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

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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIXTHREE MONTHS ENDED JUNE 30,MARCH 31, 2022 AND 2021 AND 2020

(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.Commission (the “Commission” or the “SEC”). 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, 2020, as filed with the Securities and Exchange Commission (“SEC”) on March 25, 2021, as amended by Amendment No. 1 on Form 10-K/A filed with the SEC on April 29, 2021.March 28, 2022.

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. 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.

Liquidity and Capital Resources

As of June 30, 2021,March 31, 2022, our cash balance was $4.0$1.2 million, current assets minus current liabilities was positive $6.7$3.8 million and we have no long-term liabilities. In April of 2022 we received our non-current debt and lease obligations totaled $2.8 million. This $2.8$1.4 million of debt is related to the U.S. Small Business Administration (“SBA”) Paycheck Protection Program loan (the “PPP Loan”), received pursuant to the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), that was forgiven in August 2021 as described in Note 9 to the unaudited condensed consolidated financial statements.tax refund. 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:

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. WeAs of the date of this Report on Form 10-Q, we are currently operating in agenerating negative cash flow negative position while we seek to maintain and grow our cybersecurity business and cover our public company expenses during this uncertain time. In connection with our most recent results for the six months ended June 30, 2021, we reported a loss from operations of $1.2 million after excluding non-cash items for depreciation, amortization of intangibles, stock-based compensation and our overall revenue and business levels have been impacted by the change in valuation ofCOVID-19 pandemic over the contingent earnout. Cash used in operating activities was $1.3 million for the six months ended June 30, 2021.

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.past twenty-four months. Our customer base is heavily concentrated in the healthcare provider space. The healthcare industry has experienced significant financial lossesand operational disruption due to the pandemic and are still contending with strained budgets but are showing signs of re-engagement.pandemic. Sales cycles are longer, cybersecurity projects have been delayed and pricing pressure is constant.  The resurgence ofbudgets have been constrained as healthcare providers focus on patient care and navigating the virus with the Delta Variant has caused some to return to operating with caution. Our operations team is closely monitoring the impact to the Company’s business, including its cash flows, customers and employees. We have heard and are working with a number of our active customers since the outbreak began providing relief in the form of extended payment terms and other contractual restructurings.pandemic. If the situationpandemic continues toor there are resurgences in 2022 that impact our customers’ cash flow oroperations and resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results for fiscal year 20212022 and beyond willcould be negatively impacted.

We did experience a negative financial impact from MarchDuring 2020 through June 2021 that management anticipates will continue to impact revenue and earnings for the foreseeable future due to COVID-19, primarily because many of the initial economic effects of the early stages of the COVID-19 pandemic resulting from the various shelter-in-place and other social distancing orders occurred towards the end of our first quarter of 2020. The severity and duration of the COVID-19 pandemic is uncertain, and such uncertainty will likely continue in the near term. 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 through the first quarter of 2021, we reduced staffing levelstook actions to reduce expenses, that included permanentconserve cash, and temporary cost reductions, the precise extent of which will depend on the duration of the COVID-19 disruptions to our customers and our short-term financial performance.raise additional capital. During 2021, we raised $1.4 million in additional capital through an “at-the-market” or ATM offering. In addition, we received thea $2.8 million PPP Loan pursuant(as described in Note 8 to the CARES Act,condensed consolidated financial statements below) which we anticipate will bewas fully forgiven and wein August 2021. We also received and anticipate having approximately $0.7 million per quarter in employee retention tax credits in the first second and thirdthree quarters of 2021.2021 and a $1.4 million tax refund in April 2022. With the proceeds from the tax refund, PPP Loan and the employee retention tax credits, we have triedwere able to minimize staff reductions in the areas of Sales and Delivery, our primary customer facing roles, to lessen the impact to our customers during this time of heightened security risks for the healthcare industry. If necessary, we could further reduce personnel and other variable and semi-variable costs to conserve cash and operate as a going concern. However, those actions if required, could negatively impact our ability to grow the business as well as the overall long-term outlook of the business.

On November 12, 2020, we entered into an Equity Distribution Agreement with Craig-Hallum Capital Group LLC (the “Agent”), under which we may offer and sell, from time to time at our sole discretion, shares of our common stock having an aggregate offering price of up to $5.0 million in an “at-the-market” or ATM offering, to or through the Agent.  The Company agreed to pay the Agent a commission of three percent (3.0%) of the gross sales price per share of any common stock sold through the Agent under the Equity Distribution Agreement.

During November and December of 2020, the Company received gross proceeds under the Equity Distribution agreement of $2,027,000 from the issuance of 1,315,000 shares of our common stock and paid an aggregate of $61,000 to the Agent in commissions and $123,000 in other offering-related expenses, yielding net proceeds of $1,843,000.

We believe that our existing sources of liquidity, including cash and cash equivalents, the proceeds from the PPP Loan, employee retention tax credits and tax refunds from NOL carrybacks, the ability to raise equity under our

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shelf registration (including via effective Registration Statement on Form S-3 as well as our ability to manage the Equity Distribution Agreement) and future operating cash flows, and other assetsbusiness to decrease expenses if necessary, will be sufficient to meet our projected capital needs for at least the next twelve months. As we execute our plans over the next twelve months, we intend to carefully monitor the impact of growth initiatives 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 lingering impact of the COVID-19 pandemic will likely continue toand ongoing geopolitical tensions and related economic sanctions 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.

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 unaudited condensed 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 Issued Accounting Pronouncements Adopted

None.

Recently Issued Accounting Pronouncements Not Yet Adopted

In June 2016, the FASBFinancial Accounting Standards Board (“FASB”) issued an amendment to the guidance on the measurement of credit losses on financial instruments. The amendment updates the guidance for measuring and recording credit losses on financial assets measured and amortized cost by replacing the “incurred loss” model with an “expected loss” model. Accordingly, these financial assets will be presented at the net amount expected to be collected. The amendment also requires that credit losses related to available-for-sale debt securities be recorded as an allowance through net income rather than reducing the carrying amount under the current, other-than-temporary-impairment model. The guidance is effective for smaller reporting companies for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted for annual periods after December 15, 2018. Management does not expect the impact from this guidance will have a material impact on our consolidated financial statements.

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A summary of accounts receivable is as follows:

4.3. DEFERRED COMMISSIONS

Our incremental costs of obtaining a contract, which consist of sales commissions, are deferred and amortized over the period of contract performance. Deferred commissions are included in prepaid and other current assets in our consolidated balance sheets. We had $674,000$632,000 and $730,000$760,000 of unamortized deferred commissions as of June 30, 2021,March 31, 2022 and December 31, 2020,2021, respectively. We had $184,000$241,000 and $367,000$183,000 of commissions expense for the three and six months ended June 30,March 31, 2022 and 2021, respectively. Commissions expense for the three and six months ended June 30, 2020, was $147,000 and $264,000, respectively.

5.4. PROPERTY AND EQUIPMENT

A summary of property and equipment follows:

6.5. LEASES

We previously leased approximately 9,600 square feet of office space in Austin, Texas. In March 2020, we amended this lease reducing the office space to 5,000 square feet and extended the lease term to May 31, 2022. We extended the lease term to May 31, 2023. We leased approximately 3,700 square feet of office space in Minneapolis, Minnesota. In July 2021, we amended thisThis lease extending the term toexpired on January 31, 2022.2022 and we no longer use this office space since the employees who worked from this location are now working remote. We leased approximately 18,000 square feet of office space in Mission Viejo, California. This lease terminatedexpired in April 2021. During the first quarter of 2019, we subleased this space to two subtenants. The terms of these subleases ended concurrently with the end of our lease obligation in April 2021.

We used a discount rate of 5.5% in determining our operating lease liabilities, which represented our incremental borrowing rate. Short-term leases with initial terms of twelve months or less are not capitalized.

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

Right-of-use assets and liabilities are recognized based on the present value of future minimum lease payments over the expected lease term at commencement date. Certain lease agreements contain extension options; however, we have not included such options as part of right-of-use assets and lease liabilities because we originally did not expect to extend the leases. We measure and record a right-of-use asset and lease liability based on the discount rate implicit in the lease, if known. In cases where the discount rate implicit in the lease is not known, we measure the right-of-use assets and lease liabilities using a discount rate equal to our estimated incremental borrowing rate for loans with similar collateral and duration.

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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 was comprised of the following:

Maturities of lease liabilities are as follows:

7.6. INTANGIBLE ASSETS

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

8.7. 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 sixthree months ended June 30,March 31, 2022 and 2021, $737,000 and 2020, $798,000 and $1,085,000,$738,000, 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 June 30,March 31, 2022 and 2021, $615,000 and 2020, $260,000 and $154,000,$225,000, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.

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9.

8. PAYCHECK PROTECTION PROGRAM LOAN

On April 20, 2020, we received $2,825,500$2.8 million in loan funding from the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), established pursuant to the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The unsecured loan (the “PPP Loan”) iswas evidenced by a promissory note issued by the Company (the “Note”) in favor of BMO Harris Bank N.A.

The Company used the PPP Loan proceeds to cover payroll costs, rent and utilities in accordance with the relevant terms and conditions of the CARES Act.

Under the terms of the Note and the PPP Loan, interest accrued on the outstanding principal at the rate of 1.0% per annum. The term of the Note was two years, unless sooner provided in connection with an event of default under the Note. To the extent the PPP Loan amount was not forgiven, the Company would have been obligated to make equal monthly payments of principal and interest, beginning seven months from the date of the Note, until the maturity date. The Company had not started making interest payments prior to its notice of forgiveness decision received from the SBA in August 2021. Details regarding the Note can be found in our Current Report on Form 8-K filed with the SEC on April 20, 2020.

The Company recognized interest charges associated with the PPP Loan of approximately $7,000 and $14,000 for the three and six months ended June 30,March 31, 2021. The Company recognized interest charges of approximately $6,000 for the three and six months ended June 30, 2020. The Company received notice from the SBA in August 2021 from the SBA that the full principal balance and related interest has beenwere forgiven.

10.9. PROMISSORY NOTES

In connection with the acquisition of CTEK Security, Inc. (formerly CynergisTek, Inc.), we issued a promissory note totaling $4,500,000$4.5 million to Michael McMillan (the “Seller Note”). In March 2018, the Company repaid $2,250,000 plus accrued interest on the Seller Note and agreed to amend and restate the Seller Note in the remaining principal amount of $2,250,000. The Seller Note bearsbore interest at a rate of 8% per annum, providesprovided for quarterly payments of principal and interest and maturesmatured on March 31, 2022. As of June 30, 2021,March 31, 2022, and December 31, 2020,2021, the outstanding principal balance due under the Seller Note was $422,000$0 and $703,000,$0.1 million, respectively.

Interest charges associated with the Seller Note totaled approximately $10,000$2,000 and $23,000, respectively$13,000, for the three and six months ended June 30,March 31, 2022 and 2021, and $22,000 and $46,000, respectively for the three and six months ended June 30, 2020.respectively.

11.10. REVENUES

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

11. Common Stock

On November 12, 2020, we entered into an Equity Distribution Agreement (the “Equity Distribution Agreement”) with Craig-Hallum Capital Group LLC (“Agent”) under which the Company could offer and sell, from time to time at its sole discretion, shares of its common stock to or through the Agent as its sales agent, having an aggregate offering price of up to $5.0 million.

Pursuant to the Equity Distribution Agreement, sales of our common stock, could be made under the Company’s effective Registration Statement on Form S-3 (File No. 333-249615), filed with the Securities and Exchange Commission on October 22, 2020, and the prospectus supplement relating to this offering, filed on November 12, 2020, by any method that is deemed to be an “at the market offering” as defined in Rule 415(a)(4) under the Securities Act of 1933, as amended, including block transactions. The Agent agreed to use commercially reasonable efforts to sell the common stock from time to time, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company would pay the Agent a commission of three percent (3.0%) of the gross sales price per share of our common stock sold through the Agent under the Agreement, and also provided the Agent with customary indemnification rights. The Company would also reimburse the Agent for its reasonable out-of-pocket accountable fees and disbursements in an amount not to exceed $50,000 through the fourth business day following execution of the Agreement, and in an amount not to exceed $5,000 for each quarterly period thereafter. The Company canceled the agreement in November 2021.

During September 2021, the Company received gross proceeds under the Agreement of $1.5 million from the issuance of 762,000 shares of our common stock and paid an aggregate of $0.1 million in commissions and other offering-related expenses, yielding net proceeds of $1.4 million.

During November and December 2020, the Company received gross proceeds under the Agreement of $2.0 million from the issuance of 1,315,000 shares of our common stock and paid an aggregate of $61,000 to the Agent in commissions and $0.1 million in other offering-related expenses, yielding net proceeds of $1.8 million.

12.WARRANTS, OPTIONS AND RESTRICTED STOCK UNITS

Warrant Issued for Securities Purchase Agreement

On April 3, 2020, we entered into a Securities Purchase Agreement (“Securities Purchase Agreement”) with Horton Capital Management, LLC (“Horton”) which provided that Horton was committed to purchase up to an aggregate of $2,500,000$2.5 million of shares of the Company’s common stock over the term of the agreement, at the election of the Company, which terminatedCompany. The Securities Purchase Agreement expired on March 31, 2021. Additionally, if and when the Company sold shares to Horton under the commitment, the Company agreed to grant to Horton a warrant, with the same number of shares of common stock purchased by Horton in the

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particular funding, with an exercise price equal to 125% of the purchase price of the shares of common stock sold in such funding, with a 10-year term. No purchases were made under the Securities Purchase Agreement.

Upon signing the agreement,Securities Purchase Agreement, the Company issued Horton a warrant (the “Horton Warrant”) to purchase up to 500,000 shares of common stock in consideration of Horton’s obligation to purchase the shares, at an exercise price of $2.50 per share, subject to certain anti-dilution adjustments as set forth in the warrant. The fair value of this warrant of $390,000$0.4 million was determined at the issuance date using the Black-Scholes option-pricing model and was expensed during the second quarter of 2020.

At the end ofDuring 2020 and 2021, the Company issued common stock under an equity distribution agreement receiving net proceeds of $1,843,000 from the issuance of 1,315,000 shares of our common stockEquity Distribution Agreement that resulted in a Q1 2021required anti-dilution adjustment increasingadjustments. These adjustments increased the number of shares under the Horton Warrant to 518,915524,170 and reducingreduced the exercise price to $2.41.$2.38. The resulting difference in fair value of the Horton Warrant with the new exercise price was $6,000 and$14,000, determined using the Black-Scholes option-pricing model and recorded as a deemed dividend in our consolidated statements of stockholders’ equity. As the Company has an accumulated deficit, the deemed dividend wasdividends were recorded within additional paid-in capital.

The detailed terms and conditions of the Horton Securities Purchase Agreement and the Horton Warrant can be found in the documents, which were included as Exhibits 10.1 and 10.3, respectively, to our Current Report on Form 8-K, filed with the SEC on April 7, 2020.

Below is a summary of warrant activities during the six-monththree-month period ended June 30, 2021:March 31, 2022:

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During the six months ended June 30, 2021, we granted 100,000 options to an employee to purchase shares of our common stock at an exercise price of $2.75 per share. The exercise price equals the fair value of our stock on the grant date.  The options have graded vesting annually over three years.  The fair value of the options of approximately $135,000 was determined using the Black-Scholes option-pricing model.

Below is a summary of restricted stock unit activity during the six-monththree-month period ended June 30, 2021:March 31, 2022:

13.BASIC AND DILUTED NET LOSS PER SHARE

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

For the three and six months ended June 30,March 31, 2022, potentially dilutive securities consisted of options and warrants to purchase 1,487,452 shares of common stock at prices ranging from $1.44 to $3.60 per share. Of these potentially dilutive securities, none 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. Also excluded from potentially dilutive securities are 232,800 shares of restricted stock units vested but had not been issued as of March 31, 2022.

For the three months ended March 31, 2021, potentially dilutive securities consisted of options and warrants to purchase 1,705,1991,724,700 shares of common stock at prices ranging from $1.08 to $4.86 per share. Of these potentially dilutive securities, none 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. Also excluded from potentially dilutive securities are 741,850767,850 shares of non-vested restricted stock units and 125,000100,000 shares of restricted stock units which vested but had not been issued as of June 30,March 31, 2021.

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For the three and six months ended June 30, 2020, potentially dilutive securities consisted of options and warrants to purchase 1,445,658 shares of common stock at prices ranging from $1.44 to $4.05 per share. Of these potentially dilutive securities, none 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. Also excluded from potentially dilutive securities are 45,000 shares of restricted stock units which have vested but had not been issued by period end and 863,500 shares of non-vested restricted stock units.

14.REMAINING PERFORMANCE OBLIGATIONS

We had remaining performance obligations of approximately $17.9 million as of June 30, 2021.March 31, 2022. Our remaining performance obligations represent the amount of transaction price for which work has not been performed and revenue has not been recognized. When applying Accounting Standards Codification (“ASC”) Topic 606, with only the non-cancelable portion of these contracts included in our performance obligations we had approximately $16.0$15.5 million as of June 30, 2021.March 31, 2022. We expect to recognize revenue on approximately 83%93% of the remaining non-cancelable portion of these performance obligations over the next 24 months, with the balance thereafter.

15.CONCENTRATIONS

Cash Concentrations

At times, cash balances held in financial institutions are in excess of federally insured limits. Management performs periodic evaluations of the relative credit standing of financial institutions and limits the amount of risk by selecting financial institutions with a strong credit standing.standing.

Major Customers

Our largest customer accounted for approximately 14%16% and 11%13% of our revenues for the sixthree months ended June 30,March 31, 2022 and 2021, and 2020, respectively. Our largest customer had accounts receivable totaling approximately $130,000$58,000 and $74,000$95,000 as of June 30, 2021,March 31, 2022, and December 31, 2020,2021, respectively.

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16.EARNOUT LIABILITY – BACKBONE ENTERPRISES

InOn October 31, 2019, we entered into a Stock Purchase Agreement (the “Backbone Purchase Agreement”) with Backbone Enterprises Inc., a Minnesota corporation (“Backbone”), and its stockholders, (the “Stockholders”), pursuant to which we acquired 100% of the issued and outstanding shares of common stock (the “Shares”) of Backbone from the Stockholders.

Pursuant to the Backbone Purchase Agreement, the aggregate purchase price paid for the Shares includedconsisted of (i) a cash payment of $5.5 million, less certain transaction expenses (the “Cash Consideration”), (ii) the issuance of 491,804 shares of our common stock to the Stockholders, pro rata among the Stockholders in proportion to each Stockholder’s ownership of the Shares, and (iii) an earn-out, pursuant to which the Stockholders may be entitled to an additional $4,000,000$4.0 million based upon the post-closing financial performance of Backbone, to be calculated annually based upon revenue generated by the Backbone business during each year of the three-year earn-out period. The Cash Consideration was subject to adjustment based on closing working capital of Backbone, and $1.5 million of the Cash Consideration was placed into a third-party escrow account by us, against a portion of which we may make claims for indemnification.

There was no earn-out earnedearnout paid for the first year of the agreement.earnout period. We performed a valuation of the contingent earn-out and marked down the fair value balance from $2.4 million to $1.3 million based on the potential of achieving a portion of the year two and three targets. This resulted in a gain from the reduction of the contingent earnout liability of $1.1 million in 2020. We performed an updated valuation of the contingent earn-out as of June 30, 2021, which resulted in a full write-off of the previous estimate of $1,300,000.$1.3 million.

17.EMPLOYMENT AGREEMENTS

Caleb Barlow

On July 26, 2021, Caleb Barlow, notifiedThe Company renegotiated the Board of Directors (the “Board”) of his resignation as the President and Chief Executive Officerterms of the Company, effective immediately. Mr. Barlow also informed the Board of his resignation as a member of the Board, to be effective August 26, 2021.  The Board accepted Mr. Barlow’s resignationearnout and on July 26, 2021, appointed Michael “Mac” McMillan as President and Chief Executive Officer of the Company, effective immediately.  Mr. Barlow’s resignation includes a severance payment of approximately $578,000 and the issuance of 200,000 shares of common stock as a result performed an updated valuation of the accelerated vesting and settlementcontingent earn-out as of 200,000 restricted stock units.September 30, 2021, which resulted in a recovery from the previous estimate of $0.3 million. As of December 31, 2021 we updated our valuation of the contingent earn-out which resulted in an additional recovery of $0.5 million. The earnout for year two of the earnout period totaled $0.3 million. Total cumulative amount earned for the year three earnout period through March 31, 2022 totaled 202,000 with payments related to year three earnout period during the three months ended March 31, 2022 were $49,000.

In connection with Mr. McMillan’s appointment as President and Chief Executive Officer, the Company and Mr. McMillan entered into an employment agreement (the “Employment Agreement”) to be effective as of July 26, 2021 (the “Effective Date”).  Pursuant to the Employment Agreement, Mr. McMillan will have the duties and responsibilities as are commensurate with the positions of President and Chief Executive Officer, as reasonably and lawfully directed by the Board.  The initial term of the Employment Agreement is 12 months from the Effective Date.

Pursuant to the Employment Agreement, Mr. McMillan’s base salary will be $300,000. Except in the event that Mr. McMillan’s employment is terminated for Cause (as defined below), the base salary is guaranteed and shall, in any event, be paid through the end of the 12-month term of the Employment Agreement.  The Company has the right to terminate Mr. McMillan’s employment for “Cause,” which is defined in the Employment Agreement to mean: (a) acts or omissions constituting gross negligence, recklessness or willful misconduct on the part of Mr. McMillan with respect to his obligations or otherwise relating to the business of Company; (b) Mr. McMillan’s material breach of the Employment Agreement; and (c) Mr. McMillan’s conviction or entry of a plea of nolo contendere for fraud, misappropriation or embezzlement, or any felony or crime of moral turpitude.

The preceding description of the Employment Agreement is a summary of its material terms, does not purport to be complete. The Employment Agreement was filed as Exhibit 10.1 to our Current Report on Form 8-K filed on July 26, 2021.

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

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act, and is subject to the safe harbors created by those sections. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements.

Due to possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Quarterly Report, which speak only as of the date of this Quarterly Report, or to make predictions about future performance based solely on historical financial performance. We disclaim any obligation to update forward-looking statements contained in this Quarterly Report.

Readers should carefully review the risk factors described in other documents we file from time to time with the SEC, including our Form 10-K for the fiscal year ended December 31, 2020.2021. You should interpret many of the risks identified in these reports as being heightened as a result of the ongoing and numerous adverse impacts of the COVID-19 pandemic and the global economic effect of ongoing geopolitical tensions and related economic sanctions. Our filings with the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge at www.CynergisTek.com, when such reports are available via the EDGAR system maintained by the SEC at www.sec.gov.www.sec.gov.

OVERVIEW

We are engaged in the business of helping U.S. based companies in highly regulated industries, including healthcare, be prepared to handle unforeseen cyber threats, comply with regulations, and gain the confidence that their efforts are strengthening their security posture and building resilience. This is achieved through our cybersecurity, privacy, compliance and complianceaudit services.

CynergisTek was born in healthcare and is one of the few consulting and advisory companies focused on converging security and privacy with a methodology to validate the rigor and effectiveness of their programs.the programs as a managed service. We believe that our years of experience of understanding our clients’ unique challenges allows us to provide our customers with services designed around industry best practices to improve security controls, policies and procedures and to protect sensitive information. Our team of subject matter experts and consultants are comprised of knowledgeable professionals who have learned their craft both in the classroom and through years of practical on-the-job experience, including as policy makers, attorneys and leaders in cybersecurity, privacy, compliance and compliance.audit.

Our services are categorized into four servicegrouped to facilitate and assist our clients in implementing their programs, those groups which are:follow a cyclical approach: assess, build, manage, and validate. These services are designed to meet the client where they are in their security journey as recurring managed services under long-term contracts structured to provide a sustainable and growing program, or under shorter duration consulting or professional services engagements.

·Assess – identify, measure, and test security and privacy risk of an organization’s readiness and verify and validate their programs meet compliance and business objectives through IT audits, technical testing, and risk and program assessments. 

For sophisticated organizations our Managed Security Validation® program encompasses a bundle of services from the assess, build, manage, and validate categories to deliver clarity and guidance as a consistent partner helping maintain and grow their security infrastructure.

Impact of COVID-19 Pandemic and Recent Capital Markets Disruption

In December 2019, a novel strainU.S. and global markets are experiencing volatility and disruption following the escalation of geopolitical tensions and the start of the coronavirus (COVID-19) surfaced, which spreadmilitary conflict between Russia and Ukraine. On February 24, 2022, a full-scale military invasion of Ukraine by Russian troops was reported. Although the length and impact of the ongoing military conflict is highly unpredictable, the conflict in Ukraine could lead to market disruptions, including significant volatility in commodity prices, credit and capital markets, as well as supply chain interruptions. We are continuing to monitor the situation in Ukraine and globally and was declared a pandemic by the World Health Organization in March 2020. The challenges posed by the COVID-19 pandemicassessing its potential impact on the global economy increased significantly in the first several months of 2020. In response to the COVID-19 pandemic, national and local governments around the world instituted certain measures, including travel bans, prohibitions on group events and gatherings, shutdowns of certain businesses, curfews, shelter-in-place orders and recommendations to practice social distancing. Variants of the COVID-19 virus pose similar and other unknown risks to the economy and our business.

In planningAdditionally, Russia’s prior annexation of Crimea, recent recognition of two separatist republics in the Donetsk and Luhansk regions of Ukraine and subsequent military interventions in Ukraine have led to sanctions and other penalties being levied by the United States, European Union and other countries against Russia, Belarus, the Crimea Region of Ukraine, the so-called Donetsk People’s Republic, and the so-called Luhansk People’s Republic, including agreement to remove certain Russian financial institutions from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) payment system. Additional potential sanctions and penalties have also been proposed and/or threatened. Russian military actions and the possible disruptionresulting sanctions could adversely affect the global economy and financial markets and lead to instability and lack of liquidity in capital markets, potentially making it more difficult for us to obtain additional funds.

Additionally the markets, and more specifically healthcare, have experienced an increase in pressures from rising inflation, rising interest rates. lowering bond rates and the impact to their revenues and operating margins. The resultant effect of these pressures is healthcare entities have slowed down their spend on things considered not mission critical or discretionary. Cybersecurity is discretionary as it relates to an organization’s propensity for managing risk, but it has a regulatory component which assures that organizations will continue to spend on cybersecurity.

The ongoing COVID-19 pandemic and ensuing governmental responses has caused significant uncertainty in the United States and global economies as well as the markets we serve has negatively impacted and could further materially adversely affect our business, financial condition and results of operations.

COVID-19 cases (including the spread of variants and mutant strains, such as the omicron variant) continue to surge in certain parts of the world and have resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. We remain unable to accurately predict the full impact that COVID-19 will have on our results of operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures. Our compliance with containment and mitigation measures materially impacted our day-to-day operations, and there can be no guaranty that the pandemic will not disrupt our business and operations or impair our ability to implement our business plan successfully.

More generally, the pandemic raises the possibility of an extended global economic downturn and has caused volatility in financial markets, which could affect demand for our products and services and impact our results and financial condition even after the pandemic is contained. For example, we may be unable to collect receivables from those customers significantly impacted by COVID-19. Also, a decrease in bookings in a given period could negatively affect our revenues in future periods, particularly if experienced on a sustained basis. The pandemic may also have the effect of heightening many of the other risks described in these Risk Factors and the Risk Factors set forth in the Company’s 2021 Form 10-K, particularly those risks associated with our customers.

Our current and potential customers’ businesses, specifically in the healthcare industry, have been directly impacted both financially and operationally in many ways by the pandemic. During this time, cybersecurity risks in healthcare have increased particularly with increased adoption of remote access and increased adoption of telehealth, as well as decreased budgets, diversion of resources and focus from all areas not directly related to patient care. In the current periods, the pandemic has led to customers delaying or deferring cybersecurity buying decisions, has limited our ability to visit customers and potential customers, and has resulted in an overall decrease in our orders, bookings and revenues in 2022 and 2021.

We took steps to reduce expenses throughout the Company.  This includedCompany over the past twenty-four months, including workforce reductions, substantially reducing Company travel, for a period of time, as well as our participation in trade shows and other business meetings and decreasing expenditures. We alsohave modified our business practices and implemented workforce reductions during 2020certain policies at our offices in accordance with best practices to accommodate, and at times mandate, remote work practices, including restricting employee travel, modifying employee work locations, and cancelling attendance at events and conferences. In addition, we have adapted new processes for interactions with our customers to safely manage our operations. Many of our customers have made similar modifications. If necessary, we may take further actions in the beginningbest interests of 2021, decreasing employmentour employees, customers, partners and related expenses.  Continued progressionsuppliers. There is no certainty that such measures will be sufficient to mitigate the risks posed by COVID-19, in which case our employees may become sick, our ability to perform critical functions could be harmed, and our business and operations could be negatively impacted.

With less resources allocated to cybersecurity in healthcare over the past twenty-four months, we believe risks are increasing and expect the industry will need to increase attention and spend on cybersecurity in the near future. However, the ultimate duration and impact of the COVID-19 pandemic on our business, results of operations, financial condition and cash flows is uncertain. Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business, and we anticipate that our results of operations in future periods may continue to be adversely impacted by the COVID-19 pandemic and its negative effects on global economic conditions.

As we expect the industry to begin emerging from the pandemic, we have begun to increase our sales and marketing efforts and building our sales and operational teams for growth. However, our current and potential customers’ businesses could result in a decline in customer orders, as our customerscontinue to be disrupted or they could shift purchasesseek to lower-priced or other perceived value offerings or reduce their purchases of our serviceslimit spending due to decreased budgets, reduced access to credit or various other factors, any of which could have a material adversenegatively impact onthe willingness or ability of such customers to order new, or any, services with us and ultimately adversely affect our resultsrevenues, as well as negatively impact the payment of operationsaccounts receivable and cash flow.  While the current impacts of COVID-19, including from variants thereof, are reflected in our results of operations, we cannot at this time separate the direct COVID-19 impacts from other factors that cause our performancecollections and potentially lead to vary from year to year. write-downs or write-offs.

The ultimate duration and impact of the ongoingCOVID-19 pandemic related to COVID-19 and its variants on our business, results of operations, financial condition and cash flows is dependent on future developments, including the duration and severity of the pandemic and the related length of its impact on the global economy, which areremain uncertain and given the daily evolution of the COVID-19 pandemic and the global responses to curb its spread, cannot be predicted at this time. Even after the pandemic related to COVID-19 and its variants has subsided, we may continue to experience an adverse impact to our business as a result of its national and, to some extent, global economic impact, including any recession that has occurred or may occur in the future. Furthermore, the extent to which our mitigation efforts are successful, if at all, is not presently ascertainable.  However, we anticipate that our results of operations in future periods may continue to be adversely impacted by the pandemic related to COVID-19 and its variants, and its negative effects on global economic conditions.

Our common stock currently trades on the NYSE American exchange under the stock symbol “CTEK”.

Where appropriate, references to “CynergisTek,” the “Company,” “Redspin,” “we,” “us,” or “our” include CynergisTek, Inc., a Delaware corporation and its wholly-owned subsidiaries, CTEK Solutions, Inc., a California corporation, CTEK Security, Inc., a Texas corporation, Delphiis, Inc., a California corporation and, Backbone Enterprises, Inc., a Minnesota corporation.

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RESULTS OF OPERATIONS

For the Three Months Ended June 30, 2021,March 31, 2022, Compared to the Three Months Ended June 30, 2020March 31, 2021

Revenue

Revenue decreased $0.7increased $0.5 million to $3.9$4.7 million for the three months ended June 30, 2021,March 31, 2022, as compared to the same period in 2020.2021. Managed Services revenue decreased $0.8slightly by $0.1 million due to the impact of some customers canceling contracts, delaying renewals and a slowdown in net new customers due to the COVID-19 and customers holding off on purchasing or trying to reduce budgets.pandemic. Consulting and professional services increased $0.1$0.6 million due to what we believecustomers increasing spend as they start to beget back to normal buying patterns after a period of reduced spending in response to the start of a rebound from customers pulling back last year as a result of COVID-19.COVID-19 pandemic.

Cost of Revenue

Cost of revenue consists primarily of salaries and related expenses of direct labor and indirect support staff. Cost of revenue was $2.1$2.8 million for the three months ended June 30, 2021,March 31, 2022, as compared to $3.3$2.1 million for the same period in 2020. We reduced salary and related costs associated with our reduction in force by approximately $0.7 million2021. The increase was due to the lower revenueprior year benefitting from COVID-19 and received athe $0.5 million benefit from the employee retention credit provided under the CARES Act.Act, an additional $0.1 million in additional compensation due to increased cost of labor and $0.1 million in higher costs associated with third party tools required to deliver our services.

Gross margin was 46%up 1% to 40% of revenue for the three months ended June 30, 2021.March 31, 2022. After adjusting for the prior year benefit from the employee retention tax credit, gross margin was 33%, compared to 27%39% for the same period in 2020.2021. Margins improved as a result of targeted expense reductions we made over the last few quarters in reactionhigher revenue allowing us to the lower revenue due to COVID-19.better leverage our operational overhead support.

Sales and Marketing

Sales and marketing expenses include salaries, commissions and expenses for sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses decreased towere flat at $1.2 million for each of the three months ended June 30, 2021, as compared to $1.7 million for the same period in 2020.March 31, 2022 and 2021. This decrease was due to $0.4$0.1 million in lower marketinghigher travel and sales support payrolltrade show expenses as we get back on the road as part of business development and benefit costs from the headcount reductions due to COVID-19 and recent turnover in our sales team, andgrowth initiatives offsetting $0.1 million of employee retention tax credits provided under the CARES Act offset by $0.1 million in recruiting costs to bring on a new sales leader and additional direct sales leads.for 2021.

General and Administrative

General and administrative expenses include personnel costs for finance, administration, information systems, general management, facilities expenses, professional fees, legal expenses and other administrative costs including those required to be a publicly traded company. General and administrative expenses decreased $0.3$0.2 million to $1.5 million for the three months ended June 30, 2021,March 31, 2022, compared to $1.8$1.7 million for the three months ended June 30, 2020.March 31, 2021. The decrease is due to $0.2$0.1 million less in lower payroll and benefit related costsprofessional fees due to the expense reduction efforts taken in reaction to the2021 being higher and lower revenue from COVID-19, andstock-based compensation offsetting $0.1 million of employee retention tax credits provided under the CARES Act.Act for last year.

Change in Valuation of Contingent Earn-out

We performed a valuation of the contingent earn-out to the sellers of Backbone Enterprises, Inc. as of June 30, 2021 which resulted in a reduction of the previous estimate of $1,300,000 related to the potential for payout for not meeting earn-out criteria in the final two years of the annual earn-out measurement periods.

Depreciation

Depreciation expense was consistent at $48,000 for each of the three months ended June 30, 2021, compared to $46,000 for the same period in 2020.March 31, 2022 and 2021.

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Amortization of Acquisition-Related Intangibles

Amortization of acquisition-related intangibles was consistent at $0.3 million for each of the three months ended June 30, 2021, compared to $0.4 million for the three months ended June 30, 2020. Amortization expense decreased over the comparable periods as a portion of the intangible assets became fully amortizedMarch 31, 2022 and an impairment loss of $0.9 million that was recognized at the end of 2020.2021.

Finance Cost for Equity Commitment

In April 2020 we issued a warrant to an investor in return for an obligation by them to purchase our common stock as a stated price. The fair value of this warrant of $390,000 was recorded as an expense at the time of issuance.

Net Interest Expense

Net interest expense for the three months ended June 30, 2021,March 31, 2022 was $17,000,$2,000, compared to net interest expense of $26,000$20,000 for the same period in 2020.2021. The decrease was due to lower interest expense from a lower outstanding debt balance from the paydown of the Seller note.Note.

Income Tax Benefit

Income tax expensebenefit for the three months ended June 30,March 31, 2022 and 2021 was $20,000, compared to income tax benefit of $0.7 million for the same period in 2020.$0.3 million. These amounts were based on estimated annual income tax rates we anticipate for the year.

For the Six Months Ended June 30, 2021, Compared to the Six Months Ended June 30, 2020

Revenue

Revenue decreased $1.6 million to $8.1 million for the six months ended June 30, 2021, as compared to the same period in 2020. Managed Services revenue decreased $1.3 million due to the impact of some customers canceling contracts, delaying renewals and a slowdown in net new customers due to COVID-19 and customers holding off on purchasing or trying to reduce budgets.  Consulting and professional services decreased $0.3 million primarily due to lower revenue from two customers who completed contract work in the first half of 2020 and less business as a result of COVID-19, customers holding off on delivery of previously sold professional services as they attempt to minimize spend with third-party contractors or prospects limiting their purchasing of new services as they look to reduce budgets.

Cost of Revenue

Cost of revenue was $4.2 million for the six months ended June 30, 2021, as compared to $6.8 million for the same period in 2020. We reduced salary and related costs associated with our reduction in force by approximately $1.6 million due to the lower revenue from COVID-19 and received a $1.0 million benefit from the employee retention credit provided under the CARES Act.

Gross margin was 48% of revenue for the six months ended June 30, 2021, and 30% for the same period in 2020. After adjusting for the benefit from the employee retention tax credit in 2021, gross margin was 38%. Margins improved as a result of targeted expense reductions we made over the last few quarters in reaction to the lower revenue due to COVID-19.

Sales and Marketing

Sales and marketing expenses decreased to $2.5 million for the six months ended June 30, 2021, as compared to $3.2 million for the same period in 2020.  This decrease was due to $0.5 million in lower marketing and sales support payroll and benefit costs from the headcount reductions due to COVID-19, $0.1 million less in travel costs due to COVID-19 related travel restrictions and $0.2 million of employee retention tax credits provided under the

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CARES Act and is offset by $0.1 million in recruiting costs to bring on a new sales leader and additional direct sales leads.

General and Administrative

General and administrative expenses decreased $0.8 million to $3.1 million for the six months ended June 30, 2021, compared to $3.9 million for the same period in 2020. The decrease is due to $0.4 million in lower payroll and benefit related costs due to the expense reduction efforts taken in reaction to the lower revenue from COVID-19, $0.1 million less in travel costs due to COVID-19 related travel restrictions, $0.1 million less in professional fees due to 2020 being higher due to strategic advisory and recruiting costs, and $0.2 million of employee retention tax credits provided under the CARES Act.

Change in Valuation of Contingent Earn-out

We performed a valuation of the contingent earn-out to the sellers of Backbone Enterprises, Inc. as of June 30, 2021, which resulted in a reduction of the previous estimate of $1,300,000 related to the potential for payout for not meeting earn-out criteria in the final two years of the annual earn-out measurement periods.

Depreciation

Depreciation remained relatively consistent at $96,000 for the six months ended June 30, 2021, as compared to $93,000 for the same period in 2020.

Amortization of Acquisition-Related Intangibles

Amortization of acquisition-related intangibles was $0.7 million for the six months ended June 30, 2021, compared to $0.8 million for the six months ended June 30, 2020. Amortization expense decreased over the comparable periods as a portion of the intangible assets are now fully amortized.

Finance Cost for Equity Commitment

In April 2020 we issued a warrant to an investor in return for an obligation by them to purchase our common stock as a stated price. The fair value of this warrant of $390,000 was recorded as an expense at the time of issuance.

Net Interest Expense

Net interest expense for the six months ended June 30, 2021, was $37,000, compared to $44,000 for the same period in 2020. The decrease was due to lower outstanding debt balance from the paydown of the Seller note.

Income Tax

Income tax benefit for the six months ended June 30, 2021, was $0.3 million, compared to income tax benefit of $1.2 million for the same period in 2020. These amounts were based on estimated annual income tax rates we anticipate for the year.

Liquidity and Capital Resources

As of June 30, 2021,March 31, 2022, our cash balance was $4.0$1.2 million, current assets minus current liabilities was positive $6.7$3.8 million and we have no long-term liabilities. In April of 2022 we received our non-current debt and lease obligations totaled $2.8 million. This $2.8$1.4 million of debt is related to the U.S. Small Business Administration (“SBA”) Paycheck Protection Program loan (the “PPP Loan”), received pursuant to the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), that was forgiven in August 2021 as described in Note 9 to the unaudited condensed consolidated financial statements.tax refund. 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:

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

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. WeAs of the date of this Report on Form 10-Q, we are currently operating in agenerating negative cash flow negative position while we seek to maintain and grow our cybersecurity business and cover our public company expenses during this uncertain time. In connection with our most recent results for the six months ended June 30, 2021, we reported a loss from operations of $1.2 million after excluding non-cash items for depreciation, amortization of intangibles, stock-based compensation and our overall revenue and business levels have been impacted by the change in valuation ofCOVID-19 pandemic over the contingent earnout. Cash used in operating activities was $1.3 million for the six months ended June 30, 2021.

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.past twenty-four months. Our customer base is heavily concentrated in the healthcare provider space. The healthcare industry has experienced significant financial lossesand operational disruption due to the pandemic and are still contending with strained budgets but are showing signs of re-engagement.pandemic. Sales cycles are longer, cybersecurity projects have been delayed and pricing pressure is constant.  The resurgence ofbudgets have been constrained as healthcare providers focus on patient care and navigating the virus with the Delta Variant has caused some to return to operating with caution. Our operations team is closely monitoring the impact to the Company’s business, including its cash flows, customers and employees. We have heard and are working with a number of our active customers since the outbreak began providing relief in the form of extended payment terms and other contractual restructurings.pandemic. If the situationpandemic continues toor there are resurgences in 2022 that impact our customers’ cash flow oroperations and resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results for fiscal year 20212022 and beyond willcould be negatively impacted.

We did experience a negative financial impact from MarchDuring 2020 through June 2021 that management anticipates will continue to impact revenue and earnings for the foreseeable future due to COVID-19, primarily because many of the initial economic effects of the early stages of the COVID-19 pandemic resulting from the various shelter-in-place and other social distancing orders occurred towards the end of our first quarter of 2020. The severity and duration of the COVID-19 pandemic is uncertain, and such uncertainty will likely continue in the near term. 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 through the first quarter of 2021, we reduced staffing levelstook actions to reduce expenses, that included permanentconserve cash, and temporary cost reductions, the precise extent of which will depend on the duration of the COVID-19 disruptions to our customers and our short-term financial performance.raise additional capital. During 2021, we raised $1.4 million in additional capital through an “at-the-market” or ATM offering. In addition, we received thea $2.8 million PPP Loan pursuant(as described in Note 8 to the CARES Act,condensed consolidated financial statements below) which we anticipate will bewas fully forgiven and wein August 2021. We also received and anticipate having approximately $0.7 million per quarter in employee retention tax credits in the first second and thirdthree quarters of 2021.2021 and a $1.4 million tax refund in April 2022. With the proceeds from the tax refund, PPP Loan and the employee retention tax credits, we have triedwere able to minimize staff reductions in the areas of Sales and Delivery, our primary customer facing roles, to lessen the impact to our customers during this time of heightened security risks for the healthcare industry. If necessary, we could further reduce personnel and other variable and semi-variable costs to conserve cash and operate as a going concern. However, those actions if required, could negatively impact our ability to grow the business as well as the overall long-term outlook of the business.

On November 12, 2020, we entered into an Equity Distribution Agreement with Craig-Hallum Capital Group LLC (the “Agent”), under which we may offer and sell, from time to time at our sole discretion, shares of our common stock having an aggregate offering price of up to $5.0 million in an “at-the-market” or ATM offering, to or through

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the Agent.  The Company agreed to pay the Agent a commission of three percent (3.0%) of the gross sales price per share of any common stock sold through the Agent under the Equity Distribution Agreement.

During November and December of 2020, the Company received gross proceeds under the Equity Distribution agreement of $2,027,000 from the issuance of 1,315,000 shares of our common stock and paid an aggregate of $61,000 to the Agent in commissions and $123,000 in other offering-related expenses, yielding net proceeds of $1,843,000.

We believe that our existing sources of liquidity, including cash and cash equivalents, the proceeds from the PPP Loan, employee retention tax credits and tax refunds from NOL carrybacks, the ability to raise equity under our shelf registration (including viaeffective Registration Statement on Form S-3 as well as our ability to manage the Equity Distribution Agreement) and future operating cash flows, and other assetsbusiness to decrease expenses if necessary, will be sufficient to meet our projected capital needs for at least the next twelve months. As we execute our plans over the next twelve months, we intend to carefully monitor the impact of growth initiatives 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 lingering impact of the COVID-19 pandemic will likely continue toand ongoing geopolitical tensions and related economic sanctions 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.

The impactaccompanying condensed 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 COVID-19 pandemic on the economy and our operations is fluid and constantly evolving; we willCompany be unable to continue to assessas a variety of measures to improve our financial performance and liquidity.going concern.

Application of Critical Accounting Policies and Estimates

The SEC defines critical accounting policies as those that are, in management’s view, most important to the portrayal of our financial condition and results of operations and most demanding of our judgment. The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which were prepared in accordance with accounting principles generally accepted in the U.S., which is referred to as “GAAP.” The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate these estimates, including those related to stock-based compensation, customer programs and incentives, bad debts, intangible assets, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We consider the following accounting policies to be those most important to the portrayal of our financial condition and those that require the most subjective judgment:

Revenue Recognition and Deferred Revenue

We operate under a consolidated strategy and management structure, deriving revenue from the following sources:

·Managed services 

Revenue is recognized pursuant to ASCAccounting Standard Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers”. Accordingly, revenue is recognized at an amount that reflects the consideration to which we expect to be entitled in exchange for transferring goods or services to a customer. This principle is applied using the following 5-step process: