Q3 2020 CynergisTek Inc Earnings Call
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Good day, ladies and gentlemen, and welcome to the synergistic 2023rd quarter Earnings Conference call. Today's conference is being recorded joining us today from the company includes Mr. Kayla Barlow, President and Chief Executive Officer Mr. Paul.
[music] Chief Financial Officer before we begin the formal presentation I would like to remind everyone that statements made on the call workouts, including those regarding future financial results and industry prospects. Among others are forward looking and maybe subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the conference call.
Certain of these risks and uncertainties.
Or will be described in greater detail in the company's FCC filing synergistic is under no obligation to expressly disclaims any such obligation to update or alter its forward looking statements, whether as a result of new information future results or otherwise.
At this time I turn the conference over to our CEO Caleb.
Hello. Please go ahead.
Good afternoon, everyone, a little breaking news just started thought today literally today for the second year in a row <unk> local market research has awarded synergistic.
<unk> cyber security consultants first joslin audit strategy and implementation.
In the healthcare industry. This is an award well, we're really proud of as it's an independent survey from 705 health care providers, we don't pay for placement and frankly did not even though it was coming until we saw the press release this morning at.
And 2020 been a bit of a crazy year for everyone, but to get this type.
She recognition from the industry and from our clients further demonstrates that our strategy is working we worked aggressively to add new capabilities to deal with the changing threat landscape.
Many calls a lot of assessments security validation and we've been on the phone lines, helping clients address these recent ransomware attacks with all of that.
It's a real or you can can you get recognized by our clients in the industry and I really talk year like this eating out the major players, including Clearwater Booz Allen KPMG, you why I B M fortified a host of others. So I want to make sure I mentioned this before we got into the details of the quarter.
Now towards.
We ended Q3 and into the beginning of the fourth quarter. We started to see signs of market recovery. This is shown itself in a number of ways first we're seeing clients, particularly those that have a more maturity secure more mature security posture.
Realizing that the pandemic the move towards.
Home, the rapid deployment telemedicine and new expectations for interoperability upgrades, new vulnerabilities in their security posture.
Concluding with these trends are not temporary that's created an increased willingness to enter into long term contracts with a focus on shoring up your defenses in this new world.
This was highlighted in our two recent releases with Valley Health and Arab health, both new logos to the synergistic family he's.
These cost lives were interested in the combination of our core managed services along with our strategy to go beyond just security assessments and into the validation of security controls.
We also saw some recent renewals with longstanding customers that included the addition of some of these new services increasing their commitment to security.
Second we saw progress in our efforts to diversify beyond our base, which is primarily made up of healthcare providers and into the broader end.
Industry of healthcare.
A good example of this is the recent managed services signing with a large state department of public health and the West Coast now as you can imagine health departments across the US are front and center in an effort to tract infections and manage contact Tracy.
As such they are generating.
Volumes of information that must be profit, we sat protected and secure.
Born in health care organization in Arkansas.
Really suited for this mission.
I also want to mention our recent traction would read it.
Synergistic own brand the focus was on office of security testing.
Waiting outside of our traditional health care market.
One of our strategic imperative last year with to rebuild an upscale our penetration testing team.
This now authentic security team has new people, along with new offerings, which has allowed us to win consulting contracts and one of the nation's largest media companies and a well known.
Consumer Electronics company watch attack.
These are early contract wins for our team and they demonstrate the expertise and capabilities, we brought to retrofit now.
Now we're optimistic about our ability to expand these services over the coming months as we continue to prove our capabilities opportunistically in the broader market.
No not all of our clients around the world when it comes to cope in 19 and the associated financial repercussions. They just had a significant impact on health care providers when they run into financial instability. It can impact us and this included a recent situations where a client exercise the termination for convenience clause.
Moving away from a long term contract.
In an effort to reduce costs. This impacted our pre sold revenue during the quarter as Paul will discuss now.
Now moving into next year, we anticipate budget uncertainty and healthcare providers will continue it.
It's important to note that while we see a pullback. We believe is generally does not represent losses to competition.
But rob.
Rather an increase in the technical debt, our clients are experiencing and temporary deferment of investments in security and privacy.
Unfortunately, this growing technical debt has also been notified of this area that are becoming more brazen in an effort to take down Americas hospitals right in the middle of a pandemic increasing.
In a tax increase in consequences and an increasing regulatory footprint will drive demand for our services remember what a hospital is locked up with ransomware, they're essentially down diverting patients canceling elective procedures and struggling through crisis operations with limited capabilities hospitals learned the impact.
Active limited operations can be financially devastating at the start of it.
In just the past few weeks about a dozen systems experience the same impact, but it wasn't due to coated instituted orchestrated in Branson brazen ransomware attack.
What is your perspective in just the last month, we've seen the first debt.
Yes attributed to ransomware or patient had to be diverted to another hospital died in transit and another incident, the governor for Mod deploy the Vermont National Guard in an effort to assist in the significant recovery of a hospital system that we've been starting with ransomware and that incident is still ongoing today.
Wellcare is rapidly realizing that investments in cyber security or very similar investments in masks gallons and telemedicine.
It's simply something is going to be required to remain operational in this new world.
And now that that has the attention of Ceos and boards if.
It's not how I want to see demand evolve, but it is happening and we're.
All positioned to do everything we can to help keep Americas hospitals open and seeing patients.
Now a year ago as I completed my first 100 days as the CEO I outlined a set of strategic imperatives that will guide our strategy to transform the business and return it to growth.
Now we have this call before COVID-19.
So what we found that those imperatives held true as we navigated the pandemic.
And even helped us to galvanize our decisions as we work through some of the challenges we face in our own coded response. So a year later this review where things stand.
The first thing was very clear a year ago was we needed to rebalance our costs in both overhead and infrastructure.
Over the last year, we pulled $4 million out of our annual cost structure and reduced head count by more than 25.
Other than public company costs, which is limited opportunity to influence we're running lean with 90% of our employees directly in front of customers servicing are selling.
A year ago, we also discussed the need.
To rebuild our go to market.
Fast forward today, and we've rebuilt our sales team had pivoted to be completely remote and a significantly improved our pipeline.
We slow our marketing spend as we enter coded as that was an expense we could pull back on and we're just now starting to rebuild our web.
Shovels and reinvest in promoting our brand digitally.
This is an important initiative as all of our go to market efforts have gone virtual with face to face interaction shutdown in covance.
Over the last month, we promoted the internal candidate to be every piece of marketing we conducted our annual customer conference of the virtually and our web.
Presence will be a source of investment moving forward.
Now turning to our team in many ways, we're different company than we were a year ago. Our executive team has many new faces coming to us with a great depth of expertise for both healthcare and security. Our board is also very different than it was a year ago, and we will continue to retool and upscale.
Protein.
On the delivery front, we talked a year ago about the delivery backlog long backlogs lead to dissatisfied clients and I was concerned now with the time it took to deliver on the contracts, but also the size of our project management organization with acquired management.
It has been a major area of focus and.
We're far more efficient than a year ago.
We found new ways to deliver by cross training individuals, allowing us to dramatically reduce the number of consultants on engagement by nearly half.
We reduced our project management overhead by becoming more optimized using new tools and ensuring that all of our managers are also capable of providing hourly work to.
Handle search capacity.
As we go into Q4, our utilization is nearing capacity as work that had been deferred during cobot shutdowns now returns.
Lastly, and most importantly, we set out a target to return to growth that.
That is our last remaining imperative and with a significantly reduced cost structure more efficient.
And several new offerings. This provides us with that pathway.
With that let me turn it over to Paul to revenue review, our financial performance.
Thanks, Kelly as Kelly mentioned, we're still seeing an impact from covered during the quarter and as a result of its impact on health care providers again. This impact was primarily felt in a.
Production in our pre sold revenue.
Which dropped from 19 million to 16 million, primarily due to one larger managed services customers that customer that had significant budget issues. This contract will term at the end of this year given us some time to respond.
Made significant strides towards this response with the better than expected Q3.
Bookings, although still below historical levels, it's an improvement from Q2, and we see positive signs going forward in the macro environment, which we will continue to take steps to keep you updated as things progress.
Additionally, we continue to react to the impact from Kobe by reducing expenses and focusing on opportunities to produce.
Further.
This was a key driver to our improved margins gross and operating margins in Q3 compared to the first half of this year.
As we highlighted in Q2, we took steps to significantly reduce operating expenses with both permanent and temporary measures that have reduced our cash burn to around 300 per month at these.
Revenue levels.
Couple of other reminders, we received a 2.8 million under the Paycheck protection program and expect the majority of the loan will be forgiven and we're also expecting tax relief as a result of the cares Act.
Which we carry back available losses from this year to the extent possible, which we think at this point will exceed $1 million.
In addition, the board just approved in aftermarket equity program that will allow the company from time to time to issue up to a total of $5 million of shares of the company's common stock to the public at the company's discretion. The funds raised will be used for ongoing operations and growth initiatives.
Outlook outlining our standards.
Financial disclosures revenue decreased $5.3 million to $4.5 million due to lower revenue for managed services, which reduced point $4 million to $2.7 million due to the impact of some concern customers canceling or delaying renewals and a reduction in net new customers due to colder.
Okay.
Anders funnel and consulting services increased 8.1 million to 1.8 million due to lower revenue from the synergistic business as a result of the covert offset though by $5.8 million in new and consulting professional services revenues from the acquisition of backbone in Q4 last year.
We're starting to see backbones business recovered.
In fact on the cobot impact and we expect them to be back to historical levels and growing by Q1 next year.
Gross margin was 35% for Q3 2020 compared to 34% in 2019 and 27% in Q2 of this year.
As I mentioned in my highlights this improvement in gross margin is due to staffing expense.
Since reductions we made over the last couple of quarters, along with reduced travel in reaction to the lower revenue uncoated related travel restrictions.
Sales and marketing expenses increased 1.3 million for.
For Q2 2020 compared to 1.1 for the same period in 2019. This increase was due to the addition of backbone.
DNA expense decreased $5.2 million to 1.5 million for Q3 2020 compared to the same period in 2019.
The decrease is due to point fourmillion and expense reduction efforts taken to improve operating margins offset by 2.2 million in additional cost for backbone.
Non-GAAP adjusted.
It even a loss was point $8 million for Q3 2020 compared to point Fourmillion for Q3, 2019, and 1.3 million in Q2 of this year.
The full financials, a reconciliation of GAAP to non-GAAP information can be found in the earnings release that came out today.
This concludes the financials and prepared.
Our remarks for Q3 2020 proper.
Operator, you can open the floor to questions.
Thank you, ladies and gentlemen, if youd like to ask a question you may do so by pressing star one on your telephone keypad. Please make sure the mute function on your phone is turned off so the signal can be read by our equipment.
Star one for questions or comments, we'll pause a moment.
To assemble the queue.
We'll take our first question from Jeff Basch with Fintech. Please go ahead.
Good afternoon gentlemen.
Hi, Jeff.
You mentioned that the sales trends were strengthening the end of Q3 two.
Sense do you think this is.
Reflecting the more publicized incidents so you described.
You know cyber incidents.
Well, there's two there's two components in their staff right. I mean, one is that we significantly be told our sales and go to market.
And now have a much more robust and reliable pipeline than we had a year ago. So I'll call back to the basic blocking and tackling that the second piece of this is that.
While in the midst of Kobin expected kind of in February March April issue, when we were all.
Really walk down and everyone is trying to figure out which one was up.
We use that opportunity to retool, we switched to an agile management methodology. Our team met every single day, and we continue to today and we used that time to bring forward several new offerings such as compromise.
Mrs assessments, and our partnership with awake security security validation assessments.
Reviewing run books interestingly enough we.
We knew when were public for some time that ransomware was likely the biggest threat that we can impact healthcare and unfortunately, we were right.
Right.
So as we started to see the brave and attacks over the last couple of weeks, we were very well positioned and I mean really only in the last few days has is not going back to back to back to back hauls for myself and my team, helping our clients walk through this crisis in figuring out.
What they need to do so I guess the long winded answer to your question is it's all of it but a lot of this is trying to figure out where the profit is going to be and being well positioned for that.
Okay.
There's been a lot of press and analysts to.
You know a couple of weeks.
Oh about rapidly increasing outbreaks of cold weather in the United States.
And I'm wondering if that's concerning you about to another.
Phase two of shutdowns and all I would say to adversely affect your business or do you think.
My hospitals and other health systems or.
So ER.
Better set up now the weather than not affect you as much as you might otherwise have thought.
Well I think there's two dynamics here right. So first of all at least at the moment online back in kind of February March hospitals are still seeing elective patients rights.
So elective surgeries are continuing.
They're not completely shut down just to handle cobot surgeon I think we and a lot of ways hospitals have found ways to get through this now that is not true in all areas of the country. There are some places that are being severely impacted and you know that that does.
Seem to go in ways. One is also happening. This is procurement departments I think had started to figure out what the answer isn't that you can shut everything off.
They're going to need certain capabilities and we've started to see that to return I would say to completely the normal because were not face to face with.
Clients, but we are processing deals things are a little slower than anyone would like because you can't go meet with the client.
But if we look at this I don't think we're going to see the same impact now the second factor in there is that these recent ransomware incidents. This is a little.
Little bit different than anything we've ever seen a U.S. soil before up to this point generally speaking a tax on us soil involve people stealing data.
Maybe shutting something down with the denial of service attack for a few hours by the take on a website and stealing a whole lot of data and intellectual property.
In those in all of those attacks Weve seen of late.
People were not directly impact in a way that could potentially harm them from a life safety perspective. This is different this is a change in adversarial intent were bad guys or knowing.
Targeting large hospital systems with the express intent to find their electronic health care Records lock them up and prevent the hospital from seeing patients that is what we call a kinetic impact.
And and it's devastating right.
But it it also represents a significant escalation in that adversarial intent, but what it means to the hospital system.
And I I temper my comment here by saying I don't want to sound alarmist, but the simple reality is all of these hospitals in the last few weeks.
Realized that if they don't move to shore up their defenses, it's going to be hard to remain open and that's the difference in this it's very analogous frankly to wearing a mask is that kind of the analogy of the day you might not get ransomware. If you don't invest in your security defenses.
But if you do the impact can be pretty devastating.
Yeah, the ones a lot of urgency to reissue.
That's right.
Okay I have a couple of questions for Paul.
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I think it was two quarters ago, you had mentioned the possibility of reaching a mid to high fortys on gross margin by the end.
Yeah.
So obviously, there's been a lot.
Right.
Or defer, but I'm wondering if you still see the businesses eventually being able to still achieve that goal.
We've definitely been impacted in the short term Jeff on that so we do not anticipate that we will get there this year.
But at least from our perspective.
We can get there that's going to take getting back to growth and getting back to that five to five and a half million run rate, which is kind of that critical.
Revenue level for us so as we get back to there that's where I think we'll have the ability to get back in those 40 plus.
On the margin ranges.
Okay, and with respect to its $5 million worth of shares from them. So it was referred to.
What's the status of the earlier arrangement you had I think with a large.
Institutional owner, where.
You've already issued some warrants.
They were yes, it will put that on hold for now.
Yeah, we'll put that on hold as we work through the.
Kim so.
Then, we'll revisit the need for that if necessary based on that.
The results of the ATM.
Okay, and lastly are you.
You have a couple of million dollars.
And back on your balance sheet for the backbone earn out.
You know where do you think you stand with respect to that.
But at least in the initial year did not hit the year. One are now and so we're still working and evaluating their ability and opportunity to hit.
At years, two and three.
And so that's kinda status there right now we just close the books for October which industry.
Monte much it it ended the first year. So we're still working through in evaluating our next steps there.
Okay. Thanks, guys.
Dar one for questions, we'll pause a moment to assemble the queue.
Darwan for questions or comments please.
We'll take our next question from.
Maybe Fisher with long cast advisors. Please go ahead.
Hey, Paul I can tailor. It obviously had a quick quick question I already looked at the Q.
And the performance obligations were 15.6 million, 88% to be recognized.
Hi, guys, you up or 24 months so.
That infers that sequentially over last quarter in the prior quarter, we had a little more visibility.
At least sequentially.
I Wonder if you could just disclose.
Given the strength that you've seen.
Where those performance obligations would be today.
Thank you.
Okay I'm not sure if I completely understand your question I may have you maybe.
Yes, sure. So you disclose the performance obligations, which are forward long term contracts correct yeah.
Yeah right.
And at the end of the call.
Our 930, you had 15.6 million.
And I wondered if you could disclose maybe you can maybe don't have the number available, but if you could disclose given the strength you've seen you started out the strength in your sales pipeline sales channel where that would be today.
Oh, Yeah, I can't give I can't provide that number right now that's a number we don't traditionally provide at this point so we don't get into the bookings.
Numbers at this point, probably okay could you at least disclose if it's up from where it was at the end of the quarter.
It is up since the end of the quarter.
All right. Thank you.
You bet.
Star one for questions. We will go next to William Bremer with Vanquish capital.
Hey, gentlemen, good evening.
Hey, Bill adult.
So adding bonds when all holidays last.
Question, how is your visibility look at right now I mean, we had fun precedented events that occurred this quarter.
And it seems as though you guys have and you announced.
Two major wins.
I would assume that sales cycle now given what has occurred and what has just been.
Articulated is quicker than ever in this field.
So how quickly.
And your team close.
A contract with a new entity.
Oh that is all over the map right now.
And it's all over the map because in a lot of ways procurement departments have.
A new set of muscles that we haven't historically seen bill.
In in some systems you have just a very draconian all costs are under control Everything's got to go to.
Although you know multiple levels of approval I mean, I'll give you an example that.
That recent release on the public Health Department on the West Coast, That's a deal that took.
That deal took quarter after quarter after quarter, we saw that deal in the third because of coated.
Various groups and then finally got it done on a week type of thing.
Other situations exceptionally good what's happened over the last couple of weeks, where we will close the deal in two days.
It is a it's a really good question and I guess my my long winded answer to that is it hasn't stabilized.
Guys right now and it's all over the map just depending on what's going on and the temperature.
What I will say is interesting to see is that we do see in many cases the incidents over the last couple of weeks are causing some clients to go forward and ask for versions.
Currency budget requests and also go forward asking to Reinvestigate wherever they were in their.
Kind of prospecting on 2021 budget.
Now I would say the one thing I can kind of say overall is larger deal.
Still take longer as you can imagine anything that's public still takes longer because oftentimes their ticket up a bit but we are definitely seeing cases, where some of the new services, we're able to get in the door with a new logo in a matter of a week or two and that's really encouraging because those are new growth opportunities for.
No I agree with that and as I look at your run rate right now.
Let's just take this last quarter 4.5 billion or just articulated at five five and a half depending upon the mix of course.
It's very interesting I don't see it that far away.
From that.
Let's hope.
And I was just wondering given my first question on visibility.
And what you and your sales team has a punishing is arsene, maybe quick quicker turn business.
Is it possible.
Do you have an idea of wine.
Perhaps we can get there how close are we to that it seems as though were quite close it by mistaken.
Yes.
Well go ahead, Bob go ahead, I'll, just say, it's a little early to tell Bono ballpoint you. Unfortunately that large customer that we lost for the managed services was kind of it.
No that wouldn't hit us.
As we mentioned and so we've got to make up that grounds right I think you're right from the perspective that is where we're seeing the growth we're seeing new opportunities. We did have we do have some ground to make up though.
In a bundle that all in with kind of the overall covert impact we've got to recover from somebody you know somebody.
The things that we took the hits on in Q2 and Q3 here, but.
But as it relates to net new logos and renewals and growth in the business. We're seeing it. It's just for you we've got to dig out of that hole, we have because of again, primarily this one large customer that a bunch of issues.
I think thats exactly what I was going to kind of comment on I mean, the the fluctuating thing sitting in our seat right. Now is you can see the opportunity we're grabbing at it. It's just we have to make up for that lost ground that we experienced earlier this year and.
All it took us.
One or two customers with convenience clauses and you know it it's really an interesting situation, where these are not cases, where we lost to competition. These are cases, where our clients literally just decided that they could no longer afford to pay for security provisions.
And that's a really tough thing to digest that being said I am hopeful that also when budgets that start to turn around here, we may see some of those clients return.
Yeah.
Okay, gentlemen, I, just think that the market has changed here.
And.
At at your sales cycle.
It's probably quicker than ever.
And.
Great on the budget cycle, the sales cycle and given the material events that have occurred with a top tier and one of the top entities in the country changes the landscape.
And I wish you all the best I think we'll get.
Thank you Sir appreciate the confidence.
Darwin for questions, we'll pause a moment to assemble the queue.
And ladies and gentlemen, this will conclude today's question and answer session and today's conference. We appreciate your participation.
You may now disconnect.
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No.
Mm.
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Mm.
Mm.