KORU Medical Systems Inc

NOTE 1 —NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS

KORU MEDICAL SYSTEMS, INC. (the “Company,” “KORU Medical,” “KORU,” “we,” “us” or “our”) develops, manufactures and commercializes innovative and patient-centric large volume subcutaneous infusion solutions primarily for the subcutaneous drug delivery market as governed by the United States Food and Drug Administration (the “FDA”) quality and regulatory system and international standards for quality system management. The Company operates asone segment.

BASIS OF PRESENTATION

We prepare our financial statements and accompanying notes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Certain prior year amounts have been reclassified to conform to the current year presentation in our Financial Statements.

CASH AND CASH EQUIVALENTS

For purposes of the statements of cash flows, the Company considers all short-term investments with an original maturity of three months or less to be cash equivalents. The Company has historically held cash balances in excess of $250,000 at its primary commercial bank, which exceeds FDIC insurance limits. To reduce the risk of uninsured deposits, the Company entered an insured cash sweep program with KeyBank during the second quarter of 2023 to automatically invest its uninsured bank cash balances over $250,000 into FDIC insured banks so there is no more than $250,000 maintained at any one bank. Further, as of December 31, 2023 the Company had invested $10.2 million in a US Treasury bill that matures every 90 days.

INVENTORY

Inventories of raw materials are stated at the lower of standard cost, which approximates average cost, or market value including allocable overhead. Work-in-process and finished goods are stated at the lower of standard cost or market value and include direct labor and allocable overhead.

We maintain reserves for excess and obsolete inventory resulting from the potential inability to sell certain products at prices in excess of current carrying costs. We make estimates regarding the future recoverability of the costs of these products and record provisions based on historical experience, expiration of sterilization dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write downs may be required, which could unfavorably affect future operating results.

INTANGIBLE ASSETS

Certain of our identifiable intangible assets, including patents and trademarks, are amortized using the straight-line method over their estimated useful lives which range from 6 to 20 years. All of our intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Our management is responsible for determining if impairment exists and considers various factors when making these determinations. Amortization expense related to intangible assets for the years ended December 31, 2023 and 2022 was $64,469 and $62,143, respectively.

The estimated amortization expense for the succeeding years for the intangible assets is approximately:

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INCOME TAXES

For interim income tax reporting, the Company estimates its annual effective tax rate and applies it to fiscal year-to-date pretax loss, excluding unusual or infrequently occurring discrete items. Tax jurisdictions with losses for which tax benefits cannot be realized are excluded. The Company reported an income tax expense of $4.0 million and income tax benefit of $2.0 million for the years ended December 31, 2023 and 2022, respectively.

We evaluate our deferred tax assets to determine if they are more likely than not to be realized by assessing both positive and negative evidence in accordance with ASC Topic 740, Income Taxes. After considering our cumulative pretax loss (the three-year period ending with the current year), as well as analyzing all available evidence, we have recorded a valuation allowance of $6.0 million against our net deferred tax assets during the year ended December 31, 2023. As we continue to assess the realizability of our deferred tax assets, reported pretax income and new evidence may result in a partial or full reduction of the valuation allowance in future periods.

Recurring items cause our effective tax rate to differ from the U.S. federal statutory rate of 21%, including U.S. federal R&D credits, U.S. state tax rates, and stock-based compensation.

Beginning in 2022, certain research and development costs are required to be capitalized and amortized over a five-year period under the Tax Cuts and Jobs Act enacted in December 2017. This change will impact the expected U.S. federal and state income tax expense and cash taxes to be paid for our fiscal 2023.

The Company files income tax returns in the U.S. federal jurisdiction and in various state jurisdictions. Income tax returns for years prior to fiscal 2019 are no longer subject to examination by tax authorities.

PROPERTY AND EQUIPMENT

Property and equipment are stated at original acquisition cost less accumulated depreciation. Additions and improvements are capitalized which increase the value or extend the life of an asset, while maintenance and repair costs are expensed as incurred. When assets are retired or otherwise disposed, the cost and related accumulated depreciation or amortization is removed from the respective accounts and any resulting gain or loss is included in income. Depreciation and amortization are calculated on the straight-line basis over the estimated useful lives of the assets which generally range from 3-10 years for furniture and office equipment,3-12 years for manufacturing equipment and tooling and shorter of the lease term or their estimated useful lives for leasehold improvements. Depreciation and amortization expense related to property and equipment for the years ended December 31, 2023 and 2022 was $805,921 and $524,994, respectively.

STOCK-BASED COMPENSATION

The Company maintains a stock option plan and omnibus equity incentive plan under which it grants stock options to certain executives, key employees and consultants. It also has granted stock options outside of the plans as inducement awards. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model. All options are charged against income at their fair value. The entire compensation expense of the award is recognized over the vesting period.

Shares of stock granted for director fees under the non-employee director compensation plan and under its omnibus equity incentive plan are recorded at the fair value of the shares at the grant date.

The Company issues restricted stock awards under its omnibus equity incentive plan and outside the plan as incentive awards. Restricted stock awards are equity classified and measured at the fair market value of the underlying stock at the grant date. The fair value of restricted stock awards vesting at certain market capitalization thresholds were estimated on the date of grant using the Brownian Motion Monte Carlo lattice model. The fair value of other restricted stock awards were estimated on the date of grant at the current stock price. We recognize restricted stock expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur.

NET LOSS PER COMMON SHARE

Basic net loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed by dividing net loss by the weighted average number of common and common equivalent shares outstanding during the period. The Company’s potentially dilutive common shares are those that result from diluted common stock options and unvested restricted stock awards. The calculation of diluted loss per share excluded stock options of 12,335 andzero in weighted-average shares for each of the years ended December 31, 2023 and 2022, respectively, as their effect was anti-dilutive as a result of the net loss incurred for those periods.

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The calculation of diluted loss per share excluded performance-based restricted stock and time-based restricted stock of 904,496 and 950,000 in weighted-average shares for each of the years ended December 31, 2023 and 2022, respectively, as their effect was anti-dilutive as a result of the net loss incurred for those periods.

The following securities were not included in the computation of diluted shares outstanding for the years ended December 31, 2023, and 2022 because the effect would be anti-dilutive:

Therefore, diluted weighted average number of shares outstanding and diluted net loss per share were the same as basic weighted average number of shares outstanding and net loss per share for the years ended December 31, 2023 and 2022. See “NOTE 4 — STOCK-BASED COMPENSATION” for further detail.

USE OF ESTIMATES IN THE FINANCIAL STATEMENTS

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Important estimates include but are not limited to asset lives, valuation allowances, inventory valuation, and accruals.

REVENUE RECOGNITION

The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,Revenue from Contracts with Customers, which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers.

Our revenues are derived from three business sources: (i) domestic core (which consists of US and Canada), (ii) international core, and (iii) novel therapies. Our core domestic and international revenues consist of sales of our syringe drivers, tubing and needles (“Product Revenue”) for the delivery of subcutaneous drugs that are FDA cleared for use with the KORU Medical infusion system, with the primary delivery for immunoglobulin to treat Primary Immunodeficiency Diseases (“PIDD”) and Chronic Inflammatory Demyelinating Polyneuropathy (“CIDP”). Novel therapies consist of Product Revenue for feasibility/clinical trials (pre-clinical studies, Phase I, Phase II, Phase III) of biopharmaceutical companies in the drug development process as well as non-recurring engineering services (“NRE”) revenues (including testing and registration services) received from biopharmaceutical companies to ready or customize the FREEDOM System for clinical and commercial use across multiple drug categories.

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For Product Revenue, we recognize revenues when shipment occurs, and at which point the customer obtains control and ownership of the goods. Shipping costs generally are billed to customers and are included in Product Revenue.

The Company generally does not accept return of goods shipped unless it is a Company error. The only credits provided to customers are for defective merchandise. The Company warrants the syringe driver from defects in materials and workmanship under normal use and the warranty does not include a performance obligation. The costs under the warranty are expensed as incurred.

Rebates are provided to distributors for the difference in selling price to distributor and pricing specified to select customers. In addition, rebates are provided to customers for meeting growth targets. Provisions for both distributor pricing and customer growth rebates are variable consideration and are recorded as a reduction of revenue in the same period the related sales are recorded or when it is probable the growth target will be achieved.

We recognize NRE revenue under an input method, which recognizes revenue on the basis of our efforts or inputs (for example, resources consumed, labor hours expended, costs incurred, or time elapsed) to the satisfaction of a performance obligation relative to the total expected inputs to the satisfaction of that performance obligation (i.e. completion milestone). The input method that we use is based on costs incurred.

Contracts are often modified to account for changes in contract specifications and requirements. Contract modifications exist when the modification either creates new, or changes existing, enforceable rights and obligations. Generally, when contract modifications create new performance obligations, the modification is considered to be a separate contract and revenue is recognized prospectively. When contract modifications change existing performance obligations, the impact on the existing transaction price and measure of progress for the performance obligation to which it relates is generally recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis. Contract assets primarily represent revenue earnings over time that are not yet billable based on the terms of the contracts. Contract liabilities (i.e., deferred revenue) consist of fees invoiced or paid by the Company’s customers for which the associated performance obligations have not been satisfied and revenue has not been recognized based on the Company’s revenue recognition criteria described above. As of December 31, 2023, the Company has recognized a contract asset of zero which is included in other accounts receivable in the accompanying balance sheet.

The Company established an allowance for charging off uncollectible trade accounts receivable that have both of the following characteristics: (a) They have a contractual maturity of one year or less, (b) They arose from the sale of goods or services.

The following table summarizes net revenues by geography for the years ended December 31, 2023 and 2022:

LEASES

In February 2016, the FASB issued a standard related to leases to increase transparency and comparability among organizations by requiring the recognition of right-of-use (“ROU”) assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by the Company for those leases classified as operating leases under current GAAP, while our accounting for capital leases remains substantially unchanged. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The standard became effective for us on January 1, 2019. The standard had a material impact on our balance sheets but did not have a material impact on our statements of operations. See “NOTE 5**—**LEASES” for further detail.

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ACCOUNTING PRONOUNCEMENTS RECENTLY ADOPTED

In June 2016, the FASB issued ASU No. 2016-13,Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however Topic 326 will require that credit losses be presented as an allowance rather than as a write-down. This ASU affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company adopted this standard on January 1, 2023, and it did not have a significant impact on our financial statements.

The Company considers the applicability and impact of all recently issued accounting pronouncements. Recent accounting pronouncements not specifically identified in our disclosures are either not applicable to the Company or are not expected to have a material effect on our financial condition or results of operations.

FAIR VALUE MEASUREMENTS

Fair value is the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs. To measure fair value, the Company uses the following fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable:

The carrying amounts of cash and cash equivalents, accounts receivable, prepaid expenses, accounts payable and accrued expenses are considered to be representative of their fair values because of the short-term nature of those instruments. There were no transfers between levels in the fair value hierarchy during the year ended December 31, 2023.

IMPAIRMENT OF LONG-LIVED ASSETS

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition are less than the carrying amount. The impairment loss, if recognized, would be based on the excess of the carrying value of the impaired asset over its respective fair value. No impairment losses have been recorded through December 31, 2023.

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NOTE 2 —INVENTORY

Inventory consists of:

NOTE 3 —PROPERTY AND EQUIPMENT

Property and equipment consists of the following at:

NOTE 4 —STOCK-BASED COMPENSATION

The Company has three equity incentive plans: the 2015 Stock Option Plan, as amended (the “2015 Plan”), the 2021 Omnibus Equity Incentive Plan (the “2021 Plan”), and the Non-Employee Director Compensation Plan. The Company has also issued restricted stock and stock options as employment inducement awards to its Chief Executive Officer and Chief Commercial Officer, respectively.

The 2015 plan provides for the grant of up to 6,000,000 incentive stock options and nonqualified stock options. As of December 31, 2023, there were options to purchase 2,436,250 shares of the Company’s common stock outstanding to certain executives, key employees and consultants under the 2015 Plan, of which 85,000 were issued during the year ended December 31, 2023 and 445,000 were issued during the year ended December 31, 2022. Additional options may be issued under the 2015 Plan as outstanding options are forfeited. As of December 31, 2023, there were 2,724,250 shares reserved for outstanding awards and available for issuance under the 2015 Plan.

The 2021 Plan provides for the grant of up to 1,000,000 incentive stock options, nonqualified stock options, stock awards, restricted stock awards, restricted stock units and/or stock appreciation rights to employees, consultants and directors. During the years ended December 31, 2023 and 2022, there were awards with respect to 21,100 and 97,100 shares of common stock, respectively, issued under the 2021 Plan. Additional awards may be issued under the 2021 Plan as outstanding awards are forfeited. As of December 31, 2023, there were 822,142 shares reserved for outstanding awards and available for issuance under the 2021 Plan.

Each non-employee director of the Company (other than the Chairman of the Board) is eligible to receive $110,000 annually, to be paid quarterly $12,500 in cash and $15,000 in common stock. The Chairman of the Board is eligible to receive $140,000 annually, to be paid quarterly $12,500 in cash and $22,500 in common stock. From May 18, 2021 to May 6, 2022, non-employee director compensation was paid pursuant to the 2021 Plan. Since May 6, 2022, non-employee director compensation has been paid pursuant to the Non-Employee Director Compensation Plan. All payments were and are pro-rated for partial service.

The per share weighted average fair value of stock options granted during the year ended December 31, 2023 and December 31, 2022 was $1.84 and $1.98, respectively. The fair value of each award is estimated on the grant date using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in the year ended December 31, 2023 and December 31, 2022. Historical information was the primary basis for the selection of the expected volatility, expected dividend yield and the expected lives of the options. The risk-free interest rate was selected based upon yields of the U.S. Treasury issues with a term equal to the expected life of the option being valued. We have recognized tax benefits associated with stock-based compensation of $256,315 and $231,341 for the year ended December 31, 2023 and 2022, respectively.

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Time Based Stock Options

The following table summarizes the activities for our stock options with time based vesting for the years ended December 31, 2023, and 2022.

The following table summarizes the status of the time-based stock options:

Total stock-based compensation expense was $1,940,720 and $2,083,397 for the years ended December 31, 2023, and 2022, respectively. Net cash received from option exercises for the years ended December 31, 2023, and 2022 waszero and $406,623, respectively.

The weighted-average grant-date fair value of options granted during the years ended December 31, 2023, and 2022 was $0.8 million and $1.8 million, respectively. There wereno options exercised during the year ended December 31,2023 and 1,031,250 options exercised during the year ended December 31, 2022.

The following table presents information pertaining to time- based stock options outstanding at December 31, 2023:

As of December 31, 2023, there was $3,145,616 of total unrecognized compensation cost related to non-vested time- based stock options granted under the Company’s plans. That cost is expected to be recognized over a weighted-average period of 46 months. The total fair value of shares vested as of December 31, 2023, and December 31, 2022, was $4,819,658 and $2,703,002, respectively.

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Performance Based Stock Options

Pursuant to an employment agreement entered into on November 6, 2023, with the Company’s Chief Commercial Officer, and as an inducement to his employment, the Company issued a non-qualified option to purchase 200,000 shares of common stock that vest upon achievement of sales growth milestones. The following table summarizes the activities for our unvested performance stock option awards for the twelve months ended December 31, 2023, and 2022.

As of December 31, 2023, there was $176,345 of unrecognized compensation cost related to unvested employee performance options. This amount is expected to be recognized over a weighted-average period of 36 months. We have recognized tax benefits associated with restricted stock award compensation of $1,137 andzero for the twelve months ended December 31, 2023 and 2022, respectively.

RESTRICTED STOCK AWARDS

The following table summarizes the activities for our unvested restricted stock awards for the twelve months ended December 31, 2023, and 2022.

As of December 31, 2023, there was $1,076,664 of unrecognized compensation cost related to unvested employee restricted shares. This amount is expected to be recognized over a weighted-average period of 21 months. We have recognized tax benefits associated with restricted stock award compensation of $79,326 and $101,419 for the twelve months ended December 31, 2023 and 2022, respectively.

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NOTE 5 —LEASES

We have finance and operating leases for our corporate office and certain office and computer equipment. Our two operating leases have remaining lease terms of 8.6 years and 5 years, respectively. Our three finance leases have remaining lease terms of 3.4 years,3 years, and 4.75 years, respectively.

At contract inception, we evaluate whether an arrangement is or contains a lease for which we are the lessee (that is, arrangements which provide us with the right to control a physical asset for a period of time). Operating leases are accounted for on the balance sheets with ROU assets being recognized in “Operating lease right-of-use assets” and lease liabilities recognized in “Operating lease liability – current” and “Operating lease liability, net of current portion.” Finance leases are accounted for on the balance sheets recognized in “Property and equipment, net” and lease liabilities recognized in “Finance lease liability – current” and “Finance lease liability, net of current portion.”

Operating lease expenses are recognized on a straight-line basis over the lease term. With respect to finance leases, amortization of the ROU asset is presented separately from interest expense related to the finance lease liability.

We have elected to combine lease and non-lease components for all lease contracts where we are the lessee. Additionally, for arrangements with lease terms of 12 months or less, we do not recognize ROU assets and lease liabilities and lease payments are recognized on a straight-line basis over the lease term with variable lease payments recognized in the period in which the obligation is incurred. ROU assets are measured for impairment when a triggering event occurs.

The components of lease expense were as follows:

Supplemental cash flow information related to leases was as follows:

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Supplemental balance sheet information related to leases was as follows:

Maturities of lease liabilities are as follows:

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NOTE 6 —FEDERAL AND STATE INCOME TAXES

Income tax expense consisted of the following:

The reconciliation of income taxes shown in the financial statements and amounts computed by applying the Federal expected tax rate of 21% for year 2023 and 2022 is as follows:

The significant components of deferred income tax assets, net are as follows:

Our U.S. federal and state income tax returns remain open to examination for the tax years 2020 through 2022.

NOTE 7 —MAJOR CUSTOMERS

For the years ended December 31, 2023 and December 31, 2022, approximately 66% and 64%, respectively, of the Company’s net product revenues were derived from three major customers that are distributors. As of December 31, 2023 and December 31, 2022, accounts receivable due from the three major customers was $2.6 million and $2.2 million, respectively.

The largest customer in both years is a domestic medical products and supplies distributor. Although a number of larger infusion customers have elected to consolidate their purchases through one or more distributors in recent years, we continue to maintain strong direct relationships with them. We do not believe that their continued purchase of FREEDOM System products and related supplies is contingent upon the distributor.

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NOTE 8 —COMMITMENTS AND CONTINGENCIES

The Company has been and may again become involved in legal proceedings, claims and litigation arising in the ordinary course of business. KORU Medical is not presently a party to any litigation or other legal proceeding that is believed to be material to its financial condition.

OTHER

On November 11, 2020, the Company entered into a Manufacturing and Supply Agreement with Command Medical Products, Inc. (“Command”), pursuant to which Command has agreed to manufacture and supply the Company’s subassemblies, needle sets and tubing products pursuant to the Company’s specifications and purchase orders. The first binding purchase order pursuant to the Manufacturing and Supply Agreement was made on November 17, 2020 (the “Effective Date”).

The Manufacturing and Supply Agreement provides for a term of five years from the Effective Date. Either party may terminate the Manufacturing and Supply Agreement upon a material breach by the other Party that has not been cured within 90 days, upon the bankruptcy or insolvency of the other Party or as expressly set forth elsewhere in the Agreement.

The Manufacturing and Supply Agreement also includes customary provisions relating to, among other things, delivery, inspection procedures, warranties, quality management, business continuity plans, handling and transport, intellectual property, confidentiality and indemnification.

NOTE 9 —EMPLOYEE BENEFITS

We provide a safe harbor 401(k) plan for our employees that allows for employee elective contributions, Company matching contributions and discretionary profit-sharing contributions. Employee elective contributions are funded through voluntary payroll deductions. The Company makes safe harbor matching contributions in an amount equal to 100% of the employee’s contribution, not to exceed 3% of employee’s compensation plus 50% of employee’s pay contributed between 3% and 5% of employee’s compensation. Company matching expense for the years ended December 31, 2023 and December 31, 2022 was $227,447 and $214,931, respectively. The Company has not provided for a discretionary profit-sharing contribution.

NOTE 10 —DEBT OBLIGATIONS

On July 28, 2023, the Company entered into a commercial insurance premium finance and security agreement with AON Premium Finance, LLC in the aggregate principal amount of $0.57 million bearing an annual percentage rate of 9.5%, to finance its insurance premiums. Monthly payments are due on the first of each month beginning August 1, 2023 through June 1, 2024. The balance of AON note was $314,344 as of December 31, 2023 and $433,295 as of December 31, 2022, respectively.

NOTE 11 —SUBSEQUENT EVENT

On March 8, 2024, the Company entered into a loan and security agreement with HSBC Ventures USA Inc., as lender, providing for a $5,000,000 revolving credit facility and a $5,000,000 term loan facility. Borrowings are secured by a first-priority lien on substantially all of the assets of the Company, subject to customary exceptions. The revolving credit facility matures on December 31, 2025 and the term loan matures on December 1, 2028. Our former revolving credit facility with Key Bank expired during the quarter ended September 30, 2023.

Borrowings under the revolving credit facility will bear interest at the greater of Prime or 6.50%, payable in arrears on a monthly basis and at maturity. Borrowings under the term loan will bear interest at the greater of Prime minus 0.50% or 6.50% and will be interest-only through December 31, 2025, followed by 24 equal monthly payments of principal plus interest.

The loan and security agreement contains customary affirmative covenants a financial maintenance covenant that requires the Company to maintain a minimum Adjusted Quick Ratio (defined as the ratio of the Company’s (i) unrestricted and unencumbered cash and cash equivalents maintained with the lender and its affiliates, plus eligible accounts receivable, to (ii) current liabilities) of not less than 1.50 to 1.00 tested on the last day of each month.

There are no outstanding borrowings under the facility as of March 13, 2024.

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