KORU Medical Systems Inc

NOTES TO THE UNAUDITED FINANCIAL STATEMENTS

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

NATURE OF OPERATIONS

KORU MEDICAL SYSTEMS, INC. (the “Company,” “KORU Medical,” “we,” “us” or “our”) designs, manufactures and markets proprietary portable and innovative medical devices 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 regulations and standards for quality system management. The Company operates asone segment.

BASIS OF PRESENTATION

The accompanying financial statements should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2023 (“Annual Report”). In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”), the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the audited financial statements of the Company. The accompanying interim financial statements are unaudited and reflect all adjustments which are in the opinion of management necessary for a fair statement of the Company’s financial position, results of operations, and cash flows for the periods presented. All such adjustments are of a normal, recurring nature. The Company’s results of operations and cash flows for the interim periods are not necessarily indicative of the results of operations and cash flows that it may achieve in future periods.

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. As of March 31, 2024 the Company has an investment balance of $10.2 million in a US Treasury bill that matures every 90 days.

PATENTS

Costs incurred in obtaining patents have been capitalized and are being amortized over the legal life of the patents.

STOCK-BASED COMPENSATION

The Company maintains a stock option plan and an omnibus equity incentive plan under which it grants stock options to certain executives, key employees and consultants. 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.

The Company also maintains a non-employee director compensation plan. Shares of stock granted for director fees are recorded at the fair value of the shares at the grant date.

The Company issues restricted stock 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 restricted stock awards with time-based vesting were estimated on the date of grant at the current stock price. The fair value of restricted stock awards vesting at certain annual sales growth thresholds were estimated as of the date of Board acknowledgement of the achievement, 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.

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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 net loss per share excluded stock options ofzero and 14,626, respectively, in weighted-average shares for each of the three months ended March 31, 2024 and 2023, as their effect was anti-dilutive as a result of the net loss incurred for those periods.

The calculation of diluted net loss per share excluded stock options, performance-based restricted stock and performance-based restricted stock units (PSUs) of 904,496 and 914,626 respectively, in weighted-average shares for each of the three months ended March 31, 2024 and 2023, 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 three months ended March 31, 2024, and 2023 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 three months ended March 31, 2024 and 2023.

USE OF ESTIMATES IN THE FINANCIAL STATEMENTS

The preparation of financial statements in conformity with United States generally accepted accounting principles (“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, deferred tax valuation allowances, inventory valuation, and customer rebate and incentive accruals. The results of operations for the three months ended March 31, 2024 are not necessarily indicative of the results that may be expected for the entire 2024 fiscal year.

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REVENUE RECOGNITION

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.

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 March 31, 2024, the Company has recognized a contract asset of zero.

The following table summarizes net revenues by geography for the three months ended March 31, 2024, and 2023:

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ACCOUNTING PRONOUNCEMENTS RECENTLY ADOPTED

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.

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 Company adopted the pronouncement on January 1, 2023, and there was no impact on its financial statements.

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, including investments in short-term U.S. Treasury bills, 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 three months ended March 31, 2024 and 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. The Company did not record any impairment losses through March 31, 2024.

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NOTE 2 —PROPERTY AND EQUIPMENT

Property and equipment consists of the following at:

Depreciation and amortization expense was $214,910 and $197,233 for the three months ended March 31, 2024 and 2023, respectively.

NOTE 3 —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.

The Company issues performance share units (PSUs) under its omnibus equity incentive plan. Performance share units are equity classified and measured at the fair market value of the underlying stock at the grant date.

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.

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 incentive stock options and nonqualified stock options. As of March 31, 2024, there were 2,120,000 shares reserved for outstanding awards and 604,250 shares available for issuance under the 2015 Plan. Additional options may be issued under the 2015 Plan as outstanding options are forfeited.

The 2021 Plan provides for the grant of incentive stock options, nonqualified stock options, stock awards, restricted stock awards, restricted stock units and/or stock appreciation rights to employees, consultants and directors. As of March 31, 2024, there were 656,744 shares reserved for outstanding awards and 152,811 shares available for issuance under the 2021 Plan. Additional awards may be issued under the 2021 Plan as outstanding awards are forfeited.

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. Non-employee director compensation is paid pursuant to the Non-Employee Director Compensation Plan. All payments were and are pro-rated for partial service.

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Time Based Stock Options

The following table summarizes the activities for our stock options with time based vesting for the three months ended March 31, 2024, and 2023.

The following table summarizes the status of the stock options:

Total stock-based compensation expense was $393,113 and $535,059 for the three months ended March 31, 2024, and 2023, respectively. No cash was received from option exercises for the three months ended March 31, 2024, and 2023, respectively.

The following table presents information pertaining to options outstanding at March 31, 2024:

As of March 31, 2024, there was $2,719,478 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 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 March 31, 2024, and March 31, 2023, was $3,884,426 and $3,511,874, respectively.

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Performance Based Stock Options

The following table summarizes the activities for our unvested performance based stock option awards for the three months ended March 31, 2024, and 2023.

Total stock-based compensation expense was $8,121 andzero for the three months ended March 31, 2024, and 2023, respectively.

As of March 31, 2024, there was $168,223 of unrecognized compensation cost related to unvested employee performance based options. This amount is expected to be recognized over a weighted-average period of 36 months.

Restricted Stock Awards and PSUs

The following table summarizes the activities for our restricted stock awards and PSUs for the three months ended March 31, 2024, and 2023.

Total stock-based compensation expense was $122,551 and $170,387 for the three months ended March 31, 2024, and 2023, respectively.

As of March 31, 2024, and 2023, there was $755,513 and $1,447,790 of unrecognized compensation cost related to unvested employee restricted stock awards and PSUs. This amount is expected to be recognized over a weighted-average period of 21 months.

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Common Stock Warrants

The following table summarizes the activities for our common stock warrants issued in connection with our loan financing agreement with HSBC for the three months ended March 31, 2024, and 2023.

As of March 31, 2024, and 2023, there was $52,125 andzero of unrecognized cost related to unvested warrants.

NOTE 4 —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 the AON note was $314,344 as of December 31, 2023 and $159,031 as of March 31, 2024.

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. As of March 31, 2024, there were no outstanding borrowings under the term loan nor the revolving credit facility.

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 8.4 years and 4.8 years, respectively. Our three finance leases have remaining lease terms of 3.2 years,2.75 years, and 4.5 years, respectively, as of March 31, 2024.

The components of lease expense were as follows:

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Supplemental cash flow information related to leases was as follows:

Supplemental balance sheet information related to leases was as follows:

Maturities of lease liabilities are as follows:

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NOTE 6 —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 ofzero and income tax benefit of $0.6 million for the periods ended March 31, 2024 and 2023, 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 of March 31, 2024, the valuation allowance is $6.4 million 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 2024.

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 2020 are no longer subject to examination by tax authorities.

NOTE 7 —COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

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

NOTE 8 —SUBSEQUENT EVENTS

On April 8, 2024, the Company’s appeal to BSI in connection with a prior audit matter was upheld resulting in no disruption of sales of the Company to the market and patients. Our products remain certified, marketed and sold in the EU. The Company intends to address the identified nonconformance through the routine BSI assessment process.

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