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”. 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, 2025 (the “2025 Form 10-K”), and elsewhere in this Quarterly Report on Form 10-Q (this “Quarterly Report”). We undertake no obligation to update or revise publicly any forward-looking statements, whether because 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 Quarterly 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 2025 Form 10-K. Our logo and some of our trademarks and tradenames are used in this Quarterly Report. Solely for convenience, trademarks, tradenames, and service marks referred to in this Quarterly 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 fully assert 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 Quarterly 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 Quarterly 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 Quarterly 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 “ Part II Item 1A. Risk Factors ” of this Quarterly 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. 20 In addition, unless the context otherwise requires and for the purposes of this Quarterly 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 emerging to enterprise 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 (“vCISO”), 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 asset intelligence, 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. 21 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 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. Revenue The following revenue metrics are for the six months ended March 31, 2026, compared to the six months ended March 31, 2025: ● Total revenue decreased by $452 thousand or 11.9%. ● vCISO Services revenue decreased by $644 thousand or 28.4%. ● Cybersecurity Software and Services category revenue grew by $192 thousand or 12.5%. The year-over-year decline in vCISO Services revenue reflects the loss of clients with a higher-than-average annual contract value and the transitioning of vCISO Services clients into lower revenue generating Cybersecurity Software and Services. Cybersecurity Software and Services revenue benefited from these transitions along with the expansion of the software and services offered. 22 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 six months ended March 31, 2026 and 2025: 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 March 31, 2026, and September 30, 2025, by revenue category: Trailing Twelve Months Ended March 31, 2026 September 30, 2025 vCISO Services 58.9 % 56.4 % Cybersecurity Software & Services 79.0 % 76.9 % Total 66.8 % 63.6 % 23 Results of Operations Three Months Ended March 31, 2026, Compared to Three Months Ended March 31, 2025 Three Months Ended March 31, (in thousands) 2026 2025 Revenues $ 1,576 $ 1,894 Cost of revenues 733 953 Gross profit 843 941 Gross margin 53.5 % 49.7 % Operating expenses General and administrative 724 655 Selling and marketing 388 227 Research and development 179 120 Total operating expenses 1,291 1,002 Operating loss (448 ) (61 ) Other income, net 6 9 Net loss before income tax expense (442 ) (52 ) Income tax expense 2 2 Net loss $ (444 ) $ (54 ) Net loss per common share – basic and diluted $ (0.10 ) $ (0.01 ) Weighted average common shares outstanding – basic and diluted 4,497,378 4,382,878 Revenue. Our revenue was $1.6 million for the quarter ended March 31, 2026, compared to $1.9 million for the quarter ended March 31, 2025, representing a decrease of $318 thousand or 16.8%. This decrease was primarily due to the loss of clients with higher than average contract value. Gross Profit. Our gross profit was $843 thousand and gross margin was 53.5% for the quarter ended March 31, 2026, compared to $941 thousand or 49.7% for the quarter ended March 31, 2025. The increase in our gross margin was the result of Enclave, which has a high gross margin, contributing a larger percentage of our revenue in the three months ended March 31, 2026, than for the three months ended March 31, 2025. Additional factors contributing to our gross margin increase in the quarter ended March 31, 2026, were improved utilization of service delivery employees in the current fiscal year compared to the prior fiscal year. 24 Operating Expenses. Operating expenses increased $289 thousand or 28.8% for the three months ended March 31, 2026, compared to the three months ended March 31, 2025. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expenses were $724 thousand for the three months ended March 31, 2026, compared to $655 thousand for the three months ended March 31, 2025, representing an increase of $69 thousand or 10.5%. The increase was the result of higher personnel and public entity expenses as well as the impact of the elimination of our allowance for doubtful accounts in 2025, which was not the case in 2026, partially offset by lower consulting, legal, and amortization costs in the current fiscal year. Selling and Marketing Expenses. Our sales and marketing expenses were $388 thousand for the three months ended March 31, 2026, compared to $227 thousand for the three months ended March 31, 2025, representing an increase of $161 thousand or 70.9% due to an increase in employees and compensation, consulting costs, advertising, and events. Research and Development Expenses. Our research and development expenses were $179 thousand for the three months ended March 31, 2026, compared to $120 thousand for the three months ended March 31, 2025, representing an increase of $59 thousand or 49.2% due to an increase in employees and compensation. Six Months Ended March 31, 2026, Compared to Six Months Ended March 31, 2025 Six Months Ended March 31, (in thousands) 2026 2025 Revenues $ 3,350 $ 3,802 Cost of revenues 1,598 1,987 Gross profit 1,752 1,815 Gross margin 52.3 % 47.7 % Operating expenses General and administrative 1,400 1,315 Selling and marketing 846 494 Research and development 354 273 Total operating expenses 2,600 2,082 Operating loss (848 ) (267 ) Other income, net 13 22 Net loss before income tax expense (835 ) (245 ) Income tax expense 5 4 Net loss $ (840 ) $ (249 ) Net loss per common share – basic and diluted $ (0.19 ) $ (0.06 ) Weighted average common shares outstanding – basic and diluted 4,471,765 4,364,524 25 Revenue. Our revenue was $3.4 million for the six months ended March 31, 2026, compared to $3.8 million for the six months ended March 31, 2025, representing a decrease of $452 thousand or 11.9%. This decrease was primarily due to the loss of clients with higher than average contract value. Gross Profit. Our gross profit was $1.8 million and gross margin was 52.3% for the six months ended March 31, 2026, compared to $1.8 million and gross margin was 47.7% for the six months ended March 31, 2025. The increase in our gross margin was the result of Enclave, which has a high gross margin, contributing a larger percentage of our revenue in the six months ended March 31, 2026, than for the six months ended March 31, 2025. Additional factors contributing to our gross margin increase in the six months ended March 31, 2026, were improved utilization of service delivery employees in the current fiscal year compared to the prior fiscal year. Operating Expenses. Operating expenses increased $518 thousand or 24.9% for the six months ended March 31, 2026, compared to the six months ended March 31, 2025. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expenses were $1.4 million for the six months ended March 31, 2026, compared to $1.3 million for the six months ended March 31, 2025, representing an increase of $85 thousand or 6.5%. The increase was the result of higher personnel expenses as well as the impact of the elimination of our allowance for doubtful accounts in 2025, which was not the case in 2026, partially offset by lower consulting, legal, and amortization costs in the current fiscal year. Selling and Marketing Expenses. Our sales and marketing expenses were $846 thousand for the six months ended March 31, 2026, compared to $494 thousand for the six months ended March 31, 2025, representing an increase of $352 thousand or 71.3% due to an increase in employees and compensation, consulting costs, advertising, and events. Research and Development Expenses. Our research and development expenses were $354 thousand for the six months ended March 31, 2026, compared to $273 thousand for the six months ended March 31, 2025, representing an increase of $81 thousand or 29.7% due to an increase in employees and compensation. Liquidity and Capital Resources During the six months ended March 31, 2026, we incurred a net loss of $840 thousand, and we used $854 thousand of cash in operating activities. Our primary source of liquidity and capital resources has been the $1.1 million of cash and cash equivalents at the beginning of fiscal year 2026. We had an accumulated deficit of $21.6 million as of March 31, 2026, which includes three non-operational expenses totaling $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 net working capital of $49 thousand as of March 31, 2026, compared to net working capital of $770 thousand as of September 30, 2025. The decline in net working capital was primarily due to a decrease in cash partially offset by a decrease in accrued expenses. We had $82 thousand of accounts receivable included in our deferred revenue balance of $864 thousand at March 31, 2026. We did not have any credit facilities available to us as of March 31, 2026, or as of the filing date of this Quarterly Report. 26 Cash Flows The following table summarizes selected items in our unaudited Condensed Consolidated Statements of Cash Flows for the six months ended March 31: (in thousands) 2026 2025 Net cash provided by (used in): Operating activities $ (854 ) $ 49 Investing activities 100 150 Financing activities - - 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. Cash used in operating activities was $854 thousand during the six months ended March 31, 2026, and we recorded a net loss of $840 thousand. During the same period, our non-cash charges totaled $119 thousand, comprised of $111 thousand in stock-based compensation expense and $8 thousand in depreciation. The changes in our net operating assets and liabilities include a $184 thousand decrease in accounts payable and accrued liabilities, a $63 thousand increase in deferred revenue, and a $22 thousand increase in prepaid expenses and other assets. Investing Activities During the six months ended March 31, 2026, a $100 thousand certificate of deposit matured. Financing Activities There were no financing activities during the six months ended March 31, 2026. 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 in Item 10(f) of Regulation S-K.