SideChannel, Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS SIDECHANNEL, INC. TABLE OF CONTENTS Page REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 40 FINANCIAL STATEMENTS: Balance Sheets as of September 30, 2022 and 2021 42 Statements of Operations for the years ended September 30, 2022 and 2021 43 Statements of Stockholders’ Equity for the years ended September 30, 2022 and 2021 44 Statements of Cash Flows for the years ended September 30, 2022 and 2021 45 NOTES TO FINANCIAL STATEMENTS 46 39 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of SideChannel, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of SideChannel, Inc. and Subsidiaries (the Company) as of September 30, 2022 and 2021, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the years in the two-year period ended September 30, 2022, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended September 30, 2022, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for the Business Combination of Cipherloc, Inc. —Refer to Note 3 to the financial statements Description of the Matter: As described in Note 3 to the consolidated financial statements, the Company completed an acquisition of Cipherloc, Inc. and affiliates for net consideration of $15.2 million in the year ended September 30, 2022. The Company accounted for this acquisition as a business combination. This included the issuance of 88.4 million shares of common stock valued at $9.0 million and warrants to purchase 87.6 million shares of common stock valued at $6.2 million. The fair values of identified intangible assets consisted of technology of $4.9 million. Goodwill, which represents the excess of the consideration paid over the fair value of the net tangible assets and intangible assets acquired, of $7.1 million was also recorded. The significant estimation uncertainty was primarily due to the sensitivity of the respective fair values to underlying assumptions about future performance of the acquired business. The significant assumptions used to form the basis of the forecasted results included revenue growth rates, discount rates, tax amortization benefit factor, and other intangible specific assumptions. These significant assumptions were forward-looking and could be affected by future economic and market conditions. The goodwill was evaluated at the acquisition date and the fair value of the goodwill was determined to be less than the carrying amount of the goodwill by $5.7 million. As a result, an impairment charge was recorded on the acquisition date of $5.7 million was recorded and the net carrying amount of goodwill was $1.4 million. 40 The principal considerations for our determination that performing procedures relating to the valuation of intangible assets as a critical audit matter are (1) there was a high degree of auditor judgment and subjectivity in applying procedures relating to the fair value of intangible assets acquired due to the significant judgment by management when developing the estimates and (2) significant audit effort was required in evaluating the significant assumptions relating to the estimates, including the income projections and discount rates. In addition, the audit effort involved the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence obtained. How we addressed the Matter in our Audit: Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included the following: ● Reading the underlying agreements and testing management’s application of the relevant accounting guidance ● Inquiry of management regarding the development of the assumptions used in the valuation of the intangible assets. ● Testing management’s process included evaluating the appropriateness of the valuation models, testing the completeness, accuracy, and relevance of underlying data used in the models, and testing the reasonableness of significant assumptions, including the income and expense projections. ● Reviewed the credentials and evaluated the experience, qualifications and objectivity of the Company’s specialist, a third-party valuation firm. ● Obtained an understanding of the nature of the work the Company’s specialist performed, including the objectives and scope of the specialist’s work; the methods or assumptions used; and a comparison of the methods or assumptions used with industry standards and historical data. ● Identified and evaluated assumptions developed by the specialist considering assumptions generally used in the specialist’s field; supporting evidence provided by the specialist; existing market data; historical or recent experience and changes in conditions and events affecting the Company. ● Evaluated the Company’s estimates of future revenue projections reviewing support for revenue growth rates. We tested the significant assumptions discussed above, as well as the completeness and accuracy of the underlying data used in the projected cash flows and valuations. ● Utilized professionals with specialized skill and knowledge to assist in evaluating the reasonableness of significant assumptions. /s/ RBSM LLP We have served as the Company’s auditor since 2021. Las Vegas, Nevada December 20, 2022 PCAOB ID Number 587 41 SIDECHANNEL, INC. CONSOLIDATED BALANCE SHEETS (In thousands except share and per share data) September 30, 2022 September 30, 2021 ASSETS Current assets Cash $ 3,030 $ 348 Accounts receivable, net 612 178 Deferred costs 180 — Prepaid expenses 320 306 Total current assets 4,142 832 Fixed assets — 1 Goodwill 1,356 — Intangibles 4,940 — Deferred costs 330 — Total assets $ 10,768 $ 833 LIABILITIES & STOCKHOLDERS’ EQUITY Current liabilities Accounts payable and accrued liabilities $ 786 $ 212 Deferred revenue 130 194 Promissory note payable 50 — Income taxes payable 195 — Total current liabilities 1,161 406 Deferred tax liability 211 — Total liabilities 1,372 406 Commitments and contingencies - Series A convertible preferred stock, $ 0.001 par value, 10,000,000 shares authorized; 100 and 100 shares issued and outstanding as of September 30, 2022 and 2021, respectively — — Common stock, $ 0.001 par value, 681,000,000 shares authorized; 148,724,056 and 59,900,000 shares issued and outstanding; September 30, 2022 and 2021, respectively 149 60 Additional paid-in capital 21,180 23 Accumulated deficit ( 11,933 ) 344 Total stockholders’ equity 9,396 427 Total liabilities and stockholders’ equity $ 10,768 $ 833 The accompanying notes are an integral part of these financial statements. 42 SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except share and per share data) 2022 2021 For the Year Ended September 30, 2022 2021 Revenues $ 4,789 $ 2,799 Cost of revenues 2,468 1,537 Gross profit 2,321 1,262 Operating expenses: General and administrative 1,482 656 Sales and marketing 367 96 Research and development 178 — Acquisition costs 6,186 — Goodwill impairment 5,702 — Total operating expenses 13,915 752 Operating income (loss) ( 11,594 ) 510 Other income: Other income 13 3 Total other income (expense), net 13 3 Net income (loss) before income tax expense ( 11,581 ) 513 Income tax expense 195 — Net income (loss) after income tax expense $ ( 11,776 ) $ 513 Net income (loss) per common share – Basic and diluted: $ ( 0.14 ) $ 0.01 Weighted average common shares outstanding – Basic and diluted 81,997,953 59,900,000 The accompanying notes are an integral part of these financial statements. 43 SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2022, AND 2021 (In thousands except preferred shares) Shares Amount Shares Issued Amount Paid-in Capital Accumulated Deficit Equity (Deficit) Preferred Stock Common Stock Additional Stockholders’ Shares Amount Shares Issued Amount Paid-in Capital Accumulated Deficit Equity (Deficit) Balance at, September 30, 2020 100 $ — 59,900 $ 60 $ 23 $ 131 $ 214 Equity distributions — — — — — ( 210 ) ( 210 ) Equity redemptions — — — — — ( 90 ) ( 90 ) Net income — — — — — 513 513 Balance at September 30, 2021 100 $ — 59,900 $ 60 $ 23 $ 344 $ 427 Equity distributions — — — — — ( 461 ) ( 461 ) Equity redemptions — — — — — ( 100 ) ( 100 ) Shares issued for services — — 281 1 72 — 73 Shares issued for vesting of RSUs — — 98 — — — — Acquisition costs – contingent consideration — — — — 6,061 — 6,061 Cipherloc Business Combination — — 88,445 88 15,024 60 15,172 Net loss — — — — — ( 11,776 ) ( 11,776 ) Net income (loss) — — — — — ( 11,776 ) ( 11,776 ) Balance at September 30, 2022 100 $ — 148,724 $ 149 $ 21,180 $ ( 11,933 ) $ 9,396 The accompanying notes are an integral part of these financial statements. 44 SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) 2022 2021 For the Year Ended September 30, 2022 2021 CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $ ( 11,776 ) $ 513 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 46 1 Stock-based compensation 73 — Provision for doubtful accounts 27 — Acquisition costs 6,061 — Goodwill impairment 5,702 — Changes in operating assets and liabilities: Accounts receivable ( 461 ) ( 3 ) Prepaid expenses and other assets 15 ( 238 ) Accounts payable and accrued liabilities ( 18 ) ( 14 ) Deferred revenue ( 65 ) ( 102 ) Net cash (used in) provided by operating activities ( 396 ) 157 CASH FLOWS FROM INVESTING ACTIVITIES Cash and cash equivalents acquired in connection with the Business Combination 3,589 — Net cash used in investing activities 3,589 — CASH FLOWS FROM FINANCING ACTIVITIES Equity redemptions ( 50 ) ( 90 ) Equity distributions ( 461 ) ( 210 ) Net cash (used in) financing activities ( 511 ) ( 300 ) INCREASE (DECREASE) IN CASH 2,682 ( 143 ) CASH, BEGINNING OF YEAR 348 491 CASH, END OF YEAR $ 3,030 $ 348 NON-CASH INVESTING AND FINANCING ACTIVITIES: Shares issued for services $ 43 $ — Equity redemption with note payable $ 50 $ — Assets acquired and liabilities assumed $ 11,583 $ — The accompanying notes are an integral part of these financial statements. 45 SIDECHANNEL, INC. NOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED SEPTEMBER 30, 2022, AND 2021 NOTE 1 – DESCRIPTION OF BUSINESS Our 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. Our growth strategy focuses on these three initiatives: 1. Securing new vCISO clients 2. Adding new Cybersecurity Software and Services offerings 3. Increasing adoption of Cybersecurity Software, including Enclave and Services offerings at vCISO clients In 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. During 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 solution. It allows Information Technology to easily segment the enterprise network, place the right staff in those segments and direct traffic. We expect to begin recognizing revenue from Enclave during fiscal year 2023. SideChannel, Inc. (the “ Company ” or “ SideChannel ”) was incorporated in the State of Texas on June 22, 1953, under the name “ American Mortgage Company. ” Effective August 27, 2014, we changed our name to “ Cipherloc Corporation ” and on July 5, 2022 we changed our name to “SideChannel, Inc.” Prior to September 30, 2021, the Company was a Texas corporation. The Company became a Delaware corporation effective September 30, 2021. Our headquarters are located at 146 Main Street, Suite 405, Worcester, MA, 01608. Our website is www.sidechannel.com . COVID-19 Pandemic We are following the guidance of the Centers for Disease Control and Prevention and the local regulatory authorities in regions outside the U.S. While the negative impact of COVID-19 on our business was reduced significantly throughout 2021, the spread of the virus or variants of the virus could worsen and one or more of our significant customers or suppliers could be impacted, or significant additional governmental regulations and restrictions could be imposed, thus negatively impacting our business in the future. We continue to monitor the situation closely in the regions in which we operate in the U.S. and abroad and will adjust our operations as necessary to protect the health and well-being of our employees. To the extent that further governmental mandates or restrictions are implemented in the future, we currently expect to be able to continue to operate our business in a manner similar to how we have operated over the past year. 46 NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated financial statements include the accounts of SideChannel, Inc., and its wholly-owned subsidiary, SCS, Inc. (Massachusetts). The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All intercompany balances and transactions have been eliminated. Significant accounting policies are as follows: Use of Estimates and Assumptions The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and (iii) the reported amount of net revenues and expenses recognized during the periods presented. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of financial statements; accordingly, actual results could differ from these estimates. Business Combinations Acquired businesses are accounted for using the purchase method of accounting, which requires that the purchase price be allocated to the net assets acquired at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Fair values of intangible assets are estimated by valuation models prepared by our management and third-party advisors. The assets purchased and liabilities assumed have been reflected in our consolidated balance sheets, and the operating results are included in the consolidated statements of operations and consolidated statements of cash flows from the date of acquisition. Any change in the fair value of acquisition-related contingent consideration subsequent to the acquisition date, including changes from events after the acquisition date, will be recognized in the consolidated statement of operations in the period of the estimated fair value change. Acquisition-related transaction costs, including legal and accounting fees and other external costs directly related to the acquisition, are recognized separately from the acquisition and expensed as incurred in general and administrative expense in the consolidated statements of operations. Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company did not have any cash equivalents as of September 30, 2022, and 2021. As of September 30, 2022 and 2021, our cash included cash on hand and cash in the bank. The Company maintains its cash in accounts held by highly reputable financial institutions which, at times, may exceed federally insured limits as guaranteed by the Federal Deposit Insurance Corporation (“FDIC”). The FDIC insures these deposits up to $ 250,000 . As of September 30, 2022, approximately $ 2.8 million of the Company’s cash balance was uninsured. The Company has not experienced any losses on cash. Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and do not bear interest. We grant credit to customers and generally require no collateral. We do not have any significant off-balance sheet credit exposure related to our customers. There were no customers with accounts receivable balances that exceeded 10% of accounts receivable at September 30, 2022. Cash flows from accounts receivable are recorded in operating cash flows. Fair Value of Financial Instruments The Company’s financial instruments consisted primarily of cash, accounts payable and accrued expenses, and embedded conversion features in stock warrants. The carrying amounts of such financial instruments approximate their respective estimated fair value due to the short-term maturities and approximate market interest rates of these instruments. 47 Fair value is focused on an exit price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Within the measurement of fair value, the use of market-based information is prioritized over entity specific information and a three-level hierarchy for fair value measurements is used based on the nature of inputs used in the valuation of an asset or liability as of the measurement date. The three-level hierarchy for fair value measurements is defined as follows: ● Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; ● Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability other than quoted prices, either directly or indirectly, including inputs in markets that are not considered to be active; ● Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. The fair values of the warrants issued by the Company as part of the acquisition price were determined using level 2 measurements and are discussed in further detail in Note 3. Goodwill, Intangible, and Long-Lived Assets We 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 annually at the beginning of the fourth quarter on a reporting unit basis, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. Goodwill is considered to be impaired if the fair value of a reporting unit is less than its carrying amount. 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 that it is more-likely-than-not that the fair value of the reporting unit is greater than its carrying amount, a quantitative goodwill impairment test is not required. However, if, as a result of our qualitative assessment, we determine it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, or, if we choose not to perform a qualitative assessment, we are required to perform a quantitative goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized. The quantitative goodwill impairment test 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 will be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. 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. The goodwill was evaluated at the acquisition date and the fair value of the goodwill was determined to be less than the carrying amount of the goodwill by $ 5.7 million. As a result, an impairment charge was recorded on the acquisition date of $ 5.7 million was recorded and the net carrying amount of goodwill was $ 1.4 million. None of the goodwill associated with the Business Combination is deductible for income tax purposes. We did not record indefinite-lived intangible assets in the fiscal years ended September 30, 2022 and 2021. 48 Long-lived 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. Revenue Recognition We recognize revenue in accordance with the guidance in ASC Topic 606 (Revenue from Contracts with Customers). We recognize revenue for the sale of products or services when our performance obligations under the terms of a contract with a customer are satisfied and control of the product or service has been transferred to the customer. Generally, this occurs when we deliver a product or perform a service. In certain cases, recognition of revenue is deferred until the product or service is received by the customer or at some other point in the future when we have determined that we have satisfied our performance obligations under the contract. Our contracts with customers may include a combination of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue recognition guidance is a five-step revenue recognition model that requires reporting entities to: 1. Identify the contract, 2. Identify the performance obligations of the contract, 3. Determine the transaction price of the contract, 4. Allocate the transaction price to the performance obligations, and 5. Recognize revenue. Revenue is recorded in an amount that reflects the consideration we expect to receive in exchange for those products or services. We do not have any material variable consideration arrangements, or any material payment terms with our customers other than standard payment terms which generally range from net 30 to net 90 days. Nature of Products and Services We identify, develop, and deploy cybersecurity, privacy, and risk management solutions for our clients and customers in North America. We categorize our products and services as either vCISO Services or Cybersecurity Software and Services. As a result of the Business Combination, we announced a proprietary cybersecurity software product called Enclave. We also sell third party software and services through a network of strategic partnerships. Types of Contracts with Customers Our contracts with customers are generally structured as annual subscription agreements or project specific statements of work. Our annual subscription agreements include a minimum number of service hours per year or month and a specified rate for the minimum amount of services to be delivered during the subscription time period. Payment terms and any other customer-specific acceptance criteria are also specified in the contracts and statements of work. Contract Balances We record accounts receivable at the time of invoicing. Accounts receivable, net of the allowance for doubtful accounts, is included in current assets on our balance sheet. To the extent that we do not recognize revenue at the same time as we invoice, we record a liability for deferred revenue. In certain instances, we also receive customer deposits in advance of invoicing and recording of accounts receivable. Deferred revenue and customer deposits are included in current liabilities on our consolidated balance sheets. When used, the allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, if any, historical experience, and other currently available evidence. Costs to Obtain a Contract with a Customer The only costs we incur associated with obtaining contracts with customers are sales commissions that we pay to our internal sales personnel or third-party sales representatives. These costs are calculated based on set percentages of the revenue value of each product or service sold. Commissions are considered earned by our internal sales personnel at the time we recognize revenue for a particular transaction. Commissions are considered earned by third-party sales representatives at the time that revenue is recognized for a particular transaction. We record commission expense in our consolidated statements of operations at the time the commission is earned. Commissions earned but not yet paid are included in current liabilities on our balance sheets. 49 See Note 4 for further information about our revenue from contracts with customers. Leases We account for leases in accordance with ASC Topic 842 (Leases). We determine if an arrangement is a lease at inception. A lease contract is within scope if the contract has an identified asset (property, plant or equipment) and grants the lessee the right to control the use of the asset during the lease term. The identified asset may be either explicitly or implicitly specified in the contract. In addition, the supplier must not have any practical ability to substitute a different asset and would not economically benefit from doing so for the lease contract to be in scope. The lessee’s right to control the use of the asset during the term of the lease must include the ability to obtain substantially all of the economic benefits from the use of the asset as well as decision-making authority over how the asset will be used. Leases are classified as either operating leases or finance leases based on the guidance in ASC Topic 842. Operating leases are included in operating lease ROU assets and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment and financing lease liabilities. We do not currently have any financing leases. Operating lease payments are included in cash outflows from operating activities on our consolidated statements of cash flows. We have made an accounting policy election not to apply the recognition requirements of ASC Topic 842 to short-term leases (leases with a term of one year or less at the commencement date of the lease). Lease expense for short-term lease payments is recognized on a straight-line basis over the lease term. Following the guidance of ASC Topic 842, we are not required to record ROU assets and operating lease liabilities. See Note 7 for further disclosures regarding our leases. Research and Development and Software Development Costs The Company expenses all research and development costs, including patent and software development costs. Our research and development costs incurred for the year ended September 30, 2022, were $ 178,000 . Stock-Based Compensation We account for stock-based compensation in accordance with ASC Topic 718 (Compensation – Stock Compensation) which requires that employee share-based equity awards be accounted for under the fair value method and requires the use of an option pricing model for estimating fair value of awards, which is then amortized to expense over the service periods. See further disclosures related to our stock-based compensation plans in Note 8. Legal The Company is subject to legal proceedings, claims and liabilities which arise in the ordinary course of business. The Company accrues for losses associated with legal claims when such losses are probable and can be reasonably estimated. These accruals are adjusted as additional information becomes available or circumstances change. Legal fees are charged to expense as they are incurred. Income Taxes The Company utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized. 50 The Company uses the two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not, that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating the Company’s tax positions and tax benefits, which may require periodic adjustments. The Company did no t record any liabilities for uncertain tax positions during the years ended September 30, 2022, or 2021. Net Earnings (Loss) Per Common Share Basic loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the reporting period. The weighted average number of shares is calculated by taking the number of shares outstanding and weighting them by the amount of time that they were outstanding. Diluted earnings per share reflects the potential dilution that could occur if stock options, warrants, and other commitments to issue common stock were exercised or equity awards vest resulting in the issuance of common stock that could share in the earnings of the Company. Diluted loss per share is the same as basic loss per share during periods where net losses are incurred since the inclusion of the potential common stock equivalents would be anti-dilutive as a result of the net loss. During the year ended September 30, 2022, 87,628,920 warrants, and 4,309,262 restricted stock units were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive. There were no anti-dilutive common stock equivalents outstanding during the year ended September 30, 2021. Segment Information The Company manages its operations as a single operating segment for the purposes of assessing performance and making operating decisions. The Company’s focus is on the research, development and commercialization of its technology. Warrants The Company evaluates warrants in accordance with Topic 480 of the FASB ASC and Topic 815 of the FASB ASC. The result of this accounting treatment is that the fair value of the embedded derivative, if required to be bifurcated, is marked-to-market at each balance sheet date and recorded as a liability. The change in fair value is recorded in the Statement of Operations as a component of other income or expense. Upon exercise of a warrant, it is marked to fair value at the exercise date and then that fair value is reclassified to equity. Recent Accounting Announcements FASB issues Accounting Standards Updates (“ASU”) to amend the authoritative literature in the ASC. There have been several ASUs to date that amend the original text of the ASCs. Other than those discussed below, the Company believes those ASUs issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company or (iv) are not expected to have a significant impact on the Company. Accounting Pronouncements Adopted In August 2020, FASB issued ASU 2020-06, “Debt—Debt with Conversion and Other and Derivatives and Hedging—Contracts in Entity’s Own Equity: Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity” which simplifies the accounting for convertible instruments by removing the separation models for convertible debt with a cash conversion feature and convertible instruments with a beneficial conversion feature. As a result, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost. These changes will reduce reported interest expense and increase reported net income for entities that have issued a convertible instrument that was bifurcated according to previously existing rules. Also, ASU 2020-06 requires the application of the if-converted method for calculating diluted earnings per share and the treasury stock method will be no longer available. The new guidance is effective for fiscal years beginning after December 15, 2021, with early adoption permitted no earlier than fiscal years beginning after December 15, 2020. The Company has adopted the guidance effective July 1, 2021. 51 Accounting Pronouncements Not Yet Adopted In June 2016, the FASB issued amendments to the guidance for accounting for credit losses. In November 2019, the FASB deferred the effective date of these amendments for certain companies, including smaller reporting companies. As a result of the deferral, the amendments are effective for us for reporting periods beginning after September 30, 2023. The amendments replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. The amendments require a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We plan to adopt the amendments when they become effective for us on October 1, 2023. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements. In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This guidance removes certain exceptions to the general principles in Topic 740 and enhances and simplifies various aspects of the income tax accounting guidance, including requirements such as tax basis step-up in goodwill obtained in a transaction that is not a business combination, ownership changes in investments, and interim-period accounting for enacted changes in tax law. This standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2021. Early adoption is permitted. The Company are currently evaluating the impact of ASU 2019-12 on its financial statements, which is effective for the Company in its fiscal year and interim periods beginning on October 1, 2022. NOTE 3 – REVERSE MERGER BETWEEN CIPHERLOC CORPORATION AND SIDECHANNEL, INC. (now known as SCS, Inc.) Overview of the Business Combination On July 1, 2022 (the “Closing Date”) the Company, then known as Cipherloc Corporation, a Delaware corporation, completed its acquisition (“Business Combination”) of all the outstanding equity securities of SideChannel, Inc., a Massachusetts corporation pursuant to an Equity Securities Purchase Agreement dated May 16, 2022 (the “Purchase Agreement”). On September 9, 2022, SideChannel, Inc. the acquired Massachusetts corporation and a subsidiary of the registrant, changed its name to SCS, Inc. (the “Subsidiary” or “SCS”) and Cipherloc Corporation, the Delaware parent company of the subsidiary has changed its name to SideChannel, Inc. The transaction was accounted for as a reverse acquisition (“reverse merger”) in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Under this method of accounting, SCS was deemed to be the accounting acquirer for financial reporting purposes. This determination was primarily based on the facts that, immediately following the Business Combination: (1) the majority of the Board of Directors of the combined company will be composed of directors designated by the Sellers under the terms of the Purchase Agreement; and (2) existing members of SCS management constituted the management of the combined company. Because SDS has been determined to be the accounting acquirer in the Business Combination, but not the legal acquirer, the transaction is deemed a reverse acquisition under the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. As a result, the historical financial statements of SideChannel are the historical financial statements of the combined company. Following the closing of the Business Combination, SCS, Inc. became a wholly owned subsidiary of the Company. As used herein, the words “the Company” refers to, for periods following the Business Combination, SideChannel, together with its subsidiaries, and for periods prior to the Business Combination, SideChannel Inc., and its direct and indirect subsidiaries, as applicable. 52 Summary of the Business Combination Terms Pursuant to the Purchase Agreement, on the Closing Date, the former shareholders of the Subsidiary (the “Sellers”) exchanged all of their equity securities in the Subsidiary for a total of 59,900,000 shares of the Company’s common stock (the “First Tranche Shares”), and 100 shares of the Company’s newly designated Series A Preferred Stock, $ 0.001 par value (the “Series A Preferred Stock”). The Sellers are entitled to receive up to an additional 59,900,000 shares of the Company’s common stock (the “Second Tranche Shares” and together with the First Tranche Shares and the Series A Preferred Stock, the “Shares”) at such time that the operations of the Subsidiary, as a subsidiary of the Company, achieves at least $ 5.5 million in revenue (the “Milestone”) for any twelve-month period occurring after the Closing Date and before the 48-month anniversary of the execution of the Purchase Agreement. The Second Tranche shares were valued using the closing price on July 1, 2022 of $ 0.10 per share which resulted in a fair value of $ 6.1 million. On the Closing Date, the Sellers acquired approximately 40.4% of the Company’s outstanding common stock. If the Subsidiary achieves the Milestone, and the Sellers are issued the Second Tranche Shares, and assuming that there is no other change in the number of shares outstanding prior to the issuance of the Second Tranche Shares, the Sellers will hold a total of approximately 57.5% of the Company’s outstanding common stock. The number of the Second Tranche Shares may be reduced or increased, based upon whether the Subsidiary’s working capital as of the Closing Date was less than or more than zero. The number of the Second Tranche Shares may also be subject to adjustment based upon any successful indemnification claims made by the Company pursuant to the Purchase Agreement. The Shares are subject to a Lock-Up/Leak-Out Agreement, pursuant to which, subject to certain exceptions, the Sellers may not directly or indirectly offer to sell, or otherwise transfer, any of the Shares for twenty-four months after the Closing Date without the prior written consent of the Company. Notwithstanding the foregoing, pursuant to the Lock-Up/Leak-Out Agreement, each of the Sellers may sell up to 20% of their Shares beginning twelve months after the Closing Date, and the remaining 80% of their shares of Common Stock beginning twenty-four months after the Closing Date. The Company is currently performing a formal valuation of the acquisition, including an analysis of any purchase price adjustments, and a review of the assets and liabilities acquired to determine appropriate fair values. On July 1, 2022, Sammy Davis and David Chasteen resigned from the Company’s Board of Directors (the “Board”). On that same date, the Board appointed Deborah MacConnel and Kevin Powers to fill the vacancies resulting from those resignations. On that same date, the Board expanded the number of members of the Board by two members and approved the appointments of Brian Haugli and Hugh Regan to fill the vacancies caused by the expansion, to be effective on July 19, 2022. Ms. MacConnel, Mr. Powers, and Mr. Regan are considered independent directors. As of July 19, 2022, the total number of members of the Board was six (6), including four (4) independent directors. On July 1, 2022, the Board appointed Brian Haugli to the position of Chief Executive Officer of the Company, following the resignation of David Chasteen from that position. Mr. Chasteen assumed the role of Executive Vice President of the Company on that same date. Reverse Merger Accounting The Business Combination was accounted for as a reverse merger involving only the exchange of equity. SCS is the accounting acquirer and Cipherloc is the legal acquirer. In order to account for the acquisition, management closed the books of Cipherloc on the Closing Date, closed all equity accounts to additional paid in capital and merged the balance sheets as of the Closing Date. SCS maintained its historical financial statements, only consolidating Cipherloc’s assets, liabilities, and equity as of the Closing Date. Because the transaction was between two operating companies, the consideration for Cipherloc assumed by SCS to effectuate the Business Combination was fair valued at approximately $ 15.2 million composed of $ 9.0 million in market capitalization of Cipherloc on July 1, 2022 ( 88.4 million shares outstanding and a per share price of $ 0.101 plus $ 6.2 million for the fair value of warrants outstanding on July 2, 2022). 53 Cipherloc consolidated SCS as of the closing date of the agreement, and the results of operations of Cipherloc include those of SCS. The historical financial statements of Cipherloc before the Business Combination will be replaced with the historical financial statements of SCS before the Business Combination in all future filings with the SEC. On July 5, 2022, Cipherloc amended and restated its articles of incorporation with the office of the Secretary of State of Delaware to change the Company’s name to SideChannel, Inc. The Company valued Cipherloc’s equity to determine the consideration paid and the purchase price allocation. Consideration Paid The consideration paid was determined as follows: SCHEDULE OF CONSIDERATION PAID Shares outstanding 88,445,832 Closing stock price on July 1, 2022 $ 0.10 Market capitalization on July 1, 2022 $ 8,949,834 Fair value of warrants vested at July 1, 2022 $ 6,222,412 Total fair value of Cipherloc at July 1, 2022 $ 15,172,246 The Company has utilized the following assumptions in its Black-Scholes warrant valuation model to calculate the estimated fair value of the financing warrants as of July 1, 2022: ● Exercise prices: $ 0.18 to $ 1.20 ($ 0.56 weighted average) ● Expected life in years: 1 to 8.5 years ( 3.7 weighted average) ● Annualized volatility: 168.3 % ● Risk free rate: 2.9 % to 3.0 % ● Annual Rate of dividends: 0 % The Company’s objective in estimating expected volatility is to ascertain the assumption about expected volatility that marketplace participants would likely use in determining an exchange price for an option. The Company estimates expected volatility by considering its historical volatility and also considers, based on available information, how the expected volatility of its share price may differ from historical volatility. The Company believes the implied volatility can be useful in estimating expected volatility because it is generally reflective of both historical volatility and expectations of how future volatility will differ from historical volatility. The Company has made a good faith effort to estimate volatility utilized which will result in the best estimate of expected volatility. As of July 1, 2022 the volatility rate used was 168.3 %. Purchase Price Allocation The acquisition purchase price is allocated based on the fair values of the assets acquired and liabilities assumed, which are based on management estimates and third-party appraisals. The Company engaged a valuation expert to provide guidance to management which was considered and in part relied upon in completing its purchase price allocation. The excess of the purchase price over the aggregate estimated fair value of net assets acquired was allocated to goodwill. 54 The following table summarizes the allocation of the purchase price of the assets and liabilities acquired related to the acquisition as of the closing date (in thousands): SUMMARY OF ALLOCATION OF THE PURCHASE PRICE OF THE ASSETS AND LIABILITIES ACQUIRED RELATED TO THE ACQUISITION Cash $ 3,589 Prepaid expenses and deferred costs 583 Intangible assets (IPR&D) 4,940 Goodwill 7,058 Accounts payable and accrued liabilities ( 612 ) Deferred Tax Liability ( 211 ) Accrued compensation ( 175 ) Consideration $ 15,172 Deferred Costs On July 23, 2021, Cipherloc entered into a financial advisory and consulting agreement with Paulson Investment Company, LLC (“Paulson”). The agreement with Paulson remains in place after the Business Combination. Pursuant to the agreement, Paulson will provide the following services at the Company’s request: (a) familiarize itself with the Company’s business, assets and financial condition; (b) assist the Company in developing strategic and financial objectives; (c) assist the Company in increasing its exposure in the software industry; (d) assist the Company in increasing its profile in the investment and financial community through introductions to analysts and potential investors, participation in investment conferences and exploitation of reasonably available media opportunities; € identify potentially attractive merger and acquisition opportunities; (f) review possible innovative financing opportunities and (g) render other financial advisory services as may be reasonably requested. The term of the agreement is four years from the date of the agreement, unless terminated earlier by either party as provided therein. As compensation for these services, the Company is issuing to Paulson 4,000,000 shares of the Company’s common stock and agreed to reimburse Paulson for all reasonable and documented expenses incurred by Paulson in connection with providing such services. The fair value of the shares issued was $ 720,000 which Cipherloc recognized as deferred costs which are amortized at a rate of $ 45,000 per quarter. The unamortized balance of the deferred cost was $ 555,000 at June 30, 2022. During the year ended September 30, 2022, the Company expensed $ 45,000 in amortization expenses. The unamortized balance of the deferred costs was $ 510,000 at September 30, 2022. Intangible Assets The estimated fair values of the identifiable intangible assets acquired were calculated using an income valuation approach which requires a forecast of expected future cash flows either through the use of relief-from-royalty method or multi-period excess earnings methods (“MPEEM”). The estimated useful lives are based on the Company’s experience and expectations as to the duration of the time the Company expects to realize benefits of the assets. The estimated fair values of the identifiable intangible assets acquired, estimated useful lives and related valuation methodology are as follows: SCHEDULE OF ESTIMATED FAIR VALUES OF THE IDENTIFIABLE INTANGIBLE ASSETS ACQUIRED, ESTIMATED USEFUL LIVES Intangible Assets: Preliminary Fair Value (000’s) Estimated Life in Years Discount Rate Valuation Method IPR&D $ 4,940 5 - 15 22.75 % Income (MPEEM) The Company will amortize the intangible assets above on a straight-line basis over their estimated useful life once the product is complete and ready for sale. As a finite-lived intangible asset, IPR&D will be evaluated as described in our Summary of Significant Accounting Policies in Note 2. No amortization was recorded during the fiscal year ended September 30, 2022. The Company expects to complete the product and begin sale of the product in fiscal year 2023. 55 Deferred Tax Liability As part of the Business Combination, the Company acquired federal tax net operating loss carryforwards of approximately $ 35 million. In addition the intangible asset acquired, IPR&D, has no basis for tax and resulted in a temporary difference of $ 4.9 million. These two items were offset and resulted in a deferred tax asset of approximately $ 7 million which was fully reserved. For state tax purposes, there were only limited state net operating loss carryforwards, consequently, the temporary difference from the intangible asset acquired resulted in a state deferred tax liability of $ 211,000 . Unaudited Pro Forma Operating Results The following presents the unaudited proforma combined results of operations of Cipherloc with SCS as if the entities were combined on October 1, 2020 and show activity for the years ended September 30, 2022 and September 30, 2021. SCHEDULE OF UNAUDITED PRO FORMA OPERATING RESULTS For the Year Ended September 30, 2022 For the Year Ended September 30, 2021 Revenues $ 4,789 $ 2,814 Cost of revenues ( 2,467 ) ( 1,537 ) Gross profit 2,322 1,277 Operating expenses (a) 4,860 4,063 Acquisition costs and goodwill impairment (b) — 11,888 Operating income (loss) ( 2,538 ) ( 14,674 ) Other income and (expenses) 13 194 Net income (loss) before income taxes ( 2,525 ) ( 14,480 ) Income taxes 195 — Net income (loss) $ ( 2,720 ) $ ( 14,480 ) Basic loss per share (c) $ ( 0.02 ) $ ( 0.13 ) (a) All costs incurred in connection with the acquisition have been removed from operating expenses in the proforma statement of operations. Cipherloc incurred $ 479,055 of transaction expenses and SCS incurred $ 108,655 of transaction expenses. (b) The Company deems it highly probable that SCS will achieve the Milestone which triggers contingent consideration of common stock being issued to the Sellers ( 59.9 million Second Tranche shares). This issuance is being recorded as a $ 6.1 million increase in additional paid in capital and $ 6.1 million of acquisition costs. (c) Pro forma weighted average shares outstanding are 145.1 million and 114.8 million for the years ended September 30, 2022 and 2021 respectively. NOTE 4 – REVENUE Customer Concentration During the year ended September 30, 2022, eight customers accounted for approximately 42 % of the Company’s revenues. During the year ended September 30, 2021, eight customers also accounted for approximately 45 % of the Company’s revenues. Deferred Revenue Deferred revenue is comprised mainly of unearned revenue related to CISO, Risk management and other professional services. Deferred revenue also includes contracts for professional services to be performed in the future which are recognized as revenue when SCS delivers the related service pursuant to the terms of the customer arrangement. Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was $ 130,000 at September 30, 2022, and $ 194,000 at September 30, 2021. The deferred revenue is expected to be earned within 12 months of the balance sheet date, 56 Changes in deferred revenue were as follows: SCHEDULE OF CHANGES IN DEFERRED REVENUE Year Ended September 30, 2022 Balance on September 30, 2021 $ 194 Deferral of revenue 107 Recognition of revenue ( 171 ) Balance at September 30, 2022 $ 130 Year Ended September 30, 2021 Balance on September 30, 2020 $ 296 Deferral of revenue 376 Recognition of revenue ( 478 ) Balance at September 30, 2021 $ 194 Software License Agreements During the year ended September 30, 2022, the Company recognized a minimal amount in licensing revenue from a licensing agreement between Castle Shield Holdings LLC (“Castle Shield”) and Cipherloc. The Company and Castle Shield mutually agreed to terminate this agreement on October 14, 2022. The Company announced Enclave in September 2022 which is a proprietary software product developed to provide network microsegmentation capabilities, also referred to as zero trust network access (“ZTNA”). We expect to launch the product and begin receiving revenue during fiscal year 2023. NOTE 5 – DEBT Pursuant to a Membership Interest Redemption Agreement, dated November 3, 2021, by and between the Company and Akash Desai (“Desai Redemption Agreement”), the Company promised to pay Mr. Desai $ 100,000 , without interest, in exchange for Mr. Desai’s right, title, and interest in the Company. Mr. Desai was paid $ 50,000 at on the execution of the Desai Redemption Agreement and the remaining $ 50,000 is due on or before December 31, 2023 . The implied interest on the note payable component of the Desai Redemption Agreement was deemed insignificant. NOTE 6 – RELATED PARTY TRANSACTIONS Brian Haugli, the Company’s Chief Executive Officer and a stockholder in the Company is also a principal shareholder of RealCISO Inc. (“RealCISO”). On September 22, 2020 SideChannel assigned to RealCISO Inc. certain contracts and intellectual property. The Company is a reseller of the RealCISO software. The Company receives revenue from its customers for the use of RealCISO software and pays licensing fees to RealCISO for such use. SideChannel paid $ 98,000 to RealCISO for licenses that SideChannel resold to its clients during the year ended September 30, 2022. No other related party transactions occurred during the years ending September 30, 2022, and September 30, 2021. NOTE 7 – COMMITMENTS AND CONTINGENCIES Litigation The Company is currently not involved in any litigation that it believes could have a material adverse effect on its financial condition or results of operations. Currently Pending Litigation In April 2021, Eric Marquez, the former Secretary/Treasurer and Chief Financial Officer of the Company, and certain other plaintiffs, filed a lawsuit against Cipherloc Corporation and Michael De La Garza, Cipherloc’s former Chief Executive Officer and President, in the 20 th Judicial District for Hays County, Texas (Cause No. 20-0818). The lawsuit alleges causes of action for fraud against Mr. De La Garza (for misrepresentations allegedly made by Mr. De La Garza); breach of contract, for alleged breaches of Mr. Marquez’s alleged oral employment agreement, which Mr. Marquez claims required Cipherloc pay him cash and shares of stock; unjust enrichment; quantum meruit; and rescission of certain stock purchases made by certain of the plaintiffs, as well as declaratory relief and fraud. Damages sought exceed $ 1,000,000 . The Company believes it has made all required payments and delivered the stock to the plaintiffs. The case is currently being defended by the Company. The Company believes it has meritorious defenses to the allegations, and the Company intends to continue to vigorously defend against the litigation. 57 Litigation Settled During the Year Ended September 30, 2022 In December 2017, Robert LeBlanc filed a petition against Cipherloc and Michael De La Garza, Cipherloc’s former Chief Executive Officer and President, in the 20th Judicial District for Hays County, Texas (Cause No. 18-0005). Mr. LeBlanc sought damages against Cipherloc exceeding $ 1 million, but less than $ 10 million. On May 19, 2022, Mr. LeBlanc entered into a joint settlement agreement with Cipherloc, Cipherloc’s directors and officer’s liability carrier, and Mr. De La Garza. As part of this settlement agreement, Cipherloc paid Mr. LeBlanc $ 109,432 in cash and issued him 200,000 shares of Cipherloc’s common stock in exchange for his release of Cipherloc from all past and future liabilities associated with this matter. Leases In December 2021, the Company and the landlord for its leased office space in Worcester, MA entered into a lease agreement. The lease became effective on January 1, 2022 and has a one-year term. The initial monthly rent is $ 930 , and the lease agreement provided for annual rent increases of approximately 2.7 %. The lease automatically renews for a one year term, unless either party to the lease agreement notifies the other of the intent to terminate the lease in writing at least 60 days prior to the expiration of the current term. The landlord of the property leased at 146 Main Street in Worcester, Massachusetts is not an affiliate of the Company. Prior to September 30, 2022, the Company had a month-to-month lease with Nolen & Associates to use office space along with the Company’s chairman, Tom Wilkinson, for its company headquarters in Austin, Texas. This lease was terminated on September 30, 2022. These leases have been accounted for as a month-to-month lease and no right of use asset or lease liability has been recorded at September 30, 2022. Cash Flow Impact of Leases The Company is not carrying any assets or liabilities associated with leases for the fiscal years 2022 or 2021. Therefore, the Company does not have any cash flow impacts to report for leasing activities . NOTE 8 - STOCKHOLDERS’ EQUITY Effective December 29, 2021, SCS was authorized to issue 1,000 shares of common stock with a $ 0.01 per share par value. The 1,000 shares of common stock were exchanged for 59,900,000 shares of Cipherloc common stock and 100 shares of Series A Preferred stock. As a result, the financial statements have been adjusted retroactively to reflect these shares as being outstanding as of September 30, 2020. Five individuals owned 100 % of SCS’s 1,000 shares of issued common stock with one individual owning 71 % and a second individual owning 11 % of the common stock. The remaining three shareholders each owned 6 % of the common stock. SCS did not have any convertible debt or issued preferred stock. SideChannel LLC redeemed units from Taylor Lehmann in exchange for $ 90,000 as stated in a Membership Interest Redemption Agreement executed on November 20, 2020. Mr. Lehmann received a total of $ 90,000 in redemption payments between November 23, 2020 and December 21, 2020. As explained in Note 5, in December 2021, while it was SideChannelSec LLC, the Company promised to pay Mr. Desai $ 100,000 , without interest, in exchange for Mr. Desai’s right, title, and interest in the Company. SideChannel LLC made profit sharing distributions of $ 461,000 during the fiscal year ended September 30, 2022 and $ 210,000 during the year ended September 30, 2021 in accordance with its partnership agreements. 58 Common Stock As of September 30, 2022, and 2021, the Company had 148,724,056 and 59,900,000 shares of common stock outstanding, respectively, and was authorized to issue 681,000,000 shares of common stock at a par value of $ 0.001 . Common Stock Issued for Cash The Company did not issue shares of common stock for cash during the year ended September 30, 2022. From March 31, 2021, to April 16, 2021, Cipherloc entered into a Securities Purchase Agreement (the “Purchase Agreement”), with certain accredited investors (the “Purchasers”), pursuant to which the Company sold the Purchasers an aggregate of (a) 55,549,615 shares of common stock (“Offering Shares”), and (b) warrants to purchase 55,549,615 shares of common stock of the Company (“Offering Warrants”). The Offering Shares and Offering Warrants were sold at a price of $ 0.18 per combined unit of an Offering Share and an Offering Warrant (the “Offering Price”). . Common Stock Issued for Business Combinations On July 1, 2022 the Company issued a total of 59,900,000 shares of common stock related to the Business Combination detailed in Note 3 of this Form 10-K. The Company did not issue shares for mergers and acquisitions related activity during fiscal year 2021. Common Stock Issued for Services On July 23, 2021, Cipherloc entered into a financial advisory and consulting agreement with Paulson Investment Company, LLC (“ Paulson ”). The agreement with Paulson remains in place after the Business Combination. Pursuant to the agreement, Paulson will provide the following services at the Company’s request: (a) familiarize itself with the Company’s business, assets and financial condition; (b) assist the Company in developing strategic and financial objectives; (c) assist the Company in increasing its exposure in the software industry; (d) assist the Company in increasing its profile in the investment and financial community through introductions to analysts and potential investors, participation in investment conferences and exploitation of reasonably available media opportunities; (e) identify potentially attractive merger and acquisition opportunities; (f) review possible innovative financing opportunities and (g) render other financial advisory services as may be reasonably requested. The term of the agreement is four years from the date of the agreement, unless terminated earlier by either party as provided therein. As compensation for these services, the Company issued to Paulson 4,000,000 shares of the Company’s common stock and agreed to reimburse Paulson for all reasonable and documented expenses incurred by Paulson in connection with providing such services. The 4,000,000 shares were issued to Paulson on February 24, 2022. The unamortized costs of the consulting agreement have been accounted for as part of the transaction and are being amortized over the remaining life of the agreement, The Company’s Board of Directors have elected to have each of its members receive one-half of such member’s quarterly compensation in the form of shares of the Company’s common stock, instead of cash. On September 15, 2022, the Company issued shares of 180,557 for a value of $ 33,000 to the Board of Directors for the fourth quarter of 2022. On July 1, 2022, 100,000 shares for a value of $ 10,000 were issued to an outgoing board of director. An additional $ 30,000 of stock based compensation has been recorded and reported in Shared Issued for Services on the Consolidated Statement of Shareholders Equity. The Company did not issue shares of common stock for services during the year ended September 30, 2021. Common Stock Issued for Legal Settlement On June 6, 2022, Cipherloc had entered into the mediated settlement agreement with Robert LeBlanc described above. Pursuant to that agreement, Cipherloc had issued a total of 200,000 shares of the Company’s common stock to Mr. LeBlanc. 59 Common Stock and Restricted Stock Units Issued to Directors and Officers As of this filing, the Company is making equity compensation awards to employees, directors, and contractors using the 2021 Omnibus Equity Compensation Plan (“Equity Incentive Plan”) approved by stockholders on September 13, 2021. The approval on September 13, 2021 included a reserve of 8.0 million shares for awards. The Equity Incentive Plan also allows for an annual increase in the reserve up to an amount approximately equal to five percent ( 5 %) of the fully diluted outstanding shares at the end of the prior calendar year. On June 29, 2022, the Board of Directors authorized an 8,186,106 increase in the shares reserved for the Equity Incentive Program. Awards granted under the Equity Incentive Plan in lieu of compensation are exempt from counting against the reserve. SCHEDULE OF STOCK OPTIONS 2021 Omnibus Equity Incentive Plan Reserve (000’s) Initial Reserve at September 13, 2021 8,000 Non-exempt Awards ( 5,561 ) Forfeitures 180 2022 Annual Reserve Increase 8,186 Reserve at September 30, 2022 10,805 Reserve percent of outstanding shares at September 30, 2022 7.3 % In 2022 and assumed with the Business Combination, the Company granted restricted stock units (“RSU’s”) to directors and employees with service-based vesting conditions. The restricted stock units vest over a 3 year service period. The following table summarizes the activity of our restricted stock units granted under our 2021 Equity Incentive Plan. The weighted average grant-date fair value of awards granted during the year ended September 30, 2022 was $ 0.11 per share. The remaining weighted average term to vesting is 2.4 years and the unamortized stock compensation expense is $ 427,000 . Awards were made to named executives and directors of the Company under the Equity Incentive Plan. The table below summarizes the unearned incentive compensation awards at September 30, 2022 for named officers and directors. All unearned awards made during the fiscal year were RSU’s subject to vesting over three years. SCHEDULE OF RESTRICTED STOCK UNITS VESTING Number of RSU’s RSU Grants Acquired at July 1, 2022 1,981,484 Granted 2,605,556 Vested ( 97,667 ) Canceled/Forfeited ( 180,111 ) Outstanding Grants at September 30, 2022 4,309,262 Preferred Stock As of September 30, 2022 and 2021, the Company had 100 and 100 shares of preferred stock outstanding, respectively. The shares of Series A Preferred Stock were issued as part of the Business Combination . The 100 shares of preferred stock have that were exchanged for SCS, Inc. common stock have been retroactively reflected as issued and outstanding on September 30, 2020. A The Series A Preferred Stock contains a Board Designation Right which provides that the holders of the majority of the Series A Preferred Stock have the right to elect a majority of the Company’s Board of Directors. 60 Warrants On July 1, 2022 following the Business Combination, we assumed the outstanding warrants of Cipherloc. Warrant activities for the period from July 1, 2022 to September 30, 2022 are as follows: SCHEDULE OF WARRANT ACTIVITY Number of Warrants Weighted Average Exercise Price Weighted Average Remaining Life Warrants Acquired at July 1, 2022 87,628,920 $ 0.56 4.77 Granted — — — Exercised — — — Canceled/Forfeited — — — Outstanding at September 30, 2022 87,628,920 $ 0.56 4.37 The fair value of the warrants was considered as part of the acquisition costs of Cipherloc as described in Note 3. NOTE 9 - INCOME TAXES From SCS’s inception to December 29, 2021, SCS was not subject to federal and state income taxes since it was operating as a Limited Liability Company (LLC). Effective with the conversion to a corporation, the stockholders of SCS elected to be taxed as a Subchapter C corporation under the provisions of Subchapter C of the Internal Revenue Code. Federal income taxes were the responsibility of SCS’s stockholders during the audited periods, as were certain state income taxes. Therefore, no provision or liability for income taxes is reflected in the financial statements. SCS has adopted the provisions related to accounting for uncertainty in income taxes, which defines a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Management has considered its tax positions and believes that all of the positions taken by SCS in its federal and state tax returns are more likely than not to be sustained upon examination. SCS is subject to tax examinations by federal and state tax authorities for years after 2018. SideChannelSec, LLC converted to a Massachusetts corporation on December 29, 2021. Upon this conversion SCS will be taxed as a corporation. SCS utilizes the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that the value of such assets will be realized. The provision (benefit) for income taxes from continued operations for the years ended September 30, 2022, and 2021 consist of the following: SCHEDULE OF PROVISION (BENEFIT) FOR INCOME TAXES FROM CONTINUED OPERATIONS (000’s) 2022 2021 September 30, (000’s) 2022 2021 Current: Federal $ 136 $ — State 59 — Total $ 195 $ — Deferred: Federal $ — $ — State — — Total — — Provision (benefit) for income taxes, net $ 195 $ — 61 The difference between income tax expense computed by applying the federal statutory corporate tax rate and actual income tax expense is as follows: SCHEDULE OF FEDERAL STATUTORY CORPORATE TAX RATE AND ACTUAL INCOME TAX EXPENSE September 30, 2022 2021 Statutory federal income tax rate 21 . 00 % 21.00 % Tax impact passed-through to SideChannelSec LLC members ( 21.00 ) Non-deductible contingent consideration ( 8.72 ) — Non-deductible impairment of goodwill ( 8.14 ) Non-deductible stock-based compensation ( 0.10 ) Change in state statutory tax rate 0.80 — Change in valuation allowance ( 4.84 ) — Effective tax rate ( 1.29 )% 0.00 % For the years ended September 30, 2022 and 2021, the difference between the amounts of income tax expense or benefit that would result from applying the statutory rates to pretax income to the reported income tax expense of $ 195,000 for the year ended September 2022 and $ 0 for the year ended September 2021 is the result of the non-deductible contingent consideration plus impairment of goodwill and additional net operating loss carry forward offset by the valuation allowance. The fiscal year 2021 income tax expense is $ 0 because the Company was an LLC during that fiscal year with the LLC members responsible for the income taxes generated from the Company’s income. For the same reason, the Company did not have deferred income tax assets or liabilities at September 30, 2021. Deferred income taxes result from temporary differences in the recognition of income and expenses for the financial reporting purposes and for tax purposes. The tax effect of these temporary differences representing deferred tax asset and liabilities result principally from the following: Federal SCHEDULE OF DEFERRED TAX ASSETS AND LIABILITIES 2022 2021 September 30, 2022 2021 Net operating loss carry forward $ 7,480 $ — Intangible asset – not deductible for tax ( 1,038 ) — Deferred compensation ( 59 ) — Valuation allowance ( 6,383 ) — Deferred income tax asset $ — $ — State 2022 2021 September 30, 2022 2021 Net operating loss carry forward $ 178 $ — Intangible asset – not deductible for tax ( 211 ) — Valuation allowance ( 178 ) — Deferred income tax asset $ ( 211 ) $ — The Company has a net operating loss carry forward of $ 35.6 million available to offset future taxable income. Of which, $ 2.6 million will expire within the next five years, and the remaining $ 33.0 million will expire thereafter. For income tax reporting purposes, the Company’s aggregate unused net operating losses were subject to the limitations of Section 382 of the Internal Revenue Code, as amended. The Company has adjusted the net operating losses incurred prior to 2015 to reflect only the losses not subject to limitation. The Company has provided for a valuation reserve against the net operating loss benefit, because in the opinion of management based upon the earning history of the Company, it is more likely than not that the benefits will not be realized. For income tax reporting purposes, Management has determined that net operating losses prior to February 5, 2015, are subject to an annual limitation of approximately $ 525,000 . Utilization of the pre-Business Combination net operating loss carryforwards (“pre-Combination NOL’s”) attributable to Cipherloc may become subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership changes occurred during the tax year associated with the Business Combination. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50% over a three-year period. Future ownership changes may trigger Section 382 and therefore, substantially limit the amount of pre-Combination NOL’s that can be utilized annually to offset future taxable income. The Company is current on all its federal income tax filings. The Company is subject to IRS examinations for periods beginning after September 30, 2018. NOTE 10 - SUBSEQUENT EVENTS On November 9, 2022 our Board of Directors authorized equity incentive grants totaling 2,882,539 RSU’s to four (4) employees. Each of these grants will vest over three ( 3 ) years. 62 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.