10-Q Q1 2020

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, 2020

[  ] 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 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 Stock, $.001 par value per share

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 14, 2020, was 10,449,164.



CYNERGISTEK, INC.

FORM 10-Q

TABLE OF CONTENTS

Page

PART I – FINANCIAL INFORMATION4

ITEM 1.  FINANCIAL STATEMENTS.4

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.22

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.29

ITEM 4.  CONTROLS AND PROCEDURES.29

PART II - OTHER INFORMATION29

ITEM 1A.  RISK FACTORS.29

ITEM 6.  EXHIBITS.31

SIGNATURES32



Table of Contents


PART I – FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, 2020 (unaudited)

December 31, 2019

ASSETS

Current assets:

Cash and cash equivalents

$3,065,728

$5,328,726

Accounts receivable

3,331,826

3,210,726

Unbilled services

617,186

539,535

Prepaid and other current assets

1,653,405

1,205,769

Income taxes receivable

456,128

-

Total current assets

9,124,273

10,284,756

Property and equipment, net

995,623

946,219

Deposits

72,486

72,486

Deferred income taxes

1,858,064

1,836,258

Intangible assets, net

8,169,691

8,585,882

Goodwill

23,983,483

23,983,483

Total assets

$44,203,620

$45,709,084

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable and accrued expenses

$675,814

$638,864

Accrued compensation and benefits

453,586

1,066,770

Deferred revenue

2,087,906

1,437,859

Income taxes payable

-

31,976

Current portion of promissory note to related parties

562,500

562,500

Current portion of operating lease liabilities

580,591

533,371

Total current liabilities

4,360,397

4,271,340

Long-term liabilities:

Earnout liability

2,400,000

2,400,000

Promissory note to related parties, less current portion

562,500

703,125

Operating lease liability, less current portion

144,715

158,995

Total long-term liabilities

3,107,215

3,262,120

Commitments and contingencies

Stockholders’ equity:

Common stock, par value at $0.001, 33,333,333 shares authorized, 10,379,164 shares issued and outstanding at March 31, 2020, and 10,359,164 shares issued and outstanding at December 31, 2019

10,379

10,359

Additional paid-in capital

35,232,850

34,821,863

Retained earnings

1,492,779

3,343,402

Total stockholders’ equity

36,736,008

38,175,624

Total liabilities and stockholders’ equity

$44,203,620

$45,709,084

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


4


Table of Contents


CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

Three Months Ended March 31,

2020

2019

Net revenues

$5,115,827

$5,773,657

Cost of revenues

3,423,532

3,484,639

Gross profit

1,692,295

2,289,018

Operating expenses:

Sales and marketing

1,487,347

1,481,383

General and administrative expenses

2,104,844

1,653,633

Depreciation

47,600

38,985

Amortization of acquisition-related intangibles

416,191

452,734

Total operating expenses

4,055,982

3,626,735

Loss from operations

(2,363,687)

(1,337,717)

Other income (expense):

Other income

-

9

Interest income

6,068

-

Interest expense

(24,288)

(295,905)

Total other income (expense)

(18,220)

(295,896)

Loss before provision for income taxes

(2,381,907)

(1,633,613)

Income tax benefit

531,284

144,214

Net loss from continuing operations

(1,850,623)

(1,489,399)

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

-

19,036,830

Net (loss) income

$(1,850,623)

$17,547,431

Net (loss) income per share:

From continuing operations:

Basic

$(0.18)

$(0.15)

Diluted

$(0.18)

$(0.15)

From discontinued operations:

Basic

$-

$1.97

Diluted

$-

$1.92

Net (loss) income:

Basic

$(0.18)

$1.81

Diluted

$(0.18)

$1.77

Number of weighted average shares outstanding:

Basic

10,374,497

9,673,689

Diluted

10,374,497

9,931,048

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


5


Table of Contents


CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(UNAUDITED)

 nbsp;

Additional

Total

Common Stock

Paid-in

Retained

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 equity awards granted to employees and directors

-

-

406,692

-

406,692

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

Additional

Total

Common Stock

Paid-in

Retained

Stockholders’

Shares

Amount

Capital

Earnings

Equity

Balance at December 31, 2019

10,359,164

$10,359

$34,821,863

$3,343,402

$38,175,624

Stock compensation expense for equity awards granted to employees and directors

-

-

411,007

-

411,007

Restricted stock units exercised

20,000

20

(20)

-

-

Net income

-

-

-

(1,850,623)

(1,850,623)

Balance at March 31, 2020

10,379,164

$10,379

$35,232,850

$1,492,779

$36,736,008

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


6


Table of Contents


CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

Three Months Ended March 31,

2020

2019

Cash flows from operating activities:

 Net (loss) income

$(1,850,623)

$17,547,431 

Adjustments to reconcile net (loss) income to net cash (used for)

 provided by operating activities:

 Depreciation

47,600 

75,620 

 Amortization of intangible assets

416,191 

452,734 

 Change in net deferred tax assets

(21,806)

530,847 

 Bad debt expense

30,000 

 Stock compensation expense for equity awards granted to

   employees and directors

411,007 

406,692 

 Interest expense related to loan acquisition costs

85,883 

 Gain on sale of discontinued operations before income taxes

(23,839,119)

 Other

(12,149)

(8,895)

Changes in operating assets and liabilities:

 Accounts receivable

(151,100)

77,110 

 Unbilled services

(77,651)

183,057 

 Supplies

75,252 

 Prepaid and other current assets

(447,636)

1,316,130 

 Income taxes receivable

(456,128)

 Deposits

8,068 

 Accounts payable and accrued expenses

36,950 

71,861 

 Income taxes payable

(31,976)

5,312,805 

 Accrued compensation and benefits

(613,183)

(1,325,793)

 Deferred revenue

650,047 

170,252 

   Net cash (used for) provided by operating activities

(2,070,457)

1,139,935 

Cash flows from investing activities:

 Proceeds from sale of net assets of discontinued operations

24,370,254 

 Purchases of property and equipment

(51,912)

(40,290)

   Net cash (used for) provided by investing activities

(51,912)

24,329,964 

Cash flows from financing activities:

 Payments on term loans

(15,401,786)

 Payments on promissory notes to related parties

(140,625)

(4,234,375)

 Payments on capital leases

(4)

(21,010)

 Proceeds from issuance of common stock through stock options

   and warrants

2,528 

   Net cash used for financing activities   

(140,629)

(19,654,643)

Net(decrease)increaseincashandcashequivalents   

(2,262,998)

5,815,256 

Cashandcashequivalents,beginningofperiod   

5,328,726 

6,571,381 

Cashandcashequivalents,endofperiod   

$3,065,728 

$12,386,637 

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


7


Table of Contents


CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

Three Months Ended March 31,

2020

2019

Supplemental disclosure of cash flow information:

Interest paid

$25,243

$496,489

Income taxes (refunded)

$(43,739)

$(5,409)

Non-cash investing and financing activities:

Capitalized right-to-use asset resulting from an extension of an operating lease commitment

$185,454

$-

Capitalized operating lease liability resulting from an extension of an operating lease commitment

$185,454

$-

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


8


Table of Contents


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(UNAUDITED)

1.BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of CynergisTek, Inc. and its subsidiaries (the “Company”, “we”, “us” or “CynergisTek”) have been prepared in accordance with generally accepted accounting principles of the United States of America (“GAAP”) for interim financial statements pursuant to the rules and regulations of the Securities and Exchange Commission.  Accordingly, these financial statements do not include all of the information and notes required by GAAP for complete financial statements.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as filed with the Securities and Exchange Commission (“SEC”) on March 30, 2020.

The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) that are, in the opinion of management, necessary to state fairly our financial position and results of operations as of and for the periods presented.  The results for such periods are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  As a result, actual results could differ from those estimates.

The accompanying unaudited condensed consolidated financial statements include the accounts of CynergisTek and its wholly owned subsidiaries.  All intercompany balances and transactions have been eliminated.

Based on our integration strategies, and an analysis of how our Chief Operating Decision Makers review, manage and are compensated, we have determined that the Company operates as one segment. As described in Note 18, we sold the assets used in our managed print services business division (the “MPS Business”) on March 20, 2019. For the periods presented, all revenues were derived from domestic operations. We have performed an evaluation of subsequent events through the date of filing these unaudited condensed consolidated financial statements with the SEC.

Certain prior year balances have been reclassified to conform to current period presentation. This includes adjusting our previously issued consolidated balance sheet for the year ended December 31, 2019 to reclassify Unbilled services as its own line item in current assets from Deferred revenues in current liabilities on the balance sheet.  The consolidated statement of cash flows for the three months ended March 31, 2019 was also adjusted 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 financial statements. 

Liquidity and Capital Resources

As of March 31, 2020, our cash balance was $3.1 million, current assets minus current liabilities was positive $4.7 million and our debt and lease obligations totaled $1.0 million. The level of additional cash needed to fund operations and our ability to conduct business for the next twelve months will be influenced primarily by the following factors:

our ability to manage our operating expenses and maintain gross margins while attracting, recruiting and retaining cybersecurity privacy professionals;


9


Table of Contents


demand for our services from healthcare providers; the near-term impact of the Coronavirus on our customers allocation of time and resources to security and privacy, and their ability to pay for existing services as well as enter into new contractual arrangements during a period of crisis;

general economic conditions and changes in healthcare reimbursement and regulatory environment, including effects of the COVID-19 epidemic; and

our ability to collect accounts receivable from health care customers whose operations and cash flow have been significantly impacted by COVID-19.

We have historically funded our operating costs, acquisition activities, working capital requirements and capital expenditures with cash from operations, proceeds from the issuances of our common stock and other financing arrangements. Following the sale of the MPS business in 2019, we are now a much smaller cybersecurity and privacy focused business with significantly lower debt balances and debt service obligations. However, we also have less scale over which to leverage our operating expenses and public company expenses and are currently operating in a cash flow negative position while we seek to retain our cybersecurity business during this uncertain time. For the first quarter of 2020, we reported a loss from continuing operations of $1.9 million and cash used in operating activities from continuing operations was $2.1 million.

In late 2019, a novel strain of coronavirus (COVID-19) was first detected in Wuhan, China. Following the outbreak of this virus, governments throughout the world, including in the United States of America, have quarantined certain affected regions, restricted travel and imposed significant limitations on other economic activities. Our customer base is heavily concentrated in the healthcare provider space.  This part of the healthcare industry has indicated that they are seeing significant financial losses, have started to furlough employees and are expressing uncertainty as to the short and long-term financial stability of their businesses.  Our operations team is closely monitoring the potential impact to the Company’s business, including its cash flows, customers and employees. We have heard from a number of our active customers since the outbreak began requesting relief in the form of extended payment terms, request for early termination and receivable forgiveness.  If the situation continues to impact our customers cash flow or resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results for fiscal year 2020 and beyond will be negatively impacted. Neither the length of time nor the magnitude of the negative impacts can be presently determined.

There was a small financial impact in the first quarter of 2020 due to COVID-19, primarily since many of the initial economic effects of the early stages of the COVID-19 pandemic resulting from the various shelter-in-place and other social distancing orders occurred towards the end of our first quarter. The severity and duration of the COVID-19 pandemic is uncertain and such uncertainty will likely continue in the near term and we will continue to actively monitor the situation taking into account the impact to our employees, customers and partners.

At the end of 2019 and during the first quarter of 2020 we reduced staffing levels to reduce expenses.  Our operating plan for the next twelve months includes additional permanent annualized cost reduction efforts totaling approximately $1.5 million and temporary cost reductions totaling approximately $1.0-$2.0 million the precise extent of which will depend on the duration of the COVID-19 disruptions to our customers and our short-term financial performance. In addition, we received a $2.8 million loan under the Coronavirus Aid, Relief, and Economic Security Act, and we received an equity funding commitment in the amount of $2.5 million from an existing investor.  We also have the ability to further reduce personnel and other variable and semi-variable costs to conserve cash and operate as a going concern. However, those actions if required, could negatively impact the long-term outlook of the business

As we execute our plans over the next 12 months, we intend to carefully monitor the impact on our operating expenses, working capital needs and cash balances relative to the availability of cost-effective debt and equity financing. In the event that capital is not available, we may then have to scale back operations, reduce expenses, and/or curtail future plans to manage our liquidity and capital resources.   However, we cannot provide assurance that we will be able to raise additional capital. The COVID-19 pandemic could continue to create uncertainty and volatility in the financial markets which may impact our operations and our ability to access capital and/or the terms under which we can do so.


10


Table of Contents


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.

2.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Recently Adopted Accounting Pronouncements

In August 2018, the FASB issued an amendment to the accounting guidance on cloud computing service arrangements.  The guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal use software.  The guidance also requires an entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement.  The guidance was effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years.  The adoption of this guidance did not have a material impact on our consolidated financial statements.

In August 2018, the FASB issued a new accounting standard which modifies the disclosure requirements on fair value measurements. This guidance was effective for fiscal years beginning after December 15, 2019. The amendments related to the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively. All other amendments should be applied retrospectively. An entity was permitted to early adopt any removed or modified disclosures upon issuance of this guidance and delay adoption of the additional disclosures until their effective date. The adoption did not have a material impact on our consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In December 2019, the FASB issued an amendment to the guidance on income taxes which is intended to simplify the accounting for income taxes.  The amendment eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of the deferred tax liabilities for outside basis differences.  The amendment also clarifies existing guidance related to the recognition of franchise tax, the evaluation of a step up in the tax basis of goodwill , and the effects of enacted changes in tax laws or rates in the effective tax rate computation, among other clarifications.  The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020.  Management is currently evaluating the impact the guidance will have on our consolidated financial statements.

In June 2016, the FASB issued an amendment to the guidance on the measurement of credit losses on financial instruments.  The amendment updates the guidance for measuring and recording credit losses on financial assets measured and amortized cost by replacing the “incurred loss” model with an “expected loss” model.  Accordingly, these financial assets will be presented at the net amount expected to be collected. The amendment also requires that credit losses related to available-for-sale debt securities be recorded as an allowance through net income rather than reducing the carrying amount under the current, other-than-temporary-impairment model.  The guidance is effective for smaller reporting companies for fiscal years beginning after December 15, 2022 including interim periods within those fiscal years.  Early adoption is permitted for annual periods after December 15, 2018.


11


Table of Contents


3.ACCOUNTS RECEIVABLE

A summary of accounts receivable is as follows:

March 31, 2020

December 31, 2019

Trade receivables

$3,361,826

$3,210,726

Allowance for doubtful accounts

(30,000)

-

Total accounts receivable, net

$3,331,826

$3,210,726

4.DEFERRED COMMISSIONS

Our incremental costs of obtaining a contract, which consist of sales commissions, are deferred and amortized over the period of contract performance. Effective January 1, 2018, we adopted the modified retrospective method of the new revenue recognition pronouncement. Deferred commissions are included in prepaid and other current assets in our consolidated balance sheets. We had $757,602 and $764,607 of unamortized deferred commissions as of March 31, 2020 and December 31, 2019, respectively. We had $165,010 and $256,553 of commissions expense for the three months ended March 31, 2020 and 2019, respectively.

5.PROPERTY AND EQUIPMENT

A summary of property and equipment follows:

March 31, 2020

December 31, 2019

Furniture and fixtures

$195,586

$195,586

Computers and office equipment

747,469

757,251

Right of use assets

1,843,818

1,658,364

Property and equipment at cost

2,786,873

2,611,201

Less accumulated depreciation and amortization

(1,791,251)

(1,664,982)

$995,623

$946,219

6.LEASES

We lease approximately 17,000 square feet of office space in Mission Viejo, California. This lease terminates in April of 2021. During the first quarter of 2019, we subleased this space to two subtenants. The terms of these subleases end concurrently with the end of our lease obligation in April 2021. We also leased approximately 3,600 square feet of office space in Austin, Texas. This lease terminated in September 2019. During the first quarter of 2018, we subleased this space to a subtenant. The terms of this sublease ended concurrently with the end of our lease obligation in September 2019. We also leased approximately 9,600 square feet of office space in Austin, Texas in March 2020. We amended this lease reducing the office space to 4,600 square feet and extended the lease term to May 31, 2022. We also lease approximately 3,700 square feet of office space in Minneapolis, Minnesota. This lease terminates on July 31, 2021.

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

We determine if a contract is or contains a lease at inception or modification of a contract. A contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period in exchange for consideration. Control over the use of the identified asset means the lessee has both (a) the right to obtain substantially all of the economic benefits from the use of the asset and (b) the right to direct the use of the asset.

Right-of-use assets and liabilities are recognized based on the present value of future minimum lease payments over the expected lease term at commencement date. Certain contain extension options; however, we have not included


12


Table of Contents


such options as part of right-of-use assets and lease liabilities because we originally did not expect to extend the leases. We measure and record a right-of-use asset and lease liability based on the discount rate implicit in the lease, if known. In cases where the discount rate implicit in the lease is not known, we measure the right-of-use assets and lease liabilities using a discount rate equal to our estimated incremental borrowing rate for loans with similar collateral and duration.

We elected the package of practical expedients in transition for leases that commenced prior to January 1, 2019, and therefore did not reassess (i) whether any expired or existing contracts are, or contain, leases, (ii) the lease classification for any expired or existing leases, and (iii) initial direct costs for any existing leases.  We did not elect to use hindsight for transition when considering judgments and estimates such as assessments of lease options to extend, or terminate, a lease, or to purchase the underlying asset.  We have no land easements.  For all asset classes, we elected to (i) not recognize a right-of-use asset and lease liability for leases with a term of 12 months or less and (ii) not separate non-lease components from lease components, and we have accounted for combined lease and non-lease components as a single lease component.

Operating lease expense is comprised of the following:

Three Months Ended March 31,

2020

2019

Operating lease cost

$205,452 

$100,460 

Sublet income

(115,949)

(37,442)

Net operating lease cost

$89,503 

$63,018 

Maturities of lease liabilities are as follows:

Operating Leases

2020

$453,064

2021

259,367

2022

41,690

     Total lease payments

754,121

Less imputed interest

(28,815)

     Total lease liabilities

725,306

Less current portion of lease liabilities

(580,591)

      Long-term lease liabilities

$144,715

7.INTANGIBLE ASSETS

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

March 31, 2020

December 31, 2019

Carrying

Amount

Accumulated

Amortization and Impairment

Net Book

Value

Carrying

Amount

Accumulated

Amortization and Impairment

Net Book

Value

Acquired technology

$10,100,000

$(4,274,893)

$5,825,107

$10,100,000

$(4,054,951)

$6,045,049

Customer relationships

4,650,000

(3,306,250)

1,343,750

4,650,000

(3,212,500)

1,437,500

Trademarks

2,300,000

(1,299,167)

1,000,833

2,300,000

(1,196,667)

1,103,333

Non-compete agreements

320,000

(320,000)

-

320,000

(320,000)

-

Total

$17,370,000

$(9,200,310)

$8,169,690

$17,370,000

$(8,784,118)

$8,585,882


13


Table of Contents


8.DEFERRED REVENUE

We record deferred revenues when amounts are billed to customers, or cash is received from customers, in advance of our performance. During the three months ended March 31, 2020 and 2019, $884,379 and $824,099, respectively, of managed services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods. During the three months ended March 31, 2020 and 2019, $141,666 and $287,940, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.

9.LINE OF CREDIT AND TERM LOAN

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

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

Loan Facilities

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

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

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

On March 20, 2019, we used a portion of the proceeds from the sale of the assets of the MPS Business (Note 19) to fully repay the balance of the term loan in the amount of $15,401,786, plus interest of $52,760. At that time, the Revolving Line of Credit was terminated.

Interest charges associated with the BMO term loan totaled $207,903 for the three months ended March 31, 2019.


14


Table of Contents


10.PROMISSORY NOTES

In connection with the acquisition of CTEK Security, Inc. (formerly CynergisTek, Inc.), we issued two promissory notes totaling $9,000,000 to Michael Hernandez and Michael McMillan (respectively, the “Hernandez Seller Note” and the “McMillan Seller Note”; and together the “Seller Notes”), with each of the Seller Notes having an initial principal amount of $4,500,000.  These Seller Notes bear interest at 8% per annum, require quarterly interest-only payments during the first 12 months, quarterly payments of principal and interest during the last 24 months, using a 36-month amortization period commencing from that point, with a balloon payment due on the maturity date.  The Company had the right to prepay all or any portion of the outstanding principal balance of the Seller Notes, provided that such prepayment is accompanied by accrued interest on the amount of principal prepaid, calculated to the date of such prepayment.

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

As part of the debt restructuring with BMO Harris Bank N.A., on March 12, 2018, the Company repaid $2,250,000 plus accrued interest on the McMillan Seller Note.  The Company and Mr. McMillan agreed to amend and restate the McMillan Seller Note pursuant an amended and restated promissory note (the “A&R McMillan Seller Note”).  The A&R McMillan Seller Note is in the principal amount of $2,250,000, bears interest at a rate of 8% per annum, provides for quarterly payments of principal and interest and matures on March 31, 2022.  As of March 31, 2020 and December 31, 2019, the outstanding principal balance due under the A&R McMillan Seller Note was $1,125,000 and $1,265,625, respectively. Amounts due and owing under the A&R McMillan Seller Note were subordinate to the right of payment due under the BMO Loan pursuant to a Subordination Agreement among the Company, the Bank and Mr. McMillan.

Interest charges associated with the Seller Notes totaled $24,288 and $35,106, respectively for the three months ended March 31, 2020 and 2019.

Pursuant to a separation agreement among the Company, CTEK Security, Inc. and Michael Hernandez (the “Separation Agreement”), in lieu of any earn-out payments due pursuant to the purchase agreement related to the acquisition of CTEK Security, Inc. (the “Original SPA”) that could be earned by Hernandez under the Original SPA, the Company agreed to pay Hernandez the amount of $3,750,000 in the form of a promissory note (the “Earn-out Note”). The Earn-out Note provided for (i) a maturity date of March 12, 2023, at which all principal and accrued and unpaid interest was due, (ii) a simple interest rate of 5% per annum commencing on January 1, 2018, and compounding annually, and (iii) the right of the Company to prepay all or any portion of the Earn-out Note without premium or penalty. On March 26, 2019, we used a portion of the proceeds from the sale of the assets of MPS Business (Note 18) to fully repay the Earn-out Note with interest of $234,293.

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

Pursuant to the Separation Agreement, the Company also issued a Severance Payment Note to Hernandez in the original principal amount of $343,750 (the “Severance Payment Note”). The Severance Payment Note bears interest at a rate of 5% per annum, compounded annually, allowed for prepayment by the Company and matured on January 10, 2019, at which time all principal and accrued and unpaid interest was due.  All principal and interest due under the Severance Payment Note was repaid on March 27, 2019.

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


15


Table of Contents


11.REVENUES

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

Three Months Ended March 31,

2020

2019

Managed services

$3,001,012

$2,809,063

Consulting and professional services

2,114,815

2,964,594

Net revenues

$5,115,827

$5,773,657

12.OPTIONS, WARRANTS AND RESTRICTED STOCK UNITS

Below is a summary of stock option, warrant and restricted stock activity during the three-month period ended March 31, 2020:

Options

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2019

723,215

$4.27

Granted

-

-

Exercised

-

-

Cancelled

(3,669)

3.29

Outstanding at March 31, 2020

719,546

$4.28

7.25

$-

Exercisable at March 31, 2020

219,546

$2.95

2.60

$-

Warrants

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2019

77,779

$3.03

Granted

-

-

Exercised

-

-

Cancelled

-

-

Outstanding at March 31, 2020

77,779

$3.03

2.80

$-

Exercisable at March 31, 2020

77,779

$3.03

2.80

$-

Restricted Stock Units

Shares

Weighted Average Price

Weighted Average Remaining Term in Years

Non-vested at December 31, 2019

1,078,200

$