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, 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 other documents we
file from time to time with the
OVERVIEW
We are engaged in the business of providing cybersecurity services, privacy and
compliance and other technical services to healthcare and other industries. Our
business is operated throughout
We support
We are one of the few consulting and advisory companies focused on the security and privacy of 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.
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 under long-term contracts or under shorter duration consulting or professional services engagements.
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·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.
Our common stock currently trades on the NYSE American exchange under the stock symbol "CTEK".
Where appropriate, references to "
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". 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.
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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.
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 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.
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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.
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 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 of the deferred tax assets will not be realized.
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Reference is made to our Annual Report on Form 10-K for the fiscal year ended
RESULTS OF OPERATIONS
For the Three Months Ended
Revenue
Revenue decreased
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 35% 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 increased to
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 public. General and administrative expenses decreased
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Change in valuation of contingent earn-out
We performed a valuation of the contingent earn-out to a seller of
Depreciation
Depreciation expense was consistent at
Amortization of Acquisition-Related Intangibles
Amortization of acquisition-related intangibles was
Other Income (Expense)
Net interest expense for the three months ended
Income from Discontinued Operations, Including Gain on Sale, Net of Tax
On
Income Tax Benefit
Income tax benefit for the three months ended
For the Nine Months Ended
Revenue
Revenue decreased
Cost of Revenue
Cost of revenue was
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included a catch-up after a customer signed an extended agreement and the
Gross margin was 32% of revenue for the nine months ended
Sales and Marketing
Sales and marketing expenses increased to
This increase was due to an increase in headcount to support our efforts to grow revenue including Backbone, and additional systems cost to support automation.
General and Administrative
General and administrative expenses increased
Change in valuation of contingent earn-out
We performed a valuation of the contingent earn-out to a seller of
Depreciation
Depreciation remained relatively consistent at
Amortization of Acquisition-Related Intangibles
Amortization of acquisition-related intangibles was
Finance Cost for Equity Commitment
In
Other Income (Expense)
Net interest expense for the nine months ended
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paydown of the promissory notes from the proceeds of the sale of the Managed
Print Services business in
Income Tax Benefit
Income tax benefit for the nine months ended
Income from Discontinued Operations, Including Gain on Sale, Net of Tax
On
CARES Act
On
Liquidity and Capital Resources
As of
·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 Coronavirus (COVID-19) 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;
·general economic conditions and changes in healthcare reimbursement and regulatory environment, including effects of the COVID-19 epidemic; and
·our ability to collect accounts receivable from health care customers whose operations and cash flow have been significantly impacted by COVID-19.
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 and privacy 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 maintain
and grow our cybersecurity business during this uncertain time. For the three
months ended
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In late 2019, a novel strain of coronavirus (COVID-19) was first detected in
We did experience a negative financial impact in the second and third quarters of 2020 due to COVID-19, primarily since many of the initial economic effects of the early stages of the COVID-19 pandemic resulting from the various shelter-in-place and other social distancing orders occurred towards the end of our first quarter. The severity and duration of the COVID-19 pandemic is uncertain and such uncertainty will likely continue in the near term and we will continue to actively monitor the situation taking into account the impact to our employees, customers and partners.
At the end of 2019 and throughout 2020 we reduced staffing levels to reduce
expenses. Our operating plan for the next twelve months includes permanent
annualized cost reduction efforts totaling approximately
We believe that our existing sources of liquidity, including cash and cash equivalents, the equity commitment from an existing investor, future operating cash flows, and other assets 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 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 will likely continue 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 impact of the COVID-19 pandemic on the economy and our operations is fluid and constantly evolving; we will continue to assess a variety of measures to improve our financial performance and liquidity.
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.
OFF-BALANCE SHEET ARRANGEMENTS
As of
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