BIOLARGO, INC. 10-Q

Item 1. Financial Statements BIOLARGO, INC. AND SUBSIDIAR IES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2019 AND SEPTEMBER 30 , 2020 (in thousands, except for per share data) DECEMBER 31, 2019 SEPTEMBER 30 , 2020 (unaudited) Assets Current assets: Cash and cash equivalents $ 655 $ 1,117 Accounts receivable, net of allowance 355 413 Inventories, net of allowance 16 292 Prepaid expenses and other current assets 39 51 Total current assets 1,065 1,873 In-process research and development (Note 8) 1,893 2,021 Property and equipment, net of depreciation 95 42 Other non-current assets 35 823 Right-of-use, operating lease, net of amortization 411 356 Deferred offering cost 122 — Investment in South Korean Joint Venture — 73 Total assets $ 3,621 $ 5,188 Liabilities and stockholders’ deficit Current liabilities: Accounts payable and accrued expenses $ 602 $ 766 Clyra Medical note payable (Note 8) 1,007 1,007 Note payable 50 50 Line of credit 50 223 Convertible notes payable 3,957 1,106 Discount on convertible notes payable and line of credit, net of amortization (1,472 ) (149 ) Lease liability 125 114 Deferred revenue and deposits 35 72 Total current liabilities 4,354 3,189 Long-term liabilities: Convertible notes payable 700 — Discount on convertible notes payable, net of amortization (182 ) — Liability to Clyra Medical shareholder (Note 8) 643 771 SBA program loans (PPP, EIDL) — 507 Lease liability 286 241 Total liabilities 5,801 4,708 Commitments and contingencies (Note 11) Stockholders’ equity (deficit): Preferred Series A, $.00067 Par Value, 50,000,000 shares authorized, -0- shares issued and outstanding, at December 31, 2019 and September 30, 2020, respectively. — — Common stock, $.00067 Par Value, 400,000,000 shares authorized, 166,256,024 and 221,682,140 shares issued, at December 31, 2019 and September 30, 2020, respectively. 111 148 Additional paid-in capital 121,327 135,033 Accumulated other comprehensive loss (99 ) (107 ) Accumulated deficit (123,492 ) (130,397 ) Total BioLargo, Inc. and subsidiaries stockholders’ equity (deficit) (2,153 ) 4,677 Non-controlling interest (Note 8) (27 ) (4,197 ) Total stockholders’ equity (deficit) (2,180 ) 480 Total liabilities and stockholders’ equity (deficit) $ 3,621 $ 5,188 The accompanying notes are an integral part of these unaudited consolidated financial statements . F-3 Table of Contents BIOLARGO, INC. AND SUBSIDIAR IES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30 , 2019 AND 2020 (in thousands, except for share and per share data) (unaudited) THREE MONTHS NINE MONTHS SEPTEMBER 3 0 , 20 19 SEPTEMBER 3 0 , 20 20 SEPTEMBER 3 0, 20 19 SEPTEMBER 3 0 , 20 20 Revenues Product revenue $ 396 $ 506 $ 1,013 $ 1,086 Service revenue 138 160 311 436 Total revenue 534 666 1,324 1,522 Cost of revenue Cost of goods sold (171 ) (185 ) (448 ) (422 ) Cost of service (95 ) (116 ) (238 ) (339 ) Gross profit 268 365 638 761 Selling, general and administrative expenses 1,820 1,927 4,546 5,345 Research and development 332 347 1,126 1,031 Operating loss: (1,884 ) (1,909 ) (5,034 ) (5,615 ) Other (expense) income: Interest expense (1,289 ) (318 ) (2,773 ) (1,823 ) Loss on debt extinguishment (801 ) (228 ) (1,029 ) (442 ) Tax credit 62 65 62 109 Grant income 26 — 149 64 Total other expense: (2,002 ) (481 ) (3,591 ) (2,092 ) Net loss (3,886 ) (2,390 ) (8,625 ) (7,707 ) Net loss attributable to noncontrolling interest (207 ) (284 ) (572 ) (901 ) Net loss attributable to common stockholders $ (3,679 ) $ (2,106 ) $ (8,053 ) $ (6,806 ) Net loss per share attributable to common stockholders: Loss per share attributable to common stockholders – basic and diluted $ (0.02 ) $ (0.01 ) $ (0.06 ) $ (0.04 ) Weighted average number of common shares outstanding: 156,435,220 210,212,946 148,239,912 182,959,765 Comprehensive loss: Net loss $ (3,886 ) $ (2,390 ) $ (8,625 ) $ (7,707 ) Foreign currency translation (4 ) (30 ) (1 ) (8 ) Comprehensive loss (3,890 ) (2,420 ) (8,626 ) (7,715 ) Comprehensive loss attributable to noncontrolling interest (207 ) (284 ) (572 ) (901 ) Comprehensive loss attributable to common stockholders $ (3,683 ) $ (2,136 ) $ (8,054 ) $ (6,814 ) The accompanying notes are an integral part of these unaudited consolidated financial statements . F-4 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30 , 2019 AND 2020 (in thousands, except for share data) (unaudited) Common stock Additional paid-in Accumulated Accumulated other comprehensive Non- controlling Total stockholders’ Shares Amount capital deficit Loss interest equity (deficit) Balance,December 31, 2018 141,466,071 $ 95 $ 110,222 $ (111,723 ) $ (90 ) $ 373 $ (1,123 ) Conversion of notes 1,638,479 1 218 — — — 219 Issuance of common stock for service 1,229,541 1 205 — — — 206 Issuance of common stock for interest 139,362 — 25 — — — 25 Stock option compensation expense — — 352 — — — 352 Warrants and conversion feature issued as discount on convertible notes payable and line of credit — — 1,115 — — — 1,115 Fair value of warrants for extension of debt — — 56 — — — 56 Deemed dividend — — 342 (342 ) — — — Issuance of Clyra Medical common stock — — 21 — — 89 110 Net loss — — — (2,576 ) — (173 ) (2,749 ) Foreign currency translation — — — — (4 ) — (4 ) Balance,March 31, 2019 144,473,453 $ 97 $ 112,556 $ (114,641 ) $ (94 ) $ 289 $ (1,793 ) Conversion of notes 2,767,833 2 294 — — — 296 Issuance of common stock for service 981,684 — 213 — — — 213 Issuance of common stock for interest 87,478 — 15 — — — 15 Warrant exercise 3,744,456 3 101 — — — 104 Stock issuance to officer (see note 7) 500,000 — — — — — — Stock option compensation expense — — 296 — — — 296 Warrants and conversion feature issued as discount on convertible notes payable and line of credit — — 756 — — — 756 Issuance of Clyra Medical common stock — — 74 — — 111 185 Deemed dividend — — 440 (440 ) — — — Net loss — — — (1,795 ) — (192 ) (1,987 ) Foreign currency translation — — — — (4 ) — (4 ) Balance, June 30, 2019 152,554,904 $ 102 $ 114,745 $ (116,876 ) $ (98 ) $ 208 $ (1,919 ) Conversion of notes 2,791,300 2 392 — — — 394 Issuance of common stock for service 629,198 — 166 — — — 166 Issuance of common stock for interest 395,944 — 107 — — — 107 Warrant exercise 2,300,000 2 274 — — — 276 Convert BioLargo convertible note to Clyra Medical shares — — 440 — — — 440 Stock option compensation expense — — 552 — — — 552 Debt extinguishment expense — — 619 — — — 619 Warrants and conversion feature issued as discount on convertible notes payable and line of credit — — 2,060 — — — 2,060 Issuance of Clyra Medical common stock — — 66 — — 109 175 Net loss — — — (3,679 ) — (207 ) (3,886 ) Foreign currency translation — — — — (4 ) — (4 ) Balance,September 30, 2019 158,671,346 $ 106 $ 119,421 $ (120,556 ) $ (102 ) $ 110 $ (1,021 ) F-5 Table of Contents Common stock Additional paid-in Accumulated Accumulated other comprehensive Non- controlling Total stockholders’ Shares Amount capital deficit Loss interest equity (deficit) Balance, December 31, 2019 166,256,024 $ 111 $ 121,327 $ (123,492 ) $ (99 ) $ (27 ) $ (2,180 ) Conversion of notes 3,387,649 2 432 — — — 434 Issuance of common stock for service 1,039,490 1 177 — — — 178 Issuance of common stock for interest 19,278 — 4 — — — 4 Sale of common stock for cash 4,848,305 3 898 — — — 901 Common stock issued as a financing fee; deferred offering costs 2,928,571 2 (124 ) — — — (122 ) Stock option compensation expense — — 320 — — — 320 Deemed dividend — — 100 (100 ) — — — Issuance of Clyra Medical common stock — — 15 — — 10 25 Clyra Medical stock option expense — — 420 — — — 420 Allocation of noncontrolling interest from Clyra Stock option issuance — — (448 ) — — 448 — Net loss — — — (2,274 ) — (342 ) (2,616 ) Balance, March 31, 2020 178,479,317 $ 119 $ 123,121 $ (125,866 ) $ (99 ) $ 89 $ (2,636 ) Conversion of notes 6,463,784 6 682 — — — 688 Issuance of common stock for service 1,774,033 1 271 — — — 272 Issuance of common stock for interest 297,001 — 30 — — — 30 Sale of common stock for cash 3,689,246 2 558 — — — 560 Stock option compensation expense — — 528 — — — 528 Issuance of Clyra Medical common stock — — 476 — — 348 824 Clyra Medical stock option expense — — 20 — — — 20 Clyra Medical stock for other asset (See Note 2) — — 788 — — — 788 Noncontrolling interest allocation — — 4,401 — — (4,401 ) — Net loss — — — (2,425 ) — (275 ) (2,700 ) Foreign currency translation — — — — 22 — 22 Balance, June 30, 2020 190,703,381 $ 128 $ 130,875 $ (128,291 ) $ (77 ) $ (4,239 ) $ (1,604 ) Conversion of notes 23,306,528 16 2,389 — — — 2,405 Issuance of common stock for service 619,670 — 93 — — — 93 Issuance of common stock for interest 1,412,052 1 149 — — — 150 Sale of common stock for cash 5,640,509 3 916 — — — 919 Stock option compensation expense — — 499 — — — 499 Loss on extinguishment — — 228 — — — 228 Clyra Medical shares issued as commitment fee — — 70 — — — 70 Clyra Medical stock option expense — — 140 — — — 140 Noncontrolling interest allocation — — (326 ) — — 326 — Net loss — — — (2,106 ) — (284 ) (2,390 ) Foreign currency translation — — — — (30 ) — (30 ) Balance, September 30, 2020 221,682,140 $ 148 $ 135,033 $ (130,397 ) $ (107 ) $ (4,197 ) $ 480 The accompanying notes are an integral part of these unaudited consolidated financial statements . F-6 Table of Contents BIOLARGO, INC. AND SUBSIDIAR IES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30 , 2019 AND 2020 (in thousands, except for per share data) (unaudited) SEPTEMBER 3 0 , 2019 SEPTEMBER 3 0 , 2020 Cash flows from operating activities Net loss $ (8,625 ) $ (7,707 ) Adjustments to reconcile net loss to net cash used in operating activities: Stock option compensation expense 1,201 1,712 Common stock issued in lieu of salary to officers and fees for services from vendors 587 542 Common stock issued for interest 147 184 Interest expense related to amortization of the discount on convertible notes payable and line of credit 2,381 1,575 Interest expense related to the fair value of warrants issued as consent for variable debt 54 — Loss on extinguishment of debt 1,029 442 Loss on investment in ODIN — 27 Deferred offering expense 13 — Depreciation expense 48 50 Bad debt expense — 11 Changes in assets and liabilities: Accounts receivable (72 ) (69 ) Inventories 7 (273 ) Prepaid expenses and other current assets (66 ) (12 ) Accounts payable and accrued expenses 88 164 Deferred revenue — 37 Customer deposits 27 (1 ) Net cash used in operating activities (3,181 ) (3,318 ) Cash flows from investing activities Investment in South Korean joint venture — (100 ) Leasehold improvements (27 ) — Sale of equipment — 4 Net cash used in investing activities (27 ) (96 ) Cash flows from financing activities Proceeds from sales of common stock — 2,380 Proceeds from convertible notes payable 4,335 — Proceeds from the sale of stock in Clyra Medical 470 849 Repayment of note payable (495 ) (25 ) Proceeds from warrant exercise 380 — Proceeds from SBA program loans — 507 Proceeds from line of credit Clyra Medical — 200 Repayment of line of credit Clyra Medical — (27 ) Net cash provided by financing activities 4,690 3,884 Net effect of foreign currency translation (1 ) (8 ) Net change in cash 1,481 462 Cash at beginning of period 655 655 Cash at end of period $ 2,136 $ 1,117 Supplemental disclosures of cash flow information Cash paid for: Interest $ 116 $ 81 Income taxes $ 3 $ 2 Non-cash investing and financing activities Fair value of warrants issued with convertible notes $ 3,931 $ — Conversion of convertible notes payable into common stock $ 908 $ 3,526 Convertible notes issued with original issue discount, beneficial conversion feature $ 1,008 $ — Exchange of consulting services for Clyra common shares $ — $ 788 Lincoln Park deferred offering costs, recorded as additional paid-in capital $ — $ (122 ) Deemed dividend $ 781 $ 100 Increase in liability to Clyra Medical shareholder $ — $ 129 Fair value of Clyra shares issued as a commitment fee $ — $ 70 Allocation of Clyra stock to noncontrolling interest $ — $ 4,075 Allocation of stock option expense within noncontrolling interest $ — $ 448 The accompanying notes are an integral part of these unaudited consolidated financial statements . F-7 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1. Business and Organization Description of Business BioLargo, Inc. is an innovative technology developer and environmental engineering company driven by a mission to "make life better" by delivering robust, sustainable solutions for a broad range of industries and applications, with a focus on clean water, clean air. The company also owns a minority interest in an advanced wound care subsidiary that has licensed BioLargo Technologies and it plans to spin out or sell when the appropriate opportunity is identified. Our business strategy is straightforward: we invent or acquire technologies that we believe have the potential to be disruptive in large commercial markets; we develop and validate these technologies to advance and promote their commercial success as we leverage our considerable scientific, engineering, and entrepreneurial talent; we then monetize these technical assets through a variety of business structures that may include licensure, joint venture, sale, spin off, or by deploying direct to market strategies. Liquidity / Going concern For the nine months ended September 30, 2020, we had a net loss of $7,707,000, used $3,318,000 cash in operations, and at September 30, 2020, we had a working capital deficit of $1,316,000, and current assets of $1,873,000. We do not believe operating profits in the immediate future will be sufficient to fund our current level of operations. We have been, and anticipate that we will continue to be, limited in terms of our capital resources. None of our business segments (see Note 10, “Business Segment Information”) have ever generated enough revenues to fund their operations, or to contribute to our corporate operations or overhead. Thus, in light of our cash position at year end, in order to continue operations, in calendar year 2020 we have continued to sell our stock in private securities offerings and to Lincoln Park (see Note 3). Thus far this year, we have received approximately $1.7 million from Lincoln Park (an average of approximately $160,000 per month). The proceeds we receive from stock sales to Lincoln Park is a function of stock price and volume – a lower stock price and less trading volume results in less money we can receive from Lincoln Park. Although we have relied on investment funds through our agreement with Lincoln Park this year, there is no assurance that it will continue to provide the funds we need for our operations, and if it does not, we will have to rely on other forms of financing, and there is no assurance that we will be able to do so, or if we do so, it will be on favorable terms. We also regularly pay officers and vendors equity in lieu of cash, and anticipate that we will continue to be able to do so in the future. The foregoing factors raise substantial doubt about our ability to continue as a going concern, unless we are able to continue to raise funds through stock sales to Lincoln Park or other private financings, and in the long term, our ability to attain a reasonable threshold of operating efficiencies and achieve profitable operations by licensing or otherwise commercializing products incorporating our technologies. The consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. Organization We are a Delaware corporation formed in 1991. We have four wholly-owned subsidiaries: BioLargo Life Technologies, Inc., organized under the laws of the State of California in 2006; ONM Environmental, Inc. (formerly, Odor-No-More, Inc.), organized under the laws of the State of California in 2009; BioLargo Water Investment Group Inc. organized under the laws of the State of California in 2019, which wholly owns BioLargo Water, Inc., organized under the laws of Canada in 2014; and BioLargo Development Corp., organized under the laws of the State of California in 2016. Additionally, we own 97.5% (see Note 9) of BioLargo Engineering Science and Technologies, LLC (“BLEST”), organized under the laws of the State of Tennessee in 2017. We also own 47% of Clyra Medical Technologies, Inc. (“Clyra Medical”), organized under the laws of the State of California in 2012, and consolidate their financial statements (see Note 2, subheading “Principles of Consolidation,” and Note 8). The unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to Rule 8-03 of Regulation S-X under the Securities Act of 1933, as amended. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. We are still operating in the early stages of the sales and distribution process, and therefore our operating results for the three and nine months ended September 30, 2020, are not necessarily indicative of the results that may be expected for the year ending December 31, 2020, or for any other period. These unaudited consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Annual Report on Form 10-K for the year ended December 31, 2019 filed with the Securities and Exchange Commission (the “SEC”) on March 31, 2020. 8 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 2. Summary of Significant Accounting Policies In the opinion of management, the accompanying balance sheet and related statements of operations, cash flows, and stockholders’ deficit include all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America. Principles of Consolidation The consolidated financial statements include the accounts of the Company, and its wholly- and partially-owned subsidiaries, including Clyra Medical. Management believes Clyra Medical’s financial statements are appropriately consolidated with that of the Company after reviewing the guidance of ASC Topic 810 , “Consolidation”, and concluding that BioLargo controls Clyra Medical. While BioLargo does not have voting interest control through a majority stock ownership of Clyra Medical (it owns 47% of the outstanding voting stock), it does exercise control under the “Variable Interest Model”: there is substantial board overlap, BioLargo is the primary beneficiary since it has the power to direct Clyra Medical’s activities that most significantly impact Clyra Medical’s performance, and it has the obligation to absorb losses or receive benefits (through royalties and licensing) that could be potentially significant to Clyra Medical. BioLargo has consolidated Clyra Medical’s operations for all periods presented. (See Note 8.) All intercompany accounts and transactions have been eliminated. Foreign Currency The Company has designated the functional currency of BioLargo Water, Inc., our Canadian subsidiary, to be the Canadian dollar. Therefore, translation gains and losses resulting from differences in exchange rates are recorded in accumulated other comprehensive income. Cash and Cash Equivalents The Company considers all highly liquid investments with maturities of three-months or less when acquired to be cash equivalents. Substantially all cash equivalents are held in short-term money market accounts at one of the largest financial institutions in the United States. From time to time, our cash account balances are greater than the Federal Deposit Insurance Corporation insurance limit of $250,000 per owner per bank, and during such times, we are exposed to credit loss for amounts in excess of insured limits in the event of non-performance by the financial institution. We do not anticipate non-performance by our financial institution. Accounts Receivable Trade accounts receivable are recorded net of allowances for doubtful accounts. Estimates for allowances for doubtful accounts are determined based on payment history and individual customer circumstances. The allowance for doubtful accounts as of December 31, 2019 was $24,000 and September 30, 2020 was $35,000. Credit Concentration We have a limited number of customers that account for significant portions of our revenue. For the nine months ended September 30, 2019 and 2020, each period had two customers that accounted for 10% or more of our consolidated revenues, as follows: September 30 , 2019 September 30 , 2020 Customer A <10 % 12 % Customer B 13 % <10 % Customer C 10 % <10 % 9 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) We had two customers that accounted for more than 10% of consolidated accounts receivable at December 31, 2019 and three customers that accounted for more than 10% of consolidated accounts receivable at September 30, 2020, as follows: December 31, 2019 September 30 , 2020 Customer A <20 % 15 % Customer D <10 % 15 % Customer E <10 % 10 % Customer F 14 % <10 % Customer G 13 % <10 % Inventory Inventories are stated at the lower of cost or net realizable value using the average cost method. The allowance for obsolete inventory as of December 31, 2019 and September 30, 2020 was $3,000. As of December 31, 2019, and September 30, 2020, inventories consisted of (in thousands): December 31, 2019 September 30 , 2020 Raw material $ 11 $ 180 Finished goods 5 112 Total $ 16 $ 292 Other Non-Current Assets Other non-current assets consisted of (i) security deposits of $35,000 related to our business offices, and (ii) prepaid consulting fees from the issuance of Clyra Medical stock, resulting in a fair value of $787,500 (see Note 8). Leases In February 2016, the FASB issued ASU Update No. 2016-02, “Leases,” which requires lessees to recognize most leases on their balance sheets as a right-of-use asset with a corresponding lease liability, and lessors to recognize a net lease investment. Additional qualitative and quantitative disclosures are also required. We adopted this standard effective January 1, 2019 using the effective date option, which resulted in a $399,000 gross up of assets and liabilities; this balance may fluctuate over time as we enter into new leases, extend or terminate current leases. Upon the transition to the ASC 842, the Company elected to use hindsight as a practical expedient with respect to determining the lease terms (as we considered our updated expectations of acceptance of the Westminster California facility lease renewal) and in assessing any impairment of right-of-use assets for existing leases. No impairment is expected at this time. As of September 30, 2020, the right-of-use assets on our balance sheet related to our operating leases totals $356,000. Impairment Long-lived and definite lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected future undiscounted cash flows from the use of the asset and its eventual disposition is less than the carrying amount of the asset, then an impairment loss is recognized. The impairment loss is measured based on the fair value of the asset. Any resulting impairment is recorded as a reduction in the carrying value of the related asset in excess of fair value and a charge to operating results. As of September 30, 2019 and 2020, management determined that there was no impairment of its long-lived assets, including its In-process Research and Development at Clyra Medical (see Note 8). Equity Method of Accounting On March 20, 2020, we invested $100,000 into a South Korean entity (Odin Co. Ltd., “Odin”) pursuant to a Joint Venture agreement we had entered into with BKT Co. Ltd. and its U.S. based subsidiary, Tomorrow Water. We received a 40% non-dilutive equity interest, and BKT and Tomorrow Water each received 30% equity interests for an aggregate $150,000 investment. 10 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) We account for our investment in the joint venture under the equity method of accounting. We have determined that while we have significant influence over the joint venture through our technology license and our position on the Board of Directors, we do not control the joint venture or are otherwise involved in managing the entity and we own less than a majority of the equity. Therefore, we record the asset on our consolidated balance sheet and record an increase or decrease the recorded balance by our percentage ownership of the profits or losses in the joint venture. During the nine months ended September 30, 2020, the joint venture incurred a loss and our 40% ownership share reduced our investment interest by $27,000. Earnings (Loss) Per Share We report basic and diluted earnings (loss) per share (“EPS”) for common and common share equivalents. Basic EPS is computed by dividing reported earnings by the weighted average shares outstanding. Diluted EPS is computed by adding to the weighted average shares the dilutive effect if stock options and warrants were exercised into common stock. For the three and nine months ended September 30, 2019 and 2020, the denominator in the diluted EPS computation is the same as the denominator for basic EPS due to the anti-dilutive effect of the warrants and stock options on the Company’s net loss. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the period reported. Actual results could differ from those estimates. Estimates are used when accounting for stock-based transactions, debt transactions, derivative liabilities, allowance for bad debt, asset depreciation and amortization, among others. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results of our financial statements. Share-Based Compensation Expense We recognize compensation expense for stock option awards on a straight-line basis over the applicable service period of the award, which is the vesting period. Fair value is determined on the grant date. Share-based compensation expense is based on the grant date fair value estimated using the Black-Scholes Option Pricing Model. For stock and stock options issued to consultants and other non-employees for services, the Company measures and records an expense as of the earlier of the date at which either: a commitment for performance by the non-employee has been reached or the non-employee’s performance is complete. The equity instruments are measured at the current fair value, and for stock options, the instruments are measured at fair value using the Black Scholes option model. The following methodology and assumptions were used to calculate share-based compensation for the three and nine months ended September 30, 2019 and 2020: 2019 2020 Non Plan 2018 Plan Non Plan 20 18 Plan Risk free interest rate 2.00 – 2.65% 2.0 – 2.65% 0.66 – 1.02% 0.64 – 1.90% Expected volatility 147 – 152% 147 – 152% 129 – 131% 126 – 133% Expected dividend yield — — — — Forfeiture rate — — — — Life in years 10 10 10 10 Expected price volatility is the measure by which our stock price is expected to fluctuate during the expected term of an option. Expected volatility is derived from the historical daily change in the market price of our common stock, as we believe that historical volatility is the best indicator of future volatility. The risk-free interest rate used in the Black-Scholes calculation is based on the prevailing U.S. Treasury yield as determined by the U.S. Federal Reserve. We have never paid any cash dividends on our common stock and do not anticipate paying cash dividends on our common stock in the foreseeable future. 11 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Historically, we have not had significant forfeitures of unvested stock options granted to employees and Directors. A significant number of our stock option grants are fully vested at issuance or have short vesting provisions. Therefore, we have estimated the forfeiture rate of our outstanding stock options as zero. Warrants Warrants issued with our convertible promissory notes, note payables, and lines of credit, are accounted for under the fair value and relative fair value method. The warrant is first analyzed per its terms as to whether it has derivative features or not. If the warrant is determined to be a derivative and not qualify for equity treatment, then it is measured at fair value using the Black Scholes option model, and recorded as a liability on the balance sheet. The warrant is re-measured at its then current fair value at each subsequent reporting date (it is “marked-to-market”). If the warrant is determined to not have derivative features, it is recorded into equity at its fair value using the Black Scholes option model, however, limited to a relative fair value based upon the percentage of its fair value to the total fair value including the fair value of the convertible note. The convertible note issued with the warrant is recorded at its fair value, limited to a relative fair value based upon the percentage of its fair value to the total fair value including the fair value of the warrant. Further, the convertible promissory note is examined for any intrinsic beneficial conversion feature (“BCF”) of which the convertible price of the note is less than the closing common stock price on date of issuance. If the relative fair value method is used to value the convertible promissory note and there is an intrinsic BCF, a further analysis is undertaken of the BCF using an effective conversion price which assumes the conversion price is the relative fair value divided by the number of shares the convertible debt is converted into by its terms. The BCF value is accounted for as equity. The warrant and BCF relative fair values are also recorded as a discount to the convertible promissory notes. Non-Cash Transactions We have established a policy relative to the methodology to determine the value assigned to each intangible we acquire, and/or services or products received for non-cash consideration of our common stock. The value is based on the market price of our common stock issued as consideration, at the date of the agreement of each transaction or when the service is rendered or product is received. Revenue Recognition We account for revenue in accordance with ASC 606, “revenue from Contacts with Customers”. The guidance focuses on the core principle for revenue recognition, which is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, the guidance provides that an entity should apply the following steps: Step 1: Identify the contract(s) with a customer. Step 2: Identify the performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. We have revenue from four subsidiaries, ONM, BLEST, BioLargo Water, and Clyra. ONM, BioLargo Water, and Clyra identify its contract with the customer through a written purchase order, in which the details of the contract are defined including the transaction price and method of shipment. The only performance obligation is to create and ship the product and each product has separate pricing. Revenue is recognized at a point in time when the order for its goods are shipped if its agreement with the customer is FOB manufacturer, and when goods are delivered to its customer if its agreement with the customer is FOB destination. Revenue is recognized with a reduction for sales discounts, as appropriate and negotiated in the customer’s purchase order. ONM also installs misting systems for which it bills on a time and materials basis. It identifies its contract with the customer through a written purchase order in which the details of the time to be billed and materials purchased and an estimated completion date. The performance obligation is the completion of the installation. Revenue is recognized over time as the work is performed. BLEST identifies services to be performed in a written contract, which specifies the performance obligations and the rate at which the services will be billed. Each service is separately negotiated and priced. Revenue is recognized as services are performed and completed. BLEST’s contracts typically call for invoicing for time and materials incurred for that contract. A few contracts have called for milestone or fixed cost payments, where BLEST invoices an agreed-to amount per month for the life of the contract. In these instances, completed work, billed hourly, is recognized as revenue. If the billing amount is greater or lesser than the completed work, a receivable or payable is created. These accounts are adjusted upon additional billings as the work is completed. To date, there have been no discounts or other financing terms for the contracts. 12 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) In the event that we generate revenues from royalties or license fees from our intellectual property, we anticipate a licensee would pay a license fee in one or more installments and ongoing royalties based on their sales of products incorporating or using our licensed intellectual property. Upon entering into a licensing agreement, we will determine the appropriate method of recognizing the royalty and license fees. Government Grants We have been awarded multiple research grants from governmental and quasi-governmental institutions. The grants received are considered “other income” and are included in our Consolidated Statements of Operations. We received our first grant in 2015 and have been awarded over 80 grants totaling over $3.7 million. Some of the funds from these grants are given directly to third parties (such as the University of Alberta or a third-party research scientist) to support research on our technology. The grants have terms generally ranging between nine and eighteen months and support a majority, but not all, of the related research budget costs. This cooperative research allows us to utilize (i) a depth of resources and talent to accomplish highly skilled work, (ii) financial aid to support research and development costs, (iii) independent and credible validation of our technical claims. The grants typically provide for (i) recurring monthly amounts, (ii) reimbursement of costs for research talent for which we invoice to request payment, and (iii) ancillary cost reimbursement for research talent travel related costs. All awarded grants have specific requirements on how the money is spent, typically to employ researchers. None of the funds may be used for general administrative expenses or overhead in the United States. These grants have substantially increased our level of research and development activities in Canada. We continue to apply for Canadian government and agency grants to fund research and development activities. There was no grant income for the three months ended September 30, 2020. Not all of our grant applications have been awarded, and no assurance can be made that any pending grant application, or any future grant applications, will be awarded. Fair Value of Financial Instruments Management believes the carrying amounts of the Company’s financial instruments (excluding debt and equity instruments) as of December 31, 2019, and September 30, 2020, approximate their respective fair values because of the short-term nature of these instruments. Such instruments consist of cash, accounts receivable, prepaid assets, accounts payable, lines of credit, and other assets and liabilities. Note 3. Equity Financing Lincoln Park During the three months ended March 31, 2020, pursuant to our August 2017 agreement with Lincoln Park Capital Fund, LLC (“Lincoln Park”), we elected to sell to Lincoln Park 1,398,223 shares of our common stock, for which we received $295,000 in gross and net proceeds. Additionally, we issued Lincoln Park 14,420 “additional commitment” shares required under the agreement. We did not sell any shares to Lincoln Park during the three and nine months ended September 30, 2019. In conjunction with the signing of the March 2020 agreement with Lincoln Park (see below), we recorded the remaining deferred offering costs on our August 2017 agreement totaling $122,000 as additional paid in capital on our consolidated balance sheet. On March 30, , 2020, we entered into a Purchase Agreement with Lincoln Park, pursuant to which Lincoln Park agreed to purchase from us at our request up to an aggregate of $10,250,000 of our common stock (subject to certain limitations) from time to time over a period of three years. The agreement allows us, at our sole discretion, to direct Lincoln Park to purchase shares of our common stock, subject to limitations in both volume and dollar amount. The purchase price of the shares that may be sold to Lincoln Park under the Purchase Agreement is the lower of (i) the lowest sale price on the date of purchase, or (ii) the average of the three lowest closing prices in the prior 12 business days. There are no restrictions on future financings, rights of first refusal, participation rights, penalties or liquidated damages other than a prohibition on entering into a “Variable Rate Transaction,” as defined in the agreement. Lincoln Park may not assign or transfer its rights and obligations under the Purchase Agreement. This agreement replaced the August 2017 agreement with Lincoln Park. Concurrently with the Purchase Agreement, we entered into a Registration Rights Agreement, pursuant to which we filed a registration statement on Form S-1 with the SEC on April 10, 2020. This registration statement was declared effective on April 21, 2020, and as of April 29, 2020, we commenced regular purchases under the agreement. 13 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) In the March 30, 2020 agreement, we agreed to issue 2,928,571 shares to Lincoln Park as a commitment fee, valued at $527,000 and recorded as additional paid in capital on our consolidated balance sheet as of March 31, 2020. Additionally, the Purchase Agreement provided for an initial sale of 1,785,715 shares to Lincoln Park for $250,000. We received those funds and issued the shares on March 31, 2020. Since inception of the March 30, 2020 agreement through September 30, 2020, not including the initial purchase, we sold 6,508,675 shares to Lincoln Park for $1,043,000. For the three months ended September 30, 2020, we sold 4,893,981 shares to Lincoln Park for $797,000. 2020 Unit Offering On May 1, 2020, we commenced a private offering of units, each unit consisting of (i) common stock, (ii) a four-month stock purchase warrant, and (iii) a five-year stock purchase warrant. Unit prices are set from time-to-time based on market conditions. The number of shares of common stock issued, and the number of shares available for purchase under each warrant, are based on the quotient of the unit price and investment amount (e.g., a $100,000 investment and unit price of $0.25 is equal to 400,000 shares). The four-month warrant exercise price is equal to 120% of the unit price, and the five-year warrant is equal to 150% of the unit price. During the nine months ended September 30, 2020, we received an aggregate $367,000 of investments from five investors at unit prices ranging between $0.15 and $0.18, issued 2,318,194 shares of our common stock, and issued six-month and five-year warrants (see Note 6). Note 4. Debt Obligations The following table summarizes our debt obligations outstanding as of December 31, 2019 and as of September 30, 2020 (in thousands). December 31, 2019 September 30 , 2020 C urrent liabilities: Note payable, matures on demand 60 days’ notice (or March 8, 2023) $ 50 $ 50 Line of credit, matures September 1, 2019 or later (on 30-day demand) 50 50 Inventory line of credit (Clyra Medical), matures July 6, 2020 (Note 8) — 173 Note payable issued by Clyra Medical to Scion, matures June 17, 2021 (see Note 8) 1,007 1,007 Total notes payable and line of credit $ 1,107 $ 1,280 Convertible notes payable: Convertible note, matured April 7, 2020 270 — Convertible note, matured June 20, 2020 (1) 25 — Convertible 12-month OID notes, mature beginning June 2020 (1) 3,112 — Convertible note payable, matures April 20, 2021 (1) — 100 Convertible note payable, matures August 9, 2021 — 600 Convertible notes, mature August 12 and 16, 2021 550 406 Total convertible notes payable 3,957 1,106 Total current liabilities $ 5,064 $ 2,386 L ong-term liabilities : Convertible note payable, matures August 9, 2021 $ 600 $ — SBA Paycheck Protection Program loans, mature April 2022 — 357 SBA EIDL Loan, matures July 2050 — 150 Convertible notes payable, mature April 20, 2021 (1) 100 — Total long-term liabilities $ 700 $ 507 Total $ 5,764 $ 2,893 (1) These notes are convertible at our option at maturity. 14 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) For the nine months ended September 30, 2019 and 2020, we recorded $2,773,000 and $1,823,000 of interest expense related to the amortization of discounts on convertible notes payable, and coupon interest from our convertible notes and line of credit. The following discussion includes debt instruments to which amendments were made or included other activity that management deemed appropriate to disclose. Each of the debt instruments contained in the above table are disclosed more fully in the financial statements contained in the Company’s Annual Report filed March 31, 2020. SBA Program Loans In April 2020, our subsidiaries ONM, BLEST and Clyra received $218,000, $96,000 and $43,000, respectively, received loans pursuant to the U.S. Small Business Administration Paycheck Protection Program. The loans mature in two years and incur interest at 1%. Management believes that it has fully complied with the terms of forgiveness as set forth by the Small Business Administration, and intends to apply for forgiveness of 100% of this debt at the appropriate time. Our subsidiary ONM received an Economic Injury Disaster loan from the U.S. Small Business Administration of $150,000. The term of the loan is 30 years and has a 3.75% interest rate. Monthly payments of $800 begin July 2021. Convertible Note, matured April 7, 2020 (Vista Capital) On January 7, 2019, Vista Capital Investments LLC (“Vista Capital”) invested $300,000 and in exchange we issued a convertible promissory note in the principal amount of $330,000. Originally set to mature nine months from the date of issuance, the maturity date was extended multiple times. The note earned a one-time interest charge of 12%, which was recorded as a discount on convertible notes and was amortized over the term of the note. The note allowed conversion of the note into our common stock at a price equal to 65% of the lowest closing bid price of the Company’s common stock during the 25 consecutive trading days immediately preceding the conversion date. The intrinsic value of the beneficial conversion feature resulted in a fair value totaling $300,000, and is recorded as a discount on convertible notes on our balance sheet. This discount was amortized over the term of the note as interest expense, all of which was recorded in 2019. During the three months ended March 31, 2020, Vista Capital elected to convert the remaining balance of $270,000 of the outstanding principal and interest due on the note, and we issued 2,417,059 shares of our common stock. Convertible Twelve-month OID notes From June 7, 2019 through September 30, 2019, we received $2,235,000 and issued convertible promissory notes (each, a “Twelve-Month OID Note”) in the aggregate principal amount of $2,794,000, with a 25% original issue discount, to 34 accredited investors. The original issuance discount totaled $559,000 and is recorded as a discount on convertible notes payable on our balance sheet. The intrinsic value of the beneficial conversion features resulted in an aggregate fair value of $2,235,000, and is recorded as a discount on convertible notes on our balance sheet. The discounts were amortized and recorded to interest expense over the term of the notes. These notes each mature twelve months from the date of issuance. During the three months ended September 30, 2019, in exchange for $305,000 of convertible note payables that were coming due, we issued an additional $381,000 in Twelve-Month OID Notes, with a 25% original issue discount. The original issue discount totaled $76,000 and is recorded as a discount on convertible notes payable on our balance sheet. The intrinsic value of the beneficial conversion features resulted in an aggregate fair value of $381,000 and is recorded as debt extinguishment expense on our statement of operations. The discount will be amortized and recorded to interest expense over the term of the notes. These notes mature twelve months from the date of issuance. Each Twelve-month OID Note is convertible by the investor at any time at $0.17 per share. The notes earn interest at a rate of five percent (5%) per annum, due at maturity. At the maturity of each note, the Company exercised its right to redeem the notes through the issuance of common stock at a conversion price equal to the lower of the “conversion price” (initially $0.17, as may be adjusted), and 70% of the lowest daily volume weighted average price of the Company’s common stock during the 25 trading days preceding the conversion date. During the nine months ended September 30, 2020, $3,112,000 of the remaining outstanding principal of 12-Month OID Notes was converted, and we issued 30,208,453 shares of our common stock. Of that amount, 1,415,221 shares were issued as payment for interest due on the notes. 15 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note Maturity Extensions On August 10, 2020, we and the holder of a convertible promissory note in the principal amount of $475,000 due August 12, 2020, entered into an agreement to extend the maturity date of the note to August 12, 2021. As consideration for the extension of the maturity date, we agreed to lower the conversion price from $0.17 to $0.14, we agreed extend the expiration date from September 18, 2023 to September 18, 2025, of a warrant to purchase 1,734,375 shares of common stock, and extend the expiration date from August 12, 2024 to August 12, 2025 of a warrant to purchase 2,095,588 shares of common stock. The fair value of the reduced conversion price and extended warrant expirations dates resulted in a fair value totaling $228,000, recorded as a loss on extinguishment on our statement of operations. The noteholder then converted $119,000 of principal into 848,214 shares of common stock and $24,000 of accrued interest into 169,643 shares of common stock. The outstanding balance of this note as of September 30, 2020 was $356,000. On August 10, 2020, we and the holder of a convertible promissory note in the principal amount of $75,000 due August 20, 2020, entered into an agreement in which we agreed to pay $25,000, and the holder agreed to extend the maturity date of the note to August 20, 2021. Note 5. Share-Based Compensation Issuance of Common Stock in exchange for payment of payables Payment of Officer Salaries On September 30, 2020, we issued 349,670 shares of our common stock at $0.15 per share in lieu of $52,000 of accrued and unpaid salary to our officers. On June 30, 2020, we issued 367,403 shares of our common stock at $0.16 per share in lieu of $59,000 of accrued and unpaid salary to our officers. On March 31, 2020, we issued 648,755 shares of our common stock at $0.17 per share in lieu of $110,000 of accrued and unpaid salary to our officers. On September 30, 2019, we issued 35,080 shares of our common stock in lieu of $11,000 of accrued salary and unreimbursed business expenses owed to an officer. The price per share of $0.31 was based on the closing price of our common stock on the last business day of the month. On June 28, 2019, we issued 465,875 shares of our common stock at $0.23 per share in lieu of $107,000 of accrued salary and unreimbursed business expenses owed to two of our officers. On March 29, 2019, we issued 579,996 shares of our common stock at $0.16 per share in lieu of $93,000 of accrued and unpaid obligations to our officers. All of these issuances were pursuant to our 2018 Equity Incentive Plan. Payment of Consultant Fees On September 30, 2020, we issued 270,000 shares of our common stock at $0.15 per share in lieu of $41,000 of accrued and unpaid salary to consultants. On June 30, 2020, we issued 1,406,630 shares of our common stock at $0.16 per share in lieu of $213,000 of accrued and unpaid salary to consultants. On March 31, 2020, we issued 390,735 shares of our common stock at $0.17 per share in lieu of $67,000 of accrued and unpaid obligations to consultants. On September 30, 2019, we issued 594,118 shares of our common stock at $0.26 per share in lieu of $156,000 of accrued and unpaid salary to consultants. During the three months ended June 30, 2019, we issued 515,809 shares of our common stock at a range of $0.16 – $0.23 per share in lieu of $107,000 accrued and unpaid obligations to consultants. On March 29, 2019, we issued 649,545 shares of our common stock at $0.17 per share in lieu of $113,000 of accrued and unpaid obligations to consultants. Payment of Accrued Interest On September 30, 2020, we issued 1,415,221 shares of our common stock at $0.11 per share in lieu of $150,000 of accrued and unpaid interest. On June 30, 2020, we issued 297,001 shares of our common stock at $0.16 per share in lieu of $30,000 of accrued and unpaid interest. On March 31, 2020, we issued 19,278 shares of our common stock at $0.17 per share in lieu of $4,000 of accrued interest. 16 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) On September 30, 2019, we issued 87,478 shares of our common stock at $0.17 per share in lieu of $150,000 of accrued and unpaid interest. During the three months ended June 30, 2019, we issued 87,478 shares of our common stock, at prices ranging between $0.23 - $0.43 per share, in lieu of $15,000 of accrued interest. During the three months ended March 31, 2019, we issued 139,362 shares of our common stock at a range of $0.17 – $0.23 per share in lieu of $25,000 of accrued interest. Stock Option Expense During the nine months ended September 30, 2019 and 2020, we recorded an aggregate $1,201,000 and $1,347,000, in selling general and administrative expense related to the issuance and vesting of stock options issued through our 2018 Equity Incentive Plan, our (now expired) 2007 Equity Incentive Plan, and outside of these plans. See Note 8 for information on stock option expense for options issued by subsidiary Clyra Medical. 2018 Equity Incentive Plan On June 22, 2018, our stockholders adopted the BioLargo 2018 Equity Incentive Plan (“2018 Plan”) as a means of providing our directors, key employees and consultants additional incentive to provide services. Both stock options and stock grants may be made under this plan for a period of 10 years. Our Board of Director’s Compensation Committee administers this plan. As plan administrator, the Compensation Committee has sole discretion to set the price of the options. The plan authorizes the following types of awards: (i) incentive and non-qualified stock options, (ii) restricted stock awards, (iii) stock bonus awards, (iv) stock appreciation rights, (v) restricted stock units, and (vi) performance awards. The total number of shares reserved and available for awards pursuant to this Plan as of the date of adoption of this 2018 Plan by the Board is 40 million shares. The number of shares available to be issued under the 2018 Plan increases automatically each January 1 st by the lesser of (a) 2 million shares, or (b) such number of shares determined by our Board. Activity for our stock options under the 2018 Plan for the nine months ended September 30, 2019 and September 30, 2020, is as follows: Weighted a verage Aggregate Options Exercise p rice per intrinsic o utstanding p rice per share share v alue (1) Balance, December 31, 2018 1,318,517 $0.22 – 0.43 $ 0.30 Granted 7,072,342 0.16 – 0.40 0.27 Expired — — — Balance, September 30, 2019 8,390,859 $0.16 – 0.43 $ 0.27 Non-vested (4,144,926 ) 0.16 – 0.40 0.29 Vested, September 30, 2019 4,245,933 $0.17 – 0.36 $ 0.23 Balance, December 31, 2019 9,214,356 $0.22 – 0.43 $ 0.25 Granted 9,738,196 0.15 – 0.22 0.15 Expired (1,546,518 ) 0.16 – 0.34 0.26 Balance, September 30, 2020 17,406,034 $0.16 – 0.43 $ 0.20 Non-vested (7,700,981 ) 0.17 – 0.45 0.19 Vested, September 30, 2020 9,705,053 $0.16 – 0.45 $ 0.20 $ 25,000 (1) – Aggregate intrinsic value based on closing common stock price of $0.15 at September 30, 2020. 17 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The options granted under the 2018 Plan to purchase 9,738,196 shares during the nine months ended September 30, 2020 were issued to officers, board of directors, employees and consultants: (i) we issued options to purchase 4,880,945 shares of our common stock at an exercise price of $0.14 per share to employees and consultants as a bonus during the COVID-19 pandemic. These options vest quarterly over one year and the fair value totaled $616,000; (ii) we issued options to purchase 517,500 shares of our common stock at an exercise price range of $0.14 – $0.21 per share to our CFO, with 392,500 shares having vested during the nine months ended September 30, 2020, and the remaining shares to vest 25,000 monthly through January 31, 2021, the fair value of the options issued to our CFO totals $100,000; (iii) we issued options to purchase 1,308,934 shares of our common stock at an exercise price on the respective grant date of $0.17 ,$0.16 and $0.15 per share to members of our board of directors for services performed, all options vested at issuance and the fair value of these options totaled $200,000; (iv) we issued options to purchase 1,346,732 shares of our common stock to employees as part of an employee retention plan at an exercise price on the respective date of $0.17, $0.16 and $0.15 per share; the fair value of employee retention plan options totaled $201,000 and vest quarterly over four years as long as they are retained as employees; (v) we issued options to purchase 531,298 shares of our common stock to consultants in lieu of cash for unpaid obligations totaling $74,000; and (vi) we issued options to purchase 1,152,787 shares of common stock at an exercise price ranging between $0.14 – $0.17 per share to employees to convert accrued and unpaid obligations and for previously issued options that expire. All of these options vested at issuance and the fair value totaled $156,000. All stock option expense is recorded on our consolidated statement of operations as selling, general and administrative expense. 2007 Equity Incentive Plan On September 7, 2007, and as amended April 29, 2011, the BioLargo, Inc. 2007 Equity Incentive Plan (“2007 Plan”) was adopted as a means of providing our directors, key employees and consultants additional incentive to provide services. Both stock options and stock grants may be made under this plan for a period of 10 years, which expired on September 7, 2017. The Board’s Compensation Committee administers this plan. As plan administrator, the Compensation Committee has sole discretion to set the price of the options. As of September 2017, the Plan was closed to further stock option grants. Activity for our stock options under the 2007 Plan for the nine months ended September 30, 2019 and 2020 is as follows: Weighted a verage Aggregate Options Exercise p rice per intrinsic o utstanding p rice per share share v alue (1) Balance, December 31, 2018 9,691,586 $0.23 – 0.94 $ 0.43 Expired (902,135 ) 0.28 – 0.70 0.48 Balance, September 30, 2019 8,789,451 $0.23 – 0.69 $ 0.47 $ — Balance, December 31, 2019 9,691,586 $0.23 – 0.69 $ 0.42 Expired (2,899,425 ) 0.23 – 0.58 0.38 Balance, September 30, 2020 6,792,161 $0.28 – 0.69 $ 0.44 $ — (1) – Aggregate intrinsic value based on closing common stock price of $0.15 at September 30, 2020. Non-Plan Options issued During the nine months ended September 30, 2020, we issued options to purchase 820,476 shares of our common stock at exercise prices ranging between $0.17 – $0.21 per share to vendors for fees for service. The fair value of the options issued totaled $135,000, is recorded in our selling, general and administrative expense. During the nine months ended September 30, 2019, we issued options to purchase 970,380 shares of our common stock at exercise prices ranging between $0.16 – $0.25 per share to vendors for fees for service resulting in a fair value totaling $194,000. The fair value of the options issued and vested during the nine months ended September 30, 2019 totaled $367,000, is recorded in our selling, general and administrative expense. 18 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Activity of our non-plan stock options issued for the nine months ended September 30, 2019 and 2020 is as follows: Weighted Non-plan a verage Aggregate o ptions Exercise p rice per intrinsic As of September 30 , 2019 : o utstanding p rice per share share value (1) Balance, December 31, 2018 19,319,496 $0.23 – 1.00 $ 0.43 Granted 970,380 0.16 – 0.25 0.19 Expired (691,975 ) 0.55 0.55 Balance, September 30, 2019 19,597,901 $0.16 – 1.00 $ 0.42 As of September 30 , 2020 : Balance, December 31, 2019 19,888,718 $0.23 – 1.00 $ 0.41 Granted 820,476 0.15 – 0.21 0.16 Balance, September 30, 2020 20,709,194 $0.15 – 1.00 $ 0.40 Non-vested (2,818,774 ) 0.17 – 0.45 0.45 Vested, September 30, 2020 17,890,420 $0.15 – 1.00 $ 0.39 $ — (1) – Aggregate intrinsic value based on closing common stock price of $0.15 at September 30, 2020. Note 6. Warrants We have certain warrants outstanding to purchase our common stock, at various prices, as described in the following table: Weighted a verage Aggregate Warrants Exercise p rice per intrinsic As of September 30 , 2019 : o utstanding p rice per share share value (1) Balance, December 31, 2018 26,872,430 $0.25 – 1.00 $ 0.42 Issued 24,321,947 0.10 – 0.30 0.21 Expired (7,505,746 ) 0.10 – 0.12 0.11 Balance, September 30, 2019 43,688,631 $0.10 – 1.00 $ 0.35 As of September 30 , 2020 : Balance, December 31, 2019 43,231,161 $0.16 – 1.00 $ 0.35 Issued 5,427,648 0.13 – 0.24 0.20 Expired (14,272,820 ) 0.40 – 0.49 0.46 Balance, September 30, 2020 34,385,989 $0.16 – 1.00 $ 0.29 $ 75,000 (1) – Aggregate intrinsic value based on closing common stock price of $0.15 at September 30, 2020. Warrants issued in private offering During the three months ended September 30, 2020, pursuant to our 2020 Unit Offering (see Note 3), we issued six-month stock purchase warrants to purchase an aggregate 746,528 shares of our common stock at prices from $0.192 to $0.216 per share, and five-year stock purchase warrants to purchase an aggregate 746,528 shares of our common stock at prices from $0.24 to $0.27 per share. During the nine months ended September 30, 2020, we issued six-month stock purchase warrants to purchase an aggregate 2,318,194 shares of our common stock at prices from $0.18 to $0.22 per share, and five-year stock purchase warrants to purchase an aggregate 2,318,194 shares of our common stock at prices from $0.225 to $0.27 per share. Fair Value – Interest Expense To determine interest expense related to our outstanding warrants issued in conjunction with debt offerings, the fair value of each award grant is estimated on the date of grant using the Black-Scholes option pricing model and the relative fair values are amortized over the life of the warrant. For the determination of expense of warrants issued for services, extinguishment of debt and settlement management also uses the option-pricing model. The principal assumptions we used in applying this model were as follows: 19 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) September 30, 2019 September 30, 2020 Risk free interest rate 1.42 – 2.62% 0.15 – 0.23% Expected volatility 86 – 110% 100 – 112 Expected dividend yield — — Forfeiture rate — — Expected life in years 2 – 5 0.33 – 5 The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant. Expected volatilities are based on historical volatility of our common stock. The expected life in years is based on the contract term of the warrant. Note 7. Accounts Payable and Accrued Expenses Accounts payable and accrued expenses included the following (in thousands): December 31, 2019 September 30 , 2020 Accounts payable and accrued expenses $ 346 $ 475 Accrued interest 123 122 Accrued payroll 133 169 Total accounts payable and accrued expenses $ 602 $ 766 Accounts payable and accrued expenses includes ordinary business payables incurred by the Company and its operational subsidiaries. Note 8. Noncontrolling Interest – Clyra Medical We consolidate the operations of our partially owned subsidiary Clyra Medical (see Note 2). Acquisition of In-process Research and Development On September 26, 2018, Clyra Medical entered into a transaction with Scion Solutions, LLC, for the purchase of its intellectual property, including its SkinDisc. The consideration provided to Scion is subject to an escrow agreement (“Escrow Agreement”) and earn out provisions and includes: (i) 21,000 shares of the Clyra Medical common stock; (ii) 10,000 shares of Clyra Medical common stock redeemable for 7,142,858 BioLargo common shares held by Clyra Medical; and (iii) a promissory note in the principal amount of $1,250,000 to be paid through new capital investments and revenue, as detailed below. This consideration was initially held in escrow pending Clyra Medical raising $1 million “base capital” to fund its business operations. On December 17, 2018, the parties entered into a closing agreement (“Closing Agreement”) reflecting the satisfaction of the obligation to raise $1 million “base capital”; at that time, one-half of the shares of Clyra Medical common stock exchanged for the Scion assets were released to Scion. The remaining Clyra Medical common shares (a total of 15,500 shares) remain subject to the Escrow Agreement’s performance metrics, each vesting one-fifth of the remaining shares of common stock (e.g., 2,000 shares of Clyra common stock, and an additional 1,100 shares redeemable for 785,714 BioLargo shares): (a) notification of FDA premarket clearance of certain orthopedics products, or recognition by Clyra Medical of $100,000 gross revenue; (b) the recognition by Clyra Medical of $100,000 in aggregate gross revenue; (c) the granting of all or any part of the patent application for the SkinDisc product, or recognition by Clyra Medical of $500,000 in gross revenue; (d) recognition by Clyra Medical of $1 million in aggregate gross revenue; and (e) recognition by Clyra Medical of $2 million in gross revenue. During the three months ended September 30, 2020, Clyra gross revenue exceeded $100,000, and thus the first performance metric was met. As a result, Scion vested 3,100 common shares. The fair value of the shares vested total $128,000 and was recorded on our balance sheet as In-Process Research and Development, and Liability to Clyra Medical Shareholder. 20 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Scion Solutions – Note Payable and Clyra Liability The promissory note in the principal amount of $1,250,000 issued by Clyra Medical to Scion on September 26, 2018 (“Clyra-Scion Note”) accrues interest at the rate of 5%. Principal and interest due under the note are to be paid periodically at a rate of 25% of investment proceeds received by Clyra Medical. At the initial maturity of June 17, 2020, the maturity date of the note automatically extended for 12 months and will continue to automatically extend for additional 12-month periods until the note is repaid in full. Clyra is required to make annual payments on the note in an amount equal to the greater of (i) 25% of investment proceeds received during the 12-month period, and (ii) 5% of Clyra Medical’s gross revenues. At September 30, 2020, the balance due on the Clyra-Scion Note equaled $1,007,000. The shares of BioLargo common stock held by Clyra for the benefit of Scion (the redemption shares) totals $771,000 and is recorded on our balance sheet as a liability to “Clyra Medical Shareholder”. Inventory Line of Credit On June 30, 2020, Clyra entered into a Revolving Line of Credit Agreement whereby Vernal Bay Capital Group, LLC committed to provide a $1,000,000 inventory line of credit to Clyra, with a first draw of $200,000 received July 6, 2020. Clyra is required to use funds from the line of credit to manufacture inventory. Additional draws are conditional upon Clyra presenting invoices or purchase orders to the lender equal to the greater of one-half of principal outstanding on the line of credit, and $200,000. The line of credit note earns interest at 15%, matures in one year, and requires Clyra pay interest and principal from gross product sales. For the first 180 days, on a monthly basis, Clyra is required to pay 30% of gross product sales to reduce amounts owed, and thereafter 60% of gross sales. Clyra issued Vernal Bay 323 shares of its common stock as a commitment fee for the line of credit, valued at $100,000. A security agreement of the same date grants Vernal Bay a security interest in Clyra’s inventory, as that term is defined in the Uniform Commercial Code. Clyra may prepay the note at any time. Clyra has received a second draw under this line of credit (see Note 12). Clyra Financing During the nine months ended September 30, 2020, Clyra sold 2,742 shares of its common stock at $310 per Clyra share. During June 2020, BioLargo increased its investment in Clyra by 23,004 shares. Of this amount, 22,513 shares were issued to BioLargo pursuant to an amendment to the BioLargo/Clyra license agreement whereby BioLargo has granted Clyra rights to commercialize its technology in certain medical fields. The amendment provided, among other things, for the payment of the “initial license fee” through the issuance of 22,513 shares of Clyra common stock. (See Note 2.) As of September 30, 2020, Clyra Medical had the following common (and no preferred) shares outstanding: Shareholder Shares Percent BioLargo, Inc. 49,207 47% Sanatio Capital 18,704 18% Scion Solutions ( 1 ) 18,600 17% Other 19,118 18% Total 105,629 (2) Notes: (1) Does not include an additional 12,400 shares held in escrow subject to performance metrics. (2) Does not include options to purchase 10,153 of shares of Clyra stock. 21 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) During 2019, Clyra began issuing options to its employees and consultants in lieu of compensation owed. As of December 31, 2019, the Company had issued options to purchase 7,624 shares of Clyra stock. In the three and nine months ended September 30, 2020, Clyra issued options to purchase 645 and 2,685 shares of Clyra Medical common stock. Each option issued has an exercise price of $1.00 per share, are vested upon issuance and an expiration date 10 years from the date of grant. The fair value of the options issued in the three and nine months ended September 30, 2020, totaled $140,000 and $580,000, respectively, and the additional fair value totaling $214,000 was recorded as a loss on extinguishment of debt in our consolidated statement of operations. We used the Black-Scholes model to calculate the initial fair value, assuming a stock price on date of grant of $310 per share. Because Clyra is a private company with no secondary market for its common stock, the resulting fair value was discounted by 30%. Consulting Agreement Clyra entered into a consulting agreement with Beach House Consulting, LLC, through which Jack B. Strommen will be providing consulting services to Clyra related to its sales and marketing activities, and in exchange receive $23,000 per month for a period of four years. On June 30, 2020, at Clyra’s request, Beach House Consulting agreed to accept 3,639 shares of Clyra common stock as full payment of the consulting fee, in lieu of cash. The obligation to provide the consulting services is dependent on Clyra generating an average of $250,000 in monthly sales over three consecutive months. The value of the shares issued to Beach House is recorded as a prepaid asset (see Note 2). Note 9. BioLargo Engineering, Science and Technologies, LLC In September 2017, we commenced a full-service environmental engineering firm and formed a Tennessee entity named BioLargo Engineering, Science & Technologies, LLC (“BLEST”). In conjunction with the start of this subsidiary, we entered into a three-year office lease in the Knoxville, Tennessee area (since extended), and entered into employment agreements with six scientists and engineers. The company was capitalized with two classes of membership units: Class A, 100% owned by Biolargo, and Class B, held by management of BLEST, and which initially had no “profit interest,” as that term is defined in Tennessee law. However, over the succeeding five years, the Class B members can earn up to a 30% profit interest. They were also granted options to purchase up to an aggregate 1,750,000 shares of BioLargo, Inc. common stock. The profit interest and option shares are subject to a five year vesting schedule tied to the performance of the subsidiary, including gross revenue targets that increase over time, obtaining positive cash flow by March 31, 2018 (which was not met), collecting 90% of its account receivables, obtaining a profit of 10% in its first year (and increasing in subsequent years), making progress in the scale-up and commercialization of our AOS system, and using BioLargo research scientists (such as our Canadian team) for billable work on client projects. These criteria are to be evaluated annually by BLEST’s compensation committee (which includes BioLargo’s president, CFO, and BLEST’s president), beginning September 2018. Given the significant performance criteria, the Class B units and the stock options will only be recognized in compensation expense if or when the criteria are satisfied. Since the commencement of operations, the Compensation Committee has met twice, once in September 2018, and once in November 2019. In 2018, it reviewed the operating performance and determined that the performance metrics were not met and as a result, did not award any Class B units or stock options. The Committee decided to roll forward one additional year to the time allowed for the performance metrics to be met and for the Class B units and stock options to be awarded. In November 2019, the Compensation Committee again reviewed the operating performance and determined that a portion of the performance metrics were met. It was agreed that one-half of the eligible profits interests would be vested (2.5% in the aggregate). The fair value of the profit interest was nominal and not recorded. Nevertheless, Biolargo treats the 2.5% profits interest as part of the noncontrolling interest on both the balance sheet and the statement of operations. Note 10. Business Segment Information BioLargo currently has four operating business segments, plus its corporate entity which is responsible for general corporate operations, including administrative functions, finance, human resources, marketing, legal, etc. The four operational business segments are: 1. ONM Environmental (formerly Odor-No-More) (“ONM”) -- which sells odor and volatile organic control products and services (located in Westminster, California); 2. Clyra Medical Technologies (“Clyra Medical”) -- which develops and sells medical products based on our technologies, including Clyraguard Personal Protective Spray; 3. BLEST -- which provides professional engineering services on a time and materials basis for outside clients and supports our internal operations as needed (located in Oak Ridge, Tennessee); and 22 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 4. BioLargo Water (“Water”) -- which historically focused entirely on R&D, and has now shifted its focus to commercializing the AOS technology, developing manufacturing operations for hand sanitizers and supporting the development of iodine based disinfecting products for the company (located in Edmonton, Alberta Canada). Historically, none of our operating business units have operated at a profit and therefore each required additional cash to meet its monthly expenses. The additional sources of the cash to fund the shortfall from operations of ONM, BLEST and BioLargo Water have been provided by BioLargo’s sales of debt or equity, research grants, and tax credits. Clyra Medical has been funded by third party investors who invest directly in Clyra Medical in exchange for equity ownership in that entity. The segment information for the three and nine months ended September 30, 2019 and 2020, is as follows (in thousands): Three months ended September 30, Nine months ended September 30, 201 9 20 20 201 9 20 20 Revenue ONM $ 396 $ 356 $ 1,012 $ 952 BLEST 308 334 732 778 Clyra Medical — 124 — 145 Water — 21 — 21 Intercompany revenue (170 ) (169 ) (420 ) (374 ) Total $ 534 $ 666 $ 1,324 $ 1,522 Operating loss BioLargo corporate $ (1,347 ) $ (870 ) $ (3,250 ) $ (2,970 ) ONM (90 ) (144 ) (231 ) (431 ) Clyra Medical (338 ) (491 ) (944 ) (1,219 ) BLEST 27 (298 ) (110 ) (465 ) Water (136 ) (106 ) (499 ) (530 ) Total $ (1,884 ) $ (1,909 ) $ (5,034 ) $ (5,615 ) As of September 30, 2020 BioLargo ONM Clyra BLEST Water Elimination (1) Total Tangible assets $ 867 $ 561 $ 1,332 $ 282 $ 93 $ (41 ) $ 3,094 Investment in South Korean joint venture 73 — — — — — 73 Intangible assets 2,021 — — — — — 2,021 As of December 31, 2019 BioLargo ONM Clyra BLEST Water Elimination (1) Total Tangible assets $ 862 $ 410 $ 3 $ 396 $ 77 $ (31 ) $ 1,728 Intangible assets 1,893 — — — — — 1,893 (1) – the “elimination” column reflects the net adjustment for receivables and payables generated between our related entities that are eliminated in consolidation. 23 Table of Contents BIOLARGO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 11. Commitments and Contingencies COVID-19 On March 11, 2020, the World Health Organization declared the outbreak of Coronavirus Disease 2019 (“COVID-19” or “virus”) as a global pandemic. The full impact of COVID-19 is unknown and rapidly evolving. The outbreak and any preventative or protective actions that the Company or its customers may take in respect of this virus may result in a period of disruption, including the Company’s financial reporting capabilities or its operations generally, and could potentially impact the Company’s customers and other third parties. Any resulting financial impact cannot be reasonably estimated at this time, but may materially affect the business and the Company’s financial condition and results of operations. The extent to which the COVID-19 impacts the Company’s results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions to contain the virus or treat its impact, among others. The Company has been operating remotely without any significant disruption of operations, although its clients have been disrupted. The Company is currently evaluating the impact, if any, on its financial statements, and has not yet quantified what material impacts to the financial statements may result from the actions taken by the Company and its customers in respect of this virus. Office Leases We have long-term operating leases for office, industrial and laboratory space in Westminster, California, Oak Ridge, Tennessee, and Alberta, Canada. Payments made under operating leases are charged to the Consolidated Statement of Operations and Comprehensive Loss on a straight-line basis over the term of the operating lease agreement. For the nine months ended September 30, 2019 and 2020, rental expense was $156,000 and $167,000, respectively. On January 1, 2019, we adopted ASC 842 which resulted in a right-of-use asset and lease liability. Short-term leases are not included in our analysis. The adoption resulted in an immaterial cumulative effect of an accounting change that was not recorded. The lease of our Westminster facility qualifies for the new treatment; it originated in August 2016, was originally scheduled to expire August 2020, contains a yearly escalation of 3%, and includes a four-year renewal option whereby the base rent is adjusted to then market value. We exercised our option to extend the lease for four years. It is too early for management to determine if it will extend another four years, therefore the additional four-year extension is not included in the analysis. The lease of our Oak Ridge, Tennessee facility also qualifies, and it had one executed extension to September 2022, and has one renewal option for another five years where the rental rate would adjust to greater of the current price and fair market value. No determination has been made whether to exercise the renewal option for the Oak Ridge facility. The lease of our Canadian facility is less than one year. None of our leases have additional terms related to the payments or mechanics of the lease: there are not any common area maintenance charges or tax sharing arrangements, easement provisions or any free rent. Since there is no explicit interest rate in leases, management used its incremental borrowing rate, which is estimated to be 18%. As of September 30, 2020, our weighted average remaining lease term is three years and the total remaining operating lease payments is $578,000. Note 12. Subsequent Events. Management has evaluated subsequent events through the date of the filing of this Quarterly Report and management noted the following for disclosure. Sales of Stock to Lincoln Park From October 1, 2020, through November 11, 2020, we sold 943,667 shares of our common stock to Lincoln Park (see Note 3) and received $135,000 in gross and net proceeds. These sales were registered with the SEC on Form S-1, Registration Number 333-237651. Inventory Line of Credit (Clyra Medical) Subsequent to September 30, 2020, Clyra received a draw of $60,000 on its inventory line of credit (see Note 8). 24 Table of Contents