10-Q Q1 2019

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2019

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number 000-27507

CYNERGISTEK, INC.

(Exact name of registrant as specified in its charter)

Delaware

37-1867101

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

 

11940 Jollyville Road, Suite 300-N

Austin, Texas 78759

(Address of principal executive offices, zip code)

(949) 614-0700

(Issuer’s telephone number)

N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o.

Indicated by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer oAccelerated filer o 

Non-accelerated filer þSmaller reporting company þ 

Emerging growth company  ¨

Indicate by check mark whether the registrant is a shell company (as defined by Section 12b-2 of the Exchange Act).  

Yes o No þ.



Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Shares, $.001 par value

CTEK

NYSE American

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act.

 

The number of shares of the issuer’s common stock, $0.001 par value, outstanding as of May 13, 2019, was 9,773,521.



 

CYNERGISTEK, INC.

FORM 10-Q

TABLE OF CONTENTS

Page

 

ITEM 1.FINANCIAL STATEMENTS.3 

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.20 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.26 

ITEM 4.CONTROLS AND PROCEDURES.26 

ITEM 1A.RISK FACTORS.26 

ITEM 6.EXHIBITS.27 

SIGNATURES28 



Table of Contents


PART I – FINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS. 

CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

March 31, 2019 (unaudited)

December 31, 2018

ASSETS

 

 

Current assets:

 

 

Cash and cash equivalents 

$ 12,386,637   

$ 6,571,381   

Accounts receivable, net 

4,309,391   

5,572,467   

Prepaid and other current assets 

3,763,872   

1,425,858   

Refundable income taxes 

-   

472,059   

Current assets held for sale 

-   

8,427,408   

Total current assets 

20,459,900   

22,469,173   

 

 

 

Property and equipment, net

848,131   

887,874   

Deposits

79,710   

87,778   

Deferred income taxes

1,615,173   

2,146,020   

Intangible assets, net

8,637,255   

9,089,989   

Goodwill

17,008,189   

17,008,189   

Noncurrent assets held for sale

-   

1,844,349   

Total assets

$ 48,648,358   

$ 53,533,372   

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

Current liabilities:

 

 

Accounts payable and accrued expenses 

$ 362,770   

$ 1,370,336   

Accrued compensation and benefits 

1,393,890   

1,592,765   

Deferred revenue 

1,262,627   

918,165   

Income taxes payable 

4,840,746   

-   

Note payable 

-   

343,750   

Current portion of long-term liabilities 

839,590   

3,271,052   

Current liabilities held for sale 

138,894   

7,299,561   

Total current liabilities 

8,838,517   

14,795,629   

 

 

 

Long-term liabilities:

 

 

Term loan, less current portion 

-   

12,851,617   

Promissory notes to related parties, less current portion 

1,125,000   

5,015,625   

Capital lease obligations, less current portion 

-   

1,570   

Operating lease liability, less current portion 

355,031   

436,805   

Noncurrent liabilities held for sale 

-   

58,967   

Total long-term liabilities 

1,480,031   

18,364,584   

Commitments and contingencies

 

 

Stockholders’ equity:

 

 

Common stock, par value at $0.001, 33,333,333 shares authorized, 9,723,065 shares issued and outstanding at March 31, 2019, and 9,630,050 shares issued and outstanding at December 31, 2018 

9,723   

9,630   

Additional paid-in capital 

32,319,958   

31,910,831   

Accumulated earnings (deficit) 

6,000,129   

(11,547,302)  

Total stockholders’ equity 

38,329,810   

20,373,159   

Total liabilities and stockholders’ equity 

$ 48,648,358   

$ 53,533,372   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.


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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

Three Months Ended March 31,

 

2019

2018

Net revenues

$ 5,773,657   

$ 4,374,569   

Cost of revenues

3,484,639   

2,408,780   

Gross profit 

2,289,018   

1,965,789   

 

Operating expenses:

 

 

Sales and marketing 

1,481,383   

1,367,871   

General and administrative expenses 

1,653,633   

2,169,291   

Depreciation 

38,985   

35,064   

Amortization of acquisition-related intangibles 

452,734   

452,734   

Total operating expenses 

3,626,735   

4,024,960   

Loss from operations

(1,337,717)  

(2,059,171)  

 

Other income (expense):

 

 

Other income 

8   

20   

Interest expense 

(295,905)  

(399,733)  

Total other income (expense) 

(295,897)  

(399,713)  

 

 

 

(Loss) before provision for income taxes

(1,633,613)  

(2,458,884)  

Income tax benefit

144,214   

602,472   

Net loss from continuing operations

(1,489,399)  

(1,856,412)  

Income from discontinued operations, including gain on sale, net of tax

19,036,830   

1,149,069   

Net income (loss)

$ 17,547,431   

$ (707,343)  

 

 

 

Net income (loss) per share:

 

 

From continuing operations:

 

 

Basic 

$ (0.15)  

$ (0.19)  

Diluted 

$ (0.15)  

$ (0.19)  

 

 

 

From discontinued operations:

 

 

Basic 

$ 1.97   

$ 0.12   

Diluted 

$ 1.92   

$ 0.12   

 

 

 

Net income:

 

 

Basic 

$ 1.81   

$ (0.07)  

Diluted 

$ 1.77   

$ (0.07)  

 

 

 

Number of weighted average shares outstanding:

 

 

Basic 

9,673,689   

9,586,608   

Diluted 

9,931,048   

9,586,608   


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The accompanying notes are an integral part of these condensed consolidated financial statements.

CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED MARCH 31, 2019 AND 2018

(UNAUDITED)

 

 

 

 

 

 

Additional

 

Accumulated

 

Total

 

Common Stock

 

Paid-in

 

(Deficit)

 

Stockholders’

 

Shares

 

Amount

 

Capital

 

Earnings

 

Equity

Balance at December 31, 2017

9,576,028   

 

$ 9,576   

 

$ 31,156,362   

 

$ (14,320,560)  

 

$ 16,846,378   

Stock compensation expense for options and warrants granted to employees and directors

-   

 

-   

 

11,516   

 

-   

 

11,516   

Stock compensation expense for restricted stock units granted to employees

-   

 

-   

 

176,746   

 

-   

 

176,746   

Stock options exercised

16,519   

 

17   

 

(17)  

 

-   

 

-   

Cumulative effect of adoption of revenue recognition standard ASC 606

-   

 

-   

 

-   

 

879,666   

 

879,666   

Net loss

-   

 

-   

 

-   

 

(707,343)  

 

(707,343)  

Balance at March 31, 2018

9,592,547   

 

$ 9,593   

 

$ 31,344,607   

 

$ (14,148,237)  

 

$ 17,205,963   

 

 

 

 

 

 

 

Additional

 

Accumulated

 

Total

 

Common Stock

 

Paid-in

 

(Deficit)

 

Stockholders’

 

Shares

 

Amount

 

Capital

 

Earnings

 

Equity

Balance at December 31, 2018

9,630,050   

 

$ 9,630   

 

$ 31,910,831   

 

$ (11,547,302)  

 

$ 20,373,159   

Stock compensation expense for options and warrants granted to employees and directors

-   

 

-   

 

11,286   

 

-   

 

11,286   

Stock compensation expense for restricted stock units granted to employees

-   

 

-   

 

395,406   

 

-   

 

395,406   

Restricted stock units exercised

70,000   

 

70   

 

(70)  

 

-   

 

-   

Stock options exercised

23,015   

 

23   

 

2,505   

 

-   

 

2,528   

Net income

-   

 

-   

 

-   

 

17,547,431   

 

17,547,431   

Balance at March 31, 2019

9,723,065   

 

$ 9,723   

 

$ 32,319,958   

 

$ 6,000,129   

 

$ 38,329,810   

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.


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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

Three Months Ended March 31,

 

2019

2018

Cash flows from operating activities:

 

 

Net income (loss) 

$ 17,547,431   

$ (707,343)  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

Depreciation 

75,620   

91,583   

Amortization of intangible assets 

452,734   

452,734   

Deferred income taxes 

530,847   

(230,000)  

Bad debt recoveries 

-   

(13,469)  

Stock compensation expense for warrants and options granted to employees and directors 

11,286   

11,516   

Stock compensation expense for restricted stock units granted to employees and directors 

395,406   

176,746   

Note payable issued in consideration for severance pay

-   

343,750   

Interest expense related to loan acquisition costs

85,883   

1,617   

Gain on sale of discontinued operations before income taxes

(23,839,119)  

-   

Changes in operating assets and liabilities:

 

 

Accounts receivable 

77,110   

2,700,505   

Supplies 

75,252   

70,244   

Prepaid and other current assets 

1,316,130   

(153,185)  

Deposits 

8,068   

(402)  

Accounts payable and accrued expenses 

71,861   

(709,915)  

Income taxes payable 

5,312,805   

-   

Accrued compensation and benefits 

(1,325,793)  

(996,077)  

Deferred revenue 

353,309   

(390,351)  

Net cash provided by operating activities 

1,148,830   

647,953   

Cash flows from investing activities:

 

 

Proceeds from sale of net assets of discontinued operations 

24,370,254   

-   

Purchases of property and equipment 

(49,185)  

(26,275)  

Net cash provided by (used for) investing activities 

24,321,069   

(26,275)  

Cash flows from financing activities:

 

 

Proceeds from term loan 

-   

17,250,000   

Loan acquisition fees paid 

-   

(111,250)  

Payments on term loans 

(15,401,786)  

(11,818,333)  

Payments on promissory notes to related parties   

(4,234,375)  

(6,750,000)  

Payments on capital leases   

(21,010)  

(34,862)  

Proceeds from issuance of common stock through stock options and warrants   

2,528   

-   

Net cash used for financing activities   

(19,654,643)  

(1,464,445)  

Net increase (decrease ) in cash and cash equivalents   

5,815,256   

(842,767)  

Cash and cash equivalents, beginning of period   

6,571,381   

4,252,060   

Cash and cash equivalents, end of period   

$ 12,386,637   

$ 3,409,293   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.


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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

 

Three Months Ended March 31,

 

2019

2018

Supplemental disclosure of cash flow information:

 

 

Interest paid

$  496,489   

$ 644,895   

Income taxes (refunded) paid

$    (5,409)  

$   20,262   

 

 

 

Non-cash investing and financing activities:

 

 

Capitalized right-to-use asset resulted from the adoption of ASC 842

$  -   

$ 808,841   

Capitalized operating lease liability resulted from the adoption of ASC 842

$  -   

$ 683,797   

 

The accompanying notes are an integral part of these condensed consolidated financial statements.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2019 AND 2018

(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, 2018, as filed with the Securities and Exchange Commission (“SEC”) on March 27, 2019.

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 17, we sold 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 balances have been reclassified to conform to current period presentation.

2.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS 

Recently Adopted Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard on leasing. The new standard requires companies to record most leased assets and liabilities on the balance sheet, and also proposed a dual model for recognizing expense. The Company adopted the standard as of January 1, 2019, with retroactive reporting for prior periods (the comparative option). Adoption of the new standard resulted in the recording of operating lease right-of-use ("ROU")  assets and operating lease liabilities of $808,841 and $683,797, respectively, as of January 1, 2018, with the difference due to deferred rent that were reclassified to the ROU asset value. The standard did not affect our consolidated net income or cash flows. See Note 6 for further details.

In August 2016, the FASB issued a new accounting standard which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are classified in the statement of cash flows. This guidance was effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years


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with early adoption permitted, provided that all of the amendments are adopted in the same period. Adoption of these accounting changes did not have a material impact on our consolidated financial statements.

In January 2017, the FASB issued a new accounting standard which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. This guidance was effective for the Company beginning in 2019. Adoption of these accounting changes did not have a material impact on our consolidated financial statements.

In January 2017, the FASB issued a new accounting standard simplifying the test for goodwill impairment. Currently, the fair value of the reporting unit is compared with the carrying value of the reporting unit (identified as "Step 1"). If the fair value of the reporting unit is lower than its carrying amount, then the implied fair value of goodwill is calculated. If the implied fair value of goodwill is lower than the carrying value of goodwill an impairment is recognized (identified as "Step 2"). The new standard eliminates Step 2 from the impairment test; therefore, a goodwill impairment will be recognized as the difference of the fair value and the carrying value. The new standard becomes effective on January 1, 2020, with early adoption permitted. We adopted this standard on January 1, 2019.This new standard has no impact on our financial position, results of operations and cash flows.

In May 2017, the FASB issued a new accounting standard which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC Topic 718. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This guidance is effective for the Company beginning in 2019. Adoption of these accounting changes did not have a material impact on our consolidated financial statements.

In June 2018, the FASB issued a new accounting standard which provides guidance that expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The new guidance is effective for the Company beginning in 2019, with early adoption permitted. Adoption of these accounting changes did not have a material impact on our consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In August 2018, the FASB issued a new accounting standard which modifies the disclosure requirements on fair value measurements. This guidance will be 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 is 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. We do not anticipate adoption to have a material impact on our consolidated financial statements.

 

3.ACCOUNTS RECEIVABLE 

A summary of accounts receivable is as follows:

 

 

March 31, 2019

December 31, 2018

Trade receivables

$ 4,309,391   

$ 5,572,467   

Allowance for doubtful accounts

-   

-   

Total accounts receivable, net 

$ 4,309,391   

$ 5,572,467   


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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 $991,766 and $849,975 of unamortized deferred commissions as of March 31, 2019 and 2018, respectively. We had $256,553 and $47,030 of commissions expense for the three months ended March 31, 2019 and 2018, respectively.

5.PROPERTY AND EQUIPMENT 

A summary of property and equipment follows:

 

March 31, 2019

December 31, 2018

Furniture and fixtures

$    195,586   

$    316,926   

Computers and office equipment

604,147   

563,857   

Right of use assets

683,797   

683,797   

Property and equipment at cost 

1,483,530   

1,443,240   

Less accumulated depreciation and amortization

(635,399)  

(555,365)  

 

$    848,131   

$    887,874   

 

6.LEASES 

We lease approximately 17,000 square feet of office space at 27271 Las Ramblas, Suite 200, Mission Viejo, California. This lease terminates in April 2021. During the first quarter of 2019, we subleased this space to two subtenants. The terms of these subleases end concurrently with the end of our lease obligation in April 2021.We also lease approximately 3,600 square feet of office space at 11410 Jollyville Road, Suite 2201, Austin, Texas. This lease terminates in September 2019. During the first quarter of 2018, we subleased this space to a subtenant. The terms of this sublease ends concurrently with the end of our lease obligation in September 2019. We also lease approximately 9,600 square feet of office space at 11940 Jollyville Road, Austin, Texas. This lease terminates in May 31, 2020. Operating lease expense totaled $158,642 and $184,482 for the three months ended March 31, 2019 and 2018, respectively.

We used a discount rate of 5.5% as of January 1, 2018 in determining our operating lease liability. This rate represented our incremental borrowing rate at that time. Short-term leases with initial terms of twelve months or less are not capitalized.

We also lease certain office equipment under a finance lease arrangement.

Maturities of lease liabilities are as follows:

 

Operating Leases

Finance Leases

2019

$    468,402   

$    1,013   

2020

512,632   

-   

2021

132,926   

-   

Total lease payments

1,113,960   

1,013   

Less imputed interest

(479,287)  

(19)  

Total

$    634,673   

$       994   


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7.INTANGIBLE ASSETS 

Intangible assets are amortized over expected useful lives ranging from 1.5 to 10 years and consist of the following:

 

March 31, 2019

December 31, 2018

 

Carrying

Amount

Accumulated

Amortization

Net Book

Value

Carrying

Amount

Accumulated

Amortization

Net Book

Value

 

 

 

 

 

 

 

Acquired technology

$ 9,220,608   

$ (2,426,485)  

$ 6,794,123   

$ 9,220,608   

$ (2,202,291)  

$ 7,018,317   

Customer relationships

2,933,257   

(1,992,632)  

940,625   

2,933,257   

(1,858,257)  

1,075,000   

Trademarks

1,693,978   

(841,478)  

852,500   

1,693,978   

(763,978)  

930,000   

Non-compete agreements

264,243   

(214,236)  

50,007   

264,243   

(197,571)  

66,672   

Total 

$ 14,112,086   

$ (5,474,831)  

$ 8,637,255   

$ 14,112,086   

$ (5,022,097)  

$ 9,089,989   

 

8.DEFERRED REVENUE 

We record deferred revenues when amounts are billed to customers in advance of our performance. During the three months ended March 31, 2019 and 2018,  $335,569 and $307,780, respectively, of managed services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods. During the three months ended March 31, 2019 and 2018, $290,045 and $214,970, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.

9.LINE OF CREDIT AND TERM LOAN 

On January 13, 2017, as part of the acquisition of CTEK Security, Inc. (formerly CynergisTek, Inc.), we entered into an Amended and Restated Credit Agreement (the “A&R Credit Agreement”).  The A&R Credit Agreement amended a loan and security agreement originally entered into on May 4, 2012, as amended by several amendments.  Under the A&R Credit Agreement, the term of the revolving line-of-credit was available through January 13, 2019, at an interest rate of prime plus 1.0% per annum.  The amount available to us at any given time was the lesser of (a) $5.0 million, or (b) the amount available under our borrowing base (80% of our eligible accounts receivable, minus (1) accrued client lease payables, and minus (2) accrued equipment pool liability). The A&R Credit Agreement provided a term loan facility for $14,000,000.

There were no borrowings on the line of credit for the three months ended March 31, 2018.

Interest charges associated with this term loan totaled $133,914 for the three months ended March 31, 2018.

Debt Restructuring

On March 12, 2018, we entered into a Credit Agreement (together with the other related documents defined therein, the “Credit Agreement”) with BMO Harris Bank N.A., a national banking association (“Bank”), as lender (the “BMO Loan”).

The purposes of the BMO Loan were (1) to refinance and replace the facilities under the A&R Credit Agreement, thus terminating that agreement as of March 12, 2018, (2) to refinance $2,250,000 of a promissory note held by Michael McMillan (the “McMillan Seller Note”), (3) to finance payments to Michael Hernandez, including the full repayment of a promissory note held by Hernandez (the “Hernandez Seller Note”) in the original principal amount of $4,500,000, also issued as part of the Original SPA, (4) to finance working capital, (5) for general corporate purposes and (6) to fund certain fees and expenses associated with the closing of the BMO Loan.

Loan Facilities


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Term Loan:  Pursuant to the Credit Agreement, the Bank agreed to provide a term loan in the amount of $17,250,000 to the Company, which was paid in accordance with the purpose of the BMO Loan as described above.  Pursuant to the Credit Agreement, the Company could elect that the term loan be outstanding as Base Rate Loans or Eurodollar Loans. The term loan was payable in principal payment installments on the last day of each fiscal quarter, commencing on June 30, 2018. All principal and interest not sooner paid on the term loan was due and payable on September 12, 2022, the final maturity thereof.

Revolving Line of Credit: Additionally, pursuant to the Credit Agreement, the Bank agreed to provide a revolving loan or loans to the Company in an aggregate amount of up to $5,000,000 with a $500,000 sublimit for the issuance of letters of credit. Pursuant to the Credit Agreement, the Company could elect that each borrowing of revolving loans be either Base Rate Loans or Eurodollar Loans. Each revolving loan, both for principal and interest then outstanding, matured and was due and payable on March 12, 2020, or such earlier date on which the Revolving Credit Commitment (as defined in the Credit Agreement) was terminated in whole pursuant to the Credit Agreement. There were no borrowings on the line of credit for the three months ended March 31, 2019 or 2018.

Beginning June 30, 2018, we were required to maintain certain financial covenants in connection with this credit agreement, including a total leverage ratio, a senior leverage ratio, and a fixed charge coverage ratio. These covenants contain ratios which changed over relevant periods of the credit agreement and could be found in Section 7.13 of the Credit Agreement.

Interest Rates

Base rate loans (“Base Rate Loans”) bear interest at an annual rate equal to the base rate (defined as the highest of (a) the rate of interest quoted in The Wall Street Journal, Money Rates Section as the prime rate in effect on such day, with any change in the Base Rate resulting from a change in such prime rate to be effective as of the date of the relevant change in such prime rate, (b) the sum of (i) the rate determined by the Bank to be the average of the rates per annum quoted to the Bank by two or more Federal funds brokers selected by the Bank for sale to the Bank at face value of Federal funds in the secondary market in an amount equal or comparable to the principal amount for which such rate is being determined, plus (ii) 1/2 of 1%, and (c) the overnight LIBOR rate plus 1.0%) plus an applicable margin of between 1.50% and 2.50%, depending upon the Company’s leverage ratio.

Eurodollar loans (“Eurodollar Loans”) bear interest at a rate per annum equal to the sum of the Adjusted LIBOR rate (defined as the quotient obtained by dividing (a) the LIBOR index rate by (b) the maximum reserve percentage, expressed as a decimal, at which reserves are imposed by the Board of Governors of the Federal Reserve System (or any successor) on “eurocurrency liabilities,” as defined in such Board’s Regulation D (or any successor thereto), subject to any amendments of such reserve requirement by such Board or its successor, taking into account any transitional adjustments thereto) plus an applicable margin of between 2.50% and 3.50%, depending upon the Company’s leverage ratio.

On March 12, 2018, we paid a $25,000 revolving loan commitment fee associated with the line of credit.

Interest charges associated with the BMO term loan totaled $207,903 and $50,217 for the three months ended March 31, 2019 and 2018, respectively. In addition, on March 12, 2018, we paid a $86,250 commitment fee associated with the term loan.

On March 20, 2019, we used a portion of the proceeds from the sale of the assets of CTEK Solutions business to fully repay the balance of the term loan in the amount of $15,456,984 plus interest of $52,760. At that time, the Revolving Credit Commitment was terminated.

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 Hernandez and McMillan (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,


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using a 36-month amortization period commencing from that point, with a balloon payment due on the maturity date.  Amounts due and owing under the Seller Notes are subordinate to the right of payment due under the A&R Credit Agreement pursuant to the Subordination Agreement.  The Company had the right to prepay all or any portion of the outstanding principal balance of the Seller Notes, provided that such prepayment is accompanied by accrued interest on the amount of principal prepaid, calculated to the date of such prepayment.

On March 12, 2018, the Company fully repaid the $4,500,000 plus accrued interest on the Hernandez Seller Note.

As part of the debt restructuring with BMO Harris Bank N.A., on March 12, 2018, the Company repaid $2,250,000 plus accrued interest on the McMillan Seller Note.  The Company and Mr. McMillan agreed to amend and restate the McMillan Seller Note pursuant to the A&R McMillan Seller Note.  The A&R McMillan Seller Note is in the principal amount of $2,250,000, bears interest at a rate of 8% per annum, provides for quarterly payments of principal and interest and matures on March 31, 2022.  As of March 31, 2019 and December 31, 2018, the outstanding principal balance due under the A&R McMillan Seller Note was $1,687,500 and $1,828,125, respectively. Amounts due and owing under the A&R McMillan Seller Note are 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 $35,106 and $149,425 for the three months ended March 31, 2019 and 2018, respectively.

Pursuant to the Separation Agreement, in lieu of any earn-out payments (as described in the Original SPA (as defined below)) 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 CTEK Solutions business to fully repay the Earn-out Note with interest of $234,293.

Interest charges associated with the Earn-out Note totaled $45,858 and $45,813 for the three months ended March 31, 2019 and 2018, respectively.

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.

Interest charges associated with the Severance Payment Note totaled $494 and $4,191 for the three months ended March 31, 2019 and 2018, respectively.

Amounts due and owing under the Earn-out Note and Severance Payment Note were subordinate to the right of payment due under the BMO Loan pursuant to a Subordination Agreement among the Company, the Bank and Hernandez.


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11.REVENUES 

Below is a summary of our revenues disaggregated by revenue source.

 

 

Three Months Ended March 31,

 

2019

2018

Managed services

$ 2,791,740   

$ 2,317,636   

Consulting and professional services

2,964,594   

2,021,544   

Hardware and software resales

17,323   

35,389   

Net revenues 

$ 5,773,657   

$ 4,374,569   

 

12.OPTIONS, WARRANTS AND RESTRICTED STOCK UNITS 

Below is a summary of stock option, warrant and restricted stock activity during the three-month period ended March 31, 2019:

Options

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2018

539,927   

$ 2.97   

 

 

Granted 

-   

-   

 

 

Exercised 

(21,784)  

2.75   

 

 

Cancelled 

(12,057)  

3.34   

 

 

Outstanding at March 31, 2019

506,086   

$ 2.99   

4.05   

$ 999,901   

Exercisable at March 31, 2019

496,306   

$ 3.00   

4.05   

$ 977,455   

 

Warrants

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2018

77,779   

$ 3.03   

 

 

Granted 

-   

-   

 

 

Exercised 

-   

-   

 

 

Cancelled 

-   

-   

 

 

Outstanding at March 31, 2019

77,779   

$ 3.03   

3.80   

$ 150,891   

Exercisable at March 31, 2019

77,779   

$ 3.03   

3.80   

$ 151,891   


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Restricted Stock Units

Shares

Weighted Average Price

Weighted Average Remaining Term in Years

Outstanding at December 31, 2018

810,000   

$ 3.67   

 

Granted 

42,600   

4.67   

 

Exercised 

(47,455)  

3.42   

 

Cancelled 

(24,295)  

3.50   

 

Outstanding at March 31, 2019

780,850   

$ 3.75   

1.88   

 

For the three months ended March 31, 2019 and 2018, stock-based compensation expense recognized in the consolidated statements of operations as follows:

 

Three Months
Ended March 31,

 

2019

2018

Cost of revenues

$ 175,739   

$   32,332   

Sales and marketing

63,831   

57,490   

General and administrative expense

167,122   

98,440   

Total stock-based compensation expense   

$ 406,692   

$ 188,262   


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13.NET INCOME  (LOSS) PER SHARE 

 

Basic net income (loss) per share is calculated using the weighted average number of shares of our common stock issued and outstanding during a certain period and is calculated by dividing net (loss) income by the weighted average number of shares of our common stock issued and outstanding during such period. Diluted net income (loss) per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the as-if-converted method for secured convertible notes, and the treasury stock method for options and warrants. Diluted net income (loss) per share does not include potentially dilutive securities because such inclusion in the computation would be anti-dilutive.

For the three months ended March 31, 2019, potentially dilutive securities consisted of options and warrants to purchase 583,865 shares of common stock at prices ranging from $2.28 to $4.05 per share and 780,850 shares of restricted stock units. Of these potentially dilutive securities, 209,904 of the shares of common stock underlying the options and warrants are included in the computation of diluted earnings per share because the effect of including the remaining instruments would be anti-dilutive. Also included in potentially dilutive securities are 47,455 shares of restricted stock units which vested in March 2019 but had not been issued by period end.

For the three months ended March 31, 2018, potentially dilutive securities consisted of options and warrants to purchase 280,416 shares of common stock at prices ranging from $0.90 to $6.45 per share and 500,500 shares of restricted stock units. Of these potentially dilutive securities, none 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 anti-dilutive.

 

Three Months Ended March 31,

 

2019

2018

Numerators:

 

 

Net loss from continuing operations 

$ (1,489,399)