The accompanying unaudited condensed consolidated financial statements of CynergisTek, Inc. and its subsidiaries (the “Company”, “we”, “us” or “CynergisTek”) have been prepared in accordance with generally accepted accounting principles of the United States of America (“GAAP”) for interim financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, these financial statements do not include all of the information and notes required by GAAP for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as filed with the Securities and Exchange Commission (“SEC”) on March 30, 2020.
The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) that are, in the opinion of management, necessary to state fairly our financial position and results of operations as of and for the periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full year.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from those estimates.
The accompanying unaudited condensed consolidated financial statements include the accounts of CynergisTek and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.
Based on our integration strategies, and an analysis of how our Chief Operating Decision Makers review, manage and are compensated, we have determined that the Company operates as one segment. As described in Note 18, we sold the assets used in our managed print services business division (the “MPS Business”) on March 20, 2019. For the periods presented, all revenues were derived from domestic operations. We have performed an evaluation of subsequent events through the date of filing these unaudited condensed consolidated financial statements with the SEC.
As of March 31, 2020, our cash balance was $3.1 million, current assets minus current liabilities was positive $4.7 million and our debt and lease obligations totaled $1.0 million. The level of additional cash needed to fund operations and our ability to conduct business for the next twelve months will be influenced primarily by the following factors:
We have historically funded our operating costs, acquisition activities, working capital requirements and capital expenditures with cash from operations, proceeds from the issuances of our common stock and other financing arrangements. Following the sale of the MPS business in 2019, we are now a much smaller cybersecurity and privacy focused business with significantly lower debt balances and debt service obligations. However, we also have less scale over which to leverage our operating expenses and public company expenses and are currently operating in a cash flow negative position while we seek to retain our cybersecurity business during this uncertain time. For the first quarter of 2020, we reported a loss from continuing operations of $1.9 million and cash used in operating activities from continuing operations was $2.1 million.
In late 2019, a novel strain of coronavirus (COVID-19) was first detected in Wuhan, China. Following the outbreak of this virus, governments throughout the world, including in the United States of America, have quarantined certain affected regions, restricted travel and imposed significant limitations on other economic activities. Our customer base is heavily concentrated in the healthcare provider space. This part of the healthcare industry has indicated that they are seeing significant financial losses, have started to furlough employees and are expressing uncertainty as to the short and long-term financial stability of their businesses. Our operations team is closely monitoring the potential impact to the Company’s business, including its cash flows, customers and employees. We have heard from a number of our active customers since the outbreak began requesting relief in the form of extended payment terms, request for early termination and receivable forgiveness. If the situation continues to impact our customers cash flow or resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results for fiscal year 2020 and beyond will be negatively impacted. Neither the length of time nor the magnitude of the negative impacts can be presently determined.
There was a small financial impact in the first quarter of 2020 due to COVID-19, primarily since many of the initial economic effects of the early stages of the COVID-19 pandemic resulting from the various shelter-in-place and other social distancing orders occurred towards the end of our first quarter. The severity and duration of the COVID-19 pandemic is uncertain and such uncertainty will likely continue in the near term and we will continue to actively monitor the situation taking into account the impact to our employees, customers and partners.
At the end of 2019 and during the first quarter of 2020 we reduced staffing levels to reduce expenses. Our operating plan for the next twelve months includes additional permanent annualized cost reduction efforts totaling approximately $1.5 million and temporary cost reductions totaling approximately $1.0-$2.0 million the precise extent of which will depend on the duration of the COVID-19 disruptions to our customers and our short-term financial performance. In addition, we received a $2.8 million loan under the Coronavirus Aid, Relief, and Economic Security Act, and we received an equity funding commitment in the amount of $2.5 million from an existing investor. We also have the ability to further reduce personnel and other variable and semi-variable costs to conserve cash and operate as a going concern. However, those actions if required, could negatively impact the long-term outlook of the business
As we execute our plans over the next 12 months, we intend to carefully monitor the impact on our operating expenses, working capital needs and cash balances relative to the availability of cost-effective debt and equity financing. In the event that capital is not available, we may then have to scale back operations, reduce expenses, and/or curtail future plans to manage our liquidity and capital resources. However, we cannot provide assurance that we will be able to raise additional capital. The COVID-19 pandemic could continue to create uncertainty and volatility in the financial markets which may impact our operations and our ability to access capital and/or the terms under which we can do so.
The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
In August 2018, the FASB issued an amendment to the accounting guidance on cloud computing service arrangements. The guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal use software. The guidance also requires an entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The guidance was effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The adoption of this guidance did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued a new accounting standard which modifies the disclosure requirements on fair value measurements. This guidance was effective for fiscal years beginning after December 15, 2019. The amendments related to the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively. All other amendments should be applied retrospectively. An entity was permitted to early adopt any removed or modified disclosures upon issuance of this guidance and delay adoption of the additional disclosures until their effective date. The adoption did not have a material impact on our consolidated financial statements.
In December 2019, the FASB issued an amendment to the guidance on income taxes which is intended to simplify the accounting for income taxes. The amendment eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of the deferred tax liabilities for outside basis differences. The amendment also clarifies existing guidance related to the recognition of franchise tax, the evaluation of a step up in the tax basis of goodwill , and the effects of enacted changes in tax laws or rates in the effective tax rate computation, among other clarifications. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Management is currently evaluating the impact the guidance will have on our consolidated financial statements.
In June 2016, the FASB issued an amendment to the guidance on the measurement of credit losses on financial instruments. The amendment updates the guidance for measuring and recording credit losses on financial assets measured and amortized cost by replacing the “incurred loss” model with an “expected loss” model. Accordingly, these financial assets will be presented at the net amount expected to be collected. The amendment also requires that credit losses related to available-for-sale debt securities be recorded as an allowance through net income rather than reducing the carrying amount under the current, other-than-temporary-impairment model. The guidance is effective for smaller reporting companies for fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. Early adoption is permitted for annual periods after December 15, 2018.
Our incremental costs of obtaining a contract, which consist of sales commissions, are deferred and amortized over the period of contract performance. Effective January 1, 2018, we adopted the modified retrospective method of the new revenue recognition pronouncement. Deferred commissions are included in prepaid and other current assets in our consolidated balance sheets. We had $757,602 and $764,607 of unamortized deferred commissions as of March 31, 2020 and December 31, 2019, respectively. We had $165,010 and $256,553 of commissions expense for the three months ended March 31, 2020 and 2019, respectively.
5.PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
|
March 31, 2020
|
December 31, 2019
|
Furniture and fixtures
|
$195,586
|
$195,586
|
Computers and office equipment
|
747,469
|
757,251
|
Right of use assets
|
1,843,818
|
1,658,364
|
Property and equipment at cost
|
2,786,873
|
2,611,201
|
Less accumulated depreciation and amortization
|
(1,791,251)
|
(1,664,982)
|
|
$995,623
|
$946,219
|
6.LEASES
We lease approximately 17,000 square feet of office space in Mission Viejo, California. This lease terminates in April of 2021. During the first quarter of 2019, we subleased this space to two subtenants. The terms of these subleases end concurrently with the end of our lease obligation in April 2021. We also leased approximately 3,600 square feet of office space in Austin, Texas. This lease terminated in September 2019. During the first quarter of 2018, we subleased this space to a subtenant. The terms of this sublease ended concurrently with the end of our lease obligation in September 2019. We also leased approximately 9,600 square feet of office space in Austin, Texas in March 2020. We amended this lease reducing the office space to 4,600 square feet and extended the lease term to May 31, 2022. We also lease approximately 3,700 square feet of office space in Minneapolis, Minnesota. This lease terminates on July 31, 2021.
We used a discount rate of 5.5% in determining our operating lease liability. This rate represented our incremental borrowing rate at that time. Short-term leases with initial terms of twelve months or less are not capitalized.
We determine if a contract is or contains a lease at inception or modification of a contract. A contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period in exchange for consideration. Control over the use of the identified asset means the lessee has both (a) the right to obtain substantially all of the economic benefits from the use of the asset and (b) the right to direct the use of the asset.
Right-of-use assets and liabilities are recognized based on the present value of future minimum lease payments over the expected lease term at commencement date. Certain contain extension options; however, we have not included
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such options as part of right-of-use assets and lease liabilities because we originally did not expect to extend the leases. We measure and record a right-of-use asset and lease liability based on the discount rate implicit in the lease, if known. In cases where the discount rate implicit in the lease is not known, we measure the right-of-use assets and lease liabilities using a discount rate equal to our estimated incremental borrowing rate for loans with similar collateral and duration.
We elected the package of practical expedients in transition for leases that commenced prior to January 1, 2019, and therefore did not reassess (i) whether any expired or existing contracts are, or contain, leases, (ii) the lease classification for any expired or existing leases, and (iii) initial direct costs for any existing leases. We did not elect to use hindsight for transition when considering judgments and estimates such as assessments of lease options to extend, or terminate, a lease, or to purchase the underlying asset. We have no land easements. For all asset classes, we elected to (i) not recognize a right-of-use asset and lease liability for leases with a term of 12 months or less and (ii) not separate non-lease components from lease components, and we have accounted for combined lease and non-lease components as a single lease component.
Operating lease expense is comprised of the following:
|
Three Months Ended March 31,
|
|
2020
|
2019
|
Operating lease cost
|
$205,452
|
$100,460
|
Sublet income
|
(115,949)
|
(37,442)
|
Net operating lease cost
|
$89,503
|
$63,018
|
Maturities of lease liabilities are as follows:
|
Operating Leases
|
2020
|
$453,064
|
2021
|
259,367
|
2022
|
41,690
|
Total lease payments
|
754,121
|
Less imputed interest
|
(28,815)
|
Total lease liabilities
|
725,306
|
Less current portion of lease liabilities
|
(580,591)
|
Long-term lease liabilities
|
$144,715
|
7.INTANGIBLE ASSETS
Intangible assets are amortized over expected useful lives ranging from 1.5 to 10 years and consist of the following:
|
March 31, 2020
|
December 31, 2019
|
|
Carrying
Amount
|
Accumulated
Amortization and Impairment
|
Net Book
Value
|
Carrying
Amount
|
Accumulated
Amortization and Impairment
|
Net Book
Value
|
|
|
|
|
|
|
|
Acquired technology
|
$10,100,000
|
$(4,274,893)
|
$5,825,107
|
$10,100,000
|
$(4,054,951)
|
$6,045,049
|
Customer relationships
|
4,650,000
|
(3,306,250)
|
1,343,750
|
4,650,000
|
(3,212,500)
|
1,437,500
|
Trademarks
|
2,300,000
|
(1,299,167)
|
1,000,833
|
2,300,000
|
(1,196,667)
|
1,103,333
|
Non-compete agreements
|
320,000
|
(320,000)
|
-
|
320,000
|
(320,000)
|
-
|
Total
|
$17,370,000
|
$(9,200,310)
|
$8,169,690
|
$17,370,000
|
$(8,784,118)
|
$8,585,882
|
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8.DEFERRED REVENUE
We record deferred revenues when amounts are billed to customers, or cash is received from customers, in advance of our performance. During the three months ended March 31, 2020 and 2019, $884,379 and $824,099, respectively, of managed services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods. During the three months ended March 31, 2020 and 2019, $141,666 and $287,940, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.
9.LINE OF CREDIT AND TERM LOAN
On March 12, 2018, we entered into a Credit Agreement (together with the other related documents defined therein, the “Credit Agreement”) with BMO Harris Bank N.A., a national banking association (“Bank”), as lender (the “BMO Loan”).
The purposes of the BMO Loan were (1) to refinance and replace the facilities under prior credit agreement, thus terminating that agreement as of March 12, 2018, (2) to refinance $2,250,000 of a promissory note held by Michael McMillan (the “McMillan Seller Note”), (3) to finance payments to Michael Hernandez, including the full repayment of a promissory note held by Hernandez (the “Hernandez Seller Note”) in the original principal amount of $4,500,000, issued as part of the acquisition of CTEK Security, Inc., (4) to finance working capital, (5) for general corporate purposes and (6) to fund certain fees and expenses associated with the closing of the BMO Loan.
Loan Facilities
Term Loan: Pursuant to the Credit Agreement, the Bank agreed to provide a term loan in the amount of $17,250,000 to the Company, which was paid in accordance with the purpose of the BMO Loan as described above. Pursuant to the Credit Agreement, the Company could elect that the term loan be outstanding as Base Rate Loans or Eurodollar Loans. The term loan was payable in principal payment installments on the last day of each fiscal quarter, commencing on June 30, 2018. All principal and interest not sooner paid on the term loan was due and payable on September 12, 2022, the final maturity thereof.
Revolving Line of Credit: Additionally, pursuant to the Credit Agreement, the Bank agreed to provide a revolving loan or loans to the Company in an aggregate amount of up to $5,000,000 with a $500,000 sublimit for the issuance of letters of credit. Pursuant to the Credit Agreement, the Company could elect that each borrowing of revolving loans be either Base Rate Loans or Eurodollar Loans. Each revolving loan, both for principal and interest then outstanding, matured and was due and payable on March 12, 2020, or such earlier date on which the Revolving Credit Commitment (as defined in the Credit Agreement) was terminated in whole pursuant to the Credit Agreement. There were no borrowings on the line of credit in 2019 or 2018.
Beginning June 30, 2018, we were required to maintain certain financial covenants in connection with this credit agreement, including a total leverage ratio, a senior leverage ratio, and a fixed charge coverage ratio. These covenants contain ratios which changed over relevant periods of the credit agreement and could be found in Section 7.13 of the Credit Agreement.
On March 20, 2019, we used a portion of the proceeds from the sale of the assets of the MPS Business (Note 19) to fully repay the balance of the term loan in the amount of $15,401,786, plus interest of $52,760. At that time, the Revolving Line of Credit was terminated.
Interest charges associated with the BMO term loan totaled $207,903 for the three months ended March 31, 2019.
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10.PROMISSORY NOTES
In connection with the acquisition of CTEK Security, Inc. (formerly CynergisTek, Inc.), we issued two promissory notes totaling $9,000,000 to Michael Hernandez and Michael McMillan (respectively, the “Hernandez Seller Note” and the “McMillan Seller Note”; and together the “Seller Notes”), with each of the Seller Notes having an initial principal amount of $4,500,000. These Seller Notes bear interest at 8% per annum, require quarterly interest-only payments during the first 12 months, quarterly payments of principal and interest during the last 24 months, using a 36-month amortization period commencing from that point, with a balloon payment due on the maturity date. The Company had the right to prepay all or any portion of the outstanding principal balance of the Seller Notes, provided that such prepayment is accompanied by accrued interest on the amount of principal prepaid, calculated to the date of such prepayment.
On March 12, 2018, the Company fully repaid the $4,500,000 plus accrued interest on the Hernandez Seller Note.
As part of the debt restructuring with BMO Harris Bank N.A., on March 12, 2018, the Company repaid $2,250,000 plus accrued interest on the McMillan Seller Note. The Company and Mr. McMillan agreed to amend and restate the McMillan Seller Note pursuant an amended and restated promissory note (the “A&R McMillan Seller Note”). The A&R McMillan Seller Note is in the principal amount of $2,250,000, bears interest at a rate of 8% per annum, provides for quarterly payments of principal and interest and matures on March 31, 2022. As of March 31, 2020 and December 31, 2019, the outstanding principal balance due under the A&R McMillan Seller Note was $1,125,000 and $1,265,625, respectively. Amounts due and owing under the A&R McMillan Seller Note were subordinate to the right of payment due under the BMO Loan pursuant to a Subordination Agreement among the Company, the Bank and Mr. McMillan.
Interest charges associated with the Seller Notes totaled $24,288 and $35,106, respectively for the three months ended March 31, 2020 and 2019.
Pursuant to a separation agreement among the Company, CTEK Security, Inc. and Michael Hernandez (the “Separation Agreement”), in lieu of any earn-out payments due pursuant to the purchase agreement related to the acquisition of CTEK Security, Inc. (the “Original SPA”) that could be earned by Hernandez under the Original SPA, the Company agreed to pay Hernandez the amount of $3,750,000 in the form of a promissory note (the “Earn-out Note”). The Earn-out Note provided for (i) a maturity date of March 12, 2023, at which all principal and accrued and unpaid interest was due, (ii) a simple interest rate of 5% per annum commencing on January 1, 2018, and compounding annually, and (iii) the right of the Company to prepay all or any portion of the Earn-out Note without premium or penalty. On March 26, 2019, we used a portion of the proceeds from the sale of the assets of MPS Business (Note 18) to fully repay the Earn-out Note with interest of $234,293.
Interest charges associated with the Earn-out Note totaled $45,858 for the three months ended March 31, 2019.
Pursuant to the Separation Agreement, the Company also issued a Severance Payment Note to Hernandez in the original principal amount of $343,750 (the “Severance Payment Note”). The Severance Payment Note bears interest at a rate of 5% per annum, compounded annually, allowed for prepayment by the Company and matured on January 10, 2019, at which time all principal and accrued and unpaid interest was due. All principal and interest due under the Severance Payment Note was repaid on March 27, 2019.
Interest charges associated with the Severance Payment Note totaled $494 for the three months ended March 31, 2019.
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11.REVENUES
Below is a summary of our revenues disaggregated by revenue source.
|
Three Months Ended March 31,
|
|
2020
|
2019
|
Managed services
|
$3,001,012
|
$2,809,063
|
Consulting and professional services
|
2,114,815
|
2,964,594
|
Net revenues
|
$5,115,827
|
$5,773,657
|
12.OPTIONS, WARRANTS AND RESTRICTED STOCK UNITS
Below is a summary of stock option, warrant and restricted stock activity during the three-month period ended March 31, 2020:
Options
|
Shares
|
Weighted Average Exercise Price
|
Weighted Average Remaining Term in Years
|
Aggregate
Intrinsic Value
|
Outstanding at December 31, 2019
|
723,215
|
$4.27
|
|
|
Granted
|
-
|
-
|
|
|
Exercised
|
-
|
-
|
|
|
Cancelled
|
(3,669)
|
3.29
|
|
|
Outstanding at March 31, 2020
|
719,546
|
$4.28
|
7.25
|
$-
|
Exercisable at March 31, 2020
|
219,546
|
$2.95
|
2.60
|
$-
|
Warrants
|
Shares
|
Weighted Average Exercise Price
|
Weighted Average Remaining Term in Years
|
Aggregate
Intrinsic Value
|
Outstanding at December 31, 2019
|
77,779
|
$3.03
|
|
|
Granted
|
-
|
-
|
|
|
Exercised
|
-
|
-
|
|
|
Cancelled
|
-
|
-
|
|
|
Outstanding at March 31, 2020
|
77,779
|
$3.03
|
2.80
|
$-
|
Exercisable at March 31, 2020
|
77,779
|
$3.03
|
2.80
|
$-
|
Restricted Stock Units
|
Shares
|
Weighted Average Price
|
Weighted Average Remaining Term in Years
|
Non-vested at December 31, 2019
|
1,078,200
|
$3.42
|
|
Granted
|
30,000
|
3.01
|
|
Vested
|
(20,000)
|
3.12
|
|
Cancelled and forfeited
|
(200)
|
4.67
|
|
Non-vested at March 31, 2020
|
1,088,000
|
$3.75
|
1.88
|
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For the three months ended March 31, 2020 and 2019, stock-based compensation expense recognized in the consolidated statements of operations as follows:
|
Three Months
Ended March 31,
|
|
2020
|
2019
|
Cost of revenues
|
$ 79,282
|
$ 175,739
|
Sales and marketing
|
77,293
|
63,831
|
General and administrative expense
|
254,432
|
167,122
|
Total stock-based compensation expense
|
$ 411,007
|
$ 406,692
|
13.NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is calculated using the weighted average number of shares of our common stock issued and outstanding during a certain period and is calculated by dividing net (loss) income by the weighted average number of shares of our common stock issued and outstanding during such period. Diluted net income (loss) per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the as-if-converted method for secured convertible notes, and the treasury stock method for options and warrants. Diluted net income (loss) per share does not include potentially dilutive securities because such inclusion in the computation would be anti-dilutive.
For the three months ended March 31, 2020, potentially dilutive securities consisted of options and warrants to purchase 797,325 shares of common stock at prices ranging from $2.28 to $4.86 per share. Of these potentially dilutive securities, 11,683 of the shares of common stock underlying the options and warrants are excluded in the computation of diluted earnings per share, because the effect of including the remaining instruments would be anti-dilutive. Also excluded from potentially dilutive securities are 60,000 shares of restricted stock units which vested in October 2019 but had not been issued by period end.
For the three months ended March 31, 2019, potentially dilutive securities consisted of options and warrants to purchase 583,865 shares of common stock at prices ranging from $2.28 to $4.05 per share. Of these potentially dilutive securities, 209,904 of the shares of common stock underlying the options and warrants are included in the computation of diluted earnings per share. Also included in potentially dilutive securities are 47,455 shares of restricted stock units which vested in March 2019 but had not been issued by period end.
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|
Three Months Ended March 31,
|
|
2020
|
2019
|
Numerators:
|
|
|
Net loss from continuing operations
|
$(1,850,623)
|
$(1,489,399)
|
Net income from discontinued operations
|
$-
|
$19,036,830
|
Net income (loss)
|
$(1,850,623)
|
$17,547,431
|
|
|
|
Denominator:
|
|
|
Denominator for basic calculation weighted average shares
|
10,374,497
|
9,673,689
|
|
|
|
Dilutive common stock equivalents:
|
|
|
Options and warrants
|
-
|
209,904
|
Restricted stock units vested but not issued
|
-
|
47,455
|
Denominator for diluted calculation weighted average shares
|
10,374,497
|
9,931,048
|
|
|
|
Net income (loss) per share:
From continuing operations
|
|
|
Basic net loss per share
|
$(0.18)
|
$(0.15)
|
Diluted net loss per share
|
$(0.18)
|
$(0.15)
|
|
|
|
From discontinued operations
|
|
|
Basic net income per share
|
$-
|
$1.97
|
Diluted net income per share
|
$-
|
$1.92
|
|
|
|
Net income (loss)
|
|
|
Basic net income per share
|
$(0.18)
|
$1.81
|
Diluted net income per share
|
$(0.18)
|
$1.77
|
14.REMAINING PERFORMANCE OBLIGATIONS
We had remaining performance obligations of approximately $22.6 million as of March 31, 2020. Our remaining performance obligations represent the amount of transaction price for which work has not been performed and revenue has not been recognized. When applying Topic 606, with only the non-cancelable portion of these contracts included in our performance obligations we had approximately $13.5 million as of March 31, 2020. We expect to recognize revenue on approximately 92% of the remaining non-cancelable portion of these performance obligations over the next 24 months, with the balance thereafter. We elected to utilize the practical expedient exemption to exclude from this disclosure, the amount of revenue from contracts which are not fixed-fee and where we do not have the right to invoice until the services have been performed.
15.EMPLOYMENT AGREEMENTS
Caleb Barlow
Effective August 1, 2019, we entered into an employment agreement with Caleb Barlow (the “Barlow Agreement”) pursuant to which he will serve as President and Chief Executive Officer and will have the duties and responsibilities as are commensurate with such positions. The initial term of the Barlow Agreement is 36 months and will automatically renew for subsequent 12-month terms unless either party provides written notice to the other party of a desire not to renew employment.
Mr. Barlow’s base salary is $350,000. He is entitled to incentive bonus compensation that offers the potential to receive a discretionary bonus up to 100% of his base salary. For 2019 there was no discretionary bonus paid. In addition, he receives a retention bonus totaling $500,000, with $200,000 being paid on August 1, 2019, $150,000 paid on January 1, 2020 and $150,000 payable on January 2021. Mr. Barlow also received equity compensation
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consisting of an option to purchase up to 500,000 shares of the Company’s Common Stock, subject to vesting, and 50,000 shares of restricted stock units. The options are nonqualified, and the grant was made outside of the Company's 2011 Stock Incentive Plan. The foregoing is a summary of the Barlow Agreement, and the entire agreement is included as Exhibit 10.1 to our Form 8-K filed with the SEC on July 16, 2019.
Paul T. Anthony
Effective January 1, 2016, we entered into an employment agreement with Paul T. Anthony (the “Anthony Agreement”). The Anthony Agreement provides that Mr. Anthony will continue to serve as our Executive Vice President, CFO and Corporate Secretary. We may terminate Mr. Anthony’s employment under the Anthony Agreement without cause at any time on thirty (30) days advance written notice, at which time Mr. Anthony would receive severance pay for twelve months and be fully vested in all options and warrants granted to date.
In February 2018, the Company amended the Anthony Agreement to extend the term thereof through December 31, 2020 and increased his base salary to $309,700 for 2019 and 2020. Mr. Anthony was paid a bonus of $41,841 for 2019, and his 2020 bonus will be up to 67.5% of his base salary. The entire Anthony Agreement is found as Exhibit 10.32 to our Annual Report on Form 10-K filed with the SEC on March 30, 2016, and the amendment to the Anthony Agreement, can be found as Exhibit 10.45 to our Annual Report on Form 10-K filed with the SEC on March 28, 2018.
Michael H. McMillan
On July 15, 2019, Mr. McMillan notified the Board of Directors of his decision to retire from the Company effective December 31, 2019. In connection with his planned retirement, Mr. McMillan also submitted his resignation as President and Chief Executive Officer of the Company, effective July 31, 2019. Mr. McMillan will continue to serve as a director of the Company and remained employed by the Company through his retirement date in order to assist with the transition. Mr. Mr. McMillan was given the honorary title of President and CEO Emeritus by the Board.
16.CONCENTRATIONS
Cash Concentrations
At times, cash balances held in financial institutions are in excess of federally insured limits. Management performs periodic evaluations of the relative credit standing of financial institutions and limits the amount of risk by selecting financial institutions with a strong credit standing.
Major Customers
Our largest customer accounted for approximately 12% and 25% of our revenues for the three months ended March 31, 2020 and 2019, respectively. Our largest customer had accounts receivable totaling approximately $693,000 and $342,000 as of March 31, 2020 and December 31, 2019, respectively.
17.STOCK PURCHASE AGREEMENT – BACKBONE ENTERPRISES
On October 31, 2019, we entered into a Stock Purchase Agreement (the “Purchase Agreement”) with Backbone Enterprises Inc., a Minnesota corporation (“Backbone”), and its stockholders, (the “Stockholders”), pursuant to which we acquired 100% of the issued and outstanding shares of Common Stock (the “Shares”) of Backbone from the Stockholders (the “Backbone Transaction”).
Pursuant to the Purchase Agreement, the aggregate purchase price paid for the Shares consisted of (i) a cash payment of $5,500,000, less certain transaction expenses (the “Cash Consideration”), (ii) the issuance of 491,804 shares of our Common Stock to the Stockholders (the “Securities Consideration”), pro rata among the Stockholders in proportion to each Stockholder’s ownership of the Shares, and (iii) an earn-out, pursuant to which the Stockholders may be entitled to an additional $4,000,000 based upon the post-closing financial performance of Backbone, to be calculated based upon revenue generated by the Backbone business during the three-year earn-out
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period. As of March 31, 2020, the estimated fair value of the earnout is $2,400,000. The Cash Consideration was subject to adjustment based on closing working capital of Backbone, and $1,500,000 of the Cash Consideration was placed into a third-party escrow account by us, against a portion of which we may make claims for indemnification.
The Company performed a valuation analysis of the fair value of Backbone’s assets and liabilities. The following table summarizes the allocation of the purchase price as of the acquisition date:
Cash
|
|
$27,000
|
Accounts receivable
|
|
831,000
|
Prepaid expenses and other assets
|
|
31,000
|
Identified intangible assets
|
|
2,000,000
|
Goodwill
|
|
6,976,000
|
Accrued compensation and benefits
|
|
(20,000)
|
Total allocated purchase price
|
|
$9,834,000
|
Pro Forma Information (Unaudited)
The following supplemental unaudited pro forma information presents the combined operating results of the Company and the acquired business during the three months ended March 31, 2019, as if the acquisition had occurred at the beginning of each of the periods presented. The pro forma information is based on the historical financial statements of the Company and that of the acquired business. Amounts are not necessarily indicative of the results that may have been attained had the combinations been in effect at the beginning of the periods presented or that may be achieved in the future.
Pro forma revenue
|
$6,618,000
|
Pro forma net loss from continuing operations
|
$(1,458,000)
|
Pro forma basic net loss per share
|
$(0.14)
|
Pro forma diluted net loss per share
|
$(0.14)
|
18.DISCONTINUED OPERATIONS
On March 20, 2019, we, along with our wholly-owned subsidiary, CTEK Solutions, Inc., entered into an Asset Purchase Agreement (together with the other related documents defined therein, the “Purchase Agreement”) with Vereco, LLC, a Delaware limited liability company (“Buyer”). Pursuant to the Purchase Agreement, we sold our assets used in the provision of our managed print services business division (the “MPS Business”), which had been primarily conducted by CTEK Solutions, Inc. Buyer also assumed certain liabilities relating to the MPS Business. The purchase price pursuant to the Purchase Agreement was $30,000,000, $5,000,000 of which was placed in escrow by Buyer, the release of which was contingent upon certain events and conditions specified in the Purchase Agreement. On June 20, 2019, a contingent event had not occurred and per the terms of the Purchase Agreement, $1,500,000 of the $5,000,000 was removed. The purchase price was also subject to adjustment based on closing working capital results of the MPS Business. This subsequent working capital adjustment, together with the escrow amount, increased the cash received by $1,933,247.
The following is the summary of the transaction selling the MPS Business that was finalized in October 2019:
Net proceeds from the sale of the business
|
$26,303,501
|
Book value of net assets disposed
|
(2,614,232)
|
Gain before provision for income taxes
|
23,689,269
|
Income tax expense
|
(4,197,198)
|
Net gain from sale of discontinued operations
|
$19,492,071
|
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The following is a composition of the line items constituting net income from discontinued operations for the three months ended March 31, 2019:
Net revenues
|
$12,096,885
|
Cost of revenues
|
(10,060,414)
|
Sales and marketing
|
(126,314)
|
General and administrative expenses
|
(691,398)
|
Depreciation
|
(36,635)
|
Interest expense
|
(1,956)
|
Income before provision for income taxes
|
1,180,168
|
Income tax expense
|
(306,940)
|
Net income from discontinued operations
|
$873,228
|
The following is a composition of any significant noncash operating and investing items, including depreciation, of the discontinued operations for the three months ended March 31, 2019:
Depreciation
|
$36,635
|
Stock compensation
|
$124,348
|
19.SUBSEQUENT EVENTS
Securities Purchase Agreement
On April 3, 2020, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Horton Capital Management, LLC, a Delaware limited liability company (“Purchaser”), which provides that, upon the terms and subject to the conditions and limitations set forth therein, Purchaser is committed to purchase up to an aggregate of $2,500,000 of shares of the Company’s common stock (the “Purchase Shares”) over the term of the Purchase Agreement, which terminates on March 31, 2021. Upon signing the Purchase Agreement, the Company issued Purchaser a warrant to purchase up to 500,000 shares of common stock (the “Initial Warrant”) in consideration of Purchaser’s obligation to purchase the Purchase Shares, at an exercise price of $2.50 per share, subject to certain anti-dilution adjustments as set forth in the Initial Warrant. Purchaser and its affiliates are current stockholders of the Company and, prior to the date of the Purchase Agreement, based solely on a Schedule 13D filing dated February 14, 2020, owned approximately 9.1% of the Company’s outstanding shares of common stock.
Details regarding the Purchase Agreement, the Registration Rights Agreement, the Initial Warrant and the Funding Warrant can be found in our 8-K filed on April 7, 2020.
Paycheck Protection Program
On April 20, 2020, CynergisTek, Inc., a Delaware corporation (the “Company”), as borrower, received $2,825,500 in loan funding from the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), established pursuant to the recently enacted Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The unsecured loan (the “Loan”) is evidenced by a promissory note issued by the Company (the “Note”) in favor of BMO Harris Bank N.A., a national banking association, as lender.
The Company plans to use the Loan proceeds to cover payroll costs, rent and utilities in accordance with the relevant terms and conditions of the CARES Act.
Under the terms of the Note and the Loan, interest accrues on the outstanding principal at the rate of 1.0% per annum. The term of the Note is two years, unless sooner provided in connection with an event of default under the Note. To the extent the Loan amount is not forgiven under the PPP, the Company is obligated to make equal monthly payments of principal and interest, beginning seven months from the date of the Note, until the maturity date. Details regarding the Note can be found in our 8-K filed on April 20, 2020.
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