CYNERGISTEK, INC. The following discussion presents information about our consolidated results of operations, financial condition, liquidity and capital resources and should be read in conjunction with our consolidated financial statements and the notes thereto beginning on page F-1 of this Annual Report.
Overview
We are engaged in the business of providing IT or cybersecurity services,
privacy and compliance services to the healthcare and other industries. Our
business is operated throughout
We support
We are one of the few consulting and advisory companies focused in the healthcare industry, and our years of experience of understanding the industry's unique challenges allows us to provide our customers with services designed around industry best practices and a methodology to evaluate the rigor and effectiveness of their programs to improve security controls, policies and procedures and to protect patient health information. Our team of subject matter experts and consultants are comprised of knowledgeable professionals who have learned their craft both in the classroom and through years of practical on-the-job experience, including as policy makers, attorneys and leaders in cybersecurity, privacy and compliance.
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Our services are categorized into four groups which are assessment and audit, technical testing, program development and remediation, and monitoring and advisory services. These services are delivered as recurring managed services or under consulting or professional services engagements.
·Assessment and Audit Services - identify and measure security and privacy risk of an organization's readiness and verify and validate their programs meet compliance and business objectives.
·Technical Testing Services - test the effectiveness of controls in an organization's environment.
·Program Development and Remediation Services - develop policies and procedures and playbooks to help build out a fully comprehensive risk management program and provide resources to help organizations prioritize, implement and execute initiatives to strengthen their security and privacy programs.
·Monitoring and Advisory Services - provide on-going management and oversight of specific components of an organization's security and privacy programs to address or give alerts when an issue arises and to offer our expertise that they need to accelerate the effectiveness of their programs.
Prior to
Results of Operations
Year Ended
Net Revenue
Revenue was
Cost of Revenues
Cost of revenue primarily consists of salaries and related expenses for direct
labor and indirect support staff. Cost of revenue was
Gross margin was 39% of revenue for the year ended
Sales and Marketing
Sales and marketing expenses include salaries, commissions and expenses for
sales and marketing personnel, travel and entertainment, and other selling and
marketing costs. Sales and marketing expenses were
General and Administrative
General and administrative expenses include personnel costs for finance,
administration, human resources, information systems, and general management, as
well as facilities expenses, professional fees, legal expenses and other
administrative costs. General and administrative expenses increased by
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year ended
Valuation of Contingent Earnout
In 2018, we performed a valuation of the contingent earn-out to the sellers of
Depreciation
Depreciation increased to
Amortization
Amortization expense was steady at
Revision of Useful Life and Impairment of Definite-Live Intangible Assets
At the end of 2019, we made the decision to phase out the Delphiis acquired
technology to move to another third-party platform that provides more
flexibility in the services we provide and allows us to reduce expenses related
to maintaining this tool. As a result, we updated our evaluation of the
estimated useful life of the related intangible asset and accelerating
amortization of the remaining balance of
Additionally, we identified events and circumstances related to the future
revenue projections of the cybersecurity consulting business we acquired in 2017
compared to the original projections that indicated we should review our
long-lived assets for impairment. The Company engaged a valuation expert to
assist management in updating its analysis of the fair value of the intangible
assets. We determined that the carrying value of customer relationships exceeded
its estimated fair value resulting in an impairment charge of
Other Income (Expense)
Net interest expense for the year ended
Income Tax Benefit (Expense)
Income tax benefit was
Discontinued Operations
On
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Liquidity and Capital Resources
As of
? our ability to access the capital and debt markets;
? our ability to manage our operating expenses and maintain gross margins as the Company grows while attracting, recruiting and retaining cybersecurity professionals;
? demand for our cybersecurity services from healthcare providers; the near-term impact of the Coronavirus on our customers allocation of time and resources to cybersecurity and their ability to enter into new contractual arrangements during a period of crisis; and
? general economic conditions and changes in healthcare reimbursement and regulatory environment.
We have historically funded our operating costs, acquisition activities, working
capital requirements and capital expenditures with cash from operations,
proceeds from the issuances of our common stock and other financing
arrangements. Following the sale of the MPS business in 2019, we are now a much
smaller cybersecurity focused business with significantly lower debt balances
and debt service obligations. However, we also have less scale over which to
leverage our operating expenses and public company expenses and are currently
operating in a cash flow negative position while we seek to grow the
cybersecurity business. During 2019, we reported a loss from continuing
operations of
Our operating plan for the next twelve months contemplates raising additional equity and/or debt capital, investing in enhancing our sales and operational resources while also streamlining our operations to reduce costs and improve financial performance while we expand our cybersecurity business.
While we have approximately
? In
? On
? On
If these capital resources are not available, or not available on reasonable terms, we also have the ability to significantly reduce personnel and other variable and semi-variable costs to conserve cash and operate as a going concern. However, those actions if required, could negatively impact growth and the long-term value of the business.
Further, in late 2019, a novel strain of coronavirus was first detected in
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quarantined certain affected regions, restricted travel and imposed significant limitations on other economic activities. The Company's operations team is closely monitoring the potential impact to the Company's business, including its cash flows, customers and employees. If the situation impacts our customers cash flow or resources available for cybersecurity projects, our cash flows, financial position and operating results for fiscal year 2020 and beyond will be negatively impacted. Neither the length of time nor the magnitude of the negative impacts can be presently determined.
As we execute our growth plans over the next 12 months, we intend to carefully monitor the impact of growth on our operating expenses, working capital needs and cash balances relative to the availability of cost-effective debt and equity financing. In the event that capital is not available, we may then have to scale back or freeze our organic growth plans, sell assets on less than favorable terms, reduce expenses, and/or curtail future acquisition plans to manage our liquidity and capital resources. However, we cannot provide assurance that we will be able to raise additional capital.
In addition, our business is subject to additional risks and uncertainties, including, but not limited to, those described in Item 1A. "Risk Factors".
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist primarily of purchase and other
commitments arising in the normal course of business, as further discussed below
under the section "Contractual Obligations, Contingent Liabilities and
Commitments." As of
Application of Critical Accounting Policies
The
We consider the following accounting policies to be those most important to the portrayal of our financial condition and those that require the most subjective judgment:
Revenue Recognition and Deferred Revenue
We operate under a consolidated strategy and management structure, deriving revenue from the following sources:
oManaged services
oConsulting and professional services
Revenue is recognized pursuant to ASC Topic 606, "Revenue from Contracts with Customers" (ASC 606). Accordingly, revenue is recognized at an amount that reflects the consideration to which we expect to be entitled in exchange for transferring goods or services to a customer. This principle is applied using the following 5-step process:
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1.Identify the contract with the customer - A contract with a customer exists when (i) we enter into an enforceable contract with a customer that defines each party's rights regarding the services to be transferred and identifies the payment terms related to these services, (ii) the contract has commercial substance and the parties are committed to perform, and (iii) we determine that collection of substantially all consideration to which it will be entitled in exchange for services that will be transferred is probable based on the customer's intent and ability to pay the promised consideration.
2.Identify the performance obligations in the contract - Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised services, we apply judgment to determine whether promised services are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised services are accounted for as a combined performance obligation.
3.Determine the transaction price - The transaction price is determined based on the consideration to which we will be entitled in exchange for transferring services to the customer.
4.Allocate the transaction price to the performance obligations in the contract - If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price ("SSP") basis. Determination of SSP requires judgment. We determine standalone selling price taking into account available information such as historical selling prices of the performance obligation, overall strategic pricing objective, market conditions and internally approved pricing guidelines related to the performance obligations.
5.Recognize revenue when (or as) each performance obligation is satisfied - We satisfy performance obligations over time. Revenue is recognized over the time the related performance obligation is satisfied by transferring a promised service to a customer.
Managed Services
Managed services revenue is earned monthly during the term of the contract, as services are provided at a fixed fee and is recognized ratably over the contract term beginning on the commencement date of the contract. Managed services contracts are typically long-term contracts lasting three years. Revenue related to managed services provided is recognized based on the customer utilization of such resources, which management estimates to occur ratably over the customer contract term.
Prior to our sale of the MPS business in
Consulting and Professional Services
Consulting and professional services contracts are typically short-term, project-based services rendered on either a fixed fee or a time and materials basis. These contracts are normally for a duration of less than one year. For fixed fee arrangements, revenue is normally recognized ratably over the term of the project. For time and materials arrangements, revenues are recognized as the services are rendered.
Deferred and Unbilled Revenue
We receive payments from customers based on billing schedules established in our contracts. Deferred revenue primarily consists of billings or payments received in advance of the amount of revenue recognized and
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such amounts are recognized as the revenue recognition criteria are met.
Unbilled revenue reflects our conditional right to receive payment from customers for our completed performance under contracts.
Accounts Receivable Valuation and Related Reserves
We estimate the losses that may result from that portion of our accounts receivable that may not be collectible as a result of the inability of our customers to make required payments. Management specifically analyzes customer concentration, customer creditworthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We review past due accounts on a monthly basis and record an allowance for doubtful accounts where we deem appropriate.
Impairment Review of
We periodically evaluate our intangible assets and goodwill relating to
acquisitions for impairment.
Stock-Based Compensation
Under the fair value recognition provisions of the authoritative guidance, stock-based compensation cost granted to employees is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service or performance period, which is the vesting period. Stock options and warrants issued to consultants and other non-employees as compensation for services to be provided to us are accounted for based upon the fair value of the services provided or the estimated fair value of the option or warrant, whichever can be more clearly determined. We currently use the Black-Scholes option pricing model to determine the fair value of stock options.
The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, the expected term of the award, the risk-free interest rate and any expected dividends. Compensation cost associated with grants of restricted stock units are also measured at fair value on the date of the grant. We evaluate the assumptions used to value restricted stock units on a quarterly basis. When factors change, including the market price of the stock, stock-based compensation expense may differ significantly from what has been recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting requirements and those imposed under federal and state tax laws. Deferred taxes are provided for timing differences in the recognition of revenue and expenses for income tax and financial reporting purposes and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and liabilities. Realization of the deferred tax asset is largely dependent on generating sufficient taxable income in future years. Deferred tax assets are
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reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all the deferred tax assets will not be realized. Use of our net operating loss deferred assets may be limited by changes in our ownership.
The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with no need for management's judgment in its application. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result. Please see our audited financial statements and notes thereto which begin on page F-1 of this Annual Report on Form 10-K, which contain accounting policies and other disclosures required by GAAP and please refer to the disclosures in Note 1 of our financial statements for a summary of our significant accounting policies.
Recent Accounting Pronouncements
Refer to Note 1 to the consolidated financial statements for information regarding recent accounting pronouncements.
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