SideChannel, Inc. 10-K

ITEM 1. BUSINESS Overview We are developing products and services around our patented polymorphic encryption technology, which is designed to enable secure and private data transmission. Through our licensing program, we are offering what we believe to be the first secure, commercially viable, advanced Polymorphic Encryption Core, or PEC, data-in-motion product that can be used in virtually any commercial data security industry or in sensitive application. We believe that our PEC data-in-motion product allows our customers to securely send data, with little setup time required. Beginning in 2019, we retained an entirely new management team. Our current management restructured our business to focus our resources on only products and services that we believe are deliverable, have viable economic potential, and may be publicly disclosed without adversely affecting our competitive position. The core of our product and service offerings will continue to be built around our patents and encryption technology. We believe that our Cipherloc Polymorphic Encryption Engine Core technology is a highly secure data protection technology, which has received a validation certificate from the National Institute of Standards and Technology (NIST). Prior to September 30, 2021, we were a Texas corporation. We are now a Delaware corporation. Our headquarters is located at 6836 Bee Cave Road, Building 1, Suite 279, Austin, TX 78746. The transition to becoming a Delaware corporation was approved by our shareholders at our 2021 annual meeting that was held on September 13, 2021. In addition to the reincorporation in Delaware, our shareholders approved other governance actions designed to reduce risk and accelerate our growth were approved by the shareholders. Other actions by our shareholders at the annual meeting included: ● Election of Anthony Ambrose, Sammy Davis, David Chasteen and Tom Wilkinson to our board of directors; ● Ratification of the appointment of Briggs & Veselka Co. as our independent auditor; ● Approval and adoption of our 2021 Omnibus Equity Incentive Plan; ● Granting discretionary authority to our board of directors to combine the outstanding shares of our common stock into a lesser number of outstanding shares in a reverse stock split, with the exact ratio to be determined by our board of directors, within a range of 1-for-2 to a maximum of 1-for-20; ● Approval an amendment to our Amended and Restated Articles of Incorporation to eliminate the statutory preemptive rights pursuant to Section 21.208 of the Texas Business Organizations Code in the event that the reincorporation from the State of Texas to the State of Delaware is not consummated; ● Approval , by non-binding advisory vote, of a resolution approving named executive officer compensation; and ● Approval , by non-binding advisory vote, of future non-binding advisory votes regarding future named executive officer compensation to occur every three years. Recent Transaction Between March 31, 2021 and April 16, 2021, we entered into a securities purchase agreement with certain accredited investors, pursuant to which we sold an aggregate of 55,549,615 shares of our common stock, and warrants to purchase an equal number shares of our common stock, for $0.18 per share of common stock sold, in a private placement. The price of $0.18 per share was equal to 80% of the closing sales price of our common stock on the OTCQB Market on March 30, 2021. The warrants issued with the shares of common stock have an exercise price of $0.36 per share, and may be exercised at any time prior to March 31, 2026. The warrants have anti-dilution protection that applies if we issue shares of our common stock at less than the $0.36 per share exercise price of the warrants. 4 We received approximately $10 million in gross proceeds from the sale of the shares and warrants. In connection with the private placement, we agreed to use the proceeds for working capital, and not for (i) debt repayment, other than the payment of trade payables in the ordinary course of our business or the repayment of funds we received under the paycheck protection program of the Cares Act, (ii) redemption of our stock, (iii) settlement of any litigation, or (iv) in violation of the law. Paulson Investment Company, LLC acted as the placement agent for the offering. Pursuant to our agreement then, we paid the placement agent a cash commission of $1,334,861, 13% of the gross proceeds we received from the placement, and we granted to the placement agent a ten-year warrant to purchase 8,332,439 shares of our common stock at the price of $0.18 per share. On April 29, 2021, we filed a registration statement on Form S-1 with the SEC, registering the resale of up to 119,431,669 shares of our common stock, representing (i) the shares sold in the private placement referred to above, (i) the shares issuable upon exercise of warrants issued in that private placement, and (iii) the shares issuable upon exercise of warrants issued to the placement agent in the private placement. As a result of the filing of that registration statement, the holders of the registered shares may sell those shares into the market. Products and Services We have focused our development efforts on the commercial application of our technology by advancing a Software Development Kit or SDK, for our solution. We believe that this effort has advanced our technology from theory to commercial application in the form of several products, named Sentinel, Armor, and Shield, which we make available to licensees through our SDK. In the past, we have relied on indirect sales efforts. We are currently developing new products and services designed for direct sales to customers, rather than sales through third parties. Our core technology is protected by six patents that expire between 2034 and 2037. Research and Development Our research and development expenditures for the fiscal years ended September 30, 2021 and September 30, 2020 were $616,746 and $1,689,455, respectively. During December of 2019, our management determined that the pending maturity of our patented technology justified a cessation of our academic research activities, including the elimination of our chief scientist’s role in leading various academic efforts. We allocated the cost savings from ceasing those activities entirely to product development, product engineering, and revenue-generating sales activities. Our management continued to emphasis these three areas during fiscal year 2021 and intends to continue that emphasis in our fiscal year 2022 and beyond. Competition The encryption software market sector is highly competitive, subject to rapid change, and significantly affected by new product introductions and other activities of market participants. Some of our competitors have greater financial, technical, sales, marketing and other resources than we do. Because of these and other factors, competitive conditions in the markets we compete in are likely to continue to intensify in the future. Increased competition could result in price reductions for our products and services, reductions in our net revenue and profit margins and the loss of our market share, any of which would likely harm our business. We believe that our future results depend largely upon our ability to serve our customers better than our competitors, and by offering new product enhancements, whether by internal development or acquisition. We also believe that we must provide product offerings that compete favorably against those of our competitors with respect to ease of use, reliability, performance, range of useful features, reputation and price. We anticipate that we will face increasing pricing pressures from our competitors in the future. Since there are low barriers to entry into the encryption software market, which is subject to rapid technological change, we believe that competition in our market will persist and intensify in the future. 5 Intellectual Property Protective Measures We believe that our intellectual property is an important and vital asset, which enables us to develop, market, and sell our products and services, and enhance our competitive position. Our intellectual property includes our proprietary business and technical know-how, inventions, works of authorship, and confidential information. To protect our intellectual property, we rely primarily upon legal rights in trade secrets, patents, copyrights, and trademarks, in addition to our policies and procedures, security practices, contracts, and relevant operational measures. We protect the confidentiality of our proprietary information by entering into non-disclosure agreements with our employees, contractors, and other entities with which we do business. In addition, our license agreements related to our software and proprietary information includes confidentiality terms. These agreements are generally non-transferable. We also employ access controls and associated security measures to protect our facilities, equipment, and networks. Patents, Copyrights, Trademarks, and Licenses Our products, particularly our software and related documentation, are protected under domestic and international copyright laws and other laws related to the protection of intellectual property and proprietary rights. Currently, we have six patents filed with the U.S. Patent and Trademark Office. We employ procedures to label copyrightable works with the appropriate proprietary rights notices, and we actively enforce our rights in the United States and abroad. However, these measures may not provide us with adequate protection from infringement, and our intellectual property rights may be challenged. Our Cipherloc logo is a registered trademark with the U.S. Patent and Trademark Office. In the United States, we are generally able to maintain our trademark rights and renew trademark registrations for as long as the trademarks are in use. Government Regulation Export Control Regulations . We expect that all of our products will be subject to U.S. export control laws and applicable foreign government import, export and/or use requirements. The level of such control generally depends on the nature of the products in question. Often, the level of export control is impacted by the nature of the software and encryption incorporated into our products. In those countries where such controls apply, the export of our products may require an export license or authorization. However, even if a transaction qualifies for a license exception or the equivalent, it may still be subject to corresponding reporting requirements. For the export of some of our products, we may be subject to various post-shipment reporting requirements. Minimal U.S. export restrictions apply to all our products, whether or not they perform encryption functions. If we become a Department of Defense contractor in the future, certain registration requirements may be triggered by our sales. In addition, certain of our products and related services may be subject to the International Traffic in Arms Regulations (ITAR) if our software or services are specifically designed or modified for defense purposes. If we become engaged in manufacturing or exporting ITAR-controlled goods and services (even if we do not export such items), we will be required to register with the U.S. State Department. Enhancements to our existing products may be subject to review under the Export Administration Act to determine what export classification they will receive. In addition, any new products that we release in the future will also be subject to such review before we can export them. The U.S. Congress continues to discuss t the correct level of export control in possible anti-terrorism legislation. Such export regulations may be modified at any time. Modifications to these export regulations could reduce or eliminate our ability to export some or all of our products from the United States in the future, which could put us at a disadvantage in competing with companies located outside of the U.S. Modifications to U.S. export regulations could restrict us from exporting our existing and future products. Any such modifications to export regulations may put us at a competitive disadvantage with respect to selling our products internationally. 6 Privacy Laws . We may be subject to various international, federal and state regulations regarding the treatment and protection of personally identifying and other regulated information. Applicable laws may include U.S. federal laws and implementing regulations, such as the [GLBA and HIPAA], as well as state and international laws and regulations, including the European Union General Data Protection Regulation (GDPR). Some of these laws have requirements on the transmittal of data from one jurisdiction to another. In the event our systems are compromised, many of these privacy laws require that we provide notices to our customers whose personally identifiable data may have been compromised. Additionally, if we transfer data in violation of these laws, we could be subjected to substantial fines. To mitigate the risk of having such data compromised, we use encryption and other security to protect our databases. Personnel As of the date of this Annual Report on Form 10-K, we have three full-time employees and one part-time employee. We also have four independent contractors that provide services to us. We anticipate that we will need to increase our staffing in the foreseeable future.