What changed in this filing

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Item 7. Management’s Discussion and Analysis

2022-12-20 compared with 2021-12-21 · 206 added, 188 removed, 11 unchanged (97% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing

elsewhere in this Annual Report on Form 10-K.

are developing products and services around our patented polymorphic encryption technology, which is designed to enable secure and private

data transmission.

Through a licensing program, we are offering our Polymorphic Encryption Core, or PEC, which we believe to be the first

secure commercially viable, advanced polymorphic data-in-motion product that is designed to be used in any commercial data security industry

or in sensitive applications.

To supplement our potential licensing revenue, we are building our own applications that leverage our PEC.

We believe that our innovative and patented polymorphic technology provides resistant and performant solutions to the problem of quantum

cracking through rapid deployment of our quantum encryption algorithm, which has been approved by the National Institute

of Standards and Technology.

anticipate that our operating expenses for the next twelve months will require between $2.5 and $3.5 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.

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 our current customers.

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.

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 $1.0 million 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.

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.

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 $500,000 and $750,000.

administration costs are currently minimal.

However, we expect that we will have to increase these costs if we are able to generate sufficient

revenues and 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.

expect that we will need to add customer support teams if and when potential customers adopt each of our product offerings.

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 included in our cost of goods sold.

Accounting Policies

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.

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.

methods, estimates, and judgment we use in applying our most critical accounting policies have a significant impact on the results we

report in our financial statements.

The SEC has defined “critical accounting policies” as those accounting policies that

are most important to the portrayal of our financial condition and results and require us to make our most difficult and subjective judgments,

often as a result of the need to make estimates of matters that are inherently uncertain.

Based upon this definition, our most critical

estimates are accounting for software revenue recognition, and stock issued to employees and non-employees.

Our most critical accounting

policies applicable to the periods presented are noted below.

For additional information see Note 3 Significant Accounting Policies in

the notes to our financial statements appearing elsewhere in this report.

Although we believe that our estimates and assumptions are

reasonable, they are based upon information presently available, and actual results may differ significantly from these estimates.

critical accounting policies and estimates are those related to revenue recognition, deferred income taxes, accounting for share-based

payments, and litigation.

Recognition .

We adopted the new accounting revenue standard for revenue recognition, effective October 1, 2018, using the modified

retrospective transition method applied to those contracts that were not completed as of October 1, 2018.

We present our results for

reporting periods beginning after October 1, 2018 under this new guidance, while prior period amounts are not adjusted and continue to

be reported in accordance with our historic accounting under previous revenue guidance.

See Note 3 Significant Accounting Policies in

the notes to our financial statements appearing elsewhere in this report.

contracts with customers often include promises to transfer multiple products and services to a customer.

Our determination whether products

and services are considered distinct performance obligations that should be accounted for separately, versus together, may require significant

judgment is required to determine the standalone selling price, or SSP, for each distinct performance obligation.

For products and services

aside from maintenance and support, we estimate 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.

perpetual and term software licenses 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.

For certain arrangements,

we recognize revenue based upon usage or 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, we defer revenues associated with maintenance services and recognize the revenue ratably over the term of the applicable

recognize revenues associated with professional services upon customer acceptance.

for Share-Based Payments .

As discussed further in Note 8 (Stockholders Equity (Deficit)) to our financial statements

appearing elsewhere in this report, we account for share-based awards in accordance with the authoritative guidance issued by the FASB

on stock compensation.

have used and expect to continue to use the Black-Scholes option-pricing model to compute the estimated fair value of share-based compensation

The Black-Scholes option-pricing model includes assumptions regarding dividend yields, expected volatility, expected option

term and risk-free interest rates.

The assumptions used in computing the fair value of share-based compensation expense reflect our best

estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control.

We estimate expected

volatility based primarily on historical daily price changes of our stock and other factors.

The expected option term is the number of

years that we estimate that the stock options will be outstanding prior to exercise.

We determine the estimated expected term of the

stock awards issued pursuant to SEC Staff Accounting Bulletin SAB No.

If we had used other assumptions or estimates, the share-based

compensation expense that we recorded for the years ended September 30, 2019 and September 30, 2018 could have been materially different.

Furthermore, if we use different assumptions or estimates in future periods, our share-based compensation expense could be materially

to ASC 718-20-35-7, Repurchase or Cancellation of Equity Awards, we charge to equity the amount of cash or other assets transferred (or

liabilities incurred) to repurchase an equity award, to the extent that the amount paid does not exceed the fair value of the equity

instruments repurchased at the repurchase date.

We recognize any excess of the repurchase price over the fair value of the instruments

repurchased as additional compensation cost.

MD&A should be read in conjunction with the accompanying consolidated financial statements.

In addition, please refer to the discussion

of our business and markets contained in Part 1, Item 1 of this Report.

mission is to make cybersecurity simple and accessible for mid-market and emerging 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 virtual Chief Information Security Officer (vCISO), zero trust, third-party

risk management, due diligence, privacy, threat intelligence, and managed end-point security solutions.

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.

growth strategy focuses on these three initiatives:

Securing new vCISO clients

Adding new Cybersecurity Software and Services offerings

Increasing adoption of Cybersecurity Software, including Enclave and Services offerings at vCISO clients

support of securing new vCISO clients, we expanded the sales and marketing team from one dedicated person to five during the fiscal quarter

ended during September 30, 2022.

On October 27, 2022, we announced that during the same fiscal quarter we acquired six (6) new clients

with potential annual revenue of $1.3 million.

vCISO engagements are typically twelve (12) month engagements containing a monthly subscription

and an annual renewal option and hourly rates for vCISO time and material projects range from $350 to $400.

Each of our vCISO’s

is generally embedded into the C-suite executive teams of two (2) to four (4) of our clients.

Collectively,

our cybersecurity professionals collaborate on the development of proprietary software and pursue partnerships with cybersecurity software

value added resellers (“VARs”).

Commercial relationships with VARs provide SideChannel with additional internal capabilities

to mitigate cybersecurity risks.

We earn a commission on software engagements we generate through VARs.

In 2022 VAR commissions contributed

2.4% of our revenue versus 3.2% during 2021.

September 2022 we announced a proprietary product called Enclave which simplifies an important cybersecurity task called “microsegmentation”.

Enclave seamlessly combines access control, microsegmentation, encryption and other secure networking concepts to create a comprehensive

It allows Information Technology to easily segment the enterprise network, place the right staff in those segments and direct

We expect to begin recognizing revenue from Enclave during fiscal year 2023.

internally report our revenue using two categories.

The first, “vCISO Services”, captures the revenue and related cost of

goods sold for the Chief Information Security Officer services that we provide to our clients on a “virtual” or outsourced

basis, thus the acronym “vCISO”.

Services delivered by SideChannel through our team of vCISOs include assessing the cybersecurity

risk profile, implementing policies and programs to mitigate risks, and managing the day-to-day tasks to ensure compliance with the adopted

cybersecurity framework.

Most of our clients use our vCISO services.

second revenue category encompasses an array of Cybersecurity Software and Services that our clients deem necessary to protect their

digital assets.

These include cybersecurity software owned by SideChannel and software sourced from third parties.

SideChannel earns

commissions on third-party software sales which it recognizes as revenue.

Cybersecurity services are also delivered directly by SideChannel

employees and indirectly by third party service providers.

table below reflects the revenue by category in fiscal years 2022 and 2021:

vCISO Services

Cybersecurity Software & Services

growth in vCISO Services is primarily the result of client growth and secondarily because of an increase in the revenue per client.

Cybersecurity

Software & Services revenue grew from 2021 to 2022 primarily because of an increase in the use of these services by existing Cybersecurity

Software and Services clients and secondarily because of an expansion of the services and software offered.

also monitor new and recurring revenue.

The revenue earned from clients during our first twelve months of working with them is classified

while the revenue earned with clients after our first twelve months of working with them is classified as recurring.

The following

table provides details on our new and recurring revenue for fiscal years 2022 and 2021:

vCISO Revenue

Cybersecurity Software & Services Revenue

Total Revenue

we consider revenue retention a key performance indicator.

Revenue retention is calculated by dividing recurring revenue by the prior

year total revenue.

The following table shows the revenue retention for fiscal year 2022 by revenue category.

vCISO Services

Cybersecurity Software & Services

Total Revenue Retention

of Operations

Year Ended September 30, 2022 Compared to Fiscal Year Ended September 30, 2021

Our revenue for the year ended September 30, 2021

was $15,417, a decrease of $32,566 from revenue of $47,983 for the year ended September 30, 2020.

Our revenue recognized during

the year ended September 30, 2021 was from sales that occurred during the prior fiscal year, with the revenue being

recognized over the 12 months following the invoice as cash was collected from the applicable customers.

had no new sales during our fiscal year ended September 30, 2021, even though we were expecting sales during the

period based upon information we received from our licenses.

We did not record any cost of revenues for the years ended September

30, 2021 or September 30, 2020.

general and administrative expenses decreased from $4,573,673 for the year ended September 30, 2020, to $2,597,881 for the year ended

September 30, 2021.

The decrease in general and administrative expenses in 2021, compared to 2020, primarily resulted from lower legal

expenses of $845,228, an impairment gain related to our operating leases of $824,559, a decrease in payroll related expenses of $390,788,

and decreases in various other office expenses of $139,775, such as professional fees and subscriptions, partially offset by an

increase in corporate insurance of $174,558.

sales and marketing expenses decreased to $96,125 for the year ended September 30, 2021, from $710,595 for the year ended September 30,

The decrease in sales and marketing expenses was primarily due to a decrease in payroll expense of $323,904, a decrease in consulting

of $192,650, a decrease in marketing costs of $59,301 and a decrease in travel related expenses of $38,615.

research and development expenses decreased to $616,746 for the year ended September 30, 2021, from $1,689,455 for the year ended September

The decrease in research and development expenses was primarily due to a decrease in consulting expense of $771,125 and a decrease

in payroll expense of $301,584.

total other income increased to $191,052 for the year ended September 30, 2021, from $44,332 of other expense for the year ended

September 30, 2020.

The income resulted from the partial forgiveness of our PPP loan.

Our other expenses for the year ended September

30, 2020 was the result of losses be recognized on the disposal of some of our fixed assets.

We had a net loss of $3,104,283 for the year ended

September 30, 2021, compared to a net loss of $6,970,072 for the year ended September 30, 2020.

The decrease in our net loss was

due to a significant reduction in expenses during the latter half of the year ended September 30, 2020.

Our revenue was $4.8 million for the year ended September 30, 2022, compared to $2.8 million in the prior year, an increase of $2.0

million or 71%.

We believe this increase reflects the factors previously discussed in the Overview section above.

Gross margins increased to 48.5% in fiscal year 2022 from 45.1% in fiscal year 2021 which we attribute to better utilization

of our service delivery team.

and Administrative Expenses.

Our general and administrative expenses were $1.5 million for the year ended September 30, 2022, compared

to $656,000 for the prior year, an increase of $826,000 or 126%.

The increase in general and administrative expenses primarily resulted

from increased staff and related salary and independent contractor expense;

higher professional fees and insurance related to the listed

nature of the Company.

To a lesser extent there where increase in amortization and travel related costs.

and Marketing Expenses.

Our sales and marketing expenses were $367,000 for the year ended September 30, 2022, compared to $96,000

for the prior year, an increase of $271,000 or 282% resulting from our increase in sales and marketing staff and the related salary and

independent contractor expense;

higher spend on third-party marketing services.

and Development Expenses.

Our research and development expenses were $178,000 for the year ended September 30, 2022, compared to

$0 for the prior year.

These costs arose as a result of the Business Combination and are driven by personnel expenses and costs incurred

from independent contractors related to the development of Enclave.

Expenses incurred because of the Business Combination were $6.2 million for the year ended September 30, 2022.

costs, which included the recognition of the $6.1 million of contingent consideration for 59.9 million common shares to be issued in

the Second Tranche and $100,000 of expenses for related professional services.

We recorded a $5.7 million goodwill impairment charge during the year ended September 30, 2022.

The goodwill was related

to the acquisition that occurred on July 1, 2022.

Our income tax expense was $195,000 for the year ended September 30, 2022 compared to $0 in the prior year.

is associated with the estimated federal and state income tax liability for SCS from January 1, 2022 through June 30, 2022.

and Capital Resources

had an accumulated deficit as of September 30, 2021 of $71,530,891.

We expect to continue to generate operating losses until we can generate

revenues sufficient to exceed our operating expenses.

As of September 30, 2021, we had $5,783,994 in cash.

We believe that our existing

cash balances are sufficient to fund our operations for the next 12 months.

following table summarizes, for the periods indicated, selected items in our Statements of Cash Flows:

Ended September 30,

primary source of liquidity and capital resources has been cash flow from operations.

As part of the Business Combination, we received

$3.6 million in cash from Cipherloc.

We had an accumulated deficit of $11.9 million as of September 30, 2022.

Two (2) non-recurring expenses

totaling $11.9 million are included in our accumulated deficit.

The non-recurring expenses are $6.2 million for the acquisition costs including $6.1 million related to the contingent consideration from the Business Combination and $5.7 million impairment of goodwill recorded as a result of the Business Combination.

Since the Business Combination on July 1, 2022 we expect to continue to generate operating losses until we can generate revenues sufficient

to exceed our operating expenses.

anticipate total operating expenses to range between $4.0 million and $4.7 million in the next fiscal year with cash used by operations

to range between $1.5 million and $2.0 million.

which will be funded with our existing cash balances.

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 this

positive cash flow will be achieved.

of September 30, 2022, we had $3.0 million in cash and our working capital was $3.0 million.

We believe that our existing cash balances

are sufficient to fund our operations through December 31, 2023.

following table summarizes, for the periods indicated, selected items in our Statements of Cash Flows ($000’s):

Year Ended September 30,

Net cash (used in) provided by:

Operating activities

$ (3,630,806 )

$ (6,646,091 )

Investing activities

Financing activities

the year ended September 30, 2021, we used $3,630,806 in operating activities, primarily attributable to our net loss of $3,104,283 during

the period and negative non-cash items of $633,649, which were partially offset by a net positive change in net operating assets and

liabilities of $107,126.

Our non-cash items primarily consisted of an of impairment loss of $441,597 related to an operating lease that

was terminated, and forgiveness of our PPP loan of $192,502.

The change in our net operating assets and liabilities was primarily due

to an increase in prepaid and other assets of $511,408, offset by an increase in accounts payable and accrued liabilities of $618,951.

We used cash during the year to pay for the cost of general and administrative, sales and marketing, and research and development activities,

totaling $3,310,752.

the year ended September 30, 2020, we used $6,646,091in cash in operating activities, primarily attributable to our net loss of $6,970,072,

non-cash items of $640,433 and a net change in net operating assets and liabilities of $316,452.

Non-cash items primarily consisted of

an impairment loss of $382,961 related to the termination of operating leases, stock compensation expense of $194,896, a net loss on

disposal of assets of $44,332 and depreciation of $18,243.

The change in our net operating assets and liabilities was primarily due to

an increase in prepaid and other assets of $322,912 and an increase in accounts payable and accrued liabilities of $6,460.

during the year to pay for the cost of general and administrative, sales and marketing, and research and development activities, which

combined to be $6,973,723.

used no cash in investing activities for the year ended September 30, 2021.

For the year ended September 30, 2020, we used $28,972 of

cash in investing activities, attributable to purchases of property and equipment.

the year ended September 30, 2021, we received $8,334,961 in cash from financing activities, primarily derived from the net proceeds

from our capital raise of $8,558,339 offset by a repayment of $173,378 of our PPP loan and payments for the repurchase of treasury stock

and preferred stock of $40,000 and $10,000, respectively.

the year ended September 30, 2020, we used $84,570 in cash due to financing activities, primarily due to a payment $450,000 we made for

the repurchase of treasury stock, partially offset by the proceeds from the PPP loan of $365,430.

Net cash used in operations for the year ended September 30, 2022, was $396,000.

For the year ended September 30,

2022, we recorded a net loss of $11.6 million.

During this same period, our non-cash charges primarily consisted of $6.1 million for

acquisition-related costs associated with the second tranche of common stock to be issued in connection with the Business Combination,

$5.7 million for a goodwill impairment charge, as well as $51,000 for stock-based compensation costs and $46,000 for depreciation and

amortization.

Accounts receivable increased $461,000 due to the aforementioned revenues, which increased in 2022 compared to 2021.

During the year ended September 30, 2022, we received $3.6 million in cash from the Business Combination that took

place on July 1, 2022.

During the year ended September 30, 2022, we had equity distributions of $461,000 and membership redemptions of

$100,000, of which $50,000 was paid in cash and $50,000 was through the issuance of a note payable, both related to SideChannelSec

LLC prior to its incorporation in Massachusetts as SideChannel, Inc.

on December 29, 2021.

Accounting Estimates

preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of

America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related

disclosure of contingent assets and liabilities.

On an on-going basis, we evaluate our estimates, including those related to long-lived

assets, goodwill, identifiable intangibles and deferred income tax valuation allowances.

We base our estimates on historical experience

and on appropriate and customary assumptions that we believe to be reasonable under the circumstances, the results of which form the

basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

of these accounting estimates and assumptions are particularly sensitive because of their significance to our consolidated financial

statements and because of the possibility that future events affecting them may differ markedly from what had been assumed when the financial

statements were prepared.

reference Note 2 – Summary of Significant Accounting Policies.

Intangible and Long-Lived Assets

account for goodwill and intangible assets in accordance with Accounting Standards Codification (“ASC”) Topic 350 (Intangibles-

Goodwill and Other).

Finite-lived intangible assets are amortized over their estimated useful economic life and are carried at cost less

accumulated amortization.

Goodwill is assessed for impairment at least annually in the fourth quarter, on a reporting unit basis, or

more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired.

As a part of the goodwill

impairment assessment, we have the option to perform a qualitative assessment to determine whether it is more-likely-than-not that the

fair value of a reporting unit is less than its carrying amount.

If, as a result of our qualitative assessment, we determine this is

the case, we are required to perform a goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill

impairment loss to be recognized.

The test is discussed below.

If, as a result of our qualitative assessment, we determine that it is

more-likely-than-not that the fair value of the reporting unit is greater than its carrying amounts, the goodwill impairment test is

not required.

quantitative goodwill impairment test, used to identify both the existence of impairment and the amount of impairment loss, compares

the fair value of a reporting unit with its carrying amount, including goodwill.

If the fair value of a reporting unit exceeds its carrying

amount, goodwill of the reporting unit is considered not impaired.

If the carrying amount of a reporting unit exceeds its fair value,

an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting

The goodwill impairment assessment is based upon the income approach, which estimates the fair value of our reporting units based

upon a discounted cash flow approach.

This fair value is then reconciled to our market capitalization at year end with an appropriate

control premium.

The determination of the fair value of our reporting units requires management to make significant estimates and assumptions

including the selection of control premiums, discount rates, terminal growth rates, forecasts of revenue and expense growth rates, income

tax rates, changes in working capital, depreciation, amortization and capital expenditures.

Changes in assumptions concerning future

financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting unit or the

amount of the goodwill impairment charge.

At September 30, 2022 and 2021, goodwill was $1.4 million and $0, respectively.

the initial goodwill recorded from the Business Combination of $7.1 million and determined that the carrying value exceeded the fair

value and recorded $5.7 million impairment of goodwill during the year ended September 30, 2022.

No impairment was recorded during our

fiscal year 2021.

did not record indefinite-lived intangible assets in the fiscal years ended September 30, 2022 and 2021.

assets, which consist of finite-lived intangible assets and property and equipment, are assessed 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 estimated undiscounted cash flows to the recorded

value of the asset.

If impairment is indicated, the asset is written down to its estimated fair value.

The cash flow estimates used to

determine the impairment, if any, contain management’s best estimates using appropriate assumptions and projections at that time.

We have a finite-lived intangible asset of $4.9 million and we have less than $1,000 in property and equipment.

At September 30, 2022

and 2021, finite-lived intangibles and long-lived assets were $4.9 million and $0, respectively.

We recorded no impairment charges during

either fiscal year.

Sheet Arrangements

2 unchanged sentences

Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined

in Rule 229.10(f)(1).

in Rule 229.10(f)(1) of Regulation S-K promulgated by the SEC.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis