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Form 10-Q CERBERUS CYBER SENTINEL For: Jun 30

August 15, 2022 6:09 AM EDT

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2022

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from _________ to _________

 

Commission file number: 001-41227

 

CERBERUS CYBER SENTINEL CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   83-4210278
(State or other Jurisdiction of Incorporation or Organization)   (I.R.S. Employer Identification No.)

 

6900 E. Camelback Road, Suite 240, Scottsdale, Arizona   85251
(Address of Principal Executive Offices)   (Zip Code)

 

(480) 389-3444

(Registrant’s telephone number, including area code)

 

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, $0.00001 par value   CISO   The Nasdaq Stock Market LLC

 

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 ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

 

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

 

Large accelerated filer Accelerated filer
       
Non-accelerated filer Smaller reporting company
       
    Emerging growth company

 

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 standards provided pursuant to Section 13(a) of the Exchange Act:

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No

 

As of August 12, 2022, there were 138,585,388 shares of the registrant’s common stock outstanding.

 

 

 

 
 

 

CERBERUS CYBER SENTINEL CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2022

 

TABLE OF CONTENTS

 

  Page
     
PART I. FINANCIAL INFORMATION 4
     
ITEM 1. Financial Statements (unaudited) 4
     
  Condensed Consolidated Balance Sheets 4
     
  Condensed Consolidated Statements of Operations and Comprehensive Loss 5
     
  Condensed Consolidated Statements of Changes in Stockholders’ Equity 6
     
  Condensed Consolidated Statements of Cash Flows 7
     
  Notes to Condensed Consolidated Financial Statements 8
     
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 21
     
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 29
     
ITEM 4. Controls and Procedures 29
     
PART II. OTHER INFORMATION 30
     
ITEM 1. Legal Proceedings 30
     
ITEM 1A. Risk Factors 30
     
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
     
ITEM 3. Defaults Upon Senior Securities 30
     
ITEM 4. Mine Safety Disclosures 30
     
ITEM 5. Other Information 30
     
ITEM 6. Exhibits 31
     
SIGNATURES 32

 

2

 

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q includes a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that reflect management’s current views with respect to future events and financial performance. These statements are based upon beliefs of, and information currently available to, us as of the date hereof, as well as estimates and assumptions made by us. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. When used herein, the words “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “future,” “intend,” “plan,” “predict,” “project,” “target,” “potential,” “will,” “would,” “could,” “should,” “continue” or the negative of these terms and similar expressions identify forward-looking statements. Such statements reflect our current view with respect to future events and are subject to risks, uncertainties, assumptions, and other factors, including the risks relating to our business, industry, and our operations and results of operations. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ materially from those anticipated, believed, estimated, expected, intended, or planned.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including the securities laws of the United States, we do not intend to update any of the forward-looking statements to conform these statements to actual results.

 

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. These accounting principles require us to make certain estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenue and expenses during the periods presented. Our financial statements would be affected to the extent there are material differences between these estimates and actual results. The following discussion should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this report.

 

Forward-looking statements made in this Quarterly Report on Form 10-Q include statements about:

 

●  our ability to achieve and sustain profitability of our existing lines of business and through our wholly owned subsidiaries;
our ability to raise sufficient capital to continue to acquire cybersecurity companies;
our ability to attract and retain cybersecurity talent;
our ability to identify potential acquisition targets within predetermined parameters;
our ability to successfully execute acquisitions, integrate the acquired businesses, and create synergies as a global cybersecurity consolidator;
our ability to attract and retain key technology or management personnel and to expand our management team;
the rate of growth and anticipated trends and challenges in our business and in the market for our services;
our future financial performance, including our expectations regarding our revenue, cost of revenue, operating expenses, and our ability to achieve and maintain future profitability;
sufficiency of cash and cash equivalent to meet our needs for at least the next 12 months;
our ability to attract and retain clients;
our ability to generate revenue and gross profit;
our ability to navigate through the increasingly complex cybersecurity regulatory environment;
beliefs and objectives for future operations;
our ability to stay in compliance with laws and regulations currently applicable to, or which may become applicable to, our business both in the United States and internationally;
economic and industry trends or trend analysis; and
anticipated income tax rates, tax estimates and tax standards.

 

Such statements reflect our current view with respect to future events and are subject to risks, uncertainties, assumptions, and other factors, including the risks relating to our business, industry, and our operations and results of operations. It is not possible for us to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report may not occur, and actual results could differ materially and adversely from those implied in our forward-looking statements.

 

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or events and circumstances described in the forward-looking statements will be achieved or occur. Neither we nor any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. Except as required by law, we undertake no obligation to update any forward-looking statements after the date of this report to conform these statements to actual results. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements, which are only predictions and speak only as of the date hereof.

 

3

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

CERBERUS CYBER SENTINEL CORPORATION and subsidiaries

CONDENSED Consolidated Balance Sheets

(Unaudited)

 

   June 30, 2022   December 31, 2021 
         
ASSETS          
           
Current Assets:          
Cash and cash equivalents  $8,768,520   $2,725,035 
Accounts receivable, net   4,912,065    4,840,802 
Notes receivable, related party   1,006,848    1,090,903 
Inventory   346,520    189,596 
Prepaid expenses and other current assets   3,086,063    960,965 
Contract asset   427,268    - 
Total Current Assets   18,547,284    9,807,301 
           
Property and equipment, net   2,968,786    2,394,424 
Right of use asset, net   245,426    277,578 
Intangible assets, net   8,156,166    6,540,269 
Goodwill   58,515,259    16,792,535 
Other assets   17,875    - 
           
Total Assets  $88,450,796   $35,812,107 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
           
Current Liabilities:          
Accounts payable and accrued expenses  $7,503,547   $2,709,066 
Deferred revenue   2,351,477    52,824 
Settlement liability   -    470,000 
Lease liability   116,091    196,472 
Loans payable   6,280,988    213,199 
Line of credit   369,829    - 
Convertible notes payable   2,516,667    1,500,000 
Note payable, related party   176,994    - 
Total Current Liabilities   19,315,593    5,141,561 
           
Long-term Liabilities:          
Loans payable, net of current portion   3,094,155    5,284,301 
Lease liability, net of current portion   135,380    88,040 
Note payable, related party, net of current portion   202,437    - 
           
Total Liabilities   22,747,565    10,513,902 
           
Commitments and Contingencies   -       
           
Stockholders’ Equity:          
Common stock, $.00001 par value; 250,000,000 shares authorized; 137,097,860 and 125,852,971 shares issued and outstanding on June 30, 2022 and December 31, 2021, respectively   1,371    1,258 
Additional paid-in capital   126,382,178    69,309,369 
Accumulated translation adjustment   (1,298,269)   - 
Accumulated deficit   (59,382,049)   (44,012,422)
Total Stockholders’ Equity   65,703,231    25,298,205 
           
Total Liabilities and Stockholders’ Equity  $88,450,796   $35,812,107 

 

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

 

4

 

 

CERBERUS CYBER SENTINEL CORPORATION and subsidiaries

CONDENSED Consolidated STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

 

   June 30, 2022   June 30, 2021   June 30, 2022   June 30, 2021 
   Three Months Ended   Six Months Ended 
   June 30, 2022   June 30, 2021   June 30, 2022   June 30, 2021 
                 
Revenue:                    
Security managed services  $10,376,169   $2,077,351   $18,428,394   $3,967,055 
Professional services   851,776    872,326    2,128,961    1,542,400 
Total revenue   11,227,945    2,949,677    20,557,355    5,509,455 
                     
Cost of revenue:                    
Security managed services   3,765,426    340,460    6,368,350    534,127 
Professional services   163,152    139,973    273,489    257,767 
Cost of payroll   4,707,984    1,531,910    9,153,834    2,959,612 
Stock based compensation   1,825,890    197,848    3,947,473    380,924 
Total cost of revenue   10,462,452    2,210,191    19,743,146    4,132,430 
Total gross profit   765,493    739,486    814,209    1,377,025 
                     
Operating expenses:                    
Professional fees   945,148    244,261    1,568,209    401,615 
Advertising and marketing   240,504    172,468    395,845    217,695 
Selling, general and administrative   4,468,415    1,682,879    9,171,958    3,170,520 
Stock based compensation   2,404,049    693,278    4,969,559    1,348,964 
Total operating expenses   8,058,116    2,792,886    16,105,571    5,138,794 
                     
Loss from operations   (7,292,623)   (2,053,400)   (15,291,362)   (3,761,769)
                     
Other income (expense):                    
Other income   17,425    2,179    29,968    2,384 
Interest expense, net   (64,648)   (65,641)   (108,233)   (134,336)
                     
Total other income (expense)   (47,223)   (63,462)   (78,265)   (131,952)
                     
Net loss   (7,339,846)   (2,116,862)   (15,369,627)   (3,893,721)
Foreign currency translation adjustment   (2,200,710)   -    (1,298,269)   - 
                     
Comprehensive loss  $(9,540,556)  $(2,116,862)  $(16,667,896)  $(3,893,721)
                     
Net loss per common share - basic and diluted  $(0.05)  $(0.02)  $(0.11)  $(0.03)
                     
Weighted average shares outstanding - basic   136,127,157    117,729,971    134,738,684    117,081,360 

 

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

 

5

 

 

CERBERUS CYBER SENTINEL CORPORATION and subsidiaries

CONDENSED Consolidated STATEMENTS of CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

                         
       Additional   Accumulated Other         
   Common Stock   Paid-in   Comprehensive   Accumulated     
   Shares   Amount   Capital   Gain/(Loss)   Deficit   Total 
                         
Balance at January 1, 2022   125,852,971   $1,258   $69,309,369   $-   $(44,012,422)  $25,298,205 
                               
Stock based compensation - stock options   -    -    8,179,332    -    -    8,179,332 
Stock based compensation - common stock   434,000    4    737,696    -    -    737,700 
Exercise of options   454,111    5    277,707    -    -    277,712 
Stock issued for cash in public offering   2,060,000    21    9,521,777    -    -    9,521,798 
Stock issued for True Digital acquisition   7,406,100    74    34,726,306    -    -    34,726,380 
Stock issued for VelocIT acquisition   256,678    3    (3)   -    -    - 
Stock issued for Red74 acquisition   34,000    -    -    -    -    - 
Stock issued for Creatrix acquisition   600,000    6    3,629,994    -    -    3,630,000 
Foreign currency translation   -    -    -    (1,298,269)   -    (1,298,269)
Net loss   -    -    -    -    (15,369,627)   (15,369,627)
Balance as of June 30, 2022     137,097,860   $1,371   $  126,382,178   $(1,298,269)  $  (59,382,049)  $  65,703,231 
                               
Balance at January 1, 2021   116,104,971   $1,161   $12,607,074    -   $(4,866,772)  $7,741,463 
                               
Stock based compensation - stock options   -    -    1,729,888    -    -    1,729,888 
Stock issued for cash   1,625,000    16    3,249,984    -    -    3,250,000 
Net loss   -    -    -    -    (3,893,721)   (3,893,721)
Balance as of June 30, 2021   117,729,971   $1,177   $17,586,946   $-   $(8,760,493)  $8,827,630 

 

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

 

6

 

 

CERBERUS CYBER SENTINEL CORPORATION and subsidiaries

CONDENSED Consolidated STATEMENTS OF CASH FLOWS

(Unaudited)

 

   June 30, 2022   June 30, 2021 
Cash flows from operating activities:          
Net loss  $(15,369,627)  $(3,893,721)
Adjustments to reconcile net loss to net cash used in operating activities:          
Stock based compensation - stock options   8,179,332    1,729,888 
Loss on write-off of accounts receivable   -    15,264 
Issuance of common stock for services   737,700    114,750 
Non-cash interest expense   20,834    - 
Depreciation and amortization   1,163,463    78,836 
Right of use amortization   127,805    39,029 
Amortization of debt discount   -    36,193 
Gain on termination of operating lease   (22,289)   - 
Changes in operating assets and liabilities:          
Accounts receivable, net   1,416,754    (617,769)
Inventory   (199,559)   - 
Contract assets   (261,961)   - 
Prepaids and other current assets   (2,131,480)   (160,527)
Accounts payable and accrued expenses   2,675,346    48,760 
Lease liability   120,536    (37,442)
Settlement liability   (470,000)   - 
Deferred revenue   438,672    - 
           
Net cash used in operating activities   (3,574,474)   (2,646,739)
           
Cash flows from investing activities:          
           
Purchases of property and equipment   (200,504)   - 
Cash paid in acquisitions, net   (4,914,196)   - 
           
Net cash used in investing activities   (5,114,700)   - 
           
Cash flows from financing activities:          
Proceeds from sale of common stock   9,521,798    3,250,000 
Proceeds from stock option exercise   277,712    - 
Proceeds from loan payable   5,000,000    - 
Proceeds from convertible note payable   1,000,000    - 
Proceeds from line of credit   86,585    221,346 
Payment on line of credit   -    (224,346)
Payment on loans payable   (895,053)   (22,542)
Payment on notes payable, related party   (184,758)   (50,000)
Payment of debt issuance cost   (25,000)   - 
           
Net cash provided by financing activities   14,781,284    3,174,458 
           
Effect of exchange rates on cash and cash equivalents   (48,625)   - 
           
Net increase in cash and cash equivalents   6,043,485    527,719 
           
Cash and cash equivalents - beginning of the period   2,725,035    5,197,030 
           
Cash and cash equivalents - end of the period  $8,768,520   $5,724,749 
           
Supplemental cash flow information:          
Cash paid for:          
Interest  $91,234   $91,490 
Income taxes  $-   $- 
Non-cash investing and financing activities:          
Right of use asset and lease liability recorded upon adoption of ASC 842  $226,941   $175,759 
Common stock issued in True Digital acquisition  $34,726,380   $- 
Common stock issued in Creatrix acquisition  $3,630,000   $- 
Common stock issued in VelocIT acquisition  $-   $- 
Common stock issued in RED 74 acquisition  $-   $- 

 

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

 

7

 

 

CERBERUS CYBER SENTINEL CORPORATION and subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Unless otherwise indicated or the context requires otherwise, the terms “we,” “us,” “our,” and “our company” refer to Cerberus Cyber Sentinel Corporation, a Delaware corporation (“Cerberus”), and its wholly owned subsidiaries, including GenResults, LLC, an Arizona limited liability company (“GenResults”), TalaTek, LLC, a Virginia limited liability company (“TalaTek”), Technologyville, Inc., an Illinois corporation (“Techville”), Clear Skies Security, LLC, a Georgia limited liability company (“Clear Skies”), Alpine Security, LLC, an Illinois limited liability company (“Alpine”), Catapult Acquisition Corporation, a New Jersey corporation (“VelocIT”), Southford Equities, Inc., a British Virgin Islands company (“Arkavia”), True Digital Security, Inc., a Delaware corporation (“True Digital”), RED74 LLC, a New Jersey limited liability company (“RED74”), Atlantic Technology Systems, Inc., a New Jersey corporation (“ATS”), Atlantic Technology Enterprises, Inc., a New Jersey corporation (“ATE” and together with ATS, “Atlantic”), Creatrix, Inc., a Maryland corporation (“Creatrix”), and CyberViking, LLC, an Oregon limited liability company (“CyberViking”). Unless otherwise specified, all dollar amounts are expressed in United States dollars.

 

NOTE 1 –ORGANIZATION AND BACKGROUND

 

Description of the Business

 

We are a cybersecurity and compliance company comprised of highly trained and seasoned security professionals who work with clients to enhance or create a better cyber posture in their organization. We provide a full range of cybersecurity consulting and related services, encompassing all three pillars of compliance, cybersecurity, and culture. Our services include secured managed services, compliance services, security operations center (“SOC”) services, virtual Chief Information Security Officer (“vCISO”) services, incident response, certified forensics, technical assessments, and cybersecurity training.

 

On January 5, 2022, we entered into a stock purchase agreement (the “True Digital Stock Purchase Agreement”) with certain stockholders of True Digital and an agreement and plan of merger (the “True Digital Merger Agreement”) with True Digital and certain of its other stockholders. On January 19, 2022, the transactions contemplated by the True Digital Stock Purchase Agreement and the True Digital Merger Agreement were consummated, with True Digital becoming a wholly owned subsidiary of our company.

 

On January 18, 2022, we completed a $10,300,000 underwritten public offering of shares of our common stock, pursuant to which an aggregate of 2,060,000 shares of our common stock were issued (see Note 9). In addition, we granted the underwriter warrants to purchase an aggregate of 144,200 shares of our common stock (see Note 9). We intend to use the net proceeds from the offering to fund acquisitions, sales, marketing, and general corporate purposes. In connection with the public offering, our common stock was listed on The Nasdaq Stock Market LLC.

 

On June 1, 2022, we entered into a stock purchase agreement with the stockholders of Creatrix, pursuant to which Creatrix became our wholly owned subsidiary. Creatrix offers recognized expertise in identity management as well as systems integration and software engineering, and specializes in biometrics, vetting, credentialing, and case management.

 

Basis of Presentation

 

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include our accounts and the accounts of our subsidiaries. All material intercompany accounts and transactions have been eliminated.

 

Our interim financial statements are unaudited, and in our opinion, include all adjustments of a normal recurring nature necessary for the fair presentation of the periods presented. The results for the interim periods are not necessarily indicative of the results to be expected for any subsequent period or for the year ending December 31, 2022. These unaudited financial statements and related notes should be read in conjunction with our audited financial statements for the year ended December 31, 2021.

 

8

 

 

Reclassifications

 

Certain reclassifications have been made to the financial statements for the six months ended June 30, 2021 to conform to the financial statements presentation for the six months ended June 30, 2022. These reclassifications had no effect on net loss or cash flows as previously reported.

 

Use of Estimates

 

GAAP requires management to make estimates and assumptions that affect the reported amounts in our financial statements. We periodically evaluate our estimates and adjust prospectively, if necessary. We believe our estimates and assumptions are reasonable; however, actual results could materially differ.

 

We believe the critical accounting policies discussed below affects our more significant judgments and estimates used in the preparation of the accompanying unaudited condensed consolidated financial statements. Significant estimates include the allowance for doubtful accounts, the carrying value of intangible assets and goodwill, deferred tax asset and valuation allowance, the estimated fair value of assets acquired, liabilities assumed and stock issued in business combinations, and assumptions used in the Black-Scholes option pricing model, such as expected volatility, risk-free interest rate, share price, and expected dividend rate.

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Revenue

 

Our revenue is derived from two major types of services to clients: security managed services and professional services. With respect to security managed services, we provide culture education and enablement, tools and technology provisioning, data and privacy monitoring, regulations and compliance monitoring, remote infrastructure administration, and cybersecurity services, including, but not limited to, antivirus and patch management. With respect to professional services, we provide cybersecurity consulting, compliance auditing, vulnerability assessment and penetration testing, and disaster recovery and data backup solutions.

 

Our revenue is categorized and disaggregated as reflected in our statement of operations as follows:

 

Security Managed Services

 

Security managed services revenue primarily consist of compliance, security managed services, SOC managed services, and vCISO. We considered these services to be a single performance obligation, and revenue is recognized as services and materials are provided to the customer.

 

Professional Services

 

Professional services revenue primarily consists of technical assessments, incident response and forensics, training, and other cybersecurity services. We considered these services to be a single performance obligation, and revenue is recognized in the period in which the performance obligations are satisfied.

 

Accounts Receivable

 

Accounts receivable are reported at their outstanding unpaid principal balances, net of allowances for doubtful accounts. We periodically assess our accounts and other receivables for collectability on a specific identification basis. We provide for allowances for doubtful receivables based on management’s estimate of uncollectible amounts considering age, collection history, and any other factors considered appropriate. Payments are generally due within 30 days of invoice. We write off accounts receivable against the allowance for doubtful accounts when a balance is determined to be uncollectible. As of June 30, 2022 and December 31, 2021, our allowance for doubtful accounts was $180,691 and $77,811, respectively.

 

9

 

 

Inventory

 

Inventory consists of software licenses and computer equipment for sale to customers. Inventory is measured using the first-in, first-out method and stated at lower of cost or net realizable value as of June 30, 2022 and December 31, 2021. The value of inventories is reduced for excess and obsolete inventories. We monitor inventory to identify events that would require impairment due to obsolete inventory and adjust the value of inventory when required. We recorded no inventory impairment losses for the six months ended June 30, 2022 and 2021.

 

Fair Value Measurements

 

As defined in ASC 820, Fair Value Measurements and Disclosures, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). ASC 820 establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). This fair value measurement framework applies at both initial and subsequent measurement.

 

Level 1: Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
   
Level 2: Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.
   
Level 3: Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. The significant unobservable inputs used in the fair value measurement for nonrecurring fair value measurements of long-lived assets include pricing models, discounted cash flow methodologies and similar techniques.

 

Net Loss per Common Share

 

Net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period. For dilutive securities, all outstanding options are considered potentially outstanding common stock. The dilutive effect, if any, of stock options is calculated using the treasury stock method. All outstanding convertible notes are considered common stock at the beginning of the period or at the time of issuance, if later, pursuant to the if-converted method. Since the effect of common stock equivalents is anti-dilutive with respect to losses, the options and shares issuable upon conversion thereof have been excluded from our computation of net loss per common share for the six months ended June 30, 2022 and 2021.

 

The following tables summarize the securities that were excluded from the diluted per share calculation because the effect of including these potential shares was antidilutive due to our net loss position even though the exercise price could be less than the average market price of the common shares:

 

  

June 30, 2022

  

June 30, 2021

 
Stock options   36,114,487    25,843,700 
Warrant   144,200    - 
Convertible debt   430,718    1,500,000 
Total   36,689,405    27,343,700 

 

10

 

 

Deferred Revenue

 

Deferred revenue primarily consists of billings or payments received from customers in advance of revenue recognized for the services provided to our customers or annual licenses and is recognized as services are performed or ratably over the life of the license. We generally invoice customers in advance or in milestone-based installments. Deferred revenue of $52,824 was recognized for the six months ended June 30, 2022, which was included in the deferred revenue balance as of December 31, 2021. As of June 30, 2022, deferred revenue related to such customer payments was $2,351,477, all of which is expected to be recognized during the succeeding 12-month period and is therefore presented as current.

 

Deferred revenue consisted of the following:

 

  

June 30, 2022

  

December 31, 2021

 
Security managed services  $2,172,302   $52,824 
Professional services   179,175    - 
Total deferred revenue  $2,351,477   $52,824 

 

Income Taxes

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities, including tax loss and credit carry forwards, 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.

 

We utilize ASC 740, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the unaudited condensed consolidated financial statements or tax returns. We account for income taxes using the asset and liability method to compute the differences between the tax basis of assets and liabilities and the related financial amounts, using currently enacted tax rates. A valuation allowance is recorded when it is “more likely than not” that a deferred tax asset will not be realized. At June 30, 2022 and December 31, 2021, our net deferred tax asset has been fully reserved.

 

For uncertain tax positions that meet a “more likely than not” threshold, we recognize the benefit of uncertain tax positions in the unaudited condensed consolidated financial statements. Our practice is to recognize interest and penalties, if any, related to uncertain tax positions in income tax expense in the unaudited condensed consolidated statements of operations when a determination is made that such expense is likely.

 

Recently Issued Accounting Standards

 

In May 2021, the FASB issued ASU No. 2021-04, Earnings Per Share (Topic 260), Debt — Modifications and Extinguishments (Subtopic 470-50), Compensation — Stock Compensation (Topic 718), and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the Emerging Issues Task Force). The ASU requires issuers to account for modifications or exchanges of freestanding equity-classified written call options that remain equity classified after the modification or exchange based on the economic substance of the modification or exchange. Under the ASU, an issuer determines the accounting for the modification or exchange based on whether the transaction was done to issue equity, to issue or modify debt, or for other reasons. The ASU is applied prospectively and is effective for us for fiscal years beginning after December 15, 2021 and interim periods within those fiscal years. Early adoption is permitted. We adopted the standard on January 1, 2022, and management noted that there is no material impact to the unaudited condensed consolidated financial statements.

 

In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Liabilities from Contracts with Customers. The new guidance requires contract assets and contract liabilities acquired in business combinations to be recognized in accordance with ASC Topic 606 as if the acquirer had originated the contracts. The ASU is applied prospectively and is effective for us for fiscal years beginning after December 15, 2022 and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact that adopting this standard will have on the unaudited condensed consolidated financial statements.

 

All other newly issued but not yet effective accounting pronouncements have been deemed to be not applicable or immaterial to us.

 

11

 

 

NOTE 3 – ACQUISITIONS

 

True Digital Security, Inc.

 

On January 5, 2022, we entered into the True Digital Stock Purchase Agreement with certain stockholders of True Digital and the True Digital Merger Agreement with True Digital and certain of its other stockholders. On January 19, 2022, the transactions contemplated by the True Digital Stock Purchase Agreement and the True Digital Merger Agreement were consummated, with True Digital becoming a wholly owned subsidiary of our company (the “True Digital Acquisition”). True Digital’s outstanding common stock was exchanged for the right to receive an aggregate of $6,153,000 in cash and 8,229,000 shares of our common stock, subject to a 10% holdback. In the event that no claim is made by a Cerberus Indemnitee (as defined in the True Digital Merger Agreement) within one year from closing, then we shall pay the entire amount of the 10% holdback to the shareholders of True Digital.

 

Subsequent to the issuance of these financial statements, we expect to obtain a third-party valuation on the fair value of the assets acquired, including identifiable intangible assets and the liabilities assumed for use in the purchase price allocation.

 

The following table summarizes the preliminary allocation of the purchase price to the fair values of the assets acquired and the liabilities assumed as of the transaction date:

 

      
Consideration  $40,879,380 
      
Tangible assets acquired:     
Cash   485,232 
Accounts receivable   1,404,386 
Contract assets   131,342 
Prepaid expenses and other current assets   196,825 
Property and equipment   906,006 
Other assets   17,505 
Total tangible assets   3,141,296 
      
Estimated intangible assets acquired   1,913,800 
      
Assumed liabilities:     
Accounts payable and accrued expenses   1,283,003 
Deferred revenue   1,956,600 
Line of credit   283,244 
Loans payable   181,741 
Loans payable - shareholder   543,581 
Total assumed liabilities   4,248,169 
      
Net assets acquired   806,927 
      
Goodwill (a)  $40,072,453 

 

 

 

(a)Goodwill and intangibles are not deductible for tax purposes.

 

12

 

 

Creatrix, Inc.

 

On June 1, 2022, we entered into a stock purchase agreement with the stockholders of Creatrix, pursuant to which Creatrix became our wholly owned subsidiary. We anticipate that this will expand our professional services offerings and capabilities. Creatrix offers recognized expertise in identity management as wells as systems integration and software engineering and specializes in biometrics, vetting, credentialing, and case management.

 

Subsequent to the issuance of these financial statements, we expect to obtain a third-party valuation on the fair value of the assets acquired, including identifiable intangible assets and the liabilities assumed for use in the purchase price allocation.

 

The aggregate purchase price was allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimate fair values as of the acquisition date, with the excess recorded to goodwill. During the measurement period, which will not exceed one year from closing, we will continue to obtain information to assist us in finalizing the acquisition date fair values. Any qualifying changes to our preliminary estimates will be recorded as adjustments to the respective assets and liabilities, with any residual amounts allocated to goodwill.

 

The following table summarizes the preliminary estimated acquisition date fair values of the assets acquired and liabilities assumed:

 

      
Consideration paid  $3,630,000 
      
Tangible assets acquired:     
Cash   3,572 
Accounts receivable   125,908 
Contract assets   33,965 
Prepaid expenses and other current assets   3,597 
Total tangible assets   167,042 
      
Estimated intangible assets acquired   720,400 
      
Assumed liabilities:     
Accounts payable and accrued expenses   48,001 
Loans payable   56,687 
Total assumed liabilities   104,688 
      
Net assets acquired   782,754 
      
Goodwill (a)  $2,847,246 

 

(a) Goodwill and intangibles are not deductible for tax purposes.

 

Pro forma financial information is not presented because the acquisitions were not material to our financial statements, individually or in the aggregate.

 

NOTE 4 – PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets consisted of:

 

  

June 30, 2022

  

December 31, 2021

 
Prepaid expenses  $1,653,815   $441,259 
Deferred cost of sales   729,664    12,239 
Prepaid taxes   126,675    231,014 
Prepaid insurance   391,194    46,751 
Deferred interest   184,715    229,702 
Total prepaid expenses and other current assets  $3,086,063   $960,965 

 

13

 

 

NOTE 5 – PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following:

 

  

June 30, 2022

  

December 31, 2021

 
Computer equipment  $612,612   $495,235 
Building   1,107,769    1,047,020 
Leasehold improvements   94,739    109,626 
Vehicles   63,052    63,052 
Furniture and fixtures   45,835    33,358 
Software   1,529,412    748,599 
Property and equipment gross   3,453,419    2,496,890 
Less: accumulated depreciation   (484,633)   (102,466)
Property and equipment, net  $2,968,786   $2,394,424 

 

Total depreciation expense was $178,309 and $4,424 for the three months ended June 30, 2022 and 2021, respectively, and was $332,383 and $8,848 for the six months ended June 30, 2022, and 2021, respectively.

 

NOTE 6 – INTANGIBLE ASSETS AND GOODWILL

 

The following table summarizes the changes in goodwill during the six months ended June 30, 2022:

 

Balance December 31, 2021  $16,792,535 
Acquisition of goodwill   42,919,699 
Foreign currency translation adjustment   (1,196,975)
Ending balance, June 30, 2022(1)  $58,515,259 

 

 

 

(1) As of June 30, 2022, we had not obtained a third-party valuation for the acquisitions of True Digital and Creatrix. As such, the purchase price allocation disclosed in this Quarterly Report for True Digital and Creatrix may change, and, therefore, goodwill from the acquisitions may change.

 

The following table summarizes the identifiable intangible assets as of June 30, 2022 and December 31, 2021:

 

   Useful life 

June 30, 2022

  

December 31, 2021

 
Tradenames – trademarks  Indefinite  $1,211,800   $1,211,800 
Tradenames – trademarks  5 years   3,136,872    1,798,300 
Customer base  5 - 10 years   1,836,606    1,650,000 
Non-compete agreements  2 - 5 years   806,900    675,500 
Intellectual property/technology  5 - 10 years   2,264,939    1,528,000 
Identifiable intangible assets        9,257,117    6,863,600 
Less accumulated amortization      (1,100,951)   (323,331)
Total     $8,156,166   $6,540,269 

 

The weighted average remaining useful life of identifiable amortizable intangible assets remaining is 4.47 years.

 

Amortization of identifiable intangible assets for the three months ended June 30, 2022 and 2021 was $512,503 and $34,994, respectively, and was $817,467 and $69,988 for the six months ended June 30, 2022 and 2021, respectively.

 

14

 

 

The below table summarizes the future amortization expense for the remainder of 2022 and the next four years thereafter:

 

      
2022 (remainder of)  $860,974 
2023   1,704,567 
2024   1,427,546 
2025   1,377,196 
2026   1,276,628 
Thereafter   297,455 
Finite-lived intangible assets, net   $6,944,366 

 

NOTE 7 – ACCOUNTS PAYABLE AND ACCRUED EXPENSES

 

Accounts payable and accrued expenses consisted of the following amounts:

 

  

June 30, 2022

  

December 31, 2021

 
Accounts payable  $3,163,498   $1,700,260 
Accrued payroll   1,470,348    482,588 
Accrued expenses   2,391,785    513,718 
Accrued commissions   465,416    - 
Accrued interest – related party   12,500    12,500 
Total accounts payable and accrued expenses  $7,503,547   $2,709,066 

 

NOTE 8 – RELATED PARTY TRANSACTIONS

 

Independent Consulting Agreement with Stephen Scott

 

In August 2020, we entered into an Independent Consulting Agreement with Stephen Scott, a Director of our company, with respect to advisory and consulting services relating to our strategic and business development, and sales and marketing. Mr. Scott receives a consulting fee of $11,500 per month for such services. During the three and six months ended June 30, 2022, we paid consulting fees to Mr. Scott in the amount of $34,500 and $69,000, respectively.

 

Managed Services Agreement with Hensley Beverage Company – Related Party

 

In July 2021, we entered into a 1-year Managed Services Agreement with Hensley Beverage Company to provide secured managed services. We also may be engaged by Hensley Beverage Company from time to time to provide other related services outside the scope of the Managed Services Agreement. While the agreement provides for a term through December 31, 2021, the agreement will continue until terminated by either party. For the three and six months ended June 30, 2022, we received $206,202 and $373,008 from Hensley Beverage Company for contracted services and had an outstanding receivable balance of $11,132 as of June 30, 2022.

 

Note Receivable – Related Party

 

Arkavia provided cash infusions to a related party to fund an intended wholly owned subsidiary, Arkavia Peru, for start-up and operational costs. As of June 30, 2022, the subsidiary has yet to be incorporated and as such, Arkavia has recorded the amount as a receivable. The amount outstanding at June 30, 2022 is $1,006,848 and is considered short-term and non-interest bearing.

 

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NOTE 9 – STOCKHOLDERS’ EQUITY

 

On June 14, 2022, our Board of Directors approved and recommended that our stockholders approve (i) an amended and restated certificate of incorporation to, among other things, (1) increase our authorized shares of common stock from 250,000,000 to 300,000,000 and (2) authorize the issuance of 50,000,000 shares of preferred stock, par value $0.00001 per share; and (ii) increase the number of shares authorized for issuance under our 2019 Equity Incentive Plan from 25,000,000 to 60,000,000. On June 27, 2022, stockholders holding approximately 61.96% of our outstanding voting stock executed a written consent in lieu of a special meeting of stockholders approving such amended and restated certificate of incorporation and equity plan amendment (the “Written Consent”). Pursuant to Rule 14c-2 of the Exchange Act, such amended and restated certificate of incorporation and such equity plan amendment will not become effective until at least 20 calendar days following the date on which an information statement informing stockholders of the Written Consent is first mailed to our stockholders of record. As such, no effect of such amendments is shown on the accompanying financial statements.

 

Options

 

We granted stock options vesting solely upon the continued service of the recipient. We recognize the accounting grant date fair value of equity-based awards as compensation expense over the required service period of each award.

 

The following table summarizes stock option activity:

 

   Shares  

Weighted

Average

Exercise

Price

  

Weighted

Average

Remaining

Contractual

Life (in years)

  

Aggregate

Intrinsic

Value

 
Outstanding at January 1, 2022   31,372,148   $1.84    -    - 
Granted   8,635,213    3.62    -    - 
Exercised   (454,111)   0.61    -    - 
Expired or cancelled   (3,438,763)   2.56    -    - 
Outstanding at June 30, 2022   36,114,487   $2.25    5.69   $61,600,311 
Exercisable at June 30, 2022   18,472,112   $0.84    3.32   $51,129,643 

 

Total compensation expense related to the options was $3,572,189 and $891,126 for the three months ended June 30, 2022 and 2021, respectively, and $8,179,332 and $1,729,888 for the six months ended June 30, 2022 and 2021, respectively. As of June 30, 2022, there was future compensation expense of $44,979,761 with a weighted average recognition period of 2.11 years related to the options.

 

Warrant Activity Summary

 

The following table summarizes warrant activity:

 

   Shares  

Weighted

Average

Exercise

Price

  

Weighted

Average

Remaining

Contractual

Life

(in years)

  

Aggregate

Intrinsic

Value

 
Outstanding at January 1, 2022   -   $-    -                    - 
Granted   144,200    5.00    4.51    - 
Exercised   -    -    -    - 
Expired or cancelled   -    -    -    - 
Outstanding at June 30, 2022   144,200   $5.00    4.51   $- 
Exercisable at June 30, 2022   144,200   $5.00    4.51   $- 

 

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NOTE 10 – COMMITMENTS AND CONTINGENCIES

 

Maxim Settlement Agreement

 

On October 27, 2020, we entered into an advisory agreement (the “Advisory Agreement”) with Maxim Group LLC (“Maxim”), pursuant to which the parties agreed to certain compensation obligations in the form of our common stock, cash and future rights. Certain disputes arose between the parties regarding the duties and obligations pursuant to the Advisory Agreement, resulting in the parties entering into a settlement and release agreement on January 13, 2022. As a result, we recorded a settlement liability at December 31, 2021 of $470,000 and issued 400,000 shares of our common stock to Maxim, pursuant to the settlement. During the six months ended June 30, 2022, we paid $470,000 in cash.

 

Legal Claims

 

There are no material pending legal proceedings in which we or any of our subsidiaries is a party or in which any of our directors, officers or affiliates, any owner of record or beneficially of more than 5% of any class of our voting securities, or security holder is a party adverse to us or has a material interest adverse to us.

 

Indirect Taxes

 

We are subject to indirect taxation in some, but not all, of the various states and foreign jurisdictions in which we conduct business. Laws and regulations attempting to subject commerce conducted over the Internet to various indirect taxes are becoming more prevalent, both in the U.S. and internationally, and may impose additional burdens on us in the future. Increased regulation could negatively affect our business directly, as well as the business of our customers. Taxing authorities may impose indirect taxes on the Internet-related revenue we generated based on regulations currently being applied to similar, but not directly comparable industries. There are many transactions and calculations where the ultimate indirect tax determination is uncertain. In addition, domestic and international indirect taxation laws are complex and subject to change. We may be audited in the future, which could result in changes to our indirect tax estimates. We continually evaluate those jurisdictions in which nexus exists, and believe we maintain adequate indirect tax accruals.

 

As of June 30, 2022 and December 31, 2021, our accrual for estimated indirect tax liabilities was $633,672 and $99,088, respectively, reflecting our best estimate of the potential liability based on an analysis of our business activities, revenues subject to indirect taxes, and applicable regulations. Although we believe our indirect tax estimates and associated liabilities are reasonable, the final determination of indirect tax audits, litigation, or settlements could be materially different than the amounts established for indirect tax contingencies.

 

NOTE 11 – LOANS PAYABLE AND LINES OF CREDIT

 

Loans Payable

 

Loans payable was as follows:

 

   Interest Rate  Maturities  

June 30, 2022

  

December 31, 2021

 
                
Term loans (US dollar denominated)  5.00% – 6.00%   2023 - 2027   $5,397,470   $478,712 
Term loans (Chilean peso denominated)  3.48% - 7.14%   2023 - 2029    3,977,673    5,018,788 
            9,375,143    5,497,500 
Less current portion           (6,280,988)   (213,199)
Long term loans payable          $3,094,155   $5,284,301 

 

In June 2022, we entered into bridge loans, secured by substantially all of our assets, in the principal amount of $5,000,000 bearing an interest rate of 4.00% per annum payable monthly with a maturity date of December 14, 2022. These bridge loans are guaranteed by our assets. We recorded interest expense of $8,889 during the three and six months ended June 30, 2022, respectively.

 

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Various subsidiaries in the United States are borrowers under certain term loans. These term loans require monthly principal and interest payments. These term loans are secured by various assets owned by our subsidiaries. We recorded aggregate interest expense of these term loans of $11,358 and $51,987 for the three and six months ended June 30, 2022, respectively.

 

Our Chilean subsidiary, Arkavia, is the borrower under certain term loans denominated in Chilean Pesos. These term loans require monthly principal and interest payments. These term loans are secured by various assets owned by our subsidiaries. We recorded aggregate interest expense on these term loans of $58,400 and $61,885 for the three and six months ended June 30, 2022, respectively.

 

Debt Assumed through Acquisition

 

As part of the True Digital Acquisition, we assumed $1,008,566 of debt previously held by True Digital. This debt was comprised of a revolving line of credit and four separate term loans. We repaid two of the four term loans during the six months ended June 30, 2022. The line of credit matured and was repaid in full on August 9, 2022, and the outstanding term loans mature in May 2024 and February 2027. The line of credit had an interest rate 3.25% per annum.

 

Convertible Notes Payable

 

In October 2021, we issued a convertible note in the principal amount of $1,500,000 bearing an interest rate of 5.00% per annum payable at maturity with a maturity date of January 27, 2022, with a conversion price of $5.00 per share. On March 10, 2022, we entered into an amendment to the note pursuant to which the maturity date was extended to October 27, 2022. The outstanding principal of this note was $1,500,000 at June 30, 2022. At June 30, 2022 and December 31, 2021, we recorded interest expense and accrued interest of $49,486 and $12,500, respectively, with respect to this note. We recorded interest expense of $18,493 and $36,986 during the three and six months ended June 30, 2022, respectively.

 

In June 2022, we entered into an unsecured convertible note in the principal amount of $1,000,000 bearing an interest rate of 5.00% per annum payable monthly with a maturity date of June 2023, with a conversion price of $7.65 per share. The outstanding principal of this note can be redeemed at any time by us or at maturity at 105%. At June 30, 2022, we recorded interest expense and accrued interest of $3,194 during the three and six months ended.

 

Future minimum payments under the above line of credit and loans payable due as of June 30, 2022 were as follows:

 

      
2022 (remainder of)  $7,309,895 
2023   2,167,354 
2024   909,814 
2025   871,572 
2026   507,925 
Thereafter   928,676 
Total future minimum payments   12,695,236 
Less: discount   (54,166)
Long term debt   12,641,070 
Less: current   (9,344,478)
Long term debt, net of current portion    $3,296,592 

 

NOTE 12 – LEASES

 

All of our leases are classified as operating leases. With the adoption of Topic 842, operating lease agreements are required to be recognized on the condensed consolidated balance sheet as Right of Use (“ROU”) assets and corresponding lease liabilities.

 

On January 19, 2022, we recognized additional ROU assets and lease liabilities of $226,942 from the True Digital Acquisition. We elected to not recognize ROU assets and lease liabilities arising from office leases with initial terms of 12 months or less (deemed immaterial) on the unaudited condensed consolidated balance sheets.

 

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ROU assets include any prepaid lease payments and exclude any lease incentives and initial direct costs incurred. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. The lease terms may include options to extend or terminate the lease if it is reasonably certain that we will exercise that option.

 

When measuring lease liabilities for leases that were classified as operating leases, we discounted lease payments using our estimated incremental borrowing rate at January 1, 2022. The weighted average incremental borrowing rate applied was 6.00%. As of June 30, 2022, our leases had a remaining weighted average term of 1.00 years.

 

Operating leases are included in the unaudited condensed consolidated balance sheets as follows:

 

   Classification 

June 30,

2022

  

December 31,

2021