CynergisTek Reports Third Quarter 2018 Financial Results

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 September 30, 2018

[  ] 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

371867101

(State or other jurisdiction of
incorporation or organization)

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

27271 Las Ramblas, Suite 200

Mission Viejo, California  92691

(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 þNo o.

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

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

Large accelerated filer oAccelerated filer o

Non-accelerated filer oSmaller 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 oNo þ.

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 November 8, 2018 was 9,616,133.



PART I – FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS.

CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

September 30, 2018 (unaudited)

December 31, 2017

ASSETS

Current assets:

Cash and cash equivalents

$6,355,427 

$4,252,060 

Accounts receivable, net

9,389,407 

13,264,323 

Prepaid and other current assets

1,583,463 

557,426 

Supplies

1,043,964 

1,156,006 

Total current assets

18,372,261 

19,229,815 

Property and equipment, net

648,895 

831,784 

Deposits

87,778 

87,376 

Deferred income taxes

2,930,051 

3,120,310 

Intangible assets, net

9,542,722 

10,900,924 

Goodwill

18,525,206 

18,525,206 

Total assets

$50,106,913 

$52,695,415 

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

Accounts payable and accrued expenses

$3,639,637 

$9,631,634 

Accrued compensation and benefits

3,792,516 

3,711,551 

Deferred revenue

1,144,555 

1,425,821 

Note payable

343,750 

Current portion of long-term liabilities

3,120,504 

5,494,837 

Total current liabilities

12,040,962 

20,263,843 

Long-term liabilities:

Term loan, less current portion

14,075,843 

9,438,333 

Promissory notes to related parties, less current portion

5,156,250 

6,000,000 

Capital lease obligations, less current portion

77,500 

147,861 

Total long-term liabilities

19,309,593 

15,586,194 

Commitments and contingencies

Stockholders’ equity:

Common stock, par value at $0.001, 33,333,333 shares authorized, 9,616,133 shares issued and outstanding at September 30, 2018 and 9,576,028 shares issued and outstanding at December 31, 2017

9,616 

9,576 

Additional paid-in capital

31,619,720 

31,156,362 

Accumulated deficit

(12,872,978)

(14,320,560)

Total stockholders’ equity

18,756,358 

16,845,378 

Total liabilities and stockholders’ equity

$50,106,913 

$52,695,415 

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


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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

Three Months Ended September 30,

Nine Months Ended September 30,

2018

2017

2018

2017

Net revenues

$19,216,066 

$17,897,076 

$52,536,317 

$52,950,678 

Cost of revenues

13,428,831 

11,743,838 

38,131,617 

37,847,138 

Gross profit

5,787,235 

6,153,238 

14,404,700 

15,103,540 

Operating expenses:

Sales and marketing

1,313,388 

1,329,909 

4,288,893 

4,070,765 

General and administrative

1,789,959 

1,849,164 

6,405,355 

5,876,895 

Depreciation

84,840 

97,568 

265,424 

287,727 

Amortization of acquisition-related intangibles

452,734 

520,030 

1,358,201 

1,560,716 

Total operating expenses

3,640,921 

3,796,671 

12,317,873 

11,796,103 

Income from operations

2,146,314 

2,356,567 

2,086,827 

3,307,437 

Other income (expense):

Other income

17 

1,862 

44 

1,884 

Interest expense

(348,480)

(373,408)

(1,103,592)

(1,162,289)

Total other income (expense)

(348,463)

(371,546)

(1,103,548)

(1,160,405)

Income before provision for income taxes

1,797,851 

1,985,021 

983,279 

2,147,032 

Income tax expense

(643,725)

(895,360)

(415,363)

(976,899)

Net income

$1,154,126 

$1,089,661 

$567,916 

$1,170,133 

Net income per share:

Basic

$0.12 

$0.11 

$0.06 

$0.12 

Diluted

$0.12 

$0.11 

$0.06 

$0.12 

Number of weighted average shares outstanding:

Basic

9,616,133 

9,501,760 

9,605,536 

9,387,264 

Diluted

9,762,370 

9,881,236 

9,813,098 

9,835,428 

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


5



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2018

(UNAUDITED)

Additional

Total

Common Stock

Paid-in

Accumulated

Stockholders’

Shares

Amount

Capital

Deficit

Equity

Balance at December 31, 2017

9,576,028

$9,576

$31,156,362 

$(14,320,560)

$16,845,378 

Cumulative effect of adoption of revenue recognition standard ASC 606 (Note 7)

-

-

879,666 

879,666 

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

-

-

28,996 

28,966 

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

-

-

434,402 

434,402 

Stock options exercised

40,105

40

(40)

Net income

-

-

567,916

567,916 

Balance at September 30, 2018

9,616,133

$9,616

$31,619,720 

$(12,872,978)

$18,756,358 

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

.


6



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

         Nine Months Ended September 30,

2018   

2017   

Cash flows from operating activities:

Net income

$ 567,916   

$ 1,170,133   

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

Depreciation

265,424   

287,727   

Amortization of intangible assets

1,358,201   

1,560,716   

Deferred income taxes

190,259   

726,258   

Bad debts

109,673   

109,207   

Stock compensation expense for warrants and options

      granted to employees and directors

28,996   

74,973   

Stock compensation expense for restricted stock units

      granted to employees and directors

434,402   

98,347   

Note payable issued for severance pay

343,750   

–   

Interest expense related to loan acquisition costs

17,450   

–   

Changes in operating assets and liabilities:

Accounts receivable

3,765,243   

(1,495,401)   

Supplies

112,042   

112,869   

Prepaid and other current assets

(146,370)  

(558,943)  

Deposits

(402)  

(45,854)  

Accounts payable and accrued expenses

(2,241,997)  

(2,933,971)  

Accrued compensation and benefits

80,965   

(36,368)  

Deferred revenue

(281,266)  

196,927  

Net cash provided by (used for) operating activities

4,604,286   

(733,380)  

Cash flows from investing activities:

Purchases of property and equipment

(82,535)  

(258,981)  

Amount paid to purchase CynergisTek, net of cash received

–   

(13,448,522)  

Net cash used for investing activities

(82,535)  

(13,707,503)  

Cash flows from financing activities:

Proceeds from term loan

17,250,000   

14,000,000   

Loan acquisition fees paid

(111,250)  

–   

Payments on term loans

(12,434,404)  

(2,836,667)  

Payments on promissory notes to related parties

(7,031,250)  

–   

Payments on capital leases

(91,480)  

(130,526)  

Proceeds from issuance of common stock through

       stock options and warrants

–   

66,452   

Net cash (used for) provided by financing activities

(2,418,384)  

11,099,259   

Net increase (decrease) in cash and cash equivalents

2,103,367   

(3,341,624)  

Cash and cash equivalents, beginning of period

4,252,060   

6,090,844   

Cash and cash equivalents, end of period

$ 6,355,427   

$ 2,749,220   

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


7



CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

Nine Months Ended September 30,

2018

2017

Supplemental disclosure of cash flow information:

Interest paid

$1,214,439

$920,393

Income taxes paid

$226,170

$256,252

Non-cash investing and financing activities:

Property and equipment acquired through capital leases

$-

$128,939

Common stock issued in connection with the acquisition of CynergisTek, Inc.

$-

$2,771,999

Promissory notes issued in connection with the acquisition of CynergisTek, Inc.

$-

$9,000,000

Fair value of earn-out liability in connection with the acquisition of CynergisTek, Inc.

$-

$2,356,000

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


8



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017

(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, 2017, as filed with the Securities and Exchange Commission (“SEC”) on March 28, 2018.

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 the Company’s recent integration with CTEK Security and an analysis of how our Chief Operating Decision Maker reviews, manages and is compensated, we have determined that the Company operates in two segments, services and equipment & software resale.  The equipment & software resale operating segment is not reported separately in the accompanying condensed consolidated financial statements, as this segment did not meet the quantitative thresholds established in ASC 280-10-50-12. 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.

2.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In May 2014, the FASB issued guidance which provides a single, comprehensive accounting model for revenue arising from contracts with customers (“Topic 606”). This guidance supersedes most of the existing revenue recognition guidance, including industry-specific guidance. Under this model, revenue is recognized at an amount that a company expects to be entitled to upon transferring control of goods or services to a customer, as opposed to when risks and rewards transfer to a customer. The new guidance also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flow arising from customer contracts, including significant judgments and changes in judgments. We adopted this standard beginning January 1, 2018 and are using the modified retrospective method of adoption. Under the new guidance, based on the nature of our contracts, we will continue to recognize revenue in a similar manner as with the current guidance. Additionally, the unit of accounting, that is, the identification of performance obligations, is consistent with current revenue guidance. Accordingly, the adoption of this standard did not significantly impact our revenues. The additional disclosures required by Topic 606 are presented in Notes 3, 7, 9 and 10.

In February 2016, the FASB issued a new accounting standard on leasing. The new standard will require companies to record most leased assets and liabilities on the balance sheet, and also proposes a dual model for recognizing


9



expense. This guidance will be effective in the first quarter of 2019 with early adoption permitted. We have evaluated the impact of adopting this guidance and we are preparing for the changes to be made to our consolidated financial statements. We expect the adoption of these accounting changes will materially increase our assets and liabilities but will not have a material impact on our net income or equity.

In January 2017, the FASB issued a new accounting standard simplifying the test for goodwill impairment. Currently, the fair value of the reporting unit is compared with the carrying value of the reporting unit (identified as “Step 1”). If the fair value of the reporting unit is lower than its carrying amount, then the implied fair value of goodwill is calculated. If the implied fair value of goodwill is lower than the carrying value of goodwill an impairment is recognized (identified as “Step 2”). The new standard eliminates Step 2 from the impairment test; therefore, goodwill impairment will be recognized as the difference between the fair value and the carrying value. The new standard becomes effective on January 1, 2020 with early adoption permitted. We are currently evaluating the impact that the new standard will have on our financial position, results of operations and cash flows.

In August 2016, the FASB issued a new accounting standard which is intended to reduce the existing diversity in practice in how certain cash receipts and cash payments are classified in the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted, provided that all of the amendments are adopted in the same period. We are currently evaluating the impact of adopting this standard on our consolidated financial statements.

In January 2017, the FASB issued a new accounting standard which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. This guidance will be effective for the Company for the year ending December 31, 2019 and interim reporting periods within that year. Early adoption is permitted for transactions that have not been reported in financial statements that have been issued or made available for issuance. We are currently evaluating the effect of the adoption of this guidance on our consolidated financial statements.

In May 2017, the FASB issued new accounting standard which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC Topic 718. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This guidance will be effective for the year ending December 31, 2019 and interim reporting periods within that year. Early adoption is permitted. We expect the adoption of this guidance will not have a material effect on our consolidated financial statements or footnotes.

3.REVENUES

On January 1, 2018, we adopted Topic 606 using a modified retrospective method applied to those customer contracts which were not completed as of January 1, 2018. There was no change in revenues reported using this method as compared to the previous guidance. Below is a summary of our revenues disaggregated by revenue source.

Three Months Ended September 30,

Nine Months Ended September 30,

2018

2017

2018

2017

Managed services

$13,594,227

$15,175,852

$40,155,977

$45,530,347

Consulting & professional services

2,911,982

1,931,169

6,708,121

4,837,297

Office equipment, hardware & software resales

2,709,857

790,055

5,672,219

2,583,034

Net revenues

$19,216,066

$17,897,076

$52,536,317

$52,950,678


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4.OPTIONS, WARRANTS AND RESTRICTED STOCK UNITS

Below is a summary of stock option, warrant and restricted stock activity during the nine-month period ended September 30, 2018:

Options

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2017

724,400 

$3.09

Granted

-

Exercised

(40,105)

2.74

Cancelled

(105,756)

3.88

Outstanding at September 30, 2018

578,539 

$2.97

3.82

$520,796

Exercisable at September 30, 2018

543,423 

$2.97

3.82

$488,666

Warrants

Shares

Weighted Average Exercise Price

Weighted Average Remaining Term in Years

Aggregate
Intrinsic Value

Outstanding at December 31, 2017

77,779

$3.03

Granted

-

-

Exercised

-

-

Cancelled

-

-

Outstanding at September 30, 2018

77,779

$3.03

4.55

$63,779

Exercisable at September 30, 2018

77,779

$3.03

4.55

$63,779

Restricted Stock Units

Shares

Weighted Average Price

Weighted Average Remaining Term in Years

Outstanding at December 31, 2017

506,500 

$3.35

Granted

-

Exercised

-

Cancelled

(65,500)

3.68

Outstanding at September 30, 2018

441,000 

$3.30

1.75

For the three and nine months ended September 30, 2018 and 2017, stock-based compensation expense recognized in the consolidated statements of operations as follows:

Three Months Ended September 30,

Nine Months Ended September 30,

2018

2017

2018

2017

Cost of revenues

$ 21,148

$ 5,585

$ 82,173

$ 32,509

Sales and marketing

42,625 

51,000

87,875

95,602

General and administrative

97,492

13,287

293,350

45,209

Total stock-based compensation expense   

$ 161,264

$ 69,872

$ 463,398

$ 173,320


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5.NET INCOME PER SHARE

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

For the three months ended September 30, 2018, potentially dilutive securities consisted of options and warrants to purchase 656,318 shares of common stock at prices ranging from $0.90 to $6.45 per share and 441,000 shares of restricted stock units. Of these potentially dilutive securities, only 146,237 of the shares to purchase common stock from the options and warrants and none of the shares related to the restricted stock units are included in the computation of diluted earnings per share because the effect of including these instruments would be anti-dilutive.

For the nine months ended September 30, 2018, potentially dilutive securities consisted of options and warrants to purchase 656,318 shares of common stock at prices ranging from $0.90 to $6.45 per share and 441,000 shares of restricted stock units. Of these potentially dilutive securities, only 207,562 of the shares to purchase common stock from the options and warrants and none of the shares related to the restricted stock units are included in the computation of diluted earnings per share because the effect of including these instruments would be anti-dilutive.

For the three months ended September 30, 2017, potentially dilutive securities consisted of options and warrants to purchase 1,416,747 shares of common stock at prices ranging from $0.90 to $6.45 per share. Of these potentially dilutive securities, 379,476 of the shares to purchase common stock from the options and warrants are included in the computation of diluted earnings per share because the effect of including the remaining instruments would be anti-dilutive.

For the nine months ended September 30, 2017, potentially dilutive securities consisted of options and warrants to purchase 1,416,747 shares of common stock at prices ranging from $0.90 to $6.45 per share. Of these potentially dilutive securities, 448,164 of the shares of common stock underlying the options and warrants are included in the computation of diluted earnings per share because the effect of including the remaining instruments would be anti-dilutive.

Three Months Ended September 30,

Nine Months Ended September 30,

2018

2017

2018

2017

Numerator:

Net income

$1,154,126

$1,089,661

$567,916

$1,170,133

Denominator:

Denominator for basic calculation weighted average shares

9,616,133

9,501,760

9,605,536 

9,387,264

Dilutive common stock equivalents:

Options and warrants

146,237

379,476

207,562 

448,164

Denominator for diluted calculation weighted average shares

9,762,370

9,881,236

9,813,098 

9,835,428

Net income per share:

Basic net income per share

$0.12

$0.11

$0.06

$0.12

Diluted net income per share

$0.12

$0.11

$0.06

$0.12


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6.ACCOUNTS RECEIVABLE

A summary of accounts receivable is as follows: