SideChannel, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General Information This information should be read in conjunction with the interim unaudited financial statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the audited financial statements and notes thereto and “ Part II. Other Information – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ”, contained in our Annual Report on Form 10-K for the year ended September 30, 2020, filed with the Securities and Exchange Commission on December 29, 2020 (the “ Annual Report ” or the “ Form 10-K ”). Certain capitalized terms used below and otherwise defined below, have the meanings given to such terms in the footnotes to our unaudited consolidated financial statements included above under “ Part I – Financial Information ” – “ Item 1. Financial Statements ”. Our logo and some of our trademarks and tradenames are used in this Report. This Report also includes trademarks, tradenames and service marks that are the property of others. Solely for convenience, trademarks, tradenames, and service marks referred to in this Report may appear without the ®, ™ and SM symbols. References to our trademarks, tradenames and service marks are not intended to indicate in any way that we will not assert to the fullest extent under applicable law our rights or the rights of the applicable licensors if any, nor that respective owners to other intellectual property rights will not assert, to the fullest extent under applicable law, their rights thereto. We do not intend the use or display of other companies’ trademarks and trade names to imply a relationship with, or endorsement or sponsorship of us by, any other companies. The market data and certain other statistical information used throughout this Report are based on independent industry publications, reports by market research firms or other independent sources that we believe to be reliable sources. Industry publications and third-party research, surveys and studies generally indicate that their information has been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information. We are responsible for all of the disclosures contained in this Report, and we believe these industry publications and third-party research, surveys and studies are reliable. While we are not aware of any misstatements regarding any third-party information presented in this Report, their estimates, in particular, as they relate to projections, involve numerous assumptions, are subject to risks and uncertainties, and are subject to change based on various factors, including those discussed under, and incorporated by reference in, the section entitled “ Item 1A. Risk Factors ” of this Report. These and other factors could cause our future performance to differ materially from our assumptions and estimates. Some market and other data included herein, as well as the data of competitors as they relate to Cipherloc Corp., is also based on our good faith estimates. Unless the context requires otherwise, references to the “ Company, ” “ we, ” “ us, ” “ our, ” “ Cipherloc ”, and “ Cipherloc Corp. ” refer specifically to Cipherloc Corp. and its consolidated subsidiaries. In addition, unless the context otherwise requires and for the purposes of this report only: ● “ Exchange Act ” refers to the Securities Exchange Act of 1934, as amended; ● “ SEC ” or the “ Commission ” refers to the United States Securities and Exchange Commission; and ● “ Securities Act ” refers to the Securities Act of 1933, as amended. Where You Can Find Other Information We file annual, quarterly, and current reports, proxy statements and other information with the SEC. Our SEC filings are available to the public over the Internet at the SEC’s website at www.sec.gov and are available for download, free of charge, soon after such reports are filed with or furnished to the SEC, on the “ Investor Relations ,” page of our website at https://cipherloc.net. Information on our website is not part of this Report, and we do not desire to incorporate by reference such information herein. Copies of documents filed by us with the SEC are also available from us without charge, upon oral or written request to our Secretary, who can be contacted at the address and telephone number set forth on the cover page of this Report. 16 Table of Contents Introduction Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. MD&A is organized as follows: ● Business Strategy and Plan of Operations . Discussion of our strategy moving forward and how we plan to seek to increase stockholder value. ● Results of Operations . An analysis of our financial results comparing the three and nine months ended June 30, 2021, and 2020. ● Liquidity and Capital Resources . A discussion of changes in our consolidated balance sheets, cash flows and a discussion of our financial condition. ● Critical Accounting Policies and Estimates . Accounting estimates that we believe are important to understanding the assumptions and judgments incorporated in our reported financial results and forecasts. The following discussion should be read in conjunction with Cipherloc Corporation’s financial statements and accompanying notes included elsewhere in this Report. All references to years relate to the fiscal year ended September 30 of the particular year. Business Strategy and Plan of Operations 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. As described above, our products are designed to encrypt and decrypt information. Encryption means encoding information which is readable into another form which is not readable, and which is therefore unable to be intercepted, read, or used, by someone other than the original person who encrypted the information—unless such encryption can be broken. We believe that 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. We anticipate the operating expenses for the next twelve months may require up to $7.5 million capital, which funds will come from amounts raised in the Private Offering; however, we hope to manage our business such that the existing liquidity carries the Company to positive cash flow from operations, of which there can be no assurance. This measured approach to managing cash initially emphasizes demonstrating product capabilities with current customers which is followed by a scaling exercise in all functional areas, including product development, marketing, sales, customer support, and administration. As such, the cash required for operating expenses through June 30, 2022, will most likely range from $2.4 million to $4.4 million. A summary of the operating plan by functional area is provided below. Product Development will focus on further maturing the products that we have developed. Our plan is to build out our core technologies on multiple operating system platforms as well as work with current customers to ensure our product is in line with their needs. Once these items are completed, we plan to shift to further expand our product suite to enable user-defined encryption cipher modes, as well as a remote PEC management system. This will require us to expand the team footprint rapidly to ensure that we can meet market demand. 17 Table of Contents These efforts will require more personnel as well as more infrastructure. This personnel expansion will likely require $1 million of capital. The infrastructure needed to perform these new functions is planned to be built on modern technology with scale and reliability built from the ground-up. Utilizing cloud services, we plan to provide our customers with an interface that modern software provides, but an ease of use that encryption technologies desperately need. We believe that if we are able to meet these goals, we will be at a competitive advantage from most other players in this space. Marketing efforts will emphasize qualified lead generation using very focused industry messaging and engagement. We will be participating in relevant cybersecurity and quantum computing industry events. Our advisors will help us identify the right focus areas for lead generation. Customer support teams will need to be put in place and are expected to be built around each of our product offerings. We anticipate our Support Team will scale as our business needs change. The projected costs for the first 12 months are likely to reach $500,000. These funds will be used for salaries and technology in order for the Support Team to provide the necessary support described above. Administration requirements are currently minimal, but we expect that this will change in the event the Company is able to generate revenues and add employees. The administrative resources will be ramped according to the Company’s demand to support employees, increase accounting capacity, and expand reporting and compliance capabilities. Additional leadership personnel in accounting and human resources are anticipated to precede staff additions. We also plan to add software tools to manage functional processes. Results of Operations for the three and nine months ended June 30, 2021, and 2020 Comparison of Results Revenue decreased to zero for the three months ended June 30, 2021, from $8,750 for the three months ended June 30, 2020. Revenue decreased to $15,417 for the nine months ended June 30, 2021, from $39,233 for the nine months ended June 30, 2020. Revenues decreased due to no new invoicing activity taking place in the current reporting period. SoundFi has not been operating due to theater closures and Castle Shield did not report revenue from the PEC license agreement under which it is currently operating because it didn’t launch products until late during our third fiscal quarter (this reporting period). General and administrative expenses were $197,534 and $833,260 for the three months ended June 30, 2021, and 2020, respectively. General and administrative expenses decreased primarily as a result of a gain recognized in the amount of $441,597 due to the write-off of the remaining right-of-use (ROU) assets and operating lease liability after the early termination of our final operating lease. Net of this gain, general and administrative expenses were $639,131. Compared to the same period one year ago, the current period amount reflects a decrease in headcount related costs including payroll of $93,000, due to staffing reductions initiated during the prior fiscal year, a decrease in legal fees of $146,000, due to the settlement of legal matters, decreases in board and professional fees of $51,000, and decreases in various other expenses of $13,000, offset by increases in rent of $56,000, as a result of the Virginia office lease settlement (as discussed under Note 5 – Commitments and Contingencies - Leases, to the unaudited financial statements included above) and in corporate insurance of $53,000, primarily for directors and officers liability insurance premiums. General and administrative expenses were $1,748,398 and $4,114,084 for the nine months ended June 30, 2021, and 2020, respectively. The decrease in general and administrative expenses was primarily due to a decrease in legal expenses of $1,055,000 because of settlements reached during this fiscal year, a decrease in headcount related costs including payroll and travel costs of $483,000, due to staffing reductions initiated during the prior fiscal year, a $824,000 favorable variance in the accounting for ROU assets and liability ($441,597 gain in 2021 discussed above versus a $382,625 impairment loss reported during 2020), a decrease in board and professional fees of $155,000, and a decrease in various other expenses of $143,000, offset by increases in corporate insurance of $165,000, for directors and officers liability insurance premiums and rent of $129,000 related to the Virginia office lease settlement (as discussed under Note 5 – Commitments and Contingencies - Leases, to the unaudited financial statements included above). 18 Table of Contents Selling and marketing expenses were zero and $107,842 for the three months ended June 30, 2021, and 2020, respectively. Sales and marketing expenses decreased primarily because of a decrease in payroll expenses of $79,000, a decrease in consulting related costs of $12,000, a decrease in marketing related costs of 13,000 and a decrease in travel related costs of $4,000, all of these decreases were generated by spending reductions initiated during the prior fiscal year. We expect to resume incurring sales and marketing expenses during the fourth quarter of our fiscal year ending September 30, 2021. Selling and marketing expenses were $56,250 and $695,245 for the nine months ended June 30, 2021, and 2020, respectively. Sales and marketing expenses decreased primarily because of a decrease in payroll related expenses of $323,000, a decrease in consulting related costs of $206,000, a decrease in marketed related costs of $71,000 and a decrease in travel related costs of $39,000, all of which were generated by spending reductions initiated during the prior fiscal year. Research and development costs were $169,098 and $205,613 for the three months ended June 30, 2021, and 2020, respectively. Research and development costs decreased primarily because of a decrease in payroll related expenses of $26,000 and a decrease in consulting related expenses of $11,000, both decreases were the result of the spending reductions initiated during the prior fiscal year. Research and development costs were $465,974 and $1,544,205 for the nine months ended June 30, 2021, and 2020, respectively. Research and development expenses decreased for the nine-month period ended June 30, 2021, primarily because of a decrease in consulting related costs of $750,000 and a decrease in payroll related expense of $329,000, both decreases were the result of the spending reductions initiated during the prior fiscal year. We had a net loss of $175,580 or $0.00 per share for the three months ended June 30, 2021, compared to a net loss of $1,157,743 or $0.03 per share for the three months ended June 30, 2020. The year-over-year decrease in net loss for the three months ended June 30, was a result of a decrease in operating expenses, and the PPP loan forgiveness of $192,051. For the nine months ended June 30, 2021, we had a net loss of $2,064,153 or $0.05 per share, compared to a net loss of $6,334,079 or $0.16 per share for the nine months ended June 30, 2020. Net loss for the nine months ended June 30, decreased year-over-year as a result of the decreases in legal and other operating expenses discussed earlier. Liquidity and Capital Resources We had an accumulated deficit on June 30, 2021, of $70,490,761. We expect to incur substantial expenses and generate continued operating losses until we generate revenues sufficient to meet our obligations. On June 30, 2021, we had cash of $6,848,508. On March 31, 2021, we completed the initial closing of the Private Offering in which we sold 35,757,942 shares of our common stock at a price to the public of $0.18 per share, for net proceeds of $5,497,964. During the month of April 2021, we completed additional closings pursuant to the Private Offering, in which we sold 19,791,673 shares of our common stock at a price to the public of $0.18 per share, for net proceeds of $2,850,383. The Private Offering is described in greater detail in Note 2 – New Equity Issuance , to the unaudited financial statements included above. We had working capital of $6,301,824 as of June 30, 2021, compared to working capital of $123,102 as of September 30, 2020. Working capital increased because of funds raised through the Private Offering. Cash Flows The following table summarizes, for the periods indicated, selected items in our condensed Statements of Cash Flows: Nine Months Ended June 30, 2021 2020 Net cash provided by (used in): Operating activities $ (2,566,292 ) $ (5,798,100 ) Investing activities $ — $ (28,792 ) Financing activities $ 8,334,961 $ 215,430 19 Table of Contents Operating Activities Cash used in operating activities was $2,566,292 and $5,798,100 for the nine months ended June 30, 2021, and 2020, respectively. The uses of cash during the nine months ended June 30, 2021, were mainly attributable to a net loss of $2,064,153, which was increased by the ROU asset gain of $441,597, the PPP loan forgiveness of $192,052 and a decrease in net operating assets and liabilities of $135,910. The change in our net operating assets and liabilities was primarily due to a decrease in prepaid and other assets of $450,257, offset by a decrease in accounts payable and accrued liabilities of $298,930, and a decrease in deferred revenue of $15,417. Investing Activities Cash used in investing activities was zero and $28,792 for the nine months ended June 30, 2021, and 2020, respectively. The cash used in investing activities for the nine months ended June 30, 2020, was the result of fixed asset purchases. Financing Activities Cash provided by financing activities was $8,334,961 for the nine months ended June 30, 2021. The Company sold certain securities pursuant to the Private Offering, described in Note 2 – New Equity Issuance , to the unaudited financial statements included above, and raised $8,558,339, net of issuance costs, partially offset by the cash used in relation to a lawsuit filed by the Company against James LeGanke, as Trustee of Carmel Trust II, which was settled for $50,000 in exchange for the return of 1,000,000 shares of Series A Preferred Stock and 127,500 shares of common stock to the Company and the repayment of a portion of the PPP loan plus interest in the amount of $173,928. Cash provided in financing activities for the nine months ended June 30, 2020, was due to the proceeds from the PPP loan, offset by the legal settlement with First Fire Global Opportunity Fund, LLC and the purchase of Treasury Stock for $150,000 in connection therewith (see also Note 7 - Stockholders’ Equity (Deficit) , to the unaudited financial statements included above). Additional information regarding the Private Offering and the Company’s debt can be found under Note 2 – New Equity Issuance and Note 6 – Debt , to the unaudited financial statements included above. 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. Critical Accounting Policies and Estimates 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. See Note 4 of the unaudited financial statements included in “ Part I—Item 1. Financial Statements ”, above, for a discussion of our significant accounting policies. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1). 20 Table of Contents