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 helping
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Our services are categorized into four service groups, which are: assess, build, manage, and validate. These services are designed to meet the client where they are in their security journey as recurring managed services under long-term contracts structured to provide a sustainable and growing program or under shorter duration consulting or professional services engagements.
· Assess - identify, measure, and test security and privacy risk of an
organization's readiness and verify and validate their programs meet
compliance and business objectives through IT audits, technical testing,
and risk and program assessments.
· Build - 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.
· Manage - 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.
· Validate - verify the processes, people, and technology are working
effectively and provide insight to the ROI of an organization's security
investment through advanced services requiring highly experienced
resources and/or technology to deliver.
For sophisticated organizations our Managed Security Validation® program encompasses a bundle of services from the assess, build, manage, and validate categories to deliver clarity and guidance as a consistent partner helping maintain and grow their security infrastructure through more rigorous proactive testing, evaluation and validation services.
Impact of COVID-19 Pandemic
The ongoing COVID-19 pandemic and associated economic repercussions have significantly impacted, and are expected to continue to impact, our business and our operations.
Our current and potential customers' businesses, specifically in the healthcare industry, have been directly impacted both financially and operationally in many ways by the pandemic. During this time, cybersecurity risks in healthcare have increased particularly with increased adoption of remote access and increased adoption of telehealth, as well as decreased budgets, diversion of resources and focus from all areas not directly related to patient care. In the current periods, the pandemic has led to customers delaying or deferring cybersecurity buying decisions, has limited our ability to visit customers and potential customers, and has resulted in an overall decrease in our orders, bookings and revenues in 2020 and 2021.
We took steps to reduce expenses throughout the Company over the past eighteen months, including workforce reductions, substantially reducing Company travel, trade shows and other business meetings and decreasing expenditures. As we see the industry emerging from the pandemic, and returning to a new normal in 2022, we have begun to increase our sales and marketing efforts and building our sales and operational teams for growth.
With resources allocated to cybersecurity in healthcare constrained over the past eighteen months, we believe industry risks are increasing and expect the industry will need to increase attention and budgetary spending on cybersecurity in the near future. However, the ultimate duration and impact of the COVID-19 pandemic on our business, results of operations, financial condition and cash flows is uncertain. Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business and we anticipate that our results of operations in future periods may continue to be adversely impacted by the COVID-19 pandemic and its negative effects on global economic conditions. For additional risks relating to the COVID-19 pandemic, see Item 1A. Risk Factors in Part II of this report.
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Results of Operations
Year Ended
Net Revenue
Revenue was
While COVID-19 has negatively impacted our bookings and revenue in the current periods, it has also led to new services and additional opportunities. In the fourth quarter of 2021, we saw an increase in bookings partially as a result of our investments in sales and marketing and increased demand for our services and the size of our target contracts.
Cost of Revenues
Cost of revenues primarily consists of salaries and related expenses for direct
labor and indirect support staff. Cost of revenues was
Gross margin was 46% 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 were
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Valuation of Contingent Earnout
In
In
In
The changes in the contingent earnout are included in results of operations in the accompanying consolidated statement of operations.
Depreciation
Depreciation remained consistent at
Amortization
Amortization expense decreased slightly to
Impairment of
When the Company performed its annual impairment testing as of
At the end of 2020, we identified circumstances in our business and in the
marketplace, including the impact of COVID-19 on revenue growth and market
valuation, that indicated that our goodwill and long-lived assets could be
impaired. The Company engaged a valuation expert to assist management in
updating its analysis of the fair value of the intangible assets and goodwill.
As a result of this analysis the Company recorded an impairment loss to goodwill
and intangible assets of
Finance Cost for Equity Commitment
In
Net Interest Expense
Net interest expense for the year ended
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Other Income and Expense
The Company received notice in
Income Tax Benefit
Income tax benefit was
In
Liquidity and Capital Resources
As of
· The pace at which we choose to invest resources in growing our business,
both organically and through acquisition or other transactions;
· Our ability to manage our operating expenses and maintain gross margins
while attracting, recruiting and retaining cybersecurity privacy
professionals;
· demand for our services from healthcare providers; the near-term impact of
the COVID-19 pandemic on our customers' allocation of time and resources
to security and privacy, and their ability to pay for existing services as
well as enter into new contractual arrangements during a period of crisis;
and
· general economic conditions and changes in healthcare reimbursement and
regulatory environment, including effects of the COVID-19 pandemic.
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. As of the date of this Annual Report on Form 10-K, we are generating negative cash from operations and our overall revenue and business levels have been impacted by the COVID-19 pandemic over the past eighteen months. Our customer base is heavily concentrated in the healthcare provider space. The healthcare industry has experienced financial and operational disruption due to the pandemic. Sales cycles are longer, cybersecurity projects have been delayed and budgets have been constrained as healthcare providers focus on patient care and navigating the pandemic. If the pandemic continues or there are resurgences in 2022 that impact our customers' operations and resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results for fiscal year 2022 and beyond could be negatively impacted.
During 2020 and 2021, we took actions to reduce expenses, conserve cash, and
raise additional capital. During 2021, we raised
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We believe that our existing sources of liquidity, including cash and cash equivalents, expected tax refunds, the ability to raise equity under our effective Registration Statement on Form S-3 as well as our ability to manage the business to decrease expenses if necessary, will be sufficient to meet our projected capital needs for at least the next twelve months. As we execute our plans over the next twelve months, we intend to carefully monitor the impact of growth initiatives 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 operations, reduce expenses, and/or curtail future plans to manage our liquidity and capital resources. However, we cannot provide assurance that we will be able to raise additional capital. The COVID-19 pandemic also continues to create uncertainty and volatility in the financial markets which may impact our operations and our ability to access capital and/or the terms under which we can do so.
The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
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 and Critical Accounting Estimates
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:
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Revenue Recognition and Deferred Revenue
We operate under a consolidated strategy and management structure, deriving revenue from the following sources:
· Managed services · Consulting and professional services
Revenue is recognized pursuant to Accounting Standard Codification ("ASC") Topic 606, "Revenue from Contracts with Customers". 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:
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 contracts are typically long-term contracts lasting three years. 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. 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.
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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 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, COVID-19 developments 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 and warrants. 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.
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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 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 consolidated 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 consolidated 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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