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 condensed consolidated 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. 20 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 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 deliver security leadership and infrastructure to organizations. Our cybersecurity Enclave platform and fractional security service offerings provide cybersecurity and privacy risk management solutions for our customers, built on decades of experience across government, manufacturing, and global enterprises. 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”) services, 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. Our vCISO practice helps growing and regulated organizations build security programs that are practical, measurable, and built to last. We are offering Enclave, our proprietary zero-trust security platform that simplifies important cybersecurity tasks to achieve microsegmentation. Enclave unifies asset intelligence, network segmentation, and certificate lifecycle management (“CLM”) in a single platform, combining zero trust network access with machine identity to address 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 combination strengthens security and allows organizations to implement microsegmentation strategies without adding headcount or operational complexity. Organizations partner with SideChannel when they need security strategy and security infrastructure, from the same team. 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 nine months ended June 30, 2026, compared to the nine months ended June 30, 2025: ● Total revenue decreased by $431 thousand or 7.7%. ● vCISO Services revenue decreased by $707 thousand or 22.1%. ● Cybersecurity Software and Services category revenue grew by $276 thousand or 11.6%. 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 nine months ended June 30, 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 June 30, 2026, and September 30, 2025, by revenue category: Trailing Twelve Months Ended June 30, 2026 September 30, 2025 vCISO Services 61.7 % 56.4 % Cybersecurity Software & Services 77.6 % 76.9 % Total 68.2 % 63.6 % 23 Results of Operations Three Months Ended June 30, 2026, Compared to Three Months Ended June 30, 2025 Three Months Ended June 30, (in thousands) 2026 2025 Revenues $ 1,797 $ 1,776 Cost of revenues 811 941 Gross profit 986 835 Gross margin 54.9 % 47.0 % Operating expenses General and administrative 551 715 Selling and marketing 396 242 Research and development 174 146 Total operating expenses 1,121 1,103 Operating loss (135 ) (268 ) Other income, net 3 9 Net loss before income tax expense (132 ) (259 ) Income tax expense 2 2 Net loss $ (134 ) $ (261 ) Net loss per common share – basic and diluted $ (0.03 ) $ (0.06 ) Weighted average common shares outstanding – basic and diluted 4,572,757 4,446,716 Revenue. Our revenue was $1.8 million for the quarter ended June 30, 2026, compared to $1.8 million for the quarter ended June 30, 2025, representing an increase of $21 thousand or 1.2%. This increase was primarily due to a $85 thousand increase in cybersecurity software and services partially offset by a $64 thousand decrease in vCISO services. Gross Profit. Our gross profit was $986 thousand and gross margin was 54.9% for the quarter ended June 30, 2026, compared to $835 thousand or 47.0% for the quarter ended June 30, 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 June 30, 2026, than for the three months ended June 30, 2025. Additional factors contributing to our gross margin increase in the quarter ended June 30, 2026, were improved utilization of service delivery employees in the current fiscal year compared to the prior fiscal year. Operating Expenses. Operating expenses increased $18 thousand or 1.6% for the three months ended June 30, 2026, compared to the three months ended June 30, 2025. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expenses were $551 thousand for the three months ended June 30, 2026, compared to $715 thousand for the three months ended June 30, 2025, representing a decrease of $164 thousand or 22.9%. The favorable variance was driven by decreases in personnel costs, amortization, and professional services. Selling and Marketing Expenses. Our sales and marketing expenses were $396 thousand for the three months ended June 30, 2026, compared to $242 thousand for the three months ended June 30, 2025, representing an increase of $154 thousand or 63.6% due to increases in employees and compensation, stock compensation expense, and travel and office supplies. Research and Development Expenses. Our research and development expenses were $174 thousand for the three months ended June 30, 2026, compared to $146 thousand for the three months ended June 30, 2025, representing an increase of $28 thousand or 19.2% due to an increase in employees and compensation. 24 Nine Months Ended June 30, 2026, Compared to Nine Months Ended June 30, 2025 Nine Months Ended June 30, (in thousands) 2026 2025 Revenues $ 5,147 $ 5,578 Cost of revenues 2,409 2,928 Gross profit 2,738 2,650 53.2 % 47.5 % Operating expenses General and administrative 1,951 2,030 Selling and marketing 1,242 736 Research and development 528 419 Total operating expenses 3,721 3,185 Operating loss (983 ) (535 ) Other income, net 16 31 Net loss before income tax expense (967 ) (504 ) Income tax expense 7 6 Net loss $ (974 ) $ (510 ) Net loss per common share – basic and diluted $ (0.22 ) $ (0.12 ) Weighted average common shares outstanding – basic and diluted 4,505,429 4,391,929 Revenue. Our revenue was $5.1 million for the nine months ended June 30, 2026, compared to $5.6 million for the nine months ended June 30, 2025, representing a decrease of $431 thousand or 7.7%. This decrease was primarily due to a $708 thousand decrease in vCISO services partially offset by a $277 thousand increase in cybersecurity software and services. Gross Profit. Our gross profit was $2.7 million and gross margin was 53.2% for the nine months ended June 30, 2026, compared to $2.7 million and gross margin was 47.5% for the nine months ended June 30, 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 nine months ended June 30, 2026, than for the nine months ended June 30, 2025. Additional factors contributing to our gross margin increase in the nine months ended June 30, 2026, were improved utilization of service delivery employees in the current fiscal year compared to the prior fiscal year. Operating Expenses. Operating expenses increased $536 thousand or 16.8% for the nine months ended June 30, 2026, compared to the nine months ended June 30, 2025. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expenses were $2.0 million for the nine months ended June 30, 2026, compared to $2.0 million for the nine months ended June 30, 2025, representing a decrease of $79 thousand or 3.9%. Decreases in stock compensation expense, amortization, and professional services were partially offset by increases in personnel related costs. Selling and Marketing Expenses. Our sales and marketing expenses were $1.2 million for the nine months ended June 30, 2026, compared to $736 thousand for the nine months ended June 30, 2025, representing an increase of $506 thousand or 68.8% due to an increase in employees and compensation, consulting costs, advertising, and events. Research and Development Expenses. Our research and development expenses were $528 thousand for the nine months ended June 30, 2026, compared to $419 thousand for the nine months ended June 30, 2025, representing an increase of $109 thousand or 26.0% due to an increase in employees and compensation. 25 Liquidity and Capital Resources During the nine months ended June 30, 2026, we incurred a net loss of $974 thousand, and we used $839 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 $21.8 million as of June 30, 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 $15 thousand as of June 30, 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 caused by current year operating losses. We had $165 thousand of accounts receivable included in our deferred revenue balance of $663 thousand at June 30, 2026. We did not have any credit facilities available to us as of June 30, 2026, or as of the filing date of this Quarterly Report. Cash Flows The following table summarizes selected items in our unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended June 30: (in thousands) 2026 2025 Net cash provided by (used in): Operating activities $ (839 ) $ (46 ) 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 $839 thousand during the nine months ended June 30, 2026, and we recorded a net loss of $974 thousand. During the same period, our non-cash charges totaled $219 thousand, comprised of $207 thousand in net stock-based compensation expense and $12 thousand in depreciation and amortization. The changes in our net operating assets and liabilities include $64 thousand increase in accounts receivable and $138 thousand decrease in deferred revenue. Investing Activities During the nine months ended June 30, 2026, a $100 thousand certificate of deposit matured. Financing Activities There were no financing activities during the nine months ended June 30, 2026. Critical Accounting Estimates The preparation of unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to goodwill and deferred income tax 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 Unaudited Condensed 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 June 30, 2026, there have been no significant changes to the accounting estimates that we have deemed critical. 26 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.