NOTES
TO FINANCIAL STATEMENTS
FOR
THE THREE AND NINE MONTHS ENDED JUNE 30, 2022, AND 2021
(Unaudited)
NOTE
1 - DESCRIPTION OF BUSINESS
SideChannel,
Inc. (the “Company” or “SideChannel”), formerly Cipherloc Corporation, was incorporated in the State of Texas
on June 22, 1953, under the name “American Mortgage Company.” Effective August 27, 2014, the Company changed its name to
“Cipherloc Corporation.” Effective July 5, 2022, the Company changed its name to “SideChannel, Inc.” following
its acquisition of SideChannel, Inc., a Massachusetts corporation, on July 1, 2022 (See Note 7 – Subsequent Events). Prior to September
30, 2021, the Company was a Texas corporation. The Company became a Delaware corporation effective September 30, 2021.
The
Company is a provider of cybersecurity services and technology to middle market companies. The Company’s website is www.sidechannel.com.
On
August 2, 2022, the Company changed its ticker symbol from CLOK to SDCH.
NOTE
2 - BASIS OF PRESENTATION OF INTERIM FINANCIAL STATEMENTS
The
Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America
(“U.S. GAAP”). The accompanying interim unaudited financial statements have been prepared in accordance with U.S. GAAP for
interim financial information in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X. In the Company’s
opinion, it has included all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation.
The
Company’s operating results for the nine months ended June 30, 2022 are not necessarily indicative of the results that may be expected
for the entire fiscal year ending September 30, 2022. The Company has omitted notes to the unaudited interim financial statements that
would substantially duplicate the disclosures contained in the audited financial statements for the fiscal year ended September 30, 2021.
This report should be read in conjunction with the audited financial statements and the footnotes thereto for the fiscal year ended September
30, 2021 included within the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.
NOTE
3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash
and Cash Equivalents
The
Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
The Company’s cash includes cash on hand and cash in the bank. The balance of such accounts, 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 June 30, 2022, $3,338,912 of the Company’s cash balance was uninsured. The Company has not experienced any losses related
to uninsured cash balances.
Basic
and Diluted Net Loss per Common Share
The
Company computes its basic net loss per share by dividing the net loss available to common stockholders by the weighted average number
of shares of common stock outstanding during the reporting period. The weighted average number of shares is calculated by taking the
number of shares outstanding and weighting that number by the amount of time that the applicable shares were outstanding. Diluted net
loss per share reflects the potential dilution that could occur if vested stock options, warrants, and other commitments of the Company
to issue shares of common stock were exercised, resulting in the issuance of additional shares of common stock that would share in the
earnings of the Company. As of June 30, 2022, the Company had no shares of preferred stock outstanding.
The
Company’s diluted loss per share was the same as the basic loss per share for the periods in which the Company incurred net losses
since the inclusion of potential common stock equivalents would be anti-dilutive due to the Company’s net loss. For the three months
and nine months ended June 30, 2022, the Company excluded from the calculation of diluted loss per share warrants to purchase 79,461,481
shares of its common stock, and 1,981,484 shares of its common stock issued pursuant to restricted stock units because the effect of
including those shares would be anti-dilutive. During the three and nine months ended June 30, 2021, the Company excluded from the calculation
of diluted loss per share warrants to purchase 79,461,481 shares of common stock because the effect of including those shares would be
anti-dilutive.
Reclassification
The
common stock and additional paid in capital line items on the balance sheet have been reclassified to be comparable to the current period’s
presentation. The reclassification reflects the difference in the par value of the Company’s common stock when it was a Texas corporation,
prior to September 30, 2021, and the par value of the Company’s common stock after it became a Delaware corporation, on September
30, 2021.
Research
and Development Costs
The
Company expenses all research and development costs, including patent and software development costs.
Revenue
Recognition
The
Company recognizes revenues in accordance with the provisions of Accounting Standards Codification (“ASC”) Topic 606, “Revenue
from Contracts with Customers,” including a series of amendments, issued by the Financial Accounting Standards Board (“FASB”).
Central
to the Company’s 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 when the performance obligations are satisfied. |
The
Company accounts for a promise to provide a customer with a right to access the Company’s intellectual property as a performance
obligation satisfied over time, because the customer will simultaneously receive and consume the benefit from access to the Company’s
intellectual property as the performance occurs.
Software
License Agreements
The
Company executed a software license agreement with Castle Shield Holdings, LLC (“Castle Shield”) during the fiscal year ended
September 30, 2020. That agreement includes an auto-renewing annual term. The Company did not receive any payments from Castle Shield
during the fiscal year ended September 30, 2021. The Company recognized $449 in licensing revenues from Castle Shield during the nine
months ended June 30, 2022.
Effect
of Recently Issued Amendments to Authoritative Guidance
The
Financial Accounting Standards Board (“FASB”) issues Accounting Standards Updates (“ASU”) to amend the authoritative
literature in the Accounting Standards Codification (“ASC”). There have been several ASUs to date that amend the original
text of the ASCs. Other than those discussed below, the Company believes those ASUs issued to date either (i) provide supplemental guidance,
(ii) are technical corrections, (iii) are not applicable to the Company, or (iv) are not expected to have a significant impact on the
Company.
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, 2020. Early adoption is permitted. The Company adopted
ASU 2019-12 on October 1, 2021, and the adoption of this update did not have a material impact on the Company’s financial position,
results of operations or cash flows.
In
January 2020, the FASB issued guidance to clarify certain interactions between the guidance to account for equity securities, the guidance
to account for investments under the equity method of accounting, and the guidance to account for derivatives and hedging. The new guidance
clarifies the application of measurement alternatives and the accounting for certain forward contracts and purchased options to acquire
investments. The Company adopted this guidance on October
1, 2021, and the adoption of this update did not have a material impact on the Company’s financial position, results of operations
or cash flows.
In
May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock
Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40). The new ASU addresses
an issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. This amendment
is effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years.
Early adoption is permitted. The Company does not expect the adoption of this guidance will have a material impact on its financial position,
results of operations or cash flows.
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses, which requires a financial asset
(or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance
for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s), to present the net
carrying value at the amount expected to be collected on the financial asset. The guidance is effective for fiscal years beginning after
December 15, 2019. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses
(Topic 326), which delays the effective date of the pronouncement for public business entities that are smaller reporting companies,
as defined by the SEC, to fiscal years beginning after December 15, 2022. Early adoption is permitted. The
Company does not expect the adoption of this guidance will have a material impact on its financial position, results of operations or
cash flows.
In
November 2021, the FASB issued ASU 2021-10, Government Assistance, which provided guidance to increase the transparency of government
assistance received by an entity by requiring disclosures relating to the accounting policy, nature of the assistance, and the effect
of the assistance on the financial statements. The Company is required to adopt the guidance in the first quarter of its fiscal year
2023. Early adoption is permitted. The Company does not expect the adoption of this guidance will have a material impact on its financial
position, results of operations or cash flows.
In
August 2020, the FASB issued ASU 2020-06—Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives
and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an
Entity’s Own Equity (“ASU 2020-06”) to simplify the accounting for convertible instruments by removing certain
separation models in Subtopic 470- 20, Debt with Conversion and Other Options, for convertible instruments. Under the amendments
in ASU 2020-06, the embedded conversion features in the instruments are no longer separated from the host contract for convertible instruments
with conversion features that are not required to be accounted for as derivatives under Topic 815, Derivatives and Hedging, or that do
not result in substantial premiums accounted for as paid-in capital. Consequently, a convertible debt instrument will be accounted for
as a single liability measured at its amortized cost, and a convertible preferred stock will be accounted for as a single equity instrument
measured at its historical cost, as long as no other features require bifurcation and recognition as derivatives. By removing those separation
models, the interest rate of convertible debt instruments will typically be closer to the coupon interest rate when applying the guidance
in Topic 835, Interest. The amendments in ASU 2020-06 are designed to provide financial statement users with a simpler and more consistent
starting point to perform analyses across entities. The amendments also improve the operability of the guidance and reduce, to a large
extent, the complexities in the accounting for convertible instruments and the difficulties with the interpretation and application of
the relevant guidance.
Additionally,
for convertible debt instruments with substantial premiums accounted for as paid-in capital, amendments in ASU 2020-06 added disclosures
about (1) the fair value amount and the level of fair value hierarchy of the entire instrument for public business entities and (2) the
premium amount recorded as paid-in capital. The Company adopted ASU 2020-06 on October 1, 2021, which adoption did not have a material
impact on the Company’s financial position, results of operations or cash flows.
NOTE
4– COMMITMENTS AND CONTINGENCIES
Litigation
The
Company is currently not involved in any litigation that it believes could have a material adverse effect on its financial condition
or results of operations.
In
December 2017, Robert LeBlanc filed a petition against the Company and Michael De La Garza, the Company’s former Chief Executive
Officer and President, in the 20th Judicial District for Hays County, Texas (Cause No. 18-0005). Mr. LeBlanc sought damages against the
Company exceeding $1 million, but less than $10 million. On May 19, 2022, Mr. LeBlanc entered into a joint settlement agreement with
the Company, the Company’s directors and officer’s liability carrier, and Mr. De La Garza. As part of this settlement agreement,
the Company paid Mr. LeBlanc $109,432 in cash and issued him 200,000 shares of the Company’s common stock in exchange for his release
of the Company from all past and future liabilities associated with this matter.
In
April 2020, Eric Marquez, the former Secretary/Treasurer and Chief Financial Officer of the Company, and certain other plaintiffs filed
a lawsuit against the Company and Michael De La Garza, the Company’s former Chief Executive Officer and President, 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 with the Company, which Mr. Marquez claims required the Company to pay him cash and issue him shares of the
Company’s stock; unjust enrichment; quantum meruit; and rescission of certain stock purchases made by certain of the plaintiffs,
as well as requests for declaratory relief. Damages sought exceed $1,000,000. The Company believes it has made all required payments
and delivered all required shares of stock to the plaintiffs. The case is currently being defended by the Company. The Company believes
it has meritorious defenses to the allegations, and the Company intends to continue to vigorously defend the litigation.
Leases
As
of June 30, 2022, the Company had no financial obligations for facility lease agreements, except as set forth below.
Prior
to December 1, 2021, Tom Wilkinson, the Company’s Chairman of the Board, provided the Company with the use of office space that
he rents, located at 6836 Bee Caves Road, Building 1, Suite 279, Austin, TX 78746, for its corporate headquarters. After December 1,
2021, the Company entered into a month-to-month lease agreement for this office space with Nolen & Associates, under which the Company
pays Nolen & Associates $500 per month in rent.
The
Company’s rent expense totaled $1,500 and $3,641 for the three and nine months ended June 30, 2022, and $170,265 and $306,453 for
the three and nine months ended June 30, 2021, respectively.
NOTE
5 – DEBT
On
April 6, 2020, the Company submitted an application for a $365,430 loan under the Paycheck Protection Program sponsored by the U.S. Small
Business Administration (the “SBA Loan”). On April 12, 2020, the SBA Loan application was approved, and the Company received
the loan proceeds on April 22, 2020. The SBA Loan matured on April 12, 2022.
On
January 29, 2021, the Company filed for partial forgiveness of $192,052 of the SBA Loan, which was approved on June 11, 2021. The Company’s
reductions in staff that occurred in 2020 prevented the Company from qualifying for forgiveness of the entire principal balance of the
SBA Loan.
On
April 15, 2021, the Company placed the entire $365,430 principal balance of the SBA Loan, plus an additional $1,000, into an escrow account.
Upon receiving the partial forgiveness of the SBA Loan described above, the Company paid the remaining balance of the SBA Loan, using
funds in the escrow account. The Company transferred the remaining balance of the escrow account to the Company’s operating account.
The balance of the SBA Loan was $0 as of September 30, 2021.
NOTE
6 - STOCKHOLDERS’ EQUITY
The
Company’s certificate of incorporation authorizes the issuance of up to 681,000,000 shares of common stock and 10,000,000 shares
of blank check preferred stock, each with a par value of $0.001 per share. As of June 30, 2022, the Company had 88,445,832 shares of
common stock outstanding, and had no shares of preferred stock outstanding.
Common
Stock
During
the nine months ended June 30, 2022, the Company issued 5,518,521 shares of its common stock as described below.
Beginning
with the last quarter of the Company’s fiscal year ended September 30, 2021, the Company’s board of directors 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. At its meeting in April 2021, the Company’s board of directors also approved a one-time award of
100,000 shares of the Company’s common stock to each member of the board of directors, subject to the pending approval of the Company’s
Equity Incentive Compensation Plan by the Company’s stockholders. The Company received that approval at the Company’s annual
meeting of stockholders held in September 2021. As a result, the members of the Company’s board of directors have received a total
of 744,448 shares of the Company’s common stock through the grants described above. The Company issued the shares for the one-time
awards, and the fiscal year 2021 fourth quarter awards, totaling 411,112 shares, on January 13, 2022. The Company issued the remaining
shares for the fiscal year 2022, totaling 111,112 shares, on each of January 31, 2022, March 28, 2022 and June 15, 2022.
On
July 23, 2021, the Company entered into a four year financial advisory and consulting agreement with Paulson Investment Company, LLC
(“Paulson”). Pursuant to that agreement, at the Company’s request, Paulson provides the following services: (a) familiarizing
itself with the Company’s business, assets and financial condition; (b) assisting the Company in developing strategic and financial
objectives; (c) assisting the Company in increasing its exposure in the software industry; (d) assisting 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; € identifying potentially attractive merger and acquisition
opportunities; (f) reviewing possible innovative financing opportunities and (g) rendering other financial advisory services as may be
reasonably requested by the Company. The Paulson agreement may be terminated prior to the end of the four year term by either party,
as provided in the agreement with Paulson. As compensation for the services provided by Paulson under the agreement, on March 20, 2022,
the Company issued to Paulson and three of its employees a total of 4,000,000 shares of the Company’s common stock. The shares
of common stock issued to Paulson and its employees were valued at $720,000 as of the date of the consulting agreement. The Company capitalized
the value of the common shares issued to Paulson as deferred contract costs, which the Company is amortizing to expense straight-line
over the four year contract term.
On
June 1, 2022, the Company issued a total of 574,073 shares of the Company’s common stock to four employees pursuant to the vesting
of restricted stock units held by those employees.
On
June 6, 2022, the Company entered into the mediated settlement agreement with Robert LeBlanc described above. Pursuant to that agreement,
the Company issued a total of 200,000 shares of the Company’s common stock to Mr. LeBlanc.
Restricted
Common Stock Units
On
October 22, 2021, the Company entered into restricted stock unit award agreements with four employees and one contractor. Under those
agreements, the Company granted a total of 2,000,001 shares of restricted stock. The restricted stock unit awards vest in three equal
tranches on the next three anniversaries of the date of the applicable award agreements. The value of the issued shares of restricted
stock was $260,000, based upon the $0.13 per share market price of the Company’s common stock on the date of grant.
On
June 1, 2022, the Company entered into restricted stock unit award agreements with two employees. Under those agreements, the Company
granted a total of 555,556 shares of restricted stock. The granted restricted stock vests in three equal tranches on the next three anniversaries
of the date of the applicable award agreements. The value of the granted restricted stock was $53,889, based upon the $0.10 per share
market price of the Company’s common stock on the date of grant. For the nine months ended June 30, 2022, the Company recorded
$84,305 in stock compensation expense related to the restricted unit award agreements described above.
NOTE
7 – SUBSEQUENT EVENTS
On
July 1, 2022 (the “Closing Date”), the Company completed its acquisition of all of the outstanding equity securities of SideChannel,
Inc., a Massachusetts corporation (the “Subsidiary”), in exchange for shares of the Company’s equity securities (the
“Acquisition”), pursuant to an Equity Securities Purchase Agreement, dated May 16, 2022 (the “Purchase Agreement”).
The Acquisition was previously disclosed in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission
on May 18, 2022.
Pursuant
to the Purchase Agreement, on the Closing Date, the former shareholders of the Subsidiary (the “Sellers”) exchanged all of
their equity securities in the Subsidiary for a total of 59,900,000 shares of the Company’s common stock (the “First Tranche
Shares”), and 100 shares of the Company’s newly designated Series A Preferred Stock, $0.001 par value (the “Series
A Preferred Stock”). The Sellers are entitled to receive up to an additional 59,900,000 shares of the Company’s common stock
(the “Second Tranche Shares” and together with the First Tranche Shares and the Series A Preferred Stock, the “Shares”)
at such time that the operations of the Subsidiary, as a subsidiary of the Company, achieves at least $5.5 million in revenue (the “Milestone”)
for any twelve-month period occurring after the Closing Date and before the 48-month anniversary of the execution of the Purchase Agreement.
On
the Closing Date, the Sellers acquired approximately 40.4% of the Company’s outstanding common stock. If the Subsidiary achieves
the Milestone, and the Sellers are issued the Second Tranche Shares, and assuming that there is no other change in the number of shares
outstanding prior to the issuance of the Second Tranche Shares, the Sellers will hold a total of approximately 57.5% of the Company’s
outstanding common stock. The number of the Second Tranche Shares may be reduced or increased, based upon whether the Subsidiary’s
working capital as of the Closing Date was less than or more than zero. The number of the Second Tranche Shares may also be subject to
adjustment based upon any successful indemnification claims made by the Company pursuant to the Purchase Agreement.
The
Shares are subject to a Lock-Up/Leak-Out Agreement, pursuant to which, subject to certain exceptions, the Sellers may not directly or
indirectly offer to sell, or otherwise transfer, any of the Shares for twenty-four months after the Closing Date without the prior written
consent of the Company. Notwithstanding the foregoing, pursuant to the Lock-Up/Leak-Out Agreement, each of the Sellers may sell up to
20% of their Shares beginning twelve months after the Closing Date, and the remaining 80% of their shares of Common Stock beginning twenty-four
months after the Closing Date. The Company is currently performing a formal valuation of the acquisition, including an analysis of any
purchase price adjustments, and a review of the assts and liabilities acquired to determine appropriate fair values.
On
July 1, 2022, Sammy Davis and David Chasteen resigned from the Company’s Board of Directors (the “Board”). On that
same date, the Board appointed Deborah MacConnel and Kevin Powers to fill the vacancies resulting from those resignations. On that same
date, the Board expanded the number of members of the Board by two members and approved the appointments of Brian Haugli and Hugh Regan
to fill the vacancies caused by the expansion, to be effective on July 19, 2022. Ms. MacConnel, Mr. Powers, and Mr. Regan are considered
independent directors. As of July 19, 2022, the total number of members of the Board was six (6), including four (4) independent directors.
On
July 1, 2022, the Board appointed Brian Haugli to the position of Chief Executive Officer of the Company, following the resignation of
David Chasteen from that position. Mr. Chasteen assumed the role of Executive Vice President of the Company on that same date.
On
July 1, 2022, the Board approved the Company’s entry into restricted stock unit award agreements with two employees and five members
of the Board. Under those agreements, the Company granted a total of 2,705,556 shares of restricted stock. The restricted stock awards
vest in three equal tranches on the next three anniversaries of the date of the applicable awards. The total value of the shares of restricted
stock awarded was $270,556, based upon the market price of $0.10 per share of the Company’s common stock on the grant date.
On
July 5, 2022, the Company filed a Schedule 14-F Information Statement with the Securities and Exchange Commission disclosing the change
in the majority of the members of the Board.
On
July 5, 2022, the Company changed its name to SideChannel, Inc., the same name as the Subsidiary The Company is in the process of changing
the name of the Subsidiary.
On
August 2, 2022 the Company changed its ticker symbol from CLOK to SDCH.