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, 2024, filed with the Securities and Exchange Commission on December 13, 2024 (“2024 Form 10-K”), 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 2024 Form 10-K. 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 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. 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 that we believe is currently underserved. We believe that our cybersecurity offerings will identify and develop cybersecurity, privacy, and risk management solutions for our customers. We anticipate that our target customers will continue to need cost-effective security solutions. We intend to provide more tech-enabled services to address the needs of our customers, including virtual Chief Information Security Officer (vCISO), zero trust, third-party risk management, due diligence, privacy, threat intelligence, and managed end-point security solutions. 19 We are marketing and selling Enclave, a proprietary software product that simplifies important cybersecurity tasks to achieve “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. Our growth strategy focuses on these three initiatives: 1. Increasing adoption of Enclave, 2. Securing new vCISO clients, and 3. Adding new Cybersecurity Software and Services offerings. 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 for durations longer than twelve (12) months. Hourly rates for vCISO time and material projects range from $350 to $450. 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 our 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. Sales of our proprietary software, Enclave, are also included in this revenue category. Revenue The following revenue metrics are for the three months ended December 31, 2024, compared to the three months ended December 31, 2023. ● Total revenue grew by $172 thousand or 9.9%. ● vCISO Services revenue grew by $93 thousand or 8.0%. ● Cybersecurity Software and Services category revenue grew by $79 thousand or 13.7%. In the accompanying charts, “2025” refers the first three months of fiscal year 2025 and “2024” refers to the first three months of fiscal year 2024. Fiscal year 2025 ends on September 30, 2025. 20 The year-over-year growth in vCISO Services revenue reflects both an increase in clients served and an increase in revenue per client. Cybersecurity Software & Services revenue grew 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 chart provides details on our new and retained revenue for the three months ended December 31, 2024, and 2023: 21 Further, we consider revenue retention a key performance indicator. Revenue retention is calculated by dividing retained revenue by the prior year total revenue. The following table shows the revenue retention for the trailing twelve months ended December 31, 2024, and September 30, 2024, by revenue category: Trailing Twelve Months Ended December 31, 2024 September 30, 2024 vCISO Services 64.0 % 67.7 % Cybersecurity Software & Services 70.3 % 72.2 % Total 66.1 % 69.2 % 22 Results of Operations Three Months Ended December 31, 2024, Compared to Three Months Ended December 31, 2023 Three Months Ended December 31, 2024 2023 Revenues $ 1,908 $ 1,736 Cost of revenues 1,034 891 Gross profit 874 845 Gross margin 45.8 % 48.7 % Operating expenses General and administrative 660 709 Selling and marketing 267 269 Research and development 153 126 Total operating expenses 1,080 1,104 Operating loss (206 ) (259 ) Other income, net 13 13 Net loss before income tax expense (193 ) (246 ) Income tax expense 2 - Net loss $ (195 ) $ (246 ) Revenue. Our revenue was $1.9 million for the quarter ended December 31, 2024, compared to $1.7 million for the three-month comparable prior period, an increase of $172 thousand or 9.9%. The factors driving this revenue increase include growth in vCISO engagements and higher adoption of Cybersecurity Services and Software by our new and existing clients. Gross Profit. Our gross profit was $874 thousand and gross margin was 45.8% for the quarter ended December 31, 2024, compared to $845 thousand or 48.7% for the quarter ended December 31, 2023. The decline in our gross margin was the result of an increase in revenue derived from third-party software and services, which have a lower gross margin than our direct software and services. Operating Expenses. Operating expenses decreased $24 thousand or 2.2% for the three months ended December 31, 2024, compared to the three months ended to December 31, 2023. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expense was $660 thousand for the three months ended December 31, 2024, compared to $709 thousand for the prior comparable period, a decrease of $49 thousand or 6.9%. The decrease was achieved by reducing costs related to being a publicly traded company combined with a decrease in personnel costs, which have been partially offset by an increase in accounting professional fees and stock-based compensation expenses. Selling and Marketing Expenses. Our sales and marketing expense was $267 thousand for the three months ended December 31, 2024, compared to $269 thousand for the prior comparable period, a decrease of $2 thousand or 0.7%. An increase in staffing costs was offset by a decrease in third-party providers. Research and Development Expenses. Our research and development expense was $153 thousand for the three months ended December 31, 2024, compared to $126 thousand for the prior comparable period, an increase of $27 thousand or 21.4%. The increase is the result of higher personnel costs. Liquidity and Capital Resources During the three months ended December 31, 2024, we incurred a net loss of $195 thousand, and we had $75 thousand of cash provided by operations. Our primary source of liquidity and capital resources has been the $1.0 million of cash and cash equivalents at the beginning of fiscal year 2025 supplemented with the cash provided by operations during the fiscal year. We had an accumulated deficit of $20.0 million as of December 31, 2024, comprised primarily of three (3) non-operational expenses totalling $16.8 million: $6.2 million for the contingent consideration and business combination related costs, $5.7 million for the impairment of goodwill, and $4.9 million for the impairment of intangible assets. We had working capital of $1.2 million as of December 31, 2024, compared to working capital of $1.3 million as of September 30, 2024. The decline in working capital is due to a $147 thousand decrease in accounts receivable and a $96 thousand decrease in prepaid expenses offset by a $139 thousand decrease in accounts payable and accrued liabilities. 23 Cash Flows The following table summarizes selected items in our Consolidated Statements of Cash Flows for the three months ended December 31. (In thousands) 2024 2023 Net cash provided by (used in): Operating activities $ 75 $ (184 ) Investing activities - - Financing activities - (50 ) 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. Operating activities provided $75 thousand of cash during the three months ended December 31, 2024, and we recorded a net loss of $195 thousand. During the same period, our non-cash charges totalled $160 thousand, primarily comprised of $112 thousand in stock-based compensation expense and $49 thousand in amortization and depreciation. The change in our net operating assets and liabilities was primarily due to a $147 thousand decrease in accounts receivable due to accelerated customer collections, a $96 thousand decrease in prepaid expenses as we recognized third party software and services and a $139 thousand decrease in accounts payable and accrued liabilities because of payments of bonuses, our directors and officers insurance note payable, and our litigation settlement. Investing Activities There were no investing activities for this reporting period. Financing Activities There were no financing activities for this reporting period. 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.