SideChannel, Inc. (SDCH) Earnings Call Transcript & Summary

Greetings, welcome to the SideChannel Inc. Third Quarter Financial Results Call. [Operator Instructions]. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Brian Haugli. You may begin.

Thank you. Good afternoon, everyone. Brian Haugli, CEO of SideChannel. I'm joined by our CFO, Ryan Polk, and we welcome everybody to our call. I'm going to go over a number of highlights of the company, and then Ryan will dig into some financial aspects and highlights. Obviously, the Q was released this morning before the bell, and then we will also go into Q&A. So we have some, I believe, pre-submitted, and then we can obviously take calls -- or sorry, we take questions during this. So I will begin, make sure I've got my phone good, so overall, another good quarter for side channel. I believe we are in the -- still in the right space, at the right time, focusing on the right types of clients and the right types -- with the right types of solutions, when I kind of -- I like to have discussions internally with the team from time of the top down, so I'll take that same approach with everyone here. Really starting in the industry as a whole, looking at the macroeconomic factors of what we're seeing across the U.S. and the globe, we are seeing clients becoming a little bit more budget aware or being more budget conscious. This is actually advantageous to side channel because we are focusing our capabilities towards budget aware, budget-conscious clients, specifically, obviously, the mid-market and emerging companies. So we're seeing some benefits out of this, obviously. But to be honest, we are seeing clients make some decisions about the security posture that is factored into sales and marketing, although I think our numbers are showing and our approach is showing that we're able to overcome that. The industry as a whole is also changing and adopting a lot more regulation, and I'll touch on 2 of these areas a little bit later that are definitely benefiting the work that we're able to do and what makes us attractive to clients. Digging into the organization itself, looking at starting with sales, we've grown the team to 6 members of the sales team. We've moved around, and I think we've structured the -- that part of the organization correctly for where we are right now as a company in its growth trajectory. We've been able to bring on a new account manager, and this person's role name is Matt, is able to focus on expansion inside of current clients. So it's not just enough to be able to land new clients. We want to be able to bring them more capabilities, more services, obviously, than increasing our revenue. So with the new focus on account management within the client base, we're looking forward to a lot of really good things from the sales team on a go-forward basis. Our sales development reps are SRs who are folks who are outbound, really outbound focus. They're calling their on social. They're doing outreach to prospective clients and setting up and they're setting up leads and those leads are turning into discussions, demos, proof-of-concept and then eventually sales. Our close rate is still very high. We're very proud of and very excited about the fact that when we are getting in front of clients, our close rate, our ability to actually become -- or getting in front of leads, our ability to make them a client is still very high for us, and we've been holding those numbers all along. And I feel like that's just an indicator to what we're actually providing to the market, and that's what the market is looking for. So we have the right products and services at the right time that the market is looking for those types of things. We've also started the sale of our Enclave product. We have landed 2 clients of our Enclave micro segmentation and zero trust product. We've been able to do this actually through a channel partner. And I think this is an indicator that the MSPs, the managed service providers out there, and eventually, as we move over to managed security service providers out there, see the value that they can bring to their client base with our product, and we've been -- we're very excited about that. I want to give a lot of kudos to the sales team for their ability to make that happen and bring that through the entire sales cycle. Moving over to marketing, the campaigns that we've got are still working. They are increasing. They are a variety. We go across social and e-mail, and there's a lot of great impact. There's a lot of good interest in our message, and that's obviously bringing in lead potential clients and clients and then ultimately, revenue to side channel itself. So we're still strong on social. If you're not following us, I definitely recommend all of you to subscribe to what we're doing on both LinkedIn, Twitter, but also we're putting on a tremendous amount of content on YouTube, both educational and informative on just what's going on in the industry, what's going on with in cybersecurity as a risk, but also what we're doing with our products and our services directly. So you'll continue to see that. I know there's a number of people here from the online channels, and I welcome you all. I also want to just -- we do respond and hear what you're saying. We're listening to you both as investors and its clients, what you're seeing in the world, and we want to be able to factor that into our go-forward and our go-to-market. When I'm looking at our operations internally, it's really focused on excellence and still focused on excellence. We've moved David Chasteen into the Chief Operating Officer role, and he's just excelling at that, and that focus now for all of operations and delivery to have a COO in place who can guide and oversee and lead that part of the organization for delivery to our client base, and that's very important for us because that not only shows our clients that we're serious about delivery to them, but it also shows our team and our staff that we're serious about our ability to keep them informed, keep them educated and trained keep them as part of the side channel mission and then also be able to deliver a very high-quality capability set of services and products to those clients. So we're very excited about how that's shaping up. It's leading to a standardization across our client base, which will eventually reduce costs for us. It will increase our ability to really execute within new clients when we get similar clients to our current ones, we'll be able to really scale what we're doing with those new clients because of our standardization, and we're able to expand our other services. We're seeing an increase, as you can kind of read from the 10-Q. I'll let Ryan hit the real highlights, but we're able to position more of our other services, not just virtual CSO and CSO, into our current client base and provide a very robust capability that allows them to address their cybersecurity posture, and it's appreciated by clients, obviously, because they're expanding their spend with us, but they're lowering their risk in actually a much more financially feasible and cost-effective way, and then we're also increasing our ability to sell products, not only our own products, but others. While we don't want to be necessarily in a VAR or a value-added reseller category, we are in a position where we can defensively sell the products that we know address the controls to meet the gaps, identify their clients, and again, better their posture and lower their risk. So 2 things I want to touch on before I really hand over to Ryan is kind of forward-looking both with Enclave and kind of the regulatory environments that we're seeing change side channel is going to be in a position to benefit from. First with Enclave, obviously, we've had our first sales, which is phenomenal, and it's always gratifying to see customers, paying customers, see the value of something that you've put an idea from conception into creation and then implementation, but we didn't stop there. What you're going to see over the next couple of months is the customer feedback and the industry feedback that we've gotten on Enclave, you're going to see the features and the capabilities that we're able to now start debuting and bringing out. We've listened to our clients. We've listened to our customers, and we've heard what they would also like to see in a product like this, and we've built those capabilities. So our focus around asset identification, asset management, our ability to do data flow mapping inside of an environment, our ability to identify vulnerabilities on endpoint devices and assets. These are all really key controls within any cybersecurity program that's being built. -- and yet they are traditionally not focused on, and it's because they're difficult to do. I'm not going to live as a former CISO, -- these are generally difficult controls to put in place, and that's why we focused on them. We wanted to go after what was hard, and we knew that it was -- it ended up being a priority for clients to be able to do these things, yet knowing that they don't address them causes them paying later. So our ability to release these new features over the next couple of months, you'll see in August and September, the new future releases is just going to make this product so much more attractive to our current client base, but also to new clients because of how we're approaching addressing these cyber risks with the only product, and then I think looking at the regulatory environment, there's 2 components that have come out recently that we're going to be able to capitalize on and the first one is the Department of Defense's new CMMC requirements. We've been kind of waiting the industry as a whole has been waiting very patiently for the DoD to finally kind of put their stamp of approval on and finalize the CMMC requirement. If anybody is not familiar with CMC, the high level is this. There's 3 -- there's over 300,000 defense industrial-based contractors out there in the United States, and what is that? Those are all the organizations, manufacturing and nonmanufacturing that support the Department of Defense, and the Department of Defense has built a new regulation that going forward in order to do work with the DoD to be able to have a contract with the DoD to be able to gain any revenue from the DoD, you will need to meet the CMMC regulation. We are positioned to be able to build the programs for those clients and help them meet those regulations. This is going to be an area that is going to significantly pick up because many organizations in the mid-market space in emerging tech, which I can tell you the defense department loves Emerging Tech. They do not have the in-house capabilities to be able to address what's needed, and we feel very confident in our ability to build those programs. I can say that because it's evidenced by the fact that we build today for our clients, their programs, and we build TMMC ready programs for our clients. So that's one aspect that we're looking forward to, and we see it as a growing market for side-channel to be part of as a solution provider. The other one is the if anybody isn't following, I mean, this is all investors on the call. So maybe you've seen this, but if you haven't, the SEC just laid out their brand new final rule on cybersecurity requirements around disclosures for publicly traded companies, there's around 8,500 to 9,000 publicly traded companies underneath SEC-registered guidance. They have mandated now that by the end of this year, companies will need to start disclosing their cybersecurity posture across a variety of different aspects, things like does your Board have oversight on cyber. Does management have oversight to what do they do around cybersecurity, who has experience in cybersecurity. What are your processes to be able to address cyber risks, your ability to protect, detect and respond to risks that manifest into actual incidents? And then obviously, reporting within 4 days, any material risk or any material incident to the SEC. We are in a position to be able to build those programs for those clients, and again, when you look at the Fortune 500 and only 2/3 have a CISO, really, what does that say for the other almost 8,000 companies about where is their security leadership, who's making security decisions, who's really at the helm and 5 channel is in a position to be able to be that leader and be that driver for security program, which leads to us bringing in other new capabilities, selling new products, positioning more of our services. So while the economic factors that we're seeing kind of across companies is leading to them tightening their belts, the regulations are working in our favor, and we are in a very good position to be able to capitalize on the fact that those regulations are now in place, and honestly, they're going to impact more mid-market, small business and emerging companies, then they're actually going to impact the larger companies because again, you got remember, enterprises have the resources to be able to have these programs in place. But the mid-market and emerging companies traditionally do not, and I can evidence that by the 5 years that we've been running this company, we really know the mid-market, and this is exactly what we see day in, day out. So regulations like this, mandating that these controls now being put in place is going to cause these companies to go searching for providers, and we are very, very well positioned to be that provider to those clients. So with that, I will turn it over to Ryan, who will highlight the aspects of our financials, and then we'll go into some Q&A. Ryan?

Yes. Thank you, Brian. Another good revenue quarter for side channel revenue of $1.8 million in the quarter, which is just a little over 37% higher than the same quarter last year. Sequentially, we grew by 8% or just a little over $100,000 or $3,000. Our margin improved over the second quarter of 2023 and our margin improved significantly over the prior year. This year, in the third quarter, we reported gross margin of 49.9%, which is 4.3% higher than the prior quarter, second quarter 2023 and which was 5.9% higher than the third quarter of 2022. Net loss for the quarter was just about $700,000, a little less than $0.01 a share. That includes $214,000 in a nonrecurring, noncash business combination-related expense for the shares that were issued on May 4, 2023 as part of our consolidation or business combination between Side Channel and Cypriot, which closed on July 1, 2022. Our trailing 12-month revenue reached $6.1 million for -- for the 12 months ended June 30, 2023, and revenue retention was 70.8% for that same 12-month period ending June 30, 2023. We ended the quarter with just over $1.4 million in cash. Cash used in operations during the quarter was $432,000, which is a significant reduction from the same from the prior quarter, and operating expenses really were flat. If you looked at the reported numbers in our 10-Q compared to the second quarter. But when you remove the nonrecurring noncash business combination expenses, we're actually showing a decrease. It's over $200,000. We announced last quarter in this call and in our press release around this call, that we had initiated almost $900,000 of annualized cost reductions, and so the reduction in our operating expenses that we're reporting in this quarter reflects the announcement that we made last quarter about the annualized operating experience reductions. In other words, we expect the reduction that you're seeing in our operating expenses to persist in future quarters. We also mentioned the 1 quarter ago that we expected full year revenue to range between $6.3 million and $6.5 million. We're not changing or altering that projection. We said the gross margin would be somewhere in the range of 50% to 52%. Again, we're holding on that projection, and that's for the full fiscal year, and we also noted that we expected operating losses to be lower in the second half of the year compared to the first, and you're seeing that with these results after we have to adjust for the nonrecurring noncash business related -- sorry, business combination-related costs. So we have the growth in revenue continuing. We have an increase in margin continuing, and we have a reduction in operating expenses, and we -- that's why we are confident that we can say that at this point in time, we do not believe that any further cash is needed to fund the operations of the company. So Brian summarized the financial results, and I'll I think pass it back to you and to Jenny for Q&A.

[Operator Instructions]. Your first question is coming from Rodney Baber from Paulson Investments.

Well, congratulated on getting a couple of Enclave orders in our customers. Can you give us just a little more thought process on that? You've got 2 different clients. How many seats is that involved? What kind of revenues are you talking about? You use those 2 clients to give us some perspective on what this thing could be, and let's talk a little bit about the size of that opportunity because I know there's a massive market out there of people that could use this product. So take this as a good time to kind of give us an update on that sector of what you're doing, if you would.

And Rodney, Brian will give you the -- Brian will answer or give you most of the answer to the question you're looking for. I do want to highlight that the un-played customers that Brian mentioned did not -- we did not have revenue with those customers in our -- in the June 30 quarter. The revenue from those customers is going to appear in our fourth quarter, which ends September 30. Sorry, Brian, I just want to make that point clear to everyone before we or you get into the meat of Rodney's question.

No, that's great, so I don't have the actual license counts at the end, but I would characterize both of the clients as small, under 200 seats each, and that's because the MSP, the managed service provider that actually approached us saw the value out of the Online tool and then wanted to bring it to his client base predominantly works with small businesses, so this is not -- these are not enterprise sales. Again, we've been focused on the mid-market and emerging companies, so the license counts are characterized kind of by that size because that's who that MSSP say that MSP is servicing.

What is -- like 200 seats, what number is what you'll get when you start getting revenues on? How much do you charge for a seat?

So I actually go online, so we're transparent about our pricing, our pricing models and our pricing is all publicly available on the website. I'd have to bring that up and do the math, but I unfortunately don't have the per seat license off. We also have 3 versions licenses for the product itself. But yes, our pricing is available online. We are very transparent about that, again, because that's how the mid-market likes to purchase. They want to know pricing in demos on the first call.

I think we've been -- internally, we've been thinking and expecting that initial enclave adoption is going to come and sort of drips and drafts because it's a new technology, and it's putting a pretty significant piece of software at the endpoint inside of a company's network, so you would expect, because it's new and because of how deep it's penetrating into the networks of companies that there's going to be the need and an appropriate need for people to really investigate, check this out, get familiar with it, and that's what we're experiencing, and that's what we're seeing with these first 2 clients, and we think we're feature appropriate. We think we're price point appropriate. There's a need in the market for what we're doing, and we're -- we think these initial reactions or adoptions of the technology are in line with our expectations for people to sort of -- let's say, to use a common expression, try before you buy fiber type approach. I will... And Ron, we haven't really given any projections about what we think Enclave is going to do. So we don't want to talk any numbers in that regard. But I think I think as we get some more -- as it becomes a more material component to our financials, we will definitely begin to call that number out, you'll see that in future quarters. But right now, we just haven't given any projections and we're going to be hesitant to do that. Well, I wouldn't look at the projections. I'm looking to try to size the opportunity that Enclave all for sure, the company create value for the stockholders, and now we have some points on the board.

I'm just trying to get a sense of what this could mean, and my understanding from Brian is there's thousands of potential customers for this, so I know we're a long way from that, but I'm just trying to get a sense of how significant this is going to be to the company. And let me jump out of the queue and I could have a couple of more questions, but we can pursue this some more. I'm just trying to get a sense of now that you've done something with it what that's going to mean.

So I'll jump out for a little bit. I actually do want to be able to answer. We were able to pull this up, and thanks to Trent, who's also our Head of Sales and sent this to me at the exact same time I was able to navigate to the website. We are selling the product per license for $7 per month to $15 per month per license. So the pricing is right in that ballpark, and that is right in line with what we're seeing the competition in other similar products out there being priced at. But yes, if you do navigate the sidechannel.com/enclave or you just go to sidechannel.com and you click the top, and you'll actually notice if you haven't -- we have a brand new website in kudos to our marketing lead for getting this shaped out to really deliver the message of what we're about and characterize today. If you click on products at the top of the side channel page, you'll see that drop down. You'll see Enclave right there and from there you can get to the pricing.

And Rodney Brian mentioned earlier, we mentioned earlier that we got a couple of new releases coming out that we'll announce the details of in August and September, and in each of those, these aren't minor enhancements to the product. They're actually sufficient -- they're enhancements that are sufficient for us to add to the pricing. So it becomes a more -- it becomes a larger potential per seat price for us.

One other quick thing, and then let me jump out of queue. But this regulatory thing that you talked about a little bit in detail today, that these companies are going to have to face at some point, and I know how companies can have mandates like this and they can just not care about them until the government calls them and says, you got to do something about it, and that sometimes takes years. But if they're going to deal with these in a timely fashion, size that market potential for us a little bit, give us a thought about that what do you think that could be over time? How big of a deal is that for side-channel.

Yes, so if I look at -- if the numbers I've been using are this, there's roughly 8,500 to 9,000 publicly traded companies that are considered SEC registrants. The SEC's new disclosure rules that have just come out apply to all of them. So there's very few exceptions to the rule, so we're basically talking about a market of 8,500 to roughly 9,000, just say 9,000 companies, the Fortune 500, right? So if we remove them kind of that first or even the first 1,000, you've got at least 8,000 companies that are now sitting in a position that by December of this year, need to start factoring into their disclosures on their 10-Qs, their Ks or anything else that they're publicly filing underneath and to align to SEC regulations and rules, they're going to need to start disclosing what their cybersecurity posture looks like, what their processes are, what their leadership team is and their capabilities, what their Board oversight looks like. All of these things are not going to be as just as easy as writing the paragraph as a disclosure and saying, okay, we thought about it. We wrote a disclosure. Each of these -- all these companies are going to need a capability or a set of capabilities to back up the disclosure statement that they are going to state. And what you're actually going to see from side channel is we're going to eat our own dog food first. We're going to write and publish our disclosures on how we have our cybersecurity and how we meet these things because we're publicly traded, but looking at the rest of the market. I mean, on the OTC itself, Ryan and I had some great conversations this week in New York learning about the size of the OTC market, and there's 2,000 companies right there that are all sitting looking at this new disclosure requirement going, I don't know how we're going to say the right thing to make investors very comfortable that we are doing the right thing about our cybersecurity posture. So those 2,000 companies are going to be trying to really kind of work through and figure out what that is. We are positioned to build those programs. That's what we do for our clients today that are not publicly traded, and we do that for our clients that are publicly traded. But now there's a requirement that is mandating that this gets put into place. So the market I see is that about 8,000 companies under the SEC regulations that are going to have to build a program, define it and be able to disclose it.

How do you build for this? What kind of business model does this product have for? Is it software? Or is it a customer service thing where the CISO gets involved and helps you -- how does this work?

Well, what SideChannel has been doing all along has been a combination of tech-enabled services and product. So our ability to step in with services and products are what's going to be able to meet this demand. Again, cybersecurity spend, as we see across the years, 60% of cyber spend is on services, 30% is on software, so we are positioned to be able to address that 90% of the spend in the market. So this falls in my mind, Rodney, like this falls right in line with what we're already doing and successfully doing and demonstrating to -- the Street, people want and we have what they want, which is a cybersecurity program, which is a mixture of products and services. No one is buying -- there's no silver bullet out there. That is one product that everyone is buying and it meets all the needs. It is a combination of people, process and technology to be able to put together a cohesive cybersecurity program, especially one that is going to have to stand up to SEC oversight.

How are you going to market that to people? How does the story it out about you guys having this.

I think our ability to just go out to the publicly traded companies, also partnering with the boards, right? So our ability to work with OTC markets and have direct access to those 2,000 organizations that are listed on the OTCQB or the other ones -- so I mean it's -- as far as like a go-to-market, the list of who this is applicable to is very, very public, right? If you have a stock ticker, you are somebody that we can talk to.

But there's 3, let's call them referral sources that we think -- well, we don't think we know are endorsing what we're doing, and those are SEC attorneys. Those are Investor Relations professionals, and so far in the conversations we've been able to have at least the OTC markets. So there's that universe as we begin to engage with the principles inside of those different service areas directly, that will be a key source for us to market what we just talked about.

Well, I can do more of this off-line with you, but that's a good start on hearing about it because we'll see how quickly everybody responds to second care, this new mandate. I hopefully don't jump on it, you guys will get some real momentum from that. But it sounds like a great product. Brian, I know you've talked about this regulatory thing for some time coming out in a positive way, so it's good to see this develop -- and good luck with everything. Let me jump out of the queue then. Thank you.

[Operator Instructions]. Okay. We don't appear to have any further questions, jump into queue.

Yes. We didn't -- Ryan, I didn't see any, but did we have -- I didn't see any pre-submitted or prewritten questions at all?

Okay. I will let you know, everyone jumps in. We have a question from [ Jackquelin Gaston ] who is a private investor. Jackquelin Your line is live.

I did submit a question earlier. It was about the partnerships that we have with dark beam, and I forget the other company, what exactly does that entail? I mean, are we licensing enclave to them and they sell it and we get a kickback -- or are we partnering with them as an equal partner? I guess I'm not understanding what the partnership entails.

Thanks, Jackquelin, great to hear from you. The dark beam relationship partnership is, first, is a bilateral and bidirectional referral source. So where their product, which is a threat intelligence type capability is appropriate for our customers, we're selling or actually we're reselling their product to our customers, and then conversely, they have direct sales themselves, they're a U.K.-based company, but they have direct sales themselves in the U.K. and the United States, where they're able to turn around and refer side channel and our capabilities to those clients because the functionality and what we can bring to bear does not really overlap with what they do, so we're able to partner and not step on each other's toes, so there's a bidirectional revenue and referral going on with them. I think they've got a great product. They think we've got a great product and a great set of services, and I think what you'll see across the industry is a lot of product companies don't also have services arms, and I think that makes us very unique because we were a services company first who's now building product, so our ability to step in and partner with these types of companies -- and Ryan and I are looking out for who the other partner -- who these other companies are, and Trent, who's our Head of Sales is in constant conversations with companies that want to partner with us because of our focus on the mid-market and emerging tech. So our ability to position ourselves to those companies' clients benefit us and then our ability to resell those products to our clients benefits us. And that's why we pursue these types of partnerships. But I'll also say, we don't go after every single one. Not all of these are great fits for the mid-market and small enterprise. So we are very judicious in our selection of who these companies are that we are going to partner with because there's just a brand impact, but there's also just and applicability that we don't want to waste people, our clients' times with an enterprise solution that they're ultimately not going to be able to afford or really use. So we want to bring the right solutions to clients, and then conversely, we want our partners to be able to best represent us in the right way and bring us to the right clients as well. We don't want to waste their clients' times either. So hopefully, that answers your question. if you have a follow-up.

Roughly mostly, Yes.

Okay. I think that's the end of Jacqueline's question.

Yes.

Okay. We don't know if we have any further questions in the queue, gentlemen. I can hand back to you for any closing statements.

Well, thank you, again, everybody, thank you for taking the time out of your day to listen to us and ask questions. If you follow us online, sidechannel.com, also on LinkedIn and on YouTube, really just kind of looking forward to our -- we're in Q4 right now for us and moving through the year. We're very excited. The whole team -- the whole company is very into what we are doing. We've got a great cohesive unit internally. We've got a great internal culture, a lot of excitement about what we're doing. I get a lot of feedback from people who are my peers and just out in the industry that it's a very quick yes, no, I get why you guys exist, like people need that, and that's just really reassuring to hear from the market and from others, and we're just excited to keep building this company and delivering capabilities to the underserved middle market, so on behalf of Ryan Polk, our CFO, and the rest of the executive leadership team at side channel. I just wanted to again thank you all for being part of this, and have an enjoyable day. Thank you.

Thank you very much. This does conclude today's conference call, and you can disconnect your phone lines at this time. Thank you for your participation.