CYNERGISTEK, INC. The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act of 1933, and is subject to the safe harbors created by those sections. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "may," "will" and variations of these words or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements.
Due to possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Quarterly Report, which speak only as of the date of this Quarterly Report, or to make predictions about future performance based solely on historical financial performance. We disclaim any obligation to update forward-looking statements contained in this Quarterly Report.
Readers should carefully review the risk factors described in this quarterly
report and in other documents we file from time to time with the
On
As a result of the Merger, each share of common stock of the Company ("Common
Stock") that is issued and outstanding immediately prior to the effective time
of the Merger (the "Effective Time") (other than shares owned by any subsidiary
of the Company, the Merger Sub, Clearwater or any other subsidiary of Clearwater
immediately prior to the Effective Time (all of which will be canceled) and
shares held by any holder who is entitled to, and who has perfected, appraisal
rights under
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In connection with the negotiation and execution of the Merger Agreement, the
Company has incurred legal, consulting and accounting fees of approximately
A special meeting of stockholders of the Company will be held at
OVERVIEW
We are engaged in the business of helping
Our services are grouped to facilitate and assist our clients in implementing their programs, those groups follow a cyclical approach: 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.
Impact of COVID-19 Pandemic and Recent Capital Markets Disruption
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Additionally,
Additionally, the markets, and more specifically healthcare, have experienced an increase in pressures from rising inflation, rising interest rates, lowering bond rates and the impact to their revenues and operating margins. The resultant effect of these pressures is healthcare entities have slowed down their spend on things considered not mission critical or discretionary. Cybersecurity is discretionary as it relates to an organization's propensity for managing risk, but it has a regulatory component which assures that organizations will continue to spend on cybersecurity.
The ongoing COVID-19 pandemic and ensuing governmental responses has caused
significant uncertainty in
COVID-19 cases (including the spread of variants and mutant strains, such as the omicron variant) continue to surge in certain parts of the world and have resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. We remain unable to accurately predict the full impact that COVID-19 will have on our results of operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures. Our compliance with containment and mitigation measures materially impacted our day-to-day operations, and there can be no guaranty that the pandemic will not disrupt our business and operations or impair our ability to implement our business plan successfully.
More generally, the pandemic raises the possibility of an extended global economic downturn and has caused volatility in financial markets, which could affect demand for our products and services and impact our results and financial condition even after the pandemic is contained. For example, we may be unable to collect receivables from those customers significantly impacted by COVID-19. Also, a decrease in bookings in a given period could negatively affect our revenues in future periods, particularly if experienced on a sustained basis. The pandemic may also have the effect of heightening many of the other risks described in these Risk Factors and the Risk Factors set forth in the Company's 2021 Form 10-K, particularly those risks associated with our customers.
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 2022 and 2021.
We took steps to reduce expenses throughout the Company over the past twenty-four months, including workforce reductions, substantially reducing Company travel, trade shows and other business meetings and decreasing expenditures. We have modified our business practices and implemented certain policies at our offices in accordance with best practices to accommodate, and at times mandate, remote work practices, including restricting employee travel, modifying employee work locations, and cancelling attendance at events and conferences. In addition, we have adapted new processes for interactions with our customers to safely manage our operations. Many of our customers have made similar modifications. If necessary, we may take further actions in the best interests of our employees, customers, partners and suppliers. There is no certainty that such measures will be sufficient to mitigate the risks posed by COVID-19, in which case our employees may become sick, our ability to perform critical functions could be harmed, and our business and operations could be negatively impacted.
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With less resources allocated to cybersecurity in healthcare over the past twenty-four months, we believe risks are increasing and expect the industry will need to increase attention and spend 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.
As we expect the industry to begin emerging from the pandemic, we have begun to increase our sales and marketing efforts and building our sales and operational teams for growth. However, our current and potential customers' businesses could continue to be disrupted or they could seek to limit spending due to decreased budgets, reduced access to credit or various other factors, any of which could negatively impact the willingness or ability of such customers to order new, or any, services with us and ultimately adversely affect our revenues, as well as negatively impact the payment of accounts receivable and collections and potentially lead to write-downs or write-offs.
The ultimate duration and impact of the COVID-19 pandemic on our business, results of operations, financial condition and cash flows is dependent on future developments, including the duration of the pandemic and the related length of its impact on the global economy, which remain uncertain and cannot be predicted at this time. Furthermore, the extent to which our mitigation efforts are successful, if at all, is not presently ascertainable.
Impact if the Merger Agreement is Not Approved by Stockholders or if the Merger is Not Completed for Any Other Reason
If the Merger Agreement is not approved and adopted by stockholders and the Merger is not approved by stockholders, or if the Merger is not completed for any other reason:
· CynergisTek may be required to repay the full outstanding amount of the
principal and interest owing under the Clearwater Revolving Loan
concurrent with the termination of the Merger Agreement or within 60 days
thereafter (depending on the circumstances of such termination).
· under certain specified circumstances, CynergisTek will be required to pay
Clearwater a termination fee of $710,000 , upon the termination of the
Merger Agreement;
· (a) CynergisTek will remain an independent public company; (b) CynergisTek
common stock will continue to be listed and traded on NYSE American and
registered under the Exchange Act; and (c) CynergisTek will continue to
file periodic reports with the SEC ;
· the stockholders of CynergisTek will not be entitled to, nor will they
receive, any payment for their respective shares of CynergisTek common
stock pursuant to the Merger Agreement;
· the price of CynergisTek common stock may decline significantly, and if
that were to occur, it is uncertain when, if ever, the price of
CynergisTek common stock would return to the price at which it trades as
of the date of this report;
· we anticipate that (a) management will operate the business in a manner
similar to that in which it is being operated today and (b) stockholders
will be subject to similar types of risks and uncertainties as those to
which they are currently subject, some of which have been described in
this quarterly report, and in CynergisTek's filings with the SEC ,
including in our most recent filing on Form 10-K, as amended, including,
but not limited to, risks and uncertainties with respect to CynergisTek's
business, prospects and results of operations, as such may be affected by,
among other things, the highly competitive industry in which CynergisTek
operates and economic conditions;
· the CynergisTek Board of Directors will continue to evaluate and review
CynergisTek's business operations, strategic direction and capitalization,
among other things, and will make such changes as are deemed appropriate;
irrespective of these efforts, it is possible that no other transaction
acceptable to the CynergisTek Board of Directors will be offered or that
CynergisTek's business, prospects and results of operations will be
adversely impacted.
Our common stock currently trades on the NYSE American exchange under the stock symbol "CTEK".
Where appropriate, references to "
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RESULTS OF OPERATIONS
For the Three Months Ended
Revenue
Revenue increased
Cost of Revenue
Cost of revenue consists primarily of salaries and related expenses of direct
labor and indirect support staff. Cost of revenue was
Gross margin was down 13% to 33% of revenue for the three months 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 flat at
General and Administrative
General and administrative expenses include personnel costs for finance,
administration, information systems, general management, facilities expenses,
professional fees, legal expenses and other administrative costs including those
required to be a publicly traded company. General and administrative expenses
increased to
Change in Valuation of Contingent Earn-out
We performed a valuation of the contingent earn-out to the sellers of
Depreciation
Depreciation expense was
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Amortization of Acquisition-Related Intangibles
Amortization of acquisition-related intangibles was
Net Interest Expense
Net interest expense for the three months ended
Income Tax
Income tax expense for the three months ended
For the Six Months Ended
Revenue
Revenue increased
Cost of Revenue
Cost of revenue was
Gross margin was 37% of revenue for the six months ended
Sales and Marketing
Sales and marketing expenses decreased to
General and Administrative
General and administrative expenses increased
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Change in Valuation of Contingent Earn-out
We performed a valuation of the contingent earn-out to the sellers of
Depreciation
Depreciation remained relatively consistent at
Amortization of Acquisition-Related Intangibles
Amortization of acquisition-related intangibles was
Net Interest Expense
Net interest expense for the six months ended
Income Tax
Income tax expense for the six months ended
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 lingering economic effects 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
· The continued economic uncertainty, including related to the COVID-19
pandemic, the conflict in Ukraine and related sanctions against Russia and
Belarus , and inflationary pressures (including specifically, but not
limited to, human capital costs which are essential to CynergisTek's
business), as well as the impact that such uncertainty has had, and could
continue to have, on CynergisTek's customers and industry and business and
operating results.
· The success or failure to complete the Merger and the potential impact
that the Merger Agreement may be terminated under certain circumstances
that requires us to pay Clearwater a termination fee of $710,000 ; the
outcome of any legal proceedings that may be instituted against us and
others related to the Merger Agreement; risks that the proposed Merger
disrupts our current operations or affects our ability to retain or
recruit key employees; the amount of the costs, fees, expenses and
charges related to the Merger Agreement or the Merger; risks related to
the Merger diverting management's or employees' attention from ongoing
business operations; risks that our stock price may decline significantly
if the Merger is not completed.
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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 Report on Form 10-Q, 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 twenty-four 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 and beyond 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
We recently signed a
We believe that our existing sources of liquidity, including cash and cash
equivalents, the ability to raise equity under our effective Registration
Statement on Form S-3, Clearwater Revolving Loan 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. If the
Merger does not consummate in the short-term, 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. Based
on the Company's current liquidity, and its potential merger-related costs,
including payments which would be accelerated under the revolving promissory
note if the merger were not consummated, it is anticipated that the Company
would be required to raise additional capital to meet its obligations and such
capital may not be available, or may not be available on acceptable terms at
that time. 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 lingering impact of the COVID-19
pandemic, the conflict in
The accompanying condensed 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.
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Application of Critical Accounting Policies and 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:
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.
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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.
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.
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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.
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 our 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.
Reference is made to our Annual Report on Form 10-K for the fiscal year ended
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