ONE STOP SYSTEMS, INC. - Quarter Report: 2021 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2021

OR

For the transition period from __________ to ________________

Commission File Number: 001-38371

One Stop Systems, Inc.

(Exact Name of Registrant as Specified in its Charter)

2235 Enterprise Street #110

Escondido, California 92029

(Address of principal executive offices including Zip Code

(760) 745-9883

(Registrant’s telephone number, including area code)

(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.

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 October 31, 2021, the registrant had 18,666,022 shares of common stock (par value $0.0001) outstanding.

Table of Contents

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

In our opinion, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly our financial position, results of operations, and cash flows for the interim periods presented. We have consolidated such financial statements in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Therefore, such financial statements do not include all disclosures required by accounting principles generally accepted in the United States of America. In preparing these unaudited consolidated financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the unaudited consolidated financial statements were issued by filing with the SEC.

This Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 should be read in conjunction with our audited financial statements for the year ended December 31, 2020 included in our Annual Report on Form 10-K, filed with the SEC on March 25, 2021.

The results of operations for the three and nine months ended September 30, 2021 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2021.

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Three and Nine Months Ended September 30, 2021

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

For the Three and Nine Months Ended September 30, 2020

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Nine Month Periods Ended September 30, 2021 and 2020

NOTE 1 – THE COMPANY AND BASIS OF PRESENTATION

Nature of Operations

One Stop Systems, Inc. (“we,” “our,” “OSS,” or the “Company”) was originally incorporated as a California corporation in 1999 after initially being formed as a California limited liability company in 1998. On December 14, 2017, the Company was reincorporated as a Delaware corporation in connection with its initial public offering.  The Company designs, manufactures, and markets industrial grade computer systems and components that are based on industry standard computer architectures. The Company markets its products to manufacturers of automated equipment used for media and entertainment, medical, industrial, and military applications.     

During the year ended December 31, 2015, the Company formed a wholly owned subsidiary in Germany, One Stop Systems, GmbH (“OSS GmbH”). In July 2016, the Company acquired Mission Technologies Group, Inc. (“Magma”) and its operations.

On August 31, 2018, the Company acquired Concept Development Inc. (“CDI”) located in Irvine, California.  CDI specializes in the design and manufacture of custom high-performance computing systems for airborne in-flight entertainment and networking systems.  CDI has been fully integrated into the core operations of OSS as of June 1, 2020.

On October 31, 2018, OSS GmbH acquired 100% of the outstanding stock of Bressner Technology GmbH, a Germany limited liability company located near Munich, Germany (“Bressner”).  Bressner designs and manufactures standard and customized servers, panel PCs, and PCIe expansion systems.  Bressner also provides manufacturing, test, sales and marketing services for customers throughout Europe.

Historically, the Company’s primary sources of liquidity have been provided by public and private offerings of its securities and revenues generated from its business operations.  On April 24, 2020, the Company sold $3,000,000 of Senior Secured Convertible Promissory Notes at a 10% original issue discount to an institutional investor through a registered direct offering.  On April 28, 2020, the Company received approximately $1,500,000, of government funding under the Paycheck Protection Program.  On March 3, 2021, the Company sold and issued 1,497,006 shares of its common stock to an accredited investor through a registered direct offering, resulting in net proceeds of $9,188,673.

As of September 30, 2021, the Company’s cash and cash equivalents were $3,955,215, it had $14,534,084 in short-term investments, and it had total working capital of $28,185,019.  Cash and cash equivalents held by Bressner totaled $770,603 on September 30, 2021.  Bressner’s debt covenants do not permit the use of these funds by its parent company.

During the nine month period ended September 30, 2021, the Company had operating income of $1,817,960, with cash generated by operating activities of $3,297,125.  During the year ended December 31, 2020, the Company experienced an operating loss of $424,281, with cash used in operating activities of $250,173.  

The Company’s revenue growth during 2020, slowed due to the effects of COVID-19.  However, through a reduction in force and strict cost containment, the Company was able to mitigate the effects, to some degree, of the reduced revenue attributable to the economic impact of COVID-19.

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Despite global efforts to slow the spread of the virus and to mitigate its effects, COVID-19 continues to impact worldwide economic activity, and the ongoing effects of the COVID-19 pandemic has adversely impacted, and may continue to adversely impact, many aspects of our business. In response to the COVID-19 pandemic, many state, local, and foreign governments have put in place restrictions in order to control the spread of the disease. Such restrictions, or the perception that further restrictions could occur, have resulted in business closures, work stoppages, slowdowns, delays, work-from-home policies, travel restrictions, and cancellation or postponement of events, among other effects that impacted productivity and disrupted our operations and those of our partners, suppliers, contractors, and customers.

One way that COVID-19 has directly affected our operations is that we have experienced increased pricing and/or shortages of certain parts and supplies that are necessary components to the products and services we offer to our customers, and as a result, are experiencing longer lead-times. COVID-19 has indirectly affected our operations as well. For instance, some of our customers experienced downturns or uncertainty in their own business operations and revenue, and as a result, these customers have (and may continue to) decreased or delayed their technology spending, requested pricing concessions or payment extensions, or seek to renegotiate their contracts. For example, one of our customers that uses our products and services in their business operations operates in the live event space, such as music festivals and concerts. Due to measures implemented by local and state governments to restrict public gatherings in order to stop and/or prevent the spread of COVID-19, our customer was unable to generate revenue at previous levels during these times, and as a result, we provided extended payment terms for the collection of our accounts receivables for this particular customer during the pandemic. However, all past due accounts receivables owed by this particular customer have now been received by the Company.    

During the pandemic, as state, local, and foreign governments implemented (and may continue to implement) preventative measures to contain or mitigate the outbreak of COVID-19, the usage of our products and services fluctuated following such implementation, and we cannot predict how usage levels will continue to be impacted by these preventative measures. There is no assurance that customers will continue to use our products and services, or to the same extent, as the COVID-19 pandemic begins to taper off or when it will end. As a result, it has been difficult to accurately forecast our revenues or financial results, especially given that the near and long term impact of the pandemic remains uncertain. In addition, while the potential impact and duration of the COVID-19 pandemic on the economy and our business in particular may be difficult to assess or predict, the pandemic has resulted in, and may continue to result in, significant disruption of global financial markets, and may reduce our ability to access additional capital, which could negatively affect our liquidity in the future. Our results of operations could be materially below our forecasts as well, which could adversely affect our results of operations, disappoint analysts and investors, or cause our stock price to decline.

Furthermore, a decrease in orders in a given period could negatively affect our revenues in future periods. The COVID-19 pandemic may also have the effect of heightening many of the other risks described in the “Risk Factors” section of our December 31, 2020 Annual Report on Form 10-K, filed March 25, 2021, including risks associated with our customers and supply chain. We may take further actions that alter our operations as may be required by federal, state, or local authorities, or which we determine are in our best interests. While much of our operations can be performed remotely, certain activities often require personnel to be on-site, and our ability to carry out these activities has been, and may continue to be negatively impacted if our employees or local personnel are not able to travel. In addition, for activities that may be conducted remotely, there is no guarantee that we will be as effective while working remotely because our team is dispersed and many employees and their families have been negatively affected, mentally or physically, by the COVID-19 pandemic. Decreased effectiveness and availability of our team could harm our business. In addition, we may decide to postpone or cancel planned investments in our business in response to changes in our business as a result of the spread of COVID-19, which may impact our ability to attract and retain customers and our rate of innovation, either of which could harm our business.

We do not yet know the full extent of potential delays or impacts on our business, operations, or the global economy as a whole. Currently, we are experiencing unavailability of product and limited supplies, protracted delivery dates for componentry, increasing product costs, and changes in minimum order quantities to secure product.  As a result, the Company is carrying increased inventory balances to ensure availability of product and to secure pricing.  Additionally, work-in-process and finished goods inventory has been increasing as the timing of availability of certain componentry to the production line has varied from committed delivery dates from vendors.

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While there have recently been vaccines developed and administered, and certain government orders and restrictions in particular cities, counties, and states have been lifted as the spread of COVID-19 starts to be contained and mitigated, we cannot predict the timing of the vaccine roll-out globally or the efficacy of such vaccines, including against variants of the virus, and we do not yet know how businesses, customers, contractors, suppliers, or our partners will operate in a post COVID-19 environment, especially if additional or supplemental governmental orders, limitations, and restrictions are reinstated. There may be additional costs or impacts to our business and operations, including when we are able to resume in-person activities, travel, and events. In addition, there is no guarantee that a future outbreak of this or any other widespread epidemics will not occur, or that the global economy will recover, either of which could harm our business.

Management’s plans with respect to the above are to continue their efforts towards responding to the changing economic landscape attributable to COVID-19, to continue to control costs, conserve cash, strengthen margins, and improve company-wide execution.  Specific actions implemented in 2020, by management in response to this effort included a reduction in force, a limited freeze on hiring, reduced work week, minimized overtime, travel and entertainment, and contractor costs.    

While management expects these actions to result in prospective cost containment, management is also committed to conserving cash, and securing debt and/or equity financing as required for liquidity to meet the Company’s cash requirements through at least a period of the next twelve months. Management believes potential sources of liquidity include at least the following:

As a result of management’s cost reduction plans, the Company’s sources of liquidity and management’s most recent cash flow forecasts, management believes that the Company has sufficient liquidity to satisfy its anticipated cash requirements for at least the next twelve months. However, there can be no assurance that management’s cost reduction efforts will be effective, the forecasted cash flows will be achieved, or that external sources of financing, including the issuance of debt and/or equity securities, will be available at times and on terms acceptable to the Company, or at all.  

Basis of Presentation

The accompanying consolidated financial statements have been prepared on an accrual basis of accounting in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”), as set forth in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”).  

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The unaudited consolidated financial statements herein have been prepared by the Company pursuant to the rules and regulations of the SEC.  The accompanying interim unaudited consolidated financial statements have been prepared under the presumption that users of the interim financial information have either read or have access to the audited consolidated financial statements for the latest year ended December 31, 2020.  Accordingly, note disclosures which would substantially duplicate the disclosures contained in the December 31, 2020, audited consolidated financial statements have been omitted from these interim unaudited consolidated financial statements.  The Company evaluated all subsequent events and transactions through the date of filing this report.

In the opinion of management, all adjustments considered necessary for a fair presentation have been included in the accompanying condensed consolidated financial statements.  Operating results for the three and nine months ended September 30, 2021, are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.  For further information, refer to the audited consolidated financial statements and notes for the year ended December 31, 2020, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 25, 2021.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of OSS, which include the acquisition of CDI, and its wholly owned subsidiary, OSS GmbH, which also includes the acquisition of Bressner.  Intercompany balances and transactions have been eliminated in consolidation.

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES

There have been no changes to our accounting policies disclosed in our audited consolidated financial statements and the related notes for the year ended December 31, 2020, except for the addition of a definition of, and description of our policy for short-term investments as follows:

Short-term Investments

Short-term investments consist predominantly of commercial paper, corporate debt securities, U.S. Treasury securities, and asset-backed securities. The Company classifies short-term investments based on the facts and circumstances surrounding the investments at the time of purchase and evaluates such classification as of each balance sheet date. On September 30, 2021, all short-term investments were classified as available-for-sale.

Unrealized gains and losses for available-for-sale securities are included in accumulated other comprehensive income—a component of stockholders’ equity. Realized gains and losses are determined using the specific identification method and are included in other income (expense) in the consolidated statement of operations. The Company evaluates its investments to determine whether those with unrealized loss positions are other than temporarily impaired. Impairments are considered to be other than temporary if they are related to deterioration in credit risk or if it is likely that the Company will sell the securities before recovery of their cost basis. 

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, disclosure of contingent liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates and assumptions.

On an ongoing basis, our management evaluates these estimates and assumptions, including those related to determination of standalone selling prices of our products and services, allowance for doubtful account and sales reserves, income tax valuations, stock-based compensation, goodwill, intangible assets and inventory valuations and recoverability. We base our estimates on historical data and experience, as well as various other factors that our management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities.

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As of September 30, 2021, we had $3,604,607 in net deferred tax assets (“DTAs”). These DTAs include approximately $5.3 million related to net operating loss carryforwards that can be used to offset taxable income in future periods and reduce our income taxes payable in those future periods.  At this time, we consider it more likely than not that we will have sufficient taxable income in the future that will allow us to realize these DTAs. However, it is possible that economic conditions may decrease the likelihood that we will have sufficient taxable income in the future. Therefore, unless we are able to generate sufficient taxable income from our operations, a substantial valuation allowance to reduce our U.S. DTAs may be required, which would materially increase our expenses in the period the allowance is recognized and materially adversely affect our results of operations and statement of financial condition.

On March 11, 2021, Congress passed, and the President signed into law, the American Rescue Plan Act, 2021 (the “ARP”), which includes certain business tax provisions. At this point, we do not believe that these changes will have a material impact on our income tax provision for 2021. We will continue to evaluate the impact of new legislation on our financial position, results of operations, and cash flows.

Due to the COVID-19 pandemic, there has been uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require an update to our estimates or assumptions or a revision of the carrying value of our assets or liabilities as of the date of this Quarterly Report on Form 10-Q. These estimates and assumptions may change as new events occur and additional information is obtained. As a result, actual results could differ materially from these estimates and assumptions.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”).  Under ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.  ASU 2016-02 is effective for the Company for fiscal years beginning after December 15, 2021, and interim periods within fiscal year 2023.  Early application is permitted.  Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements.  The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented.  The Company is currently evaluating the impact of adopting ASU 2016-02 on its consolidated financial statements and disclosures.  Based on our preliminary analysis, management expects the Company’s assets and liabilities to increase by the present value of the lease payments of approximately $1,256,000 with implementation as of January 1, 2022.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 amends the guidance on the impairment of financial instruments. This update adds an impairment model (known as the current expected credit losses model) that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes, as an allowance, its estimate of expected credit losses. In November 2019, ASU 2016-13 was amended by ASU 2019-10 that changed the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022, with early adoption permitted. Further, the ASU clarifies that operating lease receivables are not within the scope of ASC Subtopic 326-20 and should instead be accounted for under the new leasing standard, ASC 842. The Company is currently evaluating the impact of adopting ASU 2016-13 on its consolidated financial statements and related disclosures.

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NOTE 3 - SHORT-TERM INVESTMENTS

The Company’s short-term investments by significant investment category as of September 30, 2021, are as follows: 

Cash alternatives represents cash balances in savings accounts which are temporarily on-hand that are immediately available for investments in accordance with the Company’s investment policy.

 The Company typically invests in highly rated securities and its investment policy limits the amount of credit exposure to any one issuer. The policy requires investments in fixed income instruments denominated and payable in U.S. dollars only and requires investments to be investment grade, with a primary objective of minimizing the potential risk of principal loss.

NOTE 4 – ACCOUNTS RECEIVABLE

Accounts receivable, net consists of the following:

Unbilled receivables include amounts associated with percentage of completion and milestone billing accounting, which includes cost and gross profit earned in excess of billing, not currently billable due to contractual provisions.  (Recovery) provision for bad debt expense related to accounts receivable was $0 and $12,361 for the three month period ended September 30, 2021 and 2020, respectively, and ($4,902) and $10,950 for the nine month period ended September 30, 2021 and 2020, respectively.

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NOTE 5 – INVENTORIES

Inventories, net consist of the following:

NOTE 6 – LONG LIVED INTANGIBLE ASSETS

Definite lived intangible assets related to acquisition are as follows, as of September 30, 2021:

Definite lived intangibles assets related to acquisitions are as follows, as of December 31, 2020:

As of September 30, 2021, amortization expense of the definite lived intangible assets for the years remaining is as follows:

Amortization expense recognized during the three months ended September 30, 2021 and 2020, was $163,900 and $197,984, respectively, and $491,701 and $520,035 for the nine months ended September 30, 2021 and 2020, respectively.

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NOTE 7 – ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses and other liabilities consist of the following:

NOTE 8 – DEBT

Bank Lines of Credit

Bressner Technology GmbH has three revolving lines of credit with German institutions, including UniCredit Bank, totaling €2,700,000 (US$3,125,782) as of September 30, 2021.  Borrowing under the lines of credit bear interest at a variable rate of Euribor plus a stated rate.  The current rates as of September 30, 2021, for the lines of credit are from 3.10% to 4.0%, with the balances being open indefinitely or until occurrence of a defined change of control event.  There were no outstanding lines of credit balances as of September 30, 2021 and December 31, 2020.

Foreign Debt Obligations

Bressner has three term loans outstanding as of September 30, 2021, with a total balance outstanding of €1,500,000 (US$1,736,546) as follows:

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On April 1, 2019, Bressner entered into a note payable in the amount of €500,000 (US$586,189), which bore interest at 2.25% and matured on March 30, 2021, with monthly payments of principal and interest of €22,232 (US$24,960). The amount outstanding was paid in full as of September 30, 2021.  The balance outstanding as of December 31, 2020, was €66,446 (US$81,251);

In September 2019, Bressner entered into a note payable in the amount of €300,000 (US$336,810) which bore interest at 1.65% and matured on March 24, 2020, with a balloon payment of principal and interest.  The outstanding balance was paid in full as of September 30, 2021 and December 31, 2020; and

In September 2017, Bressner entered into a note payable, in the amount of €400,000 (US$436,272) which bore interest at 2.125% and matured on January 31, 2020 and was paid in full as of September 30, 2021 and December 31, 2020.

Notes Payable

In April 2019, the Company borrowed an aggregate of $350,000 from three individuals for a two-year period at an interest rate of 9.5% which requires the Company to make monthly principal and interest payments of $16,100 per month.  These loans were secured by the assets of the Company.  In connection with these loans, the Company issued to the noteholders warrants to purchase shares of the Company’s common stock in an amount equal to 10% of the original principal at a price per share equal to $2.15.  Accordingly, the Company issued to the noteholders warrants to purchase an aggregate of 16,276 shares of the Company’s common stock at an exercise price of $2.15 per share. The relative fair value of each warrant was $0.90.  The relative fair value of warrants was estimated using Black-Scholes with the following weighted-average assumptions: fair value of the Company’s common stock at issuance of $2.15 per share; five year contractual term; 44.60% volatility; 0.0% dividend rate; and a risk-free interest rate of 2.307%.  The total relative fair value of the warrants issued is $14,037.  These loans have matured, and all balances have been paid in full.  As such, the balances outstanding as of September 30, 2021 and December 31, 2020, were $0 and $63,188, respectively.

Notes Payable – Related Parties

In April 2019, the Company borrowed an aggregate of $1,150,000 from three individuals who serve on the Company’s board of directors for a two-year period at an interest rate of 9.5% which requires the Company to make monthly principal and interest payments of $52,900 per month.  These loans were secured by the assets of the Company.  In connection with these loans, the Company issued to the noteholders warrants to purchase shares of the Company’s common stock in an amount equal to 10% of the original principal at a price per share equal to $2.15.  Accordingly, the Company issued to the noteholders warrants to purchase an aggregate 53,490 shares of the Company’s common stock at an exercise price of $2.15 per share. The relative fair value of each warrant was $0.90.  The relative fair value of warrants was estimated using Black-Scholes with the following weighted-average assumptions: fair value of the Company’s common stock at issuance of $2.15 per share; five year contractual term; 42.60% volatility; 0.0% dividend rate; and a risk-free interest rate of 2.3067%.  The relative fair value of warrants issued is $46,121.  These loans have matured, and all balances have been paid in full, As such, the balances outstanding as of September 30, 2021 and December 31, 2020 were $0 and $206,669, respectively.

Paycheck Protection Program Loan

On April 28, 2020, the Company received authorization pursuant to the Paycheck Protection Program (“PPP”) of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) as administered by the U.S. Small Business Administration (the “SBA”) for a “PPP” loan. On May 11, 2020, the Loan was funded, and the Company received proceeds in the amount of $1,499,360 (the “PPP Loan”).

The PPP Loan, which took the form of a two-year promissory note (the “PPP Note”), matures on April 28, 2022 and bears interest at a rate of 1.0% per annum. Monthly principal and interest payments, less the amount of any potential forgiveness (discussed below), was initially to commence on October 28, 2020. The Company did not provide any collateral or guarantees for the PPP Loan, nor did the Company pay any facility charge to obtain the PPP Loan. The PPP Note provides for customary events of default, including, among others, those relating to failure to make payment, breaches of any term, obligation, covenant, or condition contained in the PPP Note and payment of unauthorized expenses or use of proceeds contrary to CARES Act rules.

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Under the original rules, all or a portion of the PPP Loan may be forgiven by the SBA and lender upon application by the Company beginning 60 days but not later than 120 days, after loan approval and upon documentation of expenditures in accordance with the SBA requirements. Under the CARES Act, loan forgiveness is available for the sum of documented payroll costs, covered rent payments, and covered utilities during the eight-week period beginning on the date of loan approval. For purposes of the CARES Act, payroll costs exclude compensation of an individual employee in excess of $100,000, prorated annually. Not more than 25% of the forgiven amount may be for non-payroll costs. Forgiveness is reduced if full-time headcount declines, or if salaries and wages for employees with salaries of $100,000 or less annually are reduced by more than 25%. In the event the PPP Loan, or any portion thereof, is forgiven pursuant to the PPP, the amount forgiven is applied to outstanding principal.

However, the Paycheck Protection Program Flexibility Act of 2020 (the “PPP Flexibility Act”), enacted on June 5, 2020, amended the original rules governing loans granted under the PPP to provide, among other changes, as follows: (i) the time period to spend the received funds was extended from the original eight weeks to twenty-four weeks from the date the PPP Loan was originated, during which PPP funds need to be expended in order to be forgiven; (ii) at least 60% of PPP funds must be spent on payroll costs, with the remaining 40% available to spend on other eligible expenses; (iii) payments are deferred until the date on which the amount of forgiveness determined is remitted to the lender, and if a borrower fails to seek forgiveness within 10 months after the last day of its covered period, then payments will begin on the date that is 10 months after the last day of the covered period; and (iv) the PPP Flexibility Act modified the CARES Act by increasing the maturity date for loans made after the effective date from two years to a minimum maturity of five years from the date on which the borrower applies for loan forgiveness. Existing PPP loans made before the new legislation retain their original two-year term, but may be renegotiated between a lender and a borrower to match the 5-year term permitted under the PPP Flexibility Act.

The Company submitted an application with the lender to forgive the PPP Loan, in accordance with SBA Procedural Notice, Control No. 5000-20057, effective as of October 2, 2020.  On May 3, 2021, the Company received notification from the SBA that its PPP Loan of $1,499,360, plus accrued interest of $14,994 had been fully forgiven and such amount has been recognized as other income in the consolidated statement of operations.

Senior Secured Convertible Note

On April 20, 2020, the Company entered into a Securities Purchase Agreement with an institutional investor, providing for the issuance by the Company of Senior Secured Convertible Promissory Notes with a principal face value of up to $6,000,000.  The notes are, subject to certain conditions, convertible into shares of the Company’s common stock, par value $0.0001 per share, at an initial conversion price per share of $2.50. The notes will be issued with a 10% original issue discount.

At the initial closing of this offering, the Company issued notes in the principal amount of $3,000,000 with a 10% original issue discount resulting in an aggregate purchase price of $2,700,000 at the initial closing.  The notes bear no interest rate (except upon event of default) and, unless earlier converted or redeemed, will mature on April 1, 2022.

Pursuant to the Securities Purchase Agreement, the Company had the right to consummate additional closings of up to an additional $3,000,000, subject to the prior satisfaction of certain closing conditions. This right expired effective April 20, 2021, and the Company may no longer consummate additional closings under the Securities Purchase Agreement.

The Notes are convertible at any time, in whole or in part, at the option of the investors, into shares of common stock at the initial conversion price of $2.50 per share. The conversion price is subject to adjustment for issuances of securities below the conversion price then in effect and for stock splits, combinations or similar events. If immediately following the close of business on the nine month anniversary of the issuance date of each note, the conversion price then in effect exceeds 135% of the volume weighted average price VWAP (the “Market Price”), the initial conversion price under any such note will be automatically lowered to the Market Price.

Commencing July 1, 2020, the Company has made monthly amortization payments equal to 1/22nd of the initial principal, any accrued and unpaid interest and late charges and any deferred or accelerated amount, of such note, which may be satisfied in cash at a redemption price equal to 105% of such installment amount (110% of such

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installment amount on notes issued at additional closings).  As of September 30, 2021, the holder has elected to defer receipt of twelve installment payments as allowed per the agreement.

Subject to the satisfaction of certain equity conditions set forth in the notes, installment amounts may be satisfied in shares of our common stock, with such installment conversion at a conversion price equal to the lower of (i) the conversion price then in effect; and (ii) the greater of (x) the floor price of $1.00 (80% of the Nasdaq market price at date of purchase agreement) and (y) the lower of (I) 82.5% the volume weighted average price of our common stock on the trading day immediately before the applicable installment date and (II) 82.5% of the quotient of (A) the sum of the volume weighted average price of our common stock for each of the three (3) trading days with the lowest volume weighted average price of our common stock during the twenty (20) consecutive trading day period ending and including the trading day immediately prior to the applicable installment date, divided by (B) three (3). Shares of our common stock to be issued with respect to any such installment will be pre-delivered on the second trading day after the applicable installment notice date (as defined in the notes) with a true-up on the applicable installment date. The market value of any installment amount below the floor price will be cash settled on the applicable installment date.

Management evaluated the embedded conversion feature to determine whether bifurcation was required as a separate derivative liability.  Management first determined that the conversion feature was not within the scope of ASC 480. It then determined that the embedded derivative should be separated from the host instrument and accounted for as a derivative instrument because it met the criteria of ASC 815-15-25-1, primarily because the contract provides for delivery of an asset that puts the recipient in substantially the same position as net settlement.  However, in part due to the Company’s adoption of ASC 2017-11 on April 1, 2020, which allowed management to disregard the down round provisions of the conversion feature, management determined that a scope exception to derivative accounting existed by satisfying the additional conditions necessary for equity classification specified by ASC 815-10-15-74 and ASC 815-40-25.  As a result of management’s analysis, the conversion feature was not accounted for separately from the debt instrument and the Company will recognize the contingent beneficial conversion feature when, or if, such is triggered.

The original issue discount of 10% on the Senior Secured Convertible Note was recorded as a debt discount, decreasing the note payable.  This debt discount is amortized to interest expense using the effective interest rate method over the term of the loan.  For the three months ended September 30, 2021 and 2020, total debt discount amortization was $26,285 and $61,518, respectively, and was $121,644 and $110,659 for the nine months ended September 30, 2021 and 2020, respectively.  Such amounts are included in interest expense in the accompanying consolidated statements of operations.

Debt issuance costs in the amount of $316,274 related to this indebtedness were deducted from the face value of the note.  Such costs are amortized to interest expense using the effective interest rate method over the term of the loan.  Total debt issuance costs amortized during the three months ended September 30, 2021 and 2020, was $27,711 and $64,855, respectively, and $128,243 and $116,662 for the nine months ended September 30, 2021 and 2020, respectively.  Such amounts are included in interest expense in the accompanying consolidated statements of operations.

Debt Discount

The relative fair value of warrants issued in connection with the notes payable described above were recorded as debt discount, decreasing notes payable and related-party notes payable and increasing additional paid-in-capital on the accompanying consolidated balance sheets.  The debt discounts are being amortized to interest expense over the term of the corresponding notes payable using the straight-line method, which approximates the effective interest method.

For the three months ended September 30, 2021 and 2020, total debt discount amortization was $0 and $72,372, respectively, and was $8,773 and $139,221 for the nine months ended September 30, 2021 and 2020, respectively.  Such amounts are included in interest expense in the accompanying consolidated statements of operations.

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A summary of outstanding debt obligations as of September 30, 2021, is as follows:

Outstanding debt obligations as of September 30, 2021, consist of the following:

Total future principal payments under notes payable and related party notes payable as of September 30, 2021, are as follows:

NOTE 9 – STOCKHOLDERS’ EQUITY

The Company’s amended and restated certificate of incorporation filed on December 14, 2017, authorizes the Company to issue 10,000,000 shares of preferred stock and 50,000,000 shares of common stock.

Stock Options

Effective June 24, 2020, the Company entered into an employment agreement with David Raun to serve as the Company’s president and chief executive officer. Pursuant to the terms of the employment agreement, Mr. Raun is entitled to receive 412,125 restricted stock units (“RSUs”) that shall vest over three years, with one third of the RSUs vesting following the one-year anniversary of the date of grant, and the remaining RSUs vesting in four equal installments, commencing nine months after the one-year anniversary of the date of grant and every nine months thereafter until fully vested; and 412,125 Incentive Stock Options (“ISOs”) pursuant to the Company’s 2017 Equity Incentive Plan, as amended whereby the exercise price for the ISOs shall be no less than the fair market value of the Company’s common stock at the date of grant, ($2.14).

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The ISOs shall vest at the end of each of the second and fourth quarters, the price of the Company’s common stock as of the end of quarter two or quarter four, as applicable, shall be determined using the ten-day trailing volume weighted average price (“VWAP”) after reporting of quarter two and quarter four earnings, as applicable.  The date of each such determination shall be referred to as a “Determination Date.”  If on any Determination Date the Company’s stock price has increased from the prior Determination Date, then a portion of the ISOs shall become vested.  The number of ISOs that shall become vested on a Determination Date is determined as follows: ((Price at Determination Date – Price at prior Determination Date) x 100) * 1,177.52 = Vested ISOs.  If on any Determination Date the Company’s stock price is $5.50 per share, all ISOs shall immediately become vested.  As of September 30, 2021, Mr. Raun’s ISOs are fully vested, but not exercised, based upon achievement of the specified performance objectives.

In the event, that Mr. Raun’s employment agreement is terminated for a reason other than “good cause” or for “good reason”, upon Mr. Raun’s execution of an effective waiver and release of claims, unvested RSUs shall accelerate so that an additional twelve (12) months of RSUs shall vest from the termination date.    

A summary of stock option activity under each of the Company’s stock option plans during the nine months ended September 30, 2021, is as follows:

The following table presents details of the assumptions used to calculate the weighted-average grant date fair value of common stock options granted by the Company.  There were no options granted during the nine month period ended September 30, 2021: