CynergisTek, Inc.

and welcome to the Synergistic Fourth Quarter and Full Year 2021 Earnings Conference Call. Just a reminder, today's conference is being recorded. At this time, I'd like to turn the conference over to Brian Flynn, Vice President of Investor Relations. Please go ahead, sir.

Welcome to Synergistic's Fourth Quarter and Full Year 2021 Earnings Call. Joining me today from the company are Mr. Mac McMillan, 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 webcast, including those regarding future financial results and industry prospects, among others, are forward-looking. These forward-looking statements can be identified by the use of forward-looking terminology, such as believes, expects, anticipates, would, could, intends, may, will, or similar expressions and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in today's conference. Certain of these risks and uncertainties are or will be described in greater detail in the company's SEC filings. Given the risks and uncertainties, listeners should not place undue reliance on any forward-looking statements and should recognize that the statements are predictions of future results which may not occur as anticipated. Synergistic is under no obligation and expressly disclaims any such obligation to update or alter its forward-looking statement, whether as a result of new information, future events, or otherwise. This time, I'd like to turn the call over to Matt McMillan, our CEO.

Ryan, thank you for getting us started this afternoon. Welcome, all of you, for joining us for today's earnings call, and thank you for taking time out of your busy day to be here as well. This marks the second earnings call since I returned last August, and even though we still have a long way to go, our fourth quarter performance showed that elements of our strategy are working. Most notably, our sales team, which just recently added its last team member, turned in a solid performance, better than expected, and our other efforts to better manage costs and alignment of resources in the company had a positive impact as well. As we head into the new year, we are watching very closely the impact that the economy and the war in Europe are having on the market and our business. Several clients have already shared that with the COVID federal relief dollars ending, They are now facing reduced operating margins from last year's losses, combined with this year's economy. But cyber remains a priority and a major concern for all of them. So we remain focused on executing our plan while working with our clients to work through these issues. I'm very pleased to share the business performance that led to a strong fourth quarter and year end. We saw continued demand for our services ending the year with 43 net new customers and improving the renewal rate of existing customers by nearly 30 points higher than it was in July. Our customer expansion included a diverse portfolio of entities from large university medical centers and nationally recognized health systems to many in adjacent markets, including those in our CMMC government offering. Our goal is to continue this momentum into 2022. We believe trends in the business will be the same this year as we have seen in previous years, with the first half of the year starting off somewhat slower, particularly with the economic pressures mentioned above, and then ramping up as the year progresses. This February marked an important milestone as we fleshed out our sales team with dedicated reps in each region across the U.S. All have been onboarded, have had initial orientation and training, and are focused on pipeline growth and closing deals. I'm happy to report that our efforts in marketing are also showing improvement, not only in managing costs, but more importantly, in lead generation and marketing activity. This quarter, the marketing team developed an aggressive marketing plan for 2022, while preparing for the busiest period of the year in marketing activity with three of the largest annual events we participate in happening in early spring. We have also seen an uptick in the prospect client face-to-face meetings, which benefits sales opportunities. We continue to experience growth in our DoD CMMC pipeline, and we've actually been able to initiate several CMMC projects. However, progress remains slow as we all wait for DoD to issue its final guidance, which is expected by the end of this month. Organizations are expectedly reluctant to begin before DoD issues that guidance. As a reminder, our focus through the end of last year was on four key areas. First, supporting sales and getting fully staffed, enabled, and aligned to effectively engage with market opportunities. Second, expanding the mission of the delivery organization to go beyond project delivery and into driving new and expanded business. Third, reassessing and prioritizing those competencies needed to support growth of the business, and fourth, revisiting our long-term strategy. Addressing the first two items, we continued to add strength to the sales team throughout the last part of the year, with our last salesperson selected just after the new year. Even though most of this team arrived in late 2021 and early 2022, they managed to drive a 23% increase in bookings in the second half of the year when compared to the first half as several reps closed deals in their first quarter on board. Our Q4 bookings of $5.8 million exceeded our expectations and added to our pre-sold revenue, which has increased by 15% or roughly $20 million by Q4 2021. This improvement is a direct result of the reorganization and refocusing efforts we initiated last fall, along with the tremendous efforts by this new sales and delivery team to identify new opportunities within our existing client base and with new prospects. Today, we have a sales team that consists of eight business development leads and inside sales reps, who, with the aid of a re-energized marketing team and revived corporate sales culture, have been able to generate and double the pipeline to date when compared to year-end 2020. We are recreating the sales culture that built Synergistec initially, and together with the top-down Together, and together from the top down, everyone in the organization is working in lockstep to identify opportunities for growth as we continue to drive the company forward. Before I talk about the second half of our focus, growth in our long-term strategy, it is probably appropriate to speak to the current cyber ecosystem. Obviously, that has become more interesting recently as the result of the conflict in Ukraine with Russia. And as many of you no doubt saw, President Biden, as well as the CISA and the FBI, issued warnings earlier this week that cyber attacks could be imminent and all critical infrastructure industries should prepare and be vigilant. Certainly, this could be a game changer in terms of the threat landscape and has caused organizations to become even more cautious. The regulatory landscape also changed in this last week. as the omnibus funding bill passed, which had several pieces of legislation regarding cybersecurity. Key among them was a universal breach reporting requirement for all critical industries. In the event of a cyber attack, they will have 72 hours to report to CISA. And if they pay a ransom, they will have 24 hours to report back. This is the shortest timeline to date for breach reporting. It will be some time before the implementing rules are written, vetted, and published that will make this requirement effective. But this will give thousands of organizations a mandatory breach reporting requirement that are not subject to one today. However, what is driving buying decisions today is more a factor of the actions of cyber insurance carriers who are requiring very specific measures to avoid large increases in premiums and the overall threat and cost of breaches. Today's healthcare landscape is evolving. The global healthcare cybersecurity market is predicted to grow by 15% year-over-year over the next five years and reach $125 billion in cumulative spend from 2020 to 2025. More than ever, we are hearing clients and prospects say that they are interested in managed services. Bad actors continue to target healthcare to disrupt business operations because of lack of financial and operational resources focused on cybersecurity. Today, with the expanding attack surface and exposure of protected health information through remote workforces, telehealth, cloud services, and an ever-growing number of supply chain vendors, cyberattacks are increasing in volume and sophistication and can be a life-and-death situation for patients. Cyber attacks on healthcare systems spiked during the pandemic, demonstrating how cyber criminals exploit opportunity and their total lack of regard for healthcare's mission. This spike is now threatening patient care as well as private data while increasing operating costs. Developing an effective response is not getting simpler either. With over 3,500 cybersecurity vendors producing and selling thousands of solutions, it is difficult for hospitals to identify what tools should be a priority. Additionally, ransomware attacks alone cost healthcare organizations $20.8 billion in downtime lawsuits, ransoms paid, lost revenue, and fees to rebuild their business in 2020, double the amount it cost in 2019, according to a Comparatech report. Attacks continue to rise with more than 300,000 new malware introduced on the web every day, resulting in a staggering increase in the number of incidents and the effects that those attacks have on business. Today, 93% of healthcare organizations have experienced at least one data breach in the past year, and healthcare accounts for more than half of the ransomware attacks experienced in the U.S. While attack methods evolve, the nature of the threat has not changed. It is still primarily about money. Responsible organizations today must prioritize cybersecurity if they want or intend to protect their business and their investments. While business disruption is perhaps the number one business risk, for healthcare, patient safety, and quality of care are still their highest priority. In 2021, it became evident that patient safety and quality of care were also being directly impacted by disruptive attacks. To make things worse, a greater number of these attacks originated from other points across their expanding attack surface that now includes remote workforce members, the Internet of Things, supply chain vendors, and business partners. The success of these attacks has also fueled an increase in their numbers. Environmental factors also contributed to an increase in the number of attacks experienced, like the number of ransomware attacks that grew exponentially during the pandemic. roughly going from one successful ransomware attack every 40 seconds in 2020 to one every 14 seconds in 2021, and now expected to reach one in every 11 seconds by the end of this year. That translates to approximately 7,200 successful ransomware attacks a day in the U.S. This immediate threat led the Emergency Care Research Institute, or ECRI, to identify cybersecurity as the number one risk in their recently released report called Top 10 Health Technology Risks for 2022. Both the financial and operational impacts of cyber attacks are increasing dramatically. Healthcare is realizing this and looking to cyber vendors for greater support and solutions. As organizations start to increase spend to improve readiness, build greater resilience into their defenses and be more productive, proactive with security, we want to be ready to support them. To meet this need and answer the need for growth, we have added several new strategic vendor solutions and re-energized several others to enhance our service offerings and move towards being a managed service provider. Our new solutions include advanced threat hunting, incident response support, managed continuous PIN testing, compromise assessments, security controls validation, and SOC services. Clients are becoming more and more aware of the threat they face and the need for more proactive security. It is not enough to have good defenses any longer and sit and wait in a defensive posture for the adversary to attack. We need to go on the offensive and build more resilience in our protections to better anticipate the threat and respond more effectively. Healthcare is also faced with the daunting task in trying to build and maintain the cyber expertise they need to meet these challenges, making managed services all that more important and attractive. As we look out over the next few years, we have four underlying pillars to our growth strategy. Our near-term tactical focus will be on driving revenue growth and margin expansion. We believe that the levers for accelerated revenue growth will be the organic growth through net new clients, further expansion of services into our current customer base, and evaluation of M&A service opportunities. Margin expansion will come from alignment with technology-based strategic partners and the ability to scale and leverage our existing delivery team for greater revenue growth. Our goal is to double the size of the business and transition from a primarily services company that we are today into a managed service provider, or MSSP. We feel that we can achieve this through a mixture of organic growth strategic partnerships, and an acquisition or merger that better positions us to be the partner of choice for customers. Again, our near-term focus in 2022 will be returning the company to core business growth, targeting four key metrics, renewals, customer penetration, net new clients, and average client spend, which will drive increased revenue and operating margin. This past fall, we saw growth in all four of these metrics. client spend, an improvement in our renewal rate, an increase in our contract size, and an increase in number of net new customers. This will continue to be our focus going forward. By targeting a greater than 85% renewal rate of managed service contracts, we will expand our pre-sold revenue and maintain a strong foundation to build on as we grow the business going forward. We will focus on expansion in our current customers and target a 20% increase to our managed service contracts today. Secondarily, we intend to grow the number of clients with two or more managed services. As we penetrate and add services to our managed service customers, we are targeting a 25% increase in average client spend, giving us greater penetration and increasing client loyalty. Achieving more managed security sales, which are typically greater in size, will help make this a reality. And finally, we want to increase our net new clients by at least 20%. Currently, we sit at approximately 200 plus clients, and we look to drive that to 240 plus in 2022. And currently, we will work to accelerate growth by evaluating M&A opportunities, enhanced strategic partnerships, and the integration of IP into our offerings. On the M&A side, we will look for opportunities in the services, MSSP, and technology space that supports or complements our existing service offerings. We plan to look at both equity and debt financing options to fund these acquisitions. Long-term, 2024, 2025, our goal is to transform into an MSSP generating opportunities to sell our own products, drive additional growth or improving margins through implementation, management, and automation of technology in combination with our existing managed services. I'll turn it over now to Paul to cover the financials and be back before we wrap up.

Thanks, Mac. Bookings this year totaled $18.9 million compared to $17.7 million last year. As a result, our pre-sold revenue continues to grow, increasing by an additional $2.8 million to $20 million. This increase in bookings was a direct result of our investments in sales and marketing, the increased demand for our services, and the size of our contracts. Addressing the Q4 standard financial disclosures, revenue was $4.4 million compared to $4.7 million in Q4 2020. The decrease from prior year was due to lower revenue from managed services, which was reduced by $0.5 million to $2.2 million due to the impact of COVID. Consulting and professional services revenue increased 0.2 million to 2.1 million when compared to Q4 2020 due to increased activity in the backbone business unit. We've started to see sequential revenue growth in Q4 16% over Q3 2021, with the majority of growth coming from an increase in consulting and professional services revenue, again, due to the backbone rebounding, higher bookings in our traditional services, as well as a seasonal increase we've historically seen in Q4. Gross margin increased 3% to 40% for Q4 2021 versus Q4 2020. And sequentially, we saw a 4% increase from Q3 to Q4 2021 after adjusting Q3 for the employee retention credits. This increase was due to the increased revenue and again demonstrates how modest growth allows for positive operating leverage in this business. SG&A expenses increased to $3.3 million for Q4 2021 compared to $2.2 million for the same period in 2020. This increase was primarily due to additional headcount, compensation-related expenses, and additional costs as we reinstated benefits that were eliminated during COVID, and an increase in sales, marketing, and travel costs now that we have a full team and are back on the road driving growth. Non-GAAP adjusted EBITDA loss was $1.4 million for Q4 2021 compared to $0.3 million last year due to this increase in SG&A, which is high level. 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 the prepared remarks for Q4. Operator, please open the floor for questions.

Thank you. If you would like to signal with questions, please press star 1 on your touchtone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star 1 for questions. And our first question will come from Matt Hewitt with Craig Hallam Capital Group.

Hi, guys. This is Lucas on for Matt Hewitt. I guess to start it off, In recent months, you've had a pretty steady cadence of customer wins and expansions. Are you seeing an increase in demand? And if so, what do you think is driving that?

Well, it's kind of a mixed bag at the moment. We're seeing an increase in demand, and we're seeing an increase in requests from, I guess, across the board. A lot of it is being driven by what's going on overseas. A lot of it's being driven by just the threat that healthcare is dealing with with respect to ransomware and other disruptive attacks that they're faced with. But we're also seeing a balance, if you will, in terms of cautiousness as a result of The economy, the same thing with what's going on overseas, and inflation and rising interest rates that are absolutely affecting a lot of the hospital's operating margins.

Thanks. That's helpful, Culler. And then I guess you also talked about how you now have a fully staffed sales team. I guess, where would you say we're at in terms of the ramp for those newer sales reps?

I'd say for the newest ones, of course, that just came on, we're probably still a good two quarters before this quarter and next, before they'll be probably fully functional is probably the best way to describe it. But I have to admit that the sales reps that we've added in the last part of the year have actually started selling a lot faster than I expected, meaning normally when a sales guy comes on or gal, you expect their first quarter to be one of orientation and building their pipeline and not necessarily closing deals, right, because of the sales cycles, et cetera. second quarter you expect them to start closing deals and by third quarter you expect them to be hitting their number. But we've actually seen I think just about every single one of our new sales people have actually started closing deals in their first quarter. And a couple of them have actually hit their number in their second quarter. So I don't want to I don't want to predict that they're all going to be that fast or they're all going to be that efficient. But I'm very impressed with the sales guys that we've hired. They've all got great backgrounds in cyber and in selling IT. Almost every single one of them also has worked in an environment where they've sold not only into adjacent markets but into healthcare as well. And we're actually seeing the benefit of that, I think. Um, and, uh, and they're, they're all, you know, they're, they're very motivated and obviously they're being very driven right now in terms of, in terms of what we need them to do. Um, and, uh, the whole organization understands that sales is the name of the game.

Great. And then finally, I guess, looking ahead to the rest of the year, is there any chance that you would expand the sales team further?

You know, that's a good question. I think it depends on some of the newer services and relationships that we're bringing on now. It may be that at some point we expand to include things like sales engineers for some of the technology in terms of selling that. But I don't want to I don't know that we're going to do that yet, but that's clearly something that might be a possibility.

And then I guess if I could just squeeze in one final question here. For hospital CEOs specifically, have you seen any movement in terms of where cybersecurity falls within their priority list?

So if you look at most of the... senior executive team's priority list for their hospitals today, you'll find cybersecurity is, it generally is one of the top three or top five priorities they have. Clearly, you know, their number one priority right now is recovering from the financial losses that they took in 2020 and 2021 because of the pandemic. and dealing with the financial pressure that they're experiencing now with the inflation and the interest rates, as I talked about, and whatnot. But if you look at their IT priorities in particular, cyber is definitely one of their top priorities.

Okay, thank you very much. That's all I had.

And our next question will come from Jerry Well, a private investor.

Hi, Mac and Paul. Hey, good to hear. Thanks for your hard work and effort and accomplishments. I just wondered if you'd give us a little update, probably maybe it's more of a Mac question, relating to the Department of Defense work that you had kind of get approved for a while back, and I know it kind of got stalled. But any updates you can give us on that?

Sure. When I came back, the company was probably positioned as best it could possibly be in terms of executing on that work and that strategy. Clearly, we were ahead of everybody else as it related to our ability to do that. For a while there, it actually looked like towards right at the end of the year that it was going to take off because we were really seeing an uptick in the growth of the pipeline. We were actually seeing folks leaning forward in terms of wanting to get started with their projects. And then, of course, DOD came out in November and kind of put the kibosh on a lot of things by totally revamping, restructuring the program, and then saying they were going to have to go back through an entirely new process of getting it approved, et cetera, et cetera, which was going to take several months. Then they came back after that and a couple things. But to make a long story short, what it really did was it caused everybody to kind of take a step back and to say, well, we don't know that we want to move forward, or we want to do this right now because what happens if DOD totally changes the requirement? I think they've gotten past that because I think the CMMCAB has done a fairly decent job of working with the Undersecretary of Acquisition and getting the message out that the program isn't going to change demonstrably. And in fact, they've actually walked back some of the changes that they had suggested back in the fall And DOD committed to putting out the final guidance, if you will, by the end of this month, March, with respect to the program. So the good news was, probably in the February time frame, we began to see organizations re-engaging, and the pipeline started moving again. The good news is right now the pipeline is continuing, for us, is continuing to grow. The number of prospects is continuing to grow. The number of proposals, so to speak, going out the door is continuing. And we do have several of the initial projects in flight now. And so we're all hoping that DOD will keep to its word and initial that final guidance in March, and hopefully it won't be anything that surprises anyone. And if it isn't, then I'm hopeful that once we get past that and we have that final guidance and we're moving towards an update of the FAR, that organizations will get more comfortable and start to move out again. But clearly, DOD has... We're all, unfortunately, at the mercy of waiting for DOD to approve the final program guidelines.

Sure, appreciate it. So relating to your projections, if you will, of growing the business, there's not a lot of reliance on that business from the DOD, and so that would, in your mind, probably be an upside from what you're expecting. Would that be a fair statement, Mack?

Well, we actually had some of that business obviously plugged into our projections for this year because at the time that we put together that budget last fall, things were moving steadily in that direction. We kind of backed that down as a result. But like I said, I'm hopeful that if the final guidance comes out at the end of this quarter, that there's still plenty of time for us to ramp to what, to, to what I think we were going to try to achieve in the first place. So I'm, I'm going to, I'm going to still stay hopeful, but, but, but I'm going to, I'm going to, I guess I'm going to be guardedly hopeful, you know, waiting to wait to see what they do.

Sure. Makes sense. One last question I'll leave is, uh, uh, relating to potential acquisitions, you know, obviously your valuation on your company, in my opinion, is very low, uh, Um, and so it would seem as though be a challenge to try to get anything done on an acquisition side. Uh, um, you know, it's, can you speak to that a little bit on, on your, what the plans would be relating to that?

Yeah, no, you're absolutely correct. I mean, it's a, it's a very challenging, um, um, part of the plan, if you will. Um, But I think it's a very important part of it in the sense that if we can find the right acquisition that is complimentary and increases revenues and customers and et cetera, then that can be accretive, or if we can find the right acquisition from a technology perspective that can enhance our ability to be more efficient in how we deliver and increase margins and whatnot. You know, the bottom line is that you're right. In terms of raising capital to do it right now is very difficult because of where our valuation is. But to me, it has to be part of our plan for growth because, you know, is going to get us somewhere, but it's not going to get us, I think, where we want to be. And, and at some point we're going to have to have to embrace acquisitions if we want to really accelerate growth.

Okay. Well, thanks for all your hard work, Mac and Paul. Appreciate it. And I appreciate everything you do. I'm all done. Thanks.

Thank you, and that does conclude the question-and-answer session. I'll now turn the conference back over to Mac McMillan.

Thank you, Operator. To summarize, we're working to achieve an increased enterprise value. As we implement and execute our plan, we believe we can drive growth in the business to achieve greater scale. We see a path to grow this company to a $50 million-plus business over the next few years through a mixture of organic and inorganic growth. That will require execution of the plan, investment in the right strategic partners, and acquisition. This will not be without challenges in the near term as clients and healthcare entities in particular grapple with inflation, rising interest rates, shrinking operating margins, as federal COVID subsidies dry up, and the uncertainty of the world situation and the associated price increases for critical essentials such as fuels. Despite all these pressures, protecting data and systems is still a high priority and an important need for businesses, and they will seek to balance these two issues. We will continue to help them to do that by increasing and adapting the services we provide to their unique needs. We are making progress but are still rebuilding with the goal to be in a growth stage as we emerge from 2022. Again, I want to thank everyone for joining the call today, and we will see you during our Q1 2022 earnings call. Thank you.

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.