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, 2023 compared to the year ended December 31, 2022 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, 2023 compared to the year ended December 31, 2022. 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.” Our Business We provide a comprehensive suite of cybersecurity consulting and related services that encompass all three critical pillars: compliance, cybersecurity, and organizational culture. Our services include managed security, compliance assessments, SOC support, vCISO services, incident response, digital forensics, technical assessments, and cybersecurity training. We’ve developed a unique offering called MCCP+ that delivers all three of these pillars through a dedicated team of subject matter experts. Unlike many cybersecurity firms focused on specific technologies or services, we remain technology-agnostic. Instead, we concentrate on building a world-class team of cybersecurity and compliance experts with diverse skillsets. Our goal is to provide our clients with truly holistic solutions that address the chronic shortage of highly skilled cybersecurity professionals. Underpinning our services is a steadfast belief that establishing a strong culture of security is essential for organizational resilience. We work closely with our clients to cultivate this security-first mindset, helping them quantify the return on their cybersecurity investments. We have developed innovative software-based IP powered by machine learning, AI, and dark web threat intelligence. These multilayered technologies aim to enhance cyber effectiveness and drive greater resiliency for enterprises. With a comprehensive portfolio of scalable IP solutions and an end-to-end team of experts, we are poised for organic growth. By optimizing the user experience and leveraging digital interfaces, we can expand our client base without adding strain to our services team. This scalability will enable us to drive increased revenue and margins concurrently. - 28 - Financial Highlights Our operating results for the year ended December 31, 2023 included the following: ● Total revenue increased by $10.5 million to $57.1 million for the year ended December 31, 2023, as compared to the year ended December 31, 2022. ● Total gross profit increased by $3.3 million to $6.0 million for the year ended December 31, 2023, as compared to the year ended December 31, 2022. Results of Operations Comparison of the Year Ended December 31, 2023, to the Year Ended December 31, 2022 Our financial results for the year ended December 31, 2023 are summarized as follows in comparison to the year ended December 31, 2022: For the Year Ended December 31, 2023 December 31, 2022 Variance Revenue: Security managed services $ 50,078,925 $ 40,920,420 $ 9,158,505 Professional services 6,979,832 5,629,197 1,350,635 Total revenue 57,058,757 46,549,617 10,509,140 Cost of revenue: Security managed services 23,671,605 15,431,523 8,240,082 Professional services 900,582 844,287 56,295 Cost of payroll 21,613,207 20,036,182 1,577,025 Stock based compensation 4,823,829 7,512,304 (2,688,475 ) Total cost of revenue 51,009,223 43,824,296 7,184,927 Total gross profit 6,049,534 2,725,321 3,324,213 Operating expenses: Professional fees 3,695,187 2,067,603 1,627,584 Advertising and marketing 474,121 804,218 (330,097 ) Selling, general and administrative 26,744,543 23,106,451 3,638,092 Stock-based compensation 7,712,671 9,885,191 (2,172,520 ) Impairment of goodwill 45,194,717 - 45,194,717 Total operating expenses 83,821,239 35,863,463 47,957,776 Loss from operations (77,771,705 ) (33,138,142 ) (44,633,563 ) Other income (expense): Other income (expense) (13,640 ) 43,332 (56,972 ) Interest expense, net (2,881,416 ) (680,921 ) (2,200,495 ) Total other income (expense) (2,895,056 ) (637,589 ) (2,257,467 ) Loss before income taxes $ (80,666,761 ) $ (33,775,731 ) $ (46,891,030 ) - 29 - Revenue Security managed services revenue increased by $9,158,505, or 22%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, primarily due to having a full year of ownership of CUATROi and NLT Secure, and new and existing customer revenue growth. Professional services revenue increased by $1,350,635, or 24%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, primarily due to having a full year of ownership of CUATROi and NLT Secure. Expenses Cost of Revenue Security managed services cost of revenue increased by $8,240,082, or 53%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due primarily to having a full year of ownership of CUATROi and NLT Secure compared to only four months in 2022, which increased our revenues from hardware and software sales and their related costs. Professional services cost of revenue increased by $56,295, or 7%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to our increase in revenue from professional services from having a full year of ownership of CUATROi and NLT Secure compared to only four months in 2022. Cost of payroll increased by $1,577,025, or 8%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to headcount costs of CUATROi and NLT Secure having a full year of ownership compared to only four months in 2022. Stock-based compensation decreased by $2,688,475, or 36%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to the timing of recognition of the reversal of expense for options forfeited by former employees, a decrease in the number of options granted in 2023, and a decline in the fair value of new options granted resulting from the decline in our share price. Operating Expenses Professional fees increased by $1,627,584, or 79%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, 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, offset by a reduction in accounting and audit fees. Advertising and marketing expenses decreased by $330,097, or 41%, for the year ended December 31, 2023, as compared to December 31, 2022, due to utilizing internal resources for advertising and marketing activities. Selling, general, and administrative expenses increased $3,638,092, or 16%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to the costs of CUATROi and NLT Secure having a full year of ownership compared to only four months in 2022. Stock-based compensation expenses decreased by $2,172,520, or 22%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to the timing of recognition of the reversal of expense for options forfeited by former employees, a decrease in the number of options granted in 2023, and a decline in the fair value of new options granted resulting from the decline in our share price. - 30 - Impairment of goodwill increased by $45,194,717, or 100%, for the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to the fair value of our reporting units falling below their carrying value in 2023, whereas in the carrying fair value of these reporting units exceeded their carrying value in 2022. Other Income (Expense) Interest expense, net increased by $2,200,495, or 323%, during the year ended December 31, 2023, as compared to the year ended December 31, 2022, due to an increase in our debt assumed through acquisitions during 2022 and obtaining short-term loans to fund operating capital in 2023. Working Capital Our working capital as of December 31, 2023, as compared to our working capital as of December 31, 2022, is summarized as follows: As of December 31, 2023 December 31, 2022 Current assets $ 10,957,814 $ 14,398,795 Current liabilities 26,071,102 23,213,039 Working capital (deficit)/surplus $ (15,113,288 ) $ (8,814,244 ) The decrease in current assets is primarily due to a decrease in cash and cash equivalents, accounts receivable and prepaid expenses and other current assets of $770,721, $2,176,570, and $524,379 respectively. The increase in current liabilities is primarily due to the increase in accounts payable and accrued expenses of $7,640,990, offset by a decrease in loans and convertible notes payable of $4,567,367 Cash Flows Our cash flows for the year ended December 31, 2023, as compared to our cash flows for the year ended December 31, 2022, can be summarized as follows: Year Ended December 31, 2023 2022 Net cash used in operating activities $ (5,920,112 ) $ (10,681,007 ) Net cash used in investing activities (160,158 ) (6,048,944 ) Net cash provided by financing activities 6,193,046 15,777,909 Effect of exchange rates on cash and cash equivalents (883,497 ) 60,170 Decrease in cash $ (770,721 ) $ (891,872 ) Operating Activities Net cash used in operating activities was $5,920,112 for the year ended December 31, 2023 and was primarily due to cash used to fund a net loss of $80,231,083, adjusted for non-cash expenses in the aggregate of $64,085,528 and additional cash increases from changes in the levels of operating assets and liabilities in the aggregate of $10,225,443, primarily as a result of an increase in accounts receivable, accounts payable and accrued expenses, and deferred revenue. 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. Investing Activities Net cash used in investing activities of $160,158 for the year ended December 31, 2023, was primarily due to cash paid to purchase property and equipment. Net cash used in investing activities of $6,048,944 for the year ended December 31, 2022, was primarily due to cash paid as part of the acquisition of True Digital. - 31 - Financing Activities Net cash provided by financing activities for the year ended December 31, 2023 was $6,193,046, which was primarily due to cash received from the sale of our common stock, and net proceeds from loans and convertible notes payable of $6,655,493 and $11,975,631, respectively, and offset by the payment of loans and convertible notes payable of $12,929,931. 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. 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, 2023, we had an accumulated deficit of $158,018,687 and working capital deficit of $15,113,288. For the year ended December 31, 2023, we had negative cash flows from operations of $5,920,112. Although our company is showing positive revenue and gross profit trends, we expect to incur further losses through the end of 2024. 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, 2023, we received $6,655,493 from public and private offerings of our common stock, $11,975,631 in net proceeds from our loans and convertible notes payable, and $491,853 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, 2023, we had $291,351,048 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. However, due to losses incurred, substantial doubt about the Company’s ability to continue as a going concern exists. We are evaluating strategies to obtain the required additional funding for future operations. These strategies may include, obtaining equity financing, issuing debt or entering into other financing arrangements, and restructuring of operations to grow revenues and decrease expenses. However, we may be unable to access further equity or debt financing when needed. As such, there can be no assurance that we will be able to obtain additional liquidity when needed or under acceptable terms, if at all. The ability for us to continue as a going concern is dependent upon our ability to successfully accomplish the plan described in the Growth Strategy paragraph and eventually attain profitable operations. The consolidated financial statements do not include any adjustments to the carrying amounts and classification of assets, liabilities, and reported expenses that may be necessary if the Company were unable to continue as a going concern. Recently Issued Accounting Pronouncements See Note 3 to our consolidated financial statements for the years ended December 31, 2023 and 2022 included elsewhere in this Annual Report. - 32 - 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. 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 a market approach. Goodwill is considered impaired if the carrying value of the reporting unit exceeds its fair value. Failure to maintain a similar market value may cause a future impairment of goodwill at the reporting unit. - 33 - 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 and recognize compensation expense for equity-based awards based on the grant date fair values of the awards. For options with service or performance-based vesting conditions, the grant date fair value is estimated using the Black-Scholes option-pricing model, which requires management to make assumptions and apply judgment in determining the grant date fair value. The most significant assumptions and judgments include estimating the expected option term, the expected stock price volatility and the risk-free interest rates. The assumptions used in our option pricing model represent management’s best estimates. If factors change and different assumptions are used, our equity-based compensation expense could be materially different in the future. We record forfeitures when they occur, based on our lack of historical data available to estimate an appropriate forfeiture rate. Changes in our forfeiture rate can have a significant impact on our equity-based compensation expense since the cumulative effect of adjusting the forfeiture rate is recognized in the period in which the estimate is changed. We will continue to use judgment in evaluating the assumptions related to our equity-based awards on a prospective basis. As we continue to accumulate additional data related to our awards, we may refine our estimates, which could materially impact our future equity-based compensation expense. Revenue Recognition Our agreements with clients are primarily service contracts that range in duration from a few months to three years. 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. 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, 2023 and 2022 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. - 34 - 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 We determine the expected stock price volatility based on the historical volatilities of our peer group, blended with our historical volatility, since there is not a sufficient trading history for our common stock. Industry peers consist of several public companies in the technology industry similar to us in size, stage of life cycle and financial leverage. We intend to continue to consistently apply this process using the same or similar public companies and continue increasing the blended proportion of our historical volatility until a sufficient trading history of our common stock becomes available. If circumstances change such that the identified companies are no longer similar to us, we will revise our peer group to substitute more suitable companies in this calculation. 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.