CISO Global, Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this Annual Report and is intended to provide information necessary to understand our audited consolidated financial statements for the year ended December 31, 2022 compared to the year ended December 31, 2021 and highlight certain other information which will enhance a reader’s understanding of our financial condition, changes in financial condition, and results of operations. In particular, the discussion is intended to provide an analysis of significant trends and material changes in our financial position and the operating results of our business during the year ended December 31, 2022 compared to the year ended December 31, 2021. These historical consolidated financial statements may not be indicative of our future performance. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains numerous forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risks described throughout this filing, particularly in “Item 1A. Risk Factors.” - 25 - Our Business We are a cybersecurity and compliance company comprised of highly trained and seasoned security professionals who work with clients to enhance or create a better cyber posture in their organization. Cybersecurity, also known as computer security or information technology security, is the protection of computer systems and networks from information disclosure, theft of or damage to their hardware, software, or electronic data, as well as from the disruption or misdirection of the services they provide. The cybersecurity industry has a supply and demand issue wherein there is more demand for cybersecurity services than there are expert and seasoned compliance and cybersecurity professionals available in the market. We seek to identify, attract, and retain highly skilled cyber and compliance teams and bring them together to provide holistic cyber services. We accomplish this through acquisitions, direct hiring, and incentivizing employees with stock options to help retain them. On an ongoing basis, we seek to identify cyber talent that is culturally aligned and that offers operating leverage through both existing customer revenue and relationships. We have invested in enterprise solutions and executive talent to integrate our different organizations into an ecosystem that works together to provide complete and holistic cybersecurity through cross pollination of solutions. The ecosystem is intended to provide additional revenue opportunities and drive overall recurring revenue. We provide a full range of cybersecurity consulting and related services, encompassing all three pillars of compliance, cybersecurity, and culture. Our services include secured managed services, compliance services, security operations center (“SOC”) services, virtual Chief Information Security Officer (“vCISO”) services, incident response, certified forensics, technical assessments, and cybersecurity training. We believe that culture is the foundation of every successful cybersecurity and compliance program. To deliver that outcome, we developed our unique offering of MCCP+ (“Managed Compliance & Cybersecurity Provider + Culture”), which is the only holistic solution that provides all three of these pillars under one roof from a dedicated team of subject matter experts. In contrast to the majority of cybersecurity firms that are focused on a specific technology or service, we seek to differentiate ourselves by remaining technology agnostic, focusing on accumulating highly sought-after topic experts. We continually seek to identify and acquire cybersecurity talent to expand our service scope and geographical coverage to provide the best possible service for our clients. We believe that bringing together a world-class team of technological experts with multi-faceted expertise in the critical aspects of cybersecurity is key to providing technology agnostic solutions to our clients in a business environment that has suffered from a chronic lack of highly skilled professionals, thereby setting us apart from competitors and in-house security teams. Our goal is to create a culture of security and to help quantify, define, and capture a return on investment from information technology and cybersecurity spending. Our brand rallies around the battle cry: “Cyber security is a Culture, not a Product.” Financial Highlights Our operating results for the year ended December 31, 2022 included the following: ● Total revenue increased by $31.4 million to $46.5 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021. ● Total gross profit increased by $0.9 million to $2.7 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021. - 26 - Results of Operations Comparison of the Year Ended December 31, 2022, to the Year Ended December 31, 2021 Our financial results for the year ended December 31, 2022 are summarized as follows in comparison to the year ended December 31, 2021: For the Year Ended December 31, 2022 December 31, 2021 Variance Revenue: Security managed services $ 40,920,420 $ 11,797,719 $ 29,122,701 Professional services 5,629,197 3,344,840 2,284,357 Total revenue 46,549,617 15,142,559 31,407,058 Cost of revenue: Security managed services 15,431,523 3,089,599 12,341,924 Professional services 844,287 515,171 329,116 Cost of payroll 20,036,182 7,596,972 12,439,210 Stock based compensation 7,512,304 2,132,554 5,379,750 Total cost of revenue 43,824,296 13,334,296 30,490,000 Total gross profit 2,725,321 1,808,263 917,058 Operating expenses: Professional fees 2,067,603 1,189,319 878,284 Advertising and marketing 804,218 435,016 369,202 Selling, general and administrative 23,106,451 9,809,200 13,297,251 Stock-based compensation 9,885,191 8,076,688 1,808,503 Impairment of goodwill - 22,078,064 (22,078,064 ) Total operating expenses 35,863,463 41,588,287 (5,724,824 ) Loss from operations (33,138,142 ) (39,780,024 ) 6,641,882 Other income (expense): Other income (expense) 43,332 (39,063 ) 82,395 Interest expense, net (680,921 ) (307,363 ) (373,558 ) PPP loan forgiveness - 980,800 (980,800 ) Total other income (expense) (637,589 ) 634,374 (1,271,963 ) Loss before income taxes $ (33,775,731 ) $ (39,145,650 ) $ 5,369,919 Revenue Security managed services revenue increased by $29,122,701, or 247%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, primarily due to revenue acquired through our completion of five acquisitions over the last 12 months and new and existing customer revenue growth. Professional services revenue increased by $2,284,357, or 68%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, primarily due to revenue acquired through our completion of five acquisitions over the last 12 months. - 27 - Expenses Cost of Revenue Security managed services cost of revenue increased by $12,341,924, or 399%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due primarily to our completion of five acquisitions over the last 12 months, which increased our revenues from hardware and software sales and their related costs. Professional services cost of revenue increased by $329,116, or 64%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to our increase in revenue from professional services from acquisitions completed over the last 12 months. Cost of payroll increased by $12,439,210, or 164%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to headcount added primarily through our completion of five acquisitions over the last 12 months. Stock-based compensation increased by $5,379,750, or 252%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to an increase of stock options awarded to our growing base of revenue generating employees. Operating Expenses Professional fees increased by $878,284, or 74%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to an increase in accounting, legal and other professional fees incurred related to our periodic SEC filings and our efforts to raise additional capital. Advertising and marketing expenses increased by $369,202, or 85%, for the year ended December 31, 2022, as compared to December 31, 2021, due to our current marketing campaign initiatives to stimulate organic revenue growth, and an increased effort to utilize more internal resources for advertising and marketing activities. Selling, general, and administrative expenses increased $13,297,251, or 136%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, primarily due to head count added through the completion of five acquisitions over the last 12 months. Stock-based compensation expenses increased by $1,808,503, or 22%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to an increase in stock options awarded to employees through the completion of five acquisitions of the last 12 months and shares issued to consultants for marketing services provided. Impairment of goodwill decreased by $22,078,064, or 100%, for the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to impairment recognized in our goodwill in 2021 whereas impairment was not present in 2022. Other Income (Expense) Interest expense, net increased by $373,558, or 122%, during the year ended December 31, 2022, as compared to the year ended December 31, 2021, due to an increase in our debt assumed through acquisition during 2022 and obtaining $6,000,000 of short-term loans to fund operating capital. Working Capital Our working capital as of December 31, 2022, as compared to our working capital as of December 31, 2021, is summarized as follows: As of December 31, 2022 December 31, 2021 Current assets $ 14,398,795 $ 9,807,301 Current liabilities 23,213,039 5,141,561 Working capital (deficit)/surplus $ (8,814,244 ) $ 4,665,740 - 28 - The increase in current assets is primarily due to a decrease in cash and cash equivalents of $891,872, offset by an increase in accounts receivable, prepaid cost of revenue and prepaid expenses and other current assets of $3,021,495, $2,622,428, and $775,924, respectively. The increase in current liabilities is primarily due to the increase in accounts payable and accrued expense, deferred revenue, and loans and convertible notes payable of $5,601,271, $4,419,316 and $8,595,632, respectively. Cash Flows Our cash flows for the year ended December 31, 2022, as compared to our cash flows for the year ended December 31, 2021, can be summarized as follows: Year Ended December 31, 2022 2021 Net cash used in operating activities $ (10,681,007 ) $ (7,385,129 ) Net cash (used in)/provided by investing activities (6,048,944 ) 2,050,057 Net cash provided by financing activities 15,777,909 2,863,077 Effect of exchange rates on cash and cash equivalents 60,170 - Decrease in cash $ (891,872 ) $ (2,471,995 ) Operating Activities Net cash used in operating activities was $10,681,007 for the year ended December 31, 2022 and was primarily due to cash used to fund a net loss of $33,775,182, adjusted for non-cash expenses in the aggregate of $20,752,668 and additional cash increases from changes in the levels of operating assets and liabilities in the aggregate of $2,341,507, primarily as a result of an increase in accounts payable and other deferred revenue. Net cash used in operating activities was $7,385,129 for the year ended December 31, 2021 and was primarily due to cash used to fund a net loss of $39,145,650, adjusted for non-cash expenses in the aggregate of $33,853,661, partially offset by cash generated by changes in the levels of operating assets and liabilities in the aggregate of $2,093,140, primarily as a result of an increase in accounts receivable and other current assets. Investing Activities Net cash used in investing activities of $6,048,944 for the year ended December 31, 2022, was primarily due cash paid as part of the acquisition of True Digital. Net cash provided by investing activities of $2,050,057 for the year ended December 31, 2021, was due to cash acquired in the acquisitions of VelocIT, Atlantic, RED74 and Arkavia. Financing Activities Net cash provided by financing activities for the year ended December 31, 2022 was $15,777,909, which was primarily due to cash received from the sale of our common stock, and net proceeds from loans and notes payable of $10,689,087 and $6,061,585, respectively, and offset by the payment of loans of $2,452,905. Net cash provided by financing activities for the year ended December 31, 2021 was $2,863,077, which was primarily due to cash received from the sale of our common stock, and proceeds from loans and notes payable of $3,250,000 and $1,863,474, respectively, and offset by payments on loans of $2,300,397. Liquidity The accompanying consolidated financial statements have been prepared on the basis that we will continue as a going concern, which contemplates realization of assets and satisfying liabilities in the normal course of business. At December 31, 2022, we had an accumulated deficit of $77,787,604 and working capital deficit of $8,814,244. For the year ended December 31, 2022, we had a loss from operations of $33,138,142 and negative cash flows from operations of $10,681,007. Although our company is showing positive revenue and gross profit trends, we expect to incur further losses through the end of 2023. - 29 - To date, we have funded operations primarily through the sale of equity in public offerings, private placements, loan proceeds, and revenue generated by our services. During the year ended December 31, 2022, we received $10,689,087 from our public offerings of our common stock, $5,975,000 in net proceeds from our bridge loans, and $1,480,142 from the exercise of stock options. On June 27, 2022, our Registration Statement on Form S-3 was declared effective, and we may offer and sell from time to time, in one or more series, any of our securities, for total gross proceeds up to $300,000,000. As of December 31, 2022, we had $298,734,727 of available funding from our S-3 Registration Statement from which we may issue our securities to fund current and future operations. Going Concern The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. For the year ended December 31, 2022, we incurred a net loss of $33,775,182, had negative cash flows from operations of $10,681,007, and working capital deficit of $8,814,244. These matters raise substantial doubt as to our ability to continue as a going concern. Our existence is dependent upon our ability to develop profitable operations. We are devoting substantially all of our efforts to developing our business, reducing overhead costs, and raising capital, although there can be no assurance that our efforts will be successful. No assurance can be given that our actions will result in profitable operations or the resolution of liquidity problems. The accompanying consolidated financial statements do not include any adjustments that might result should we be unable to continue as a going concern. In order to improve our liquidity, in addition to a planned reduction in overhead costs, we are actively pursuing additional debt and/or equity financing through discussions with investment bankers and private investors. There can be no assurance that we will be successful in our efforts to secure additional financing. The financial statements do not include any adjustments relating to the recoverability of assets and the amount or classification of liabilities that might be necessary should we be unable to continue as a going concern. - 30 - Recently Issued Accounting Pronouncements See Note 3 to our consolidated financial statements for the years ended December 31, 2022 and 2021 included elsewhere in this Annual Report. Critical Accounting Policies and Estimates Use of Estimates The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at dates of the financial statements and the reported amounts of revenue and expenses during the periods. Our significant estimates and assumptions include the recoverability and useful lives of long-lived assets, stock-based compensation, and the valuation allowance related to our deferred tax assets. Certain of our estimates, including the carrying amount of intangible assets and goodwill, could be affected by external conditions, including those unique to us and general economic conditions. It is reasonably possible that these external factors could have an effect on our estimates and could cause actual results to differ from those estimates. Fair Value Measurement The fair value measurement guidance clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in the valuation of an asset or liability. It establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under the fair value measurement guidance are described below: Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities; Level 2 - Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; or Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity). Business Combination We allocate the purchase price of an acquired business to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values on the acquisition date. Any excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. The purchase price allocation process requires management to make significant estimates and assumptions, especially at the acquisition date with respect to intangible assets. Direct transaction costs associated with the business combination are expensed as incurred. The allocation of the consideration transferred in certain cases may be subject to revision based on the final determination of fair values during the measurement period, which may be up to one year from the acquisition date. We include the results of operations of the business that it has acquired in its consolidated results prospectively from the date of acquisition. - 31 - If the business combination is achieved in stages, the acquisition date carrying value of the acquirer’s previously held equity interest in the acquiree is re-measured to fair value at the acquisition date; any gains or losses arising from such re-measurement are recognized in profit or loss. Intangible Assets Intangible assets are comprised of trademarks, customer bases, non-compete agreements and intellectual property with original estimated useful lives with a range of 2 to 15 years. Once placed into service, we amortize the cost of the intangible assets over their estimated useful lives on a straight-line basis. Goodwill Goodwill represents the excess of the purchase price of the acquired business over the estimated fair value of the identifiable net assets acquired. Goodwill is not amortized but is tested for impairment at least annually at year end, at the reporting unit level or more frequently if events or changes in circumstances indicate that the asset might be impaired. Goodwill is tested for impairment at the reporting level by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. If the reporting unit does not pass the qualitative assessment, then the reporting unit’s carrying value is compared to its fair value. The fair values of the reporting units are estimated using market and discounted cash flow approaches. Goodwill is considered impaired if the carrying value of the reporting unit exceeds its fair value. The discounted cash flow approach uses expected future operating results. Failure to achieve these expected results may cause a future impairment of goodwill at the reporting unit. Impairment of Long-lived Assets We will periodically evaluate the carrying value of long-lived assets to be held and used when events and circumstances warrant such a review and at least annually. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced for the cost to dispose. Stock-Based Compensation We measure the cost of services received in exchange for an award of equity instruments based on the fair value of the award. For employees and directors, the fair value of the award is measured on the grant date and for non-employees, the fair value of the award is generally re-measured on vesting dates and interim financial reporting dates until the service period is complete. Awards granted to directors are treated on the same basis as awards granted to employees. Revenue Recognition Our agreements with clients are primarily service contracts that range in duration from a few months to one year. We recognize revenue when control of these services is transferred to the client for an amount, referred to as the transaction price, which reflects the consideration to which we are expected to be entitled in exchange for those goods or services. A contract with a client exists only when: ● the parties to the contract have approved it and are committed to perform their respective obligations; ● we can identify each party’s rights regarding the distinct services to be transferred (“performance obligations”); ● we can determine the transaction price for the services to be transferred; and ● the contract has commercial substance, and it is probable that we will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the client. - 32 - We do not adjust the promised amount of consideration for the effects of a significant financing component since we expect, at contract inception, that the period between the time of transfer of the promised goods or services to the client and the time the client pays for these goods or services to be generally one year or less. Our credit terms to clients generally average thirty days, although in some cases payments are required in 15 days. We do not disclose the value of unsatisfied performance obligations for contracts with original expected duration of one year or less. See Note 3 to our consolidated financial statements for the years ended December 31, 2022 and 2021 included elsewhere in this Annual Report for additional information regarding revenue recognition and deferred revenue. Reimbursed Expenses We include reimbursed expenses in revenue and costs of revenue as we are primarily responsible for fulfilling the promise to provide the specified service, including the integration of the related services into a combined output to the client, which are inseparable from the integrated service. These costs include such items as consumables, transportation and travel expenses, over which we have discretion in establishing prices. Costs of Revenue Costs of revenue include (i) compensation and benefits for billable employees and consultants directly involved with delivering services offerings and engagements; (ii) consumables used for the services; and (iii) other expenses directly related to service contracts such as professional services, meals and travel expenses. Volatility in Stock-Based Compensation The volatility is based on historical volatilities of companies in comparable stages as well as the historical volatility of companies in the industry and, by statistical analysis of the daily share-pricing model. The volatility of stock-based compensation at any point in time is based on historical volatility of similar companies in the industry for the last two to five years. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures, or capital resources. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Because we are a smaller reporting company, we are not required to provide the information called for by this Item. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information called for by Item 8 is included beginning on page F-1 contained in this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. - 33 -