CynergisTek, Inc.

Good day, ladies and gentlemen, and welcome to the Synergistic 2020 Third Quarter Earnings Conference Call. Today's conference is being recorded. Joining us today from the company includes Mr. Caleb Barlow, President and Chief Executive Officer, and Mr. Paul Anthony, Chief Financial Officer. Before we begin the formal presentation, I'd like to remind everyone that some statements made on the call and webcasts, including those regarding future financial results and industry prospects, among others, are forward-looking and may be 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 are or will be described in greater detail in the company's SEC filing. Synergistic is under no obligation to expressly disclaim 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'd like to turn the conference over to our CEO, Caleb Barlow. Please go ahead.

Good afternoon, everyone. A little breaking news to start us off today. Early today, for the second year in a row, Black Book Market Research has awarded Synergistic as the top cybersecurity consultants for assessment, 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 healthcare providers, we don't pay for placement, and frankly, did not even know it was coming until we saw the press release this morning. 2020 has been a bit of a crazy year for everyone, but to get this type of recognition from the industry and from our clients further demonstrates that our strategy is working. We've worked aggressively to add new capabilities to deal with a changing threat landscape, including compromise assessments, security validation, and we've been on the front lines helping clients address these recent ransomware attacks. With all of that, it's a real honor to continue to get recognized by our clients in the industry in a really tough year like this. Beating out some major players, including Clearwater, Booz Allen, KPMG, EY, IBM, Fortify, and a host of others. So I wanted to make sure I mentioned this before we got into the details of the quarter. Now, towards the end of Q3 and into the beginning of the fourth quarter, we started to see signs of market recovery. This has shown itself in a number of ways. First, we're seeing clients, particularly those that have a more mature security posture, Realizing that the pandemic, the move to work from home, the rapid deployment of telemedicine, and new expectations for interoperability have created new vulnerabilities in our security posture. Concluding that these trends are not temporary has created an increased willingness to enter into long-term contracts with a focus on shoring up their defenses in this new world. This was highlighted in our two recent releases with Valley Health and Fairview Health. both new logos to the Synergistic family. These customers 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 long-standing 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 health care providers and into the broader industry of health care. A good example of this is the recent managed services signing with a large State Department of Public Health on the West Coast. Now, as you can imagine, health departments across the U.S. are front and center in the effort to track infections and manage contact tracing. As such, they're generating volumes of information that must be properly assessed, protected, and secured. Born in healthcare, our organization and our consultants are ideally suited for this mission. I also want to mention our recent traction with RedStim, a synergistic-owned brand that focuses on offensive security testing outside of our traditional healthcare market. One of our strategic imperatives last year was to rebuild and upskill our penetration testing team. This now offensive security team has new people along with new offerings. which has allowed us to win consulting contracts in one of the nation's largest media companies and a well-known consumer electronics company, Logitech. These are early contract wins for our team, and they demonstrate the expertise and capabilities we've brought to Redspin. 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 markets. Now, not all of our clients are out of the woods when it comes to COVID-19 and the associated financial repercussions. This has had a significant impact on healthcare providers. When they run into financial instability, it can impact us, and this included a recent situation where a client exercised a termination for convenience clause, stepping 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, moving into next year, we anticipate budget uncertainty in health care providers will continue. It's important to note that while we see a pullback, we believe this generally does not represent losses to competition, but 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 noted by adversaries that are becoming more brazen in an effort to take down America's hospitals right in the middle of a pandemic. Increasing attacks, increasing consequences, and an increasing regulatory footprint will drive demand for our services. Remember, when 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 learn that the impact of limited operations can be financially devastating at the start of COVID. In just the past few weeks, about a dozen systems experienced the same impact, but it wasn't due to COVID. It was due to an orchestrated and brazen ransomware attack. Now, putting this into perspective, in just the last month, we've seen the first death attributed to ransomware, where a patient had to be diverted to another hospital and die in transit. In another incident, the governor of Vermont deployed the Vermont National Guard to assist in the significant recovery of a hospital system that was infected with ransomware. That incident is still ongoing today. Healthcare is rapidly realizing that investments in cybersecurity are very similar to investments in masks, gowns, and telemedicine. It's simply something that's going to be required to remain operational in this new world. And now that that has the attention of CEOs and boards, it's not how I want to see demand evolve, but it is happening. And we're well-positioned to do everything we can to help keep America's 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 would guide our strategy to transform the business and return it to growth. Now, we had this call before COVID-19 hit, but we found that those imperatives held true as we navigated the pandemic. It even helped us to galvanize our decisions as we worked through some of the challenges we faced in our own COVID response. So a year later, let's review where things stand. The first thing that 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 headcount 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 or 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, have pivoted to be completely remote, and have significantly improved our pipeline. We slow-rolled our marketing spend as we entered COVID, as that was an expense we could pull back on. And we're just now starting to rebuild our web presence, 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 interactions shut down due to COVID. Over the last month, we've promoted an internal candidate to be our VP of marketing, we conducted our annual customer conference, albeit virtually, and our web presence will be a source of investment moving forward. Now turning to our team, in many ways we're a 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 upskill our team. On the delivery front, we talked a year ago about the delivery backlog. Long backlogs lead to dissatisfied clients, and I was concerned not only the time it took to deliver on the contract, but also the size of our project management organization that was required to manage it. This has been a major area of focus, and we're far more efficient than a year ago. We've found new ways to deliver by cross-training individuals, allowing us to dramatically reduce the number of consultants on an engagement by nearly half. We've reduced our project management overhead by becoming more optimized, using newer 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 COVID shutdowns now returns. Lastly, and most importantly, we set out a target to return to growth. That is our last remaining imperative. And with a significantly reduced cost structure, a more efficient team, and several new offerings, this provides us with that pathway. With that, let me turn it over to Paul to review our financial performance.

Thanks, Caleb. As Caleb mentioned, we're still seeing an impact from COVID during the quarter as a result of its impact on health care providers. Again, this impact was primarily felt in a reduction in our pre-sold revenue, which dropped from $19 million to $16 million, primarily due to one larger managed services customer that had significant budget issues. This contract will term at the end of this year, giving us some time to respond. We 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 COVID by reducing expenses and focusing on opportunities to reduce further. This was a key driver to our improved margins, gross and operating margins in Q3 when 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. A couple other reminders. We received the $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 when 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 an at-the-market 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. Outlining our standard financial disclosures, revenue decreased by 0.3 million to 4.5 million due to lower revenue for managed services, which reduced 0.4 million to 2.7 million due to the impact of some customers canceling or delaying renewals and a reduction in net new customers due to COVID. Professional and consulting services increased 0.1 million to 1.8 million due to Lower revenue from the synergistic business as a result of the COVID offset, though, by $0.8 million in new and consulting professional services revenues from the acquisition of Backbone in Q4 last year. We're starting to see Backbone's business recovered from the COVID 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 this year. As I mentioned in my highlights, this improvement in gross margin is due to staff and expense reductions we made over the last couple quarters, along with reduced travel in reaction to the lower revenue and COVID-related travel restrictions. Sales and marketing expenses increased 1.3 million for Q2 2020 compared to 1.1 for the same period in 2019. This increase was due to the addition of backbone. G&A expense decreased by 0.2 million to 1.5 million. for Q3 2020 compared to the same period in 2019. The decrease is due to 0.4 million in expense reduction efforts taken to improve operating margins offset by 0.2 million in additional costs for backbone. Non-GAAP adjusted EBITDA loss was 0.8 million for Q3 2020 compared to 0.4 million for Q3 2019 and 1.3 million in Q2 of this year. The full financials and reconciliation of GAAP to non-GAAP information can be found in the earnings release that came out today. This concludes the financials and prepared remarks for Q3 2020. Operator, you can open the floor to questions.