What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-12-27 compared with 2022-12-20 · 145 added, 124 removed, 93 unchanged (74% of the section changed)

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

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

In addition, please refer to the discussion

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying

consolidated financial statements and the notes thereto.

In addition, please refer to the discussion of our business and markets contained

in Part 1, Item 1 of this Annual Report on Form 10-K.

mission is to make cybersecurity simple and accessible for mid-market and emerging companies, a market that we believe is currently underserved.

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

We now have over 20 C-suite level

information security officers, who possess combined experience of over 400 years in the industry.

To date, SideChannel has created over

50 multi-layered cybersecurity programs for its clients.

growth strategy focuses on these three initiatives:

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

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

ended during September 30, 2022.

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

with potential annual revenue of $1.3 million.

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

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

Each of our vCISO’s

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

Collectively,

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

value added resellers (“VARs”).

Commercial relationships with VARs provide SideChannel with additional internal capabilities

to mitigate cybersecurity risks.

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

In 2022 VAR commissions contributed

2.4% of our revenue versus 3.2% during 2021.

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

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

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

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

internally report our revenue using two categories.

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

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

basis, thus the acronym “vCISO”.

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

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

cybersecurity framework.

We internally report our revenue using two categories.

The first, “vCISO Services,” captures the revenue the Chief Information Security Officer services that we provide to our clients

on a “virtual” or outsourced basis, thus the acronym “vCISO.” Services delivered by SideChannel through our team

of vCISOs include assessing the cybersecurity risk profile, implementing policies and programs to mitigate risks, and managing the day-to-day

tasks to ensure compliance with the adopted cybersecurity framework.

Most of our clients use our vCISO services.

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

digital assets.

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

SideChannel earns

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

Cybersecurity services are also delivered directly by SideChannel

employees and indirectly by third party service providers.

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

vCISO engagements typically include a fixed monthly

subscription fee with durations longer than twelve (12) months.

Hourly rates for vCISO time and material projects range from $350 to $425.

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

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

to protect their digital assets.

These augment our vCISO offering and include a full range of other cybersecurity products and services

delivered through a team of security engineers along with a network of third-party service providers and value-added resellers

Commercial relationships with third-party service providers and VARs provide SideChannel with additional internal

capabilities to mitigate cybersecurity risks.

We earn licensing revenue from software contracts and commissions from third-party service

provider partnerships which are included in this revenue category.

September 2022 we announced a proprietary product called Enclave which simplifies important cybersecurity tasks called

“asset inventory” and “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.

The following revenue metrics are for the twelve months ended September 30, 2023, versus the same period in 2022.

These summary metrics are accompanied by a table that reflects the revenue by category in fiscal years 2023 and 2022.

Total revenue grew by $1.8 million or 37.2%.

vCISO Services category revenue grew by $1.3 million or 42.4%.

Cybersecurity Software and Services category revenue grew by $0.5 million or 27.9%.

vCISO Services

Cybersecurity Software & Services

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

Cybersecurity

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

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

also monitor new and recurring revenue.

Cybersecurity Software

growth in vCISO Services reflects both growth in clients served and an increase in revenue per client.

Cybersecurity Software & Services revenue grew from 2022 to 2023 primarily because of an increase in the use of these services

by existing Cybersecurity Software and Services clients and secondarily because of an expansion of the services and software

also monitor new and retained revenue.

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

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

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

The following

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

vCISO Revenue

Cybersecurity Software & Services Revenue

table provides details on our new and retained revenue for fiscal years 2023 and 2022:

Cybersecurity Software &

Total Revenue

we consider revenue retention a key performance indicator.

Revenue retention is calculated by dividing recurring revenue by the prior

Revenue retention is calculated by dividing retained revenue by the prior

year total revenue.

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

The following table shows the revenue retention for fiscal years 2023 and 2022 by revenue category.

vCISO Services

Cybersecurity Software & Services

Total Revenue Retention

of Operations

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Our general and administrative expenses were $3.6 million for the year ended September 30, 2023, compared

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

to $1.5 million for the prior year, an increase of $2.1 or 142.5%.

The increase in general and administrative expenses primarily resulted

from increased staff and related salary and independent contractor expense;

from increased staff and related costs including equity-based compensation;

higher professional fees and insurance related to the listed

nature of the Company.

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

To a lesser extent there were increases in amortization and travel-related costs.

and Marketing Expenses.

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

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

independent contractor expense;

higher spend on third-party marketing services.

Our sales and marketing expenses were $1.3 million for the year ended September 30, 2023, compared to $367,000

for the prior year, an increase of $970,000 or 264.3% resulting from our increase in sales and marketing staff and the related costs

combined with a higher spend on third-party marketing services.

and Development Expenses.

Our research and development expenses were $669,000 for the year ended September 30, 2023, compared to

$0 for the prior year.

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

from independent contractors related to the development of Enclave.

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

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

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

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

The goodwill was related

to the acquisition that occurred on July 1, 2022.

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

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

$178,000 for the prior year, an increase of $491,000 or 275.8%.

These costs arose as a result of the Business Combination and are driven

by personnel expenses and costs incurred from independent contractors related to the development of Enclave.

Goodwill Impairment .

The goodwill impairment was zero ($0) for the year ended September 30, 2023.

We recorded a $5.7 million goodwill impairment charge during

the year ended September 30, 2022.

The goodwill was related to the acquisition that occurred on July 1, 2022.

Asset Impairment.

The intangible asset impairment was $4.9 million for the year ended September 30, 2023, and zero ($0) for the

We recorded a finite-lived intangible asset of $4.9 million as a result of acquiring Enclave in the Business

Our impairment testing indicated the full value of this finite-lived intangible asset should be impaired as of

September 30, 2023.

Incurring impairment neither indicates a decrease in our emphasis on Enclave as a key initiative nor does it

suggest a lack of market interest in the product.

Acquisition costs were $214,000 for the year ended September 30, 2023, which are attributed to an increase in the Second

Tranche shares due to the Closing Working Capital Adjustment from the Business Combination.

The costs totaling $6.2 million in the prior year were driven by the Business Combination.

Other Income.

Other Income was $29,000 and $13,000 for fiscal years 2023 and 2022 respectively, which reflect interest income from the cash on deposit

Tax Expense (Benefit).

We recorded an income tax benefit of $379,000 for the year ended September 30, 2023, compared to an

income tax expense of $195,000 for the year ended September 30, 2022.

The fiscal year 2022 expense was an estimate of federal and

state income tax liability for SCS which was accounted for as a liability on our September 30, 2022, balance sheet.

The actual amount of federal and state income taxes due by SCS of $27,000.

The net of these two amounts

is a $168,000 tax benefit that we recognized in the current fiscal year.

In addition, a deferred state tax liability was recognized for

a book versus tax basis difference upon the Business Combination.

During the year ended September 30, 2023, this deferred tax liability

was reduced to zero resulting in a deferred income tax benefit of $211,000.

and Capital Resources

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

As part of the Business Combination, we received

$3.6 million in cash from Cipherloc.

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

Two (2) non-recurring expenses

totaling $11.9 million are included in our accumulated deficit.

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

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

to exceed our operating expenses.

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

to range between $1.5 million and $2.0 million.

which will be funded with our existing cash balances.

We intend to manage our business

such that our current cash reserves will allow us to reach positive cash flow from our operations, but we cannot assure you that this

positive cash flow will be achieved.

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

We believe that our existing cash balances

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

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

During fiscal year 2023, we incurred a net loss of

$7.0 million and used $1.9 million of cash in operations.

Our primary source of liquidity and capital resources has been the $3.6 million

in cash received from Cipherloc in the Business Combination in the prior fiscal year.

We had an accumulated deficit of $11.9 million as

of September 30, 2022.

Three (3) non-recurring expenses totaling $16.8 million are included in our accumulated deficit.

The non-recurring

expenses are $6.2 million for the acquisition costs, including $6.1 million related to the contingent consideration from the Business Combination, $5.7 million impairment of goodwill recorded as a result of the Business Combination, and $4.9 million impairment of intangible assets.

Our accumulated deficit at September 30, 2023 was

$18.9 million.

The following table summarizes, for the periods indicated,

selected items in our Statements of Cash Flows ($000’s):

Year Ended September 30,

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Financing activities

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

For the year ended September 30,

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

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

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

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

amortization.

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

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

place on July 1, 2022.

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

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

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

on December 29, 2021.

Operating Activities .

Net cash used

in operations for the year ended September 30, 2023, was $1.9 million as compared to $396,000 for the year ended September 30, 2022.

During fiscal year 2023, we recorded intangible asset impairment of $4.9 million and non-cash charges of $805,000 for amortization and

stock compensation expense.

Our net accounts receivable grew by $222,000 compared to one year ago due to increased sales activity

and we experienced a $547,000 decrease in accounts payable and accrued liabilities primarily due to adjustments made to tax liabilities.

These uses of cash were offset by a $150,000 increase in our deferred revenue balance.

Investing Activities .

We used $32,000

on the purchase of fixed assets during the twelve months ended September 30, 2023.

Financing Activities .

During the year

ended September 30, 2023, there was no cash provided by or used in financing activities.

As of September 30, 2023, we had $1.1 million

in cash and our working capital was $1.5 million.

We believe that our existing cash balances are sufficient to fund our operations

through at least December 31, 2024.

operating expenses during fiscal year 2023 were $5.6 million excluding $214,000 of acquisition costs and intangible asset

impairment of $4.9 million.

Since May, 2023 through the date of this report, we have eliminated approximately $1.2

million of annual operating expenses which have enabled us to lower our breakeven revenue point and allowed us to expect a lower amount

of total operating expenses for fiscal year 2024 than we incurred during 2023.

The operating expense reductions are being achieved

by staff reductions in all areas of the business and the elimination of non-essential third-party supplier relationships.

anticipate total operating expenses to range between $3.7 million and $4.3 million in the next fiscal year with cash flow from operations

ranging between negative $300,000 and positive $100,000, which, if negative, will be funded with our existing cash balances.

to manage our business such that our current cash reserves will allow us to reach positive cash flow from our operations, but we cannot

assure if and when positive cash flow will be achieved.

We don’t currently have any credit facilities available to us;

we have had discussions with several lenders about establishing a line of credit secured by our accounts receivable.

Accounting Estimates

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statements were prepared.

reference Note 2 – Summary of Significant Accounting Policies.

Intangible and Long-Lived Assets

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amount of the goodwill impairment charge.

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

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

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

No impairment was recorded during our

fiscal year 2021.

At September 30, 2023 and 2022, goodwill was $1.4 million.

In 2022, we evaluated the initial goodwill recorded from the Business Combination of $7.1 million and determined that the carrying value

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

The fair value of the goodwill at September 30, 2023, as determined by our impairment analysis, is in excess of the

carrying value;

thus, we have incurred no impairment of goodwill in fiscal year 2023.

did not record indefinite-lived intangible assets in the fiscal years ended September 30, 2023, and 2022.

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.

assets, which consist of finite-lived intangible assets and property and equipment, are assessed for impairment whenever events or

changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful

lives of these assets are no longer appropriate.

Each impairment test is based on a comparison of the estimated undiscounted cash

flows to the recorded value of the asset.

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

The cash flow estimates used to

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

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

At September 30, 2022

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

We recorded no impairment charges during

either fiscal year.

cash flow estimates used to determine the impairment, if any, contain management’s best estimates using appropriate

assumptions and projections at that time.

We have a finite-lived intangible asset of $4.9 million and we have less than $30,000 in

property and equipment.

At September 30, 2023 and 2022, finite-lived intangibles and long-lived assets were zero ($0) and $4.9

million, respectively.

The intangible impairment was $4.9 million for the year ended September 30, 2023 and zero ($0) for the prior

We recorded a finite-lived intangible asset of $4.9 million as a result of acquiring Enclave through the Business Combination.

The difficulty of projecting the amount and timing of future revenues caused us to conclude a full impairment of the asset was

impairment neither indicates a decrease in our emphasis on Enclave as a key initiative nor does it suggest a lack of market interest

in the product.

Sheet Arrangements

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

What changed 10-K

Item 7. Management’s Discussion and Analysis