NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019
(1)Basis of Presentation and Summary of Significant Accounting Policies
Business Activity
We are engaged in the business of helping U.S. based companies in highly regulated industries, including healthcare be prepared to handle unforeseen cyber threats, comply with regulations, and gain the confidence that their efforts are strengthening their security posture and building resilience. This is achieved through our cybersecurity, privacy and compliance services.
Liquidity and Capital Resources
As of December 31, 2020, our cash balance was $5.6 million, current assets minus current liabilities was positive $7.7 million and our non-current debt and lease obligations, excluding contingent earnout liability of $1.3 million, totaled $3.0 million. This includes $2.8 million of debt related to the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loan, received pursuant to the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), 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;
·demand for our services from healthcare providers; the near-term impact of the 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 pandemic.
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. Our most recent results for the most recent three months ended December 31, 2020, we reported a loss from operations of $16.3 million. After excluding $15.9 million of non-cash items for depreciation, amortization of intangibles, stock-based compensation, change in valuation of contingent earn-out and impairment of intangible assets and goodwill our adjusted loss from operations was $0.3 million. Cash used in operating activities was $0.4 million for the three months ended December 31, 2020. Additionally, since September 30, 2020 we saw an increase in our pre-sold revenue of $1.6 million to $17.2 million, at December 31, 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
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businesses. Our operations team is closely monitoring the 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 2021 and beyond will be negatively impacted.
We did experience a negative financial impact from March through the end of 2020 that will continue to impact revenue and earnings for the foreseeable future 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 of 2020. 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 that included permanent and temporary cost reductions 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 PPP loan CARES Act, which we anticipate will be fully forgiven. With the proceeds from the PPP Loan we have tried to minimize staff reductions in the areas of Sales and Delivery, the primary customer facing roles, to lessen the impact to our customers during this time of heightened security risks for the healthcare industry. If necessary, 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.
On November 12, 2020, we entered into the Equity Distribution Agreement with the Agent under which we may offer and sell, from time to time at our sole discretion, shares of our common stock having an aggregate offering price of up to $5.0 million in an “at-the-market” or ATM offering, to or through the Agent. Pursuant to the Equity Distribution Agreement, sales of the common stock, if any, will be made under the Company’s effective Registration Statement on Form S-3 (File No. 333-249615), previously filed with the Securities and Exchange Commission on October 22, 2020, and the prospectus supplement relating to this offering, filed on November 12, 2020, by any method that is deemed to be an “at the market offering” as defined in Rule 415(a)(4) under the Securities Act of 1933, as amended, including block transactions. The Agent agreed to use commercially reasonable efforts to sell the common stock from time to time, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company agreed to pay the Agent a commission of three percent (3.0%) of the gross sales price per share of any common stock sold through the Agent under the Equity Distribution Agreement, and also has provided the Agent with customary indemnification rights.
Through December 31, 2020, the Company received gross proceeds under the Agreement of $2,027,000 from the issuance of 1,315,000 shares of our common stock, and paid an aggregate of $61,000 to the Agent in commissions and $123,000 in other offering-related expenses, yielding net proceeds of $1,843,000.
We believe that our existing sources of liquidity, including cash and cash equivalents, the proceeds from the PPP loan, the ability to raise equity under our shelf registration (including via the Equity Distribution Agreement) and 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. 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.
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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 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.
Basis of Presentation
The accompanying consolidated financial statements were prepared in conformity with Generally Accepted Accounting Principles (GAAP), and include the accounts of CynergisTek, Inc. and our wholly owned subsidiaries. All intercompany balances and transactions were eliminated.
As described in more detail in our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 8, 2017, Auxilio, Inc., a Nevada corporation (“Auxilio”) changed its name and state of incorporation from the State of Nevada to the State of Delaware by merging (the “Reincorporation”) with and into its wholly owned subsidiary, CynergisTek, Inc., a Delaware corporation, which was established for the purpose of the Reincorporation. As a result of the Reincorporation, Auxilio ceased to exist as a separate entity. As of the date of the Reincorporation, each outstanding share of Auxilio’s Common Stock was deemed, by operation of law, to represent the same number of shares of our Common Stock. In accordance with Rule 12g-3 under the Securities Exchange Act of 1934, as amended, the shares of our Common Stock were deemed to be registered under Section 12(b) of the Exchange Act as a successor to Auxilio. Effective as of September 8, 2017, the Company’s trading symbol changed to “CTEK.”
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 year ended December 31, 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 and audited consolidated financial statements.
Use of Estimates
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 and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition and Deferred Revenue
Revenue is recognized pursuant to ASC Topic 606, “Revenue from Contracts with Customers”. Accordingly, revenue is recognized at an amount that reflects the consideration to which we expect to be entitled in exchange for transferring goods or services to a customer. This principle is applied using the following 5-step process:
1.Identify the contract with the customer - A contract with a customer exists when (i) we enter into an enforceable contract with a customer that defines each party’s rights regarding the services to be transferred and identifies the payment terms related to these services, (ii) the contract has commercial substance and the parties are committed to perform, and (iii) we determine that collection of substantially all consideration to which it will be entitled in exchange for services that will be transferred is probable based on the customer’s intent and ability to pay the promised consideration.
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2.Identify the performance obligations in the contract - Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised services, we apply judgment to determine whether promised services are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised services are accounted for as a combined performance obligation.
3.Determine the transaction price - The transaction price is determined based on the consideration to which we will be entitled in exchange for transferring services to the customer.
4.Allocate the transaction price to the performance obligations in the contract - If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price ("SSP") basis. Determination of SSP requires judgment. We determine standalone selling price taking into account available information such as historical selling prices of the performance obligation, overall strategic pricing objective, market conditions and internally approved pricing guidelines related to the performance obligations.
5.Recognize revenue when (or as) each performance obligation is satisfied - We satisfy performance obligations over time. Revenue is recognized over the time the related performance obligation is satisfied by transferring a promised service to a customer.
Managed Services
Managed services contracts are typically long-term contracts lasting three years. Revenue is earned monthly during the term of the contract, as services are provided at a fixed fee and is recognized ratably over the contract term beginning on the commencement date of the contract. Revenue related to managed services provided is recognized based on the customer utilization of such resources, which management estimates to occur ratably over the customer contract term.
Consulting and Professional Services
Consulting and professional services contracts are typically short-term, project-based services rendered on either a fixed fee or a time and materials basis. These contracts are normally for a duration of less than one year. For fixed fee arrangements, revenue is recognized ratably over the expected term of the project. For time and materials arrangements, revenues are recognized as the services are rendered.
Deferred and Unbilled Revenue
We receive payments from customers based on billing schedules established in our contracts. Deferred revenue primarily consists of billings or payments received in advance of the amount of revenue recognized and such amounts are recognized as the revenue recognition criteria are met. Unbilled revenue reflects our conditional right to receive payment from customers for our completed performance under contracts.
Cash and Cash Equivalents
For purposes of the statement of cash flows and balance sheet classification, cash equivalents include all highly liquid debt instruments with original maturities of three months or less which are not securing any corporate obligations.
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Accounts Receivable
We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts. Our estimate is based on historical collection experience and a review of the current status of trade accounts receivable.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation. Depreciation of the property and equipment is provided using the straight-line method over the assets’ estimated economic lives, which range from two to seven years. Expenditures for maintenance and repairs are charged to expense as incurred.
Goodwill and Indefinite-Lived Intangible Assets
The Company evaluates its intangible assets for impairment when events or circumstance indicate the carrying amount of these assets may not be recoverable. Intangible assets with definite lives are amortized over their estimated useful lives to their estimated residual values. Significant judgments and assumptions are required in the impairment evaluations.
Goodwill is not amortized and is tested for impairment at least annually, or whenever events or changes in circumstance indicate the carrying amount of the asset may be impaired. The annual impairment test is performed as of December 31 each year. Significant judgement is involved in determining if an indicator of impairment has occurred. The Company may consider indicators such as deterioration in general economic conditions, adverse changes in the markets in which the reporting unit operates, increases in input costs that have negative effects on earnings and cash flows, or a trend of negative or declining cash flows over multiple periods, among others. The fair value that could be realized in an actual transaction may differ from that used to evaluate the impairment of goodwill.
The Company may first review for goodwill impairment by assessing the qualitative factors to determine whether any impairment may exist. For a reporting unit in which the Company concludes, based on the qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount (or if the Company elects to skip the optional qualitative assessment), the Company is required to perform a quantitative impairment test, which includes measuring the fair value of the reporting unit and comparing it to the reporting unit’s carrying amount. If the fair value of a reporting unit exceeds its carrying value, the goodwill of the reporting unit is not impaired. If the carrying value of a reporting unit exceeds its fair value, the Company must record an impairment loss for the amount that the carrying value of the reporting unit, including goodwill, exceeds the fair value of the reporting unit.
The Company completed its annual assessment for goodwill impairment and determined that goodwill was impaired as of December 31, 2020 and recorded an impairment loss to goodwill of $15.6 million, which was charged to operating expenses in the current period (Note 6).
Long-Lived Assets
In accordance with ASC Topic 350, long-lived assets, such as definite-lived intangible assets, to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value of asset less the cost to sell.
During the year ended December 31, 2020, management determined there was an impairment to the Customer Relationship asset associated with the Backbone acquisition of $0.9 million due to lower revenue from existing customers as compared to plan (Note 6).
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During the year ended December 31, 2019, management determined there was an impairment due to the reduction in the useful life of Acquired Technology assets associated with the Delphiis acquisition and an impairment to the customer relationship asset associated with the Cynergistek, Inc. acquisition in 2017 (Note 6).
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting requirements and those imposed under federal and state tax laws. Deferred taxes are provided for timing differences in the recognition of revenue and expenses for income tax and financial reporting purposes and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and liabilities. Realization of the deferred tax asset is dependent on generating sufficient taxable income in future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all the deferred tax assets will not be realized. The use of net operating loss deferred tax assets may be limited due to changes in the Company’s ownership structure.
Fair Value of Financial Instruments
ASC Topic 820, “Fair Value Measurements,” defines fair value, provides a framework for measuring fair value and expands the disclosures required for fair value measurements.
The fair value hierarchy consists of three broad levels, which are described below:
Level 1 - Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2 - Observable inputs, other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, and capital lease obligations approximate fair value due to the short-term nature of these financial instruments. The carrying amount of our debt approximates its fair value as we believe the credit markets have not materially changed since the original borrowing dates, and related interest rates are variable.
Stock-Based Compensation
We account for stock options granted to employees, non-employees, and directors using the accounting guidance in ASC 718 “Stock Compensation” (“ASC 718”). In accordance with ASC 718, we estimate the fair value of service-based options and performance-based options on the date of grant, using the Black-Scholes pricing model. We recognize compensation expense for stock option awards over the requisite or implied service period of the grant. With respect to performance-based awards, compensation expense is recognized when the performance target is deemed probable.
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For the years ended December 31, 2020 and 2019, stock-based compensation and other equity instrument related expenses recognized in the consolidated statements of operations excluding amounts in discontinued operations (Note 20) is as follows:
|
Year Ended December 31,
|
|
2020
|
2019
|
Cost of revenues
|
$ 362,037
|
$ 208,163
|
Sales and marketing
|
176,247
|
257,151
|
General and administrative expenses
|
972,647
|
833,617
|
Finance cost for equity commitment
|
390,000
|
-
|
Total stock-based compensation expense
|
$ 1,900,931
|
$ 1,298,931
|
The weighted average estimated fair value of stock options granted during 2020 and 2019 was $0.60 and $1.70 per share, respectively. Estimated fair values were determined using the Black-Scholes option-pricing model, which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility of the stock, the expected dividend payments, and the risk-free interest rate over the expected life of the option. The assumptions used in the Black-Scholes model were as follows for stock options granted:
|
2020
|
2019
|
Risk-free interest rate
|
0.05%-1.6%
|
2.4%
|
Expected volatility of our Common Stock
|
61.03%-62.36%
|
48.59%
|
Dividend yield
|
0%
|
0%
|
Expected life of options
|
3 years
|
3 years
|
The Black-Scholes model was developed for estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Because option valuation models require the use of subjective assumptions, changes in these assumptions can materially affect the fair value of the options.
Compensation cost associated with grants of restricted stock units are also measured at fair value on the date of grant and such costs are recognized over the respective vesting periods. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense.
On April 3, 2020 upon signing a Securities Purchase Agreement (see Note 12), the Company issued a warrant to purchase up to 500,000 shares of common stock in consideration of an 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.
Basic and Diluted Net Income (Loss) Per Share
In accordance with ASC Topic 260, “Earnings Per Share,” basic net income per share is calculated using the weighted average number of shares of Common Stock issued and outstanding during a certain period and is calculated by dividing net income by the weighted average number of shares of Common Stock issued and outstanding during such period. Diluted net income 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.
As of December 31, 2020, potentially dilutive securities consisted of options and warrants to purchase 1,618,618 shares of our Common Stock at prices ranging from $1.44 to $4.86 per share. Of these
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potentially dilutive securities, none of the shares of Common Stock underlying the options and warrants were 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 168,000 shares of restricted stock units which have vested but had not been issued by year end.
As of December 31, 2019, potentially dilutive securities consisted of options and warrants to purchase 800,994 shares of our Common Stock at prices ranging from $2.28 to $4.86 per share. Of these potentially dilutive securities, only 81,945 of the shares of Common Stock underlying the options and warrants were included in the computation of diluted earnings per share, because the effect of including the remaining instruments would be anti-dilutive. Also included in potentially dilutive securities are 60,000 shares of restricted stock units which vested in October 2019 but had not been issued by year end 2019.
The following table sets forth the computation of basic and diluted net (loss) income per share:
|
Year Ended December 31,
|
|
2020
|
2019
|
Numerator:
|
|
|
Net loss from continuing operations
|
$ (18,468,488)
|
$ (5,414,383)
|
Net income from discontinued operations
|
$ -
|
$ 20,305,087
|
Net (loss) income
|
$(18,468,488)
|
$ 14,890,704
|
|
|
|
Denominator:
|
|
|
Denominator for basic calculation weighted averages
|
10,573,123
|
9,858,562
|
|
|
|
Dilutive Common Stock equivalents:
|
|
|
Options and warrants
|
-
|
81,945
|
Restricted stock units vested but not issued
|
-
|
60,000
|
Denominator for diluted calculation weighted average
|
10,573,123
|
10,000,507
|
|
|
|
Net (loss) income per share:
|
|
|
From continuing operations
|
|
|
Basic net loss per share
|
$ (1.75)
|
$ (0.55)
|
Diluted net loss per share
|
$ (1.75)
|
$ (0.55)
|
|
|
|
From discontinued operations
|
|
|
Basic net income per share
|
$ -
|
$ 2.06
|
Diluted net income per share
|
$ -
|
$ 2.03
|
|
|
|
Net (loss) income
|
|
|
Basic net (loss) income per share
|
$ (1.75)
|
$ 1.51
|
Diluted net (loss) income per share
|
$ (1.75)
|
$ 1.49
|
Segment Reporting
Based on an analysis of how our Chief Operating Decision Makers review, manage and allocate resources, as well as how our management team is organized and compensated, we have determined that the Company operates in one segment. For the years ended December 31, 2020 and 2019, all revenues were derived from domestic operations.
Recently Issued Accounting Pronouncements Adopted
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
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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 January 2020, the FASB issued an amendment clarifying the interaction between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance is effective for fiscal years beginning after December 15, 2020. Management does not expect the impact of this guidance will 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 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.
(2)Revenues
Below is a summary of our revenues disaggregated by revenue source.
|
Year Ended December 31,
|
|
2020
|
2019
|
Managed services
|
$ 11,467,977
|
$ 11,887,108
|
Consulting & professional services
|
7,404,248
|
9,477,702
|
Net revenues
|
$ 18,872,235
|
$ 21,364,810
|
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(3)Accounts Receivable
A summary of accounts receivable follows:
|
As of December 31,
|
|
2020
|
2019
|
Trade receivables
|
$ 2,083,761
|
$ 3,210,726
|
Allowance for doubtful accounts
|
20,625
|
-
|
|
$ 2,063,136
|
$ 3,210,726
|
(4)Deferred Commissions
Our incremental costs of obtaining a contract, which consist of sales commissions on multi-year contracts, are deferred and amortized over the period of contract performance. Deferred commissions are included in prepaid and other current assets in our consolidated balance sheets. As of December 31, 2020, we had $730,000 related to unamortized deferred commissions and recorded $631,000 of commissions expense for the year ended December 31, 2020. As of December 31, 2019, we had $765,000 related to unamortized deferred commissions and recorded $876,000 of commissions expense for the year ended December 31, 2019.
(5)Property and Equipment
A summary of property and equipment follows:
|
As of December 31,
|
|
2020
|
2019
|
Furniture and fixtures
|
$ 235,245
|
$ 195,586
|
Computers and office equipment
|
792,181
|
757,251
|
Right of use assets
|
1,843,818
|
1,658,364
|
Property and equipment at cost
|
2,871,244
|
2,611,201
|
Less accumulated depreciation and amortization
|
(2,329,719)
|
(1,664,982)
|
|
$ 541,525
|
$ 946,219
|
Depreciation expense for property and equipment amounted to approximately $190,000 and $146,000 for the years ended December 31, 2020 and 2019, respectively.
(6)Intangible Assets and Goodwill
Intangible assets are amortized over expected useful lives ranging from 1.5 to 10 years and consist of the following as of December 31, 2020 and 2019:
|
December 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
|
$ (4,934,720)
|
$ 5,165,280
|
$ 10,100,000
|
$ (4,054,951)
|
$ 6,045,049
|
Customer relationships
|
4,650,000
|
(4,445,000)
|
205,000
|
4,650,000
|
(3,212,500)
|
1,437,500
|
Trademarks
|
2,300,000
|
(1,606,663)
|
693,337
|
2,300,000
|
(1,196,667)
|
1,103,333
|
Total
|
$ 17,050,000
|
$ (10,986,383)
|
$ 6,063,617
|
$ 17,050,000
|
$ (8,464,118)
|
$ 8,585,882
|
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At the end of 2020, we identified events and circumstances related to future revenue projections, a shortfall in the actual overall financial performance of Backbone as compared to plan. The Company engaged a valuation expert to assist management in updating its analysis of the fair value of the intangible assets. We determined that the carrying value of customer relationships exceeded its estimated fair value resulting in an impairment charge of $0.8 million in 2020.
At the end of 2019, we made the decision to phase out the Delphiis acquired technology to move to another third-party platform that provides more flexibility in the services we provide and allows us to reduce expenses related to maintaining this tool. As a result, we updated our evaluation of the estimated useful life of the related intangible asset and accelerating amortization of the remaining balance of $77,000 in 2019. Additionally, we identified events and circumstances related to the future revenue projections of the cybersecurity consulting business we acquired in 2017 compared to the original projections that indicated we should review our long-lived assets for impairment. The Company engaged a valuation expert to assist management in updating its analysis of the fair value of the intangible assets. We determined that the carrying value of customer relationships exceeded its estimated fair value resulting in an impairment charge of $0.5 million in 2019.
The amortization of intangible assets expected in future years is as follows:
December 31,
|
Amortization
|
2021
|
$ 1,362,122
|
2022
|
1,052,122
|
2023
|
1,040,063
|
2024
|
963,102
|
2025
|
831,192
|
Thereafter
|
815,016
|
Total
|
$ 6,063,617
|
Goodwill consists of the following as of December 31, 2020 and 2019:
|
December 31, 2020
|
December 31, 2019
|
|
Gross
Carrying
Amount
|
Accumulated
Impairment
|
Net
Carrying
Amount
|
Gross
Carrying
Amount
|
Accumulated
Impairment
|
Net
Carrying
Amount
|
Delphiis, Inc.
|
$ 956,639
|
$ (837,126)
|
$ 119,513
|
$ 956,639
|
$ (837,126)
|
$ 119,513
|
Redspin
|
1,192,000
|
(719,387)
|
472,613
|
1,192,000
|
(719,387)
|
472,613
|
CTEK Security, Inc
|
16,416,063
|
(14,789,000)
|
1,627,063
|
16,416,063
|
-
|
16,416,063
|
Backbone
|
6,975,294
|
(800,000)
|
6,175,294
|
6,975,294
|
-
|
6,975,294
|
Total goodwill
|
$ 25,539,996
|
$(17,145,513)
|
$8,394,483
|
$ 25,539,996
|
$ (1,556,513)
|
$23,983,483
|
At the end of 2020, we identified events and circumstances related to future revenue projections, a shortfall in the actual overall financial performance of CynergisTek and Backbone as compared to plan, and a recurring need for working capital that indicated we should review our goodwill for impairment. The Company engaged a valuation expert to assist management in updating its analysis of the fair value of goodwill. As a result of this analysis the Company recorded an impairment loss to goodwill of $15.6 million in 2020.
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(7)Deferred Revenue
We record deferred revenues when amounts are billed to customers, or cash is received from customers, in advance of our performance. Approximately $1,119,000 and $811,000 of managed services revenues were recognized during the years ended December 31, 2020 and 2019, respectively, that was included in deferred revenue at the beginning of the respective periods. Approximately $165,000 and $73,000 of consulting and professional services revenues were recognized during the years ended December 31, 2020 and 2019, respectively, that was included in deferred revenue at the beginning of the respective periods.
(8)Remaining Performance Obligations
We had remaining performance obligations of approximately $17,200,000 as of December 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 $14,400,000 as of December 31, 2020. We expect to recognize revenue on approximately 82% of the December 31, 2020 remaining non-cancelable portion of these performance obligations over the next 24 months, with the balance thereafter.
(9)Term Loans
BMO Credit Agreement
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 $17,300,000 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 20) to fully repay the balance of the term loan in the amount of $15,400,000, plus interest of $53,000. At that time, the Credit Agreement was terminated. Interest charges associated with the BMO term loan totaled $208,000 for the year ended December 31, 2019.
Paycheck Protection Program
On April 20, 2020, we received $2,826,000 in loan funding from the SBA PPP, established pursuant to 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 used 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 accelerated 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 $20,000 for the year ended December 31, 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 and therefore has not classified the loan as a current obligation.
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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 a debt restructuring, 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 has a 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 December 31, 2020, and 2019, the outstanding principal balance due under the A&R McMillan Seller Note was $703,000 and $1,266,000, respectively.
Interest charges associated with the Seller Note totaled $81,000 and $126,000, respectively for the years ended December 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 20) to fully repay the Earn-out Note with interest of $234,000.
Interest charges associated with the Earn-out Note totaled $0 for the year ended December 31, 2019.
Pursuant to the Separation Agreement, the Company also issued a Severance Payment Note to Hernandez in the original principal amount of $344,000 (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 year ended December 31, 2019.
(11)Common Stock
On November 12, 2020 we entered into an Equity Distribution Agreement (the “Agreement”) with Craig-Hallum Capital Group LLC (“Agent”) under which the Company may offer and sell, from time to time at
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its sole discretion, shares of its $0.001 par value common stock (“Common Stock”), to or through the Agent as its sales agent, having an aggregate offering price of up to $5,000,000.
Pursuant to the Agreement, sales of the Common Stock, can be made under the Company’s effective Registration Statement on Form S-3 (File No. 333-249615), filed with the Securities and Exchange Commission on October 22, 2020, and the prospectus supplement relating to this offering, filed on November 12, 2020, by any method that is deemed to be an “at the market offering” as defined in Rule 415(a)(4) under the Securities Act of 1933, as amended, including block transactions. The Agent agreed to use commercially reasonable efforts to sell the Common Stock from time to time, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company will pay the Agent a commission of three percent (3.0%) of the gross sales price per share of any Common Stock sold through the Agent under the Agreement, and also has provided the Agent with customary indemnification rights. The Company will also reimburse the Agent for its reasonable out-of-pocket accountable fees and disbursements in an amount not to exceed $50,000 through the fourth business day following execution of the Agreement, and in an amount not to exceed $5,000 for each quarterly period thereafter.
Through December 31, 2020, the Company received gross proceeds under the Agreement of $2,027,000 from the issuance of 1,315,000 shares of our common stock, and paid an aggregate of $61,000 to the Agent in commissions and $123,000 in other offering-related expenses, yielding net proceeds of $1,843,000.
(12)Warrants
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 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
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detailed terms and conditions of such documents are filed as Exhibits 10.1 and 10.3, respectively, to Current Report on Form 8-K filed with the SEC on April 7, 2020.
Below is a summary of warrant activity during the years ended December 31, 2020 and 2019:
|
Number of Shares
|
Weighted Average Exercise Price
|
Weighted Average Remaining Term in Years
|
Aggregate Intrinsic Value
|
Outstanding at January 1, 2019
|
77,779
|
$ 3.03
|
|
|
Granted in 2019
|
-
|
$ -
|
|
|
Exercised in 2019
|
-
|
$ -
|
|
|
Cancelled in 2019
|
-
|
$ -
|
|
|
Outstanding at December 31, 2019
|
77,779
|
$ 3.03
|
3.05
|
$21,000
|
Granted in 2020
|
500,000
|
$ 2.50
|
|
|
Exercised in 2020
|
-
|
$ -
|
|
|
Cancelled in 2020
|
-
|
$ -
|
|
|
Outstanding at December 31, 2020
|
577,779
|
$ 2.57
|
8.29
|
$ -
|
|
|
|
|
|
Warrants exercisable at December 31, 2020
|
577,779
|
$ 2.57
|
8.29
|
$ -
|
(13)Stock Options and Stock Incentive Plans
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. As of December 31, 2020, there were 1,472,555 shares available for issuance under the 2020 Plan.
Additional information with respect to the stock option activity is as follows:
|
Number of Shares
|
Weighted Average Exercise Price
|
Weighted Average Remaining Term in Years
|
Aggregate Intrinsic Value
|
Outstanding at January 1, 2019
|
539,599
|
$ 2.97
|
|
|
Granted in 2019
|
500,000
|
$ 4.86
|
|
|
Exercised in 2019
|
(105,584)
|
$ 2.73
|
|
|
Cancelled in 2019
|
(210,800)
|
$ 3.12
|
|
|
Outstanding at December 31, 2019
|
723,215
|
$ 4.27
|
7.47
|
$ 83,206
|
Granted in 2020
|
480,000
|
$ 1.46
|
|
|
Exercised in 2020
|
-
|
$ -
|
|
|
Cancelled in 2020
|
(162,376)
|
$ 2.39
|
|
|
Outstanding at December 31, 2020
|
1,040,839
|
$ 3.27
|
9.66
|
$ 46,750
|
|
|
|
|
|
Options exercisable at December 31, 2020
|
302,506
|
$ 3.95
|
6.09
|
$ -
|
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Table of Contents
The following table summarizes information about stock options outstanding and exercisable at December 31, 2020:
Range of
Exercise Prices
|
Number of Shares Outstanding
|
Weighted Average Remaining in Contractual Life
in Years
|
Outstanding Options Weighted Average Exercise Price
|
Number of Options Exercisable
|
Exercisable Options Weighted Average Exercise Price
|
$0.90 to $2.27
|
405,000
|
9.67
|
$ 1.45
|
-
|
$ -
|
$2.28 to $2.72
|
57,670
|
2.00
|
$ 2.47
|
57,670
|
$ 2.47
|
$2.73 to $4.86
|
578,169
|
7.91
|
$ 4.62
|
244,836
|
$ 4.62
|
$2.28 to $4.86
|
1,040,839
|
8.27
|
$ 3.27
|
302,506
|
$ 3.95
|
Unamortized compensation expense associated with unvested options is $652,000 as of December 31, 2020. The weighted average period over which these costs are expected to be recognized is approximately three years.
(14)Restricted Stock Units
The fair value of restricted stock awards is estimated by the market price of the Company’s Common Stock at the date of grant. Restricted stock activity during the years ended December 31, 2020 and 2019, are as follows:
|
Number of Shares
|
Weighted Average Grant-Date Fair Value per Share
|
Weighted Average Vesting Period in Years
|
Non-vested at January 1, 2019
|
810,000
|
$ 3.67
|
|
Granted in 2019
|
447,700
|
3.11
|
|
Vested in 2019
|
(131,726)
|
4.22
|
|
Cancelled and forfeited in 2019
|
(57,774)
|
3.95
|
|
Non-vested at December 31, 2019
|
1,068,200
|
$ 3.42
|
|
Granted in 2020
|
55,000
|
$ 2.38
|
|
Vested in 2020
|
(514,500)
|
1.75
|
|
Cancelled and forfeited in 2020
|
(53,350)
|
3.28
|
|
Non-vested at December 31, 2020
|
555,350
|
$ 3.38
|
1.24
|
As of December 31, 2020 and 2019 there were 168,000 and 60,000 restricted stock units vested but not yet issued, respectively, During the years ended December 31, 2020 and 2019, we issued a total of 55,000 and 447,700 shares, respectively, of restricted stock units to key employees and members of the Board of Directors. The shares cliff vest after three years of continuous employment or one continuous of year of
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Table of Contents
service on the Board. The cost recognized for these restricted stock units totaled $1,199,889 and $1,280,336 for the years ended December 31, 2020 and 2019, respectively.
(15)Income Taxes
For the years ended December 31, 2020 and 2019, the components of income tax benefit are as follows:
|
Year Ended December 31,
|
|
2020
|
2019
|
Current provision:
|
|
|
Federal
|
$ (1,903,792)
|
$ (1,814,143)
|
State
|
-
|
(296,088)
|
|
(1,903,792)
|
(2,110,231)
|
Deferred:
|
|
|
Federal
|
(2,129,541)
|
735,508
|
State
|
(1,111,916)
|
(154,385)
|
|
(3,141,457)
|
581,423
|
Income tax benefit
|
$ (5,045,249)
|
$ (1,528,808)
|
Income tax benefit amounted to $5,045,249 and $1,528,808 for the years ended December 31, 2020 and 2019, respectively (an effective rate of 21% for 2020 and 22% for 2019). A reconciliation of the income tax benefit with amounts determined by applying the statutory U.S. federal income tax rate to loss before income taxes is as follows:
|
Year Ended December 31,
|
|
2020
|
2019
|
Computed tax at federal statutory rate of 21%
|
$ (4,937,885)
|
$ (1,458,070)
|
State taxes, net of federal benefit
|
(799,414)
|
(355,978)
|
Intangibles
|
960,871
|
-
|
Non-deductible items
|
2,934
|
15,316
|
Other
|
(271,755)
|
269,924
|
|
$ (5,045,249)
|
$ (1,528,808)
|
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows:
F-25
Table of Contents
|
Year Ended December 31,
|
|
2020
|
2019
|
Deferred tax assets:
|
|
|
Accrued salaries/vacation
|
$ 70,200
|
$ 103,300
|
Accrued other
|
10,200
|
19,200
|
Amortization of intangible assets
|
3,477,400
|
728,500
|
State taxes
|
68,400
|
51,900
|
Stock options
|
1,094,700
|
1,137,600
|
Net operating loss carryforwards
|
673,200
|
44,700
|
Total deferred tax assets
|
5,394,100
|
2,085,200
|
|
|
|
Deferred tax liabilities:
|
|
|
Depreciation
|
92,600
|
123,200
|
Other
|
342,375
|
125,742
|
Total deferred tax liabilities
|
434,975
|
248,942
|
|
|
|
Net deferred tax assets
|
$ 4,959,125
|
$ 1,836,258
|
At December 31, 2020, we estimate $11.7 million of net operating loss carryforwards that may be applied against future taxable income for state purposes, and an immaterial amount of net operating loss carryforwards remaining for federal purposes.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits NOL carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before January 01, 2021. In addition, the CARES Act allows NOLs incurred in taxable years beginning after December 31, 2017 and before January 01, 2021 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. We are currently evaluating the impact of various provisions of the CARES Act, but at present, expect that the NOL carryback provision of the CARES Act would result in a material cash benefit to us.
We evaluate our tax positions each reporting period to determine the uncertainty of such positions based upon one of the following conditions: (1) the tax position is not ‘‘more likely than not’’ to be sustained, (2) the tax position is ‘‘more likely than not’’ to be sustained, but for a lesser amount, or (3) the tax position is ‘‘more likely than not’’ to be sustained, but not in the financial period in which the tax position was originally taken. We have evaluated our tax positions for all jurisdictions and all years for which the statute of limitations remains open. We have determined that no liability for unrecognized tax benefits and interest was necessary.
The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those differences become deductible. Management considers the scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Management believes that it is more likely than not that the Company will realize the benefits of the net deferred tax assets as of December 31, 2020 and 2019.
(16) Retirement Plan
Our professional employer organization sponsors a 401(k) plan for the benefit of our employees who are at least 21 years of age. Our management determines, at its discretion, the annual and matching contribution. For the years ended December 31, 2020 and 2019, we made matching contributions totaling $215,000 and $418,000, respectively. This decrease in 2020 is expected to be temporary due to COVID-19 related cost reductions.
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Table of Contents
(17) Commitments
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 5,000 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 18,000 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 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:
|
Year Ended December 31,
|
|
2020
|
2019
|
Operating lease cost
|
$ 720,672
|
$ 695,862
|
Sublet income
|
(464,845)
|
(447,211)
|
Net operating lease cost
|
$ 255,827
|
$ 248,651
|
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Table of Contents
Maturities of lease liabilities are as follows:
|
Operating Leases
|
2021
|
$ 259,367
|
2022
|
41,690
|
Total lease payments
|
301,057
|
Less imputed interest
|
(8,628)
|
Total lease liabilities
|
292,429
|
Less current portion of lease liabilities
|
(252,398)
|
Long-term lease liabilities
|
$ 40,031
|
Employment Agreements
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 2020 and 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. In connection with the Barlow Agreement, 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 only a summary of the Barlow Agreement. The detailed terms and conditions of the full agreement are included as Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on July 16, 2019.
Effective January 1, 2016, we entered into an employment agreement with Paul T. Anthony. The agreement provided that Mr. Anthony serve as our Executive Vice President, CFO and Corporate Secretary. In February 2018, the Company amended the Anthony Agreement to extend the term thereof through December 31, 2020 and increased his base salary to $310,000 for 2019 and 2020. Mr. Anthony earned a bonus $0 and of $41,841 for 2020 and 2019, respectively.
On January 4, 2021, the Company entered into a new employment agreement (the “Anthony Agreement”) with Mr. Anthony on substantially the same terms and conditions as Mr. Anthony’s prior employment agreement, which was replaced and superseded by the new agreement. Pursuant to the Anthony Agreement, Mr. Anthony will have the duties and responsibilities as are commensurate with the positions of Secretary, Treasurer and Chief Financial Officer, as reasonably and lawfully directed by the Company’s Chief Executive Officer and Board of Directors (the “Board”). The initial term of the Anthony Agreement is 36 months from the Effective Date and the Anthony Agreement 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.
Pursuant to the Anthony Agreement, Mr. Anthony’s base salary remains the same for 2021 at $310,000 and increases in 2022 based on two times the average percentage salary increase of the Company’s active employees during 2021. Subsequent increases to base salary will be subject to the discretion of the Compensation Committee of the Board (the “Compensation Committee”). Mr. Anthony is entitled to the same incentive bonus compensation of up to 67.5% of his base salary, and equity compensation may be granted from time to time based on the discretion and recommendation of the Compensation Committee and Board. Mr. Anthony is entitled to one-time, lump-sum amounts equal to the employee tax portion required to be paid plus the amount necessary to put Mr. Anthony in the same after-tax position (taking into
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account any and all applicable federal, state, and local income, employment and excise taxes, including any income and employment taxes imposed on the payment itself) that he would have been in if he had not incurred any tax liability on settlement of the restricted stock units, as a result of the settlement of the 90,000 restricted stock units that were granted on each of October 8, 2018 and November 13, 2019. Each such payment shall be paid within 30 days of settlement of the applicable restricted stock units. The Company has the right to terminate Mr. Anthony’s employment 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.
The detailed terms and conditions of the Anthony Agreement are included as Exhibit 10.8 to this Annual Report on Form 10-K.
(18)Concentrations
Cash Concentrations
At times, cash and cash equivalent 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
For the year ended December 31, 2020, there was one customer that generated at least 10% of our revenues. This customer represented a total of 11% of revenues. As of December 31, 2020, net accounts receivable due from this customer totaled approximately $74,000.
For the year ended December 31, 2019, there was one customer that generated at least 10% of our revenues. This customer represented a total of 14% of revenues. As of December 31, 2019, net accounts receivable due from this customer totaled approximately $140,000.
(19)Stock Purchase Agreement – Backbone Enterprises, Inc.
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.
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. 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.
As of December 31, 2020, there was no earnout paid for the first year and the maximum earnout for years two and three totals $2,700,000. In 2020 after the completion of year one, we performed a valuation of the contingent earn-out and marked down the fair value balance from $2.4 million to $1.3 million based on the potential of achieving a portion of the year two and three targets. This resulted in a gain from the reduction of the contingent earnout liability of $1.1 million in 2020.
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The Company has performed a valuation analysis of the fair value of Backbone Enterprises, Inc.’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
|
|
20,000
|
Identified intangible assets (Note 6)
|
|
2,000,000
|
Goodwill (Note 6)
|
|
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 year ended December 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.
|
Year Ended December 31, 2019
|
Pro forma revenue
|
$ 24,454,000
|
Pro forma net income
|
$ 14,986,000
|
Pro forma basic net income per share
|
$ 1.52
|
Pro forma diluted net income per share
|
$ 1.50
|
(20)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 $1,900,000.
The following is a summary of the transaction selling the MPS Business:
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:
|
Year Ended 2019
|
Net revenues
|
$ 12,096,885
|
Cost of revenues
|
(10,060,414)
|
Sales and marketing
|
(201,295)
|
General and administrative expenses
|
(676,630)
|
Depreciation
|
(36,635)
|
Other income (expense)
|
(1,955)
|
Income before provision for income taxes
|
1,119,956
|
Income tax expense
|
(306,940)
|
Net income from discontinued operations
|
$ 813,016
|
The following is a composition of the capital expenditures, and any significant noncash operating and investing items, including depreciation, of the discontinued operations.
|
Year Ended 2019
|
Stock compensation
|
$ 124,348
|
Depreciation
|
$ 36,635
|
(21)Subsequent Events
The Company has evaluated subsequent events after the consolidated balance sheet date of December 31, 2020 through the date of filing. Based upon the Company's evaluation, management has determined that, no subsequent events have occurred that would require recognition in the accompanying consolidated financial statements or disclosure in the notes thereto.
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