UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2024
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-38728
AVALON GLOBOCARE CORP.
(Exact name of registrant as specified in its charter)
4400 Route 9 South, Suite 3100
Freehold, New Jersey
07728
(Address of principal executive offices)
(732)780-4400
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of May 30, 2024, 11,104,534 shares of common stock, $0.0001 par value per share, were outstanding.
For the Quarterly Period Ended March 31, 2024
Table of Contents
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PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements.
AVALON GLOBOCARE CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying notes to the condensed consolidated financial statements.
1
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)
2
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
For the Three Months Ended March 31, 2024
3
For the Three Months Ended March 31, 2023
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – ORGANIZATION AND NATURE OF OPERATIONS
Avalon GloboCare Corp. (the “Company” or “ALBT”) is a Delaware corporation. The Company was incorporated under the laws of the State of Delaware on July 28, 2014.
The Company is a commercial stage company dedicated to developing and delivering innovative, transformative, precision diagnostics and clinical laboratory services. The Company is working to establish a leading role in the innovation of diagnostic testing, utilizing proprietary technology to deliver precise, genetics-driven results. Through its membership interest in a laboratory, the Company also provides laboratory services, offering a broad portfolio of diagnostic tests, including drug testing, toxicology, and a broad array of test services, from general bloodwork to anatomic pathology, and urine toxicology.
On February 7, 2017, the Company formed Avalon RT 9 Properties, LLC (“Avalon RT 9”), a New Jersey limited liability company. On May 5, 2017, Avalon RT 9 purchased a real property located in Township of Freehold, County of Monmouth, State of New Jersey, having a street address of 4400 Route 9 South, Freehold, NJ 07728. This property was purchased to serve as the Company’s world-wide headquarters for all corporate administration and operations. In addition, the property generates rental income. Avalon RT 9 owns this office building. Avalon RT 9’s business consists of the ownership and operation of the income-producing real estate property in New Jersey. As of March 31, 2024, the occupancy rate of the building is 89.4%.
On July 18, 2018, the Company formed a wholly owned subsidiary, Avactis Biosciences Inc. (“Avactis”), a Nevada corporation, which is a patent holding company. Commencing on April 6, 2022, the Company owns 60% of Avactis and Arbele Biotherapeutics Limited (“Arbele Biotherapeutics”) owns 40% of Avactis. Avactis owns 100% of the capital stock of Avactis Nanjing Biosciences Ltd., a company incorporated in the PRC on May 8, 2020 (“Avactis Nanjing”), which only owns a patent and is not considered an operating entity.
On October 14, 2022, the Company formed a wholly owned subsidiary, Avalon Laboratory Services, Inc. (“Avalon Lab”), a Delaware company. On February 9, 2023, Avalon Lab purchased forty percent (40%) of the issued and outstanding equity interests of Laboratory Services MSO, LLC, a private limited company formed under the laws of the State of Delaware on September 6, 2019 (“Lab Services MSO”), and its subsidiaries. Lab Services MSO, through its subsidiaries, is engaged in providing laboratory testing services.
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NOTE 1 – ORGANIZATION AND NATURE OF OPERATIONS (continued)
Details of the Company’s subsidiaries which are included in these condensed consolidated financial statements as of March 31, 2024 are as follows:
Avalon Healthcare System, Inc.
(“AHS”)
Delaware
May 18, 2015
Avalon RT 9 Properties LLC
(“Avalon RT 9”)
New Jersey
February 7, 2017
Avalon (Shanghai) Healthcare Technology Co., Ltd.
(“Avalon Shanghai”)
PRC
April 29, 2016
Genexosome Technologies Inc.
(“Genexosome”)
Nevada
July 31, 2017
Avactis Biosciences Inc.
(“Avactis”)
July 18, 2018
Avactis Nanjing Biosciences Ltd.
(“Avactis Nanjing”)
May 8, 2020
Avalon Laboratory Services, Inc.
(“Avalon Lab”)
October 14, 2022
NOTE 2 – BASIS OF PRESENTATION AND GOING CONCERN CONDITION
Basis of Presentation
These interim condensed consolidated financial statements of the Company and its subsidiaries are unaudited. In the opinion of management, all adjustments (consisting of normal recurring accruals) and disclosures necessary for a fair presentation of these interim condensed consolidated financial statements have been included. The results reported in the condensed consolidated financial statements for any interim periods are not necessarily indicative of the results that may be reported for the entire year. The accompanying condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and do not include all information and footnotes necessary for a complete presentation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”). The Company’s condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 filed with the Securities and Exchange Commission on April 15, 2024.
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NOTE 2 – BASIS OF PRESENTATION AND GOING CONCERN CONDITION (continued)
Going Concern
The Company is a commercial stage company dedicated to developing and delivering innovative, transformative, precision diagnostics and clinical laboratory services. The Company is establishing a leading role in the innovation of diagnostic testing, utilizing proprietary technology to deliver precise, genetics-driven results. The Company also provides laboratory services through its 40% equity investment in Lab Services MSO, offering a broad portfolio of diagnostic tests, including drug testing, toxicology, and a broad array of test services, from general bloodwork to anatomic pathology, and urine toxicology. In addition, the Company owns commercial real estate that houses its headquarters in Freehold, New Jersey. These condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates, among other things, the realization of assets and the satisfaction of liabilities in the normal course of business.
As reflected in the accompanying condensed consolidated financial statements, the Company had a working capital deficit of approximately $7,026,000 at March 31, 2024 and had incurred recurring net losses and generated negative cash flow from operating activities of approximately $1,368,000 and $916,000for the three months ended March 31, 2024, respectively.
The Company has a limited operating history and its continued growth is dependent upon the continuation of generating rental revenue from its income-producing real estate property in New Jersey and income from equity method investment through its forty percent (40%) interest in Lab Services MSO and obtaining additional financing to fund future obligations and pay liabilities arising from normal business operations. In addition, the current cash balance cannot be projected to cover the operating expenses for the next twelve months from the release date of this report. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent on the Company’s ability to raise additional capital, implement its business plan, and generate significant revenues. There are no assurances that the Company will be successful in its efforts to generate significant revenues, maintain sufficient cash balance or report profitable operations or to continue as a going concern. The Company plans on raising capital through the sale of equity to implement its business plan. However, there is no assurance these plans will be realized and that any additional financings will be available to the Company on satisfactory terms and conditions, if any.
The accompanying condensed consolidated financial statements do not include any adjustments related to the recoverability or classification of asset-carrying amounts or the amounts and classification of liabilities that may result should the Company be unable to continue as a going concern.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Changes in these estimates and assumptions may have a material impact on the condensed consolidated financial statements and accompanying notes. Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the financial statements, which management considered in formulating its estimate, could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from those estimates.
Significant estimates during the three months ended March 31, 2024 and 2023 include the useful life of investment in real estate and intangible assets, the assumptions used in assessing impairment of long-term assets, the valuation of deferred tax assets and the associated valuation allowances, the valuation of stock-based compensation, the assumptions used to determine fair value of warrants and embedded conversion features of convertible note payable, and the fair value of the consideration given and assets acquired in the purchase of 40% of Lab Services MSO.
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NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair Value of Financial Instruments and Fair Value Measurements
The Company adopted the guidance of Accounting Standards Codification (“ASC”) 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:
The fair value of the Company’s assets and liabilities, which qualify as financial instruments under ASC Topic 820, “Fair Value Measurement,” approximates the carrying amounts represented in the accompanying condensed consolidated financial statements, primarily due to their short-term nature.
Assets and liabilities measured at fair value on a recurring basis. Certain assets and liabilities are measured at fair value on a recurring basis. These assets and liabilities are measured at fair value on an ongoing basis. These assets and liabilities include derivative liability.
Derivative liability. Derivative liability is carried at fair value and measured on an ongoing basis.The table below reflects the activity of derivative liability measured at fair value for the three months ended March 31, 2024:
ASC 825-10 “Financial Instruments”, allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.
Cash and Cash Equivalents
At March 31, 2023 and December 31, 2023, the Company’s cash balances by geographic area were as follows:
For purposes of the condensed consolidated statements of cash flows, the Company considers all highly liquid instruments with a maturity of three months or less when purchased and money market accounts to be cash equivalents. The Company had no cash equivalents at March 31, 2024 and December 31, 2023.
9
Credit Risk and Uncertainties
The Company maintains a portion of its cash on deposits with bank and financial institution within the U.S. that at times may exceed federally-insured limits of $250,000. The Company manages this credit risk by concentrating its cash balances in high quality financial institutions and by periodically evaluating the credit quality of the primary financial institutions holding such deposits. The Company has not experienced any losses in such bank accounts and believes it is not exposed to any risks on its cash in bank accounts. At March 31, 2024, there were no balances in excess of the federally-insured limits.
The Company’s concentrations of credit risk with respect to its rent receivable is limited due to short-term payment terms. The Company also performs ongoing credit evaluations of its tenants to help further reduce credit risk.
Investment in Unconsolidated Company
The Company uses the equity method of accounting for its investment in, and earning or loss of, investees that it does not control but over which it does exert significant influence. The Company applies the equity method by initially recording these investments at cost, as equity method investments, subsequently adjusted for equity in earnings and cash distributions.
The Company considers whether the fair value of its equity method investment has declined below its carrying value whenever adverse events or changes in circumstances indicate that recorded value may not be recoverable. If the Company considers any decline to be other than temporary (based on various factors, including historical financial results and the overall health of the investee), then a write-down would be recorded to estimated fair value. See Note 5 for discussion of equity method investments.
The Company classifies distributions received from equity method investments using the cumulative earnings approach. Distributions received are considered returns on the investment and classified as cash inflows from operating activities. If, however, the investor’s cumulative distributions received, less distributions received in prior periods determined to be returns of investment, exceeds cumulative equity in earnings recognized, the excess is considered a return of investment and is classified as cash inflows from investing activities.
Real Property Rental Revenue
The Company has determined that ASC 606 does not apply to rental contracts, which are within the scope of other revenue recognition accounting standards.
Rental income from operating leases is recognized on a straight-line basis under the guidance of ASC 842. Lease payments under tenant leases are recognized on a straight-line basis over the term of the related leases. The cumulative difference between lease revenue recognized under the straight-line method and contractual lease payments are included in rent receivable on the condensed consolidated balance sheets.
Commitments and Contingencies
In the normal course of business, the Company is subject to contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters. Liabilities for such contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.
Per Share Data
ASC Topic 260 “Earnings per Share,” requires presentation of both basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
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Per Share Data (continued)
Basic net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing net loss by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. For the three months ended March 31, 2024 and 2023, potentially dilutive common shares consist of the common shares issuable upon the conversion of convertible preferred stock and convertible note (using the if-converted method) and exercise of common stock options and warrants (using the treasury stock method). Common stock equivalents are not included in the calculation of diluted net loss per share if their effect would be anti-dilutive. In a period in which the Company has a net loss, all potentially dilutive securities are excluded from the computation of diluted shares outstanding as they would have had an anti-dilutive impact.
The following table summarizes the securities that were excluded from the diluted per share calculation because the effect of including these potential shares was antidilutive:
Segment Reporting
The Company uses “the management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. The Company’s chief operating decision maker is the Chief Executive Officer (“CEO”) and president of the Company, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company.
On February 9, 2023, the Company purchased 40% of Lab Services MSO. Commencing from the purchase date, February 9, 2023, the Company is active in the management of Lab Services MSO. During the three months ended March 31, 2024 and 2023, the Company operated in two reportable business segments: (1) the real property operating segment, and (2) laboratory testing services segment (which commenced with the purchase date, February 9, 2023) since Lab Services MSO’s operating results are regularly reviewed by the Company’s chief operating decision maker to determine the resources to be allocated to the segment and assess its performance. The Company regularly reviews the operating results and performance of Lab Services MSO, for which the Company accounts for under the equity method.
Reclassification
Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications have no effect on the previously reported financial position, results of operations and cash flows.
11
Recent Accounting Standards
In December 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. This guidance is intended to enhance the transparency and decision-usefulness of income tax disclosures. The amendments in ASU 2023-09 address investor requests for enhanced income tax information primarily through changes to disclosure regarding rate reconciliation and income taxes paid both in the U.S. and in foreign jurisdictions. ASU 2023-09 is effective for fiscal years beginning after December 15, 2024 on a prospective basis, with the option to apply the standard retrospectively. Early adoption is permitted. The company is currently evaluating this guidance to determine the impact it may have on its condensed consolidated financial statements disclosures.
Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its consolidated financial condition, results of operations, cash flows or disclosures.
NOTE 4 – PREPAID EXPENSE AND OTHER CURRENT ASSETS
At March 31, 2024 and December 31, 2023, prepaid expense and other current assets consisted of the following:
NOTE 5 – EQUITY METHOD INVESTMENTS
On February 9, 2023 (the “Closing Date”), the Company entered into and closed an Amended and Restated Membership Interest Purchase Agreement (the “Amended MIPA”), by and among Avalon Laboratory Services, Inc., a wholly owned subsidiary of the Company (the “Buyer”), SCBC Holdings LLC (the “Seller”), the Zoe Family Trust, Bryan Cox and Sarah Cox as individuals (each an “Owner” and collectively, the “Owners”), and Laboratory Services MSO, LLC.
Pursuant to the terms and conditions set forth in the Amended MIPA, the Buyer acquired from the Seller, forty percent (40%) of the issued and outstanding equity interests of Lab Services MSO (the “Purchased Interests”). The consideration paid by Buyer to Seller for the Purchased Interests consisted of $20,666,667, which was comprised of (i) $9,000,000 in cash, (ii) $11,000,000 pursuant to the issuance of 11,000shares of the Company’s Series B Convertible Preferred Stock (the “Series B Preferred Stock”), stated value $1,000(the “Series B Stated Value”), which approximated the fair value, and (iii) a $666,667 cash payment on February 9, 2024. The Series B Preferred Stock is convertible into shares of the Company’s common stock at a conversion price per share equal to $3.78, which approximated the market price at the date of closing, or an aggregate of 2,910,053 shares of the Company’s common stock, which are subject to a lock-up period and restrictions on sale.
12
NOTE 5 – EQUITY METHOD INVESTMENTS (continued)
Lab Services MSO, through its subsidiaries, is engaged in providing laboratory testing services. Avalon Lab and an unrelated company, have an ownership interest in Lab Services MSO of 40% and 60%, respectively.
In accordance with ASC 810, the Company determined that Lab Services MSO does not qualify as a Variable Interest Entity, nor does it have a controlling financial interest over the legal entity. However, the Company determined that it does have significant influence as a result of its board representation. Therefore, the Company treats the equity investment in the consolidated financial statements under the equity method. Under the equity method, the investment is initially recorded at cost, adjusted for any excess of the Company’s share of the purchased-date fair values of the investee’s identifiable net assets over the cost of the investment (if any). At February 9, 2023 (date of investment), the excess of the Company’s share of the fair values of the investee’s identifiable net assets over the cost of the investment was approximately $19,460,000 which was attributable to intangible assets and goodwill. Thereafter, the investment is adjusted for the post purchase change in the Company’s share of the investee’s net assets and any impairment loss relating to the investment.
Intangible assets consist of the valuation of identifiable intangible assets acquired, representing trade names and customers relationships, which are being amortized on a straight-line method over the estimated useful life of 15 years. The straight-line method of amortization represents the Company’s best estimate of the distribution of the economic value of the identifiable intangible assets. For the three months ended March 31, 2024 and for the period from February 9, 2023 (date of investment) through March 31, 2023, amortization expense of these intangible assets amounted to $166,733 and $135,830, respectively, which was included in income (loss) from equity method investment — Lab Services MSO in the accompanying condensed consolidated statements of operations and comprehensive loss.
Goodwill represents the excess of the purchase price paid over the fair value of net assets acquired in the business acquisition of Lab Services MSO incurred on February 9, 2023. Goodwill is not amortized but is tested for impairment at least once annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired.
For the three months ended March 31, 2024 and for the period from February 9, 2023 (date of investment) through March 31, 2023, the Company’s share of Lab Services MSO’s net income was $274,202 and $46,739, respectively, which was included in income (loss) from equity method investment — Lab Services MSO in the accompanying condensed consolidated statements of operations and comprehensive loss.
In the three months ended March 31, 2024, activity recorded for the Company’s equity method investment in Lab Services MSO is summarized in the following table:
As of March 31, 2024, the Company’s carrying value of the identified intangible assets and goodwill which are included in the equity investment carrying amount was $9,225,911 and $259,579, respectively. As of December 31, 2023, the Company’s carrying value of the identified intangible assets and goodwill which are included in the equity investment carrying amount was $9,392,644 and $259,579, respectively.
The tables below present the summarized financial information, as provided to the Company by the investee, for the unconsolidated company:
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NOTE 6 – CONVERTIBLE NOTE PAYABLE
May 2023 Convertible Note
On May 23, 2023, the Company entered into securities purchase agreements with Mast Hill Fund, L.P. (“Mast Hill”) for the issuance of 13.0% senior secured promissory notes in the aggregate principal amount of $1,500,000 (collectively, the “May 2023 Convertible Note”) convertible into shares of common stock, par value $0.0001 per share, of the Company, as well as the issuance of 75,000 shares of common stock as a commitment fee and warrants for the purchase of 230,500 shares of common stock of the Company. The Company and its subsidiaries have also entered into a security agreement, creating a security interest in certain property of the Company and its subsidiaries to secure the prompt payment, performance and discharge in full of all of the Company’s obligations under the May 2023 Convertible Note. Principal amount and interest under the May 2023 Convertible Note are convertible into shares of common stock of the Company at a conversion price of $4.50 per share unless the Company fails to make an amortization payment when due, in which case the conversion price shall be the lower of $4.50 or the trading price of the shares, subject to a floor of $1.50.
Mast Hill acquired the May 2023 Convertible Note with principal amount of $1,500,000 and paid the purchase price of $1,425,000 after an original issue discount of $75,000. On May 23, 2023, the Company issued (i) a warrant to purchase 125,000 shares of common stock with an exercise price of $4.50exercisable until the five-year anniversary of May 23, 2023, (ii) a warrant to purchase 105,500 shares of common stock with an exercise price of $3.20 exercisable until the five-year anniversary of May 23, 2023, which warrant shall be cancelled and extinguished against payment of the May 2023 Convertible Note, and (iii) 75,000 shares of common stock as a commitment fee for the purchase of the May 2023 Convertible Note, which were earned in full as of May 23, 2023. On May 23, 2023, the Company delivered such duly executed May 2023 Convertible Note, warrants and common stock to Mast Hill against delivery of such purchase price.
The Company is obligated to make amortization payments in cash to Mast Hill towards the repayment of the May 2023 Convertible Note, as provided in the following table:
In connection with the issuance of the May 2023 Convertible Note, the Company incurred debt issuance costs of $175,162 (including the issuance of 10,000warrants as a finder’s fee) which is capitalized and will be amortized into interest expense over the term of the May 2023 Convertible Note.
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NOTE 6 – CONVERTIBLE NOTE PAYABLE (continued)
May 2023 Convertible Note (continued)
Based upon the Company’s analysis of the criteria contained in ASC 815, the Company determined that all the warrants issued to Mast Hill and a third party as a finder’s fee met the definition of a derivative liability, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 105,500 warrants with an exercise price of $3.20 exercisable until the five-year anniversary of May 23, 2023, which warrant shall be cancelled and extinguished against payment of the May 2023 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 135,000 warrants with an exercise price of $4.50 exercisable until the five-year anniversary of May 23, 2023 was classified as derivative liability on May 23, 2023. The fair values of the 135,000 warrants with an exercise price of $4.50exercisable until the five-year anniversary of May 23, 2023 issued on May 23, 2023 were computed using the Black-Scholes option-pricing model with the following assumptions: stock price of $1.96, volatility of 88.80%, risk-free rate of 3.76%, annual dividend yield of 0% and expected life of 5 years.
In accordance with ASC 470-20-25-2, proceeds from the sale of a debt instrument with stock purchase warrants are allocated to the two elements based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at time of issuance. The portion of the proceeds allocated to the warrants are accounted for as derivative liability. The remainder of the proceeds are allocated to the debt instrument portion of the transaction.
In accordance with ASC 480-10-25-14, the Company determined that the conversion provisions contain an embedded derivative feature and the Company valued the derivative feature separately, recording debt discount and derivative liability in accordance with the provisions of the convertible debt (see Note 7). However, management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the embedded conversion feature has been estimated to be zero.
The Company recorded a total debt discount of $349,654 related to the original issue discount, common shares issued and warrants issued to Mast Hill, which will be amortized over the term of the May 2023 Convertible Note.
For the three months ended March 31, 2024, amortization of debt discount and debt issuance costs and interest expense related to the May 2023 Convertible Note amounted to $131,204 and $29,793, respectively, which have been included in interest expense — amortization of debt discount and debt issuance cost and interest expense — other on the accompanying condensed consolidated statements of operations and comprehensive loss.
July 2023 Convertible Note
On July 6, 2023, the Company entered into securities purchase agreements with Firstfire Global Opportunities Fund, LLC (“Firstfire”) for the issuance of 13.0% senior secured promissory notes in the aggregate principal amount of $500,000 (collectively, the “July 2023 Convertible Note”) convertible into shares of common stock, par value $0.0001 per share, of the Company, as well as the issuance of 25,000 shares of common stock as a commitment fee and warrants for the purchase of 76,830 shares of common stock of the Company. The Company and its subsidiaries have also entered into a security agreement, creating a security interest in certain property of the Company and its subsidiaries to secure the prompt payment, performance and discharge in full of all of the Company’s obligations under the July 2023 Convertible Note. Principal amount and interest under the July 2023 Convertible Note are convertible into shares of common stock of the Company at a conversion price of $4.50 per share unless the Company fails to make an amortization payment when due, in which case the conversion price shall be the lower of $4.50 or the trading price of the shares, subject to a floor of $1.50.
Firstfire acquired the July 2023 Convertible Note with principal amount of $500,000 and paid the purchase price of $475,000 after an original issue discount of $25,000. On July 6, 2023, the Company issued (i) a warrant to purchase 41,665 shares of common stock with an exercise price of $4.50exercisable until the five-year anniversary of July 6, 2023, (ii) a warrant to purchase 35,165 shares of common stock with an exercise price of $3.20 exercisable until the five-year anniversary of July 6, 2023, which warrant shall be cancelled and extinguished against payment of the July 2023 Convertible Note, and (iii) 25,000 shares of common stock as a commitment fee for the purchase of the July 2023 Convertible Note, which were earned in full as of July 6, 2023. On July 6, 2023, the Company delivered such duly executed July 2023 Convertible Note, warrants and common stock to Firstfire against delivery of such purchase price.
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July 2023 Convertible Note (continued)
The Company is obligated to make amortization payments in cash to Firstfire towards the repayment of the July 2023 Convertible Note, as provided in the following table:
In connection with the issuance of the July 2023 Convertible Note, the Company incurred debt issuance costs of $74,204 (including the issuance of 3,333warrants as a finder’s fee), which is capitalized and will be amortized into interest expense over the term of the July 2023 Convertible Note.
Based upon the Company’s analysis of the criteria contained in ASC 815, the Company determined that all the warrants issued to Firstfire and a third party as a finder’s fee meet the definition of a derivative liability, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 35,165 warrants with an exercise price of $3.20 exercisable until the five-year anniversary of July 6, 2023, which warrant shall be cancelled and extinguished against payment of the July 2023 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 44,998 warrants with an exercise price of $4.50 exercisable until the five-year anniversary of July 6, 2023 was classified as a derivative liability on July 6, 2023. The fair values of the 44,998 warrants with an exercise price of $4.50 exercisable until the five-year anniversary of July 6, 2023 issued on July 6, 2023 were computed using the Black-Scholes option-pricing model with the following assumptions: stock price of $1.42, volatility of 88.52%, risk-free rate of 4.37%, annual dividend yield of 0% and expected life of 5 years.
The Company recorded a total debt discount of $89,191 related to the original issue discount, common shares issued and warrants issued to Firstfire, which will be amortized over the term of the July 2023 Convertible Note.
For the three months ended March 31, 2024, amortization of debt discount and debt issuance costs and interest expense related to the July 2023 Convertible Note amounted to $40,848 and $13,001, respectively, which have been included in interest expense — amortization of debt discount and debt issuance cost and interest expense — other on the accompanying condensed consolidated statements of operations and comprehensive loss.
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October 2023 Convertible Note
On October 9, 2023, the Company entered into securities purchase agreements with Mast Hill and Firstfire for the issuance of 13.0% senior secured promissory notes in the aggregate principal amount of $700,000 (collectively, the “October 2023 Convertible Note,” and, collectively with the May 2023 Convertible Note and the July 2023 Convertible Note, the “2023 Convertible Notes”) convertible into shares of common stock, par value $0.0001 per share, of the Company, as well as the issuance of 70,000 shares of common stock as a commitment fee and warrants for the purchase of 192,500 shares of common stock of the Company. The Company and its subsidiaries have entered into that certain security agreements, creating a security interest in certain property of the Company and its subsidiaries to secure the prompt payment, performance and discharge in full of all of the Company’s obligations under the October 2023 Convertible Note. Principal amount and interest under the October 2023 Convertible Note are convertible into shares of common stock of the Company at a conversion price of $1.50 per share unless the Company fails to make an amortization payment when due, in which case the conversion price shall be the lower of $1.50 or the market price (as defined in the October 2023 Convertible Note) of the shares.
Mast Hill acquired the October 2023 Convertible Note with principal amount of $350,000 and paid the purchase price of $332,500 after an original issue discount of $17,500. On October 9, 2023, the Company issued (i) a warrant to purchase 52,500 shares of common stock with an exercise price of $2.50exercisable until the five-year anniversary of October 9, 2023, (ii) a warrant to purchase 43,750 shares of common stock with an exercise price of $1.80 exercisable until the five-year anniversary of October 9, 2023, which warrant shall be cancelled and extinguished against payment of the October 2023 Convertible Note, and (iii) 35,000 shares of common stock as a commitment fee for the purchase of the October 2023 Convertible Note, which were earned in full as of October 9, 2023. On October 9, 2023, the Company delivered such duly executed October 2023 Convertible Note, warrants and common stock to Mast Hill against delivery of such purchase price.
The Company is obligated to make amortization payments in cash to Mast Hill towards the repayment of the October 2023 Convertible Note, as provided in the following table:
Firstfire acquired the October 2023 Convertible Note with principal amount of $350,000 and paid the purchase price of $332,500 after an original issue discount of $17,500. On October 9, 2023, the Company issued (i) a warrant to purchase 52,500 shares of common stock with an exercise price of $2.50exercisable until the five-year anniversary of October 9, 2023, (ii) a warrant to purchase 43,750 shares of common stock with an exercise price of $1.80 exercisable until the five-year anniversary of October 9, 2023, which warrant shall be cancelled and extinguished against payment of the October 2023 Convertible Note, and (iii) 35,000 shares of common stock as a commitment fee for the purchase of the October 2023 Convertible Note, which were earned in full as of October 9, 2023. On October 9, 2023, the Company delivered such duly executed October 2023 Convertible Note, warrants and common stock to Firstfire against delivery of such purchase price.
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October 2023 Convertible Note (continued)
The Company is obligated to make amortization payments in cash to Firstfire towards the repayment of the October 2023 Convertible Note, as provided in the following table:
In connection with the issuance of the October 2023 Convertible Note, the Company incurred debt issuance costs of $95,349 (including the issuance of 8,400 warrants as a finder’s fee), which is capitalized and will be amortized into interest expense over the term of the October 2023 Convertible Note.
Based upon the Company’s analysis of the criteria contained in ASC 815, the Company determined that all the warrants issued to Mast Hill and Firstfire and a third party as a finder’s fee meet the definition of a derivative liability, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 87,500 warrants with an exercise price of $1.80 exercisable until the five-year anniversary of October 9, 2023, which warrant shall be cancelled and extinguished against payment of the October 2023 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 113,400 warrants with an exercise price of $2.50 exercisable until the five-year anniversary of October 9, 2023 was classified as a derivative liability on October 9, 2023. The fair values of the 113,400 warrants with an exercise price of $2.50 exercisable until the five-year anniversary of October 9, 2023 issued on October 9, 2023 were computed using the Black-Scholes option-pricing model with the following assumptions: stock price of $0.77, volatility of 89.70%, risk-free rate of 4.75%, annual dividend yield of 0% and expected life of 5 years.
The Company recorded a total debt discount of $128,748 related to the original issue discount, common shares issued and warrants issued to Mast Hill and Firstfire, which will be amortized over the term of the October 2023 Convertible Note.
For the three months ended March 31, 2024, amortization of debt discount and debt issuance costs and interest expense related to the October 2023 Convertible Note amounted to $56,024 and $22,688, respectively, which have been included in interest expense — amortization of debt discount and debt issuance cost and interest expense — other on the accompanying condensed consolidated statements of operations and comprehensive loss.
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March 2024 Convertible Note
On March 7, 2024, the Company entered into securities purchase agreements with Mast Hill Fund, L.P. for the issuance of 13.0% senior secured promissory notes in the aggregate principal amount of $700,000 (collectively, the “March 2024 Convertible Note”) convertible into shares of common stock, par value $0.0001 per share, of the Company, as well as the issuance of 105,000 shares of common stock as a commitment fee and warrants for the purchase of 252,404 shares of common stock of the Company. The Company and its subsidiaries have also entered into a security agreement, creating a security interest in certain property of the Company and its subsidiaries to secure the prompt payment, performance and discharge in full of all of the Company’s obligations under the March 2024 Convertible Note. Principal amount and interest under the March 2024 Convertible Note are convertible into shares of common stock of the Company at a conversion price of $1.00per share unless the Company fails to make an amortization payment when due, in which case the conversion price shall be the lower of $1.00 or the market price (as defined in the March 2024 Convertible Note) of the shares.
Mast Hill acquired the March 2024 Convertible Note with principal amount of $700,000 and paid the purchase price of $665,000 after an original issue discount of $35,000. On March 7, 2024, the Company issued (i) a warrant to purchase 131,250 shares of common stock with an exercise price of $2.00exercisable until the five-year anniversary of March 7, 2024, (ii) a warrant to purchase 121,154 shares of common stock with an exercise price of $1.30 exercisable until the five-year anniversary of March 7, 2024, which warrant shall be cancelled and extinguished against payment of the March 2024 Convertible Note, and (iii) 105,000 shares of common stock as a commitment fee for the purchase of the March 2024 Convertible Note, which were earned in full as of March 7, 2024. On March 7, 2024, the Company delivered such duly executed March 2024 Convertible Note, warrants and common stock to Mast Hill against delivery of such purchase price.
The Company is obligated to make amortization payments in cash to Mast Hill towards the repayment of the March 2024 Convertible Note, as provided in the following table:
In connection with the issuance of the March 2024 Convertible Note, the Company incurred debt issuance costs of $74,379 (including the issuance of 10,500warrants as a finder’s fee) which is capitalized and will be amortized into interest expense over the term of the March 2024 Convertible Note.
Based upon the Company’s analysis of the criteria contained in ASC 815, the Company determined that all the warrants issued to Mast Hill and a third party as a finder’s fee met the definition of a derivative liability, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 121,154 warrants with an exercise price of $1.30 exercisable until the five-year anniversary of March 7, 2024, which warrant shall be cancelled and extinguished against payment of the March 2024 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 141,750 warrants with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 was classified as derivative liability on March 7, 2024. The fair values of the 141,750 warrants with an exercise price of $2.00exercisable until the five-year anniversary of March 7, 2024 issued on March 7, 2024 were computed using the Black-Scholes option-pricing model with the following assumptions: stock price of $0.40, volatility of 85.24%, risk-free rate of 4.07%, annual dividend yield of 0% and expected life of 5 years.
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March 2024 Convertible Note (continued)
The Company recorded a total debt discount of $97,374 related to the original issue discount, common shares issued and warrants issued to Mast Hill, which will be amortized over the term of the March 2024 Convertible Note.
For the three months ended March 31, 2024, amortization of debt discount and debt issuance costs and interest expense related to the March 2024 Convertible Note amounted to $14,313 and $6,233, respectively, which have been included in interest expense — amortization of debt discount and debt issuance cost and interest expense — other on the accompanying condensed consolidated statements of operations and comprehensive loss.
2023 Convertible Notes and March 2024 Convertible Notes – Events of Default
The 2023 Convertible Notes and the March 2024 Convertible Note contain customary events of default, upon the occurrence of which (after giving effect to the right to cure of the borrower), the notes shall become due and payable and the borrower shall pay to the lender/s an amount equal to the principal amount then outstanding under such notes plus accrued interest (including any Default Interest, as defined in the 2023 Convertible Notes and the March 2024 Convertible Note, respectively), provided, however, that Mast Hill and Firstfire (collectively, the “Convertible Notes Lenders”) may in their sole discretion determine to accept payment part in shares of the Company’s common stock (pursuant to the conversion formula set forth in the 2023 Convertible Notes and the March 2024 Convertible Note) and part in cash.
During the quarter ended March 31, 2024, the Company’s market capitalization fell below $5 million, which constitutes an event of default under the 2023 Convertible Notes and the March 2024 Convertible Note.
Pursuant to Section 3.22 of the 2023 Convertible Notes (and the March 2024 Convertible Note), the Company (as borrower under such notes) has a right to cure such default within ten (10) calendar days (the “Cure Period”) after the earlier of (i) the date the borrower receives notice from the lenders demanding cure of such default, or (ii) the first date that the then Chief Executive Officer, Chief Financial Officer, or Board of Directors of the borrower has actual knowledge of the existence of the default.
The Company did not receive any notice from the Convertible Notes Lenders with respect to the event of default. The Company first had actual knowledge of the existence of the default on April 29, 2024 and received a waiver from the Convertible Notes Lenders, waiving this event of default on May 29, 2024. Although this waiver was not within the Cure Period, the Convertible Notes Lenders provided a full waiver to the event of default prior to the issuance of this report.
On May 23, 2024, the Company received a waiver to the required amortization payment under the May 2023 Convertible Note. Pursuant to the waiver, the Company received an extension until June 10, 2024 to allow time for the payment to be made or to allow the Company to refinance the Convertible Notes.
In addition, the Company failed to file this report in a timely manner during the prescribed period following the Company’s filing of a 12b-25 extension with respect thereto, which would have triggered an event of default under the 2023 Convertible Notes and the March 2024 Convertible Note but for receipt by the Company of the waiver with respect to this event of default from the Convertible Notes Lenders on the original due date of this report (which was reaffirmed by the waiver dated May 29, 2024).
As a result, the 2023 Convertible Notes and the March 2024 Convertible Note are no longer in default as of the date of this report. The events of default described above did not have an accounting impact on the Company’s unaudited financial statements for the quarter ended March 31, 2024 since the events of default were cured either within the Cure Period or prior to the date of this report and no penalties associated with such events of default under the 2023 Convertible Notes and the March 2024 Convertible Note were ever triggered. In addition, the Company is in the process of refinancing the 2023 Convertible Notes and the March 2024 Convertible Note into one new note, which will also remove the $5million market capitalization covenant so that it is not an event of default in the future.
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NOTE 7 – DERIVATIVE LIABILITY
As stated in Note 6, May 2023 Convertible Note, July 2023 Convertible Note, October 2023 Convertible Note, and March 2024 Convertible Note, the Company determined that the convertible note payable contains an embedded derivative feature in the form of a conversion provision which is adjustable based on future prices of the Company’s common stock. In accordance with ASC 815-10-25, each derivative feature is initially recorded at its fair value using the Black-Scholes option valuation method and then re-value at each reporting date, with changes in the fair value reported in the statements of operations. However, on May 23, 2023, July 6, 2023, October 9, 2023, March 7, 2024, and March 31, 2024, management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the embedded conversion feature has been estimated to be zero.
On May 23, 2023, the Company issued 240,500 warrants to Mast Hill and a third party as a finder’s fee (see Note 6). Upon evaluation, the warrants meet the definition of a derivative liability under FASB ASC 815, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the105,500 warrants with an exercise price of $3.20 exercisable until the five-year anniversary of May 23, 2023, which warrant shall be cancelled and extinguished against payment of the May 2023 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 135,000warrants with an exercise price of $4.50 exercisable until the five-year anniversary of May 23, 2023 was classified as a derivative liability on May 23, 2023.
On March 31, 2024, the estimated fair value of the 135,000 warrants with an exercise price of $4.50 exercisable until the five-year anniversary of May 23, 2023 as derivative liability was $5,796. The estimated fair value of the warrants was computed as of March 31, 2024 using Black-Scholes option-pricing model, with the following assumptions: stock price of $0.32, volatility of 81.49%, risk-free rate of 4.21%, annual dividend yield of 0% and expected life of 4.1 years.
On July 6, 2023, the Company issued 80,163 warrants to Firstfire and a third party as a finder’s fee (see Note 6). Upon evaluation, the warrants meet the definition of a derivative liability under FASB ASC 815, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 35,165 warrants with an exercise price of $3.20 exercisable until the five-year anniversary of July 6, 2023, which warrant shall be cancelled and extinguished against payment of the July 2023 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 44,998 warrants with an exercise price of $4.50 exercisable until the five-year anniversary of July 6, 2023 was classified as a derivative liability on July 6, 2023.
On March 31, 2024, the estimated fair value of the 44,998 warrants with an exercise price of $4.50 exercisable until the five-year anniversary of July 6, 2023 as derivative liability was $2,314. The estimated fair value of the warrants was computed as of March 31, 2024 using Black-Scholes option-pricing model, with the following assumptions: stock price of $0.32, volatility of 84.10%, risk-free rate of 4.21%, annual dividend yield of 0% and expected life of 4.3 years.
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NOTE 7 – DERIVATIVE LIABILITY (continued)
On October 9, 2023, the Company issued 200,900 warrants to Mast Hill and Firstfire and a third party as a finder’s fee (see Note 6). Upon evaluation, the warrants meet the definition of a derivative liability under FASB ASC 815, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 87,500 warrants with an exercise price of $1.80 exercisable until the five-year anniversary of October 9, 2023, which warrant shall be cancelled and extinguished against payment of the October 2023 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 113,400 warrants with an exercise price of $2.50 exercisable until the five-year anniversary of October 9, 2023 was classified as a derivative liability on October 9, 2023.
On March 31, 2024, the estimated fair value of the 113,400 warrants with an exercise price of $2.50 exercisable until the five-year anniversary of October 9, 2023 as derivative liability was $9,422. The estimated fair value of the warrants was computed as of March 31, 2024 using Black-Scholes option-pricing model, with the following assumptions: stock price of $0.32, volatility of 82.77%, risk-free rate of 4.21%, annual dividend yield of 0% and expected life of 4.5 years.
On March 7, 2024, the Company issued 262,904 warrants to Mast Hill and a third party as a finder’s fee (see Note 6). Upon evaluation, the warrants meet the definition of a derivative liability under FASB ASC 815, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 121,154 warrants with an exercise price of $1.30 exercisable until the five-year anniversary of March 7, 2024, which warrant shall be cancelled and extinguished against payment of the March 2024 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 141,750 warrants with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 was classified as a derivative liability on March 7, 2024.
On March 31, 2024, the estimated fair value of the 141,750 warrants with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 as derivative liability was $14,742. The estimated fair value of the warrants was computed as of March 31, 2024 using Black-Scholes option-pricing model, with the following assumptions: stock price of $0.32, volatility of 81.89%, risk-free rate of 4.21%, annual dividend yield of 0% and expected life of 4.9 years.
Increases or decreases in fair value of the derivative liability is included as a component of total other (expenses) income in the accompanying condensed consolidated statements of operations and comprehensive loss. The changes to the derivative liability resulted in a decrease of $31,212 in the derivative liability and the corresponding increase in other income as a gain for the three months ended March 31, 2024.
NOTE 8 – NOTE PAYABLE, NET
On September 1, 2022, the Company issued a balloon promissory note in the form of a mortgage on its headquarters to a third party company in the principal amount of $4,800,000, which carries interest of 11.0% per annum. Interest is due in monthly payments of $44,000 beginning November 1, 2022 and payable monthly thereafter until September 1, 2025 when the principal outstanding and all remaining interest is due. The principal of $4,800,000 can be extended for an additional 36 months, provided that the Company has not defaulted. The Company may not prepay the principal of $4,800,00 for a period of 12 months. The principal of $4,800,000 is secured by a first mortgage on the Company’s real property located in Township of Freehold, County of Monmouth, State of New Jersey, having a street address of 4400 Route 9 South, Freehold, NJ 07728.
In May 2023, the Company borrowed $1,000,000 from the same lender. The principal of $1,000,000 accrues interest at an annual rate of 13.0% and is payable in monthly installments of interest-only in the amount of $10,833, commencing in June 2023 and continuing through October 2025 (at which point any unpaid balance of principal, interest and other charges are due and payable). The loan is secured by a second-lien mortgage on certain real property and improvements located at 4400 Route 9, Freehold, Monmouth County, New Jersey.
The note payable as of March 31, 2024 and December 31, 2023 is as follows:
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NOTE 8 – NOTE PAYABLE, NET (continued)
For the three months ended March 31, 2024 and 2023, amortization of debt issuance costs related to note payable amounted to $29,807 and $22,205, respectively, which have been included in interest expense — amortization of debt discount and debt issuance cost on the accompanying condensed consolidated statements of operations and comprehensive loss. For the three months ended March 31, 2024 and 2023, interest expense related to note payable amounted to $164,500 and $132,000, respectively, which have been included in interest expense - other on the accompanying condensed consolidated statements of operations and comprehensive loss.
NOTE 9 – RELATED PARTY TRANSACTIONS
Rental Revenue from Related Party and Rent Receivable – Related Party
The Company leases space of its commercial real property located in New Jersey to a company, D.P. Capital Investments LLC, which is controlled by Wenzhao Lu, the Company’s largest shareholder and chairman of the Board of Directors. The term of the related party lease agreement is five years commencing on May 1, 2021 and will expire on April 30, 2026.
For both the three months ended March 31, 2024 and 2023, the related party rental revenue amounted to $12,600 and has been included in rental revenue on the accompanying condensed consolidated statements of operations and comprehensive loss. At March 31, 2024 and December 31, 2023, the related party rent receivable totaled $12,100 and $124,500, respectively, which has been included in rent receivable on the accompanying condensed consolidated balance sheets, and no allowance for doubtful accounts was deemed to be required on the receivable.
Services Provided by Related Party
From time to time, Wilbert Tauzin, a director of the Company, and his son provide consulting services to the Company. As compensation for professional services provided, the Company recognized consulting expenses of $16,731 and $26,457 for the three months ended March 31, 2024 and 2023, respectively, which have been included in professional fees on the accompanying condensed consolidated statements of operations and comprehensive loss.
Accrued Liabilities and Other Payables – Related Parties
In 2017, the Company acquired Beijing Genexosome for a cash payment of $450,000. As of March 31, 2024 and December 31, 2023, the unpaid acquisition consideration of $100,000, was payable to Dr. Yu Zhou, former director and former co-chief executive officer and 40% owner of Genexosome, and has been included in accrued liabilities and other payables — related parties on the accompanying condensed consolidated balance sheets.
From time to time, Lab Services MSO paid shared expense on behalf of the Company. In addition, Lab Services MSO made a payment of $666,667 for equity method investment payable on behalf of the Company in the first quarter of 2024. As of March 31, 2024 and December 31, 2023, the balance due to Lab Services MSO amounted to $666,666 and $72,746, respectively, which has been included in accrued liabilities and other payables — related parties on the accompanying condensed consolidated balance sheets.
As of March 31, 2024 and December 31, 2023, $44,308 and $33,712 of accrued and unpaid interest related to borrowings from Wenzhao Lu, the Company’s largest shareholder and chairman of the Board of Directors, respectively, have been included in accrued liabilities and other payables — related parties on the accompanying condensed consolidated balance sheets.
Borrowing from Related Party
On August 29, 2019, the Company entered into a Line of Credit Agreement (the “Line of Credit Agreement”) providing the Company with a $20 million line of credit (the “Line of Credit”) from Wenzhao Lu (the “Lender”), the largest shareholder and Chairman of the Board of Directors of the Company. The Line of Credit allows the Company to request loans thereunder and to use the proceeds of such loans for working capital and operating expense purposes until the facility matures on December 31, 2024. The loans are unsecured and are not convertible into equity of the Company. Loans drawn under the Line of Credit bear interest at an annual rate of5% and each individual loan is payable three years from the date of issuance. The Company has a right to draw down on the line of credit and not at the discretion of the related party Lender. The Company may, at its option, prepay any borrowings under the Line of Credit, in whole or in part at any time prior to maturity, without premium or penalty. The Line of Credit Agreement includes customary events of default. If any such event of default occurs, the Lender may declare all outstanding loans under the Line of Credit to be due and payable immediately.
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NOTE 9 – RELATED PARTY TRANSACTIONS (continued)
Borrowing from Related Party (continued)
There was no Line of Credit activity during the three months ended March 31, 2024. As of both March 31, 2024 and December 31, 2023, the outstanding principal balance was $850,000.
For the three months ended March 31, 2024 and 2023, the interest expense related to related party borrowing amounted to $10,596 and $2,021, respectively, and has been reflected as interest expense — related party on the accompanying condensed consolidated statements of operations and comprehensive loss.
As of March 31, 2024 and December 31, 2023, the related accrued and unpaid interest for Line of Credit was $44,308 and $33,712, respectively, and has been included in accrued liabilities and other payables — related parties on the accompanying condensed consolidated balance sheets.
As of March 31, 2024, the Company has used approximately $6.8 million of the credit facility, and has approximately $13.2 million remaining available under the Line of Credit.
Membership Interest Purchase Agreement
On November 17, 2023, the Company entered into a Membership Interest Purchase Agreement (the “Purchase Agreement”) with Wenzhao Lu (the “Purchaser”), the largest shareholder and Chairman of the Board of Directors of the Company, pursuant to which (i) the Purchaser will acquire from the Company 30% of the total outstanding membership interests of Avalon RT 9, a wholly owned subsidiary of the Company for a cash purchase price of $3,000,000 (the “Acquisition”), and (ii) for a period of twelve months following the closing of the Acquisition, the Purchaser shall have the option to purchase from the Company up to an additional 70% of the outstanding membership interests of Avalon RT 9 for a purchase price of up to $7,000,000 (the “Option”), subject to the terms and conditions of a membership interest purchase agreement to be negotiated and entered into between the Purchaser and the Company at such time that the Purchaser desires to exercise the Option The Company received $1,696,186 and $485,714 from Wenzhao Lu as of March 31, 2024 and December 31, 2023, respectively, which was recorded as advance from sale of noncontrolling interest – related party on the accompanying condensed consolidated balance sheets. As of the date of this report, the Acquisition has not been consummated and the performance of the Company’s obligations under the Purchase Agreement is subject to the Company obtaining written consent from Mast Hill and Firstfire under the 2023 Convertible Notes, so the consummation of the Acquisition would not constitute an event of default under such notes. In addition, the Company received a waiver from Mast Hill and First Fire on May 29, 2024 stating that the consummation of this transaction in the future will not be considered an event of default under the provisions of the Convertible Notes.
NOTE 10 – EQUITY
Common Shares Issued as Convertible Note Payable Commitment Fee
During the three months ended March 31, 2024, the Company issued a total of 105,000 shares of its common stock as commitment fee for the purchase of March 2024 Convertible Note. These shares were valued at $42,000, the fair market value on the grant date using the reported closing share price on the date of grant, and the Company recorded it as debt discount.
Options
The following table summarizes the shares of the Company’s common stock issuable upon exercise of options outstanding at March 31, 2024:
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NOTE 10 – EQUITY (continued)
Options (continued)
Stock option activity for the three months ended March 31, 2024 was as follows:
The aggregate intrinsic value of both stock options outstanding and stock options exercisable at March 31, 2024 was $0.
The fair values of options granted during the three months ended March 31, 2024 were estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions: volatility of 91.17%, risk-free rate of 3.93%, annual dividend yield of 0%, and expected life of5.00 years. The aggregate fair value of the options granted during the three months ended March 31, 2024 was $12,137.
The fair values of options granted during the three months ended March 31, 2023 were estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions: volatility of 143.99% - 145.73%, risk-free rate of 3.58% - 3.94%, annual dividend yield of 0%, and expected life of 5.00 years. The aggregate fair value of the options granted during the three months ended March 31, 2023 was $176,786.
For the three months ended March 31, 2024 and 2023, stock-based compensation expense associated with stock options granted amounted to $13,533 and $68,262, of which, $5,103 and $51,336 was recorded as compensation and related benefits, $8,430 and $11,457 was recorded as professional fees, and $0 and $5,469 was recorded as research and development expenses, respectively.
A summary of the status of the Company’s nonvested stock options granted as of March 31, 2024 and changes during the three months ended March 31, 2024 is presented below:
Warrants
The following table summarizes the shares of the Company’s common stock issuable upon exercise of warrants outstanding at March 31, 2024:
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Warrants (continued)
Stock warrant activity for the three months ended March 31, 2024 was as follows:
The aggregate intrinsic value of both stock warrants outstanding and stock warrants exercisable at March 31, 2024 was $0.
Warrants Issued in March 2024
In connection with the issuance of March 2024 Convertible Note (See Note 6), the Company issued (i) a warrant to purchase 131,250 shares of common stock with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024, (ii) a warrant to purchase 121,154 shares of common stock with an exercise price of $1.30 exercisable until the five-year anniversary of March 7, 2024, which warrant shall be cancelled and extinguished against payment of the March 2024 Convertible Note, to Mast Hill; and issued a warrant to purchase 10,500 shares of common stock with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 to a third party as a finder’s fee.
Based upon the Company’s analysis of the criteria contained in ASC 815, the Company determined that all the warrants issued to Mast Hill and a third party as a finder’s fee meet the definition of a derivative liability, as the Company cannot avoid a net cash settlement under certain circumstances. Management determined the probability of failing to make an amortization payment when due to be remote and as such the fair value of the 121,154 warrants with an exercise price of $1.30 exercisable until the five-year anniversary of March 7, 2024, which warrant shall be cancelled and extinguished against payment of the March 2024 Convertible Note, has been estimated to be zero. Accordingly, the fair value of the 141,750 warrants with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 was classified as a derivative liability on March 7, 2024. The fair values of the 141,750 warrants with an exercise price of $2.00exercisable until the five-year anniversary of March 7, 2024 issued on March 7, 2024 were computed using the Black-Scholes option-pricing model with the following assumptions: stock price of $0.40, volatility of 85.24%, risk-free rate of 4.07%, annual dividend yield of 0% and expected life of 5 years.
The warrants with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 issued to Mast Hill to purchase 131,250 shares of the Company’s common stock were treated as a discount on the convertible note payable and were valued at $20,374 and will be amortized over the term of the March 2024 Convertible Note.
The warrants with an exercise price of $2.00 exercisable until the five-year anniversary of March 7, 2024 issued to a third party as a finder’s fee to purchase 10,500 shares of the Company’s common stock were treated as convertible debt issuance costs and were valued at $1,679 and will be amortized over the term of the March 2024 Convertible Note.
A summary of the status of the Company’s nonvested stock warrants issued as of March 31, 2024 and changes during the three months ended March 31, 2024 is presented below:
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NOTE 11 - STATUTORY RESERVE AND RESTRICTED NET ASSETS
The Company’s PRC subsidiary, Avalon Shanghai, is restricted in its ability to transfer a portion of its net asset to the Company. The payment of dividends by entities organized in China is subject to limitations, procedures and formalities. Regulations in the PRC currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China.
The Company is required to make appropriations to certain reserve funds, comprising the statutory surplus reserve and the discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (“PRC GAAP”). Appropriations to the statutory surplus reserve are required to be at least 10% of the after-tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entity’s registered capital. Appropriations to the discretionary surplus reserve are made at the discretion of the Board of Directors. The statutory reserve may be applied against prior year losses, if any, and may be used for general business expansion and production or increase in registered capital, but are not distributable as cash dividends. The Company did not make any appropriation to statutory reserve for Avalon Shanghai during the three months ended March 31, 2024 as it incurred net loss in the period. As of March 31, 2024 and December 31, 2023, the restricted amount as determined pursuant to PRC statutory laws totaled $6,578.
Relevant PRC laws and regulations restrict the Company’s PRC subsidiary, Avalon Shanghai, from transferring a portion of its net assets, equivalent to its statutory reserve and its share capital, to the Company’s shareholders in the form of loans, advances or cash dividends. Only PRC entity’s accumulated profit may be distributed as dividend to the Company’s shareholders without the consent of a third party. As of both March 31, 2024 and December 31, 2023, total restricted net assets amounted to $1,106,578.
NOTE 12 – CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY
Pursuant to the requirements of Rule 12-04(a), 5-04(c) and 4-08(e)(3) of Regulation S-X, the condensed financial information of the parent company shall be filed when the restricted net assets of consolidated subsidiary exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year. For purposes of this test, restricted net assets of consolidated subsidiary shall mean that amount of the Company’s proportionate share of net assets of consolidated subsidiary (after intercompany eliminations) which as of the end of the most recent fiscal year may not be transferred to the parent company by subsidiary in the form of loans, advances or cash dividends without the consent of a third party.
The Company performed a test on the restricted net assets of consolidated subsidiary in accordance with such requirement and concluded that it was not applicable to the Company as the restricted net assets of the Company’s PRC subsidiary did not exceed 25% of the consolidated net assets of the Company, therefore, the condensed financial statements for the parent company have not been required.
NOTE 13 - CONCENTRATIONS
Customers
The following table sets forth information as to each customer that accounted for 10% or more of the Company’s revenue for the three months ended March 31, 2024 and 2023.
Two customers, which are third party, whose outstanding receivable accounted for 10% or more of the Company’s total outstanding rent receivable at March 31, 2024, accounted for 72.7% of the Company’s total outstanding rent receivable at March 31, 2024.
Two customers, of which, one is a related party and the other is a third party, whose outstanding receivable accounted for 10% or more of the Company’s total outstanding rent receivable at December 31, 2023, accounted for 80.6% of the Company’s total outstanding rent receivable at December 31, 2023.
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NOTE 13 - CONCENTRATIONS (continued)
Suppliers
No supplier accounted for 10% or more of the Company’s purchase during the three months ended March 31, 2024 and 2023.
NOTE 14 – SEGMENT INFORMATION
On February 9, 2023, the Company purchased 40% of Lab Services MSO. Commencing from the purchase date, February 9, 2023, the Company is active in the management of Lab Services MSO. During the three months ended March 31, 2024 and 2023, the Company operated in two reportable business segments: (1) the real property operating segment, and (2) laboratory testing services segment (which commenced with the purchase date, February 9, 2023) since Lab Services MSO’s operating results are regularly reviewed by the Company’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. The Company regularly reviews the operating results and performance of Lab Services MSO, which is the Company’s equity method investee. Information with respect to these reportable business segments for the three months ended March 31, 2024 and 2023 was as follows:
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NOTE 14 – SEGMENT INFORMATION (continued)
NOTE 15 – COMMITMENTS AND CONTINGENCIES
Operating Leases Commitment
The Company is a party to leases for office space. These lease agreements will expire through February 2025. Rent expense under all operating leases amounted to approximately $32,000 and $33,000 for the three months ended March 31, 2024 and 2023, respectively.
Supplemental cash flow information related to leases for the three months ended March 31, 2024 and 2023 is as follows:
The following table summarizes the lease term and discount rate for the Company’s operating lease as of March 31, 2024:
The following table summarizes the maturity of lease liabilities under operating lease as of March 31, 2024:
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NOTE 15 – COMMITMENTS AND CONTINGENCIES (continued)
Joint Venture – Avactis Biosciences Inc.
On July 18, 2018, the Company formed a wholly owned subsidiary, Avactis Biosciences Inc. (“Avactis”), a Nevada corporation, which focuses on accelerating commercial activities related to cellular therapies as well as cellular immunotherapy including CAR-T, CAR-NK, TCR-T and others. When formed, Avactis was designed to integrate and optimize the Company’s global scientific and clinical resources to further advance the use of cellular therapies to treat certain cancers, however the Company is no longer pursuing any commercial activities with respect to cellular immunotherapy and CAR-T, in particular. As of April 6, 2022, the Company owns 60% of Avactis and Arbele Biotherapeutics Limited (“Arbele Biotherapeutics”) owns 40% of Avactis. Avactis owns 100% of the capital stock of Avactis Nanjing Biosciences Ltd., a company incorporated in the PRC on May 8, 2020 (“Avactis Nanjing”), which only owns a patent and is not considered an operating entity.
The Company is required to contribute $10 million (or equivalent in RMB) in cash and/or services, which shall be contributed in tranches based on milestones to be determined jointly by Avactis and the Company in writing subject to the Company’s cash reserves. Within 30 days, Arbele Biotherapeutics shall make contribution of $6.66 million in the form of entering into a License Agreement with Avactis granting Avactis an exclusive right and license in China to its technology and intellectual property pertaining to CAR-T/CAR-NK/TCR-T/universal cellular immunotherapy technology and any additional technology developed in the future with terms and conditions to be mutually agreed upon the Company and Avactis and services. As of the date hereof, the License Agreement has not been finalized by the parties.
In addition, the Company is responsible for contributing registered capital of RMB 5,000,000 (approximately $0.7 million) for working capital purposes as required by local regulation, which is not required to be contributed immediately and will be contributed subject to the Company’s discretion. As of the date hereof, Avactis’ activities have been limited to that of a patent holding company and there is no other activity or planned contributions in the rest of 2024.
NOTE 16 – SUBSEQUENT EVENTS
Management has evaluated subsequent events through the date of the issuance date of these financial statements. Management is not aware of any significant events that occurred subsequent to the balance sheet date that would have a material effect on the financial statements and would require adjustment or disclosure thereto.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 under Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “can,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential” and other similar words and expressions of the future. Accordingly, factors that may affect our results include, but are not limited to:
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All forward-looking statements are expressly qualified in their entirety by this cautionary notice. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this report or the date of the document incorporated by reference into this report. We have no obligation, and expressly disclaim any obligation, to update, revise or correct any of the forward-looking statements, whether as a result of new information, future events or otherwise. We have expressed our expectations, beliefs and projections in good faith, and we believe they have a reasonable basis. However, we cannot assure you that our expectations, beliefs or projections will result or be achieved or accomplished.
The following discussion and analysis of our financial condition and results of operations for the three months ended March 31, 2024 and 2023 should be read in conjunction with our condensed consolidated financial statements and related notes to those condensed consolidated financial statements that are included elsewhere in this report.
Overview
We are a commercial stage company dedicated to developing and delivering innovative, transformative, precision diagnostics and clinical laboratory services. We are working towards establishing a leading role in the innovation of diagnostic testing, utilizing proprietary technology to deliver precise, genetics-driven results. As a first step into the laboratory market, we completed an acquisition of a 40% membership interest in Laboratory Services MSO, LLC (“Lab Services MSO”), which closed in February 2023.
We have the following areas of focus:
Laboratory Acquisitions
We have embarked on a laboratory rollup strategy focused on forming joint ventures and acquiring laboratories that are accretive to our commercial strategy. As a first step, in February of 2023, we acquired a 40% membership interest in Lab Services MSO.
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Research and Development
We are focused on bringing forward intellectual property through joint patent filings with the Massachusetts Institute of Technology (MIT). We completed a sponsored research and co-development project with MIT led by Professor Shuguang Zhang as Principal Investigator. Using the unique QTY code protein design platform, six water-soluble variant cytokine receptors have been successfully designed and tested to show binding affinity to the respective cytokines. We currently are focused on bringing forward the intellectual property associated with this program through joint patent submissions.
Product Commercialization
We have begun the commercialization and development of a versatile breathalyzer system.
We were granted exclusive distributorship rights for the KetoAir from Qi Diagnostics for the following territories: North America, South America, the EU and the UK. For our commercialization strategy, we intend to target the diabetes and obesity markets. On May 31,2024, we plan to formally launch sales of the KetoAir at the 2024 KetoCon Hack Your Health conference in Texas. We plan to sell the product through the KetoAir website and social media. We believe the KetoAir device has some competitive advantages to other methods for measuring ketosis and expect initial sales to occur in the United States.
The KetoAir is a handheld device that allows the user to detect acetone levels in exhaled breath. The acetone level is in concentration units (ppm, part-per-million) such that the user will know his/her real-time ketosis status: inadequate ketosis (0-3.99 ppm), mild ketosis (4-9.99 ppm), optimal ketosis (10-40 ppm), or alarming level (> 40 ppm). The KetoAir is registered with the United States FDA as a Class I medical device. The device is also paired with an “AI Nutritionist” software program (via Bluetooth connection) which is downloadable from Google Play (for Android mobile phones, approved) and iPhone (the app is currently being reviewed by Apple iOS AppStore). It helps users monitor and manage their ketogenic diet and related programs. We believe the KetoAir can be an essential tool to help diabetic patients adhere to their therapeutic programs and optimize their ketogenic dietary management.
Other Areas
In order to preserve cash and focus on our core laboratory rollup strategy and product commercialization, we have currently suspended all research and development efforts related to cellular therapy in order to redirect our funding efforts to our core business strategies outlined above.
We are a commercial stage company dedicated to developing and delivering innovative, transformative, precision diagnostics and clinical laboratory services. We are focused on establishing a leading role in the innovation of diagnostic testing, utilizing proprietary technology to deliver precise, genetics-driven results. We also provide laboratory services, offering a broad portfolio of diagnostic tests, including drug testing, toxicology, and a broad array of test services, from general bloodwork to anatomic pathology, and urine toxicology.
In addition, we own commercial real estate that houses our headquarters in Freehold, New Jersey. We also have income from equity method investment through our forty percent (40%) interest in Lab Services MSO. These condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates, among other things, the realization of assets and the satisfaction of liabilities in the normal course of business.
As reflected in the accompanying condensed consolidated financial statements, we had working capital deficit of approximately $7,026,000 at March 31, 2024 and had incurred recurring net losses and generated negative cash flow from operating activities of approximately $1,368,000 and $916,000 for the three months ended March 31, 2024, respectively.
We have a limited operating history and our continued growth is dependent upon the continuation of generating rental revenue from our income-producing real estate property in New Jersey and income from equity method investment through our forty percent (40%) interest in Lab Services MSO and obtaining additional financing to fund future obligations and pay liabilities arising from ordinary course business operations. In addition, the current cash balance cannot be projected to cover our operating expenses for the next twelve months from the release date of this report. These matters raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to raise additional capital, implement our business plan, and generate sufficient revenues. There are no assurances that we will be successful in our efforts to generate sufficient revenues, maintain sufficient cash balance or report profitable operations or to continue as a going concern. We plan on raising capital through the sale of equity to implement our business plan. However, there is no assurance these plans will be realized and that any additional financings will be available to us on satisfactory terms and conditions, if any.
The accompanying condensed consolidated financial statements do not include any adjustments related to the recoverability or classification of asset-carrying amounts or the amounts and classification of liabilities that may result should we be unable to continue as a going concern.
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Critical Accounting Policies
The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Changes in these estimates and assumptions may have a material impact on the condensed consolidated financial statements and accompanying notes. Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the financial statements, which management considered in formulating its estimate, could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from those estimates.
Significant estimates during the three months ended March 31, 2024 and 2023 include the useful life of investment in real estate and intangible assets, the assumptions used in assessing impairment of long-term assets, the valuation of deferred tax assets and the associated valuation allowances, the valuation of stock-based compensation, the assumptions used to determine fair value of warrants and embedded conversion features of convertible note payable, and the fair value of the consideration given and assets acquired in the purchase of our equity interest in Lab Services MSO.
We use the equity method of accounting for our investment in, and earning or loss of, company that we do not control but over which we do exert significant influence. We apply the equity method by initially recording these investments at cost, as equity method investments, subsequently adjusted for equity in earnings and cash distributions.
We consider whether the fair value of our equity method investment has declined below its carrying value whenever adverse event or change in circumstance indicates that recorded value may not be recoverable. If we consider any decline to be other than temporary (based on various factors, including historical financial results and the overall health of the investee), then a write-down would be recorded to estimated fair value.
We classify distributions received from equity method investments using the cumulative earnings approach. Distributions received are considered returns on the investment and classified as cash inflows from operating activities. If, however, the investor’s cumulative distributions received, less distributions received in prior periods determined to be returns of investment, exceeds cumulative equity in earnings recognized, the excess is considered a return of investment and is classified as cash inflows from investing activities.
Real Property Rental
We have determined that ASC 606 does not apply to rental contracts, which are within the scope of other revenue recognition accounting standards.
We do not offer promotional payments, customer coupons, rebates or other cash redemption offers to its customers.
Income Taxes
We are governed by the income tax laws of China and the United States. Income taxes are accounted for pursuant to ASC 740 “Accounting for Income Taxes,” which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The charge for taxes is based on the results for the period as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
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Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probable that taxable profit will be available against which deductible temporary differences can be utilized.
Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is changed to equity. Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and we intend to settle its current tax assets and liabilities on a net basis.
For details of applicable new accounting standards, please, refer to Recent Accounting Standards in Note 3 of our condensed consolidated financial statements accompanying this report.
RESULTS OF OPERATIONS
Comparison of Results of Operations for the Three Months Ended March 31, 2024 and 2023
For the three months ended March 31, 2024, we had real property rental revenue of $314,588, as compared to $296,165 for the three months ended March 31, 2023, an increase of $18,423, or 6.2%. The increase was primarily attributable to the increase in the number of tenants occupying the building in the three months ended March 31, 2024 as compared to the three months ended March 31, 2023. We expect that our revenue from real property rent will remain at its current level with minimal increase in the near future.
Real Property Operating Expenses
Real property operating expenses consist of property management fees, property insurance, real estate taxes, depreciation, repairs and maintenance fees, utilities and other expenses related to our rental properties.
For the three months ended March 31, 2024, our real property operating expenses amounted to $263,126, as compared to $248,445for the three months ended March 31, 2023, an increase of $14,681 or 5.9%. The increase was primarily due to an increase in repairs and maintenance fee of approximately $11,000 and an increase in other miscellaneous items of approximately $4,000.
Real Property Operating Income
Our real property operating income for the three months ended March 31, 2024 was $51,462, representing an increase of $3,742 or 7.8%, as compared to $47,720 for the three months ended March 31, 2023. The increase was primarily attributable to the increase in real property rental revenue as described above. We expect our real property operating income will remain at its current level with minimal increase in the near future.
Income (Loss) from Equity Method Investment – Lab Services MSO
For the three months ended March 31, 2024, we had income from our investment in Lab Services MSO of $107,469, which consists of our share of Lab Services MSO’s net income of $274,202 and amortization of identifiable intangible assets acquired from Lab Services MSO acquisition of $166,733. For the three months ended March 31, 2023, we had loss from our investment in Lab Services MSO of $89,091, which consists of our share of Lab Services MSO’s net income of $46,739 and amortization of identifiable intangible assets acquired from Lab Services MSO acquisition of $135,830. We purchased 40% of Lab Services MSO on February 9, 2023. In the third quarter of 2023, Lab Services MSO acquired Merlin Technologies, Inc. which is a medical equipment retail company. Lab Services MSO has also opened a new laboratory, Veritas Laboratories LLC (“Veritas”). Veritas is a CLIA-certified and COLA-accredited laboratory located in Scottsdale, Arizona that offers a wide range of high-quality testing, including drug testing, genetic testing, urinary testing and COVID-19 PCR testing. We expect to continue to receive income from our investment in Lab Services MSO in the near future.
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Other Operating Expenses
For the three months ended March 31, 2024 and 2023, other operating expenses consisted of the following:
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Loss from Operations
As a result of the foregoing, for the three months ended March 31, 2024, loss from operations amounted to $843,062, as compared to $2,753,327 for the three months ended March 31, 2023, a decrease of $1,910,265 or 69.4%.
Other (Expense) Income
Other (expense) income mainly includes third party and related party interest expense, change in fair value of derivative liability, and other miscellaneous expense.
Other expense, net, totaled $524,451 for the three months ended March 31, 2024, as compared to $166,417 for the three months ended March 31, 2023, an increase of $358,034, or 215.1%, which was primarily attributable to an increase in third party interest expense of approximately $354,000, mainly driven by the increase in amortization of debt discount and debt issuance cost of approximately $250,000 and the increased interest expense of approximately $104,000 from third party debts in the three months ended March 31, 2024.
We did not have any income taxes expense for the three months ended March 31, 2024 and 2023 since we incurred losses in these periods.
Net Loss
As a result of the factors described above, our net loss was $1,367,513 for the three months ended March 31, 2024, as compared to $2,919,744 for the three months ended March 31, 2023, a decrease of $1,552,231 or 53.2%.
Net Loss Attributable to Avalon GloboCare Corp. Common Shareholders
The net loss attributable to our common shareholders was $1,367,513 or $0.12 per share (basic and diluted) for the three months ended March 31, 2024, as compared to $2,919,744 or $0.29 per share (basic and diluted) for the three months ended March 31, 2023, a decrease of $1,552,231 or 53.2%.
Foreign Currency Translation Adjustment
Our reporting currency is the U.S. dollar. The functional currency of our parent company, AHS, Avalon RT 9, and Avalon Lab is the U.S. dollar and the functional currency of Avalon Shanghai is the Chinese Renminbi (“RMB”). The financial statement of our subsidiary whose functional currency is the RMB are translated to U.S. dollars using period end rate of exchange for assets and liabilities, average rate of exchange for revenues, costs, and expenses and cash flows, and at historical exchange rate for equity. Net gains and losses resulting from foreign exchange transactions are included in the results of operations. As a result of foreign currency translations, which are a non-cash adjustment, we reported a foreign currency translation loss of $2,920 and a foreign currency translation gain of $3,670 for the three months ended March 31, 2024 and 2023, respectively. This non-cash loss/gain had the effect of increasing/decreasing our reported comprehensive loss in each respective period.
Comprehensive Loss
As a result of our foreign currency translation adjustment, we had comprehensive loss of $1,370,433 and $2,916,074 for the three months ended March 31, 2024 and 2023, respectively.
Liquidity and Capital Resources
We have a limited operating history and our continued growth is dependent upon the continuation of generating rental revenue from our income-producing real estate property in New Jersey and income from equity method investment through our equity interest in Lab Services MSO, as well as obtaining additional financing to fund future obligations and pay liabilities arising from ordinary course business operations. In addition, the current cash balance cannot be projected to cover our operating expenses for the next twelve months from the release date of this report. These matters raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to raise additional capital, implement our business plan, and generate sufficient revenues. There are no assurances that we will be successful in our efforts to generate sufficient revenues, maintain sufficient cash balance or report profitable operations or to continue as a going concern. As described below, we have raised additional capital through the sale of equity and debt and we plan to raise additional capital in the future through the sale of equity or debt to implement our business plan. However, there is no assurance these plans will be realized and that any additional financings will be available to us on satisfactory terms and conditions, if at all.
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Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations as they come due and otherwise operate on an ongoing basis. At March 31, 2024 and December 31, 2023, we had cash balance of approximately $305,000 and $285,000, respectively. These funds are kept in financial institutions located as follows:
The following table sets forth a summary of changes in our working capital deficit from December 31, 2023 to March 31, 2024:
Our working capital deficit increased by $1,113,698 to $7,025,517 at March 31, 2024 from $5,911,819 at December 31, 2023. The increase in working capital deficit was primarily attributable to a decrease in rent receivable of approximately $109,000 driven by collection efforts in the three months ended March 31, 2024, an increase in accrued liabilities and other payables – related parties of approximately $605,000 mainly due to our equity method investment payable paid by a related party on our behalf, and a significant increase in advance from sale of noncontrolling interest – related party of approximately $1,210,000 resulting from advance received in connection with the membership interest purchase agreement entered into in November 2023 in the three months ended March 31, 2024, offset by a decrease in equity method investment payable of approximately $667,000 resulting from payment made by a related party on our behalf in the first quarter of 2024, and a decrease in convertible note payable, net, of approximately $95,000 mainly due to the repayments made to lenders of $866,000, which was partially offset by the issuance of the March 2024 Convertible Note with principal of $700,000 in the first quarter of 2024 (as described below).
Because the exchange rate conversion is different for the condensed consolidated balance sheets and the condensed consolidated statements of cash flows, the changes in assets and liabilities reflected on the condensed consolidated statements of cash flows are not necessarily identical with the comparable changes reflected on the condensed consolidated balance sheets.
Cash Flows for the Three Months Ended March 31, 2024 Compared to the Three Months Ended March 31, 2023
The following summarizes the key components of our cash flows for the three months ended March 31, 2024 and 2023:
Net cash flow used in operating activities for the three months ended March 31, 2024 was $915,709, which primarily reflected our consolidated net loss of approximately $1,368,000, and the non-cash items adjustment, primarily consisting of income from equity method investment of approximately $107,000, offset by distribution of earnings from equity method investment of approximately $161,000, and amortization of debt issuance costs and debt discount of approximately $272,000, and the changes in operating assets and liabilities, primarily consisting of a decrease in rent receivable of approximately $113,000 driven by our collection efforts.
Net cash flow used in operating activities for the three months ended March 31, 2023 was $1,834,810, which primarily reflected our consolidated net loss of approximately $2,920,000, and the changes in operating assets and liabilities, primarily consisting of an increase in prepaid expense and other assets of approximately $87,000, offset by an increase in accrued liabilities and other payables of approximately $635,000 which was primarily attributable to an increase in accrued professional fees of approximately $414,000 resulting from the increase in professional service related to our acquisition of Lab Services MSO and an increase in accrued research and development fees of approximately $62,000 and an increase in other payables of approximately $159,000, and the non-cash items adjustment primarily consisting of depreciation of approximately $61,000, stock-based compensation and service expense of approximately $327,000, and loss from equity method investments of approximately $99,000.
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We expect our cash used in operating activities to increase due to the following:
There was no investing activity during the three months ended March 31, 2024.
Net cash flow used in investing activities was $20,185 for the three months ended March 31, 2023. During the three months ended March 31, 2023, we made payment for purchase of property and equipment of approximately $20,000.
Net cash flow provided by financing activities was $936,772 for the three months ended March 31, 2024 as compared to $750,000 for the three months ended March 31, 2023. During the three months ended March 31, 2024, we received net proceeds from issuance of convertible debt and warrants of approximately $592,000 (net of original issue discount of $35,000 and cash paid for convertible note issuance costs of approximately $73,000), and advance from sale of noncontrolling interest in subsidiary of approximately $1,210,000, offset by repayments made for convertible debt of $866,000. During the three months ended March 31, 2023, we received proceeds from related party borrowings of $750,000.
The following trends are reasonably likely to result in a material decrease in our liquidity over the near to long term:
August 2019 Credit Facility
In the third quarter of 2019, we entered a $20 million credit facility (Line of Credit) provided by our Chairman, Wenzhao Lu. The unsecured credit facility bears interest at a rate of 5% and provides for maturity on drawn loans 36 months after funding. As of March 31, 2024, we have used approximately $6.8 million of the credit facility and have approximately $13.2 million remaining available under the Line Credit.
ATM
In June 2023, we entered into a sales agreement (the “Sales Agreement”) with Roth Capital Partners, LLC (“Roth”) under which we may offer and sell from time to time shares of our common stock having an aggregate offering price of up to $3.5 million. From July 1, 2023 to May 15, 2024, Roth has sold an aggregate of 456,627 shares of our common stock at an average price of $1.39 per share to investors. We received net cash proceeds of $616,259, net of cash paid for sales agent’s commission and other fees of $19,132.
March 2024 Convertible Note Financing
In March 2024, we entered into a security purchase agreement with a lender (the “March 2024 Lender”) and closed on the issuance of a 13.0% senior secured convertible promissory note in the principal amount of $700,000 (the “March 2024 Convertible Note”), as well as the issuance of 105,000 shares of common stock as a commitment fee and warrants for the purchase of up to 252,404 shares of our common stock. We and our subsidiaries also entered into security agreements in connection with the March 2024 Convertible Note, creating a security interest in certain property of the Company and its subsidiaries to secure the prompt payment, performance and discharge in full of all of our obligations under the March 2024 Convertible Note.
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In addition to the March 2024 Convertible Note, as of the date of this report, we have outstanding the May 2023 Convertible Note with Mast Hill, the July 2023 Convertible Note with Firstfire and the October 2023 Convertible Note with Mast Hill and Firstfire (collectively, the “2023 Notes Lenders”), each as defined and further discussed in Item 1 of this report under “Note 6. Convertible Note Payable” (collectively, the “2023 Convertible Notes”). The 2023 Convertible Notes and the March 2024 Convertible Note contain customary events of default, upon the occurrence of which (after giving effect to the right to cure of the borrower), the notes shall become due and payable and the borrower shall pay to the lender/s an amount equal to the principal amount then outstanding under such notes plus accrued interest (including any Default Interest, as defined in the 2023 Convertible Notes and the March 2024 Convertible Note, respectively), provided, however, that the 2023 Notes Lenders and the March 2024 Lender may in their sole discretion determine to accept payment part in shares of the Company’s common stock (pursuant to the conversion formula set forth in the 2023 Convertible Notes and the March 2024 Convertible Note) and part in cash.
The Company did not receive any notice from the 2023 Notes Lenders or the March 2024 Lender with respect to the event of default. The Company first had actual knowledge of the existence of the default on April 29, 2024 and received a waiver from the 2023 Notes Lenders and the March 2024 Lender, waiving this event of default on May 29, 2024. Although this waiver was not within the Cure Period, the lenders provided a full waiver to the event of default prior to the issuance of this report.
In addition, the Company failed to file this report in a timely manner during the prescribed period following the Company’s filing of a 12b-25 extension with respect thereto, which would have triggered an event of default under the 2023 Convertible Notes and the March 2024 Convertible Note but for receipt by the Company of the waiver with respect to this event of default from the 2023 Notes Lenders and the March 2024 Lender on the original due date of this report (which waiver was reaffirmed on May 29, 2024).
Furthermore, on May 23, 2024, the Company received a waiver to the required amortization payment under the May 2023 Convertible Note. Pursuant to the waiver, the Company received an extension until June 10, 2024 to allow time for the payment to be made or to allow the Company to refinance the Convertible Notes.
As a result, the 2023 Convertible Notes and the March 2024 Convertible Note are no longer in default as of the date of this report. The events of default described above did not have an accounting impact on the Company’s unaudited financial statements for the quarter ended March 31, 2024 since the events of default were either cured within the Cure Period or prior to the date of this report and no penalties associated with such events of default under the 2023 Convertible Notes and March 2024 Convertible Notes were ever triggered.
We estimate that based on current plans and assumptions, that our available cash will be insufficient to satisfy our cash requirements under our present operating expectations through cash flow provided by operations, and cash available under our ATM and lending facilities and sales of equity. Other than funds received as described above and cash resource generating from our operations, we presently have no other significant alternative source of working capital. We have used these funds to fund our operating expenses, pay our obligations and grow our company. We will need to raise significant additional capital to fund our operations and to provide working capital for our ongoing operations and obligations. Therefore, our future operation is dependent on our ability to secure additional financing. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our common stock and a downturn in the U.S. equity and debt markets could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses or experience unexpected cash requirements that would force us to seek alternative financing. Furthermore, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. The inability to obtain additional capital may restrict our ability to grow and may reduce our ability to continue to conduct business operations. If we are unable to obtain additional financing, we will be required to cease our operations. To date, we have not considered this alternative, nor do we view it as a likely occurrence.
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Foreign Currency Exchange Rate Risk
We ceased all operations in China in 2022, with the exception of a small administrative office. We do not expect nor do we plan that there will be further revenue generated from PRC operations in the foreseeable future. Thus, exchange rate fluctuations between the RMB and the US dollar do not have a material effect on us. For the three months ended March 31, 2024 and 2023, we had an unrealized foreign currency translation loss of approximately $3,000 and an unrealized foreign currency translation gain of approximately $4,000, respectively, because of changes in the exchange rate.
Inflation
The effect of inflation on our revenue and operating results was not significant.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act, we are not required to provide the information required by this Item.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
In connection with the preparation of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2024, our management, including our principal executive officer and principal financial officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures, which are defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act.
Based on this evaluation, management concluded that our disclosure controls and procedures were not effective as of March 31, 2024 due to the material weaknesses that were previously reported in our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the SEC on April 15, 2024, that have not yet been remediated, and our lack of the controls needed to monitor our continuous compliance with contracts, including debt agreements. Management’s plan to remediate these material weaknesses is described in detail in such Annual Report on Form 10-K for the year ended December 31, 2023.
Changes in Internal Controls Over Financial Reporting
There were no changes in our internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may become involved in legal proceedings arising in the ordinary course of our business. We are not presently a party to any legal proceedings that, if determined adversely to us, we believe would individually or in the aggregate have a material adverse effect on our business, results of operations, financial condition or cash flows.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the SEC on April 15, 2024, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K may not be the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
There have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023 filed with the SEC on April 15, 2024.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
We issued 105,000 shares of our common stock as a commitment fee and warrants for the purchase of up to 252,404 shares of our common stock in connection with the issuance of the March 2024 Note to the March 2024 Lender.
In March 2024, we issued a five-year warrant to purchase 10,500 shares of our common stock with an exercise price of $2.00 as a finder’s fee in connection with our note offering in March 2024.
The offers, sales, and issuances of the securities described above were deemed to be exempt from registration under the Securities Act in reliance on Section 4(a)(2) of the Securities Act, or Regulation D promulgated thereunder as transactions by an issuer not involving a public offering. The recipients of securities in each of these transactions acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the securities issued in these transactions. Each of the recipients of securities in these transactions was an accredited or sophisticated person and had adequate access, through employment, business or other relationships, to information about us.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
As outlined fully in Part I, Item 1, Note 6 above, the Company defaulted on the Senior Secured Convertible Notes with Mast Hill and First Fire.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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ITEM 5. OTHER INFORMATION
(a) 2023 Convertible Notes and March 2024 Convertible Notes – Events of Default.
As of the date of this report, we have outstanding the 2023 Convertible Notes with the 2023 Notes Lenders and the March 2024 Convertible Note with the March 2024 Lender, each as further discussed in Item 1 of this report under “Note 6. Convertible Note Payable.” The 2023 Convertible Notes and the March 2024 Convertible Note contain customary events of default, upon the occurrence of which (after giving effect to the right to cure of the borrower), the notes shall become due and payable and the borrower shall pay to the lender/s an amount equal to the principal amount then outstanding under the 2023 Convertible Notes and the March 2024 Convertible Note plus accrued interest (including any Default Interest, as defined in the 2023 Convertible Notes and the March 2024 Convertible Note, respectively), provided, however, that the 2023 Notes Lenders and the March 2024 Lender may in their sole discretion determine to accept payment part in shares of the Company’s common stock (pursuant to the conversion formula set forth in the 2023 Convertible Notes and the March 2024 Convertible Note) and part in cash.
(b) None of the Company’s directors and officers adopted, modified, or terminated a Rule 10b5-1 trading arrangement or a non- Rule 10b5-1 trading arrangement during the Company's fiscal quarter ended March 31, 2024 (each as defined in Item 408 of Regulation S-K under the Securities Exchange Act of 1934, as amended).
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ITEM 6. EXHIBITS
The exhibits filed as part of this Quarterly Report on Form 10-Q are listed in the exhibit index included herewith and are incorporated by reference herein.
EXHIBIT INDEX
Exhibit No.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
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