General Information
This information should be read in conjunction with the interim unaudited
financial statements and the notes thereto included in this Quarterly Report on
Form 10-Q, 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, 2020, filed with the Securities
and Exchange Commission on December 29, 2020 (the "Annual Report" or the "Form
10-K").
Certain capitalized terms used below and otherwise defined below, have the
meanings given to such terms in the footnotes to our unaudited consolidated
financial statements included above under " Part I - Financial Information" -
"Item 1. Financial Statements" .
Our logo and some of our trademarks and tradenames are used in this Report. This
Report also includes trademarks, tradenames and service marks that are the
property of others. 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 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 to 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 to imply a
relationship with, or endorsement or sponsorship of us by, any other companies.
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. While we are not aware
of any misstatements regarding any third-party information presented in this
Report, 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 Cipherloc
Corp., is also based on our good faith estimates.
Unless the context requires otherwise, references to the "Company," "we," "us,"
"our," "Cipherloc", and "Cipherloc Corp." refer specifically to Cipherloc Corp.
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.
Where You Can Find Other Information
We file annual, quarterly, and current reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's website at www.sec.gov and are available for download,
free of charge, soon after such reports are filed with or furnished to the SEC,
on the "Investor Relations," page of our website at https://cipherloc.net.
Information on our website is not part of this Report, and we do not desire to
incorporate by reference such information herein. Copies of documents filed by
us with the SEC are also available from us without charge, upon oral or written
request to our Secretary, who can be contacted at the address and telephone
number set forth on the cover page of this Report.
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Introduction
Our Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is provided in addition to the accompanying financial
statements and notes to assist readers in understanding our results of
operations, financial condition, and cash flows. MD&A is organized as follows:
? Business Strategy.
? Products and Services.
? Plan of Operations
? Material Agreements.
? Results of Operations.
? Liquidity and Capital Resource.
? Critical Accounting Policies.
The following discussion should be read in conjunction with Cipherloc
Corporation's financial statements and accompanying notes included elsewhere in
this Report.
All references to years relate to the fiscal year ended September 30 of the
particular year.
Business Strategy
We are developing products and services around our patented polymorphic
encryption technology designed to enable a more efficient and stronger layer of
protection to be added to existing solutions. Through a licensing program, we
anticipate offering the first secure commercially viable advanced "Polymorphic
Encryption Core" ("PEC") software developers kit to be used in any commercial
data security industry and/or in sensitive applications.
As described above, our products are designed to encrypt and decrypt
information. Encryption means encoding information which is readable into
another form which is not readable and which is therefore unable to be
intercepted, read or used, by someone other than the original person who
encrypted the information-unless such encryption can be broken.
We believe that our innovative and patented polymorphic technology eliminates
the flaws and inadequacies associated with today's encryption algorithms.
Instead of dealing with large monolithic blocks of data, our approach decomposes
the information to be protected into multiple segments. These individual
segments each have a unique encryption key, utilize different encryption
algorithms, are randomly grouped into different lengths, and can be further
re-encrypted. Since segments are independent from each other and are
individually protected, our technology is not susceptible to computational
attacks. In fact, the strength of our technology improves as compute power
increases.
Products and Services
During 2018 and 2019, we attempted to market several products, services and
solutions. The initial solution suite was marketed under several product names.
CipherLoc EDGE, a solution to be installed on mobile/handset devices, was
designed to enable data to be securely sent between any two mobile devices.
CipherLoc ENTERPRISE, a solution to be installed on desktops, laptops and tablet
computers, was designed to enable data to be securely sent between any two
platforms. CipherLoc GATEWAY, a solution to be installed on servers, was
designed to enable end-to-end data protection to and from servers, computers,
tablets, and/or mobile devices via the GATEWAY-protected servers. CipherLoc
SHIELD was designed as a solution to be used as a data storage platform.
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During 2018 and 2019, there were forward-looking public announcements by the
Company's then-management of product names or segments that were not delivered
to the market and are not presently available to customers. Our current
management restructured the Company to invest material resources into only
products and services that are deliverable, have viable economic potential, and
may be publicly disclosed without adversely affecting our competitive position.
The core of our product and service offerings will continue to be built around
our patents and our polymorphic encryption technology, which is a highly secure,
quantum-ready data protection technology carrying FIPS 140-2 (Federal
Information Processing Standard 140-2)(an information technology security
accreditation program for validating that the cryptographic modules produced by
private sector companies meet well-defined security standards) validation
certificate #3381, for the "CipherLoc Polymorphic Encryption Engine Core"
solution by the National Institute of Standards and Technology (NIST).
Since 2020, we have focused our development efforts to develop commercial
application of our technology by advancing a Software Development Kit ("SDK")
for the Polymorphic Encryption Core. By doing so, we have allowed potential
customers to integrate and configure the PEC using the SDK. Cipherloc's
technology has advanced from theory to commercial application in the form of
these products:
? Data-in-Motion: Data-in-Motion products utilize the Polymorphic
Encryption Core (PEC) to encrypt and transmit data between two separate
locations. We currently have developed products called Sentinel, Armor,
and Shield which employ this technique.
? Sentinel - The software package that would allow a customer to
build a post-quantum encryption solution into their product
environment. This product is a software solution.
? Armor - Employs the sentinel solution in a hardware appliance that
can be deployed in front of any IT system and encrypts the traffic
between paired Armor devices with little setup.
? Data-at-Rest
? Shield - Securely encrypts data, using the PEC, that is placed on
a hard drive or in a database for long term storage.
Our products help to solve two challenges which cybersecurity professionals
have:
(1) Securing old and non-traditional network hardware.
(2) Preparing all networks for the introduction of new ciphers including the
next NIST standard which should be released by the end of 2024.
The core technology in these products is protected by six patents that expire
between 2034 and 2037. The existing technology can be used today to solve
current customer problems and can be used in the future to provide agile
adoption of quantum ready encryption.
Plan of Operations
We anticipate the operating expenses for the next twelve months may require up
to $7.5 million capital, which funds will come from amounts raised in the
Private Offering; however, we hope to manage our business such that the existing
liquidity carries the Company to positive cash flow from operations, of which
there can be no assurance. This measured approach to managing cash initially
emphasizes demonstrating product capabilities with current customers which is
followed by a scaling exercise in all functional areas, including product
development, marketing, sales, customer support, and administration. As such,
the cash required for operating expenses through June 30, 2021, will most likely
range from $2.4 million to $4.4 million. A summary of the operating plan by
functional area is provided below.
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Product Development will focus on further maturing the products that we have
developed. Our plan is to build out our core technologies on multiple operating
system platforms as well as work with current customers to ensure our product is
in line with their needs. Once these items are completed, we plan to shift to
further expand our product suite to enable user-defined encryption cipher modes,
as well as a remote PEC management system. This will require us to expand the
team footprint rapidly to ensure that we can meet market demand.
These efforts will require more personnel as well as more infrastructure. This
personnel expansion will likely require $1 million of capital. The
infrastructure needed to perform these new functions is planned to be built on
modern technology with scale and reliability built from the ground-up. Utilizing
cloud services, we plan to provide our customers with an interface that modern
software provides, but an ease of use that encryption technologies desperately
need. We believe that if we are able to meet these goals, we will be at a
competitive advantage from most other players in this space. Marketing efforts
will emphasize qualified lead generation using very focused industry messaging
and engagement. We will be participating in relevant cybersecurity and quantum
computing industry events. Our advisors will help us identify the right focus
areas for lead generation. Customer support teams will need to be put in place
and are expected to be built around each of our product offerings. We anticipate
our Support Team will scale as our business needs change. The projected costs
for the first 12 months are likely to reach $500,000. These funds will be used
for salaries and technology in order for the Support Team to provide the
necessary support described above. Administration requirements are currently
minimal but we expect that this will change in the event the Company is able to
generate revenues and add employees. The administrative resources will be ramped
according to the Company's demand to support employees, increase accounting
capacity, and expand reporting and compliance capabilities. Additional
leadership personnel in accounting and human resources are anticipated to
precede staff additions. We also plan to add software tools to manage functional
processes.
Material Agreements
On February 15, 2019, we entered into a Software License Agreement with SoundFi
Systems, LLC ("SoundFi"), pursuant to which we granted SoundFi a non-exclusive
license to use our Shield/Edge product and Secured Watermark product. The
agreement had an initial term of one year, automatically renewable thereafter
for up to three additional one-year periods, if neither party terminates the
agreement prior to thirty days before such renewal date. The agreement
automatically renewed on February 15, 2020 and 2021, and is currently in effect
until February 15, 2022. The agreement includes standard and customary
indemnification obligations, warranty disclaimers and limitations of liability.
Amounts are payable to us under the agreement based on the number of downloads
per year of the licensed products (resetting each year), ranging from a fee of
$0.012 per download for downloads 3,000,001 to 5,000,000 (no fee is due for the
first 3 million downloads), to a fee of $0.00075 per download for downloads
greater than 100,000,000. There are also base license fees payable of $50,000
per year for our Shield/Edge product and $25,000 per year for our Secured
Watermark product. We recognized $50,000 of revenue from SoundFi during the
first two quarters of fiscal 2020.
Effective on January 16, 2020, and effective the same date, we entered into an
Authorized Reseller Agreement with Castle Shield Holdings, LLC ("Castle"),
pursuant to which we agreed to grant Castle a non-exclusive license to use,
store and reproduce, integrate, combine, incorporate and sell, our Polymorphic
Encryption Core (PEC) product in the United States. We also appointed Castle our
non-exclusive authorized reseller of the proprietary polymorphic encryption
engine in the United States. The agreement provides Castle, subject to the terms
of the agreement, the right to resell our proprietary polymorphic encryption
engine to its customers. The agreement provides for Castle to be responsible for
all technical support. The agreement contains customary confidentiality terms,
indemnification terms, limitation of liability terms, non-solicitation terms
(prohibiting Castle from providing services to a company known to Castle to
compete with us for a period of one year following the termination of the
agreement) and representations and warranties. The agreement has an initial term
of one year, automatically renewable thereafter for additional one-year terms
unless terminated by either party prior to such automatic renewal. The agreement
automatically renewed on January 16, 2021, and is currently in effect until
January 16, 2022. Fees due under the agreement are based on the number of
authorized users licensed. We have not generated any reseller revenues pursuant
to this agreement to date.
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On March 6, 2020, and effective the same date, we entered into a Technology
Partnership and Authorized Reseller Agreement with ECS Federal, LLC ("ECS"),
pursuant to which we agreed to grant ECS a non-exclusive license to use, store
and reproduce, integrate, combine, incorporate and sell, our Polymorphic
Encryption Core (PEC) product in the United States. We also appointed ECS our
non-exclusive authorized reseller of the proprietary polymorphic encryption
engine in the United States. The agreement provides ECS, subject to the terms of
the agreement, the right to resell our proprietary polymorphic encryption engine
to its customers. The agreement provides for ECS to be responsible for all
technical support. The agreement contains customary confidentiality terms,
indemnification terms, limitation of liability terms and representations and
warranties. The agreement has an initial term of one year, automatically
renewable thereafter for additional one-year terms unless terminated by either
party prior to such automatic renewal. Fees due under the agreement are based on
the number of authorized users using our products, depending on the number of
users and type of user (public sector versus private sector), which amounts are
payable to us monthly in arrears, 45 days after delivery of confirmation of each
month's fees due. We have not generated any reseller revenues pursuant to this
agreement to date.
Effective on August 13, 2020, and effective the same date, we entered into an
Authorized Reseller /Developer Agreement with Arnouse Digital Devices ("ADDC"),
pursuant to which we agreed to grant ADDC a non-exclusive license to use, store
and reproduce, integrate, combine, incorporate and sell, our Sentinel
Application in the United States. We also appointed ADDC as our non-exclusive
authorized reseller of the Sentinel Application in the United States. The
agreement contains customary confidentiality terms, indemnification terms,
limitation of liability terms, non-solicitation terms (prohibiting ADDC from
providing services to a company known to ADDC to compete with us for a period of
one year following the termination of the agreement) and representations and
warranties. The agreement has an initial term of one year, automatically
renewable thereafter for additional one-year terms unless terminated by either
party prior to such automatic renewal. Fees due under the agreement are based on
the number of authorized users licensed. We have not generated any reseller
revenues pursuant to this agreement to date.
Results of Operations for the three and six months ended March 31, 2021 and 2020
Novel Coronavirus (COVID-19)
On March 11, 2020, the World Health Organization declared the COVID-19 outbreak
a pandemic. The COVID-19 pandemic is affecting the United States and global
economies and may affect our operations and those of third parties on which we
rely. While the potential economic impact brought by, and the duration of the
COVID-19 pandemic is difficult to assess or predict, the impact of the COVID-19
pandemic on the global financial markets may reduce our ability to access
capital, which could negatively impact our short-term and long-term liquidity.
The ultimate impact of the COVID-19 pandemic is highly uncertain and subject to
change. We do not yet know the full extent of potential delays or impacts on our
business, financing or the global economy as a whole. However, these effects
could have a material impact on our liquidity, capital resources, operations and
business and those of the third parties on which we rely.
During 2020 and into 2021, the COVID-19 pandemic has interrupted our sales and
marketing activities and restricted face-to-face interaction between our team
members and our partners. This slowed the pace of our development and the
expansion of our deal pipeline. Government action for the current pandemic or
the emergence of a new viral outbreak may negatively impact the adjustments we,
our licensees, and their and our, customers, and our partners have made to
resume business under new protocols.
The future impact of COVID-19 on our business and operations is currently
unknown. The pandemic is developing rapidly and the full extent to which
COVID-19 will ultimately impact us depends on future developments, including the
duration and spread of the virus, as well as potential seasonality of new
outbreaks.
Comparison of Results
Revenue decreased to $6,667 for the three months ended March 31, 2021 from
$11,733 for the three months ended March 31, 2020. Revenue decreased to $15,417
for the six months ended March 31, 2021 from $30,483 for the six months ended
March 31, 2020. Revenues decreased due to no new invoicing activity taking place
in the current reporting period.
General and administrative expenses were $889,172 and $1,976,044 for the three
months ended March 31, 2021 and 2020, respectively. General and administrative
expenses decreased primarily as a result of the impairment loss on the
right-of-use (ROU) assets of $447,025 recorded last year, a decrease in legal
fees of $433,000, due to the settlement of legal matters, a decrease in
headcount related costs including payroll and travel costs of $208,000, due to
staffing reductions initiated during the prior fiscal year, decreases in board
and professional fees of $137,000, and decreases in various other expenses of
$10,000 offset by an increase in corporate insurance of $55,000, primarily for
directors and officers liability insurance premiums.
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General and administrative expenses were $1,550,864 and $3,280,824 for the six
months ended March 31, 2021 and 2020, respectively. The decrease in general and
administrative expenses was primarily due to a decrease in legal expenses of
$803,000, a decrease in headcount related costs including payroll and travel
costs of $451,000, due to staffing reductions initiated during the prior fiscal
year, the impairment loss on the ROU assets of $447,025 recorded last year, a
decrease in board and professional fees of $87,000, and a decrease in various
other expenses of $54,000 offset by an increase in corporate insurance of
$112,000, for directors and officers liability insurance premiums.
Selling and marketing expenses were $31,250 and $331,359 for the three months
ended March 31, 2021 and 2020, respectively. Sales and marketing expenses
decreased primarily as a result of a decrease in payroll expenses of $177,000, a
decrease in consulting related costs of $61,000, a decrease in marketing related
costs of $45,000 and a decrease in travel related costs of $18,000, all of these
decreases were generated by spending reductions initiated during the prior
fiscal year.
Selling and marketing expenses were $56,250 and $587,403 for the six months
ended March 31, 2021 and 2020, respectively. Sales and marketing expenses
decreased primarily as a result of a decrease in payroll related expenses of
$243,000, a decrease in consulting related costs of $195,000, a decrease in
marketed related costs of $58,000 and a decrease in travel related costs of
$35,000, all of which were generated by spending reductions initiated during the
prior fiscal year.
Research and development costs were $175,083 and $772,577 for the three months
ended March 31, 2021 and 2020, respectively. Research and development costs
decreased primarily as a result of a decrease in consulting related expenses of
$490,000 and a decrease in payroll related expenses of $107,000, both decreases
were the result of the spending reductions initiated during the prior fiscal
year.
Research and development costs were $296,876 and $1,338,592 for the six months
ended March 31, 2021 and 2020, respectively. Research and development expenses
decreased for the six-month period ended March 31, 2021 primarily as a result of
a decrease in consulting related costs of $739,000 and a decrease in payroll
related expense of $303,000, both decreases were the result of the spending
reductions initiated during the prior fiscal year.
We had a net loss of $1,088,838 or $0.04 per share for the three months ended
March 31, 2021, compared to a net loss of $3,068,247 or $0.08 per share for the
three months ended March 31, 2020. Net loss for the three months ended March 31,
2021, decreased mainly as a result of us generating insufficient gross profit to
cover our operating expenses. For the six months ended March 31, 2021, we had a
net loss of $1,888,573 or $0.07 per share, compared to a net loss of $5,176,336
or $0.13 per share for the six months ended March 31, 2020. Net loss for the six
months ended March 31, 2021, decreased mainly as a result of us generating
insufficient gross profit to cover our operating expenses.
Liquidity and Capital Resources
We had an accumulated deficit on March 31, 2021 of $70,315,181. We expect to
incur substantial expenses and generate continued operating losses until we
generate revenues sufficient to meet our obligations. On March 31, 2021, we had
cash of $5,628,853. On March 31, 2021, we completed the initial closing of the
Private Offering in which we sold 35,757,942 shares of our common stock at a
price to the public of $0.18 per share, for net proceeds of $5,497,964.
Subsequently, we sold the following securities after March 31, 2021 pursuant to
the Private Offering:
Date of Closing Shares Sold Warrants Sold Gross Proceeds
April 7, 2021 7,513,893 7,513,893 $ 1,352,501
April 9, 2021 8,683,336 8,683,336 $ 1,563,000
April 16, 2021 3,594,444 3,594,444 $ 647,000
19,791,673 19,791,673 $ 3,562,501
The Private Offering is described in greater detail in Note 2 - New Equity
Issuance , to the unaudited financial statements included above.
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We had working capital of $3,817,835 as of March 31, 2021, compared to working
capital of $123,102 as of September 30, 2020. Working capital increased as a
result of funds raised in the Private Offering.
Cash Flow
The following table summarizes, for the periods indicated, selected items in our
condensed Statements of Cash Flows:
Six Months Ended
March 31,
2021 2020
Net cash provided by (used in):
Operating activities $ (898,950 ) $ (4,190,651 )
Investing activities $ - $ (28,792 )
Financing activities $ 5,447,964 $ (150,000 )
Operating Activities
Cash used in operating activities was $898,950 and $4,190,651 for the six months
ended March 31, 2021 and 2020, respectively. The uses of cash during the quarter
ended March 31, 2021, were attributable to a net loss of $1,888,573, which was
offset by a non-cash stock compensation expense of $79,655 and a decrease in net
operating assets and liabilities of $909,968. The change in our net operating
assets and liabilities was primarily due to a decrease in prepaid and other
assets of $342,544 and an increase in accounts payable and accrued liabilities
of $582,841, partially offset by a decrease in deferred revenue of $15,417.
Investing Activities
Cash used in investing activities was zero and $28,792 for the six months ended
March 31, 2021 and 2020, respectively. The cash used in investing activities for
the six months ended March 31, 2020, was the result of fixed asset purchases.
Financing Activities
Cash provided by financing activities was $5,447,964 for the six months ended
March 31, 2021. The Company sold certain securities pursuant to the Private
Offering, described in Note 2 - New Equity Issuance , to the unaudited
financial statements included above, and raised $5,497,964, net of issuance
costs, partially offset by the cash used in relation to a lawsuit filed by the
Company against James LeGanke, as Trustee of Carmel Trust II, which was settled
for $50,000 in exchange for the return of 1,000,000 shares of Series A Preferred
Stock and 127,500 shares of common stock to the Company. Cash used in financing
activities for the six months ended March 31, 2020, was due to the legal
settlement with First Fire Global Opportunity Fund, LLC and the purchase of
Treasury Stock for $150,000 in connection therewith (see " Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds-Issuer Purchases of
Securities ", below).
Additional information regarding the Private Offering and the Company's debt can
be found under Note 2 - New Equity Issuance and Note 6 - Debt , to the
unaudited financial statements included above.
Off-Balance Sheet Arrangements
We did not have during the periods presented, nor do we currently have, any
off-balance sheet arrangements as defined under applicable SEC rules.
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Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP). The preparation of
these financial statements requires the use of estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent liabilities at the date of the financial statements and the reported
amount of revenues and expenses during the reporting period. Our management
periodically evaluates the estimates and judgments made. Management bases its
estimates and judgments on historical experience and on various factors that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates as a result of different assumptions or conditions.
See Note 4 of the unaudited financial statements included in " Part I-Item 1.
Financial Statements ", above, for a discussion of our significant accounting
policies.
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