UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
(Mark one)
For
the quarterly period ended
For the transition period from ___________ to ___________
Commission
File No.
(Exact name of registrant as specified in its charter)
State of Incorporation |
IRS Employer Identification No. |
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
| Title of Each Class | Trading Symbol | Name of Each Exchange on Which Registered | ||
| N/A |
Indicate
by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days:
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule
405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant
was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ | |
| ☒ | Smaller reporting company | |||
| Emerging growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act). Yes ☐
As of August 2, 2023, the registrant had [] shares of common stock outstanding.
SIDECHANNEL, INC.
TABLE OF CONTENTS
| 2 |
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SIDECHANNEL, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
| June 30, 2023 | September 30, 2022 | |||||||
| (Unaudited) | ||||||||
| ASSETS | ||||||||
| Current assets | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable, net | ||||||||
| Deferred costs | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Total current assets | ||||||||
| Fixed assets | ||||||||
| Goodwill | ||||||||
| Intangibles | ||||||||
| Deferred costs | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES & STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities | ||||||||
| Accounts payable and accrued liabilities | $ | $ | ||||||
| Deferred revenue | ||||||||
| Promissory note payable | ||||||||
| Income taxes payable | ||||||||
| Total current liabilities | ||||||||
| Deferred tax liability | ||||||||
| Total liabilities | ||||||||
| Commitments and contingencies | ||||||||
| Series A convertible preferred stock, $ par value, shares authorized; and shares issued and outstanding as of June 30, 2023 and September 30, 2022, respectively | ||||||||
| Common stock, $ par value, shares authorized; and shares issued and outstanding as of June 30, 2023 and September 30, 2022, respectively | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total stockholders’ equity | ||||||||
| Total liabilities and stockholders’ equity | $ | $ | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 3 |
SIDECHANNEL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| 2023 | 2022 | 2023 | 2022 | |||||||||||||
| Revenues | $ | $ | $ | $ | ||||||||||||
| Cost of revenues | ||||||||||||||||
| Gross profit | ||||||||||||||||
| Operating expenses | ||||||||||||||||
| General and administrative | ||||||||||||||||
| Selling and marketing | ||||||||||||||||
| Research and development | ||||||||||||||||
| Business Combination related costs | ||||||||||||||||
| Total operating expenses | ||||||||||||||||
| Operating income (loss) | ( | ) | ( | ) | ||||||||||||
| Other income (expense), net | ||||||||||||||||
| Net income (loss) before income tax expense | $ | ( | ) | $ | $ | ( | ) | $ | ||||||||
| Income tax expense | ||||||||||||||||
| Net income (loss) after income tax expense | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ||||||
| Net income (loss) per common share – basic and diluted | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ||||||
| Weighted average common shares outstanding – basic and diluted | ||||||||||||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
| 4 |
SIDECHANNEL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except preferred shares)
(Unaudited)
| For the Nine Months Ended June 30, 2023 | ||||||||||||||||||||||||||||
| Preferred Stock | Common Stock | Additional Paid-in | Accumulated | Stockholders’ | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Deficit | Equity | ||||||||||||||||||||||
| Balance at September 30, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||
| Shares issued for services | ||||||||||||||||||||||||||||
| Stock-based compensation expense | — | |||||||||||||||||||||||||||
| Net loss | — | — | ( | ) | ( | ) | ||||||||||||||||||||||
| Balance at December 31, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||
| Shares issued for services | — | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | |||||||||||||||||||||||||||
| Net loss | — | — | ( | ) | ( | ) | ||||||||||||||||||||||
| Balance at March 31, 2023 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||
| Shares issued for services | — | |||||||||||||||||||||||||||
| Stock-based compensation expense | — | |||||||||||||||||||||||||||
| Net loss | — | — | ( | ) | ( | ) | ||||||||||||||||||||||
| Conversion of Preferred to Common | ( | ) | — | |||||||||||||||||||||||||
| Business Combination – Contingent Consideration | — | |||||||||||||||||||||||||||
| Balance at June 30, 2023 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||||||||||
| For the Nine Months Ended June 30, 2022 | ||||||||||||||||||||||||||||
| Preferred Stock | Common Stock | Additional Paid-in | Accumulated | Stockholders’ | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Earnings | Equity | ||||||||||||||||||||||
| Balance at September 30, 2021 | $ | $ | $ | $ | $ | | ||||||||||||||||||||||
| Equity redemptions | — | — | ( | ) | ( | ) | ||||||||||||||||||||||
| Equity distributions | — | — | ( | ) | ( | ) | ||||||||||||||||||||||
| Net income | — | — | ||||||||||||||||||||||||||
| Balance at December 31, 2021 | $ | $ | $ | $ | $ | |||||||||||||||||||||||
| Net income | — | — | ||||||||||||||||||||||||||
| Balance at March 31, 2022 | $ | $ | $ | $ | $ | |||||||||||||||||||||||
| Net loss | — | — | ( | ) | ( | ) | ||||||||||||||||||||||
| Balance at June 30, 2022 | $ | $ | $ | $ | $ | |||||||||||||||||||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
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SIDECHANNEL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| Nine Months Ended | ||||||||
| June 30, | ||||||||
| 2023 | 2022 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net income (loss) | $ | ( | ) | $ | ||||
| Adjustments to reconcile net (loss) income to net cash flows provided by or (used in) operating activities: | ||||||||
| Amortization | ||||||||
| Stock-based compensation | ||||||||
| Business Combination related costs | ||||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | ( | ) | ( | ) | ||||
| Unbilled revenue | ||||||||
| Prepaid expenses and other assets | ||||||||
| Accounts payable and accrued liabilities | ( | ) | ||||||
| Deferred revenue | ( | ) | ||||||
| Net cash provided by (used in) operating activities | ( | ) | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchase of fixed assets | ( | ) | ||||||
| Net cash used in investing activities | ( | ) | ||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Equity redemption | ( | ) | ||||||
| Equity distribution | ( | ) | ||||||
| Net cash used in financing activities | ( | ) | ||||||
| (DECREASE) INCREASE IN CASH | ( | ) | ||||||
| CASH, BEGINNING OF PERIOD | ||||||||
| CASH, END OF PERIOD | $ | $ | ||||||
| NON-CASH INVESTING AND FINANCING ACTIVITIES: | ||||||||
| Equity redemption with notes payable | $ | $ | ||||||
| Stock-based compensation included in accounts payable and accrued liabilities | $ | $ | ||||||
The accompanying notes are an integral part of these unaudited consolidated financial statements.
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SIDECHANNEL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – NATURE OF OPERATIONS
Our mission is to make cybersecurity simple and accessible for mid-market and emerging companies, a market we believe is currently underserved. Our cybersecurity offerings identify and develop cybersecurity, privacy, and risk management solutions for our customers. Our growth plan to address the needs of our customers is to provide more effective and cost-efficient products and tech-enabled services cybersecurity and related services including virtual Chief Information Security Officer (“vCISO”), zero trust, third-party risk management, due diligence, privacy, threat intelligence, and managed end-point security solutions. Zero trust is a security framework requiring all users to be continuously validated being granted or keeping access to digital assets, data, and applications.
During September 2022, we announced a proprietary product called Enclave, which simplifies an important cybersecurity tactic called “microsegmentation”. Enclave seamlessly combines access control, microsegmentation, encryption, and other secure networking concepts creating a comprehensive solution. It allows information technology professionals to easily segment the enterprise network, place the right assets in those segments, and direct network traffic. We expect to begin recognizing revenue from Enclave during fiscal year 2023.
Our growth strategy focuses on these three initiatives:
| 1. | Securing new vCISO clients; | |
| 2. | Adding new Cybersecurity Software and Services (“Cybersecurity Software and Services”) offerings, such as Enclave; and | |
| 3. | Increasing adoption of Cybersecurity Software, including Enclave, and Services offerings at vCISO clients. |
vCISO
clients typically enter into twelve (12) month engagements consisting of a monthly subscription with an annual renewal option, as well
as additional vCISO time and material projects, which additional time’s cost to customers ranges from $
On July 1, 2022 (the “Closing Date”) we completed an acquisition (“Business Combination”) of all the outstanding equity securities of SideChannel, Inc., a Massachusetts corporation, pursuant to an Equity Securities Purchase Agreement dated May 16, 2022 (the “Purchase Agreement”). On September 9, 2022, SideChannel, Inc., the acquired Massachusetts corporation and a wholly owned subsidiary of the registrant, changed its name to SCS, Inc. (“SCS”). Cipherloc Corporation, the Delaware parent company of SCS, has changed its name to SideChannel, Inc. (“SideChannel”). As used herein, the words “the Company” refers to, for periods from July 1, 2022 and forward, SideChannel, and for periods prior to July 1, 2022, SCS, and its direct and indirect subsidiaries, as applicable.
As part of the Business Combination, the former stockholders of SCS (the “Sellers”) transferred all of their equity securities in SCS for a total of shares of the Company’s common stock (the “First Tranche Shares”), and shares of the Company’s newly designated Series A Preferred Stock, $ par value (the “Series A Preferred Stock”). The In addition the Sellers were entitled to receive up to an additional 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 SCS, as a subsidiary of the Company, achieved at least $ 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 number of the Second Tranche Shares could have been reduced or increased, based upon whether SCS’ working capital as of the Closing Date is less than or more than zero (“Closing Working Capital Adjustment”). The number of the Second Tranche Shares was also subject to adjustment based upon any successful indemnification claims made by the parties pursuant to the Purchase Agreement.
The Business Combination was treated as a reverse acquisition (reverse merger), in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Under this method of accounting, SCS was deemed to be the accounting acquirer for financial reporting purposes. This determination was primarily based on the facts immediately following the Business Combination that: (1) a majority of the Board of Directors of the combined company will be composed of directors designated by the Sellers under the terms of the Purchase Agreement; and (2) existing members of SCS management constituted the management of the combined company. As SCS was determined to be the accounting acquirer in the Business Combination, but not the legal acquirer, the transaction was deemed a reverse acquisition under the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations.
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Our headquarters are located at 146 Main Street, Suite 405, Worcester, MA, 01608. Our website is www.sidechannel.com.
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.
In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position, results of operations, and changes in cash flows for the interim periods presented. Certain footnote information has been condensed or omitted from these consolidated financial statements. Therefore, these consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in our Form 10-K for the year ended September 30, 2022 (the “2022 Form 10-K”) filed on December 20, 2022, with the Securities and Exchange Commission (“SEC”).
Subsequent Events
On July 1, 2023 Brian Haugli, our chief executive officer, was granted restricted stock units as stated in his annual employment agreement and approved by our Board of Directors (“Board”).
Segment Information
We manage our operations as a single operating segment for the purposes of assessing performance and making operating decisions.
| 8 |
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. Business Combination related transaction costs, including legal and accounting fees and other external costs directly related to the acquisition, are recognized separately from the acquisition and expensed as incurred in general and administrative expense in the consolidated statements of operations.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, our note payable, and embedded conversion features in our stock warrants. Our cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are carried at cost which approximates fair value, due to the short maturities of the accounts. Our note payable’s carrying amount approximates it fair value due to the short remaining term.
ASC Topic 820 (Fair Value Measurement) establishes a fair value hierarchy for instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and our own assumptions (unobservable inputs). The fair values of the warrants issued by us as part of the Business Combination were determined using Level 2 inputs in accordance with the guidance in ASC Topic 820.
Goodwill, Intangible, and Long-Lived Assets
We account for goodwill and intangible assets in accordance with ASC Topic 350 (Intangibles – Goodwill and Other) and ASC Topic 360 (Property, Plant and Equipment). Finite-lived intangible assets are amortized over their estimated useful economic life and are carried at cost less accumulated amortization. Goodwill is assessed for impairment annually at the beginning of the fourth quarter on a reporting unit basis, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. Goodwill is considered to be impaired if the fair value of a reporting unit is less than its carrying amount.
If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss will be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.
Long-lived assets, which consist of finite-lived intangible assets and property and equipment, are assessed for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Each impairment test is based on a comparison of the estimated undiscounted cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value. The cash flow estimates used to determine the impairment, if any, contain management’s best estimates using appropriate assumptions and projections at that time.
Revenue Recognition
We recognize revenue in accordance with the guidance in ASC Topic 606 (Revenue from Contracts with Customers). We recognize revenue for the sale of products or services when our performance obligations under the terms of a contract with a customer are satisfied and control of the product or service has been transferred to the customer. Generally, this occurs when we deliver a product or perform a service. In cases when customers are invoiced in advance or pay in advance of our product or service delivery, recognition of revenue is deferred until 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.
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We do not have any material variable consideration arrangements, or any material payment terms with our customers other than standard payment terms which generally range from net 30 to net 90 days.
Nature of Products and Services
We identify, develop, and deploy cybersecurity, privacy, and risk management solutions for our clients and customers in North America. We categorize our products and services as either vCISO Services or Cybersecurity Software and Services. As a result of the Business Combination, we announced a proprietary cybersecurity software product called Enclave. We also sell third party software and services through a network of strategic partnerships.
Types of Contracts with Customers
Our contracts with customers are generally structured as annual subscription agreements or project specific statements of work. Our annual subscription agreements include a minimum number of service hours per year or month and a specified rate for the minimum amount of services to be delivered during the subscription period. Payment terms and any other customer-specific acceptance criteria are also specified in the contracts and statements of work.
Contract Balances
We record accounts receivable at the time of invoicing. Accounts receivable, net of the allowance for doubtful accounts, is included in current assets on our balance sheet. To the extent that we do not recognize revenue at the same time as we invoice, we record a liability for deferred revenue. In certain instances, we also receive customer deposits in advance of invoicing and recording of accounts receivable. Deferred revenue and customer deposits are included in current liabilities on our consolidated balance sheets.
When used, the allowance for doubtful accounts reflects our estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, if any, historical experience, and other currently available evidence.
Costs to Obtain a Contract with a Customer
The only costs we incur associated with obtaining contracts with customers are sales commissions that we pay to our internal sales personnel or third-party sales representatives. These costs are calculated based on set percentages of the revenue value of each product or service sold. Commissions are considered earned by our internal sales personnel at the time we recognize revenue for a particular transaction. Commissions are considered earned by third-party sales representatives at the time that revenue is recognized for a particular transaction. We record commission expense in our consolidated statements of operations at the time the commission is earned. Commissions earned but not yet paid are included in current liabilities on our balance sheets.
See Note 4 for further information about our revenue from contracts with customers.
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Leases
We account for leases in accordance with ASC Topic 842 (Leases). We determine if an arrangement is a lease at inception. A lease contract is within scope if the contract has an identified asset (property, plant or equipment) and grants the lessee the right to control the use of the asset during the lease term. The identified asset may be either explicitly or implicitly specified in the contract. In addition, the supplier must not have any practical ability to substitute a different asset and would not economically benefit from doing so for the lease contract to be in scope. The lessee’s right to control the use of the asset during the term of the lease must include the ability to obtain substantially all of the economic benefits from the use of the asset as well as decision-making authority over how the asset will be used. Leases are classified as either operating leases or finance leases based on the guidance in ASC Topic 842. Operating leases are included in operating lease ROU assets and operating lease liabilities in our consolidated balance sheets. We do not currently have any operating lease ROU assets and operating lease liabilities. Finance leases are included in property and equipment and financing lease liabilities. We do not currently have any financing leases.
Operating lease payments are included in cash outflows from operating activities on our consolidated statements of cash flows.
We have made an accounting policy election not to apply the recognition requirements of ASC Topic 842 to short-term leases (leases with a term of one year or less at the commencement date of the lease). Lease expense for short-term lease payments is recognized on a straight-line basis over the lease term.
We account for stock-based compensation in accordance with ASC Topic 718 (Compensation – Stock Compensation) which requires that employee share-based equity awards be accounted for under the fair value method and requires the use of an option pricing model for estimating fair value of awards, which is then amortized to expense over the service periods. See further disclosures related to our stock-based compensation plans in Note 8.
Income Taxes
We utilize the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carryforwards and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized.
Earnings (loss) per common share - basic is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during each period. Earnings (loss) per common share - diluted is computed by dividing earnings (loss) by the weighted average number of common shares and common share equivalents outstanding during each period. Common share equivalents represent unvested shares of restricted stock and stock options and are calculated using the treasury stock method. Common share equivalents are excluded from the calculation if their effect is anti-dilutive.
Warrants
We account for warrants in accordance with ASC Topics 480 and 815. The result of this accounting treatment is that the fair value of the embedded derivative, if required to be bifurcated, is marked-to-market at each balance sheet date and recorded as a liability. The change in fair value is recorded in our Consolidated Statement of Operations as a component of other income or expense. Upon exercise of a warrant, it is marked to fair value at the exercise date and then that fair value is reclassified to equity.
Effect of Recently Issued Amendments to Authoritative Accounting Guidance
In June 2016, the FASB issued amendments to the guidance for accounting for credit losses. In November 2019, the FASB deferred the effective date of these amendments for certain companies, including smaller reporting companies. As a result of the deferral, the amendments are effective for us for reporting periods beginning after September 30, 2023. The amendments replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires the use of a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. The amendments require a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We plan to adopt the amendments when they become effective for us on October 1, 2023. The adoption of this standard is not expected to have a material impact on our consolidated financial statements.
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NOTE 3 – ACQUISITIONS
Reverse Merger Between Cipherloc Corporation and SideChannel, Inc. (now known as SCS, Inc.)
As discussed further in Note 3 to our consolidated financial statements in our 2022 Form 10-K, on the Closing Date, the Sellers exchanged all of their equity securities in SCS for a total of shares of the Company’s common stock (“First Tranche Shares”), and shares of the Company’s Series A Preferred Stock, $ par value. The Sellers were entitled to receive up to an additional shares of the Company’s common stock (“Second Tranche Shares”) at such time that the operations of SCS, as a subsidiary of the Company, achieved at least $ million in revenue (“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 $ per share which resulted in a fair value of $ million.
During the twelve months ending March 31, 2023, the Milestone was achieved by the operations of SCS with trailing twelve-month revenue equaling $ million. The combined Second Tranche shares and the Closing Working Capital Adjustment shares were issued on May 5, 2023.
The following presents the unaudited proforma combined results of operations of Cipherloc with SCS as if the entities were combined on October 1, 2021, and show activity for the three months and nine months ended June 30, 2022.
For the Three Months Ended June 30, 2022 | For the Nine Months Ended June 30, 2022 | |||||||
| (In thousands, except share and per share data) | ||||||||
| Revenues | $ | $ | ||||||
| Cost of revenues | ||||||||
| Gross profit | $ | $ | ||||||
| Operating expenses | ||||||||
| Operating loss | $ | ( | ) | $ | ( | ) | ||
| Other income | ||||||||
| Net loss before income taxes | ( | ) | ( | ) | ||||
| Income taxes | $ | $ | ||||||
| Net loss | $ | ( | ) | $ | ( | ) | ||
| Basic loss per share (a) | $ | ( | ) | $ | ( | ) | ||
| (a) |
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NOTE 4 – REVENUE FROM CONTRACTS FROM CUSTOMERS
Customer Concentration
No
customer individually accounted
Deferred Revenue
Deferred
revenue was $
Changes in deferred revenue for the nine months ended June 30, 2023 were as follows:
| (In thousands) | ||||
| Balance on September 30, 2022 | $ | |||
| Deferral of revenue | ||||
| Recognition of revenue | ( | ) | ||
| Balance at June 30, 2023 | $ | |||
We internally report our revenue using two categories. The first, “vCISO Services”, captures the revenue for the Chief Information Security Officer services that we provide to our clients on a fractional, virtual or outsourced basis; thus, we use the acronym “vCISO”. Services delivered by SideChannel through our team of vCISOs include assessing the cybersecurity risk profile, implementing policies and programs to mitigate risks, and managing the day-to-day tasks to ensure compliance with the adopted cybersecurity framework. Most of our clients use our vCISO services.
Our second revenue category encompasses an array of “Cybersecurity Software and Services” that our clients deem necessary to protect their digital assets. These include cybersecurity software owned by SideChannel and software sourced from third parties. SideChannel earns commissions on third-party software sales which it recognizes as revenue. Cybersecurity services are also delivered directly by SideChannel employees and indirectly by third party service providers.
The table below reflects the revenue by category for the nine months ended June, 2023 and 2022:
| Nine Months Ended June 30 | ||||||||||||||||||||||||
| (In thousands) | 2023 | 2022 | ||||||||||||||||||||||
| % of Total | % of Total | $ Change | % Change | |||||||||||||||||||||
| Revenue | ||||||||||||||||||||||||
| vCISO Services | $ | % | $ | % | $ | % | ||||||||||||||||||
| Cybersecurity Software & Services | % | % | % | |||||||||||||||||||||
| Total | $ | $ | $ | % | ||||||||||||||||||||
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NOTE 5 – DEBT
Pursuant
to a Membership Interest Redemption Agreement, dated November 3, 2021, by and between the SCS and Akash Desai (“Desai Redemption
Agreement”), we promised to pay Mr. Desai $
The implied interest on the note payable component of the Desai Redemption Agreement was deemed insignificant.
NOTE 6 – RELATED PARTY TRANSACTIONS
Brian
Haugli, our Chief Executive Officer and one of our stockholders, is also a principal shareholder of RealCISO Inc. (“RealCISO”).
On September 22, 2020, SideChannel assigned to RealCISO certain contracts and intellectual property. We are a reseller of RealCISO software.
We receive revenue from our customers for the use of RealCISO software and we pay licensing fees to RealCISO for such use. During the
nine months ended June 30, 2023, we paid $
David
Chasteen, our Executive Vice President of Sales, has an amount payable to the Company in relation to the payroll taxes paid by the Company
on his behalf for restricted stock units that vested during calendar year 2022. The balance due is $
NOTE 7 – COMMITMENTS AND CONTINGENCIES
Litigation
In
April 2021, Eric Marquez, our former Secretary/Treasurer and Chief Financial Officer, and certain other plaintiffs, filed a lawsuit against
Michael De La Garza, our former Chief Executive Officer and President, and us in the 20th Judicial District for Hays County,
Texas (Cause No. 20-0818). The lawsuit alleges causes of action for fraud against Mr. De La Garza (for misrepresentations allegedly made
by Mr. De La Garza); breach of contract, for alleged breaches of Mr. Marquez’s alleged oral employment agreement, which Mr. Marquez
claims required that we pay him cash and shares of stock; unjust enrichment; quantum meruit; and rescission of certain stock purchases
made by certain of the plaintiffs, as well as declaratory relief and fraud. Damages sought exceed $
We are not currently involved in any additional litigation that we believe could have a material adverse effect on our financial condition or results of operations.
We grant equity compensation awards to employees, directors, and contractors under the 2021 Omnibus Equity Compensation Plan (“Equity Incentive Plan”) approved by stockholders on September 13, 2021.
In 2022 the Company granted restricted stock units to directors and employees with service-based vesting conditions. The restricted stock units vest over a -year service period.
| 14 |
Weighted Average Grant Date Fair Value | Number of Restricted Stock Units | |||||||
| Outstanding Grants at September 30, 2022 | $ | |||||||
| Granted | ||||||||
| Vested | ( | ) | ||||||
| Canceled/Forfeited | ||||||||
| Outstanding Grants at June 30, 2023 | $ | |||||||
We
incurred stock-based compensation expense of $ and $ respectively for the three months and nine months ended June 30, 2023.
Unamortized stock compensation expense is $
NOTE 9 - STOCKHOLDERS’ EQUITY
Effective December 29, 2021, SCS was authorized to issue shares of common stock with a $ per share par value all of which were issued and outstanding at December 29, 2021. The shares of common stock were exchanged for shares of Cipherloc common stock and shares of Series A Preferred Stock of Cipherloc. As a result, the financial statements have been adjusted retroactively to reflect these shares as being outstanding as of September 30, 2020.
As
explained in Note 5, in December 2021, we promised to pay Mr. Desai $
SideChannel
LLC, a predecessor entity to SCS, made profit sharing distributions of $
Common Stock
As of June 30, 2023, and 2022, we had and shares of common stock outstanding, respectively. We had shares of common stock outstanding at September 30, 2022.
Common Stock Issued for Cash
We did not issue shares of common stock for cash during the nine months ended June 30, 2023.
Common Stock Issued for Business Combinations
We issued shares for Business Combination related activity during the nine months ended June 30, 2023 (Note 3).
Common Stock Issued for Services
Our
Board has elected to have each of its non-executive members receive one-half of such member’s quarterly compensation in the form
of shares of the Company’s common stock, instead of cash. On June 30, 2023, the Company issued shares of common stock as
compensation for a value of $
Common Stock Issued Under Equity Incentive Plan
We
have issued shares of common stock as incentive compensation during the nine months ended June 30, 2023 for the vesting of
restricted stock units granted at an average grant date fair value of $ per share. The grant date fair value of the common stock issued as incentive compensation
during the nine months ended June 30, 2023 is $
Common Stock Issued For Conversion of Series A Preferred Stock
During the quarter ended June 30, 2023, we issued shares of common stock for the conversion of shares Series A Preferred stock.
Preferred Stock
As of June 30, 2023, we had shares of Series A Preferred Stock outstanding. During the three months ended June 30, 2023, shares of Series A Preferred Stock were converted into shares of common stock. The Series A Preferred Stock shares were issued as part of the Business Combination.
The shares of Series A Preferred Stock that were exchanged for SCS, Inc. common stock have been retroactively reflected as issued and outstanding as of September 30, 2021.
Warrants
Prior to the July 1, 2022 Business Combination, Cipherloc had outstanding warrants which continue to be binding on the Company after the Business Combination.
The following table summarizes warrant activity for the period from September 30, 2022 to June 30, 2023:
Number of Warrants | Weighted Average Exercise Price | Weighted Average Remaining Life | |||||||||||
| Outstanding at September 30, 2022 | $ | ||||||||||||
| Granted | — | ||||||||||||
| Exercised | — | ||||||||||||
| Canceled/Forfeited | ( | ) | — | ||||||||||
| Outstanding at June 30, 2023 | $ | ||||||||||||
| 15 |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in our Management’s Discussion and Analysis of Financial Condition and Results of Operations, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 and elsewhere in this Form 10-Q. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
This information should be read in conjunction with the interim unaudited financial statements and the notes thereto included in this Report, and the audited financial statements and notes thereto and “Part II. Other Information – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, contained in our Annual Report on Form 10-K for the year ended September 30, 2022, filed with the Securities and Exchange Commission on December 20, 2022.
Our logo and some of our trademarks and tradenames are used in this Report. Solely for convenience, trademarks, tradenames, and service marks referred to in this Report may appear without the ®, ™ and SM symbols. References to our trademarks, tradenames and service marks herein are not intended to indicate in any way that we will not assert to the fullest extent under applicable law our rights or the rights of the applicable licensors if any, nor that respective owners of other intellectual property rights will not assert, to the fullest extent under applicable law, their rights thereto. We do not intend the use or display of other companies’ trademarks and trade names herein to imply a relationship with, or endorsement or sponsorship of us by, any other persons, firm or entity, except as otherwise so expressly indicated.
The market data and certain other statistical information used throughout this Report are based on independent industry publications, reports by market research firms or other independent sources that we believe to be reliable sources. Industry publications and third-party research, surveys and studies generally indicate that their information has been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information. We are responsible for all of the disclosures contained in this Report, and we believe these industry publications and third-party research, surveys and studies are reliable. We are not aware of any misstatements regarding any third-party information presented in this Report; however, their estimates, in particular, as they relate to projections, involve numerous assumptions, are subject to risks and uncertainties, and are subject to change based on various factors, including those discussed under, and incorporated by reference in, the section entitled “Item 1A. Risk Factors” of this Report. These and other factors could cause our future performance to differ materially from our assumptions and estimates. Some market and other data included herein, as well as the data of competitors as they relate to SideChannel (as defined herein), is also based on our good faith estimates.
Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” “SideChannel,” and “SideChannel, Inc.” refer specifically to SideChannel, Inc. and its consolidated subsidiaries.
In addition, unless the context otherwise requires and for the purposes of this report only:
| ● | “Exchange Act” refers to the Securities Exchange Act of 1934, as amended; | |
| ● | “SEC” or the “Commission” refers to the United States Securities and Exchange Commission; and | |
| ● | “Securities Act” refers to the Securities Act of 1933, as amended. |
| 16 |
All references to years relate to the fiscal year ended September 30 of the particular year.
Overview
Our Business
Our mission is to make cybersecurity simple and accessible for mid-market and emerging companies, a market we believe is currently underserved. Our cybersecurity offerings identify and develop cybersecurity, privacy, and risk management solutions for our customers. We target customers that need cost-effective security solutions. Our growth plan to address the needs of our customers is to provide more effective and cost-efficient products and tech-enabled services cybersecurity and related including virtual Chief Information Security Officer (“vCISO”), zero trust, third-party risk management, due diligence, privacy, threat intelligence, and managed end-point security solutions.
The Company’s website is www.sidechannel.com.
In support of securing new vCISO clients, we expanded the sales and marketing team from one (1) dedicated person to six (6) since July 1, 2022. vCISO engagements are typically multi-year relationships which consist of a monthly subscription and an annual renewal option as well as additional vCISO time and material projects, which such additional time’s cost to customers ranges from $350 to $450 per hour. Each of our vCISOs generally embed into the C-suite executive teams of between two (2) to five (5) of our clients, and generally report to the chief executive officer, chief financial officer, or general counsel.
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 licensing revenue on software engagements we generate through VARs.
The following are revenue metrics for the three months ended June 30, 2023 versus the comparable prior year period:
| ● | Total revenue grew by $474,000 or 37.1%. | |
| ● | vCISO Services category revenue grew by $516,000 or 64.8%. | |
| ● | Cybersecurity Software and Services category revenue decreased by $42,000 or 8.8%. | |
| ● | VAR licensing revenue contributed 1.7% of our total revenue versus 3.0% during same quarter in the prior comparable period. |
Our selling and marketing efforts are gaining new vCISO Services clients which is the primary reason for the growth in that category. Our new Cybersecurity Software and Services revenue combined with the growth of this category at existing clients was not enough to exceed revenue from the unusually high number of non-recurring Cybersecurity Software and Services projects executed during the prior year quarter ended June 30, 2022.
The following are revenue metrics for the nine months ended June 30, 2023 versus the comparable prior year period.
| ● | Total revenue grew by $1.4 million or 38.0%. | |
| ● | vCISO Services category revenue grew by $1.0 million or 45.9%. | |
| ● | Cybersecurity Software and Services category revenue grew by $0.3 million or 24.9%. | |
| ● | VAR licensing revenue contributed 6.1% during fiscal year 2023 versus 2.9% in the prior comparable period. |
We monitor new and retained revenue on a trailing twelve-month basis. The revenue earned from clients during our first twelve months of working with them is classified as “new”; 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 retained revenue for the twelve months ended June 30, 2023 and 2022:
| Trailing Twelve Months Ended June 30, | ||||||||||||||||||||||||
| (In thousands) | 2023 | 2022 | ||||||||||||||||||||||
| % of Total | % of Total | $ Change | % Change | |||||||||||||||||||||
| vCISO Services | ||||||||||||||||||||||||
| New | $ | 2,401 | 58.6 | % | $ | 2,056 | 72.3 | % | $ | 345 | 16.8 | % | ||||||||||||
| Retained | 1,693 | 41.4 | % | 789 | 27.7 | % | 904 | 114.6 | % | |||||||||||||||
| Total | $ | 4,094 | $ | 2,845 | $ | 1,249 | 43. 9% | |||||||||||||||||
| Cybersecurity Software and Services | ||||||||||||||||||||||||
| New | $ | 601 | 29.3 | % | $ | 913 | 57.3 | % | $ | (312 | ) | -34.2 | % | |||||||||||
| Retained | 1,448 | 70.7 | % | 679 | 42.7 | % | 769 | 113.3 | % | |||||||||||||||
| Total | $ | 2,049 | $ | 1,592 | $ | 457 | 28.7 | % | ||||||||||||||||
| Total (vCISO Services and Cybersecurity Software and Services combined) | ||||||||||||||||||||||||
| New | $ | 3,002 | 48.9 | % | $ | 2,969 | 66.9 | % | $ | 33 | 1.1 | % | ||||||||||||
| Retained | 3,141 | 51.1 | % | 1,468 | 33.1 | % | 1,673 | 114.0 | % | |||||||||||||||
| Total | $ | 6,143 | $ | 4,437 | $ | 1,706 | 38.4 | % | ||||||||||||||||
Further, we consider trailing twelve revenue retention a key performance indicator. Revenue retention is calculated by dividing retained revenue in the measurement period by the total revenue for the previous twelve-month time frame. The following table shows the revenue retention by category for the twelve months ended June 30, 2023 and September 30, 2022. We changed the revenue classification for certain invoice line items between vCISO and Cybersecurity Software and Services which impacted the retention calculations for each category for the twelve months ended September 30, 2022. The originally reported numbers from the Form 10-K and the revised retention rates after the line item classification changes are provided in the table below.
| Twelve Months Ended | ||||||||||||
June 30, 2023 | September 30, 2022 | September 30, 2022 | ||||||||||
| Revised | Form 10-K | |||||||||||
| Revenue Retention | ||||||||||||
| vCISO Services | 59.5 | % | 73.7 | % | 75.3 | % | ||||||
| Cybersecurity Software and Services | 91.0 | % | 80.8 | % | 78.1 | % | ||||||
| Total | 70.8 | % | 76.5 | % | 76.5 | % | ||||||
| 17 |
Results of Operations
Three Months Ended June 30, 2023 Versus Three Months Ended June 30, 2022
Comparison of Results
The increases noted in each operating expense area are a trend that we expect to recur in the final quarter of the current fiscal year (three months ended September 30, 2023). We do not anticipate the same level of year-over-year variances during each quarter of our fiscal year ended September 30, 2024.
Revenue. Our revenue was $1.8 million for the quarter ended June 30, 2023, compared to $1.3 million for the three-month comparable prior period; an increase of $474,000 or 37%. The factors driving this this revenue increase is a growth in vCISO Services revenue which was slightly offset by a decrease in Cybersecurity Software and Services revenue.
Gross Margins. Our gross margins increased to 49.9% for the quarter ended June 30, 2023, from 44.0% for the quarter ended June 30, 2022, as a result of better utilization of service delivery employees and a more favorable mix of services.
General and Administrative Expenses. Our general and administrative expense was $834,000 for the three months ended June 30, 2023, compared to $407,000 for the prior comparable period, an increase of $427,000 or 105%. The significant increase in general and administrative expenses primarily resulted from the costs associated with being a public company and the addition of administrative personnel. New costs related to being a public company include stock-based compensation, board compensation, investor relations services, and increased insurance and professional services. The costs associated with being a public company became part of our expense structure as a result of the Business Combination.
Selling and Marketing Expenses. Our sales and marketing expense was $340,000 for the three months ended June 30, 2023, compared to $50,000 for the prior comparable period, an increase of $290,000 or 580%. The increase was driven by the recent additions to our staff discussed earlier and the related salary and independent contractor expense along with higher spend on third-party marketing services.
Research and Development Expenses. Our research and development expense was $180,000 for the three months ended June 30, 2023, compared to $0 for the prior comparable period. These costs are driven by the personnel and independent contractor expenses related to the development of Enclave. The Enclave development costs became part of our expense structure as a result of the Business Combination.
Business Combination Related Costs – We recorded Business Combination related costs of $214,000 for the three months ended June 30, 2023. These costs were associated with the shares issued during the quarter in connection with the working capital adjustment related to the Business Combination.
Nine Months Ended June 30, 2023 Versus Nine Months Ended June 30, 2022
Comparison of Results
Revenue. Our revenue was $4.9 million for the nine months ended June 30, 2023, compared to $3.6 million for the nine-month comparable prior period; an increase of $1.3 million or 38%. The growth is attributed to gaining new clients which was partially offset by a reduction in non-recurring project compared to the prior year.
Gross Margins. Our gross margins increased to 50.4% for the nine months ended June 30, 2023, from 49.5% for the nine months ended June 30, 2022, which reflects cost reductions we achieved on our service lines through the increased use of employees versus independent contractors.
General and Administrative Expenses. Our general and administrative expense was $2.9 million for the nine months ended June 30, 2023, compared to $0.8 million for the prior comparable period, an increase of $2.1 million or 263%. The significant increase in general and administrative expenses primarily resulted from the costs associated with being a public company and the addition of administrative personnel. New costs related to being a public company include stock-based compensation, board compensation, investor relations services, and increased insurance and professional services.
Selling and Marketing Expenses. Our selling and marketing expense was $1.1 million for the nine months ended June 30, 2023, compared to $130,000 for the prior comparable period, an increase of $970,000 or 734%. The increase was driven by the recent additions to our staff discussed earlier and the related salary and independent contractor expense along with higher spend on third-party marketing services.
Research and Development Expenses. Our research and development expense was $483,000 for the nine months ended June 30, 2023, compared to $0 for the prior year. These costs are driven by the personnel and independent contractor expenses related to the development of Enclave. The Enclave development costs became part of our expense structure as a result of the Business Combination.
Business Combination Related Costs – We recorded Business Combination related costs of $214,000 for the three months ended June 30, 2023. These costs were associated with the shares issued during the quarter in connection with the working capital adjustment related to the Business Combination.
Liquidity and Capital Resources
We had an accumulated deficit of $14.1 million as of June 30, 2023. We expect to incur continued operating losses until we generate revenues sufficient to cover our expected ongoing obligations and expenses. On June 30, 2023, we had cash of $1.4 million. We maintain our cash in accounts held by reputable financial institutions which, at times, may exceed federally insured limits guaranteed by the Federal Deposit Insurance Corporation (“FDIC”). The FDIC insures these deposits up to $250,000. As of June 30, 2023, approximately $1.2 million of the Company’s cash balance was uninsured. The Company has not experienced any losses of cash in any of these financial institutions.
We had working capital of $1.6 million as of June 30, 2023, compared to working capital of $3.0 million as of September 30, 2022. The decline in working capital is primarily attributed to the use of cash to fund operating losses during the last nine months.
Cash Flows
The following table summarizes, for the nine months ended June 30, selected items in our Consolidated Statements of Cash Flows:
| (In thousands) | 2023 | 2022 | ||||||
| Net cash provided by (used in): | ||||||||
| Operating activities | $ | (1,560 | ) | $ | 564 | |||
| Investing activities | (24 | ) | — | |||||
| Financing activities | — | (483 | ) | |||||
| 18 |
Operating Activities
We receive cash each month from revenue generated from our clients. We use this cash and a portion of our cash reserves to pay for our monthly expenses. Material cash requirements include personnel costs and the expenses associated with being a public reporting company.
We used $1.6 million of cash reserves for operating activities during the nine months ended June 30, 2023 and recorded a net loss of $2.1 million. During the same period, our non-cash charges totaled $721,000 comprised of $372,000 in stock-based compensation expense, $135,000 in amortization, and $214,000 in Business Combination related costs. The change in our net operating assets and liabilities was due to an $262,000 increase in accounts receivable due to a growth in monthly invoicing, a $158,000 decrease in prepaid expenses as we recognized our annual directors and officers insurance premium that is prepaid annually in July, a $247,000 decrease in accounts payable and accrued liabilities because of payments made on our directors and officers insurance note payable, and a $228,000 increase in deferred revenue due to a growth in annual software invoicing with our clients.
Investing Activities
We had fixed asset purchases of $24,000 during the nine months ended June 30, 2023 related to an upgrade in our website.
Financing Activities
The were no cash activities in financing for the nine months ended June 30, 2023.
New or Recently Adopted Accounting Standards
See the Notes to our consolidated financial statements in this Report for information concerning the implementation and impact of new or recently adopted accounting standards.
Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Certain of our accounts, including goodwill, identifiable intangibles, and deferred tax assets and liabilities, including related valuation allowances, are based upon estimates. We base our estimates on historical experience and on appropriate and customary assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Some of these accounting estimates and assumptions are particularly sensitive because of their significance to our consolidated financial statements and because of the possibility that future events affecting them may differ markedly from what had been assumed when the financial statements were prepared. As of June 30, 2023, there have been no significant changes to the accounting estimates that we have deemed critical. Our critical accounting estimates are more fully described in our 2022 Form 10-K .
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements, as defined under applicable SEC rules, during the periods presented, nor do we currently have any such arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1) of the SEC.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As required by Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this quarterly report, at the reasonable assurance level.
The material weaknesses identified relate to the fact that we did not design and maintain an effective control environment commensurate with our financial reporting requirements, including (a) lack of a sufficient number of trained professionals with an appropriate level of accounting knowledge, training and experience and (b) lack of accounting research on critical accounting policies including business combinations and specifically the valuation of warrants in calculating the consideration paid during the Business Combination. Management’s general assessment of the above processes in light of the company’s size, maturity and complexity, as to the design and effectiveness of the internal controls over financial reporting is that the key controls and procedures in each of these processes provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
| 19 |
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the nine months ended June 30, 2023, that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting, including any corrective actions regarding significant deficiencies and material weaknesses.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints, and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may become party to litigation or other legal proceedings that we consider to be a part of the ordinary course of our business.
Such current litigation or other legal proceedings are described in and incorporated by reference in this “Part II - Item 1. Legal Proceedings” of this Form 10-Q from, “Part I - Item 1. Financial Statements” in the notes to financial statements in “Litigation” in Note 7 – Commitments and Contingencies. We believe that the resolution of currently pending matters will not individually or in the aggregate have a material adverse effect on our financial condition or results of operations. Our assessment of current litigation or other legal claims could change in light of the discovery of facts not presently known to us, or by decisions of judges, juries, or other finders of fact, that are not in accord with management’s evaluation of the possible liability or outcome of such litigation or claims.
Additionally, the outcome of litigation is inherently uncertain. If one or more legal matters are resolved against us in a reporting period for amounts in excess of management’s expectations, our financial condition and operating results for that reporting period could be materially adversely affected.
ITEM 1A. RISK FACTORS
We currently maintain all our cash in one financial institution and our deposits exceed the Federal Deposit Insurance limits leaving most of our cash uninsured. Although we have not experienced any loss of funds, we cannot assure you such a loss will not occur in the future.
Disruptions to the economy, and the US banking system caused by recent bank failures, and the related costs or losses associated with uninsured deposits, responsive measures by federal or state, governments, or banking regulators, potential future disruptions in access to bank deposits or lending commitments, could materially adversely affect our income, net income and other results of operations by increasing our cost and decreasing our access to capital, suppressing the resources of our customers and potential customers to purchase our products and services, and otherwise generally depressing activity in the economy.
There have been no further material changes from the risk factors previously disclosed in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended September 30, 2022, filed with the Commission on December 20, 2022 (the “Form 10-K”).
| 20 |
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Sales of Securities
Except as previously disclosed in Form 8-K dated May 9, 2023 respecting the issuance of 62,016,618 shares of common stock in the Business Combination, and as previously disclosed in the Form 8-K dated June 15, 2023 respecting the issuance of 100 shares of common stock upon the conversion of the outstanding 100 shares of Series A Preferred Stock, there have been no sales of unregistered securities during the quarter ended June 30, 2023, and from the period from September 30, 2022, to the filing date of this Report, which have not previously been disclosed in the Company’s Quarterly Reports on Form 10-Q.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
| Incorporated by Reference | ||||||||||||
Exhibit No. |
Description | Form | File No. | Exhibit | Filing Date |
Filed/Furnished Herewith | ||||||
| 31.1* | Certification of Principal Executive Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | ||||||||||
| 31.2* | Certification of Principal Financial Officer Pursuant to the Securities Exchange Act of 1934, Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | X | ||||||||||
| 32.1** | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | X | ||||||||||
| 32.2** | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | X | ||||||||||
| 101.INS* | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. XBRL Instance Document | X | ||||||||||
| 101.SCH* | Inline XBRL Taxonomy Extension Schema Document XBRL Taxonomy Extension Schema Document | X | ||||||||||
| 101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document XBRL Taxonomy Extension Calculation Linkbase Document | X | ||||||||||
| 101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document XBRL Taxonomy Extension Definition Linkbase Document | X | ||||||||||
| 101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document XBRL Taxonomy Extension Label Linkbase Document | X | ||||||||||
| 101.LAB* | Inline XBRL Taxonomy Extension Presentation Linkbase Document XBRL Taxonomy Extension Presentation Linkbase Document | X | ||||||||||
| 104* | Inline XBRL for the cover page of this Quarterly Report on Form 10-Q, included in the Exhibit 101 Inline XBRL Document Set | X | ||||||||||
| * | Filed electronically herewith. |
| ** | Furnished electronically herewith, not filed. |
| 21 |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SIDECHANNEL, INC. | ||
| Date: August 9, 2023 | By: | /s/ Brian Haugli |
| Brian Haugli | ||
Chief Executive Officer (Principal Executive Officer) | ||
| SIDECHANNEL, INC. | ||
| Date: August 9, 2023 | By: | /s/ Ryan Polk |
| Ryan Polk | ||
Chief Financial Officer (Principal Accounting/Financial Officer) | ||
| 22 |