SideChannel, Inc. 10-Q

ITEM 1. FINANCIAL STATEMENTS SIDECHANNEL, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) December 31, 2022 September 30, 2022 (Unaudited) ASSETS Current assets Cash $ 2,553 $ 3,030 Accounts receivable, net 570 612 Deferred costs 180 180 Prepaid expenses and other current assets 274 320 Total current assets 3,577 4,142 Fixed assets — — Goodwill 1,356 1,356 Intangibles 4,940 4,940 Deferred costs 285 330 Total assets $ 10,158 $ 10,768 LIABILITIES & STOCKHOLDERS’ EQUITY Current liabilities Accounts payable and accrued liabilities $ 698 $ 786 Deferred revenue 74 130 Promissory note payable 50 50 Income taxes payable 195 195 Total current liabilities 1,017 1,161 Deferred tax liability 211 211 Total liabilities 1,228 1,372 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 December 31, 2022 and September 30, 2022 — — Common stock, $ 0.001 par value, 681,000,000 shares authorized; 148,904,613 and 148,724,056 shares issued and outstanding; December 31, 2022 and September 30, 2022 149 149 Additional paid-in capital 21,316 21,180 Accumulated deficit ( 12,535 ) ( 11,933 ) Total stockholders’ equity 8,930 9,396 Total liabilities and stockholders’ equity $ 10,158 $ 10,768 The accompanying notes are an integral part of these unaudited consolidated financial statements. 3 Table of Contents SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share data) (Unaudited) 2022 2021 Three Months Ended December 31, 2022 2021 Revenues $ 1,546 $ 1,048 Cost of revenues 681 476 Gross profit 865 572 Operating expenses General and administrative 1,030 205 Sales and marketing 307 43 Research and development 135 — Total operating expenses 1,472 248 Operating income (loss) ( 607 ) 324 Other income (expenses) Other income (expense), net 5 4 Net income (loss) $ ( 602 ) $ 328 Net loss per common share – basic and diluted $ ( 0.00 ) $ 0.01 Weighted average common shares outstanding – basic and diluted 148,733,860 59,900,000 The accompanying notes are an integral part of these unaudited consolidated financial statements. 4 Table of Contents SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In thousands, except preferred shares) (Unaudited) December 31, 2021 Shares Amount Shares Amount Capital Deficit Equity For the Three Months ended Preferred Stock Common Stock Additional Paid-in Accumulated Stockholders’ December 31, 2021 Shares Amount Shares Amount Capital Deficit Equity Balance at September 30, 2021 100 $ — 59,900 $ 60 $ 23 $ 344 $ 427 Equity redemptions — — — — ( 100 ) ( 100 ) Equity distributions — — — — — ( 461 ) ( 461 ) Net income — — — — — 328 328 Balance at December 31, 2021 100 $ — 59,900 $ 60 $ 23 $ 111 $ 194 For the Three Months ended Preferred Stock Common Stock Additional Paid-in Accumulated Stockholders’ December 31, 2022 Shares Amount Shares Amount Capital Deficit Equity Balance at September 30, 2022 100 $ — 148,724 $ 149 $ 21,180 $ ( 11,933 ) $ 9,396 Shares issued for services — — 181 18 18 Stock-based compensation expense issued to directors & employees — — — — 118 — 118 Net loss — — — — — ( 602 ) ( 602 ) Net income (loss) — — — — — ( 602 ) ( 602 ) Balance at December 31, 2022 100 $ — 148,905 $ 149 $ 21,316 $ ( 12,535 ) $ 8,930 The accompanying notes are an integral part of these unaudited consolidated financial statements. 5 Table of Contents SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) 2022 2021 Three Months Ended December 31, 2022 2021 CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $ ( 602 ) $ 328 Adjustments to reconcile net (loss) income to net cash flows used in operating activities: Amortization 45 — Stock-based compensation 115 — Changes in operating assets and liabilities: Accounts receivable 42 136 Unbilled revenue — 95 Prepaid expenses and other assets 46 — Accounts payable and accrued liabilities ( 67 ) 163 Deferred revenue ( 56 ) ( 130 ) Net cash used in operating activities ( 477 ) 592 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of fixed assets — — Net cash used in investing activities — — CASH FLOWS FROM FINANCING ACTIVITIES: Equity redemption — ( 50 ) Equity distribution — ( 461 ) Net cash used in financing activities — ( 511 ) (DECREASE) INCREASE IN CASH ( 477 ) 81 CASH, BEGINNING OF PERIOD 3,030 348 CASH, END OF PERIOD $ 2,553 $ 429 Stock-based compensation included in accounts payable and accrued liabilities $ 21 NON-CASH INVESTING AND FINANCING ACTIVITIES: Equity redemption with notes payable $ 50 The accompanying notes are an integral part of these unaudited consolidated financial statements. 6 Table of Contents SIDECHANNEL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2022 AND 2021 (Dollars in thousands except shares and per share data) NOTE 1 – NATURE OF OPERATIONS Our mission is to make cybersecurity simple and accessible for mid-market and emerging companies, a market we believe is currently underserved. Our cybersecurity offerings identify and develop cybersecurity, privacy, and risk management solutions for our customers. We target customers that need cost-effective security solutions. Our growth plan to address the needs of our customers is to provide more effective and cost-efficient products and tech-enabled services cybersecurity and related including virtual Chief Information Security Officer (“vCISO”), zero trust, third-party risk management, due diligence, privacy, threat intelligence, and managed end-point security solutions. Our growth strategy focuses on these three initiatives: 1. Securing new vCISO clients; 2. Adding new Cybersecurity Software and Services (“Cybersecurity Software and Services”) offerings; and 3. Increasing adoption of Cybersecurity Software, including Enclave, and Services offerings at vCISO clients. vCISO clients typically enter into twelve (12) month engagements consisting of a monthly subscription with an annual renewal option, as well as additional vCISO time and material projects, which range from $ 350 to $ 450 per hour. Each vCISO is embedded into the C-suite of from two (2) to five (5) of our clients. During September 2022, we announced a proprietary product called Enclave, which simplifies an important cybersecurity tactic called “microsegmentation”. Enclave seamlessly combines access control, microsegmentation, encryption, and other secure networking concepts to create a comprehensive solution. It allows information technology professionals to easily segment the enterprise network, place the right assets in those segments, and direct network traffic. We expect to begin recognizing revenue from Enclave during fiscal year 2023. On July 1, 2022 (the “Closing Date”) we completed an 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 wholly owned subsidiary of the registrant, changed its name to SCS, Inc. (the “Subsidiary” or “SCS”). Cipherloc Corporation, the Delaware parent company of the Subsidiary, has changed its name to SideChannel, Inc. (“SideChannel”). As used herein, the words “the Company” refers to, for periods from July 1, 2022 and forward, SideChannel, and for periods prior to July 1, 2022, SCS, and its direct and indirect subsidiaries, as applicable. The Business Combination was treated as a reverse acquisition (reverse merger), in accordance with U.S. 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 immediately following the Business Combination that: (1) a 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. As SCS was determined to be the accounting acquirer in the Business Combination, but not the legal acquirer, the transaction was deemed a reverse acquisition under the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. 7 Table of Contents American Mortgage Company, the predecessor in interest to the Company was incorporated in the State of Texas on June 22, 1953. Effective August 27, 2014, American Mortgage Company changed its name to “Cipherloc Corporation.” Cipherloc Corporation (“Cipherloc”) reincorporated in Delaware effective September 30, 2021, and on July 5, 2022, Cipherloc changed its name to “SideChannel, Inc.” 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 2022, 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 two years. NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Use of Estimates The accompanying consolidated financial statements include our accounts and those of our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Certain of our accounts, including goodwill, identifiable intangibles, and deferred tax assets and liabilities, including related valuation allowances, are based upon estimates. In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position, results of operations, and changes in cash flows for the interim periods presented. Certain footnote information has been condensed or omitted from these consolidated financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in our Form 10-K for the year ended September 30, 2022 (the “2022 Form 10-K”) filed on December 20, 2022, with the Securities and Exchange Commission (“SEC”). Subsequent Events We have assessed our operations and determined that there were no material subsequent events requiring adjustment to, or disclosure in, our consolidated financial statements for the three months ended December 31, 2022 . Segment Information We manage our operations as a single operating segment for the purposes of assessing performance and making operating decisions. 8 Table of Contents 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. Fair Value of Financial Instruments Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, our note payable, and embedded conversion features in our stock warrants. Our cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are carried at cost which approximates fair value, due to the short maturities of the accounts. Our note payable’s carrying amount approximates it fair value due to the short remaining term. ASC Topic 820 (Fair Value Measurement) establishes a fair value hierarchy for instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and our own assumptions (unobservable inputs). The fair values of the warrants issued by us as part of the Business Combination were determined using Level 2 inputs in accordance with the guidance in ASC Topic 820. Goodwill, Intangible, and Long-Lived Assets We account for goodwill and intangible assets in accordance with ASC Topic 350 (Intangibles – Goodwill and Other) and ASC Topic 360 (Property, Plant and Equipment). 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. 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. 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. 9 Table of Contents 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 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 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. See Note 4 for further information about our revenue from contracts with customers. 10 Table of Contents 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. We do not currently have any operating lease ROU assets and operating lease liabilities. 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. 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. Income Taxes We utilize 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 years 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 if it is more likely than not that such assets will not be realized. Basic and Diluted Net Loss per Common Share Earnings (loss) per common share - basic is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during each period. Earnings (loss) per common share - diluted is computed by dividing earnings (loss) by the weighted average number of common shares and common share equivalents outstanding during each period. Common share equivalents represent unvested shares of restricted stock and stock options and are calculated using the treasury stock method. Common share equivalents are excluded from the calculation if their effect is anti-dilutive. Warrants We account for warrants in accordance with ASC Topics 480 and 815. 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 our Consolidated 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. Effect of Recently Issued Amendments to Authoritative Accounting Guidance 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 our 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 adoption of this standard is not expected to have a material impact on our consolidated financial statements. 11 Table of Contents NOTE 3 – ACQUISITIONS Reverse Merger Between Cipherloc Corporation and SideChannel, Inc. (now known as SCS, Inc.) As discussed further in Note 3 to our consolidated financial statements in our 2022 Form 10-K, on the Closing Date, the former stockholders 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. As of December 31, 2022, our trailing twelve-month revenue was $ 5.3 million. The following presents the unaudited proforma combined results of operations of Cipherloc with SCS as if the entities were combined on October 1, 2021, and show activity for the three months ended December 31, 2021. SCHEDULE OF UNAUDITED PROFORMA OPERATIONS RESULTS For the Three Months Ended December 31, 2021 Revenues $ 1,048 Cost of revenues ( 476 ) Gross profit 572 Operating expenses 900 Operating loss ( 328 ) Other income 4 Net loss before income taxes ( 324 ) Income taxes — Net loss $ ( 324 ) Basic loss per share (a) $ ( 0.00 ) (a) Pro forma weighted average shares outstanding were 148.1 million for the three months ended December 31, 2021. 12 Table of Contents NOTE 4 – REVENUE FROM CONTRACTS FROM CUSTOMERS Customer Concentration During the three months ended December 31, 2022, eight customers accounted for approximately 42 % of our revenues. During the three months ended December 31, 2021, eight customers also accounted for approximately 38 % of our revenues. None of the customers individually accounted for over 10 % of our revenue during the three months ended December 31, 2022 and 2021. Deferred Revenue Deferred revenue was $ 74,000 at December 31, 2022. The deferred revenue is expected to be earned within 12 months of the balance sheet date. Changes in deferred revenue were as follows: SCHEDULE OF CHANGES IN DEFERRED REVENUE Three Months Ended December 31, 2022 Balance on September 30, 2022 $ 130 Deferral of revenue 13 Recognition of revenue ( 69 ) Balance at December 31, 2022 $ 74 We internally report our revenue using two categories. The first, “vCISO Services”, captures the revenue 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. Our 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. The table below reflects the revenue by category for the three months ended December 31, 2022 and 2021: SCHEDULE OF REVENUE BY CATEGORY Three Months Ended December 31 2022 2021 % of Total % of Total $ Change % Change Revenue vCISO Services $ 1,010 65.4 % $ 629 60.0 % $ 381 60.6 % Cybersecurity Software & Services 536 34.6 % 419 40.0 % 117 27.9 % Total $ 1,546 $ 1,048 $ 498 47.5 % 13 Table of Contents NOTE 5 – DEBT Pursuant to a Membership Interest Redemption Agreement, dated November 3, 2021, by and between the SCS and Akash Desai (“Desai Redemption Agreement”), we promised to pay Mr. Desai $ 100,000 , without interest, in exchange for Mr. Desai’s right, title, and interest SCS. Mr. Desai was paid $ 50,000 at 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, our Chief Executive Officer and one of our stockholders, is also a principal shareholder of RealCISO Inc. (“RealCISO”). On September 22, 2020, SideChannel assigned to RealCISO certain contracts and intellectual property. We are a reseller of RealCISO software. We receive revenue from our customers for the use of RealCISO software and we pay licensing fees to RealCISO for such use. During the three months ended December 31, 2022, we paid $ 36,000 to RealCISO for additional licenses that SideChannel can resell to its clients. Ryan Polk, our Chief Financial Officer, David Chasteen, our Executive Vice President of Sales and Nick Hnatiw, our Chief Technology Officer each have amounts payable to the Company in relation to the payroll taxes paid by the Company on their behalf for RSU’s that vested during calendar year 2022. The combined balance due from these three individuals is $ 16,622 and is recorded in prepaid and other current assets as of December 31, 2022. At the time of this Quarterly Report on Form 10-Q (“this Report”) was filed, Mr. Polk had paid the Company in full for his portion of this obligation. No other related party transactions occurred during the three months ended December 31, 2022. NOTE 7 – COMMITMENTS AND CONTINGENCIES Litigation We are not currently involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. In April 2021, Eric Marquez, our former Secretary/Treasurer and Chief Financial Officer, and certain other plaintiffs, filed a lawsuit against Michael De La Garza, our former Chief Executive Officer and President, and us 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 that we 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 . We believe we have made all required payments and delivered the stock to the plaintiffs. We believe we have meritorious defenses to the allegations, and we intend to continue to vigorously defend against the litigation. NOTE 8 – STOCK BASED COMPENSATION We grant equity compensation awards to employees, directors, and contractors under the 2021 Omnibus Equity Compensation Plan (“Equity Incentive Plan”) approved by stockholders on September 13, 2021. In 2022 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. 14 Table of Contents The following table summarizes the activity for unvested RSU’s granted to directors and employees during the quarter ended December 31, 2022: SCHEDULE OF UNVESTED RESTRICTED STOCK UNITS ACTIVITY Weighted Average Grant Date Fair Value Number of RSU’s Outstanding Grants at September 30, 2022 $ 0.11 4,309,262 Granted $ 0.14 2,882,539 Vested — — Canceled/Forfeited — — Outstanding Grants at December 31, 2022 $ 0.12 7,191,801 We incurred stock-based compensation expense of $ 115,000 for the three months ended December 31, 2022. Unamortized stock compensation expense is $ 727,000 as of December 31, 2022. NOTE 9 - 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 common stock and 100 shares of Series A Preferred Stock of Cipherloc. As a result, the financial statements have been adjusted retroactively to reflect these shares as being outstanding as of September 30, 2020. As explained in Note 5, in December 2021, we promised to pay Mr. Desai $ 100,000 , without interest, in exchange for Mr. Desai’s right, title, and interest in SCS. SideChannel LLC made profit sharing distributions of $ 489,000 during the three months ended December 31, 2021. in accordance with its partnership agreements. Common Stock As of December 31, 2022, and 2021, we had 148,904,613 and 59,900,000 shares of common stock outstanding, respectively, and were authorized to issue 681,000,000 shares of common stock at a par value of $ 0.001 . Common Stock Issued for Cash We did not issue shares of common stock for cash during the three months ended December 31, 2022. Common Stock Issued for Business Combinations We did not issue shares for mergers or acquisitions related activity during the three months ended December 31, 2022. Common Stock Issued for Services Our Board of Directors (“Board”) has 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 December 27, 2022, the Company issued 180,557 shares of common stock as compensation for a value of $ 18,000 to the Board for the first quarter of fiscal year 2023. Common Stock Issued Under Equity Incentive Plan We did not issue shares of common stock as incentive compensation during the three months ended December 31, 2022. Preferred Stock As of December 31, 2022, we had 100 shares of Series A Preferred Stock outstanding. These shares were issued as part of the Business Combination . The 100 shares of Series A Preferred Stock that were exchanged for SCS, Inc. common stock have been retroactively reflected as issued and outstanding as of September 30, 2020. 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 our Board of Directors. Warrants Prior to the July 1, 2022 Business Combination, Cipherloc had outstanding warrants which continue to be binding on the Company after the Business Combination. The following table summarizes warrant activity for the period from September 30, 2022 to December 31, 2022: SCHEDULE OF WARRANT ACTIVITY Number of Warrants Weighted Average Exercise Price Weighted Average Remaining Life Outstanding at September 30, 2022 87,793,920 $ 0.56 5.02 Granted — — — Exercised — — — Canceled/Forfeited ( 75,000 ) 2.00 — Outstanding at December 31, 2022 87,718,920 $ 0.56 4.68 15 Table of Contents