SideChannel, Inc. 10-Q

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, 2023, filed with the Securities and Exchange Commission on December 27, 2023. 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. 14 Table of Contents All references to years relate to the fiscal year ended September 30 of the particular year. Overview Our Business We internally report our revenue using two categories. The first, “vCISO Services,” captures the revenue the Chief Information Security Officer services that we provide to our clients on a “virtual” or outsourced basis, thus the acronym “vCISO.” Services delivered by SideChannel through our team of vCISOs include assessing the cybersecurity risk profile, implementing policies and programs to mitigate risks, and managing the day-to-day tasks to ensure compliance with the adopted cybersecurity framework. Most of our clients use our vCISO services. vCISO engagements typically include a fixed monthly subscription fee with durations longer than twelve (12) months. Hourly rates for vCISO time and material projects range from $350 to $425. Each of our vCISOs is generally embedded into the C-suite executive teams of two (2) to four (4) of our clients. Our second revenue category encompasses an array of Cybersecurity Software and Services that our clients deem necessary to protect their digital assets. These augment our vCISO offering and include a full range of other cybersecurity products and services delivered through a team of security engineers along with a network of third-party service providers and value-added resellers (“VARs”). Commercial relationships with third-party service providers and VARs provide SideChannel with additional internal capabilities to mitigate cybersecurity risks. We earn licensing revenue from software contracts and commissions from third-party service provider partnerships which are included in this revenue category. Our growth strategy focuses on these three initiatives: 1. Securing new vCISO clients, 2. Adding new Cybersecurity Software and Services offerings, and 3. Increasing adoption of Cybersecurity Software, including Enclave and Services offerings at vCISO clients We are offering proprietary software called Enclave which simplifies important cybersecurity tasks called “asset inventory” and “microsegmentation.” Enclave seamlessly combines access control, microsegmentation, encryption and other secure networking concepts to create a comprehensive solution. It allows Information Technology to easily segment the enterprise network, place the right staff in those segments and direct traffic. Revenue The following revenue metrics are for the three months ended December 31, 2023, versus the same period in fiscal year 2023 and the table reflects the revenue by category for the first three months of fiscal years 2024 and 2023. (in thousands) 2024 2023 % of Total % of Total $ Change % Change Revenue vCISO Services $ 1,161 66.9 % $ 1,019 65.9 % $ 142 13.9 % Cybersecurity Software & Services 575 33.1 % 527 34.1 % 48 9.1 % Total $ 1,736 $ 1,546 $ 190 12.3 % The growth in vCISO Services reflects both growth in clients served and an increase in revenue per client. Cybersecurity Software & Services revenue grew from 2023 to 2024 primarily because of an increase in the use of these services by existing Cybersecurity Software and Services clients and secondarily because of an expansion of the services and software offered. We also monitor new and retained revenue. 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 three months ended December 31, 2024 and 2023. We initiated fewer vCISO Services engagements during the three months ended December 31. 2023 than we did during the three months ended December 31, 2022. We attribute the decrease to ineffective lead generation campaigns launched during the last half of fiscal year 2023. (in thousands) 2024 2023 % of Total % of Total $ Change % Change Revenue vCISO New $ 355 30.6 % $ 641 62.9 % $ (286 ) (44.6 )% Retained 806 69.4 % 378 37.1 % 428 113.2 % Total $ 1,161 $ 1,019 $ 152 13.9 % Cybersecurity Software & Services New $ 188 32.7 % $ 177 33.6 % $ 11 6.2 % Retained 387 67.3 % 350 66.4 % 37 10.6 % Total $ 575 $ 527 $ 47 9.1 % Total Revenue New $ 543 31.3 % $ 818 52.9 % $ (275 ) (33.6 )% Retained 1,193 68.7 % 728 47.1 % 465 63.9 % Total $ 1,736 $ 1,546 $ 190 12.3 % 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 December 31, 2023 and September 30, 2023. Trailing Twelve Months Ended December 31, 2023 September 30, 2023 vCISO Services 65.6 % 60.8 % Cybersecurity Software & Services 86.2 % 89.4 % Total 72.7 % 71.0 % 15 Table of Contents Results of Operations Three Months Ended December 31, 2023 Versus Three Months Ended December 31, 2022 Comparison of Results Revenue. Our revenue was $1.7 million for the quarter ended December 31, 2023, compared to $1.5 million for the three-month comparable prior period; an increase of $190,000 or 12%. The factors driving this revenue increase include improved revenue retention and a growth in vCISO engagements. Gross Margins. Our gross margin was $845,000 or 48.7% for the quarter ended December 31, 2023, compared to $865K or 5 6 .0% for the quarter ended December 31, 2022. The decline in our gross margin was the result of less effective utilization of our service delivery employees. Operating Expenses. We initiated expense reductions from May 2023 to December 2023 that impacted all areas of our company. These reductions resulted in a $368,000 or 25.0% decrease in total operating expenses for the three months ended December 31, 2023 compared to the three months ended to December 31, 2022. The changes for each operating expense area are discussed below. The expense reductions were intended to increase the likelihood of achieving positive cash flow from operating activities during fiscal year 2024. General and Administrative Expenses. Our general and administrative expense was $709,000 for the three months ended December 31, 2023, compared to $1,030,000 for the prior comparable period, a decrease of $321,000 or 31.1%. The decrease was achieved by reducing executive positions and eliminating investor communication costs. Selling and Marketing Expenses. Our sales and marketing expense was $269,000 for the three months ended December 31, 2023, compared to $269,000 for the prior comparable period, a decrease of $38,000 or 12.4%. The decrease was driven by a reduction in staff and third-party service provider costs. Research and Development Expenses. Our research and development expense was $126,000 for the three months ended December 31, 2023, compared to $135,000 for the prior comparable period, a decrease of $9,000 or 6.7%. The decrease is the result of a staff reduction. Liquidity and Capital Resources We had an accumulated deficit of $19.2 million as of December 31, 2023. Our accumulated deficit has been primarily driven by three non-recurring expenses totaling $16.8 million: $6.2 million for acquisition costs, including $6.1 million related to the contingent consideration from the Business Combination; $5.7 million impairment of goodwill recorded as a result of the Business Combination, and $4.9 million impairment of intangible assets. We expect to incur continued operating losses until we generate revenues sufficient to cover our expected ongoing obligations and expenses. On December 31, 2023, we had cash of $819,000. 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 December 31, 2023, approximately $569,000 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 $1.4 million as of December 31, 2023, compared to working capital of $1.5 million as of September 30, 2023. The decline in working capital is primarily attributed to the use of cash to fund operating losses during the last three months. Cash Flows The following table summarizes selected items in our Consolidated Statements of Cash Flows for the three months ended December 31: (In thousands) 2023 2022 Net cash provided by (used in): Operating activities $ (184 ) $ (477 ) Investing activities - - Financing activities (50 ) - 16 Table of Contents 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 $184,000 of cash for operating activities during the three months ended December 31, 2023 and recorded a net loss of $246,000. During the same period, our non-cash charges totaled $136,000 comprised of $88,000 in stock-based compensation expense and $48,000 in amortization and depreciation. The change in our net operating assets and liabilities was primarily due to a $103,000 decrease in prepaid expenses as we recognized our annual directors and officers insurance premium that is prepaid annually in July and a $101,000 decrease in accounts payable and accrued liabilities because of payments made on our directors and officers insurance note payable. Investing Activities There were no cash activities in investing for this reporting period. Financing Activities We paid a $50,000 note payable to Mr. Akash Desai in December 2023. The note payable was related to a December 2021 agreement for the redemption of Mr. Desai’s interest in SideChannel LLC. The December 2023 payment completed our obligations to Mr. Desai. 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 December 31, 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 2023 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.