##### Table of Contents



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 September 30, 2010
 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 7 th Street, 4 th 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,
 þ o
 o o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
(Do not check if smaller reporting company)
    
    Smaller reporting company þ
 o þ
  Class
    
    Outstanding at November 12, 2010Common Stock, $.001 par value per share
    
    64,939,225 shares




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##### 



PagePART I  Financial InformationItem 1. Financial Statements (unaudited):
    
    
    3Consolidated Balance Sheets  As of September 30, 2010 and December 31, 2009
    
    
    3Consolidated Statements of Operations  Three and Nine months ended September 30, 2010 and 2009
    
    
    4Consolidated Statements of Cash Flows  Nine months ended September 30, 2010 and 2009
    
    
    5Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 4T. Controls and Procedures
    
    
    23PART II  Other InformationItem 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    24Item 3. Defaults Upon Senior Securities
    
    
    24Item 5. Other Information
    
    
    24Item 6. Exhibits
    
    
    25Signatures
    
    
    26CertificationsExhibit 3.3Exhibit 3.4Exhibit 10.1Exhibit 10.2Exhibit 10.3Exhibit 10.4Exhibit 10.5Exhibit 31.1Exhibit 31.2Exhibit 32.1
   2




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##### Table of Contents



Item 1. Financial Statements
 DIGITILITI, INC.
 
 CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 September 30,
    
    
    December 31,2010
    
    
    2009ASSETSCurrent AssetsCash
    
    $
    223,650
    
    
    $
    141,086Accounts receivable, net
    
    
    438,518
    
    
    
    484,203Prepaid and other current assets
    
    
    141,499
    
    
    
    220,304Total current assets
    
    
    803,667
    
    
    
    845,593Property and equipment, net
    
    
    239,972
    
    
    
    444,675Software license, net
    
    
    509,862
    
    
    
    713,199Deferred financing costs
    
    
    6,668
    
    
    
    113,334Other assets
    
    
    6,322
    
    
    
    7,322Total assets
    
    $
    1,566,491
    
    
    $
    2,124,123LIABILITIES AND STOCKHOLDERS DEFICITLIABILITIESCurrent LiabilitiesAccounts payable
    
    $
    507,918
    
    
    $
    436,389Accounts payable  related parties
    
    
    
    
    
    
    7,861Accrued expenses
    
    
    599,784
    
    
    
    1,222,143Notes payable
    
    
    231,540
    
    
    
    518,371Current maturities of convertible debt
    
    
    525,530
    
    
    
    2,032,771Deferred income
    
    
    14,486
    
    
    
    Current maturities of capital lease obligations
    
    
    34,325
    
    
    
    45,819Total current liabilities
    
    
    1,913,583
    
    
    
    4,263,354Other LiabilitiesConvertible debt, non-current
    
    
    250,000
    
    
    
    1,646,502Capital lease obligations, non-current
    
    
    
    
    
    
    24,043Deferred rent
    
    
    4,364
    
    
    
    11,552Other liabilities
    
    
    3,607
    
    
    
    3,607Total liabilities
    
    
    2,171,554
    
    
    
    5,949,058STOCKHOLDERS DEFICITSeries A
Convertible Preferred Stock, $0.001 par value;
1,200,000 shares authorized for Series A, 724,187 outstanding
shares issued and outstanding
    
    
    724
    
    
    
    Series B Convertible Preferred Stock, $1.00 par value;
2,000,000 shares authorized for Series B, 300,000 shares
issued and outstanding
    
    
    300,000
    
    
    
    Common stock, $.001 par value; 100,000,000 shares
authorized, 64,939,225 and 38,808,736 shares issued and
outstanding, respectively
    
    
    64,940
    
    
    
    38,809Additional paid-in capital
    
    
    24,107,750
    
    
    
    15,952,089Accumulated deficit
    
    
    (25,078,477
    )
    
    
    (19,815,833
    )Total stockholders deficit
    
    
    (605,063
    )
    
    
    (3,824,935
    )Total liabilities and stockholders deficit
    
    $
    1,556,491
    
    
    $
    2,124,123
 See accompanying notes to consolidated financial statements.
  3




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DIGITILITI, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2010
    
    
    2009
    
    
    2010
    
    
    2009REVENUES
    
    $
    555,386
    
    
    $
    760,017
    
    
    $
    1,719,520
    
    
    $
    2,479,965COST OF REVENUES
    
    
    418,141
    
    
    
    492,490
    
    
    
    1,098,509
    
    
    
    1,499,013GROSS PROFIT
    
    
    137,245
    
    
    
    267,527
    
    
    
    621,011
    
    
    
    980,952OPERATING EXPENSESSelling and marketing
    
    
    239,490
    
    
    
    62,046
    
    
    
    616,068
    
    
    
    267,375General and administrative
    
    
    362,733
    
    
    
    359,764
    
    
    
    1,978,671
    
    
    
    1,726,501Research and development
    
    
    242,736
    
    
    
    206,504
    
    
    
    774,719
    
    
    
    539,383Total operating expenses
    
    
    844,959
    
    
    
    628,314
    
    
    
    3,369,458
    
    
    
    2,533,259LOSS FROM OPERATIONS
    
    
    (707,714
    )
    
    
    (360,787
    )
    
    
    (2,748,447
    )
    
    
    (1,552,307
    )OTHER EXPENSESGain (Loss) on extinguishment of debt
    
    
    2,866
    
    
    
    (108,187
    )
    
    
    (315,428
    )
    
    
    (108,187
    )Interest expense
    
    
    (90,790
    )
    
    
    (226,217
    )
    
    
    (2,198,769
    )
    
    
    (2,506,941
    )Total other expenses
    
    
    (87,924
    )
    
    
    (334,404
    )
    
    
    (2,514,197
    )
    
    
    (2,615,128
    )NET LOSS
    
    $
    (795,638
    )
    
    $
    (695,191
    )
    
    $
    (5,262,644
    )
    
    $
    (4,167,435
    )NET LOSS PER SHARE  BASIC AND DILUTED
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.10
    )
    
    $
    (0.12
    )WEIGHTED-AVERAGE SHARES OUTSTANDING
BASIC AND DILUTED
    
    
    64,433,023
    
    
    
    34,648,490
    
    
    
    50,631,136
    
    
    
    33,845,310
 See accompanying notes to consolidated financial statements.
  4




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DIGITILITI, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Nine Months EndedSeptember 30,2010
    
    
    2009OPERATING ACTIVITIESNet loss
    
    $
    (5,262,644
    )
    
    $
    (4,167,435
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization expense
    
    
    252,497
    
    
    
    526,413Amortization of software licenses
    
    
    222,619
    
    
    
    290,799Beneficial conversion feature on converted notes
    
    
    1,522,950
    
    
    
    977,029Amortization of deferred financing costs
    
    
    39,050
    
    
    
    187,065Amortization of discount on convertible debt
    
    
    324,173
    
    
    
    750,804Loss on extinguishment of debt
    
    
    315,428
    
    
    
    108,187Warrants expense
    
    
    387,067
    
    
    
    302,297Bad debt expense
    
    
    
    
    
    
    20,692Shares issued for services
    
    
    152,340
    
    
    
    Employee stock option expense
    
    
    214,742
    
    
    
    356,940Changes in operating assets and liabilities:Accounts receivable
    
    
    45,685
    
    
    
    (60,947
    )Prepaid and other current assets
    
    
    78,805
    
    
    
    49,510Other assets
    
    
    1,000
    
    
    
    Accounts payable
    
    
    139,590
    
    
    
    202,028Accounts payable  related parties
    
    
    (7,861
    )
    
    
    12,902Accrued expenses
    
    
    203,060
    
    
    
    330,448Deferred income
    
    
    14,486
    
    
    
    Deferred rent
    
    
    (7,188
    )
    
    
    (4,956
    )Net cash used in operating activities
    
    
    (1,364,201
    )
    
    
    (118,221
    )INVESTING ACTIVITIESPurchase of property and equipment
    
    
    (47,794
    )
    
    
    (29,678
    )Purchase of software license
    
    
    (19,282
    )
    
    
    Net cash used in investing activities
    
    
    (67,076
    )
    
    
    (29,678
    )FINANCING ACTIVITIESProceeds from sale of common stock, net of issuance costs
    
    
    1,199,050
    
    
    
    Proceeds from the exercise of warrants
    
    
    509,900
    
    
    
    Proceeds
from issuance of Series B Convertible Preferred Stock
    
    
    300,000
    
    
    
    Proceeds from note payable
    
    
    
    
    
    
    287,197Proceeds from issuance of convertible debt
    
    
    
    
    
    
    630,000Financing costs
    
    
    
    
    
    
    (54,500
    )Payments on capital lease obligations
    
    
    (35,537
    )
    
    
    (352,678
    )Payments on notes payable  related parties
    
    
    
    
    
    
    (2,000
    )Payments on notes payable
    
    
    (364,572
    )
    
    
    (279,572
    )Payments on convertible notes
    
    
    (95,000
    )
    
    
    Net cash provided by financing activities
    
    
    1,513,841
    
    
    
    228,447
  5




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##### Table of Contents



DIGITILITI, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
  Nine Months EndedSeptember 30,2010
    
    
    2009NET INCREASE IN CASH
    
    
    82,564
    
    
    
    80,548CASH AT BEGINNING OF PERIOD
    
    
    141,086
    
    
    
    36,317CASH AT END OF PERIOD
    
    $
    223,650
    
    
    $
    116,865Supplemental Cash Flow InformationCash paid for interest
    
    $
    75,094
    
    
    $
    59,802Cash paid for income taxes
    
    
    
    
    
    
    Non-Cash Financing and Investing ActivitiesCommon stock issued for debt and accrued interest
    
    
    3,265,973
    
    
    
    Preferred stock issued for debt and accrued interest
    
    
    724,187
    
    
    
    Common stock issued for liabilities
    
    
    12,879
    
    
    
    Notes payable issued for addition to property and maintenance
fees
    
    
    56,634
    
    
    
    Accrued interest converted to debt principal
    
    
    21,107
    
    
    
    Equipment acquired under capital lease
    
    
    
    
    
    
    8,230Notes payable issued to acquire software
    
    
    
    
    
    
    104,025Shares issued for accrued interest on convertible debt
    
    
    
    
    
    
    335,503Shares issued for convertible debt
    
    
    
    
    
    
    2,312,700Reclassification of related party debt to non-related party debt
    
    
   
    
    
    
    857,484Discount on convertible debt
    
    
    
    
    
    
    237,163
 See accompanying notes to consolidated financial statements.
  6




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DIGITILITI, INC.
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 (UNAUDITED)
 1. Basis of Presentation and Accounting Policies
  Correction of a Prior Period
    Three months ended September 30, 2009As
Previously 
Reported
    
    
    Adjustments
    
    
    As RevisedGeneral
& administrative
    
    $
    (320,413
    )
    
    $
    (39,351
    )
    
    $
    (359,764
    )Total operating expenses
    
    $
    (588,963
    )
    
    $
    (39,351
    )
    
    $
    (628,314
    )Net loss from operations
    
    $
    (321,436
    )
    
    $
    (39,351
    )
    
    $
    (360,787
    )Net loss
    
    $
    (655,840
    )
    
    $
    (39,351
    )
    
    $
    (695,191
    )Net loss per share  Basic and Diluted
    
    $
    (0.02
    )
    
    
    
    
    
    $
    (0.02
    )Weighted-Average shares outstanding  Basic and Diluted
    
    
    34,648,490
    
    
    
    
    
    
    
    34,648,490
  7




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##### Table of Contents



Nine months ended September 30, 2009As
Previously 
Reported
    
    
    Adjustments
    
    
    As RevisedGeneral
& administrative
    
    $
    (1,534,336
    )
    
    $
    (192,165
    )
    
    $
    (1,726,501
    )Total operating expenses
    
    $
    (2,341,094
    )
    
    $
    (192,165
    )
    
    $
    (2,533,259
    )Net loss from operations
    
    $
    (1,360,142
    )
    
    $
    (192,165
    )
    
    $
    (1,552,307
    )Net loss
    
    $
    (3,975,270
    )
    
    $
    (192,165
    )
    
    $
    (4,167,435
    )Net loss per share  Basic and Diluted
    
    $
    (0.12
    )
    
    
    
    
    
    $
    (0.12
    )Weighted-Average shares outstanding  Basic and Diluted
    
    
    33,845,310
    
    
    
    
    
    
    
    33,845,310
  Software Revenue Recognition
      Reclassifications
   8




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##### Table of Contents



New Accounting Pronouncements
  (i)
    
    provide updated guidance on whether multiple deliverables exist, how
the deliverables in an arrangement should be separated, and how the
consideration should be allocated;(ii)
    
    require an entity to allocate revenue in an arrangement using
estimated selling prices (ESP) of deliverables if a vendor does not
have vendor-specific objective evidence of selling price (VSOE) or
third-party evidence of selling price (TPE);(iii)
    
    eliminate the use of the residual method and require an entity to
allocate revenue using the relative selling price method; and(iv)
    
    expand the disclosure requirements to require an entity to provide
both qualitative and quantitative information about the significant
judgments made in applying the revised guidance and subsequent
changes in those judgments that may significantly affect the timing
or amount of revenue recognition.
    2. Going Concern
    9




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3. Notes Payable
  4. Convertible Debt
        10




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##### Table of Contents



Convertible debt at December 31, 2009
    
    $
    3,679,273Less: principal payments
    
    
    (95,000
    )Less: principal converted to equity
    
    
    (3,187,300
    )Add: write-off of discount
    
    
    243,715Add: Amortization of discount
    
    
    134,842Subtotal
    
    $
    775,530Less: current maturities
    
    
    (525,530
    )Long-term portion of convertible debt
    
    $
    250,000
  5. Equity
      a)
    
    The Companys common stock trades at $0.60 per share for more than 10 consecutive days;
 b)
    
    The Company conducts a capital raise of common stock at a price of at least $0.50 per
share and raises at least $5 million of gross proceeds; or
 c)
    
    At least 2/3 of the authorized shares of the Series A Convertible Preferred Stock have
been converted to common shares.
  11




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##### Table of Contents



a)
    
    The Companys common stock trades at $1.00 per share for more than 20 consecutive days;
 b)
    
    The Company conducts a capital raise of common stock at a price of at least $0.50 per
share and raises at least $5 million of gross proceeds; or
 c)
    
    At least 2/3 of the authorized shares of the Series B Convertible Preferred Stock have
been converted to common shares.
 6. Stock Options
    WeightedWeighted-
    
    
    AverageAverage
    
    
    RemainingOptions
    
    
    Exercise Price
    
    
    Life (yrs)Outstanding at December 31, 2009
    
    
    2,370,000
    
    
    
    0.37Granted
    
    
    100,000
    
    
    
    0.35Canceled
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding at September 30,2010
    
    
    2,470,000
    
    
    
    0.37
    
    
    
    3.3Exercisable at September 30, 2010
    
    
    1,638,153
    
    
    
    0.36
    
    
    
    3.1
  7. Stock Warrants
    12




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WeightedWeighted-
    
    
    AverageAverage
    
    
    RemainingWarrants
    
    
    Exercise Price
    
    
    Life (yrs)Outstanding at December 31, 2009
    
    
    9,510,348
    
    
    
    0.79Granted
    
    
    2,040,000
    
    
    
    0.36Exercise
    
    
    (2,549,500
    )
    
    
    0.92Forfeited
    
    
    (817,500
    )
    
    
    0.57Outstanding at September 30, 2010
    
    
    8,183,348
    
    
    
    0.67
    
    
    
    3.68Exercisable
    
    
    8,183,348
    
    
    
    0.67
    
    
    
    3.68
  8. Commitments and Contingencies
   13




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9. Subsequent Events
    1.
    
    250,000 warrants with a five-year life and a $0.35 per share exercise price as a
result of the successful launch of the Companys DigiLIBE product prior to March 31,
2010. These warrants will vest on January 14, 2011, and have a fair value of $55,000,
as calculated using the Black-Scholes option pricing model. Variables used in the
Black-Scholes option-pricing model for the warrants included: (1) discount rate of
1.18%, (2) expected life of five years, (3) expected volatility of 443% and (4) zero
expected dividends.
 2.
    
    250,000 warrants with a five-year life and an exercise price of $0.22
for raising $2.35M of
capital prior to June 30, 2010. These warrants will vest on December 1, 2010,
if the Company raises $1.3 million in additional capital as of November 30, 2010, and have a
fair value of $55,000, as calculated using the Black-Scholes option pricing model.
Variables used in the Black-Scholes option-pricing model for the warrants included: (1)
discount rate of 1.18%, (2) expected life of five years, (3) expected volatility of
443% and (4) zero expected dividends.
  14




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3.
    
    250,000 warrants with a five-year life and an exercise price of $0.22 for his assistance in
facilitating a new CEO transition, along with his continued assistance in providing
technical advice and investor relations expertise. These warrants will vest on January
14, 2011, and have a fair value of $55,000, as calculated using the Black-Scholes
option pricing model. Variables used in the Black-Scholes option-pricing model for the
warrants included: (1) discount rate of 1.18%, (2) expected life of five years, (3)
expected volatility of 443% and (4) zero expected dividends.
  1.
    
    2010 Long-Term Incentive
Plan. As a result, the Companys Board of Directors approved the grant to each non-employee
directors of 5,000 options. The issuance of these options occurred automatically as part of the provisions of the incentive plan.
 2.
    
    Amendment of the Companys Certificate of Incorporation to increase the number of
authorized shares from 110,000,000 to 135,000,000 shares and allocate the additional shares
to common stock.
   15




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Item 2. Managements Discussions and Analysis of Financial Condition and Results of Operations.
 Forward-looking Statements
    Executive Summary
 The Business
    The DigiBak legacy business
   16




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The Emerging New DigiLIBE Product
  Growing both Business Segments:
  (i)
    
    to solve a major industry and customer problem of managing continually growing
information volume and associated cost of storage and retrieval;
 (ii)
    
    to be able to access a larger share of opportunity in the information management
storage business;
 (iii)
    
    to offer significant technological advantages in corporate policy level control of
information and ability to leverage knowledge from the information it creates; and
 (iv)
    
    to optimize how we synergistically allocate capital and resources between both
business.
   17




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##### Table of Contents



Intellectual Property Protection
  The Market and Resellers
 nd rd
 Company Funding
    1.
    
    A $2,000,000 equity offering initiated in October 2009 and closed in May 2010.
This equity offering originally reflected a maximum offering of $1,000,000, but was
increased to $1,500,000 during the first quarter of 2010 and increased again to
$2,000,000 in April 2010. This equity round of financing offered shares of our common
stock at $0.20 per share and was closed in May 2010 resulting in $1,715,550 in equity
proceeds through the issuance of 9,290,000 common shares.
 2.
    
    The Company conducted an equity offering of Series B Convertible Preferred
Stock reflecting a $1.00 par value that is convertible into 5 shares of the Companys
common stock. On September 29, 2010, the Company closed on the sale of $300,000 worth
of Series B Convertible Preferred Stock.
  18




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##### Table of Contents



1.
    
    $2,537,300 of unsecured debt
plus accrued interest of $728,672 associated with the $5.5
million offering was converted into 16,329,869 common shares, and
 2.
    
    2,549,500 warrants were exercised into an equal number of common shares providing for
$509,900 of additional equity proceeds, and
 3.
    
    $650,000 of secured debt
plus accrued interest of $74,186 were converted into 724,187
Series A convertible preferred shares.
  Liquidity and Capital Resources
     19




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Results of Operations
 For the 3 month periods ended September 30, 2010 and 2009
      20




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For the 9 month periods ended September 30, 2010 and 2009
   rd
   21




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Off-Balance Sheet Arrangements
   22




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Item 4T. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
   Changes in internal control over financial reporting
   23




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PART II  OTHER INFORMATION
 Item 2.
Unregistered Sales of Equity Securities and use of Proceeds.
  **
    
    (See Financial footnote 5-must disclose each sale/issuance in lieu of paying for services that occurred in 3rd Q not disclosed in an
8-K) so may need to add more as necessary).
  
 Item 3. Defaults Upon Senior Securities.
   
 Item 5. Other Information.
      24




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Item 6. Exhibits.
   25




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SIGNATURES
  Digitiliti, Inc.Date:      November 12, 2010
    By:
    /s/ Ehssan TaghizadehEhssan Taghizadeh President and CEODate:      November 12, 2010
    By:
    /s/ William McDonaldWilliam McDonald, CFO  26




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INDEX TO EXHIBITS
 Exhibit No.
    
    Description of Exhibit3.1
    
    
    Amended and Restated Certificate of Incorporation filed with the Secretary of State
of Delaware on May 18, 2008 (incorporated by reference to Exhibit 3.5 to the
registrants form 10-K filed with the Commission on May 1, 2009)3.2
    
    
    Certificate of Designation for Series A Convertible Preferred Stock filed with the
Secretary of State of Delaware on June 30, 2010 (incorporated by reference to
Exhibit 4.1 to the Form 8-K filed with the Commission on July 7, 2010)3.3
    *
    
    Certificate of Amendment of Certificate of Incorporation filed with the Secretary
of State of Delaware on October 20, 20103.4
    *
    
    Certificate of Designation for Series B Convertible Preferred Stock filed with the
Secretary of State of Delaware on November 10, 201010.1
    *
    
    Form of Non-Qualified Stock Option Agreement under the 2010 Long-Term Incentive Plan.10.2
    *
    
    Form of Incentive Stock Option Agreement under the 2010 Long-Term Incentive Plan.10.3
    *
    
    Form of Initial Grant Director Non-Qualified Stock Option Agreement under the 2010
Long-Term Incentive Plan.10.4
    *
    
    Form of Additional Grant Director Non-Qualified Stock Option Agreement under the
2010 Long-Term incentive Plan.10.5
    *
    
    Form of Restricted Stock Award Agreement under the 2010 Long-Term Incentive Plan.31.1
    *
    
    302 Certification of CEO, Ehssan Taghizadeh31.2
    *
    
    302 Certification of CFO, William McDonald32.1
    *
    
    906 Certification
 *
    
    Filed herewith  27