SideChannel, Inc. (SDCH) Earnings Call Transcript

Greetings. Welcome to the SideChannel Fiscal Year 2026 Q3 Financial Results Update. [Operator Instructions]. Please note, this conference is being recorded. I will now turn the conference over to your host, Brian Haugli, Chief Executive Officer. You may begin.

Thanks for everybody for joining. I'm Brian Haugli, CEO of SideChannel. Ryan Polk, our CFO, is also with me. I'll give you the quarter, then I'm going to go straight at the liquidity question because I'd rather you hear that from me than find it in the filing. Ryan will take you through the financials then I'll cover where the business is heading, and we'll open it up. Q3 was our first quarter of year-over-year revenue growth in 5 quarters. Revenue was $1.8 million, up $21,000 or 1.2%. That's a small number, but I want to be clear about why it matters anyway. For more than a year, this company was shrinking. This quarter, it didn't, and it stopped shrinking while we were also taking cost out. Gross margin was 54.9%, up 790 basis points from 47% a year ago. Two things drove that. Enclave carries a high gross margin, and it made up more of the mix, and we got better utilization out of our delivery team. Operating expenses were up 1.6%, $18,000 on a $1.1 million base, essentially flat against a quarter a year ago that we've since restructured. Net loss was $134,000 or $0.03 a share against $261,000 or $0.06 last year. We cut the quarterly loss roughly half. And we grew cash sequentially in the quarter, small, but the direction changed. Nine-month numbers are not as good, and I'm not going to present them as if they are. Revenue is down 7.7% to $5.1 million, net loss -- sorry, $974,000 against the $510,000. Most of that damage is in the first half before the cost structure changed. Cost reduction started landing in the March quarter. Q3 is the first clean look at the business after that work. Now the part I'm not going to make you ask about. Our 10-Q includes a going concern disclosure and it states that substantial doubt about our ability to continue as a going concern is not alleviated. That is unchanged from our last filing. I want to tell you exactly what that means and what it doesn't. We end the quarter with $326,000 in cash and no debt. We have no credit facility. Net working capital was around 15,000. Management's position stated in the filing is that to operate for the next 12 months, we need to either raise additional equity or debt on acceptable terms or eliminate a significant portion of our product offering and cost structure that goes with it. Neither of those has happened yet. That is why the doubt is not alleviated. Here's what I'd ask you to hold alongside that. The accounting conclusion did not change this quarter. The operating trend underneath it did, revenue grew, margins expanded 790 basis points. Operating expenses were flat. We cut the quarterly loss in half in the cash grew sequentially. Those are the inputs that eventually move the conclusion. One quarter doesn't move it. It's the right direction. One structural item worth noting, roughly 231,000 warrants from our 2021 private placement expired between March 31 and April 16. Those warrants carried terms that significantly restricted our options for raising capital. They're gone. Our capital structure is cleaner today than it was 2 quarters ago. We also withdrew the Series A Preferred designation in Delaware on July 27, which returns those shares to undesignated preferred available to the Board. I'm not going to speculate about outcomes on this call. I'm just telling you what the filing says and what changed operationally. I'm going to ask Ryan to take you through the numbers.

Thank you, Brian. As Brian mentioned, revenue up this quarter. The mix for that revenue continues to shift as we've seen so far this year with the growth in our services and software category, that category of revenue is now larger than our vCISO revenue. And this is the first time that we've reported that. We're now at 1.6% of revenue from our cybersecurity software and services versus 48.4% for vCISO. Inside of that vCISO category, retained revenue is essentially flat. Our decline in that category year-over-year is really a new client acquisition gap, not enough delivery or a retention problem. And speaking of retention, trailing 12-month revenue retention, which we report each quarter is up to 68.2% at the end of June versus 63.6% at September 30. We saw improvements in both vCISO up to 61.7%, and our cybersecurity software and services up to 77.6%. A third -- or actually, a second theme that I want to highlight in this update is also something Brian mentioned, which is our operating expenses, they were up just slightly for the quarter on a year-over-year basis, up just 18,000. And so the year-over-year trend of significant growth in operating expenses that we reported in the first half of the year has been reversed. We mentioned in some previous reports that we have cut significant amounts of operating expenses out of our structure and you're seeing the benefit of that in Q3, and you'll see that again in our Q -- in our -- in the K that we filed after our September year end. The balance sheet, as Brian mentioned, continues to hold no debt, cash up slightly on a quarter-over-quarter basis. Reporting positive cash flow from operations for the third quarter. And so we end the quarter also with a healthy deferred revenue balance of $663,000. So Brian, thanks for the opportunity to give that update. I'll pass it back to you.

I want to point out one number Ryan just gave you the most important number and thing in this filing and it isn't in the headline. So for the first time, cybersecurity software and services is a bigger share of our revenue than vCISO services, 51.6% against 48.4%. A year ago, that was 42.7% against 57.3%. That crossover is a strategy working, and it's why gross margins moved 790 basis points. Underneath it, two things are true at once, and I'd rather give you both. The good one, our vCISO retention improved and retained revenue held flat about $2 million. Clients to work with us stay and the work is profitable. What sell off is new vCISO logos, $486,000 this year against $1.2 million last year. That's a demand generation and a sales capacity problem. It's a fixable problem, and it's a different problem than clients leaving us. The hard one. We spent an additional $506,000 on selling and marketing over 9 months and revenue went down. I own that. Some of that spend built the pipeline and the partner motion that produce this quarter's churn. Some of it didn't keep, some of it didn't earn. And we reset the cost structure accordingly starting in March quarter. You're seeing the result in Q3 operating expenses being flat. On the platform side, Enclave brings asset intelligence, network segmentation and certificate life cycle management together in one place. This quarter, we shipped the integration that pushes Enclave data into GRC workflows as continuous compliance evidence. Asset inventory, certificate expiry, host firewall coverage, segmentation and vulnerability status collected automatically instead of screenshot it once a year. That's the difference between an assessment and a program that you can actually run. It's the infrastructure I wanted when I was the one running security programs of the Pentagon and then as the CSO at the Hanover. The team should be able to deploy it and run it with their partners without adding headcount. On AI, and I'll be precise, because there's a lot of noise in this word right now. We're using AI inside our own delivery to speed up assessments, policy documentation and risk deliverables and inside sales and marketing operations. The objective is more client coverage per practitioner without proportional head count and without taking our CSOs out of the room with the clients. That's a margin story, not a product announcement. Where that leaves us? We're a smaller company than we were a year ago and a more efficient one. The quarter turned. The balance sheet is thin and we've been direct with you about that. Our job for the next 2 quarters is to convert the pipeline into new logos and keep the cost line where we put it. Operator, I'll turn it over to you for questions.

[Operator Instructions]. We currently have no questions in the queue. I'd like to turn the floor back to management for any closing remarks.

Okay. I was expecting questions, but -- well, thanks, everybody. The short version, the quarter turned, the margin structure is materially better, and we've been straight with you about the balance sheet. Ryan and I are reachable if you want to follow up. Thanks, everybody, and have a good one.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.