| (1) Basis of Presentation and Summary of Significant Accounting Policies | (1) Basis
of Presentation and Summary of Significant Accounting Policies Business Activity 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 and compliance services. Liquidity and Capital Resources As of December 31, 2020, our cash balance
was $5.6 million, current assets minus current liabilities was positive $7.7 million and our non-current debt and lease obligations, excluding
contingent earnout liability of $1.3 million, totaled $3.0 million. This includes $2.8 million of debt related to the U.S. Small Business
Administration (“SBA”) Paycheck Protection Program (“PPP”) loan, received pursuant to the Coronavirus Aid, Relief,
and Economic Security Act (“CARES Act”), that we anticipate will be fully forgiven as described in Note 9. The level of additional
cash needed to fund operations and our ability to conduct business for the next twelve months will be influenced primarily by the following
factors:
· our ability to manage our operating expenses and maintain gross margins while attracting, recruiting and retaining cybersecurity privacy
professionals;
· demand for our services from healthcare providers; the near-term impact of the COVID-19 on our customers allocation of time and resources
to security and privacy, and their ability to pay for existing services as well as enter into new contractual arrangements during a period
of crisis;
· general economic conditions and changes in healthcare reimbursement and regulatory environment, including effects of the COVID-19
epidemic; and
· our ability to collect accounts receivable from health care customers whose operations and cash flow have been significantly impacted
by COVID-19 pandemic. We have historically funded our operating
costs, acquisition activities, working capital requirements and capital expenditures with cash from operations, proceeds from the issuances
of our common stock and other financing arrangements. Following the sale of the MPS Business in 2019, we are now a much smaller cybersecurity
and privacy focused business with significantly lower debt balances and debt service obligations. However, we also have less scale over
which to leverage our operating expenses and public company expenses and are currently operating in a cash flow negative position while
we seek to maintain and grow our cybersecurity business during this uncertain time. Our most recent results for the most recent three
months ended December 31, 2020, we reported a loss from operations of $16.3 million. After excluding $15.9 million of non-cash items for
depreciation, amortization of intangibles, stock-based compensation, change in valuation of contingent earn-out and impairment of intangible
assets and goodwill our adjusted loss from operations was $0.3 million. Cash used in operating activities was $0.4 million for the three
months ended December 31, 2020. Additionally, since September 30, 2020 we saw an increase in our pre-sold revenue of $1.6 million to $17.2
million, at December 31, 2020. In late 2019, a novel strain of coronavirus
(COVID-19) was first detected in Wuhan, China. Following the outbreak of this virus, governments throughout the world, including in the
United States of America, have quarantined certain affected regions, restricted travel and imposed significant limitations on other economic
activities. Our customer base is heavily concentrated in the healthcare provider space. This part of the healthcare industry has indicated
that they are seeing significant financial losses, have furloughed employees and are expressing uncertainty as to the short and long-term
financial stability of their businesses. 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. If the situation continues to impact our
customers cash flow or resources available for cybersecurity and privacy projects, our cash flows, financial position and operating results
for fiscal year 2021 and beyond will be negatively impacted. We did experience a negative financial impact
from March through the end of 2020 that will continue to impact revenue and earnings for the foreseeable future due to COVID-19, primarily
since many of the initial economic effects of the early stages of the COVID-19 pandemic resulting from the various shelter-in-place and
other social distancing orders occurred towards the end of our first quarter of 2020. The severity and duration of the COVID-19 pandemic
is uncertain and such uncertainty will likely continue in the near term and we will continue to actively monitor the situation taking
into account the impact to our employees, customers and partners. At the end of 2019 and throughout 2020 we
reduced staffing levels to reduce expenses that included permanent 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. In addition, we received a $2.8
million PPP loan CARES Act, which we anticipate will be fully forgiven. With the proceeds from the PPP Loan we have tried to minimize
staff reductions in the areas of Sales and Delivery, the 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 the long-term
outlook of the business. On November
12, 2020, we entered into the Equity Distribution Agreement with 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. Through
December 31, 2020, the Company received gross proceeds under the 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, the ability to raise equity under our shelf registration (including
via the Equity Distribution Agreement) and future operating cash flows, and other assets 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
on our operating expenses, working capital needs and cash balances relative to the availability of cost-effective debt and equity financing.
In the event that capital is not available, we may then have to scale back operations, reduce expenses, and/or curtail future plans to
manage our liquidity and capital resources. However, we cannot provide assurance that we will be able to raise additional capital. The
COVID-19 pandemic will likely continue to create uncertainty and volatility in the financial markets which may impact our operations and
our ability to access capital and/or the terms under which we can do so. The impact of the COVID-19 pandemic on the
economy and our operations is fluid and constantly evolving; we will continue to assess a variety of measures to improve our financial
performance and liquidity. The accompanying consolidated financial statements
do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities
that might be necessary should the Company be unable to continue as a going concern. Basis of Presentation The accompanying consolidated financial statements were prepared
in conformity with Generally Accepted Accounting Principles (GAAP), and include the accounts of CynergisTek, Inc. and our wholly owned
subsidiaries. All intercompany balances and transactions were eliminated. 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 Reincorporation, 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.” Certain prior year balances have been reclassified to conform
to current period presentation. This includes adjusting our previously issued consolidated balance sheet for the year ended December 31,
2019 to gross up and reclassify unbilled services to a separate line item in current assets from deferred revenues. The consolidated statement
of cash flows for the year ended December 31, 2019 was also reclassified to reflect this change. The reclassification did not have any
impact on the consolidated statements of stockholders’ equity nor the consolidated statements of operations. The Company analyzed
the impact of the reclassification and determined that the adjustment was not material to its previously issued and audited consolidated
financial statements. Use of Estimates 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 and disclosure of
contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Revenue Recognition and Deferred Revenue Revenue is recognized pursuant to 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: 1. Identify the contract
with the customer 2. Identify the performance
obligations in the contract 3. Determine the transaction
price 4. Allocate the transaction
price to the performance obligations in the contract 5. Recognize revenue
when (or as) each performance obligation is satisfied Managed Services Managed services contracts are typically
long-term contracts lasting three years. Revenue is earned monthly during the term of the contract, as services are provided at a fixed
fee and is recognized ratably over the contract term beginning on the commencement date of the contract. Revenue related to managed services
provided is recognized based on the customer utilization of such resources, which management estimates to occur ratably over the customer
contract term. Consulting and Professional Services Consulting and professional services contracts
are typically short-term, project-based services rendered on either a fixed fee or a time and materials basis. These contracts are normally
for a duration of less than one year. For fixed fee arrangements, revenue is recognized ratably over the expected term of the project.
For time and materials arrangements, revenues are recognized as the services are rendered. Deferred and Unbilled Revenue We receive payments from customers based on billing schedules
established in our contracts. Deferred revenue primarily consists of billings or payments received in advance of the amount of revenue
recognized and such amounts are recognized as the revenue recognition criteria are met. Unbilled revenue reflects our conditional right
to receive payment from customers for our completed performance under contracts. Cash and Cash Equivalents For purposes of the statement of cash flows and balance sheet
classification, cash equivalents include all highly liquid debt instruments with original maturities of three months or less which are
not securing any corporate obligations. Accounts Receivable We provide an allowance for doubtful accounts equal to the
estimated uncollectible amounts. Our estimate is based on historical collection experience and a review of the current status of trade
accounts receivable. Property and Equipment Property and equipment are carried at cost less accumulated
depreciation. Depreciation of the property and equipment is provided using the straight-line method over the assets’ estimated economic
lives, which range from two to seven years. Expenditures for maintenance and repairs are charged to expense as incurred. Goodwill and Indefinite-Lived Intangible Assets The Company evaluates its intangible assets for impairment
when events or circumstance indicate the carrying amount of these assets may not be recoverable. Intangible assets with definite lives
are amortized over their estimated useful lives to their estimated residual values. Significant judgments and assumptions are required
in the impairment evaluations. Goodwill is not amortized and is tested for impairment at least
annually, or whenever events or changes in circumstance indicate the carrying amount of the asset may be impaired. The annual impairment
test is performed as of December 31 each year. Significant judgement is involved in determining if an indicator of impairment has occurred.
The Company may consider indicators such as deterioration in general economic conditions, adverse changes in the markets in which the
reporting unit operates, increases in input costs that have negative effects on earnings and cash flows, or a trend of negative or declining
cash flows over multiple periods, among others. The fair value that could be realized in an actual transaction may differ from that used
to evaluate the impairment of goodwill. The Company may first review for goodwill impairment by assessing
the qualitative factors to determine whether any impairment may exist. For a reporting unit in which the Company concludes, based on the
qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount (or
if the Company elects to skip the optional qualitative assessment), the Company is required to perform a quantitative impairment test,
which includes measuring the fair value of the reporting unit and comparing it to the reporting unit’s carrying amount. If the fair
value of a reporting unit exceeds its carrying value, the goodwill of the reporting unit is not impaired. If the carrying value of a reporting
unit exceeds its fair value, the Company must record an impairment loss for the amount that the carrying value of the reporting unit,
including goodwill, exceeds the fair value of the reporting unit. The Company completed its annual assessment for goodwill impairment
and determined that goodwill was impaired as of December 31, 2020 and recorded an impairment loss to goodwill of $15.6 million, which
was charged to operating expenses in the current period (Note 6). Long-Lived Assets In accordance with ASC Topic 350, long-lived assets, such as
definite-lived intangible assets, to be held and used are analyzed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If there are indications of impairment, the Company uses future undiscounted
cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event
such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated
fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value of asset less the cost to sell. During the year ended December 31, 2020, management determined
there was an impairment to the Customer Relationship asset associated with the Backbone acquisition of $0.9 million due to lower revenue
from existing customers as compared to plan (Note 6). During the year ended December 31, 2019, management determined
there was an impairment due to the reduction in the useful life of Acquired Technology assets associated with the Delphiis acquisition
and an impairment to the customer relationship asset associated with the Cynergistek, Inc. acquisition in 2017 (Note 6). Income Taxes Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial reporting requirements and those imposed under federal and state
tax laws. Deferred taxes are provided for timing differences in the recognition of revenue and expenses for income tax and financial reporting
purposes and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax
assets and liabilities. Realization of the deferred tax asset is dependent on generating sufficient taxable income in future years. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all
the deferred tax assets will not be realized. The use of net operating loss deferred tax assets may be limited due to changes in the Company’s
ownership structure. Fair Value of Financial Instruments ASC Topic 820, “Fair Value Measurements,” defines
fair value, provides a framework for measuring fair value and expands the disclosures required for fair value measurements. The fair value hierarchy consists of three broad levels, which
are described below: Level 1 - Quoted prices in active markets for identical assets
or liabilities that the entity has the ability to access. Level 2 - Observable inputs, other than quoted prices included
in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets
and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3 - Unobservable inputs that are supported by little
or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models,
discounted cash flow methodologies and similar techniques that use significant unobservable inputs. The carrying amounts of cash and cash equivalents, accounts
receivable, accounts payable and accrued expenses, and capital lease obligations approximate fair value due to the short-term nature of
these financial instruments. The carrying amount of our debt approximates its fair value as we believe the credit markets have not materially
changed since the original borrowing dates, and related interest rates are variable. Stock-Based Compensation We account for stock options granted to employees, non-employees,
and directors using the accounting guidance in ASC 718 “Stock Compensation” (“ASC 718”). In accordance with ASC
718, we estimate the fair value of service-based options and performance-based options on the date of grant, using the Black-Scholes pricing
model. We recognize compensation expense for stock option awards over the requisite or implied service period of the grant. With respect
to performance-based awards, compensation expense is recognized when the performance target is deemed probable. For the years ended December 31, 2020 and 2019, stock-based
compensation and other equity instrument related expenses recognized in the consolidated statements of operations excluding amounts in
discontinued operations (Note 20) is as follows:
Year Ended December 31,
2020 2019
Cost of revenues $ 362,037 $ 208,163
Sales and marketing 176,247 257,151
General and administrative expenses 972,647 833,617
Finance cost for equity commitment 390,000 -
Total stock-based compensation expense $ 1,900,931 $ 1,298,931 The weighted average estimated fair value of stock options
granted during 2020 and 2019 was $0.60 and $1.70 per share, respectively. Estimated fair values were determined using the Black-Scholes
option-pricing model, which values options based on the stock price at the grant date, the expected life of the option, the estimated
volatility of the stock, the expected dividend payments, and the risk-free interest rate over the expected life of the option. The assumptions
used in the Black-Scholes model were as follows for stock options granted:
2020 2019
Risk-free interest rate 0.05%-1.6% 2.4%
Expected volatility of our Common Stock 61.03%-62.36% 48.59%
Dividend yield 0% 0%
Expected life of options 3 years 3 years The Black-Scholes model was developed for estimating the fair
value of traded options that have no vesting restrictions and are fully transferable. Because option valuation models require the use
of subjective assumptions, changes in these assumptions can materially affect the fair value of the options. Compensation cost associated with grants of restricted stock
units are also measured at fair value on the date of grant and such costs are recognized over the respective vesting periods. If there
are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any
remaining unearned share-based compensation expense. On April 3, 2020 upon signing a Securities Purchase Agreement
(see Note 12), the Company issued a warrant to purchase up to 500,000 shares of common stock in consideration of an 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 was determined using the Black-Scholes option-pricing model and was expensed during the second quarter
of 2020. The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate of 0.05%, (ii) estimated
volatility of 59.81%; (iii) dividend yield of 0.0%; and (iv) contractual life of the warrants of ten years. Basic and Diluted Net Income (Loss) Per Share In accordance with ASC Topic 260, “Earnings Per Share,”
basic net income per share is calculated using the weighted average number of shares of Common Stock issued and outstanding during a certain
period and is calculated by dividing net income by the weighted average number of shares of Common Stock issued and outstanding during
such period. Diluted net income per share is calculated using the weighted average number of common and potentially dilutive common shares
outstanding during the period, using the as-if converted method for secured convertible notes, and the treasury stock method for options
and warrants. As of December 31, 2020, potentially dilutive securities consisted
of options and warrants to purchase 1,618,618 shares of our Common Stock at prices ranging from $1.44 to $4.86 per share. Of these potentially
dilutive securities, none of the shares of Common Stock underlying the options and warrants were 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 168,000 shares of restricted stock units which have vested but had not been issued by year end. As of December 31, 2019, potentially dilutive securities consisted
of options and warrants to purchase 800,994 shares of our Common Stock at prices ranging from $2.28 to $4.86 per share. Of these potentially
dilutive securities, only 81,945 of the shares of Common Stock underlying the options and warrants were included in the computation of
diluted earnings per share, because the effect of including the remaining instruments would be anti-dilutive. Also included in potentially
dilutive securities are 60,000 shares of restricted stock units which vested in October 2019 but had not been issued by year end 2019. The following table sets forth the computation of basic and
diluted net (loss) income per share:
Year Ended December 31,
2020 2019
Numerator:
Net loss from continuing operations $ (18,468,488) $ (5,414,383)
Net income from discontinued operations $ - $ 20,305,087
Net (loss) income $(18,468,488) $ 14,890,704
Denominator:
Denominator for basic calculation weighted averages 10,573,123 9,858,562
Dilutive Common Stock equivalents:
Options and warrants - 81,945
Restricted stock units vested but not issued - 60,000
Denominator for diluted calculation weighted average 10,573,123 10,000,507
Net (loss) income per share:
From continuing operations
Basic net loss per share $ (1.75) $ (0.55)
Diluted net loss per share $ (1.75) $ (0.55)
From discontinued operations
Basic net income per share $ - $ 2.06
Diluted net income per share $ - $ 2.03
Net (loss) income
Basic net (loss) income per share $ (1.75) $ 1.51
Diluted net (loss) income per share $ (1.75) $ 1.49 Segment Reporting Based on an analysis of how our Chief Operating Decision Makers
review, manage and allocate resources, as well as how our management team is organized and compensated, we have determined that the Company
operates in one segment. For the years ended December 31, 2020 and 2019, all revenues were derived from domestic operations. Recently Issued Accounting Pronouncements Adopted In August 2018, the FASB issued an amendment to the accounting
guidance on cloud computing service arrangements. The guidance aligns the requirements for capitalizing implementation costs incurred
in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or
obtain internal use software. The guidance also requires an entity to expense the capitalized implementation costs of a hosting arrangement
that is a service contract over the term of the hosting arrangement. The guidance was effective for fiscal years beginning after December
15, 2019, and interim periods within those fiscal years. The adoption of this guidance did not have a material impact on our consolidated
financial statements. In August 2018, the FASB issued a new accounting standard which
modifies the disclosure requirements on fair value measurements. This guidance was effective for fiscal years beginning after December
15, 2019. The amendments related to the range and weighted average of significant unobservable inputs used to develop Level 3 fair value
measurements, and the narrative description of measurement uncertainty should be applied prospectively. All other amendments should be
applied retrospectively. An entity was permitted to early adopt any removed or modified disclosures upon issuance of this guidance and
delay adoption of the additional disclosures until their effective date. The adoption of this guidance did not have a material impact
on our consolidated financial statements. Recently Issued Accounting Pronouncements Not Yet Adopted In January 2020, the FASB issued an amendment clarifying the
interaction between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance
is effective for fiscal years beginning after December 15, 2020. Management does not expect the impact of this guidance will have a material
impact on our consolidated financial statements. In December 2019, the FASB issued an amendment to the guidance
on income taxes which is intended to simplify the accounting for income taxes. The amendment eliminates certain exceptions related to
the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of
the deferred tax liabilities for outside basis differences. The amendment also clarifies existing guidance related to the recognition
of franchise tax, the evaluation of a step up in the tax basis of goodwill, and the effects of enacted changes in tax laws or rates in
the effective tax rate computation, among other clarifications. The guidance is effective for fiscal years, and interim periods within
those fiscal years, beginning after December 15, 2020. Management is currently evaluating the impact the guidance will have on our consolidated
financial statements. In June 2016, the FASB issued an amendment to the guidance
on the measurement of credit losses on financial instruments. The amendment updates the guidance for measuring and recording credit losses
on financial assets measured and amortized cost by replacing the “incurred loss” model with an “expected loss”
model. Accordingly, these financial assets will be presented at the net amount expected to be collected. The amendment also requires that
credit losses related to available-for-sale debt securities be recorded as an allowance through net income rather than reducing the carrying
amount under the current, other-than-temporary-impairment model. The guidance is effective for smaller reporting companies for fiscal
years beginning after December 15, 2022 including interim periods within those fiscal years. Early adoption is permitted for annual periods
after December 15, 2018. Management does not expect the impact from this guidance will have a material impact on our consolidated financial
statements. |
