SideChannel, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in our Management’s Discussion and Analysis of Financial Condition and Results of Operations, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, and elsewhere in this Current Report on Form 10-Q. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Overview Through a licensing program, we have offered our customers the right to use our Polymorphic Encryption Core, (“PEC”), which is a secure, advanced polymorphic data-in-motion product. Recently, one licensee, Castle Shield, began to report early-stage product sales from its software tools that contain our PEC. To supplement the legacy licensing program, we are building our own applications that we intend to sell directly to enterprises and managed security service providers (“MSSP”). On February 14, 2022, we announced the launch of Cipherloc Enclave, our first internally developed product, through a press release and the filing of a Current Report on Form 8-K. Cipherloc Enclave is a micro-segmentation product designed as an easy-to-use platform designed for organizations that are seeking to control communication between devices and fully encrypt traffic between those devices. Enclave is designed to provide a simple and cost-effective solution, as compared to current complex cost-prohibitive solutions, which we believe require technical personnel to operate. Cipherloc Enclave is designed to make micro-segmentation available to everyone at a low cost, and with minimum technical administration. Cipherloc’s Enclave platform will be available through a free plan or a fee per user plan, designed to fit the needs of the two types of end users of the platform. The free tier will give individuals the ability to use the platform for hobby and educational purposes. The paid tier will focus on business users, allowing them to have a more private experience that addresses security and optimization gaps that many companies face in today’s ever-changing technology environment. We anticipate that our operating expenses for the next twelve months will require between $2.0 and $2.7 million of cash, which will come from the net proceeds we received from a private placement of our securities held between March 31, 2021, and April 16, 2021. We intend to manage our business such that our current cash reserves will allow us to reach positive cash flow from our operations, but we cannot assure you that will occur. Our proposed approach to managing our cash will initially emphasize demonstrating our products’ capabilities with early adopters of Cipherloc Enclave. We will follow those efforts with using our remaining cash to scale all of our functional areas, including product development, marketing, sales, customer support, and administration. We intend to focus our product development efforts on building new software and services to work with our existing core technology, while continuing to support our existing licensees. These efforts will require more personnel, as well as more infrastructure. We expect the increase in product development activities will require approximately $600,000 of our cash over the next 12 months. We plan to build the infrastructure we need to perform these new functions on modern technology, with scale and reliability. We plan to utilize cloud services to provide our customers with an interface that modern software provides, but also an ease of use that we believe encryption technologies desperately need. We believe that, if we are able to build our infrastructure, as described above, we will have a competitive advantage over most other participants in our market. We intend to have our sales and marketing efforts emphasize qualified lead generation, using very focused industry messaging and engagement. We plan to participate in relevant cybersecurity and quantum computing industry events. We have also formed a board of advisors designed to help us identify the correct product focus areas and market segmentation. This board of advisors includes professionals from cybersecurity, technology business development and software marketing. We estimate that the expenses we will incur for sales and marketing during the next fiscal year will range between $600,000 and $800,000. We expect that we will have to increase administrative costs if we are successful in generating revenue and need to hire additional employees. Our administrative resources will have to be increased according to our demand to support our employees, increase accounting capacities, and expand our reporting and compliance capabilities. We expect that we will need additional personnel in our accounting and human resources functions to support these expected staff additions. We also plan to add software tools to help us manage our internal processes. We expect that we will need to add customer support teams if and when potential customers adopt each of our product offerings. We project the costs of customer support for our fiscal year 2022 will likely range from $100,000 to $300,000. We believe that these funds will be used primarily for salaries and technology to support these efforts. These expenses will be reported as part of our cost of goods sold. 13 Table of Contents Results of Operations Three and Six Months Ended March 31, 2022, Versus Three and Six Months Ended March 31, 2021 Comparison of Results Our revenue decreased to $251 for the three months ended March 31, 2022, from $6,667 for the three months ended March 31, 2021. This decrease was due to lower licensee revenue for the period compared to the prior fiscal year. Our revenue decreased from $15,417 for the six months ended March 31, 2021 to $251 for the six months ended March 31, 2022, primarily due to low licensing activity taking place during the six months ended March 31, 2022. Our general and administrative expenses were $607,014 and $889,172, respectively, for the three months ended March 31, 2022, and 2021. General and administrative expenses decreased in fiscal 2022, primarily as a result of (i) $108,711 in headcount related costs, including payroll and travel costs (ii) a decrease in professional fees of $106,941, (iii) a decrease in rent expenses of $96,268, and, (iv) a decrease in legal of $81,384 as a result of the settlement of various litigations matters during 2021. The decrease in general and administrative expenses was partially offset by an increase of $45,000 in amortization of deferred costs related to the private placement fees we paid to the placement agent of the private placement of shares of our common stock in March and April of 2021 and increase in other expenses of $46,146 and an increase in board fees of $20,000. Our general and administrative expenses were $1,076,030 and $1,550,864 for the six months ended March 31, 2022, and 2021, respectively. The decrease in general and administrative expenses in 2022 was primarily due to (i) a decrease in legal expenses of $163,870, (ii) a decrease in rent of $134,047, (iii) a decrease in professional fees of $127,067, (iv) a decrease in board fees of $120,000, and, (v) a decrease in headcount related costs, including payroll and travel costs, of $94,814, due to bonus payouts in the prior fiscal year. The decrease in general and administrative expenses were partially offset by an increase of $90,000 in amortization of deferred costs related to the private placement fees we paid to the placement agent of the private placement of shares of our common stock in March and April of 2021 and increases in other expenses of $75,144. Our sales and marketing expenses were $52,375 and $31,250 for the three months ended March 31, 2022, and 2021, respectively. Our sales and marketing expenses increased in fiscal 2022 by $37,500 related to the sales consultant expense and $14,875 brand and website marketing costs, partially offset by a $31,250 decrease in headcount expense related to sales employees in 2021. Our selling and marketing expenses were $105,768 and $56,250 for the six months ended March 31, 2022, and 2021, respectively. Our sales and marketing expenses increased in fiscal 2022 primarily as a result of (i) an increase in consultant expense of $75,000, and (ii) an increase in marketing related costs of $29,750, partially offset by a $55,232 decrease in headcount related costs incurred during 2021. Our research and development expenses were $140,919 and $175,083 for the three months ended March 31, 2022, and 2021, respectively. Our research and development expense increased in fiscal 2021 primarily due to personnel related costs. Our research and development expenses were $270,558 and $296,876 for the six months ended March 31, 2022 and 2021, respectively. Our research and development expenses decreased for the six-month period ended March 31, 2022 primarily as a result of a decrease in consulting related costs of $72,254, partially offset by an increase in payroll related expense of $45,937, both of which were the result of the spending reductions we initiated during the prior fiscal year. We had a net loss of $800,057, or $0.01 per share, for the three months ended March 31, 2022, compared to a net loss of $1,088,838, or $0.04 per share, for the three months ended March 31, 2021. The year-over-year decrease in the net loss for the three months ended March 31, 2022, was primarily due to a decrease in operating expenses from the prior fiscal year. For the six months ended March 31, 2022, we had a net loss of $1,452,105, or $0.02 per share, compared to a net loss of $1,888,573 or $0.07 per share, for the six months ended March 31, 2021. Liquidity and Capital Resources We had an accumulated deficit of $72,982,996 as of March 31, 2022. We expect to incur expenses and generate continued operating losses until we can generate revenues sufficient to cover our expected ongoing expenses. On March 31, 2022, we had cash of $4,390,059, primarily representing proceeds of the private placement of shares of our common stock in March and April 2021. As of March 31, 2022, we had working capital of $4,279,557, compared to working capital of $4,756,094 as of September 30, 2021. Cash Flows The following table summarizes, for the periods indicated, selected items in our condensed Statements of Cash Flows: Six Months Ended March, 2022 2021 Net cash provided by (used in): Operating activities $ (1,393,935 ) $ (898,950 ) Investing activities $ — $ — Financing activities $ — $ 5,447,964 14 Table of Contents Operating Activities We used cash in operating activities in the amounts of $1,393,935 and $898,950 for the six months ended March 31, 2022, and March 31, 2021, respectively. Our uses of cash during the six months ended March 31, 2022, were mainly attributable to a net loss of $1,452,105, which was partially offset by $90,000 in amortization of deferred costs, $51,568 in stock compensation expense, and an increase in our net operating assets and liabilities of $83,398. The change in our net operating assets and liabilities was primarily due to an increase in accounts payable and accrued liabilities of $220,022, which was partially offset by a decrease in prepaid and other assets of $136,624. Cash used in operating activities was $898,950 for the six months ended March 31, 2021. The uses of cash during the quarter ended March 31, 2021, were attributable to a net loss of $1,888,573, which was offset by a non-cash stock compensation expense of $79,655 and a decrease in net operating assets and liabilities of $909,968. The change in our net operating assets and liabilities was primarily due to a decrease in prepaid and other assets of $342,544 and an increase in accounts payable and accrued liabilities of $582,841, partially offset by a decrease in deferred revenue of $15,417. Investing Activities We had no cash used in investing activities for either of the six months ended March 31, 2022, or March 31, 2021. Financing Activities Cash provided by financing activities was $5,447,964 for the six months ended March 31, 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 $5,497,964, 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. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements, as defined under applicable SEC rules, during the periods presented, nor do we currently have any such arrangements. 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).