SideChannel, Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS CIPHERLOC CORPORATION TABLE OF CONTENTS Page REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 14 FINANCIAL STATEMENTS: Balance Sheets as of September 30, 2020 and 2019 15 Statements of Operations for the years ended September 30, 2020 and 2019 16 Statements of Stockholders’ Equity (Deficit) for the years ended September 30, 2020 and 2019 17 Statements of Cash Flows for the years ended September 30, 2020 and 2019 18 NOTES TO FINANCIAL STATEMENTS 19 13 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Cipherloc Corporation Opinion on the Financial Statements We have audited the accompanying balance sheets of Cipherloc Corporation (the “Company”) as of September 30, 2020 and 2019, and the related statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the two-year period ended September 30, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended, in conformity with accounting principles generally accepted in the United States of America. The Company’s Ability to Continue as a Going Concern The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred recurring losses from its operations, has negative working capital, and a significant accumulated deficit, which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Briggs & Veselka Co. We have served as the Company’s auditor since 2019. Houston, Texas December 28, 2020 14 CIPHERLOC CORPORATION BALANCE SHEETS September 30, 2020 September 30, 2019 ASSETS Current assets Cash $ 1,079,839 $ 7,839,472 Prepaid expenses 258,424 121,371 Total current assets 1,338,263 7,960,843 Other assets 200,000 7,566 Operating lease ROU asset 291,140 — Fixed assets, net — 40,182 Total assets $ 1,829,403 $ 8,008,591 LIABILITIES & STOCKHOLDERS’ EQUITY (DEFICIT) Current liabilities Accounts payable and accrued liabilities $ 840,234 $ 650,681 Accrued compensation 10,000 142,293 Operating lease liability – current portion 132,608 — Paycheck protection program loan – current portion 216,902 — Deferred revenue 15,417 28,400 Total current liabilities 1,215,161 821,374 Paycheck protection program loan – long term 148,528 — Operating lease liability – long-term portion 603,676 — Total liabilities 1,967,365 821,374 Commitments and contingencies Series A convertible preferred stock, $0.01 par value, 1,000,000 shares authorized; 1,000,000 shares issued and outstanding as of September 30, 2020 and September 30, 2019 10,000 10,000 Common stock, $0.01 par value, 681,000,000 shares authorized; 27,505,196 and 40,792,510 shares outstanding; and 40,792,510 and 40,792,510 issued as of September 30, 2020 and September 30, 2019, respectively 407,925 407,925 Treasury stock, at cost 13,287,314 shares (550,000 ) — Additional paid-in capital 68,420,721 68,225,828 Accumulated deficit (68,426,608 ) (61,456,536 ) Total stockholders’ equity (deficit) (137,962 ) 7,187,217 Total liabilities and stockholders’ equity (deficit) $ 1,829,403 $ 8,008,591 The accompanying notes are an integral part of these financial statements. 15 CIPHERLOC CORPORATION STATEMENTS OF OPERATIONS For the Year Ended September 30, 2020 2019 Revenues $ 47,983 $ 46,600 Cost of revenues — — Gross profit 47,983 46,600 Operating expenses: General and administrative 4,573,673 3,372,047 Sales and marketing 710,595 1,772,197 Research and development 1,689,455 1,744,480 Total operating expenses 6,973,723 6,888,724 Operating loss (6,925,740 ) (6,842,124 ) Other (expenses) income: Loss on disposal of asset (44,332) — Interest income, net — 8,101 Total other income, net (44,332 ) 8,101 Net loss $ (6,970,072 ) $ (6,834,023 ) Net loss per common share - Basic and diluted: $ (0.18 ) $ (0.17 ) Weighted average common shares outstanding - Basic and diluted 39,495,185 40,792,510 The accompanying notes are an integral part of these financial statements. 16 CIPHERLOC CORPORATION STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2020 AND 2019 Preferred Stock Common Stock Additional Stockholders’ Shares Amount Shares Issued Amount Treasury Stock Paid-in Capital Accumulated Deficit Equity (Deficit) Balance at, September 30, 2018 1,000,000 $ 10,000 40,743,917 $ 407,438 $ 0 $ 68,169,157 $ (54,622,513 ) $ 13,964,082 Common stock issued to an employee — — 9,346 94 11,122 — 11,216 Stock option expense issued to directors and officers — — — — 45,942 — 45,942 Common stock issued for services — — 20,000 200 39,800 — 40,000 Correction of shares outstanding — — 19,247 193 (193 ) — — Refund of oversubscription — — — — (40,000 ) — (40,000 Net loss — — — — — (6,834,023 ) (6,834,023 ) Balance at September 30, 2019 1,000,000 $ 10,000 40,792,510 $ 407,925 $ 0 $ 68,225,825 $ (61,456,536 ) $ 7,187,217 Stock option expense issued to directors and officers — — — — 194,896 — 194,896 Purchase of treasury stock — — — — $ (550,000 ) — — $ (550,000 ) Net loss — — — — — (6,970,072 ) (6,970,072 ) Balance at September 30, 2020 1,000,000 $ 10,000 40,792,510 $ 407,925 $ (550,000 ) $ 68,420,721 $ (68,426,608 ) $ (137,962 ) The accompanying notes are an integral part of these financial statements. 17 CIPHERLOC CORPORATION STATEMENTS OF CASH FLOWS For the Year Ended September 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (6,970,072 ) $ (6,834,023 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 18,243 16,927 Stock-based compensation 194,896 57,158 Impairment loss 382,961 — Loss on disposal of asset 44,333 — Stock issued for services — 40,000 Changes in operating assets and liabilities: Prepaid expenses and other assets (322,912 ) (116,719 ) Accounts payable and accrued liabilities 1 51,736 598,638 Accrued compensation (132,293 ) 69,804 Deferred revenue (12,983 ) 28,400 Net cash used in operating activities (6,646,091 ) (6,139,815 ) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of fixed assets (28,972 ) (37,059 ) Net cash used in investing activities (28,972 ) (37,059 ) CASH FLOWS FROM FINANCING ACTIVITIES Purchase of treasury stock (450,000 ) — Proceeds from PPP loan 365,430 — Repayment of oversubscription — (40,000 ) Net cash provided by (used in) financing activities (84,570 ) (40,000 ) DECREASE IN CASH (6,759,633 ) (6,216,874 ) CASH, BEGINNING OF YEAR 7,839,472 14,056,346 CASH, END OF YEAR $ 1,079,839 $ 7,839,472 NON-CASH INVESTING AND FINANCING ACTIVITIES : Capitalization of ROU asset $ 746,125 $ — ST operating lease liability recorded $ 61,264 $ — LT operating lease liability recorded $ 684,861 $ — Unpaid treasury stock $ 100,000 — The accompanying notes are an integral part of these financial statements. 18 CIPHERLOC CORPORATION NOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED SEPTEMBER 30, 2020 AND 2019 NOTE 1 - DESCRIPTION OF BUSINESS Cipherloc Corporation (the “Company” or “Cipherloc”) was incorporated in the State of Texas on June 22, 1953 as American Mortgage Company. Effective August 27, 2014, the Company changed its name to Cipherloc Corporation. NOTE 2 - GOING CONCERN 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 into the start of calendar year 2022. If we are unsuccessful doing so, then the Company will cease operations. At September 30, 2020, the Company had not yet achieved profitable operations. We had a net loss of approximately $7.0 million for the year ended September 30, 2020 and had an accumulated deficit in aggregate of approximately $68.4 million since our inception. We expect to incur further losses in the development of our business. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. The Company’s ability to continue as a going concern is dependent on its ability to generate future profitable operations and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. Management’s plan to address the Company’s ability to continue as a going concern includes: (1) obtaining debt or equity funding from private placement or institutional sources; (2) generating cash flow from operations. Although management believes that it will be able to obtain the necessary funding to allow the Company to remain a going concern through the methods discussed above, there can be no assurances that such methods will prove successful. These financial statements have been prepared assuming that the Company will continue as a going concern and therefore, the financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classifications of liabilities that may result from the outcome of this uncertainty. NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Significant accounting policies are as follows: Use of Estimates and Assumptions The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and (iii) the reported amount of net revenues and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, actual results could differ from these estimates. The Company’s most significant estimate relates to the valuation of its convertible note. Legal The Company is subject to legal proceedings, claims and liabilities which arise in the ordinary course of business. The Company accrues for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred. Cash and Cash Equivalents and Concentration of Credit Risk The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company did not have any cash equivalents as of September 30, 2020 and 2019. At September 30, 2020 and 2019, cash includes cash on hand and cash in the bank. The Company maintains its cash in accounts held by large, globally recognized banks which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures these deposits up to $250,000. As of September 30, 2020, $829,839 of the Company’s cash balance was uninsured. The Company has not experienced any losses on cash. Fixed Assets Fixed assets are recorded at cost and depreciation is provided over the estimated useful lives of the related assets using the straight-line method for financial statement purposes. Equipment and furniture are depreciated over an estimated useful life of three (3) to five (5) years. Leasehold improvements are depreciated over the lesser of the related lease term or a useful life of ten (10) years. Software is depreciated over an estimated useful life of three (3) years. Long-Lived Assets Long-lived assets are evaluated for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the undiscounted future cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value. There was no impairment recorded during the year ended September 30, 2019. During the year ended September 30, 2020, the Company recorded an impairment loss of $382,961 related to its Virginia lease. In addition, the Company recorded a loss of $44,336 on the disposal of fixed assets. 19 Fair Value of Financial Instruments The Company’s financial instruments consisted primarily of cash, accounts payable and accrued expenses, deferred revenue, convertible note payable, as well as embedded conversion features. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments. Fair value is focused on an exit price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Within the measurement of fair value, the use of market-based information is prioritized over entity specific information and a three-level hierarchy for fair value measurements is used based on the nature of inputs used in the valuation of an asset or liability as of the measurement date. The three-level hierarchy for fair value measurements is 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 other than quoted prices, either directly or indirectly, including inputs in markets that are not considered to be active; ● Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. The fair values of the embedded conversion features in the Company’s convertible notes and of the warrants issued by the Company were determined using level 2 measurements and are discussed in further detail in Notes 5 and 8, respectively. Customer Concentration During the year ended September 30, 2020 two customers accounted for approximately 100% of the Company’s revenues. During the year ended September 30, 2019, one customer accounted for approximately 100% of the Company’s revenues. 20 Revenue Recognition The Company recognizes revenues in accordance with the provisions of Accounting Standards Update 2014-09, “Revenue from Contracts with Customers,” and a series of amendments which together we identify as “ASC Topic 606”. This new accounting standard, which we adopted on October 1, 2018 using the permitted modified retrospective method, outlines a single comprehensive model for entities to use in accounting for revenues arising from contracts with customers. The new standard supersedes most previous revenue recognition guidance, including industry-specific guidance. The effect of the adoption of ASC Topic 606 on retained earnings as of October 1, 2018 was not material. The differences between our reported operating results for the nine months ended June 30, 2020, which reflect the application of the new standard on our contracts, and the results that would have been reported if the accounting was performed pursuant to the accounting standards previously in effect, also were not material. Central to the new revenue recognition guidance is a five-step revenue recognition model that requires reporting entities to: 1. Identify the contract, 2. Identify the performance obligations of the contract, 3. Determine the transaction price of the contract, 4. Allocate the transaction price to the performance obligations, and 5. Recognize revenue. The Company accounts for a promise to provide a customer with a right to access the Company’s intellectual property as a performance obligation satisfied over time because the customer will simultaneously receive and consume the benefit from the entity’s performance of providing access to its intellectual property as the performance occurs. Nature of Products and Services Licenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where the license is being modified at the direction of the customer the revenue is being recognized ratably over the term of the arrangement. Revenue allocated to software maintenance and support services is recognized ratably over the contractual support period. Professional services are primarily related to software implementation services and associated revenue is recognized upon customer acceptance. Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records a contract asset or receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For perpetual licenses with multi-year product maintenance agreements, the Company generally invoices customers at the beginning of the coverage period. For multi-year subscription licenses, the Company generally invoices customers annually at the beginning of each annual coverage period. The Company records a contract asset related to revenue recognized for multi-year on-premises licenses as its right to payment is conditioned upon providing product support and services in future years. There were no accounts receivable balances on September 30, 2020 and 2019. There was no adjustment needed to the accounts receivable for the cumulative effect of applying ASC 606 under the modified retrospective method. There was no impact on the opening balance contract assets and liabilities, for the cumulative effect of applying ASC 606 under the modified retrospective method as of October 1, 2018. Deferred revenue is comprised mainly of unearned revenue related maintenance and technical support on term and perpetual licenses. Maintenance and technical support revenue are recognized ratably over the coverage period. Deferred revenue also includes contracts for professional services to be performed in the future which are recognized as revenue when the company delivers the related service pursuant to the terms of the customer arrangement. 21 Changes in deferred revenue were as follows: Year Ended September 30, 2019 Balance on September 30, 2018 $ — Cumulative effect of applying ASC 606 under the modified retrospective method* — Deferral of revenue 75,000 Recognition of revenue (46,600 ) Balance at September 30, 2019 $ 28,400 Year Ended September 30, 2020 Balance on September 30, 2019 $ 28,400 Deferral of revenue 35,000 Recognition of revenue (47,983 ) Balance at September 30, 2020 $ 15,417 *See Note (1) Summary of Significant Accounting Policies, section (s) to our Financial Statements for further information. Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was $15,417 as of September 30, 2020, of which the Company expects to recognize 100% of the revenue over the next 12 months. Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 90 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined its contracts generally do not include a significant financing component. The primary purpose of the Company’s invoicing terms is to provide customers with simplified and predictable ways of purchasing its products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with maintenance and support revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with product revenue recognized upon delivery. Significant Judgments 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. 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 may 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. In cases where the license is being modified at the direction of the customer the revenue is being recognized 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. Assets Recognized from Costs to Obtain a Contract with a Customer The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The Company has determined that its sales commission program meets the requirements for cost capitalization. Total capitalized costs to obtain a contract were immaterial during the periods presented. The Company applies a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. Software license revenue is generally recognized when a signed contract or other persuasive evidence of an arrangement exists, the software has been electronically delivered, the license fee is fixed or is measured on a paid user basis, and collection of the resulting receivable is probable. When contracts contain multiple elements wherein Vendor-Specific Objective Evidence (“VSOE”) exists for all undelivered elements, we account for the delivered elements in accordance with the “Residual Method.” VSOE of fair value for maintenance and support is established by a stated renewal rate, if substantive, included in the license arrangement or rates charged in stand-alone sales of maintenance and support. Revenue from subscription license agreements, which include software, rights to unspecified future products and maintenance, is recognized ratably over the term of the subscription period. When the fair value of VSOE of post contract customer support cannot be determined, the revenue is recognized ratably over the contract period. The only remaining undelivered element was post contract support services, and accordingly, the revenues were recognized on a pro rata basis prospectively over the terms of the related contracts. Deferred revenue results from fees billed to or collected from customers for which revenue has not yet been recognized. The Company had deferred revenue of $15,417 and $28,400 as of September 30, 2020 and 2019, respectively. 22 Research and Development and Software Development Costs The Company expenses all research and development costs, including patent and software development costs. Our research and development costs incurred for the years ended September 30, 2020 and 2019 were $1,689,455 and $1,744,480, respectively. Stock-Based Compensation The Company measures the cost of services provided by employees and non-employees in exchange for an award of an equity instrument based on the grant-date fair value of the award. There were stock options issued during the year ended September 30, 2020, however, awards were subsequently forfeited. Outstanding awards are the awards issued for the fiscal year 2019. There were both fully vested stock grants and stock options granted to employees and non-employees during the year ended September 30, 2019. As such, compensation cost was recognized for grant as well as a ratable portion for the stock options vesting over a three-year time frame. The Company accounts for share-based payments in accordance with the authoritative guidance issued by the FASB on share-based compensation, which establishes the accounting for transactions in which an entity exchanges its equity instruments for goods or services. Under the provisions of the authoritative guidance, share-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period), net of actual forfeitures. The Company estimates the fair value of share-based payments using the Black-Scholes option-pricing model. Additionally, share-based awards to non-employees are expensed over the period in which the related services are rendered at their fair value. All share-based awards are expected to be fulfilled with new shares of common stock. 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. Income Taxes The Company utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized. The Company uses the two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company’s tax positions and tax benefits, which may require periodic adjustments. The Company did not record any liabilities for uncertain tax positions during the years ended September 30, 2020 or 2019. 23 Basic and Diluted Net Loss per Common Share Basic loss per share is computed by dividing net loss available to common shareholders by the weighted average number of common shares outstanding during the reporting period. The weighted average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding. Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest resulting in the issuance of common stock that could share in the earnings of the Company. As of September 30, 2020, and 2019, the Company had 1,000,000 shares of preferred stock outstanding, which are convertible into 1,500,000 shares of common stock. Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss. During the year ended September 30, 2020, 24,146,866 warrants, 800,000 stock options and 1,000,000 shares of convertible preferred stock were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive. During the year ended September 30, 2019, 24,290,866 warrants, 1,100,000 stock options, and 1,000,000 shares of convertible preferred stock were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive. Recent Accounting Announcements The Financial Accounting Standards Board (“FASB”) issues Accounting Standards Updates (“ASU”) to amend the authoritative literature in the ASC. There have been several ASUs to date that amend the original text of the ASCs. Other than those discussed below, the Company believes those ASUs issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company or (iv) are not expected to have a significant impact on the Company. In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This guidance removes certain exceptions to the general principles in Topic 740 and enhances and simplifies various aspects of the income tax accounting guidance, including requirements such as tax basis step-up in goodwill obtained in a transaction that is not a business combination, ownership changes in investments, and interim-period accounting for enacted changes in tax law. This standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2020. Early adoption is permitted. The Company are currently evaluating the impact of ASU 2019-12 on its financial statements, which is effective for the Company in its fiscal year and interim periods beginning on October 1, 2021. In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements (Topic 820) – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement , to modify the disclosure requirements for fair value measurements. The ASU removes certain disclosure requirements related to transfers between fair value hierarchy levels and valuation processes for Level 3 fair value measurements. It modifies certain disclosure requirements for investments in entities that calculate net asset value. It adds certain disclosure requirements regarding gains and losses for recurring Level 3 fair value measurements and unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company adopted ASU 2018-13 on October 1, 2019 and the adoption of this update did not have a material impact on the Company’s notes to the financial statements. In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting , to expand the scope of Topic 718, Compensation – Stock Compensation , which currently only includes share-based payments to employees, to include share-based payments issued to nonemployees for goods or services. Thus, accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company adopted ASU 2018-07 on October 1, 2019 and the adoption of this update did not have a material impact on the Company’s financial position, results of operations and cash flows. In February 2016, the FASB issued ASU 2016-02, Leases, which aims to make leasing activities more transparent and comparable and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset (ROU) and corresponding lease liability, including leases currently accounted for as operating leases. Leases of mineral reserves and related land leases have been exempted from the standard. We adopted ASU 2016-02, Leases, on October 1, 2019. We elected the “package of practical expedients” within the standard which permits us not to reassess prior conclusions about lease identification, lease classification and initial direct costs. We made an accounting policy election to not separate lease and non-lease components for all leases. The adoption of this standard resulted in the recognition of right-of-use assets and lease liabilities of $0.2 million, which were not previously recorded on our balance sheet. 24 NOTE 4 – FIXED ASSETS, NET As of September 30, 2020, and 2019, fixed assets consisted of the following: September 30, 2020 2019 Equipment and furniture $ — $ 37,875 Leasehold improvements — 17,630 Software — 12,676 — 68,181 Accumulated depreciation — (27,999 ) Fixed assets, net $ — $ 40,182 Depreciation expense for the years ended September 30, 2020 and 2019 was $18,243 and $16,927, respectively. The fixed assets were disposed of during 2020. NOTE 5 – SOFTWARE LICENSES Software License Agreements During fiscal year 2019, the Company entered into a one-year agreement with SoundFi LLC (“SoundFi”) which will automatically renew for subsequent one-year periods unless otherwise terminated by either party. Cipherloc received $25,000 from SoundFi during the year ended September 30, 2020. The Company executed an annual software licensing agreement with Castle Shield during the year ended September 30, 2020 which also include auto-renewing terms. Castle Shield made a $10,000 payment to the Company based on the terms of their agreement with Cipherloc. During the year ended September 30, 2020, the Company recognized $47,983 in licensing revenue from the SoundFi and Castle Shield agreements. 25 NOTE 6 – DEBT On April 6, 2020, to supplement its cash balance, the Company submitted their application for a Paycheck Protection Program (“PPP”) loan (the “SBA loan”) sponsored by the U.S. Small Business Administration in the amount of $365,430. On April 12, 2020, Company’s SBA loan application was approved, and the Company received loan proceeds on April 22, 2020. The SBA loan has an interest rate of 1% and matures on April 12, 2022. Section 1106 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP. The PPP and loan forgiveness are intended to provide economic relief to small businesses, such as the Company, that are adversely impacted under the COVID-19 Emergency Declaration issued by President Donald J. Trump on March 13, 2020. As a result of staff reductions during 2020, the Company expects the ultimate amount of loan forgiveness to be minimal. The Paycheck Protection Program loan balance at September 30, 2020 was $365,430 Future Minimum Paycheck Protection Program loan payment by Fiscal Year 2021 $ 216,902 2022 148,528 Total Paycheck Protection Program loan $ 365,430 NOTE 7 – RELATED PARTY TRANSACTIONS Employees related to Ex Chief Executive Officer Skylar, Olivia and Robin De La Garza, immediate family members of former CEO Michael De La Garza, earned $52,278, $47,176 and $53,000, respectively, in compensation for the year ended September 30, 2019. In August 2019, Robin and Skylar De La Garza were terminated as employees of the Company. The Company also paid $11,394 in educational costs of Skylar De La Garza and $6,200 in moving expenses of Olivia De La Garza. Michael De La Garza was the CEO and director of the Company during the period of time when these payments were made. See Note 8 for additional related party transactions. NOTE 8 – COMMITMENTS AND CONTINGENCIES Litigation The Company is currently not involved in any litigation that it believes could have a material adverse effect on its financial condition or results of operations. A disgruntled former consultant has brought an action in Texas state court against the Company and its former chief executive officer, alleging fraud and misrepresentation pertaining to stock and payments alleged to be owed to the consultant. The Company believes it has made all required payments and delivered the stock to the consultant. The consultant has also included a claim of partial ownership of certain of the Company’s patents, which management believes is without merit. The case is currently being defended by the Company and costs relating thereto have been submitted to the Company’s insurance carrier. In August 2019, the Board of Directors formed a special committee of independent directors (the “Special Committee”) to investigate certain activities of Michael De La Garza (“De La Garza”), our former chief executive officer. Also in that same month, the Company initiated litigation against De La Garza in the District Court of Travis Country, Texas (the “Court”). On September 25, 2019, the Court entered a temporary injunction against De La Garza enjoining him from numerous acts. The Special Committee investigated certain activities of De La Garza, including the Ageos, LLC Operating Agreement, the QHCI/Noun note receivable, an advance/bonus, personal expenditures, and other items. All amounts expended have been expensed as of September 30, 2019. The Company also sued De La Garza, among others, in federal district court seeking to invalidate the issuance of preferred stock to him in 2015. The preferred stock shares were converted to 13.5 million shares of common stock by De La Garza during 2018. All litigation matters with Michael De La Garza were settled on August 28, 2020 with De La Garza agreeing to return 13.1 million shares of common stock to the Company and the Company agreeing to pay De La Garza $400,000 between September 30, 2020 and September 30, 2021. At September 20, 2020, Cipherloc owed $100,000 in settlement payments which will be made in $25,000 payments on December 1, 2020, March 1, 2021, June 1, 2021, and September 1, 2021. 26 The Company is seeking to invalidate the issuance of 1 million shares of Cipherloc preferred stock to former director and chief financial officer, Pamela Thompson, which stock is now being held by the Carmel Trust II, in or around 2011. As such, the Company has sued James LeGanke, as Trustee of Carmel Trust II, in federal court as part of its efforts to invalidate those shares. The Company alleges that Thompson failed to comply with both state law and Company bylaws when she and then CEO, Michael De La Garza, caused the Company to issue the preferred stock to themselves as purported compensation. The lawsuit is ongoing, and its resolution is unknown. On October 13, 2020, Ageos, LLC, a Virginia limited liability company (“Ageos”), filed a Third Party Complaint against Cipherloc (Third Party Case No. GV20015643-00) in connection with the pending action titled Scandium, LLC v. Ageos, LLC (Case No. GV20014313-00) in the General District Court for Fairfax County in the Commonwealth of Virginia. The action relates to an operating agreement, by and between Cipherloc and Ageos, whereby Cipherloc agreed to guarantee Ageos’s lease in order to enable the leasing of space in Fairfax County, VA. Cipherloc subsequently terminated the agreement with Ageos and offered to take over the space as an accommodation. Ageos declined. Ageos’s third party complaint demands from Cipherloc, among other things, all damages obtained by Scandium, LLC against Ageos; (ii) other compensatory damages in connection with certain lease payments under the lease discussed above; and (iii) pre-judgment interest. This lawsuit is ongoing, and its resolution is unknown. Leases In February 2019, the Company and the landlord for its leased office space in Buda, Texas entered into a new lease agreement, and the Company reduced its rented space from approximately 3,900 to 1,302 square feet. The new lease became effective on February 1, 2019 and has a three-year term. The initial monthly rent is $2,566, and the lease agreement provided for annual rent increases of approximately 2.7%. The lease automatically renews for a three-year term, unless either party to the lease agreement notifies the other of the intent to terminate the lease in writing at least 180 days prior to the expiration of the current term. In July 2020, the Company executed a lease termination agreement with the landlord for an early termination fee of $10,546 and forfeited the existing security deposit of $2,566. There are no future payments related to this lease. In October 2018, the Company leased approximately 3,900 square feet of office space on North Scottsdale Road in Scottsdale, Arizona. The lease for this facility began on October 4, 2018 and originally continued until October 31, 2021. Annual rent of $77,180 was prepaid for the first year from November 1, 2018 to October 31, 2019, and the lease agreement provides for annual rent increases of approximately 5.0%. In June 2020, the Company executed a lease termination agreement with the landlord for an early termination fee of $27,013 and forfeited the existing security deposit of $9,796. There are no future payments related to this lease. In February 2020, the Company leased approximately 3,666 square feet of office space on 2107 Wilson Boulevard, Arlington, Virginia. The lease for this facility began on February 1, 2020 and continues until July 31, 2025. The base annual rent is $159,471, a $100,000 security deposit was paid, and abatement of monthly rent payments was provided until August 1, 2020, and the lease provides for annual rent increases of approximately 2.5%. The amount of future payments guaranteed is $822,082. As the result of restructuring actions intended to conserve cash during the COVID-19 crisis, the landlord of the Wilson Boulevard space was notified that the Company no longer needed the space and is seeking an amicable and reasonable termination of the lease agreement. As of September 30, 2020, the Company had one lease agreements for facilities. Leases with an initial term of 12 months or less are not recorded on our Balance Sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. Leases with initial terms in excess of 12 months are recorded as operating or financing leases in our Balance Sheet. Lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an implicit rate, we use a secured incremental borrowing rates based on the information available at commencement date, including lease term, in determining the present value of future payments. The operating lease asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that the option will be exercised. 27 At inception, the Company determines if an arrangement contains a lease and whether that lease meets the classification criteria of a finance or operating lease. Some of the Company’s lease arrangements contain lease components (e.g. minimum rent payments) and non-lease components (e.g. maintenance, labor charges, etc.). The Company generally accounts for each component separately based on the estimated standalone price of each component. For certain leases, the Company accounts for the lease and non-lease components as a single lease component. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating Leases Operating leases are included in operating lease ROU lease assets, and operating lease liabilities and operating long-term lease liabilities on the Balance Sheets. Lease expense for operating leases is recognized on a straight-line basis over the lease term. Variable lease expense is recognized in the period in which the obligation for those payments is incurred. Lease expense is included in general and administrative expense in the statements of operations and is reported net of lease income. Lease income is not material to the results of operations for the quarter ended June 30, 2020. The Company announced a corporate restructuring on June 30, 2020 which will result in the abandonment of certain office spaces. The Company has recorded an impairment charge of approximately $382,962 which is the estimate of the future payments less projected sublease income from the abandoned office space. Cash Flows An initial right-of-use asset of $233,751 was recognized as a non-cash asset addition with the adoption of the new lease accounting standard. Cash paid for amounts included in the present value of operating lease liabilities was $28,534 during third quarter 2020 and is included in operating cash flows. In February 2020, the Company’s new lease in Arlington, Virginia added approximately $746,000 in new lease obligations. The weighted average remaining lease terms and discount rates for all of our operating lease were as follows as of September 30, 2020: Remaining lease term and discount rate: September 30, 2020 Weighted average remaining lease terms (years) Lease facilities 4.83 Weighted average discount rate Lease facilities 4.35 % Significant Judgements Significant judgements include the discount rates applied, the expected lease terms, and lease renewal options. There are three leases with a renewal option. Using the practical expedient, the Company utilized existing lease classifications as of September 30, 2019. As a result, the lease renewal options were not changed on implementation. Future annual minimum lease obligations at September 30, 2020 are as follows: Year ending September 30 Amount 2021 $ 162,135 2022 166,180 2023 170,322 2024 174,575 2025 148,870 $ 822,082 Rent expense totaled $218,997 and $150,575 for the years ended September 30, 2020 and 2019, respectively. 28 NOTE 9 - STOCKHOLDERS’ EQUITY (DEFICIT) Common Stock As of September 30, 2020, and 2019, the Company had 27,505,196 and 40,792,510 shares of common stock outstanding, respectively, and were authorized to issue 681,000,000 shares of common stock at a par value of $0.01. Treasury Stock Management determines the fair value of stock issuances using the closing stock price on the grant date. During the year ended September 30, 2020, the Company came to a settlement with First Fire and purchased back 149,557 shares and recorded such shares as Treasury Stock. First Fire received $150,000 in exchange for the 149,557 shares. During the year ended September 30, 2020, the Company reached a settlement and as result received surrendered shares of 13,137,757 share and recorded such shares as Treasury Stock. Common Stock Issued for Cash During the year ended September 30, 2019, the Company refunded $40,000 for an oversubscription of common stock made by an investor related to the private placement of shares in fiscal year 2018. The refund was made in lieu of an issuance of shares. Common Stock and Stock Options Issued to Directors and Officers During the year ended September 30, 2019, the Company issued 9,346 vested shares of common stock with a fair value of $11,216 to an employee, which was recorded as stock-based compensation expenses in research and development expense in the statement of operations. During the year ended September 30, 2019, the Company issued 1,100,000 shares of stock options to the Board of Directors and officers with a fair value of $862,000, of which $42,942 was recorded as stock-based compensation expenses in research and development and general administration expense. Options will vest over a three-year period ratably. Of the 1,100,000, 1,000,000 options have a strike price of $0.85 and the remaining 100,000 have a strike price of $0.75. During 2020, 620,000 stock options were granted to employees. Also during 2020, 920,000 stock options were cancelled due to the termination of employment. As of September 30, 2020, 800,000 stock options are outstanding. None of the stock options are in the money and the unamortized amount of stock compensation as of September 30, 2020 is $383,453. Year Ended September 30, 2019 Balance on September 30, 2018 — New Awards 1,100,000 Options Cancelled — Balance at September 30, 2019 1,100,000 Year Ended September 30, 2020 Balance on September 30, 2019 1,100,000 New Awards 620,000 Options Cancelled (920,000 ) Balance at September 30, 2020 800,000 Common Stock Issued 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 Pycnocline, LLC for management consulting services, which was recorded in research and development expense. 29 Preferred Stock As of September 30, 2020, and 2019, the Company had 1,000,000 and 1,000,000 shares of restricted preferred stock outstanding, respectively. Each share of preferred stock is convertible into the Company’s common stock at a rate of one (1) preferred share to 1.5 common shares. Each share of preferred stock has 1.5 votes on all matters presented to be voted by the holders of common stock. The holders of preferred stock can only convert the shares if agreed to by the Board of Directors. If declared by the Board of Directors, holders of preferred stock are entitled to receive dividends prior and in preference to any declaration or payment of any dividend on the common stock of the Company. In the event of liquidation or dissolution of the Company, holders of preferred stock shall be paid out of the assets of the Company prior and in preference to any payment or distribution to holders of common stock of the Company. Warrants During the year ended September 30, 2018, the Company issued warrants to purchase 75,000 shares of common stock. These warrants were issued with an exercise price of $2.00 and a term of five years. No warrants were issues during fiscal years 2020 and 2019. Additionally, in connection with shares sold through a PPM, the Company issued warrants to purchase 144,000 shares of common stock. These warrants were issued with an exercise price of $4.50 and a term of two years. Lastly, in connection with shares sold through an additional PPM, the Company issued warrants to purchase 18,837,900 shares of common stock. These warrants were issued with an exercise price of $1.20 and a term of five years. The company issued warrants to purchase an additional 5,398,970 shares of common stock to its underwriters. These warrants were issued with an exercise price of $1.00 and a term of ten years. Warrant activity for the years ended September 30, 2020 and 2019 is as follows: Number of Warrants Weighted Average Exercise Price Weighted Average Remaining Life Outstanding at September 30, 2018 25,015,866 $ 1.27 5.83 Granted — — — Exercised — — — Canceled/Forfeited (725,000 ) 4.50 — Outstanding at September 30, 2019 24,290,866 1.14 4.84 Granted — — — Exercised — — — Canceled/Forfeited (544,000 ) 2.11 — Outstanding at September 30, 2020 23,746,866 $ 1.12 3.74 30 NOTE 10 - INCOME TAXES The provision (benefit) for income taxes from continued operations for the years ended September 30, 2020 and 2019 consist of the following: September 30, 2020 2019 Current: Federal $ — $ — State — — $ — $ — Deferred: Federal $ (1,396,673 ) $ (1,301,000 ) State — — (239,000 ) (1,301,000 ) Valuation allowance 1,396,673 1,301,000 Provision (benefit) for income taxes, net $ — $ — The difference between income tax expense computed by applying the federal statutory corporate tax rate and actual income tax expense is as follows: September 30, 2020 2019 Statutory federal income tax rate 21.0 % 21.0 % Non-deductible stock-based compensation and other permanent differences (0.1 ) (0.07 ) Change in statutory tax rate (0.0 ) (13.0 ) Valuation allowance (20.90 ) (20.93 ) Effective tax rate 0.0 % 0.0 % Deferred income taxes result from temporary differences in the recognition of income and expenses for the financial reporting purposes and for tax purposes. The tax effect of these temporary differences representing deferred tax asset and liabilities result principally from the following: September 30, 2020 2019 Net operating loss carry forward $ 6,126,911 $ 4,778,000 Deferred compensation 3,853,777 3,806,000 Valuation allowance (9,980,688 ) (8,584,000 ) Deferred income tax asset $ — $ — The Company has a net operating loss carry forward of $29.2 million available to offset future taxable income. Of which, $2.6 million will expire within the next five years, and the remaining $26.6 million will expire thereafter. For income tax reporting purposes, the Company’s aggregate unused net operating losses were subject to the limitations of Section 382 of the Internal Revenue Code, as amended. The Company has adjusted the net operating losses incurred prior to 2015 to reflect only the losses not subject to limitation. The Company has provided for a valuation reserve against the net operating loss benefit, because in the opinion of management based upon the earning history of the Company; it is more likely than not that the benefits will not be realized. For income tax reporting purposes, Management has determined that net operating losses prior to February 5, 2015 are subject to an annual limitation of approximately $525,000. For the years ended September 30, 2020 and 2019, the difference between the amounts of income tax expense or benefit that would result from applying the statutory rates to pretax income to the reported income tax expense of $0 is the result of the net operating loss carry forward and the related valuation allowance, as well as non-deductible stock-based compensation. The Company anticipates it will continue to record a valuation allowance against the losses of certain jurisdictions, primarily federal and state, until such time as it is able to determine it is “more-likely-than-not” the deferred tax asset will be realized. Such position is dependent on whether there will be sufficient future taxable income to realize such deferred tax assets. The Company’s effective tax rate may vary from period to period based on changes in estimated taxable income or loss by jurisdiction, changes to the valuation allowance, changes to federal, state or foreign tax laws, future expansion into areas with varying country, state, and local income tax rates, deductibility of certain costs and expenses by jurisdiction. The Company is current on all its federal income tax filings. An extension will be filed for the September 30, 2020 tax return. On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was signed into law in the U.S. The Tax Act has resulted in significant changes to the U.S. corporate income tax system. These changes include a federal statutory rate reduction from 35% to 21%, the elimination or reduction of certain domestic deductions and credits, and limitations on the deductibility of interest expense and executive compensation. These changes were effective beginning in 2018. NOTE 11 - SUBSEQUENT EVENTS On October 16, 2020, David Chasteen, a director, was appointed the Chief Executive Officer of the Company. On November 12, 2020, Milton Mattox, Cipherloc Chief Operating Officer, tendered his resignation which was accepted by the Chief Executive Officer. Mattox assisted in the transition to interim Chief Technology Officer Nick Hnatiw who was engaged as an independent contractor on November 18, 2020. Mattox’s last day with the Company was December 15, 2020. 31 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.