The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019
(UNAUDITED)
1.BASIS OF PRESENTATION
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.
Certain prior year balances have been reclassified to conform to current period presentation. This includes adjusting our previously issued consolidated balance sheet for the year ended December 31, 2019 to gross up and reclassify unbilled services to a separate line item in current assets from deferred revenues. The consolidated statement of cash flows for the nine months ended September 30, 2019 was also reclassified to reflect this change. The reclassification did not have any impact on the consolidated statements of stockholders’ equity nor the consolidated statements of operations. The Company analyzed the impact of the reclassification and determined that the adjustment was not material to its previously issued consolidated financial statements.
Liquidity and Capital Resources
As of September 30, 2020, our cash balance was $4.3 million, current assets minus current liabilities was positive $4.2 million and our non-current debt and lease obligations totaled $3.9 million. This includes $2.8 million of debt related to the Paycheck Protection Program loan that we anticipate will be fully forgiven as described in Note 9. 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:
·our ability to manage our operating expenses and maintain gross margins while attracting, recruiting and retaining cybersecurity privacy professionals;
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·demand for our services from healthcare providers; the near-term impact of the Coronavirus (COVID-19) on our customers allocation of time and resources to security and privacy, and their ability to pay for existing services as well as enter into new contractual arrangements during a period of crisis;
·general economic conditions and changes in healthcare reimbursement and regulatory environment, including effects of the COVID-19 epidemic; and
·our ability to collect accounts receivable from health care customers whose operations and cash flow have been significantly impacted by COVID-19.
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 maintain and grow our cybersecurity business during this uncertain time. For the three months ended September 30, 2020, we reported a loss from operations of $1.7 million. After excluding $0.9 million of non-cash items for depreciation, amortization of intangibles, reduction-in force costs and stock-based compensation our adjusted loss from operations was $0.8 million. Cash used in operating activities was $1.0 million for the three months ended September 30, 2020.
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 furloughed 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 and are working with a number of our active customers since the outbreak began providing relief in the form of extended payment terms and other contractual restructurings. 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 full magnitude of the negative impacts can be presently determined.
We did experience a negative financial impact in the second and third quarters 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 throughout 2020 we reduced staffing levels to reduce expenses. Our operating plan for the next twelve months includes permanent annualized cost reduction efforts totaling approximately $3.5 million and temporary cost reductions totaling approximately $2.0-$3.0 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, which we anticipate will be fully forgiven, and we have an equity funding commitment in the amount of $2.5 million from an existing investor. We could 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.
We believe that our existing sources of liquidity, including cash and cash equivalents, the equity commitment from an existing investor, future operating cash flows, and other assets will be sufficient to meet our projected capital needs for at least the next twelve months. As we execute our plans over the next twelve 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.
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However, we cannot provide assurance that we will be able to raise additional capital. The COVID-19 pandemic will likely 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 impact of the COVID-19 pandemic on the economy and our operations is fluid and constantly evolving; we will continue to assess a variety of measures to improve our financial performance and liquidity.
The accompanying condensed 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.
2.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Pronouncements
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 of this guidance did not have a material impact on our consolidated financial statements.
Recently Issued Accounting Pronouncements Not Yet Adopted
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 intra-period 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. Management does not expect the impact from this guidance will have a material impact on our consolidated financial statements.
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3.ACCOUNTS RECEIVABLE
A summary of accounts receivable is as follows:
|
September 30, 2020
|
December 31, 2019
|
Trade receivables
|
$ 1,898,434
|
$ 3,210,726
|
Allowance for doubtful accounts
|
-
|
-
|
Total accounts receivable, net
|
$ 1,898,434
|
$ 3,210,726
|
4.DEFERRED COMMISSIONS
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 $660,624 and $870,911 of unamortized deferred commissions as of September 30, 2020 and 2019, respectively. We had $169,025 and $493,389 of commissions expense for the three and nine months ended September 30, 2020, respectively. Commissions expense for the three and nine months ended September 30, 2019 were $206,730 and $669,450, respectively.
5.PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
|
September 30, 2020
|
December 31, 2019
|
Furniture and fixtures
|
$ 235,246
|
$ 195,586
|
Computers and office equipment
|
782,921
|
757,251
|
Right of use assets
|
1,843,818
|
1,658,364
|
Property and equipment at cost
|
2,861,985
|
2,611,201
|
Less accumulated depreciation and amortization
|
(2,151,036)
|
(1,664,982)
|
|
$ 710,949
|
$ 946,219
|
6.LEASES
We previously 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 lease approximately 3,700 square feet of office space in Minneapolis, Minnesota. This lease terminates on July 31, 2021. 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 used a discount rate of 5.5% in determining our operating lease liabilities which represented our incremental borrowing rate. 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 lease agreements contain extension options; however, we have not included 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
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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
September 30,
|
Nine Months Ended
September 30,
|
|
2020
|
2019
|
2020
|
2019
|
Operating lease cost
|
$ 171,220
|
$ 78,008
|
$ 550,467
|
$ 253,857
|
Sublet income
|
(116,299)
|
(13,877)
|
(348,546)
|
(62,868)
|
Net operating lease cost
|
$ 54,921
|
$ 64,131
|
$ 201,921
|
$ 190,989
|
Maturities of lease liabilities are as follows:
|
Operating Leases
|
2020 (remaining fiscal year)
|
$ 147,736
|
2021
|
259,367
|
2022
|
41,690
|
Total lease payments
|
448,793
|
Less imputed interest
|
(13,503)
|
Total lease liabilities
|
435,290
|
Less current portion of lease liabilities
|
(370,565)
|
Long-term lease liabilities
|
$ 64,725
|
7.INTANGIBLE ASSETS
Intangible assets are amortized over expected useful lives ranging from 1.5 to 10 years and consist of the following:
|
September 30, 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
|
$ (4,714,778)
|
$ 5,385,222
|
$ 10,100,000
|
$ (4,054,951)
|
$ 6,045,049
|
Customer relationships
|
4,650,000
|
(3,493,750)
|
1,156,250
|
4,650,000
|
(3,212,500)
|
1,437,500
|
Trademarks
|
2,300,000
|
(1,504,164)
|
795,836
|
2,300,000
|
(1,196,667)
|
1,103,333
|
Total
|
$ 17,050,000
|
$ (9,712,692)
|
$ 7,337,308
|
$ 17,050,000
|
$ (8,464,118)
|
$ 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 nine months ended September 30, 2020 and 2019, $1,114,528 and $1,114,150, respectively, of managed services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods. During the nine months ended September 30, 2020 and 2019, $165,292 and $350,555, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.
9.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”). Pursuant to the Credit Agreement, the Bank agreed to provide a term loan in the amount of $17,250,000 to the Company. 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.
On March 20, 2019, we used a portion of the proceeds from the sale of the assets of the MPS Business (Note 18) 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 Credit Agreement was terminated.
Interest charges associated with the BMO term loan totaled $0 and $207,903 for the three and nine months ended September 30, 2019.
Paycheck Protection Program
On April 20, 2020, we received $2,825,500 in loan funding from the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), established pursuant to the 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.
The Company is using 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.
The Company recognized interest charges associated with the PPP Loan of $7,122 and $12,928 for the three and nine months ended September 30, 2020. To the extent the principal balance is forgiven, the related interest would be forgiven as well. The Company does anticipate the loan will be fully forgiven.
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.
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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 September 30, 2020, and December 31, 2019, the outstanding principal balance due under the A&R McMillan Seller Note was $843,750 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 $18,924 and $64,726, respectively for the three and nine months ended September 30, 2020, and $30,267 and $98,106, respectively for the three and nine months ended September 30, 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 the 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 $0 and $45,858 for the three and nine months ended September 30, 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 nine months ended September 30, 2019.
11.REVENUES
Below is a summary of our revenues disaggregated by revenue source.
|
Three Months Ended
September 30,
|
Nine Months Ended
September 30,
|
|
2020
|
2019
|
2020
|
2019
|
Managed services
|
$ 2,732,612
|
$ 3,103,249
|
$ 8,653,277
|
$ 8,789,947
|
Consulting and professional services
|
1,770,297
|
1,662,751
|
5,503,930
|
6,807,170
|
Net revenues
|
$ 4,502,909
|
$ 4,766,000
|
$ 14,157,207
|
$ 15,597,117
|
12.WARRANTS, OPTIONS AND RESTRICTED STOCK UNITS
Warrant Issued for Securities Purchase Agreement
On April 3, 2020, we entered into a Securities Purchase Agreement with Horton Capital Management, LLC (“Horton”), a Delaware limited liability company, which provides that, upon the terms and subject to the conditions
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and limitations set forth therein, Horton is committed to purchase up to an aggregate of $2,500,000 of shares of the Company’s common stock over the term of the agreement, at the election of the Company, which terminates on March 31, 2021. Additionally, if and when the Company sells the shares to Horton under the commitment, the Company agreed to grant to Horton a warrant, with the same number of shares of common stock purchased by Horton in the particular funding, with an exercise price equal to 125% of the purchase price of the shares of common stock sold in such funding, with a 10-year term. No purchases have occurred.
Upon signing the agreement, the Company issued Horton a warrant to purchase up to 500,000 shares of common stock in consideration of Horton’s obligation to purchase the shares, at an exercise price of $2.50 per share, subject to certain anti-dilution adjustments as set forth in the warrant. The fair value of this warrant of $390,000 was determined using the Black-Scholes option-pricing model and was expensed during the second quarter of 2020. The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate of 0.05%, (ii) estimated volatility of 59.81%; (iii) dividend yield of 0.0%; and (iv) contractual life of the warrants of ten years. The foregoing summary of the agreement and warrant. The detailed terms and conditions of such documents are filed as Exhibits 10.1 and 10.3, respectively, to our 8-K filed with the SEC on April 7, 2020.
Below is a summary of warrant activities during the nine-month period ended September 30, 2020:
Warrants
|
Shares
|
Weighted Average Exercise Price
|
Weighted Average Remaining Term in Years
|
Aggregate
Intrinsic Value
|
Outstanding at December 31, 2019
|
77,779
|
$ 3.03
|
3.05
|
$ 21,000
|
Granted
|
500,000
|
$ 2.50
|
|
|
Exercised
|
-
|
-
|
|
|
Cancelled
|
-
|
-
|
|
|
Outstanding at September 30, 2020
|
577,779
|
$ 2.57
|
8.54
|
$ -
|
Exercisable at September 30, 2020
|
577,779
|
$ 2.57
|
8.54
|
$ -
|
2020 Equity Incentive Plan
On June 15, 2020, our stockholders approved the 2020 Equity Incentive Plan (“2020 Plan”) that included shares from our predecessor stock incentive plan. The 2020 Plan increased the total number of shares available for issuance by 1,000,000 to 3,745,621 shares of our common stock and it provides for the granting of stock options, stock appreciation rights and restricted stock to our employees, members of the Board and service providers.
Below is a summary of stock option, warrant and restricted stock unit activities during the nine-month period ended September 30, 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
|
2.82
|
$ 83,206
|
Granted
|
225,000
|
$ 1.42
|
|
|
Exercised
|
-
|
-
|
|
|
Cancelled
|
(12,375)
|
3.22
|
|
|
Outstanding at September 30, 2020
|
935,840
|
$ 3.60
|
7.53
|
$ -
|
Exercisable at September 30, 2020
|
377,507
|
$ 3.79
|
5.11
|
$ -
|
During the nine months ended September 30, 2020, we granted a total of 225,000 options to employees to purchase shares of our common stock at an exercise prices ranging from $1.08 to $1.53 per share. The exercise price equals
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the fair value of our stock on the grant date. The option has graded vesting annually over three years. The fair value of the options of $131,000 was determined using the Black-Scholes option-pricing model. The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate of 0.05%-0.16%; (ii) estimated volatility of 61.85%; (iii) dividend yield of 0.0%; and (iv) expected life of the options of three years.
Restricted Stock Units
|
Shares
|
Weighted Average Price
|
Weighted Average Remaining Term in Years
|
Non-vested at December 31, 2019
|
1,078,200
|
$ 3.42
|
1.71
|
Granted
|
55,000
|
2.38
|
|
Vested
|
(279,500)
|
3.74
|
|
Cancelled and forfeited
|
(8,200)
|
3.74
|
|
Non-vested at September 30, 2020
|
845,500
|
$ 3.22
|
1.13
|
There are 55,000 shares of restricted stock units which have vested but have not yet been issued as of September 30, 2020.
For the three months and nine months ended September 30, 2020 and 2019, stock-based compensation and other equity instrument related expenses recognized in the consolidated statements of operations as follows:
|
Three Months Ended
September 30,
|
Nine Months Ended
September 30,
|
|
2020
|
2019
|
2020
|
2019
|
Cost of revenues
|
$ 96,283
|
$ 40,989
|
$ 382,739
|
$ 257,294
|
Sales and marketing
|
34,758
|
53,234
|
192,649
|
187,200
|
General and administrative
|
247,036
|
231,377
|
819,961
|
568,960
|
Finance cost for equity commitment
|
-
|
-
|
390,000
|
-
|
Total stock-based compensation and other equity instrument related expenses
|
$ 378,077
|
$ 325,600
|
$ 1,785,349
|
$ 1,013,454
|
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 and nine months ended September 30, 2020, potentially dilutive securities consisted of options and warrants to purchase 1,513,619 shares of common stock at prices ranging from $1.08 to $4.05 per share. Of these potentially dilutive securities, none of the shares to purchase common stock from the options and warrants are included 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 55,000 shares of restricted stock units which have vested but had not been issued by period end and 845,500 shares of non-vested restricted stock units.
For the three months ended September 30, 2019, potentially dilutive securities consisted of options and warrants to purchase 432,378 shares of common stock at prices ranging from $2.28 to $4.05 per share and 760,000 shares of restricted stock units. Of these potentially dilutive securities, none of the shares to purchase common stock from the
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options and warrants and none of the shares related to the restricted stock units are included in the computation of diluted earnings per share because the effect of including these instruments would be anti-dilutive.
For the nine months ended September 30, 2019, potentially dilutive securities consisted of options and warrants to purchase 432,378 shares of common stock at prices ranging from $2.28 to $4.05 per share and 772,600 shares of restricted stock units. Of these potentially dilutive securities, 156,093 of the shares to purchase common stock from the options and warrants or shares related to the restricted stock units are included in the computation of diluted earnings per share because the effect of including these instruments would be dilutive.
|
Three Months Ended
September 30,
|
Nine Months Ended
September 30,
|
|
2020
|
2019
|
2020
|
2019
|
Numerators:
|
|
|
|
|
Net loss from continuing operations
|
$ (1,276,399)
|
$ (1,256,656)
|
$ (5,581,684)
|
$ (3,685,321)
|
Net (loss) income from discontinued operations
|
$ -
|
$ (6,500)
|
$ -
|
$ 18,878,149
|
Net (loss) income
|
$ (1,276,399)
|
$ (1,263,156)
|
$ (5,581,684)
|
$ 15,192,828
|
|
|
|
|
|
Denominator:
|
|
|
|
|
Denominator for basic calculation weighted average shares
|
10,597,024
|
9,795,147
|
10,486,334
|
9,754,014
|
|
|
|
|
|
Dilutive common stock equivalents:
|
|
|
|
|
Options and warrants
|
-
|
-
|
-
|
156,093
|
|
|
|
|
|
Denominator for diluted calculation weighted average shares
|
10,597,024
|
9,795,147
|
10,486,334
|
9,910,107
|
|
|
|
|
|
Net (loss) income per share:
From continuing operations
|
|
|
|
|
Basic
|
$ (0.12)
|
$ (0.13)
|
$ (0.53)
|
$ (0.38)
|
Diluted
|
$ (0.12)
|
$ (0.13)
|
$ (0.53)
|
$ (0.38)
|
|
|
|
|
|
From discontinued operations
|
|
|
|
|
Basic
|
$ -
|
$ (0.00)
|
$ -
|
$ 1.94
|
Diluted
|
$ -
|
$ (0.00)
|
$ -
|
$ 1.90
|
|
|
|
|
|
Net (loss) income
|
|
|
|
|
Basic
|
$ (0.12)
|
$ (0.13)
|
$ (0.53)
|
$ 1.56
|
Diluted
|
$ (0.12)
|
$ (0.13)
|
$ (0.53)
|
$ 1.53
|
14.REMAINING PERFORMANCE OBLIGATIONS
We had remaining performance obligations of approximately $15.6 million as of September 30, 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 $12.2 million as of September 30, 2020. We expect to recognize revenue on approximately 88% 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.
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15.EMPLOYMENT AGREEMENTS
Caleb Barlow
Effective August 1, 2019, we entered into an employment agreement with Caleb Barlow (the “Barlow Agreement”) pursuant to which Mr. Barlow serves as President and Chief Executive Officer and has 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 having been paid on August 1, 2019, $150,000 paid on January 1, 2020 and $150,000 payable in January 2021. Mr. Barlow also received equity compensation 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. The detailed terms and conditions of the full agreement are 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 serves 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 earned a bonus of $41,841 for 2019, and his 2020 bonus can be up to 67.5% of his base salary. The foregoing summary of the Anthony Agreement and the amendment. The detailed terms and conditions of the full agreement, are included as Exhibit 10.32 to our Annual Report on Form 10-K filed with the SEC on March 30, 2016, and the full amendment, which is included as Exhibit 10.45 to our Annual Report on Form 10-K filed with the SEC on March 28, 2018.
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 this year accounted for approximately 9% of our revenues for the nine months ended September 30, 2020 compared to our largest customer in 2019 that accounted for 17% of our revenues for the nine months ended September 30, 2019. These customers had accounts receivable totaling approximately $242,000 and $700,000 as of September 30, 2020 and December 31, 2019, respectively.
17.STOCK PURCHASE AGREEMENT – BACKBONE ENTERPRISES
On October 31, 2019, we entered into a Stock Purchase Agreement (the “Backbone 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.
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Pursuant to the Backbone 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, 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 period. As of September 30, 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 and nine months ended September 30, 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.
|
Three Months Ended
September 30, 2019
|
Nine Months Ended
September 30, 2019
|
Pro forma revenue
|
$ 5,627,000
|
$ 18,267,000
|
Pro forma net loss from continuing operations
|
$ (1,251,443)
|
$ (3,629,000)
|
Pro forma basic net loss per share
|
$ (0.12)
|
$ (0.35)
|
Pro forma diluted net loss per share
|
$ (0.12)
|
$ (0.35)
|
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.
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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
|
The following is a composition of the line items constituting net income (loss) from discontinued operations:
|
Three Months Ended
September 30, 2019
|
Nine Months Ended
September 30, 2019
|
Net revenues
|
$ -
|
$ 12,096,885
|
Cost of revenues
|
-
|
(10,060,414)
|
Sales and marketing
|
(4,981)
|
(196,314)
|
General and administrative expenses
|
-
|
(676,630)
|
Depreciation
|
-
|
(36,635)
|
Interest expense
|
-
|
(1,956)
|
Income before provision for income taxes
|
(4,981)
|
1,124,937
|
Income tax expense
|
(1,519)
|
(306,940)
|
Net (loss) income from discontinued operations
|
$ (6,500)
|
$ 817,997
|
The following is a composition of any significant noncash operating and investing items, including depreciation, of the discontinued operations for the three and nine months ended September 30, 2019:
|
Three Months Ended
September 30, 2019
|
Nine Months Ended
September 30, 2019
|
Depreciation
|
$ -
|
$ 36,635
|
Stock compensation
|
$ -
|
$ 124,348
|
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