SideChannel, Inc. 10-K

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock is traded on the over-the-counter market and quoted on the OTCQB Venture Market run by OTC Markets Group under the symbol “CLOK.” As of December 23, 2020, there were 27,505,196 shares of common stock of the Company issued and outstanding, and there were 1,121 holders of the Company’s common stock. The actual number of holders of our common stock is greater than this number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers or held by other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities. Dividends We did not declare any dividends for the year ended September 30, 2020. Our Board of Directors does not intend to declare dividends in the foreseeable future. The declaration, payment, and amount of any future dividends will be made at the discretion our Board of Directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors as the Board of Directors considers relevant. There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend. Transfer Agent The Transfer Agent and Registrar for our common stock is Pacific Stock Transfer Company located in Las Vegas, Nevada. Recent Sales of Unregistered Securities Stock Issued for Cash During the year ended September 30, 2020, there was no stock issued for cash. Stock and Stock Options Issued to Board of Directors and Officers During the year ended September 30, 2020, the Company issued 620,000 stock options to employees that were subsequently forfeited due to employee terminations. Stock compensation expense for $194,896 was recognized in the period. During the year ended September 30, 2019, the Company issued 9,346 shares of common stock with a fair value of $11,216 to its employees as part of their compensation. The Company also issued 1,100,000 stock options to members of the board of directors and officers with a Black Scholes value of $862,000 to vest ratably over a three-year period. Stock compensation expense for $45,942 was recognized in the period. During the year ended September 30, 2020, 300,000 stock options were cancelled due to the termination of employment. As of September 30, 2020, 800,000 stock options are outstanding. None of the shares are in the money and the unamortized amount of stock compensation as of September 30, 2020 is $383,453. Stock Issued for Services During the year ended September 30,2020, the Company did not issue any stock for services. During the year ended September 30, 2019, the Company issued 20,000 shares of common stock with a fair value of $40,000 to a consultant for consulting services rendered. The foregoing offers, sales and issuances were exempt from registration under Section 4(a)(2) of the Securities Act. ITEM 6. SELECTED FINANCIAL DATA The Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined in Rule 229.10(f)(1). 8 ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing elsewhere in this Annual Report on Form 10-K. Our Business We are developing products and services around our patented polymorphic encryption technology designed to enable a more efficient and stronger layer of protection to be added to existing solutions. Through a licensing program, we anticipate offering the first secure commercially viable advanced “Polymorphic Encryption Core” (“PEC”) software developers kit to be used in any commercial data security industry and/or in sensitive applications. Our innovative and patented polymorphic technology eliminates the flaws and inadequacies associated with today’s encryption algorithms. Instead of dealing with large monolithic blocks of data, our approach decomposes the information to be protected into multiple segments. These individual segments each have a unique encryption key, utilize different encryption algorithms, are randomly grouped into different lengths, and can be further re-encrypted. Since segments are independent from each other and are individually protected, our technology is not susceptible to computational attacks. In fact, the strength of our technology improves as compute power increases. Critical Accounting Policies Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions. The methods, estimates, and judgment we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The SEC has defined “critical accounting policies” as those accounting policies that are most important to the portrayal of our financial condition and results and require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based upon this definition, our most critical estimates are accounting for convertible debt and embedded derivatives, software revenue recognition, and stock issued to employees and non-employees. Our most critical accounting policies applicable to the periods presented are noted below. For additional information see Note 2, “Significant Accounting Policies” in the notes to our financial statements appearing elsewhere in this report. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available, and actual results may differ significantly from these estimates. Our critical accounting policies and estimates are those related to revenue recognition, deferred income taxes, accounting for share-based payments, and litigation. Revenue Recognition . We adopted the new accounting revenue standard for revenue recognition effective October 1, 2018 using the modified retrospective transition method applied to those contracts which were not completed as of October 1, 2018. Results for reporting periods beginning after October 1, 2018 are presented under this new guidance, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under previous revenue guidance. See Note (1) Summary of Significant Accounting Policies. The Company’s contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. 9 Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. For products and services aside from maintenance and support, the Company estimates SSP by adjusting the list price by historical discount percentages. SSP for software and hardware maintenance and support fees is based on the stated percentages of the fees charged for the respective products. The Company’s perpetual and term software licenses have significant standalone functionality and therefore revenue allocated to these performance obligations are recognized at a point in time upon electronic delivery of the download link and the license keys. For certain arrangements revenue is recognized based on usage or ratably over the term of the arrangement. Product maintenance and support services are satisfied over time as they are stand-ready obligations throughout the support period. As a result, revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract. Revenues associated with professional services are recognized at a point in time upon customer acceptance. Accounting for Share-Based Payments . As discussed further in Note (10) Share-Based Payment Arrangements , to our consolidated financial statements, we account for share-based awards in accordance with the authoritative guidance issued by the FASB on stock compensation. We have used and expect to continue to use the Black-Scholes option-pricing model to compute the estimated fair value of share-based compensation expense. The Black-Scholes option-pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of share-based compensation expense reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility based primarily on historical daily price changes of our stock and other factors. The expected option term is the number of years that we estimate that the stock options will be outstanding prior to exercise. The estimated expected term of the stock awards issued has been determined pursuant to SEC Staff Accounting Bulletin SAB No. 110. If other assumptions or estimates had been used, the share-based compensation expense that was recorded for the years ended September 30, 2019 and 2018 could have been materially different. Furthermore, if different assumptions or estimates are used in future periods, share-based compensation expense could be materially impacted in the future. Under ASC 718-20-35-7, Repurchase or Cancellation of equity awards, the amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of the instruments repurchased shall be recognized as additional compensation cost. 10 Results of Operations Fiscal Year Ended September 30, 2020 Compared to Fiscal Year Ended September 30, 2019 Revenue increased to $47,983 for the year ended September 30, 2020 from $46,600 for the year ended September 30, 2019. There was no cost of revenues for the years ended September 30, 2020 or September 30, 2019. General and administrative expenses increased to $4,573,673 for the year ended September 30, 2020 from $3,372,047 for the year ended September 30, 2019. The increases in general and administrative expenses primarily resulted from higher legal expenses of $1,043,820, an impairment loss related to the operating leases of $382,962, increase in stock compensation of $153,355 , an increase in corporate insurance of $142,197 and an increase in salary expense of $101,099 offset by decrease in payroll taxes of $236,369 along with, the decrease in miscellaneous expense over last year that included payments totaling $416,000 to Quality Healthcare International, Inc. (“QHI”) and Noun Energy. Sales and marketing expenses decreased to $710,595 for the year ended September 30, 2020 from $1,772,197 for the year ended September 30, 2019. Sales and marketing expenses decreased primarily due to non-recurring payments made to Ageos during 2019 to hire individual sales consultants under contract with the Company for $1,217,072 and a decrease in travel related costs of $49,559 offset by an increase in salary expense of $205,029. Research and development expenses decreased to $1,689,455 for the year ended September 30, 2020 from $1,744,480 for the year ended September 30, 2019. Research and development expenses decreased primarily as a result lower salary expense of $604,489, a decrease in stock compensation of $15,615 offset by an increase in consulting expense of $565,079 Total other expenses, net, increased to $44,332 for the year ended September 30, 2020 from $8,101 for the year ended September 30, 2019. The increase is a result of losses on the disposal of fixed assets. Liquidity and Capital Resources We had an accumulated deficit as of September 30, 2020 of $68,426,608. We expect to generate continued operating losses until we generate revenues sufficient to exceed our operating expenses. At September 30, 2020, we had $1,079,839 in cash. We do not believe that our existing cash balances are sufficient to fund future operations for the next 12 months. We are considering options to issue additional equity as a means to increase liquidity sufficient to fund operations through December 31, 2021. 11 Cash Flows The following table summarizes, for the periods indicated, selected items in our Statements of Cash Flows: Year Ended September 30, 2020 2019 Net cash (used in) provided by: Operating activities $ (6,646,091 ) $ (6,139,815 ) Investing activities $ (28,972 ) $ (37,059 ) Financing activities $ (84,570 ) $ (40,000 ) Operating Activities For the year ended September 30, 2020, cash used in operating activities was $6,646,091, primarily attributable to a net loss of $6,970,072 non-cash items of $640,433 and a net change in net operating assets and liabilities of $316,452. Non-cash items primarily consisted of an impairment loss of $382,961 related to operating leases, stock compensation expense of $194,896, a net loss on disposal of assets of $44,332 and depreciation of $18,243. The change in our net operating assets and liabilities was primarily due to an increase in prepaid and other assets of $322,912 and an increase in accounts payable and accrued liabilities of $6,460. The Company used cash during the year to pay for the cost of general and administrative, sales and marketing, and research and development activities which combined to be $6,973,723. For the year ended September 30, 2019, cash used in operating activities was $6,139,815, primarily attributable to a net loss of $6,834,023, partially offset by the net change in our net operating assets and liabilities of $580,123 and non-cash charges of $114,085. The change in our net operating assets and liabilities was primarily due to an increase in prepaid expenses and other assets of $116,719 and an increase in accounts payable and accrued liabilities of $696,842. Non-cash charges consisted of stock compensation of $57,158, shares issued in exchange for services of $40,000 and depreciation of $16,927. Investing Activities Cash used in investing activities was $28,972 and $37,059, attributable to the purchases of property and equipment for the years ended September 30, 2020 and 2019, respectively. Financing Activities For the year ended September 30, 2020, cash provided by financing activities was $215,430, primarily derived from the proceeds from the PPA loan of $365,430, offset by a payment of $450,000 for the repurchase of treasury stock. For the years ended September 30, 2019, cash used in financing activities was $40,000, was due to a payout related to an oversubscription on a capital raise. Off-Balance Sheet Arrangements We did not have during the periods presented, nor do we currently have, any off-balance sheet arrangements as defined under applicable SEC rules. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined in Rule 229.10(f)(1). 12