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 With our acquisition of SideChannel, Inc., a Massachusetts corporation, on July 1, 2022, we expanded our capabilities to include providing cybersecurity programs to mid-market companies, which are designed to help those companies protect their assets. With the additional of SideChannel, we now employ what we believe to be among the market’s most skilled and experienced talent to help our clients to improve their defenses against cybercrime. With the SideChannel acquisition, we now have over 20 C-suite level information security officers, who possess combined experience of over 400 years in the industry. To date, SideChannel has created over 50 multi-layered cybersecurity programs for its clients. Our mission is to make cybersecurity easy and accessible for mid-market companies, a market that we believe is currently underserved. We believe that our cybersecurity offerings will identify and develop cybersecurity, privacy and risk management solutions for our customers. We anticipate that our target customers will continue to need cost effective security solutions. We intend to provide more tech-enabled services to address the needs of our customers, including third-party risk management, due diligence, privacy, threat intelligence, and managed end-point security solutions. We believe that our customers, and prospective customers, in the mid-market will favor our approach, as it provides them with an efficient way to work with a single vendor to manage and oversee their cybersecurity programs. We also believe that our approach will reduce our customers’ overall security costs and streamline their ability to increase their sales, reduce regulatory risks and monitor their risk posture. We believe that we provide a full range of cybersecurity solutions through our in-house delivery capabilities, and through our network of subcontractors. We work with our clients to help them select the right cybersecurity tools, products, and solutions. We believe that our use of subcontractors allows us to quickly move directly into implementation of projects, which we believe reduces the risk to our customer. Our subcontractors also provide us with sales leads and referrals, and may resell our services to their own client base. We believe that this allows us to maximize our sales efforts, reduce expense of sales, and gain new customers. Prior to our acquisition of SideChannel, we offered our customers a license 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 our legacy licensing program, we are building our own applications that we intend to sell directly to enterprises and managed security service providers. On February 14, 2022, we announced the launch of Enclave, our first internally developed product. Enclave is a product designed to be an easy-to-use platform for organizations that are seeking to control communication between devices; and to fully encrypt traffic between those devices. Enclave is designed to provide a simple and cost-effective solution for multiple devices, as compared to current complex cost-prohibitive solutions, which we believe require technical personnel to operate. Enclave is designed to make micro-segmentation available to everyone at a low cost, and with minimum technical administration. The Enclave platform is 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 plan will give individual users the ability to use the platform for hobby and educational purposes. The fee per user plan will focus on business users, allowing them to have a more private experience that addresses security and optimization gaps that we believe many companies face in today’s ever-changing technology environment. We anticipate that we will need between $2.0 million and $2.7 million of cash to cover our operating expenses for the next twelve months. We expect to cover those expenses with the net proceeds we received from a private placement of our securities in the first quarter of our fiscal year 2021. We further anticipate that the SideChannel acquisition may mitigate or reduce our use of cash for operating expenses. We intend to manage our business such that our current cash reserves will be sufficient to allow us to reach positive cash flow from our operations, but we cannot assure you that will occur. 14 Table of Contents Results of Operations Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021 Our revenue was $198 for the three months ended June 30, 2022, compared to zero revenue for the three months ended June 30, 2021. The revenue in fiscal 2022 was related to our licensing agreement with Castle Shield. Our general and administrative expense was $1,107,310 for the three months ended June 30, 2022, compared to $197,534 for the three months ended June 30, 2021, an increase of $909,776, or 461%. The increase was driven by several factors including: (i) $479,075 in costs related to the SideChannel acquisition; (ii) an increase in headcount related expenses of $335,232; and (iii) a $45,000 increase in the amortization of deferred costs related to private placement fees. The increase in general and administrative expense was partially offset by (i) a reduction of $441,597 as a result of a recognized gain related to the write-off of remaining right-of-use (ROU) assets and operating lease liability after the early termination of our final operating lease; and (ii) decreases in other items, including a reduction of $192,732 in legal expense, as well as a decrease of $168,765 in rent expense. Our selling and marketing expenses were $82,548 for the three months ended June 30, 2022, compared to zero for the three months ended June 30, 2021. Our sales and marketing expenses in fiscal 2022 include (i) consultant expenses of $37,500, (ii) $34,875 in brand and website marketing costs, and (iii) stock compensation expense of $10,173. Our research and development expenses were $191,258 for the three months ended June 30, 2022, compared to $169,098 for the three months ended June 30, 2021, an increase of $22,160 or 13%. The increase was primarily due to a $58,020 increase in development expenses, as well as a $26,672 increase in personnel related costs. These increases were partially offset by a $62,532 decrease in consultant expenses. Our other income (expense) was zero for the three months ended June 30, 2022, compared to other income of $191,052 for the three months ended June 30, 2021. The other income in fiscal 2021 was related to the Paycheck Protection Program, or PPP, partial loan forgiveness we received, partially offset by a minor amount of interest expense. Nine Months Ended June 30, 2022, Compared to Nine Months Ended June 30, 2021 Our revenue was $449 for the nine months ended June 30, 2022, compared to $15,417 for the nine months ended June 30, 2021, a decrease of $14,968, or 97%. The reduction in our revenue in fiscal 2022 was due to low sales activity from our licensees during the nine months ended June 30, 2022. Our general and administrative expense was $2,183,340 for the nine months ended June 30, 2022, compared to $1,748,398 for the nine months ended June 30, 2021, an increase of $434,942, or 25%. The increase in our general and administrative expense was driven by several factors including: (i) $479,075 in SideChannel acquisition related costs in fiscal 2022; (ii) an increase in headcount related expenses of $232,384; and (iii) a $135,000 increase in the amortization of deferred costs related to private placements fees. These increases in general and administrative expense were partially offset by decreases in other items, including (i) a reduction of $441,597 in general and administrative expense in fiscal 2021 as a result of a gain we recognized related to the write-off of our remaining right-of-use (ROU) assets and an operating lease liability after the early termination of our final operating lease; (ii) a reduction of $356,602 in legal expense; (iii) a decrease of $302,811 in rent expense and (iv) a decrease in professional fees of $165,485. Our selling and marketing expense was $188,316 for the nine months ended June 30, 2022, compared to $56,250 for the nine months ended June 30, 2021, an increase of $132,066, or 235%. The increase in our sales and marketing expense was the result of several factors including: (i) an increase of $112,500 in consultant expenses; and (ii) an increase of $64,625 in brand and website marketing costs. These increased selling and marketing expenses were partially offset by a $45,059 decrease in headcount related costs during fiscal 2021 that were not incurred in the current fiscal year. 15 Table of Contents Our research and development expense were $461,816 for the nine months ended June 30, 2022, compared to $465,974 for the nine months ended June 30, 2021, a decrease of $4,158 or 1%. The slight reduction in our research and development expense was primarily the result of a $134,786 decrease in consulting related costs, resulting from the spending reductions we initiated during the prior fiscal year. This cost reduction was partially offset by an increase in payroll related expense of $72,608 and an increase of $58,020 in product development expenses. Our other income (expense) was zero for the nine months ended June 30, 2022, compared to other income of $191,052 for the nine months ended June 30, 2021. The other income in fiscal 2021 was related to the partial forgiveness of our PPP loan, partially offset by a minor amount of interest expense. Liquidity and Capital Resources We had an accumulated deficit of $74,363,914 as of June 30, 2022. We expect to continue to incur expenses, and generate continued operating losses, until we can generate revenues that are sufficient to cover our expected ongoing expenses. We anticipate that our operating expenses for the next twelve months will require between $2.0 million and $2.7 million of cash. We expect to cover those expenses with some of the net proceeds we received from a private placement of our equity securities in the first quarter of our fiscal year 2021. We further anticipate the SideChannel acquisition will mitigate or reduce our use of cash for operating expenses. We intend to manage our business so that our current cash reserves will be sufficient to allow us to reach positive cash flow from our operations, but we cannot assure you that will occur. We do not currently have access to any credit facilities and we cannot guarantee that we will be able to access any credit facilities if needed. On June 30, 2022, we had cash and cash equivalents of $3,588,912, primarily representing proceeds from the private placement of shares of our common stock in March and April of 2021. As of June 30, 2022, we had working capital of $3,010,376, 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: Nine Months Ended June, 2022 2021 Net cash provided by (used in): Operating activities $ (2,195,082 ) $ (2,566,292 ) Investing activities $ — $ — Financing activities $ — $ 8,334,961 16 Table of Contents Operating Activities. For the nine months ended June 30, 2022, we recorded a net loss of $2,833,023. Our net cash used in operating activities during this period was $2,195,082. During the nine months ended June 30, 2022, we had non-cash charges of $135,000 for amortization of deferred costs related to private placement fees. In addition, we recorded $84,305 of stock-based compensation expense during the period. Our prepaid expenses declined by $251,645, reflecting the amortization of those prepaid expenses during fiscal 2022. We also settled $854,000 of our accounts payable and accrued liabilities through the issuance of 4,744,448 shares of our common stock to our creditors. We issued another 200,000 shares of our common stock to cover $14,000 in legal settlement expenses. Our accrued compensation expense increased by $175,000 during fiscal 2022 as a result of bonuses paid to our employees as of June 30, 2022. Investing Activities. We had no investing activities during the nine months ended June 30, 2022. Financing Activities. We had no financing activities during the nine months ended June 30, 2022. Off-Balance Sheet Arrangements During the nine months ended June 30, 2022, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our interests. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with GAAP 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. Our 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. As of June 30, 2022, there have been no significant changes to the accounting estimates and assumptions that we have deemed critical in the past. Our critical accounting estimates and assumptions are more fully described in our Annual Report on Form 10-K for our fiscal year 2021. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), we are not required to provide the information required by this Item, as we are a “smaller reporting company,” as defined by Rule 229.10(f)(1).