ONE STOP SYSTEMS, INC. - Quarter Report: 2022 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, 2022

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, 2022, the registrant had 20,032,449 shares of common stock (par value $0.0001) outstanding.

Table of Contents

PART_1_FINANCIAL_INFORMATION

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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 presented 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 three and nine month periods ended September 30, 2022, should be read in conjunction with our audited financial statements for the year ended December 31, 2021, included in our Annual Report on Form 10-K, filed with the SEC on March 24, 2022.

The results of operations for the three and nine month periods ended September 30, 2022, are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2022.

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ONE STOP SYSTEMS, INC. (OSS)

CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes to unaudited consolidated financial statements

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ONE STOP SYSTEMS, INC. (OSS)

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

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, 2022

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 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, 2022 and 2021

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 specialized high-performance computing modules and systems, which are designed to target edge computing deployments. 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 provides standard and customized servers, panel PCs, and PCIe expansion systems.  Bressner also provides manufacturing, test, sales and marketing services for customers throughout Europe.

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.

The negative impact of the COVID-19 pandemic and the impact on the global economy and capital markets resulting from the geopolitical instability caused in part by the ongoing military conflict between Russia and Ukraine, including inflation and Federal Reserve interest rate increases, have contributed to global supply chain issues and economic uncertainty, which has negatively affected our operations. Additionally, during the third quarter, the general consensus among economists continue to suggest that we should expect a higher recession risk to continue over the next year, which could result in further economic uncertainty and volatility in the capital markets in the near term and could negatively affect our operations.

Currently, we are experiencing increased pricing, longer lead-times, unavailability of product and limited supplies, protracted delivery dates, changes in minimum order quantities to secure product, and/or shortages of certain parts and supplies that are necessary components for the products and services we offer to our customers.   As a result, the Company is carrying increased inventory balances to ensure availability of necessary products and to secure pricing.  

These global issues and concerns regarding general economic decline or recession are also impacting some of our customers, who are experiencing slowing growth or uncertainty in their own business operations and revenue, and as a result, these customers may need to decrease or delay their technology spending, request pricing concessions or payment extensions, or seek to renegotiate their contracts.

With respect to our media and entertainment business, we are seeing an acceleration in our customer’s investment in cloud technology and a drive towards less intelligent compute capability at the edge to reduce the costs of their componentry.  This is particularly true of their virtual products, which do not require the same level of

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ruggedization as this system is not typically operated in harsh environments and for which software is being developed to eventually provide a real-time cloud solution.  As a result, our customer may transition to a lower cost, commodity type equipment solution.  We anticipate that we may begin to experience a decrease in the demand for our high-compute, ruggedized media and entertainment focused equipment and our expertise in this area in the second half of 2023.

As a result of these global and customer issues, it may be difficult to accurately forecast our revenues or financial results, especially given the near and long term impact of the pandemic, geopolitical issues, inflation, the Federal Reserve interest rate increases and the potential for a recession.  In addition, while the potential impact and duration of these issues on the economy and our business may be difficult to assess or predict, these world events have 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. These global issues and events may also have the effect of heightening many 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 from time to time, or which we determine are in our best interests. In addition, we may decide to postpone or abandon planned investments in our business in response to changes in our business, which may impact our ability to attract and retain customers and our rate of innovation, either of which could harm our business.

Management plans with respect to the above are to continue their efforts towards responding to the changing economic landscape, to continue to control costs, conserve cash, strengthen margins through the introduction of new product lines focusing on the autonomous truck diving and artificial intelligence compute capabilities for military and industrial applications, and improve company-wide execution.

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”).  

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, 2021.  Accordingly, note disclosures which would substantially duplicate the disclosures contained in the December 31, 2021, audited consolidated financial statements have been omitted from these interim unaudited consolidated financial statements.  The Company’s management has 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 month periods ended September 30, 2022, are not necessarily indicative of the results that may be expected for the year ending December 31, 2022.  For further information, refer to the audited consolidated financial statements and notes for the year ended December 31, 2021, included in the Company’s Annual Report on Form 10-K filed with the SEC on March 24, 2022.

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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, 2021, except for the addition of a definition of, and description of our policy for accounting for leases in accordance with the adoption of ASU No. 2016-02, Leases (“ASU 2016-02”) as follows:

Leases

In February 2016, the FASB issued ASU No. 2016-02, “Leases” which sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a contract (i.e., lessees and lessors). The standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases. A lease must be classified as a finance lease if any of the following criteria are met: the lease transfers ownership of the asset by the end of the lease term, the lease contains an option to purchase the asset that is reasonably certain to be exercised, the lease term is for a major part of the remaining useful life of the asset or the present value of the lease payments equals or exceeds substantially all of the fair value of the asset. A lease is classified as an operating lease if it does not meet any of these criteria.  The Company determines if a contract is or contains a lease at inception or modification of a contract. A contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period in exchange for consideration.  Control over the use of the identified asset means the lessee has both (a) the right to obtain substantially all of the economic benefits from the use of the asset and (b) the right to direct the use of the asset.  This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease.

Right-of-use assets and liabilities are initially measured at cost, which primarily comprises the initial amount of the lease liability, plus any initial direct costs incurred, consisting mainly of brokerage commissions, less any lease incentives received.  All right of use assets are reviewed for impairment.  The lease liability is initially measured at the present value of future minimum lease payments over the expected lease term at the commencement date of each lease. The Company measures and records a right-of-use asset and lease liability based on the discount rate implicit in the lease, if known. Generally, the Company cannot determine the interest rate implicit in the lease because it does not have access to the lessor's estimated residual value or the amount of the lessor's deferred initial direct costs.  

In these cases where the discount rate implicit in the lease is not known, the Company measures the right-of-use assets and lease liabilities using a discount rate equal to the Company's incremental borrowing rate it pays on current debt instruments or would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms.

The Company and its subsidiary have no leases classified as finance leases.  The Company and its subsidiary currently lease plant, office facilities and equipment under operating leases expiring through August 2024. As of September 30, 2022, the weighted average remaining lease term for our operating leases was 23 months.  The weighted average discount rate for our operating leases was 12.8%.

The Company’s lease agreements may include options to extend the lease following the initial term. On a case-by-case basis, the Company’s management determines if it is reasonably certain to exercise the renewal option; such renewal options were included in determining the initial lease term.

We elected the package of practical expedients in transition for leases that commenced prior to January 1, 2022, and therefore did not reassess (i) whether any expired or existing contracts are, or contain, leases, (ii) the lease classification for any expired or existing leases, and (iii) initial direct costs for any existing leases. We elected to use hindsight for transition when considering judgments and estimates such as assessments of lease options to extend, or terminate, a lease, or to purchase the underlying asset. As result of the adoption of ASC 842, the Company recognized an accumulative adjustment to beginning retained earnings for the 2022 fiscal year of $44,533.

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For all asset classes, we elected to (i) not recognize a right-of-use asset and lease liability for leases with a term of 12 months or less and (ii) not separate non-lease components from lease components, and we have accounted for combined lease and non-lease components as a single lease component. Variable lease payments associated with the Company’s leases are recognized upon occurrence of the event, activity, or circumstance in the lease agreement on which those payments are assessed.  For those leases that are subsequently modified for terms, such changes may require a remeasurement of the lease liability.

Lease expense for operating leases consists of the lease payments plus any initial direct costs, primarily brokerage commissions, and is recognized on a straight-line basis over the lease term.  Included in lease expense are any variable lease payments incurred in the period that were not included in the initial lease liability.  Lease expense for finance leases consists of the amortization of the right-of-use asset on a straight-line basis over the lease term and interest expense determined on an amortized cost basis.  The lease payments are allocated between a reduction of the lease liability and interest expense.

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.  

As of September 30, 2022, we had $3,778,217 in net deferred tax assets (“DTAs”). These DTAs include approximately $7,100,000 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 certain 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 may have a material adverse effect on our results of operations and statement of financial condition.

On August 16, 2022, Congress passed, and the President signed into law, the Inflation Reduction Act, 2022 (“the “IRA”), which includes certain business tax provisions. The Company does not expect the IRA to have a material impact on the Company’s effective tax rate or income tax provision for the year ending December 31, 2022.

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 2022. We will continue to evaluate the impact of new legislation on our financial position, results of operations, and cash flows.

The U.S. Tax Cuts and Jobs Act (“TCJA”) was signed into law on December 22, 2017. Guidance continues to be issued clarifying the application of this legislation and recent proposed legislation known as Build Back Better is under consideration within both houses of U.S. Congress. Significant business and international provisions have been proposed in various versions of the framework of the bill that could increase our total tax expense. We cannot predict the overall impact that the additional guidance and proposed changes may have on our business. Some jurisdictions have raised tax rates and it is reasonable to expect that other global taxing authorities will be reviewing current legislation for potential modifications in reaction to the implementation of U.S. tax legislation, current economic conditions, and COVID-19 response costs.

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Due to the COVID-19 pandemic, economic uncertainty, inflation, increases in interest rates, capital markets disruption, which has been significantly impacted by geopolitical instability due to the ongoing military conflict between Russia and Ukraine, and supply chain issues, our business, financial condition and results of operations could be materially adversely affected by any negative impact from these events. 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 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. Management is currently evaluating the impact of adopting ASU 2016-13 on its consolidated financial statements and related disclosures.

NOTE 3 - SHORT-TERM INVESTMENTS

The Company’s short-term investments by significant investment category as of September 30, 2022, are as follows: 

The Company’s short-term investments by significant investment category as of December 31, 2021, are as follows: 

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Cash alternatives represents cash balances in savings accounts and U.S. Treasury Bills that 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:

Provision (recovery) for bad debt expense related to accounts receivable was $9,918 and $0 for the three month periods ended September 30, 2022 and 2021, respectively, and $5,125 and $(4,902) for the nine month periods ended September 30, 2022 and 2021, respectively.

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, 2022:

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Definite lived intangibles assets related to acquisitions are as follows, as of December 31, 2021:

As of September 30, 2022, amortization expense of the definite lived intangible assets for the years remaining is as follows:

Amortization expense recognized during the three month periods ended September 30, 2022 and 2021, was $15,808 and $163,900, respectively, and $47,424 and $491,700 for the nine month periods ended September 30, 2022 and 2021, respectively.

NOTE 7 – ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses and other liabilities consist of the following:

NOTE 8 – DEBT

Bank Lines of Credit

The Company obtained a domestic revolving line of credit of $2,000,000 in April 2022, which renews on an annual basis at the current prime rate.  To access this line of credit the Company must maintain cash and investments balances at a minimum of $4,000,000.  No balance is outstanding on September 30, 2022.

Bressner has three revolving lines of credit with German institutions, including UniCredit Bank and VR Bank with total availability of up to €2,200,000 (US$2,175,320) as of September 30, 2022.  Borrowings under the lines of credit bear interest at a variable rate of Euribor plus a stated rate.  The current rates as of September 30, 2022, for the lines of credit range from 3.10% to 4.0%, with the balances remaining open indefinitely or until occurrence of a defined change of control event.  There were no outstanding lines of credit balances as of September 30, 2022 and December 31, 2021.

Bressner has five term loans outstanding as of September 30, 2022, with an aggregate balance outstanding of €3,316,778 (US$3,246,403) as follows:

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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 required 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, 2022 and December 31, 2021, were $0.

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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 required 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, 2022 and December 31, 2021 were $0.

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 were amortized to interest expense over the term of the corresponding notes payable using the straight-line method, which approximated the effective interest method.

Amortization of debt discounts of $0 and $0 were recognized as interest expense for the three month periods ended September 30, 2022 and 2021, respectively, and $0 and $8,773 were recognized as interest expense for the nine month periods ended September 30, 2022 and 2021, 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”), was scheduled to mature on April 28, 2022 and bore 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 provided 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.

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 income.

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 were, 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. Notes issued under the Securities Purchase Agreement had a 10% original issue discount.

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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 bore no interest rate (except upon event of default) and, unless earlier converted or redeemed, were scheduled to 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 were convertible at any time, in whole or in part, at the option of the investors, into shares of Company common stock at the initial conversion price of $2.50 per share. The conversion price was subject to adjustment for the issuances of securities at a price 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 exceeded 135% of the volume weighted average price VWAP (the “Market Price”), the initial conversion price under any such note would be automatically lowered to the Market Price.

Subject to the satisfaction of certain equity conditions set forth in the notes, installment amounts could 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 would 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 would be cash settled on the applicable installment date.

Commencing July 1, 2020, the Company 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 could be satisfied in cash at a redemption price equal to 105% of such installment amount (110% of such installment amount on notes issued at additional closings).  The remaining balance of the notes of $2,590,909 was converted into Company common stock on March 30, 2022; accordingly, the outstanding balance of the notes as of September 30, 2022 was $0.

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, due in part 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 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 month periods ended September 30, 2022 and 2021, total debt discount amortization was $0 and $26,285, respectively.  For the nine month periods ended September 30, 2022 and 2021, total debt discount amortization was $1,161 and $121,644, respectively.  Such amounts are included in interest expense in the accompanying consolidated statements of income.

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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 month periods ended September 30, 2022 and 2021, was $0 and $27,711, respectively.  Debt issuance costs amortized during the nine month periods ended September 30, 2022 and 2021, was $1,223 and $128,243, respectively.  Such amounts are included in interest expense in the accompanying consolidated statements of income.

A summary of outstanding debt obligations as of September 30, 2022, is as follows:

Outstanding debt obligations as of September 30, 2022, consist of the following: