SideChannel - Earnings Call - Q1 2025

Executive Summary

• Q1 FY25 revenue grew 9.9% YoY to $1.91M with gross margin of 45.8% (down 290 bps YoY); OpEx fell 2.1% YoY; net loss improved to $0.20M; cash, cash equivalents and short-term investments ended at ~$1.4M.
• Management reiterated no formal financial guidance but emphasized three priorities: accelerate Enclave (software) adoption, expand vCISO services, and deepen program adoption at existing clients; near‑term cash from operations will fund higher sales and marketing investments.
• Execution catalysts: growing federal traction (now two DoD clients), new Enclave “machine identity management” capability, channel strategy leverage, and APAC business development addition; all positioned to expand Enclave placements and pipeline.
• Watchlist risks: gross margin compression vs. prior year (45.8% vs. 48.7%), and trailing 12‑month revenue retention down to 66.1% (from 72.3% in Q3 FY24) as churn normalizes; cash remains stable enabling targeted growth investments.

What Went Well and What Went Wrong

• What Went Well

  • Revenue and cost control: “Revenue of $1.9 million; 9.9% greater than FY 2024 first quarter… Operating expenses decreased $24 thousand, or 2.1%... Net loss of $195 thousand” and cash/short‑term investments up to ~$1.4M.
  • Strategic clarity and higher‑margin mix: CEO’s three objectives place Enclave first as a scalable, higher‑margin product to reinvest in R&D and profitable growth.
  • Federal and channel progress: Two DoD clients with an initial paid POC expected to scale; Enclave added machine identity management to win sector‑specific use cases. Also expanding channel motion to sell “to one, reach many” via MSP/MSSP partners.

• What Went Wrong

  • Margin compression: Gross margin declined 290 bps YoY to 45.8% (vs. 48.7% in Q1 FY24), pressuring profitability.
  • Retention drifted lower: TTM revenue retention was 66.1% as of Dec 31, 2024, below 69.2% at FY24 and 72.3% at Q3 FY24, indicating churn or down‑sell weighed on services.
  • No numerical guidance: Management reiterated they do not provide formal financial guidance; investments will step up for sales/marketing, which may mute near‑term cash build.

Transcript

Ryan Polk (CFO)

Greetings. Welcome to the SideChannel Fiscal Year 2025 Q1 Financial Results Update Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

Brian Haugli (CEO)

Thank you, and good afternoon, everyone. It's Brian Haugli. I'm CEO of SideChannel. I just want to cover quickly kind of our view of how Q1 went. We won't rehash everything that's in the queue, but you will undoubtedly have some questions about it, so we can answer those in a bit. I'm joined by our CFO, Ryan Polk. He'll touch some highlights on the financials. Really, Q1 for us, obviously, it's an off-calendar quarter than our fiscal quarter. We are looking at October, November, and December. From a services standpoint, as we've talked about previously, there's a bit of seasonality. There's also some differences in how people kind of treat the end of the year. The US government, a lot of governments start in October 1, so we align with them. A lot of other companies are ending their year, and they start January 1.

It's good and bad. Some companies are looking to cut costs in that last quarter, and they're not spending, and they're waiting until January 1 when they get a new budget cycle to start. We also see kind of last-minute spends pop up, especially right after Thanksgiving. You start seeing companies start saying, "Hey, we've got some extra budget. We got to spend it this year." We're definitely seeing all of that. It's just the natural way that the business goes, especially with services and software purchases. Overall, I think we started off 2025 very well. I'm excited us being already into February and what we're working on in Q2. It's kind of just looking at Q1. I want to touch on kind of three major aspects and focus areas for the company.

We've debuted this to the board, socialized this, instilled this internally in the company. It's really our go-forward business strategy. I'll just hit some high points. A version of what I'm going to say will obviously be in a transcript from here, but we'll also have one that goes out in our monthly IR newsletter. If you don't receive that, shame on you. If you're on this call and you're not receiving our IR newsletter, go to our investor page and sign up there, and you will get added to that list, and we send that out monthly. Ryan and I work on that personally, and then through a couple of other people doing some QA, then push that out for everyone. It's really just trying to highlight some of the things that are happening from my desk, Ryan's desk, the company as a whole.

We like to just try to keep the investors informed. You'll see a version of what I'm about to say make its way into an upcoming monthly newsletter. We really have three areas for where our growth is going to sit on a go-forward. We've aligned on this. We've agreed on it. The company is looking at resource planning to support hitting these three strategic objectives. They are in order: growing our proprietary software revenue with Enclave, two, increasing our vCISO, sale, and service engagements, and three, expanding program adoption at current clients. I'll briefly touch on the first one. Why do we want to obviously push the needle and everything with Enclave? It's recurring revenue for stability. It's a scalable product across markets. It allows us to penetrate larger markets in space, including mid-size businesses and emerging industries, without a proportional increase in operational costs.

If you've been following our story, you know that we're very keen on keeping operational costs under control and managed. Selling software has got a higher margin for sustainable growth. Proprietary software offers significantly higher profit margins compared to services, enabling us to reinvest in R&D, other strategic initiatives, while enhancing our overall profitability. These are all really good things to have as a software company, as a services company with access to software, especially if it's our own intellectual property. The product has been making some really great rounds. As you can see from announcements, we've added some additional salespeople, a new focus on Asia-Pacific, the Middle East, and even looking at Latin America.

You're going to see our spend now really kind of focus on the next 12 months on growing the sales and marketing team, looking at new markets, looking at new sectors, and really focusing, again, on our number one business priority and objective, growing our proprietary software revenue through Enclave. Our second and third points are our business today. We're not releasing ourselves from anything on what's going on with services. We love our services. Our clients love our services. You can see that it's growing. Again, we really want to focus our spend and any types of expenses or costs around the Enclave product. What we are able to do with the vCISO engagements and increasing those, you'll see the sales team, you'll see the marketing initiatives, again, still support what we're doing from a services side. That's really kind of going downstream too.

It's not just this top-level vCISO. We've really been able to do some phenomenal work through broadening our engineering services and capability, our new cloud security and architecture practice, as well as just kind of all-around advisory, risk assessments, strategic assessments at clients, which are great wedges and entry points for us to start working with new logos. Why is increasing vCISO engagements important for us? We're meeting a market demand for fractional leadership. With the increasing cybersecurity threats and limited budgets, we're seeing this at our clients. Organizations are seeking cost-effective leadership solutions like our vCISO and making this a high-growth market segment. We're seeing it take off. It's other industries. We are seeing an increase in competition, although we still believe that we do stand alone on quality because we believe experience matters, and that's how we lead. We're strengthening long-term client relationships.

vCISO engagements build trust and position SideChannel as a critical strategic partner, often leading to other additional services or product adoption such as Enclave. When you're in the position as a vCISO at a client, you're able to then say, "Hey, listen, this is what your program should look like. By the way, I've got a catalog of solutions I know works. This should work for you." Clients are looking to adopt that. Number two here really supports our number one objective, growing proprietary software revenue. By having our services in engagements at clients, we're in a much better position to be able to place Enclave in as the solution to address vulnerabilities, risks, gaps, whatever. We also have the ability and the focus, number three, to expand our program adoption. What are we doing at our current clients? How can we broaden our client penetration?

Expanding program adoption integrates multiple touchpoints within a client cybersecurity framework. It creates deeper relationships and increases overall client value. We have the ability to cross-sell opportunities. We have a comprehensive approach to program adoption, unlock opportunities to introduce complementary products and services, boost total revenue per client. Again, supporting initiatives one and two. We are in a client. They trust us. We are doing the right thing. We have solutions like Enclave that we can then position for them to benefit from. Lastly, our ultimate goal for clients is driving their overall maturity and retaining them. By helping clients implement structured and scalable cybersecurity programs, we can address their immediate needs and create pathways for longer-term retention as their cybersecurity partner. Again, this all leads back to the growth of our brand, the revenue, and the value to shareholders.

I just wanted to kind of highlight really what we're looking at from a strategic standpoint for SideChannel going forward. You're going to see everything we're doing is aligning to these three. In fact, internally, kind of the cadence now is you need to kind of think about if you're working on something, is it supporting and how is it supporting one of these three initiatives? If it's not, we really need to have a good reason as to why we're working on it. This is where we centered the team. I'll speak on behalf of the board, on my executive leadership team, our ELT, and anyone else who's like we've talked about this with. We even did this all-company-wide previous week at one of our all staffs. There's an excitement and understanding around this. It makes sense. It aligns everyone.

It gives us a really nice go-forward. It's clear. We believe that this is going to be of substantial benefit for SideChannel's growth. With that, I'll turn it over to Ryan. We'll go to Q&A, and then I'll come back to close this out.

Ryan Polk (CFO)

Thank you, Brian. Appreciate that. Just wanted, before we get into the comments around the Q1, I want to remind anyone on the call who has not yet participated in our annual meeting that voting is still open for our annual meeting, which is held next Wednesday, February 12th, at 9:00 A.M. Eastern Time. Please reach out to me if you need some help accessing our voting site, and I will assist you in casting your ballot in our annual meeting. It's been kind of a same-story type quarter for us. Revenue growth just under 10% this quarter, year-on-year, every year basis. Cash increased our fifth, I think our fourth consecutive quarter, I should say, fourth consecutive quarter of cash increase, cash provided by operations. We end the quarter with $1.4 million of cash and cash equivalents and short-term investments.

Our short-term investments, as noted in the Q, are time deposits, another way of saying certificates of deposit. We are putting our cash into some interest-bearing accounts like certificates of deposit to generate a little bit of interest income. That is really the nature of our short-term investments. We're not doing anything with mutual funds or other forms of securities. Looking ahead, we've been saying that the cash line is there's plenty of things in place that would likely allow us to increase our cash from operations. Brian just mentioned three things in our strategy and some plans that are being developed to support that strategy that are likely to use some of that cash provided by operations. We don't give guidance on any of our financial measures.

If you've seen us grow cash for the last four quarters, just keep in mind we are going to be making some investments using that cash to do things that we think get the word out about our products and services to more people with the intent of having that generate revenue increases in future quarters. Those conclude our summary comments on the financial statements for this quarter. John, we'll take questions now from the phone line.

Operator (participant)

Absolutely. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Once again, please press star one if you have a question or comment. It looks like our first question is coming from Luke Wheatley, private investor. Please proceed.

Luke Wheatley (Analyst)

Hey, Brian. How's it going?

Brian Haugli (CEO)

Good. Thanks for joining.

Luke Wheatley (Analyst)

Yes, sir. Just a couple of questions. I saw the team, how you thought about wanting to expand internationally before really getting things home at home. 10% is a good growth number, but it's not excellent. I know you all want excellent. How did you think about building out that sales team internationally before adding more salespeople at home?

Brian Haugli (CEO)

Yeah. You cut out. Maybe it was my phone. I apologize. I just want to make sure I get your question right because it cut out a little bit. You're asking about the sales team just as we're building it. We've recently added DT. His real name is David Tran, but he goes by DT because it's really beneficial for us because we have now three Davids on the sales team. DT's focus is on APAC. Nick and I know him from just working in the industry, and he's just very well regarded. It was kind of opportunistic, honestly. He was kind of looking around at other products from a sales standpoint and started talking to Nick, our CTO, and me about what we're doing with Enclave. He was very intrigued.

He's got a deep background in network engineering, so he's got the skill set to do this. His entire network is Asia-Pacific, South Korea, China, Japan, Kuala Lumpur, Malaysia, Australia, and also in the Middle East. He was just like, "Hey, listen, I would really love to get involved. I really like Enclave. I think you could do really well. Let me bring this out into these markets. You guys aren't really out there." He's got some insights into what these markets are looking for. It's actually kind of informing our product roadmap. Honestly, it was kind of opportunistic. I think we started out Enclave just trying to focus on US and Canada, also obviously US federal markets, specifically DOD markets. Look, this opportunity came up, and it just seemed like a very, very good one. It's the early days.

Like I said, Nick and I know him from elsewhere, and we've seen him in action. He does have the network. He does have the cred. We're just looking to kind of capitalize on an opportunity and get out there to some of these other markets. Hopefully, that kind of answers your question because I'm still.

Luke Wheatley (Analyst)

Okay. Gotcha. No, yeah. That definitely helps to answer the question. I really appreciate that. Just a quick follow-up, if that's okay. How do you work with.

Brian Haugli (CEO)

Yeah. Hey.

Luke Wheatley (Analyst)

Yeah.

Brian Haugli (CEO)

Just real quick, I kind of missed what are we doing with the US team, right, and the core team here. You would not have noticed we just brought on Rachel. We stole her from CrowdStrike. Very motivated individual, really understands the space, and just really personable. She is just doing business development. She is getting us, building us kind of that top-of-funnel, those qualified leads. She is already showing a lot of promise, and she is already actually getting things into the sales pipeline. I think she is on, I mean, we hired her right before Christmas. What you are going to see from the sales team is growing that type of role, getting more people who are going to focus on getting meetings, getting us in front of the right opportunities.

The rest of the team that we have is obviously there to support that and then close those deals and get us into accounts, manage those accounts, grow those accounts. You're going to see kind of the sales-specific strategy is focusing on direct outbound, obviously via Rachel and what Dave Barton are doing. You're also going to see kind of this channel approach where we've had a lot of success with building channel partnerships under Dave Menichello. Now we're going to take that with Enclave and be able to bring Enclave into the channel. That is important because that channel is filled with managed service providers, managed security service providers, other types of VARs and service providers. Each of them have 10, 20, hundreds of clients. We're able to sell to one and effectively sell to many.

Ideally, we're able to get into any of these service providers' tech stack and replace current technologies that they have, and they start using Enclave with all their clients. You're going to start seeing a focus on that as well. That is really where how we're kind of nailing things down from a sales execution. I just didn't want to discount what we are still growing kind of locally, if you will, if you want to say locally from a US standpoint.

Luke Wheatley (Analyst)

Okay. Got it. Yep. Thank you very much. I would love to hear about how you think about compensating your sales associates. What sort of mix is incentive-based, and what sort of mix is just straight salary? Also, on the last call, we had you all, you could not give a ton of background with the Department of Defense contract. I was just wondering if you could give some more background with how that is going and what sort of revenue you all are seeing from that.

Brian Haugli (CEO)

Sure. On the comp standpoint, it's kind of a variety. It's base plus commissions. We try to do tiered commissions. You kind of unlock different commission levels at different levels. Look, you want these guys and girls to be hungry. You want them to be incentivized by doing better at sales. That's what we're trying to align their commission structure towards. Pretty industry-standard stuff. I mean, I don't think we're doing anything that's outside the norm when you look at how tiered compensation structures are built for folks. Obviously, more senior-level people command more senior commissions and structures than more junior-level people. Yeah, I think what we're doing is pretty standard for what you'd see.

Anybody who's come to want to join us, it's kind of understood where they're going to fit and what we're able to do because, again, we're kind of following some standard structures. On the DOD side, yeah, I mean, again, we really can't dig into and disclose a whole lot just on the nature of the clients. We do have two Department of Defense clients now, completely different Department of Defense clients. We're doing this through subcontract because the cost for us to be able to build a direct federal or DOD sales model, that would just be the length on that is longer, and the costs just we're not seeing it. Through partnerships, we're now able to do this.

Actually, the second new client, which looks to be significantly larger than our first DOD client, is actually not just a resale and an implementation, but it's actually an integration into a solution that our partner has been able to position there. It is very exciting from our standpoint, the use case. You'll notice actually the new feature of Enclave. It's called machine identity management or non-person identity, where you and I have a user account that we log on to email or computers. The computer itself actually has an account, and that needs to be managed, and that's managed through certificates. We were actually able to develop a capability into Enclave. Actually, Nick will tell you we already had the capability. We just had to expose the dashboard in it to be able to win this client because that sector is looking for this type of solution.

Believe it or not, the commercial solutions that are out there are not as appealing from everything we have heard and learned from the DOD. We are up to two federal clients now with the product. That second one just started in the beginning of January, first or second week of January. Basically, initial proof of concept, paid proof of concept, and with the intention of once we tick all the boxes on the technical, we have to make sure it works. It does what we say it does, which it does. Once they check all those boxes, they look to implement and roll out to their enterprise environments. Hopefully, we will be able to share more on that as the year progresses.

We probably won't be able to share who or where exactly those are, but I think you will see the revenue numbers come through on Enclave to be able to then determine how big of a solution this is and opportunity this has been for us.

Luke Wheatley (Analyst)

Okay. Gotcha. That is still mostly stuck in your deferred or not even yet? Just still getting it implemented and set up?

Ryan Polk (CFO)

Ryan, actually, I don't know. Is that your answer to that?

Yeah. Yeah. That's true. To date, our invoicing for Enclave has been done at an annual license basis. When that invoice goes into our deferred revenue account on the balance sheet as a liability, we recognize one-twelfth of that license fee each month as revenue.

Luke Wheatley (Analyst)

Okay. Got it. I appreciate it. Final question, if you'll allow me. I really appreciate the back and forth here. Give me one second here. Is that Carolina Advanced Digital that you all are working with when you're selling these products to the DOD?

Brian Haugli (CEO)

We have a partnership with them, but they are not our partner on these two opportunities that we've and these two deals now. Yeah, Susan and John Jetterbush, the two principals at Carolina Advanced Digital, phenomenal people. Really love working with them. We did work with them to get Enclave onto the GSA and the NASA SEWP federal vehicles. Our other partners also have those opportunities. They are really focused on state level in the southeast. I think some federal, but they really do quite a bit more southeastern state level, state college, universities because they're headquartered down there in North Carolina. The southeast states are really where their focus has been. No, these opportunities have not been through them.

Luke Wheatley (Analyst)

Why are you familiar with them? They're really great folks.

Brian Haugli (CEO)

I do not know them personally, but I was just trying to learn more about your contracts that you can access to the GSA and that sort of thing. I ran into them. Not familiar with them, but ran into the name.

Luke Wheatley (Analyst)

Got it. Got it. All right. I really appreciate it. That's all I had. Y'all have a good day.

Brian Haugli (CEO)

Sure. Thank you.

Operator (participant)

Once again, if there are any remaining questions or comments, please indicate so by pressing Star 1 on your touch-tone phone. We have no further questions from the phone lines. Ryan, I'd like to turn it back to you. See if you have any questions in your queue.

Ryan Polk (CFO)

No questions visible to me in the webcast console. Brian, I think ready for closing comments.

Brian Haugli (CEO)

Sure. Yeah. I just checked the boards online and all my other messages, and I didn't see anything else that we didn't cover. Hopefully, we have covered everything around. There was a nice ask about plans for overseas, but I think we just went over that and new government contracts. Yeah, again, look, we're excited about another quarter in the books. We're already working well within Q2 here. It's kind of, I'll be honest, a little weird kind of looking back to a month and a half ago when we're honestly just kind of thinking about what we're doing right now and going forward. Hopefully, this was valuable for everyone to kind of learn and hear about what our strategy now is, what we're set, and what we're going to grow towards. Obviously, if you have any questions, please reach out.

There is a—excuse me—there is an IR email address that you can reach out to. That is obviously just [email protected]. Feel free to, if you have any questions or you want to follow up, you can get in contact with us that way. Check out sidechannel.com. We have the newsletter, like I mentioned. Please get yourself added to that list so you can stay up to date with our weekly or, sorry, our monthly newsletter on investor relations, really just trying to tailor towards you, shareholders, and interested parties. With that, let's keep going. I look forward to speaking to you in a couple of months and moving things on for 2025. Thank you.

Operator (participant)

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

Ryan Polk (CFO)

All right, John. Thank you.

Brian Haugli (CEO)

Yeah. Thanks, John. Good stuff.

Operator (participant)

Thank you. Thank you, gentlemen.

Brian Haugli (CEO)

Take care.

Operator (participant)

Take care.

Ryan Polk (CFO)

All right.