SideChannel, Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying consolidated financial statements and the notes thereto. In addition, please refer to the discussion of our business and markets contained in Part 1, Item 1 of this Annual Report on Form 10-K. 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 continue to expand our catalogue of services and solutions to address the cybersecurity needs of our customers, including virtual Chief Information Security Officer, cyber program strategy, zero trust, third-party risk management, compliance readiness, cloud security services, privacy, threat intelligence, managed end-point security solutions, and cybersecurity awareness. We are marketing and selling Enclave, a proprietary software product that simplifies important cybersecurity tasks to achieve “microsegmentation.” By combining zero trust network access with certificate management and machine identity, Enclave seamlessly creates a unified security architecture that eliminates traditional network vulnerabilities. This integration enables IT teams to enforce precise access policies based on verified machine identities. Certificate-based identities allow a simplified management for any certificate-based communication, while the zero trust framework continuously validates every connection attempt. This powerful combination delivers robust security without the typical management overhead, allowing organizations to implement sophisticated microsegmentation strategies with remarkable simplicity and minimal resource requirements. Our growth strategy focuses on these three initiatives: ● Increasing adoption of Enclave: By promoting Enclave and our other cybersecurity solutions to our existing vCISO clients, we aim to deepen our relationships and provide comprehensive, integrated security solutions. This supports the increased demand for zero trust strategies and remote worker technologies. ● Securing new vCISO Services Clients: As organizations plan to increase security investments due to breaches and the rising complexity of cyber threats, we aim to expand our client base by offering flexible, expert vCISO services that address budget constraints and the need for rapid security posture establishment. ● Adding new Cybersecurity Software and Services offerings: We plan to enhance our portfolio by incorporating transformational technologies such as AI-based security operations, data security posture management, polymorphic encryption, cyber-physical system security, and application security posture management. This aligns with industry trends and the anticipated incremental spend on application and data security due to generative AI. We internally report our revenue using two categories: ● vCISO Services: This category captures the revenue from the Chief Information Security Officer services that we provide to our clients on a “virtual” or outsourced basis. Embedded into the C-suite executive teams of our clients, our vCISOs deliver services including 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. Engagements typically include a fixed monthly subscription fee and exceed 12 months because of renewal options of 1, 3, 6, or 12 months. ● Cybersecurity Software and Services: This category encompasses an array of cybersecurity software and services that our clients deem necessary to protect their digital assets, including Enclave. 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 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. 28 Revenue The following revenue metrics are for the twelve months ended September 30, 2025, versus the same period in 2024. These summary metrics are accompanied by pie charts that reflect the revenue by category in fiscal years 2025 and 2024: ● Total revenue declined by $49 thousand or 0.7%. ● vCISO Services category revenue decreased by $715 thousand or 14.9%. ● Cybersecurity Software and Services category revenue grew by $666 thousand or 25.6%. The year-over-year decline in vCISO Services revenue reflects new vCISO client acquisition not exceeding vCISO client churn and the transitioning of vCISO Services clients into lower revenue generating Cybersecurity Software & Services. Cybersecurity Software & Services revenue benefited from these transitions along with the expansion of the software and services offered. 29 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 fiscal years 2025 and 2024: 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 fiscal years 2025 and 2024 by revenue category. Trailing Twelve Months Ended September 30, 2025 September 30, 2024 vCISO Services 56.4 % 67.7 % Cybersecurity Software & Services 76.9 % 72.2 % Total 63.6 % 69.2 % 30 Results of Operations Fiscal Year Ended September 30, 2025, Compared to Fiscal Year Ended September 30, 2024 Twelve Months Ended September 30, 2025 2024 Revenues $ 7,351 $ 7,400 Cost of revenues 3,847 3,868 Gross profit 3,504 3,532 Gross margin 47.7 % 47.7 % Operating expenses General and administrative 2,894 3,155 Selling and marketing 966 771 Research and development 562 546 Total operating expenses 4,422 4,472 Operating loss (918 ) (940 ) Other income, net 40 41 Net loss before income tax expense (878 ) (899 ) Income tax expense 14 5 Net loss after income tax expense $ (892 ) $ (904 ) Revenue. Our revenue was $7.4 million for the year ended September 30, 2025, compared to $7.4 million in the prior year, a decrease of $49 thousand or 0.7%. We believe this decrease reflects the factors previously discussed in the Overview section above. Gross Margin. Gross margin was 47.7% in each of the fiscal years 2025 and 2024. We have experienced an increase in higher gross margin Enclave revenue which was offset by increased revenue from lower gross margin third-party services and software. Operating Expenses . Total operating expenses during fiscal year 2025 were $4.4 million compared to fiscal year 2024 total operating expenses of $4.5 million, a decrease of $50 thousand or 1.1%. General and Administrative Expenses. Our general and administrative expenses were $2.9 million for the year ended September 30, 2025, compared to $3.2 million for the prior year, a decrease of $261 thousand or 8.3%. The decrease in general and administrative expenses primarily resulted from lower professional services, stock-based compensation, and insurance costs. These favorable variances were partially offset by an increase in personnel related costs. Selling and Marketing Expenses. Our selling and marketing expenses were $966 thousand for the year ended September 30, 2025, compared to $771 thousand for the prior year, an increase of $195 thousand or 25.3% resulting from an increase in personnel costs and advertising expenses. Research and Development Expenses. Our research and development expenses were $562 thousand for the year ended September 30, 2025, compared to $546 thousand for the prior year, an increase of $16 thousand or 2.9%. Increases in personnel and consulting costs were partially offset by a decrease in stock-based compensation. Other Income. Other Income was $40 thousand and $41 thousand for fiscal years 2025 and 2024 respectively, which reflects interest income from the cash on deposit at our bank. Income Tax Expense. We recorded income tax expense of $14 thousand in the fiscal year ended September 30, 2025, compared to $5 thousand for the year ended September 30, 2024. Our income tax expense is attributed to accruals for state income taxes in the various jurisdictions where we have customers, employees, or property. 31 Liquidity and Capital Resources During fiscal year 2025, we incurred a net loss of $878 thousand, and we had $130 thousand of cash used by operations. Our primary source of liquidity and capital resources was the $1.3 million of cash, cash equivalents, and short-term investments at the beginning of fiscal year 2025. We had an accumulated deficit of $20.7 million as of September 30, 2025. The following table summarizes, for the periods indicated, selected items in our Statements of Cash Flows: (In thousands) 2025 2024 Net cash provided by (used in): Operating activities $ (130 ) $ 307 Investing activities 150 (265 ) Financing activities - (50 ) Total cash provided by (used) $ 20 $ (8 ) Operating Activities . Net cash used by operations for the year ended September 30, 2025, was $130 thousand compared to $307 thousand provided by operations for the year ended September 30, 2024. During fiscal year 2025, we recorded net, non-cash charges of $498 thousand for depreciation, amortization and stock-based compensation expense. Our net accounts receivable decreased by $179 thousand due to earlier payment of invoices by our clients as well as a decrease in revenue. We also experienced a $286 thousand increase in deferred revenue because of higher payments from clients in advance of receiving software and services. These two sources of cash were partially offset by a $214 thousand decrease in accounts payable and accrued liabilities. Investing Activities . We purchased and sold short-term investments in the form of time deposits during fiscal year 2025, yielding a net of $150 thousand provided by investing activities. Financing Activities . We had zero ($0) cash provided by or used in financing activities during fiscal year 2025. As of September 30, 2025, we had $1.2 million in cash, cash equivalents, and short-term investments; and our working capital was $0.8 million. We believe that our existing cash balances are sufficient to fund our operations through at least December 31, 2026. We expect to fund our operations with our existing cash balance and any cash flow generated by operations. We intend to manage our business such that our expenses will allow us to sustain positive cash flow from our operations, but we cannot assure this will occur. We don’t currently have any credit facilities available to us; however, we have had discussions with several lenders about establishing a line of credit secured by our accounts receivable. Critical Accounting Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to long-lived assets, goodwill, identifiable intangibles and deferred income tax assets and liabilities including their related valuation allowances. 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. 32 Goodwill, Intangible and Long-Lived Assets We account for goodwill and intangible assets in accordance with Accounting Standards Codification (“ASC”) Topic 350 (Intangibles- Goodwill and Other). 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 at least annually in the fourth quarter, on a reporting unit basis, or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. As a part of the goodwill impairment assessment, we have the option to perform a qualitative assessment to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. If, because of our qualitative assessment, we determine this is the case, we are required to perform a goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized. The test is discussed below. If, because of our qualitative assessment, we determine that it is more-likely-than-not that the fair value of the reporting unit is greater than its carrying amounts, the goodwill impairment test is not required. The quantitative goodwill impairment test, used to identify both the existence of impairment and the amount of impairment loss, compares the fair value of a reporting unit with its carrying amount, including goodwill. 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 shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. The goodwill impairment assessment is based upon the income approach, which estimates the fair value of our reporting units based upon a discounted cash flow approach. This fair value is then reconciled to our market capitalization at year end with an appropriate control premium. The determination of the fair value of our reporting units requires management to make significant estimates and assumptions including the selection of control premiums, discount rates, terminal growth rates, forecasts of revenue and expense growth rates, income tax rates, changes in working capital, depreciation, amortization and capital expenditures. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting unit or the amount of the goodwill impairment charge. Goodwill was $1.4 million at both September 30, 2025 and 2024. The fair value of the goodwill at September 30, 2025, as determined by our impairment analysis, was more than the carrying value; thus, we had no impairment of goodwill in fiscal year 2025. We did not record indefinite-lived intangible assets in the fiscal years ended September 30, 2025 and 2024. 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. We have $17 thousand in property and equipment at September 30, 2025. At September 30, 2025 and 2024, finite-lived intangibles and long-lived assets were zero ($0) and zero ($0), respectively. 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. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined in Rule 229.10(f)(1) of Regulation S-K promulgated by the SEC. 33