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 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. 18 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 continue to expand our catalogue of services and solutions to address the cybersecurity needs of our customers, including virtual Chief Information Security Officer (“vCISO” or “vCISOs”), 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: 1. Increasing adoption of Enclave, 2. Securing new vCISO Services 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 generated by outsourcing fractional, vCISOs to our clients on an ongoing basis. 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 Services engagements typically include a fixed monthly subscription fee for durations longer than twelve (12) months. Hourly rates for vCISO Services 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 Services offering and include a full range of other cybersecurity products and services delivered on an ongoing or project basis through our team of cybersecurity professionals 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. This revenue category includes both licensing revenue from software contracts and commissions from third-party service provider partnerships and sales of our proprietary software, Enclave. 19 Revenue The following revenue metrics are for the six months ended March 31, 2025, compared to the six months ended March 31, 2024: ● Total revenue grew by $139 thousand or 3.8%. ● vCISO Services revenue decreased by $109 thousand or 4.4%. ● Cybersecurity Software and Services category revenue grew by $248 thousand or 21.2% 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 & Services revenue benefited from these transitions along with the expansion of the software and services offered. 20 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, 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 the trailing twelve months ended March 31, 2025, and September 30, 2024, by revenue category: Trailing Twelve Months Ended March 31, 2025 September 30, 2024 vCISO Services 57.5 % 67.7 % Cybersecurity Software & Services 73.7 % 72.2 % Total 62.4 % 69.2 % Results of Operations Three Months Ended March 31, 2025, Compared to Three Months Ended March 31, 2024 Three Months Ended March 31, (in thousands) 2025 2024 Revenues $ 1,894 $ 1,927 Cost of revenues 953 1,059 Gross profit 941 868 Gross margin 49.7 % 45.0 % Operating expenses General and administrative 655 849 Selling and marketing 227 156 Research and development 120 123 Total operating expenses 1,002 1,128 Operating loss (61 ) (260 ) Other income, net 9 8 Net loss before income tax expense (52 ) (252 ) Income tax expense 2 1 Net loss $ (54 ) $ (253 ) 21 Revenue. Our revenue was $1.9 million for the quarter ended March 31, 2025, compared to $1.9 million for the quarter ended March 31, 2024, a decrease of $33 thousand or 1.7%. This decrease is primarily due to the loss of clients with higher than average contract value during the second half of fiscal year 2024 and the first half of fiscal year 2025. Gross Profit. Our gross profit was $941 thousand and gross margin was 49.7% for the quarter ended March 31, 2025, compared to $868 thousand or 45.0% for the quarter ended March 31, 2024. The increase in our gross margin was the result of lower bonus expense accrued in the current fiscal year than what was accrued in the prior fiscal year. Another factor contributing to our gross margin improvement was that Enclave had positive gross margin in the three months ended March 31, 2025, on higher sales volume versus a negative gross for the three months ended March 31, 2024, on a lower amount of revenue. Operating Expenses. Operating expenses decreased $126 thousand or 11.2% for the three months ended March 31, 2025, compared to the three months ended March 31, 2024. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expense was $655 thousand for the three months ended March 31, 2025, compared to $849 thousand for the three months ended March 31, 2024, a decrease of $194 thousand or 22.9%. The decrease was achieved by reducing costs related to being a publicly traded company combined with a decrease in stock-based compensation expenses as well as adjusting our allowance for doubtful accounts to zero. Selling and Marketing Expenses. Our sales and marketing expense was $227 thousand for the three months ended March 31, 2025, compared to $156 thousand for the three months ended March 31, 2024, an increase of $71 thousand or 45.5% due to an increase in employees and compensation. Research and Development Expenses. Our research and development expense was $120 thousand for the three months ended March 31, 2025, compared to $123 thousand for the three months ended March 31, 2024, a decrease of $3 thousand or 2.4%. Lower stock-based compensation was partially offset by an increase in salaries. Six Months Ended March 31, 2025, Compared to Six Months Ended March 31, 2024 Six Months Ended March 31, (in thousands) 2025 2024 Revenues $ 3,802 $ 3,663 Cost of revenues 1,987 1,950 Gross profit 1,815 1,713 Gross margin 47.7 % 46.8 % Operating expenses General and administrative 1,315 1,558 Selling and marketing 494 425 Research and development 273 249 Total operating expenses 2,082 2,232 Operating loss (267 ) (519 ) Other income, net 22 21 Net loss before income tax expense (245 ) (498 ) Income tax expense 4 1 Net loss $ (249 ) $ (499 ) 22 Revenue. Our revenue was $3.8 million for the six months ended March 31, 2025, compared to $3.7 million for the six-month ended March 31, 2024, an increase of $139 thousand or 3.8%. This revenue increase is driven by growth in Cybersecurity Services and Software by our new and existing clients, offset by a decrease in vCISO Services revenue. Gross Profit. Our gross profit was $1.8 million and gross margin was 47.7% for the six months ended March 31, 2025, compared to $1.7 million or 46.8% for the six months ended March 31, 2024. The increase in our gross margin was the result of an increase in margin on Cybersecurity Software and Services, largely driven by increased Enclave sales and the elimination of certain fixed costs related to the delivery of Enclave. Operating Expenses. Operating expenses decreased $150 thousand or 6.7% for the six months ended March 31, 2025, compared to the six months ended March 31, 2024. The changes for each operating expense area are discussed below. General and Administrative Expenses. Our general and administrative expense was $1.3 million for the six months ended March 31, 2025, compared to $1.6 million for the six months ended March 31, 2024, a decrease of $243 thousand or 15.6%. The decrease was achieved by reducing costs related to being a publicly traded company combined with a decrease in consulting costs, travel costs, stock-based compensation expense, and our allowance for doubtful accounts, which have been partially offset by an increase in accounting professional fees. Selling and Marketing Expenses. Our sales and marketing expense was $494 thousand for the six months ended March 31, 2025, compared to $425 thousand for the six months ended March 31, 2024, an increase of $69 thousand or 16.2%. An increase in employees and compensation was partially offset by a decrease in consultant-related costs and a decrease in stock-based compensation expense. Research and Development Expenses. Our research and development expense was $273 thousand for the six months ended March 31, 2025, compared to $249 thousand for the six months ended March 31, 2024, an increase of $24 thousand or 9.6%. The increase is the result of higher personnel costs. Liquidity and Capital Resources During the six months ended March 31, 2025, we incurred a net loss of $249 thousand, and we had $199 thousand of cash provided by operations and investing activities. 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 March 31, 2025, comprised primarily of three (3) 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 working capital of $1.2 million as of March 31, 2025, compared to working capital of $1.3 million as of September 30, 2024. The decline in working capital is primarily due to a seasonal increase in deferred revenue. Cash Flows The following table summarizes selected items in our Condensed Consolidated Statements of Cash Flows for the six months ended March 31: (In thousands) 2025 2024 Net cash provided by (used in): Operating activities $ 49 $ (152 ) Investing activities 150 - Financing activities - (50 ) 23 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 provided by operating activities was $49 thousand during the six months ended March 31, 2025, and we recorded a net loss of $249 thousand. During the same period, our non-cash charges totaled $252 thousand, comprised of $155 thousand in stock-based compensation expense net of RSUs sold by employees and $98 thousand in amortization and depreciation, offset by a $1 thousand adjustment to the legal settlement paid in stock. We typically invoice clients annually for third-party service contracts and software licenses during our second fiscal quarter. The volume of annual billing is higher this year compared to the prior year, resulting in an increase in deferred revenue of $337 thousand partially offset by increases in accounts receivable and prepaid expenses along with the $128 thousand use of cash for the payment of accounts payable and accrued liabilities. Investing Activities A $250 thousand certificate of deposit matured on February 5, 2025; $100 thousand was reinvested in a certificate of deposit maturing on August 5, 2025, resulting in $150 thousand provided by the sale of short-term investments. 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.