SideChannel, Inc. 10-K

ITEM 8. FINANCIAL STATEMENTS SIDECHANNEL, INC. TABLE OF CONTENTS Page REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (PCAOB ID Number 587 ) 45 FINANCIAL STATEMENTS: Balance Sheets as of September 30, 2023 and 2022 46 Statements of Operations for the years ended September 30, 2023 and 2022 47 Statements of Stockholders’ Equity for the years ended September 30, 2023 and 2022 48 Statements of Cash Flows for the years ended September 30, 2023 and 2022 49 NOTES TO FINANCIAL STATEMENTS 50 44 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., (the Company) as of September 30, 2023 and 2022, 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, 2023, 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, 2023 and 2022, and the results of its operations and its cash flows for each of the years in the two-year period ended September 30, 2023, 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. We determined that there are no critical audit matters. /s/ RBSM LLP We have served as the Company’s auditor since 2021. Las Vegas, Nevada December 27, 2023 RBSM LLP (PCAOB ID Number 587) 45 SIDECHANNEL, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data) September 30, 2023 September 30, 2022 ASSETS Current assets Cash $ 1,053 $ 3,030 Accounts receivable, net 834 612 Deferred costs 180 180 Prepaid expenses and other current assets 381 320 Total current assets 2,448 4,142 Fixed assets, net 30 — Goodwill 1,356 1,356 Intangible assets — 4,940 Deferred costs 150 330 Total assets $ 3,984 $ 10,768 LIABILITIES & STOCKHOLDERS’ EQUITY Current liabilities Accounts payable and accrued liabilities $ 613 $ 786 Deferred revenue 280 130 Promissory note payable 50 50 Income taxes payable 11 195 Total current liabilities 954 1,161 Deferred tax liability — 211 Total liabilities 954 1,372 Commitments and contingencies - - Series A convertible preferred stock, $ 0.001 par value, 10,000,000 shares authorized; 0 and 100 shares issued and outstanding as of September 30, 2023 and 2022, respectively — — Common stock, $ 0.001 par value, 681,000,000 shares authorized; 213,854,781 and 148,724,056 shares issued and outstanding as of September 30, 2023 and 2022, respectively 214 149 Additional paid-in capital 21,755 21,180 Accumulated deficit ( 18,939 ) ( 11,933 ) Total stockholders’ equity 3,030 9,396 Total liabilities and stockholders’ equity $ 3,984 $ 10,768 46 SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share data) (Unaudited) 2023 2022 Twelve Months Ended September 30, 2023 2022 Revenues $ 6,572 $ 4,789 Cost of revenues 3,240 2,468 Gross profit 3,332 2,321 Operating expenses General and administrative 3,586 $ 1,482 Selling and marketing 1,337 367 Research and development 669 178 Goodwill impairment — 5,702 Intangible asset impairment 4,940 — Acquisition costs 214 6,186 Total operating expenses 10,746 13,915 Operating loss ( 7,414 ) ( 11,594 ) Other income, net 29 13 Net loss before income tax expense $ ( 7,385 ) $ ( 11,581 ) Income tax expense (benefit) ( 379 ) 195 Net loss after income tax expense (benefit) $ ( 7,006 ) $ ( 11,776 ) Net loss per common share – basic and diluted $ ( 0.04 ) $ ( 0.14 ) Weighted average common shares outstanding – basic and diluted 175,274,762 81,997,953 47 SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In thousands, except preferred shares) (Unaudited) Preferred Shares Preferred Par Value Common Shares Common Par Value Additional Paid-in-Capital Accumulated Earnings / (Deficit) Stockholders’ Equity For the Twelve Months Ended September 30, 2023 and 2022 Preferred Shares Preferred Par Value Common Shares Common Par Value Additional Paid-in-Capital Accumulated Earnings / (Deficit) Stockholders’ Equity Balance at September 30, 2021 100 $ — 59,900 $ 60 $ 23 $ 344 $ 427 Equity redemptions — — — — — ( 100 ) ( 100 ) Equity distributions — — — — — ( 461 ) ( 461 ) Shares issued for services — — 281 1 42 — 43 Shares issued for vesting of RSUs — — 98 — 30 — 30 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 ) Balance at September 30, 2022 100 $ — 148,724 $ 149 $ 21,180 $ ( 11,933 ) $ 9,396 Balance 100 $ — 148,724 $ 149 $ 21,180 $ ( 11,933 ) $ 9,396 Shares issued for services — — 771 — 66 — 66 Stock-based compensation expense — — 2,343 3 357 — 360 Conversion of Preferred to Common ( 100 ) — — — — — — Business Combination – Contingent Consideration 62,017 62 152 214 Net loss — — — — — ( 7,006 ) ( 7,006 ) Balance at September 30, 2023 — $ — 213,855 $ 214 $ 21,755 $ ( 18,939 ) $ 3,030 Balance — $ — 213,855 $ 214 $ 21,755 $ ( 18,939 ) $ 3,030 48 SIDECHANNEL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands, unaudited) 2023 2022 Year Ended September 30, 2023 2022 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ ( 7,006 ) $ ( 11,776 ) Adjustments to reconcile net loss to net cash flows used in operating activities: Depreciation and Amortization 182 46 Stock-based compensation 405 73 Provision for doubtful accounts 3 27 Business combination related costs 214 6,061 Goodwill impairment — 5,702 Intangible asset impairment 4,940 — Changes in operating assets and liabilities: Accounts receivable ( 225 ) ( 461 ) Unbilled revenue — — Prepaid expenses and other assets ( 61 ) 15 Accounts payable and accrued liabilities ( 547 ) ( 18 ) Deferred revenue 150 ( 65 ) Net cash used in operating activities ( 1,945 ) ( 396 ) CASH FLOWS FROM INVESTING ACTIVITIES: Cash and cash equivalents acquired in connection with the Business Combination 3,589 Purchase of fixed assets ( 32 ) — Net cash provided by (used in) investing activities ( 32 ) 3,589 CASH FLOWS FROM FINANCING ACTIVITIES: Equity redemption — ( 50 ) Equity distribution — ( 461 ) Net cash used in financing activities — ( 511 ) (DECREASE) INCREASE IN CASH ( 1,977 ) 2,682 CASH, BEGINNING OF PERIOD 3,030 348 CASH, END OF PERIOD $ 1,053 $ 3,030 NON-CASH INVESTING AND FINANCING ACTIVITIES: Shares issued for services $ 66 $ 43 Equity redemption with notes payable $ — $ 50 Stock-based compensation included in accounts payable and accrued liabilities $ 21 $ — Assets acquired and liabilities assumed $ — $ 11,583 49 SIDECHANNEL, INC. NOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED SEPTEMBER 30, 2023, AND 2022 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 product and service offerings provide cybersecurity and privacy 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. 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 vCISO engagements typically contain a monthly subscription and rates for vCISO time and material projects ranging from $ 350 to $ 425 per hour. Each of our vCISOs is generally embedded into the C-suite executive teams of two (2) to four (4) of our clients. We augment our vCISO offering with a full range of other cybersecurity products and services through a team of security engineer employees combined with a network of third-party service providers and value-added resellers. 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 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 SCS 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, Inc., together with its subsidiaries. Our headquarters are located at 146 Main Street, Suite 405, Worcester, MA, 01608. Our website is www.sidechannel.com . 50 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 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. Reclassifications Certain prior year amounts have been reclassified to be comparable with the current year’s presentation. 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 We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. We did not have any cash equivalents as of September 30, 2023, and 2022. As of September 30, 2023, and 2022, our cash included cash on hand and cash in the bank. We maintain our 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, 2023, approximately $ 0.8 million of our cash balance was uninsured. We have 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. We had one (1) customer with an accounts receivable balance that exceeded 10% of accounts receivable at September 30, 2023. Cash flows from accounts receivable are recorded in operating cash flows. Fair Value of Financial Instruments Our financial instruments consisted primarily of cash, accounts receivable, 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. 51 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 during 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 of July 1, 2022, and the fair value of the goodwill was determined to be less than the carrying amount of the goodwill by $ 5.702 thousands. 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 as of September 30, 2022. 52 The goodwill was evaluated at the balance sheet date of September 30, 2023. For fiscal year 2023, we recorded no impairment of goodwill. For fiscal year 2022, we incurred $ 5.7 million of goodwill impairment. 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, 2023, and 2022. 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. We recorded $ 4.9 million of finite-lived intangible assets in the form of Acquired In Process Research & Development (“AIPR&D”) as a result of acquiring Enclave in the Business Combination as of September 30, 2022. Under ASC 805, AIPR&D are initially recognized at fair value and classified as finite-lived assets until the successful completion or abandonment of the associated research and development efforts. During the development period, these assets will not be amortized as charges to earnings; instead, these assets will be tested for impairment on an annual basis or more frequently if impairment indicators are identified. An impairment loss is measured based on the excess of the carrying amount over the asset’s fair value. Our impairment testing as of September 30, 2023, indicated the full value of this finite-lived intangible asset should be impaired. The difficulty of projecting the amount and timing of future revenues caused us to conclude a full impairment of the asset was appropriate. 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. The Company did not record any finite-lived intangible asset impairment for the year ended September 30, 2022. 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 15 to net 90 days. Nature of Products and Services We identify, develop, and deploy cybersecurity and privacy 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. In addition to Enclave, our proprietary software product, we also sell third-party software and services through a network of strategic partnerships. 53 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 purchased 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. We maintain an allowance for doubtful accounts (“allowance”) equal to 3 % of the ending quarterly accounts receivable balance. The allowance is rounded up to the nearest $10,000. Costs to Obtain a Contract with a Customer The only costs we incur associated with obtaining contracts with customers are marketing costs incurred with third-party service providers and sales commissions that we pay to our employees, contractors, or third-party sales representatives. Commissions 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. 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. 54 Research and Development and Software Development Costs We expense all research and development costs, including patent and software development costs. Our research and development costs incurred for the year ended September 30, 2023, were $ 669,000 . 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 We are subject to legal proceedings, claims, and liabilities which arise in the ordinary course of business, and we accrue 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 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 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. We use 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. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments. We did no t record any liabilities for uncertain tax positions during the years ended September 30, 2023, or 2022. Net 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 our earnings. 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, 2023, 69,281,020 warrants and 8,636,973 restricted stock units were excluded from the calculation of diluted loss per share because their effect would be anti-dilutive. At September 30, 2022, anti-dilutive warrants and restricted stock units outstanding were 87,628,920 and 4,309,262 , respectively. 55 Segment Information We manage our operations as a single operating segment for the purposes of assessing performance and making operating decisions. Our focus is on the research, development, and commercialization of our technology. Warrants We evaluate 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, we believe those ASUs issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to us, or (iv) are not expected to have a significant impact on us. Accounting Pronouncements Adopted 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. We adopted it on October 1, 2022, without material impact on our financial statements. 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. 56 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 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 SCS 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, Inc., together with its subsidiaries. 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 were 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, achieved 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. The number of the Second Tranche Shares could have been 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 was also subject to adjustment based upon any successful indemnification claims made by the Company pursuant to the Purchase Agreement. As previously disclosed in Form 8-K dated May 9, 2023, a total of 62,016,618 shares of common stock were issued for the Second Tranche and Closing Working Capital Adjustment. 57 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. 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). 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 have been 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 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 %. 58 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. 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 (AIPR&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; (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 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 years ended September 30, 2023, and September 30, 2022, the Company expensed $ 180,000 and $ 45,000 in amortization expenses respectively. The unamortized balance of the deferred costs was $ 330,000 at September 30, 2023. 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 as of September 30, 2022: SCHEDULE OF ESTIMATED FAIR VALUES OF THE IDENTIFIABLE INTANGIBLE ASSETS ACQUIRED, ESTIMATED USEFUL LIVES Intangible Assets: Preliminary Fair Value (in thousands) Estimated Life in Years Discount Rate Valuation Method AIPR&D $ 4,940 5 - 15 22.75 % Income (MPEEM) 59 We conducted a fair value analysis of the intangible assets acquired as of September 30, 2023 and concluded that the full carrying value of this asset should be impaired. Our balance sheet as of September 30, 2023 reflects this conclusion. 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. Deferred Tax Liability As part of the Business Combination, we acquired federal tax net operating loss carryforwards of approximately $ 35 million. In addition, the intangible asset acquired, AIPR&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 $ 7.0 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 at September 30, 2022. At September 30, 2023, there were additional state net operating loss carryforwards to offset the temporary difference from the intangible asset acquired, resulting in a state deferred tax liability of zero ($ 0 ). Unaudited Pro Forma Operating Results The following presents the unaudited proforma combined results of operations of Cipherloc with SCS for the year ended September 30, 2022 as if the entities were combined on October 1, 2020. SCHEDULE OF UNAUDITED PROFORMA OPERATIONS RESULTS (In thousands, except per share data) For the Year Ended September 30, 2022 Revenues $ 4,789 Cost of revenues 2,467 Gross profit 2,322 Operating expenses (a) 4,860 Operating income (loss) ( 2,538 ) Other income and (expenses) 13 Net income (loss) before income taxes ( 2,525 ) Income taxes 195 Net income (loss) $ ( 2,720 ) Basic loss per share (b) $ ( 0.03 ) (a) All costs incurred in connection with the acquisition have been removed from operating expenses in the proforma statement of operations. In fiscal year 2022, Cipherloc incurred $ 479,000 of transaction expenses and SCS incurred $ 109,000 of transaction expenses. (b) Pro forma weighted average shares outstanding are 82.0 million for the year ended September 30, 2022. NOTE 4 – REVENUE Customer Concentration No one customer accounted for more than ten percent ( 10 %) of our revenues during the years ended September 30, 2023, and 2022. 60 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 we deliver 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 $ 280,000 at September 30, 2023, and $ 130,000 at September 30, 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 Year Ended September 30, 2023 Balance on September 30, 2022 $ 130 Revenue deferred 553 Revenue recognized ( 403 ) Balance at September 30, 2023 $ 280 Year Ended September 30, 2022 Balance on September 30, 2021 $ 194 Revenue deferred 107 Revenue recognized ( 171 ) Balance at September 30, 2022 $ 130 Software License Agreements During the year ended September 30, 2022, we recognized a minimal amount in licensing revenue from a licensing agreement between Castle Shield Holdings LLC (“Castle Shield”) and Cipherloc. We and Castle Shield mutually agreed to terminate this agreement on October 14, 2022. We 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”). NOTE 5 – DEBT Pursuant to a Membership Interest Redemption Agreement, dated November 3, 2021, by and between us 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 in us. 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. 61 NOTE 6 – RELATED PARTY TRANSACTIONS Brian Haugli, our Chief Executive Officer and our 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. We are a reseller of the RealCISO software. We receive revenue from our customers for the use of RealCISO software and pays licensing fees to RealCISO for such use. For the years ended September 30, 2023, and 2022, SideChannel paid $ 26,000 and $ 98,000 to RealCISO for licenses, respectively. We also received $ 63,000 from RealCISO for software development services that we began providing Real CISO during fiscal year 2023. No other related party transactions occurred during the years ending September 30, 2023, and September 30, 2022. NOTE 7 – COMMITMENTS AND CONTINGENCIES Litigation We are currently not involved in any litigation that we believe 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 Cipherloc Corporation, 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 . We believe we have made all required payments and delivered the stock to the plaintiffs. The case is currently being defended by us. We believe we have meritorious defenses to the allegations, and we intend to continue to vigorously defend against the litigation. Leases In December 2021, we and our landlord for our leased office space in Worcester, Massachusetts, entered into a lease agreement. The lease became effective on January 1, 2022 and has a one-year term. The initial monthly rent was $ 930 and increased to $ 948 on January 1, 2023 a 2 % increase, per the lease agreement. 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 ours. This lease has been accounted for as a month-to-month lease, and no right of use asset or lease liability has been recorded at September 30, 2023. Cash Flow Impact of Leases We are not carrying any assets or liabilities associated with leases for the fiscal years 2023 or 2022. We lease an office at 146 Main Street in Worcester, Massachusetts, for which we expect to pay approximately $ 12,000 over the next twelve (12) months . 62 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 of the Business Combination. The financial statements have been adjusted retroactively to reflect the Cipherloc shares received as being outstanding the outstanding shares of SCS as of September 30, 2020. SCS did not have any convertible debt or issued preferred stock. As explained in Note 5, in December 2021, while it was SideChannelSec LLC, the Company promised to pay Mr. Desai $ 50,000 , 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, in accordance with its partnership agreements. We ceased operations as an LLC on December 29, 2021, and since then have had zero ($ 0 ) equity distributions. Common Stock As of September 30, 2023, and 2022, we had 213,854,781 and 148,724,056 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 We did not issue shares of common stock for cash during the years ended September 30, 2023, and September 30, 2022. Common Stock Issued for Business Combinations On July 1, 2022, we 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. On May 4, 2023, we issued a total of 62,016,618 shares of common stock for the Second Tranche ( 59,900,000 shares) and Closing Working Capital Adjustment ( 2,116,618 shares). Common Stock Issued for Services Our 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. We also use stock as a form of compensation for independent contractors who provide professional services to us in sales, marketing, or administration. During fiscal year 2023, the fair market value of stock issued for services totaled $ 66,000 for 770,978 shares of common stock compared to $ 43,000 for 280,557 shares of common stock in fiscal year 2022. Common Stock Issued for Legal Settlement On June 6, 2022, Cipherloc entered into a mediated settlement agreement with Robert LeBlanc. Pursuant to that agreement, Cipherloc had issued a total of 200,000 shares of the Company’s common stock to Mr. LeBlanc. No shares were issued for legal settlement during fiscal year 2023. 63 Common Stock and Restricted Stock Units Issued to Directors and Officers As of this filing, we are granting 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 (In thousands) Initial Reserve at September 13, 2021 8,000 Non-exempt Awards ( 13,735 ) Forfeitures 1,038 Annual Reserve Increases 8,186 Reserve at September 30, 2023 3,489 Reserve percent of outstanding shares at September 30, 2023 1.6 % We have granted and intend to continue granting restricted stock units (“RSU’s”) to directors, employees, and contractors 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 Equity Incentive Plan. SCHEDULE OF RESTRICTED STOCK UNITS VESTING Outstanding Equity Compensation Grants (In thousands) Number of RSU’s RSU Grants Acquired at July 1, 2022 3,731 Granted 956 Vested ( 198 ) Canceled/Forfeited ( 180 ) Outstanding Grants at September 30, 2022 4,309 Granted 8,174 Vested ( 2,988 ) Canceled/Forfeited ( 858 ) Outstanding Grants at September 30, 2023 8,637 The weighted average grant-date fair value of all awards granted during the year ended September 30, 2023, was $ 0.10 per share. The unamortized stock compensation expense at September 30, 2023, is $ 694,000 and the remaining weighted average term to vesting is 2.3 years. 64 Preferred Stock As of September 30, 2023, and 2022, we had zero ( 0 ) 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 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 contained a Board Designation Right which provides that the holders of the majority of the Series A Preferred Stock had the right to elect a majority of our Board of Directors. All 100 shares of Series A Preferred Stock were converted to common stock on June 12, 2023. 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, 2023, are as follows: SCHEDULE OF WARRANT ACTIVITY Number of Warrants (000’s) Weighted Average Exercise Price Weighted Average Remaining Life Warrants Acquired at July 1, 2022 87,794 $ 0.56 3.82 Granted — — — Exercised — — — Canceled/Forfeited — — — Outstanding at September 30, 2022 87,794 $ 0.56 3.57 Granted — — — Exercised — — — Canceled/Forfeited ( 18,513 ) ( 1.20 ) — Outstanding at September 30, 2023 69,281 $ 0.39 3.31 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. 65 The provision (benefit) for income taxes from continued operations for the years ended September 30, 2023, and 2022 consist of the following: SCHEDULE OF PROVISION (BENEFIT) FOR INCOME TAXES FROM CONTINUED OPERATIONS (000’s) 2023 2022 September 30, (In thousands) 2023 2022 Current: Federal $ ( 136 ) $ 136 State ( 32 ) 59 Total $ ( 168 ) $ 195 Deferred: Federal $ — $ — State ( 211 ) — Total ( 211 ) — Provision (benefit) for income taxes, net $ ( 379 ) $ 195 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, 2023 2022 Statutory federal income tax rate 21.00 % 21.00 % Non-deductible contingent consideration ( 1.89 ) ( 8.72 ) Non-deductible impairment of goodwill — ( 8.14 ) Non-deductible stock-based compensation — ( 0.10 ) Prior Year Adjustment 1.58 — Non-deductible meals & entertainment ( 0.22 ) — State tax 3.02 0.80 Change in valuation allowance ( 18.36 ) ( 4.84 ) Effective tax rate 5.13 % — % For the years ended September 30, 2023, and 2022, 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 benefit $ 379,000 for the year ended September 30, 2023, and income tax expense of $ 195,000 for the year ended September 30, 2022. The September 30, 2022, expense of $ 195,000 was accrued as an estimate of income taxes due by SCS, Inc. for activity prior to the Business Combination. The actual taxes due by SCS, Inc. for such activity was zero ($ 0 ) resulting in a reversal of the $ 195,000 accrual during fiscal year 2023. The reversal was partially offset by $ 27,000 of state income taxes incurred by the Company during fiscal year 2023. In addition, a deferred tax liability was recognized for a book versus tax basis difference for state income taxes upon the business combination with Cipherloc in 2022. 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 . 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 2023 2022 September 30, 2023 2022 Net operating loss carry forward $ 7,603 $ 7,480 Intangible asset – not deductible for tax ( 1,038 ) ( 1,038 ) AIPR&D capitalization 126 Other 7 Deferred compensation 38 ( 59 ) Valuation allowance ( 6,736 ) ( 6,383 ) Deferred income tax asset $ — $ — 66 State 2023 2022 September 30, 2023 2022 Net operating loss carry forward $ 225 $ 178 Intangible asset – not deductible for tax ( 218 ) ( 211 ) Other 36 Valuation allowance ( 43 ) ( 178 ) Deferred income tax asset $ — $ ( 211 ) The Company has a net operating loss carry forward of $ 36.2 million available to offset future taxable income, of which, $ 2.6 million will expire within the next five years, $ 12.5 million will expire thereafter, and the remaining $ 21.1 million will not expire. 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 NOLs 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, 2019, and all net operating losses we may use in future federal tax filings are subject to IRS examination. NOTE 10 - SUBSEQUENT EVENTS On November 6, 2023, Anthony Ambrose, a current Member of our Board of Directors (“Board”), and the Chairman of the Nomination and Corporate Governance Committee, informed us of his upcoming retirement from the Board. Mr. Ambrose will remain a member of the Board until our next Annual Meeting of Stockholders (“Annual Meeting”), at which time Mr. Ambrose will not stand for re-election as a Member of the Board. Mr. Ambrose’s departure is not the result of any disagreement with our management, our Board, or us on any matter related to its operations, policies, or practices. 67 In recognition of Mr. Ambrose’s tenure and contributions to us during his nearly five years of service as a member of the Board, we will accelerate the vesting of Mr. Ambrose’s 333,334 restricted stock units, which were awarded to Mr. Ambrose on July 2, 2022 and previously scheduled to vest pro-ratably on June 1, 2024 and on June 1, 2025. The full amount of unvested restricted stock units will now vest on January 2, 2024. The full terms of Mr. Ambrose’s separation will be formalized in a forthcoming Separation Agreement between us and Mr. Ambrose. Also on November 7, 2023, we announced an offer (“Offer to Exchange”) made to certain holders of 55,549,615 of our warrants issued during 2021 with an exercise price of $ 0.36 and expiration dates between March 31, 2026 and April 16, 2026 (“2021 Investor Warrants”). The Offer to Exchange provided 2021 Investor Warrant holders one (1) share of common stock for every six 2021 Investor Warrants and one (1) New Warrant for every two and one-half (2.5) 2021 Investor Warrants. The Offer to Exchange expired at 5:00 PM EST on December 26, 2023 (“Expiration Date”). The New Warrants being offered have a five ( 5 ) year term, an exercise price of $ 0.18 , and an automatic conversion if the bid price of the stock is equal to or greater than $ 0.36 for 30 consecutive days. On November 14, 2023, the Offer to Exchange was amended to include an Amended New Warrant Agreement which removed a restriction on the cashless exercise of the New Warrant. On November 21, 2023, we received a Comment Letter from the SEC about the Offer to Exchange. On December 1, 2023 we filed a response with the SEC to the Comment Letter and on December 4, 2023, we filed an Amended Offer to Exchange which reflected the clarifications and corrections requested by the SEC. The Offer to Exchange was made as an offer for all or none of the 2021 Investor Warrants. At its meeting on December 11, 2023, our Board approved waiving the all or nothing clause and authorized us to close the offer on the Expiration Date if the percentage of 2021 Investor Warrants validly tendered and not validly withdrawn exceed 65% of the total 2021 Investor Warrants outstanding. The Expiration Date was also changed to December 26, 2023. On December 11, 2023, we received a Comment Letter from the SEC requesting clarifications on three responses we submitted regarding the November 21, 2023 Comment Letter. On December 21, 2023, we filed an Amended Offer to Exchange which reflected the clarifications requested by the SEC. On December 26, 2023, we closed the Offer to Exchange and issued 7,270,958 shares of common stock and 17,415,437 New Warrants in exchange for 43,538,501 2021 Investor Warrants ( 78.4 % of the total outstanding 2021 Investor Warrants). 68 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.