)
    
    solving a major industry and customer problem of managing continually growing
information volume and associated cost of storage and retrieval;
 (ii)
    
    being able to access a larger share of opportunity in the information management
storage business;
 (iii)
    
    offering significant technological advantages in corporate policy level control of
information and ability to leverage knowledge from the information it creates; and
 (iv)
    
    optimizing how we synergistically allocate capital and resources between both business.
  13




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14




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Liquidity and Capital Resources
            15




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Results of Operations
 For the three month periods ended March 31, 2011 and 2010
        16




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Off-Balance Sheet Arrangements
  
 Item 4.
    
    Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
     17




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Changes in internal control over financial reporting
  
 PART II  OTHER INFORMATION
 
 Item 1.
    
    Legal Proceedings.
  
 Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds.
  
 Item 3.
    
    Defaults Upon Senior Securities.
  
 Item 6.
    
    Exhibits.
   18




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SIGNATURES
  Digitiliti, Inc.Date: May 23, 2011
    By:
    /s/ Ehssan TaghizadehEhssan Taghizadeh, President, CEO (Principal Executive Officer)Date: May 23, 2011
    By:
    /s/ William McDonaldWilliam McDonald, CFO (Principal Accounting  Officer)  19




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INDEX TO EXHIBITS
 Exhibit No.
    
    Description of Exhibit31.1
    
    
    302 Certification of CEO, Ehssan Taghizadeh31.2
    
    
    302 Certification of CFO, William McDonald32.1
    
    
    906 Certification99.1
    
    
    Settlement Agreement and Release dated March 8, 2010 (incorporated by
reference to Exhibit 99.1 to the registrants Current Report on Form 8-K
filed with the Commission on March 23, 2010).10.1
    
    
    Form of Convertible Promissory Note and Warrant Purchase Agreement dated
as of February 28, 201110.2
    
    
    Form of Secured Convertible Promissory Note dated as of February 28, 201110.3
    
    
    Form of Security Agreement10.4
    
    
    Form of Warrant Agreement10.5
    
    
    Form of Repayment of Miner Note Obligations and Release of Miner
Security Interest Agreement
  20