CYNERGISTEK, INC.

FORM 10-Q

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

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

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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTSTATEMENTS OF STOCKHOLDERS’ EQUITY

NINETHREE MONTHS ENDED SEPTEMBERJUNE 30, 20172022 and 2021

(UNAUDITED)

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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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CYNERGISTEK, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NINESIX MONTHS ENDED SEPTEMBERJUNE 30, 20172022 AND 20162021

(UNAUDITED)

1.BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Cynergistek,CynergisTek, Inc. and its subsidiaries (the “Company”, “we”, “us”“Company,” “we,” “us,” or “Cynergistek”“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, 2016,2021, as filed with the Securities and Exchange Commission (“SEC”)SEC on March 29, 2017.28, 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 CynergistekCynergisTek and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

Based on our integration strategies, and management strategies,an analysis of how our Chief Operating Decision Makers review, manage and are compensated, we operate in a single businesshave determined that the Company operates as one segment. For the periods presented, all revenues were derived from domestic operations.

As described in more detail in our Current Report on Form 8-K filed with the Securities and Exchange Commission on September 8, 2017, Auxilio, Inc., a Nevada corporation (“Auxilio”) changed its name and state of incorporation from the State of Nevada to the State of Delaware by merging (the “Reincorporation”) with and into its wholly-owned subsidiary, CynergisTek, Inc., a Delaware corporation, which was established for the purpose of the Reincorporation.   As a result of the Reincorporation, Auxilio ceased to exist as a separate entity.  As of the date of the merger, each outstanding share of Auxilio’s common stock was deemed, by operation of law, to represent the same number of shares of our common stock.  In accordance with Rule 12g-3 under the Securities Exchange Act of 1934, as amended, the shares of our common stock were deemed to be registered under Section 12(b) of the Exchange Act as a successor to Auxilio.  Effective as of September 8, 2017, the Company’s trading symbol changed to “CTEK.”  

As part of the Reincorporation, two wholly owned subsidiaries of the Company also changed their corporate names, as follows: (i) Auxilio Solutions, Inc., a California corporation, has changed its name to CTEK Solutions, Inc.; and (ii) CynergisTek, Inc., a Texas corporation, has changed its name to CTEK Security, Inc. (“CTEK Security”).  

We have performed an evaluation of subsequent events through the date of filing these unaudited condensed consolidated financial statements with the SEC.

Effective

On May 23, 2022, we entered into the Merger Agreement (defined below) as described in Note 2 to the condensed consolidated financial statements below.

Liquidity and Capital Resources

As of June 30, 2022, our cash balance was $1.4 million, current assets minus current liabilities was positive $2.4 million and we have no long-term liabilities. In April of 2022 we received a $1.4 million tax refund and in August of 2022 we delivered a revolving promissory note to Clearwater (defined below) in the principal amount not to exceed $750,000 in connection with the Clearwater Revolving Loan (defined below), as described in Note 10 to the condensed consolidated financial statements below. 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. As of the date of this Report on January 13, 2017,Form 10-Q, we are generating negative cash from operations and our overall revenue and business levels have been impacted by the COVID-19 pandemic over the past twenty-four months. Our customer base is heavily concentrated in the healthcare provider space. The healthcare industry has experienced financial and operational disruption due to the pandemic. Sales cycles are longer, cybersecurity projects have been delayed and budgets have been constrained as healthcare providers focus on patient care and navigating the pandemic. If the pandemic continues or there are resurgences in 2022 and beyond that impact our customers’ operations and resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results for fiscal year 2022 and beyond could be negatively impacted.

During 2020 and 2021, we took actions to reduce expenses, conserve cash, and 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 a $2.8 million PPP Loan (as described in Note 9 to the condensed consolidated financial statements below) which was fully forgiven in August 2021. We also received approximately $0.7 million per quarter in employee retention tax credits in the first three quarters of 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 were 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.

We recently delivered a revolving promissory note in the principal amount up to $750,000 to Clearwater which allows the Company effected a reverse stock splitto draw upon the available credit in increments of at least $50,000 as and when needed, as described in Note 10 to the condensed consolidated financial statements below.

We believe that our existing sources of liquidity, including cash and cash equivalents, the ability to raise equity under our effective Registration Statement on Form S-3, the $750,000 Clearwater Revolving Loan as well as our ability to manage the business to decrease expenses, if necessary, will be sufficient to meet our projected capital needs for at least the next twelve months. If the Merger does not consummate in the short-term, 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. Based on the Company’s current liquidity, and its common stockpotential merger-related costs, including payments which would be accelerated under the revolving promissory note if the merger were not consummated, it is anticipated that the Company would be required to raise additional capital to meet its obligations and such capital may not be available, or may not be available on acceptable terms at a ratiothat time. 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 1-for-3. No fractional sharesthe COVID-19 pandemic, the conflict in Ukraine and related sanctions against Russia and Belarus, and inflationary pressures (including specifically, but not limited to, human capital costs which are essential to CynergisTek’s business), as well as the impact that such uncertainty has had, and could continue to have, on CynergisTek’s customers and industry and business and operating results 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 accompanying condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of common stock were issued,recorded asset amounts and no cash or other consideration were paidclassification of liabilities that might be necessary should the Company be unable to continue as a resultgoing concern.

2. PENDING MERGER WITH CLEARWATER COMPLIANCE LLC

On May 23, 2022, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Clearwater Compliance LLC, a Tennessee limited liability company ( “Clearwater”), and Clearwater Compliance Acquisition Company I, a Delaware corporation and a wholly owned subsidiary of the reverse stock split. Instead,Clearwater (the “Merger Sub”). Clearwater is a portfolio company of funds affiliated with Altaris Capital Partners, LLC. The Merger Agreement provides, subject to its terms and conditions, for the acquisition of the Company issued one whole shareby Clearwater through the merger of post-reverse stock split common stock in lieuMerger Sub with and into the Company, with the Company surviving the Merger as a wholly owned subsidiary of each fractional share of common stock. Clearwater (the “Merger”).

As a result of the reverse stock split, the Company’sMerger, each share of common stock was reducedof the Company (“Common Stock”) that is issued and outstanding immediately prior to 8,185,936the effective time of the Merger (the “Effective Time”) (other than shares from 24,557,224owned by any subsidiary of the Company, the Merger Sub, Clearwater or any other subsidiary of Clearwater immediately prior to the Effective Time (all of which will be canceled) and shares asheld by any holder who is entitled to, and who has perfected, appraisal rights under Delaware law) will be automatically converted into the right to receive cash in an amount of December 31, 2016. All$1.25 per share, amountswithout interest, subject to any required withholding of taxes (the “Merger Consideration”). Additionally, each outstanding and numberunexercised Company stock option at the Effective Time shall vest in full and automatically be canceled and converted into the right to receive the excess, if any, of sharesthe Merger Consideration over the exercise price per share of such stock option; provided that, in the unaudited condensed consolidated financial statementsevent that the exercise price of any such stock option is equal to or greater than the Merger Consideration, such stock option will be canceled, without any consideration being payable in respect thereof and related notes have been retroactively

Tableno further force or effect; and each Company restricted stock unit that is then outstanding and unvested shall vest in full and automatically be canceled and converted into the right to receive the Merger Consideration. Also, at or prior to the Effective Time, any outstanding but unexercised warrants to purchase Common Stock shall be canceled and, in certain circumstances, payment therefor will be paid to such warrant holders in accordance with the terms of Contentstheir respective warrants.

restated

In connection with the negotiation and execution of the Merger Agreement, the Company has incurred legal, consulting and accounting fees of approximately $406,000 through the quarter ended June 30, 2022.

A special meeting of stockholders of the Company will be held at 3:00 p.m. Central Time on August 31, 2022, to reflectapprove and adopt the reverse stock split resulting inMerger Agreement and approve the reclassification of $15,749 from common stock to additional paid in capital at January 1, 2015.Merger, among other matters.

Certain accounts have been reclassified to conform to current period presentation.

23.RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

Recently Issued Accounting Pronouncements Not Yet Adopted

In November 2015,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 presentation of deferred income taxes.carrying amount under the current, other-than-temporary-impairment model. The guidance requires that deferred tax assets and liabilities be classified as non-current in the condensed consolidated balance sheet. This guidance was adopted early by us and resulted in the Company classifying its deferred tax assets as non-current assets.

In May 2014, the FASB issued guidance which provides a single, comprehensive accounting model for revenue arising from contracts with customers. 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. Considering the one-year delay in the required adoption date for the guidance as issued in July 2015, the new guidance is effective for us beginning in 2018 and may be applied retrospectively to all prior periods presented or through a cumulative adjustment to the opening retained earnings balance in the year of adoption. We will adopt this standard beginning January 1, 2018 and expect to use the modified retrospective method of adoption. Under the new guidance, based on the nature of our contracts, we expect to continue to recognize revenue in a similar manner as with the current guidance. Additionally, we expect the unit of accounting, that is, the identification of performance obligations, will be consistent with current revenue guidance. Accordingly, the adoption of this standard is not expected to have a material impact on our revenues.

In March 2016, the FASB issued a new accounting standard regarding stock compensation: improvements to employee share-based payment accounting, that simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new standard was effectivesmaller reporting companies for fiscal years beginning after December 15, 2016,2022, including interim periods within those fiscal years. Early adoption is permitted for annual years, and early adoption was permitted. We adopted the new standard prospectively in 2017. The adoption of the new standard did not have a material effect on our unaudited condensed consolidated financial statements for the three months and nine months ended September 30, 2017, and we doperiods after December 15, 2018. Management does not expect that the adoption of the new standard will have a material effect on our consolidated financial statements for the year ended December 31, 2017.

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 expense. Thisimpact from 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 incomeconsolidated financial statements.

4. DEFERRED COMMISSIONS

Our incremental costs of obtaining a contract, which consist of sales commissions, are deferred and amortized over the period of contract performance. Deferred commissions are included in prepaid and other current assets in our consolidated balance sheets. We had $553,000 and $760,000 of unamortized deferred commissions as of June 30, 2022, and December 31, 2021, respectively. We had $241,000 and $406,000 of commissions expense for the three and six months ended June 30, 2022, respectively. Commissions expense for the three and six months ended June 30, 2021, was $184,000 and $367,000, respectively.

5. PROPERTY AND EQUIPMENT

A summary of property and equipment follows:

6. 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. This lease term expired on January 31, 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 expired 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 equity.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 January 2017,cases where the FASBdiscount 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.

For all asset classes, we elected to (i) not recognize a right-of-use asset and lease liability for leases that we leased 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:

7. INTANGIBLE ASSETS

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

8. DEFERRED REVENUE

We record deferred revenues when amounts are billed to customers, or cash is received from customers, in advance of our performance. During the three months ended June 30, 2022 and 2021, $575,000 and $654,000, 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, 2022 and 2021, $276,000 and $243,000, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.

During the six months ended June 30, 2022 and 2021, $833,000 and $798,000, respectively, of managed services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods. During the six months ended June 30, 2022 and 2021, $681,000 and $260,000, respectively, of consulting and professional services revenues were recognized, that were included in deferred revenue at the beginning of the respective periods.

9. PAYCHECK PROTECTION PROGRAM LOAN

On April 20, 2020, we received $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”) is 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 on April 20, 2020.

The Company recognized interest charges of approximately $7,000 and $14,000, respectively for the three and six months ended June 30, 2021. The Company received notice from the SBA in August 2021 that the full principal balance and related interest were forgiven.

10. PROMISSORY NOTES

In connection with the acquisition of CTEK Security, Inc. (formerly CynergisTek, Inc.), we issued a new accounting standard simplifyingpromissory note totaling $4,500,000 to Michael McMillan (the “Seller Note”). In March 2018, the testCompany 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 bore interest at a rate of 8% per annum, provided for goodwill impairment. Currently,quarterly payments of principal and interest and matured on March 31, 2022. As of June 30, 2022, and December 31, 2021, the outstanding principal balance due under the Seller Note was $0 and $0.1 million, respectively.

Interest charges associated with the Seller Note totaled approximately $0 and $2,000, respectively for the three and six months ended June 30, 2022, and $10,000 and $23,000, respectively for the three and six months ended June 30, 2021.

In August of 2022, we issued a revolving promissory note in a principal amount of up to $750,000 to Clearwater (the “Clearwater Note”). The Clearwater Note bears interest at a rate of 10.0% per annum and provides for quarterly payments of principal and interest. CynergisTek may make advances under the Clearwater Note in such amounts and at such times as we request from time to time in increments of at least $50,000, but not more than $750,000 in the aggregate (“the Clearwater Revolving Loan”).

The Clearwater Note matures and any remaining outstanding principal balance and all accrued and unpaid interest shall become due and payable upon the earliest to occur of (i) the five-year anniversary of the date hereof, (ii) the termination of the Merger Agreement, or (iii) the incurrence by CynergisTek or any of its subsidiaries of any debt of any kind whatsoever from a third party, other than payables incurred in the ordinary course of business; provided, however, that (x) if the Merger Agreement is terminated pursuant to Sections 7.1(a), 7.1(b), 7.1(c), 7.1(d), or 7.1(g) of the Merger Agreement, then all outstanding principal and interest under the Clearwater Note shall be due and payable by the 60th day following such termination; and (y) if the Merger Agreement is terminated in connection with the entry into an Acquisition Transaction (as such term is defined in the Merger Agreement), then CynergisTek shall be required to repay all outstanding interest and principal then due under the Clearwater Note as a condition to, and prior to or concurrently with, the termination of the Merger Agreement by CynergisTek.

11. REVENUES

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

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 $2.5 million of shares of the Company’s common stock over the term of the agreement, at the election of the Company. The Stock Purchase Agreement expired on March 31, 2021. No purchases were made under the Securities Purchase Agreement.

Upon signing the 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 $0.4 million was determined using the Black-Scholes option-pricing model and was expensed during the second quarter of 2020.

During 2020 and 2021, the Company issued common stock under the Equity Distribution Agreement that resulted in required anti-dilution adjustments. These adjustments increased the number of shares under the Horton Warrant to 524,170 and reduced the exercise price to $2.38. The resulting difference in fair value of the reporting unitHorton Warrant was $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 dividends were recorded within additional paid-in capital.

The Horton Warrant provides that in the event of a fundamental transaction, including the consolidation or merger of CynergisTek with or into another person (such as the Merger as described in Note 2 to the condensed consolidated financial statements above), CynergisTek may elect to purchase the Horton Warrant from the holder thereof by paying an amount of cash equal to the Black Scholes Value (as determined based on the Black and Scholes Option Pricing Model obtained from the “OV” function on a Bloomberg Terminal as of the day of consummation of the applicable fundamental transaction, as described in the Horton Warrant) of the remaining unexercised portion of the Horton Warrant, subject to a cap of $300,000. Because the actual Black Scholes Value of the remaining unexercised portion of the Horton Warrant is compared withprojected to exceed the carryingcap, CynergisTek will be required, prior to the Merger, to purchase or cancel the Horton Warrant in exchange for payment of $300,000. The payment of such amount for the cancellation of the Horton Warrant has been included in the overall equity value of the reporting unit (identified as "Step 1"). If the fair valueproposed Merger transaction.

The detailed terms and conditions of the reporting unitHorton 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 lower than its carrying amount, thena summary of warrant activities during the implied fair valuesix-month period ended June 30, 2022:

2020 Equity Incentive Plan

The 2020 Equity Incentive Plan provides for a total number of goodwill is calculated. Ifshares available for issuance of 3,745,621 shares of our common stock, and it provides for the implied fair valuegranting of goodwill is lower than the carrying value of goodwill an impairment is recognized (identified as "Step 2"). The new standard eliminates Step 2 from the impairment test; therefore, a goodwill impairment will be recognized as the differencestock options, stock appreciation rights, restricted stock units and restricted stock to our employees, members of the fair valueBoard of Directors and service providers. As of June 30, 2022, there were 211,000 shares available for issuance under 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.

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3.OPTIONS, WARRANTS AND RESTRICTED STOCK UNITSPlan.

Below is a summary of stock option warrantactivities during the six-month period ended June 30, 2022:

Each stock option (whether vested or unvested) that is outstanding as of immediately prior to the Merger as described in Note 2 to the condensed consolidated financial statements above shall vest in full effective immediately prior to the Merger and shall automatically be canceled and converted into the right to receive an amount in cash, without interest, equal to the product of (i) the total number of shares of CynergisTek common stock underlying such stock option, multiplied by (ii) the excess, if any, of the Merger Consideration over the applicable exercise price per share of such stock option. Because the applicable exercise price of all stock options is greater than the Merger Consideration, all stock options will be canceled at the time of the Merger without any consideration.

Below is a summary of restricted stock unit activity during the nine-monthsix-month period ended SeptemberJune 30, 2017:2022:

During the nine months ended September 30, 2017, we granted a total of 25,000 options to our employees and directors to purchase shares of our common stock at an exercise price of $3.06 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 was determined using the Black-Scholes option-pricing model.  The assumptions used to calculate the fair market valueThere are as follows: (i) risk-free interest rate of 0.38%; (ii) estimated volatility of 46.29%; (iii) dividend yield of 0.0%; and (iv) expected life of the options of three years.

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During the nine months ended September 30, 2017, we issued a total of 130,000232,800 shares of restricted stock units to key employees and memberswhich have vested but had not yet been issued as of the Board of Directors. The shares vest after three years of continuous employment. The average price of the stock on the grant date was $4.78. The cost recognized for theseJune 30, 2022.

Each restricted stock units totaled $54,163unit that is outstanding and $98,347, respectively, forunvested as of immediately prior to the threeMerger shall vest in full, effective immediately prior to the Merger, and nine months ended September 30, 2017,shall automatically be canceled and is includedconverted into the right to receive from an amount in sales and marketing expense incash, without interest, equal to the accompanying Condensed Consolidated Statementproduct of Operations.(i) the aggregate number of shares of CynergisTek common stock underlying the restricted stock unit multiplied by (ii) the Merger Consideration.

For the three and ninesix months ended SeptemberJune 30, 20172022 and 2016,2021, stock-based compensation expenseand other equity instrument related expenses recognized in the consolidated statements of operations were as follows:

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4.NET INCOME PER SHARE13. Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Realization of deferred tax assets is dependent on future earnings, if any, the timing and amount of which is uncertain. A valuation allowance, in an amount equal to the net deferred tax asset of $6,853,130 as of June 30, 2022 has been established to reflect these uncertainties.

14. BASIC AND DILUTED NET LOSS PER SHARE

Basic net incomeloss 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 incomeloss 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 incomeloss 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 SeptemberJune 30, 2017,2022, potentially dilutive securities consisted of options and warrants to purchase 1,416,7471,484,452 shares of common stock at prices ranging from $0.90$1.44 to $6.45$3.30 per share. Of these potentially dilutive securities, 379,476none 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 449,450 shares of non-vested restricted stock units and 232,800 shares of restricted stock units which vested but had not been issued as of June 30, 2022.