##### 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 June 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 
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 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
 þ o
 Rule 12b-2
 Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ(Do not check if smaller reporting company)
 o þ
  Class
    
    Outstanding at August 13, 2010Common Stock, $.001 par value per share
    
    64,745,000 shares




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##### 



PagePART I  Financial InformationItem 1. Financial Statements (unaudited):
    
    
    3Consolidated Balance Sheets  As of June 30, 2010 and December 31, 2009
    
    
    3Consolidated Statements of Operations  Three and Six months ended June 30, 2010 and 2009
    
    
    4Consolidated Statements of Cash Flows  Six months ended June 30, 2010 and 2009
    
    
    5Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 4T. Controls and Procedures
    
    
    24PART II  Other InformationItem 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 3. Defaults Upon Senior Securities
    
    
    25Item 6. Exhibits
    
    
    25Signatures
    
    
    26CertificationsExhibit 4.1Exhibit 4.2Exhibit 31.1Exhibit 31.2Exhibit 32.1
   2




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Item 1. Financial Statements
 DIGITILITI, INC.
 
 CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
 June 30,
    
    
    December 31,2010
    
    
    2009ASSETSCurrent AssetsCash
    
    $
    455,140
    
    
    $
    141,086Accounts receivable
    
    
    431,562
    
    
    
    484,203Prepaid and other current assets
    
    
    157,265
    
    
    
    220,304Total current assets
    
    
    1,043,967
    
    
    
    845,593Property and equipment, net
    
    
    318,403
    
    
    
    444,675Software license, net
    
    
    569,405
    
    
    
    713,199Deferred financing costs
    
    
    8,869
    
    
    
    113,334Other assets
    
    
    7,322
    
    
    
    7,322Total assets
    
    $
    1,947,966
    
    
    $
    2,124,123LIABILITIES AND STOCKHOLDERS DEFICITLIABILITIESCurrent LiabilitiesAccounts payable
    
    $
    444,256
    
    
    $
    436,389Accounts payable  related parties
    
    
    
    
    
    
    7,861Accrued expenses
    
    
    711,481
    
    
    
    1,222,143Notes payable
    
    
    231,540
    
    
    
    518,371Current maturities of convertible debt
    
    
    572,179
    
    
    
    2,032,771Deferred income
    
    
    10,722
    
    
    
    Current maturities of capital lease obligations
    
    
    44,923
    
    
    
    45,819Total current liabilities
    
    
    2,015,101
    
    
    
    4,263,354Other LiabilitiesConvertible debt, non-current
    
    
    271,383
    
    
    
    1,646,502Capital lease obligations, non-current
    
    
    
    
    
    
    24,043Deferred rent
    
    
    6,760
    
    
    
    11,552Other liabilities
    
    
    3,607
    
    
    
    3,607Total liabilities
    
    
    2,296,851
    
    
    
    5,949,058STOCKHOLDERS DEFICITSeries A
Convertible Preferred Stock, $0.001 par value; 1,200,000
shares authorized, 723,895 shares issued and outstanding
    
    
    724
    
    
    
    Common stock, $.001 par value; 100,000,000 shares authorized, 64,209,298 and 38,808,736 shares issued and outstanding,
respectively
    
    
    64,210
    
    
    
    38,809Additional paid-in capital
    
    
    23,286,621
    
    
    
    15,448,392Accumulated deficit
    
    
    (23,700,440
    )
    
    
    (19,312,136
    )Total stockholders deficit
    
    
    (348,885
    )
    
    
    (3,824,935
    )Total liabilities and stockholders deficit
    
    $
    1,947,966
    
    
    $
    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
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009RestatedREVENUES
    
    $
    539,007
    
    
    $
    859,669
    
    
    $
    1,164,134
    
    
    $
    1,719,948COST OF REVENUES
    
    
    378,397
    
    
    
    544,118
    
    
    
    680,368
    
    
    
    1,006,523GROSS PROFIT
    
    
    160,610
    
    
    
    315,551
    
    
    
    483,766
    
    
    
    713,425OPERATING EXPENSESSelling and marketing
    
    
    201,285
    
    
    
    118,578
    
    
    
    376,578
    
    
    
    205,329General and administrative
    
    
    1,078,605
    
    
    
    621,349
    
    
    
    1,537,236
    
    
    
    1,213,923Research and development
    
    
    262,241
    
    
    
    242,372
    
    
    
    531,983
    
    
    
    332,879Total operating expenses
    
    
    1,542,131
    
    
    
    982,299
    
    
    
    2,445,797
    
    
    
    1,752,131LOSS FROM OPERATIONS
    
    
    (1,381,521
    )
    
    
    (666,748
    )
    
    
    (1,962,031
    )
    
    
    (1,038,706
    )OTHER EXPENSESLoss on extinguishment of debt
    
    
    (318,294
    )
    
    
    
    
    
    
    (318,294
    )
    
    
    Interest expense
    
    
    (1,879,849
    )
    
    
    (290,477
    )
    
    
    (2,107,979
    )
    
    
    (2,280,724
    )Total other expenses
    
    
    (2,198,143
    )
    
    
    (290,477
    )
    
    
    (2,426,273
    )
    
    
    (2,280,724
    )NET LOSS
    
    $
    (3,579,664
    )
    
    $
    (957,225
    )
    
    $
    (4,388,304
    )
    
    $
    (3,319,430
    )NET LOSS PER SHARE  BASIC AND DILUTED
    
    $
    (0.08
    )
    
    $
    (0.03
    )
    
    $
    (0.10
    )
    
    $
    (0.10
    )WEIGHTED-AVERAGE SHARES OUTSTANDING
BASIC AND DILUTED
    
    
    45,663,981
    
    
    
    34,231,316
    
    
    
    43,503,332
    
    
    
    33,437,064
 See accompanying notes to consolidated financial statements.
  4




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DIGITILITI, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 Six Months EndedJune 30,2010
    
    
    2009OPERATING ACTIVITIESNet loss
    
    $
    (4,388,304
    )
    
    $
    (3,319,430
    )Adjustments to reconcile net loss to net cash used by
operating activities:Depreciation expense
    
    
    166,868
    
    
    
    376,335Amortization of software licenses
    
    
    149,332
    
    
    
    193,866Beneficial conversion feature on converted notes
    
    
    1,478,707
    
    
    
    977,029Amortization of deferred financing costs
    
    
    36,849
    
    
    
    140,879Amortization of discount on convertible debt
    
    
    317,205
    
    
    
    751,058Loss on extinguishment of debt
    
    
    318,294
    
    
    
    Warrants expense
    
    
    387,959
    
    
    
    266,717Bad debt expense
    
    
    
    
    
    
    20,692Shares issued for services
    
    
    113,495
    
    
    
    Employee stock option expense
    
    
    68,342
    
    
    
    108,784Changes in operating assets and liabilities:Accounts receivable
    
    
    52,641
    
    
    
    (107,392
    )Prepaid and other current assets
    
    
    63,039
    
    
    
    995Accounts payable
    
    
    75,928
    
    
    
    122,635Accrued expenses
    
    
    291,325
    
    
    
    278,826Due to related parties
    
    
    (7,861
    )
    
    
    3,668Deferred income
    
    
    10,722
    
    
    
    Deferred rent
    
    
    (4,792
    )
    
    
    (3,334
    )Net cash used in operating activities
    
    
    (870,251
    )
    
    
    (188,672
    )INVESTING ACTIVITIESPurchase of property and equipment
    
    
    (40,596
    )
    
    
    Purchase of software license
    
    
    (5,538
    )
    
    
    (5,880
    )Net cash used in investing activities
    
    
    (46,134
    )
    
    
    (5,880
    )FINANCING ACTIVITIESProceeds from issuance of convertible debt
    
    
    
    
    
    
    350,000Financing costs
    
    
    
    
    
    
    (35,000
    )Proceeds from sale of common stock, net of issuance costs
    
    
    1,214,050
    
    
    
    Proceeds from the exercise of warrants
    
    
    500,900
    
    
    
    Payments on capital lease obligations
    
    
    (24,939
    )
    
    
    (225,655
    )Proceeds from notes payable  related parties
    
    
    
    
    
    
    75,000Proceeds from note payable
    
    
    
    
    
    
    165,197Payments on notes payable
    
    
    (364,572
    )
    
    
    (139,572
    )Payments on convertible notes
    
    
    (95,000
    )
    
    
    Net cash provided by financing activities
    
    
    1,230,439
    
    
    
    189,970
  5




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DIGITILITI, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 Six Months EndedJune 30,2010
    
    
    2009NET INCREASE (DECREASE) IN CASH
    
    
    314,054
    
    
    
    (4,582
    )CASH AT BEGINNING OF PERIOD
    
    
    141,086
    
    
    
    36,317CASH AT END OF PERIOD
    
    $
    455,140
    
    
    $
    31,735Supplemental Cash Flow InformationCash paid for interest
    
    $
    56,842
    
    
    $
    44,307Cash paid for income taxes
    
    
    
    
    
    
    Non-Cash Financing and Investing ActivitiesNotes 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
    
    
    
    
    
    
    104,025Common stock issued for debt and accrued interest
    
    
    3,167,833
    
    
    
    2,648,203Preferred stock issued for debt and accrued interest
    
    
    723,895
    
    
    
    Common stock issued for liabilities
    
    
    12,879
    
    
    
    Discount on convertible debt
    
    
    
    
    
    
    212,852
 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
  Restatement of Prior Period
  The six months ended June 30, 2009:
 As previouslyReported
    
    
    Adjustments
    
    
    AdjustedInterest expense
    
    $
    1,509,271
    
    
    $
    771,453
    
    
    $
    2,280,724Net loss
    
    $
    2,547,977
    
    
    $
    771,453
    
    
    
    3,319,430Loss per share  Basic and diluted
    
    
    0.08
    
    
    
    0.02
    
    
    
    0.10
 Software Revenue Recognition
     7




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Reclassifications
  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.
     8




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2. Going Concern
   3. Notes Payable
  4. Convertible Debt
      9




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Convertible debt at December 31, 2009
    
    $
    3,679,273Less: principal payments
    
    
    (95,000
    )Less: principal converted to equity
    
    
    (3,112,300
    )Add: write-off of discount
    
    
    236,747Add: Amortization of discount
    
    
    134,842Subtotal
    
    $
    843,562Less: current maturities
    
    
    (572,179
    )Long-term portion of convertible debt
    
    $
    271,383
 5. Equity
      10




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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.
 6. Stock Options
    WeightedWeighted-
    
    
    AverageAverage
    
    
    RemainingOptions
    
    
    Exercise Price
    
    
    Life (yrs)Outstanding at December 31, 2009
    
    
    1,845,000
    
    
    
    0.37Granted
    
    
    100,000
    
    
    
    0.35Canceled
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding at June 30,2010
    
    
    1,945,000
    
    
    
    0.37
    
    
    
    3.7Exercisable at June 30, 2010
    
    
    1,035,265
    
    
    
    0.37
    
    
    
    3.6
  7. Stock Warrants
    11




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WeightedWeighted-
    
    
    AverageAverage
    
    
    RemainingWarrants
    
    
    Exercise Price
    
    
    Life (yrs)Outstanding at December 31, 2009
    
    
    9,510,348
    
    
    
    0.79Granted
    
    
    1,940,000
    
    
    
    0.36Exercised
    
    
    (2,504,500
    )
    
    
    0.92Forfeited
    
    
    (592,500
    )
    
    
    0.62Outstanding at June 30, 2010
    
    
    8,353,348
    
    
    
    0.67
    
    
    
    3.93Exercisable
    
    
    8,103,348
    
    
    
    0.67
    
    
    
    3.92
  8. Commitments and Contingencies
    12




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9. Subsequent Events
  1.
    
    $75,000 of unsecured debt
plus accrued interest of $23,140 was converted into 490,702
common shares,
 2.
    
    45,000 warrants were exercised into an equal number of common shares providing for
$9,000 of additional equity proceeds, and
 3.
    
    $25,000 of secured debt plus accrued interest of $3,367 was converted into 28,367
Series A Convertible Preferred shares.
   13




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Item 2. Managements Discussions and Analysis of Financial Condition and Results of Operations.
 Forward-looking Statements
    Plan of Operation
 The Business
   
    
    Organizations want to be able to govern their information;
 
    
    People want to be able to access their information;
 
    
    People and organizations want to be able to leverage the content of the information
stored at the company, even if it is archived;
 
    
    People and organizations want to be able to put disparate pieces of content together
in a context that can be used to advantage; and
 
    
    People and organizations want to be able to do this simply and inexpensively.
   14




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The DigiBak legacy business
  
    
    XO Communications Level 5 RAID System Data Center;
 
    
    High performance fiber channel and iSCSI RAID Systems or Arrays (ìRAID
Systemsî);
 
    
    Foundry Networks Fast Iron Gigabit Ethernet Switches;
 
    
    Qlogic fiber channel switches and iSCSI adapters;
 
    
    Dell Power Edge servers;
 
    
    N+1 Grid Architecture for backup;
 
    
    Diesel powered generators to protect against power outages;
 
    
    Unlimited bandwidth to grow;
and
 
    
    Exanet Global Files System and IBM DS4100 RAID Systems.
      15




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The Emerging New DigiLibe Product
   (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.
  16




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Intellectual Property Protection
  The Market and Resellers
 nd
   17




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Internal Operations and Capabilities
        1.
    
    A $5.5 million offering of 12% convertible notes initiated in March 2007 and
completed in September 2008,
 2.
    
    A $250,000 convertible note
dated October 16, 2008, that reflected a 12% interest rate
issued to a shareholder,
 3.
    
    A $250,000 convertible note
dated November 11, 2008, that reflected a 12% interest rate
issued to a shareholder,
 4.
    
    A $750,000 offering of 12% secured convertible notes initiated in April 2009
and completed in October 2009, and
 5.
    
    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.
   18




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1.
    
    $2,607,700 of debt converted under terms of our Modification Proposal, and2.
    
    $2,184,500 of debt extended under terms of our Modification Proposal, and3.
    
    $707,800 of debt that remained unchanged and reflected the original terms of issuance.
     1.
    
    $2,462,300 of unsecured debt plus accrued interest of $705,532 associated with the $5.5
million offering was converted into 15,839,167 common shares, and
 2.
    
    2,504,500 warrants were exercised into an equal number of common shares providing for
$500,900 of additional equity proceeds, and
 3.
    
    $650,000 of secured debt plus accrued interest of $73,895 were converted into 723,895
Series A convertible preferred shares.
  4.
    
    $75,000 of unsecured debt
plus accrued interest of $23,140 associated with the $5.5
million offering was converted into 490,702 common shares, and
 5.
    
    45,000 warrants were exercised into an equal number of common shares providing for
$9,000 of additional equity proceeds, and
 6.
    
    $25,000 of secured debt plus accrued interest of $3,367 were converted into 28,367
Series A convertible preferred shares.
   19




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Liquidity and Capital Resources
       Results of Operations
 For the 3 month periods ended June 30, 2010 and 2009
   20




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21




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For the 6 month periods ended June 30, 2010 and 2009
       22




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Off-Balance Sheet Arrangements
   23




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Item 4T. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
   Changes in internal control over financial reporting
   24




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PART II  OTHER INFORMATION
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
  
 Item 3. Defaults Upon Senior Securities.
  Item 5. Other Information.
 
 Item 6. Exhibits.
   25




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SIGNATURES
  Digitiliti, Inc.Date:      August 16, 2010
    By:
    /s/ Roy A. BauerRoy A. Bauer, President, CEODate:      August 16, 2010
    By:
    /s/ William McDonaldWilliam McDonald, CFO  26




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INDEX TO EXHIBITS
 Exhibit No.
    
    Description of Exhibit4.1
    
    
    Subscription Agreement pertaining to conversion of debt and exercise of warrants under Incentive Offer4.2
    
    
    Subscription Agreement pertaining to exercise of warrants under Incentive Offer31.1
    
    
    302 Certification of CEO, Roy A. Bauer31.2
    
    
    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).
  27