Modular Medical, Inc. 10-K

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Accounting Firm – Farber Hass Hurley LLP F-2 Consolidated Balance Sheets F-4 Consolidated Statements of Operations F-5 Consolidated Statements of Stockholders’ Equity (Deficit) F-6 Consolidated Statements of Cash Flows F-7 Notes to Consolidated Financial Statements F-8 F- 1 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Audit Committee and Stockholders of Modular Medical, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Modular Medical, Inc. (the “Company”) as of March 31, 2023 and 2022, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Substantial Doubt about the Company's Ability to Continue as a Going Concern The accompanying consolidated financial statements have been prepared to assume the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has incurred losses from operations and needs to raise additional funds to meet its obligations and sustain its future operations until profitability is achieved. These circumstances raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated financial statements and (ii) involved especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. F- 2 Going Concern As described further in Note 1, the Company has incurred losses since inception, and expects to continue to incur operating losses for the foreseeable future and incur cash outflows from operations as it continues to invest in the development and subsequent commercialization of its product. The Company expects that its research and development and general and administrative expenses will continue to increase, and, as a result, the Company will need to generate significant product revenues to achieve profitability. These circumstances raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements are issued. We identified management’s assessment of the Company’s ability to continue as a going concern as a critical audit matter due to the inherent complexities and uncertainties related to the Company’s projections of operations. The primary procedures we performed to address this critical audit matter included: - We evaluated the reasonableness of key assumptions underlying management’s conclusion. - We evaluated that the disclosures included in the Form 10-K were complete and accurate and in accordance with accounting principles generally accepted in the United States of America. - We evaluated the impact of the Company’s existing financing arrangements and future capital needs over the next 12 months on its ability to continue as a going concern. Stock-Based Compensation As discussed in Note 8, during the year ended March 31, 2023, the Company granted options to purchase shares of its common stock to employees, directors and consultants. Management is required to analyze the fair value of each option granted and amortize it over its vesting period. We identified the recognition of stock options as a critical audit matter due to the significant judgments made by management when developing underlying assumptions regarding the fair value of the options. The primary procedures we performed to address this critical audit matter included: - We gained an understanding of Company’s processes and controls in place for determining the fair value of each granted option. - We evaluated the option price model management selected to determine the fair value, and analyzed the underlying data used in the calculations. - We also recalculated the fair value of each option granted. /s/ Farber Hass Hurley LLP Firm ID 223 We have served as the Company’s auditor since 2018. Chatsworth, California June 26, 2023 F- 3 Modular Medical, Inc. Consolidated Balance Sheets March 31, 2023 2022 ASSETS CURRENT ASSETS Cash and cash equivalents $ 3,799,324 $ 9,076,372 Prepaid expenses and other 146,866 313,422 Security deposit 100,000 — TOTAL CURRENT ASSETS 4,046,190 9,389,794 Property and equipment, net 1,721,311 235,959 Right of use assets, net 1,477,747 120,693 Security deposit — 100,000 TOTAL NON-CURRENT ASSETS 3,199,058 456,652 TOTAL ASSETS $ 7,245,248 $ 9,846,446 LIABILITIES AND STOCKHOLDERS’ EQUITY CURRENT LIABILITIES Accounts payable $ 285,383 $ 299,951 Accrued expenses 338,698 524,891 Short-term lease liabilities 355,224 144,857 TOTAL CURRENT LIABILITIES 979,305 969,699 Long-term lease liabilities 1,189,967 39,957 TOTAL LIABILITIES 2,169,272 1,009,656 Commitments and Contingencies (Note 11) STOCKHOLDERS’ EQUITY Preferred Stock, $ 0.001 par value, 5,000,000 shares authorized, none issued and outstanding — — Common Stock, $ 0.001 par value, 50,000,000 shares authorized, 10,949,389 shares and 10,461,898 shares issued and outstanding as of March 31, 2023 and 2022, respectively 10,949 10,462 Additional paid-in capital 53,523,734 43,406,099 Accumulated deficit ( 48,458,707 ) ( 34,579,771 ) TOTAL STOCKHOLDERS’ EQUITY 5,075,976 8,836,790 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 7,245,248 $ 9,846,446 The accompanying notes are an integral part of these audited consolidated financial statements. F- 4 Modular Medical, Inc. Consolidated Statements of Operations Year Ended March 31, 2023 2022 Operating expenses Research and development $ 9,061,744 $ 7,729,240 General and administrative 4,816,567 7,197,162 Total operating expenses 13,878,311 14,926,402 Loss from operations ( 13,878,311 ) ( 14,926,402 ) Other income 975 368,920 Interest expense — ( 2,752,229 ) Loss on debt extinguishment — ( 1,321,450 ) Loss before income taxes ( 13,877,336 ) ( 18,631,161 ) Provision for income taxes 1,600 1,600 Net loss $ ( 13,878,936 ) $ ( 18,632,761 ) Net loss per share Basic and diluted $ ( 1.28 ) $ ( 2.74 ) Shares used in computing net loss per share Basic and diluted 10,880,527 6,807,710 The accompanying notes are an integral part of these audited consolidated financial statements. F- 5 Modular Medical, Inc. Consolidated Statements of Stockholders’ Equity (Deficit) Additional Stockholders’ Common Stock Paid-In Accumulated Equity Shares Amount Capital Deficit (Deficit) Balance as of March 31, 2021 6,302,050 $ 6,302 $ 14,665,559 $ ( 15,947,010 ) $ ( 1,275,149 ) Issuance of common stock upon public offering, net of issuance costs 2,500,000 2,500 13,657,500 — 13,660,000 Issuance of common stock in settlement of convertible notes and accrued interest 1,511,276 1,511 6,506,254 — 6,507,765 Placement of common stock 30,864 31 249,969 — 250,000 Warrants issued with convertible notes — — 3,700,632 — 3,700,632 Shares issued for services 90,000 90 594,310 — 594,400 Shares issued for reverse stock split 1,211 1 ( 1 ) — — Issuance of common stock under equity incentive plan 26,497 27 172,091 — 172,118 Stock-based compensation — — 3,859,785 — 3,859,785 Net loss — — — ( 18,632,761 ) ( 18,632,761 ) Balance as of March 31, 2022 10,461,898 $ 10,462 $ 43,406,099 $ ( 34,579,771 ) $ 8,836,790 Issuance of common stock and warrants in equity offering, net 449,438 449 7,371,898 — 7,372,347 Shares issued for services 11,264 11 21,716 — 21,727 Issuance of common stock under equity incentive plan 26,789 27 86,021 — 86,048 Stock-based compensation — — 2,638,000 — 2,638,000 Net loss — — — ( 13,878,936 ) ( 13,878,936 ) Balance as of March 31, 2023 10,949,389 $ 10,949 $ 53,523,734 $ ( 48,458,707 ) $ 5,075,976 The accompanying notes are an integral part of these audited consolidated financial statements. F- 6 Modular Medical, Inc. Consolidated Statements of Cash Flows Year ended March 31, 2023 2022 Cash Flows from operating activities Net loss $ ( 13,878,936 ) $ ( 18,632,761 ) Adjustments to reconcile net loss to net cash used in operating activities: Gain on PPP note forgiveness — ( 368,780 ) Loss on debt extinguishment — 1,321,450 Stock-based compensation expense 2,724,048 4,031,902 Depreciation and amortization 152,399 117,490 Accrued interest — 666,338 Shares issued for services 202,669 395,950 Amortization of debt issuance costs — 1,833,618 Other — 274 Changes in assets and liabilities: Prepaid expenses and other assets ( 14,384 ) 65,652 Lease right-of-use assets 203,047 79,431 Accounts payable and accrued expenses ( 200,762 ) 354,948 Change in lease liabilities ( 199,725 ) ( 125,040 ) Net cash used in operating activities ( 11,011,644 ) ( 10,259,528 ) Cash flows from investing activities Purchases of property and equipment ( 1,637,751 ) ( 54,764 ) Net cash used in investing activities ( 1,637,751 ) ( 54,764 ) Cash flows from financing activities Proceeds from private placement, net — 250,000 Proceeds from issuance of convertible notes, net — 4,137,199 Proceeds from issuance of promissory note — 2,100,000 Repayment of promissory note — ( 2,100,000 ) Proceeds from issuance of common stock and warrants, net 7,372,347 13,535,000 Net cash provided by financing activities 7,372,347 17,922,199 Net increase (decrease) in cash and cash equivalents ( 5,277,048 ) 7,607,907 Cash and cash equivalents, at beginning of year 9,076,372 1,468,465 Cash and cash equivalents, at end of year $ 3,799,324 $ 9,076,372 Supplemental disclosure: Noncash investing and financing activities: Right of use asset obtained in exchange for lease liabilities $ 1,560,101 $ — Fair value of detachable warrants issued with convertible notes $ — $ 3,700,632 Conversion of convertible notes and accrued interest into common stock $ — $ 7,253,876 Cash paid for: Income taxes $ 1,600 $ 1,600 Interest paid $ — $ 262,000 The accompanying notes are an integral part of these audited consolidated financial statements. F- 7 MODULAR MEDICAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Modular Medical, Inc. (the Company) was incorporated in Nevada in October 1998 under the name Bear Lake Recreation, Inc. The Company had no material business operations from 2002 until approximately 2017 when it acquired all of the issued and outstanding shares of Quasuras, Inc., a Delaware corporation (Quasuras). As the major shareholder of Quasuras retained control of both the Company and Quasuras, the share exchange was accounted for as a reverse merger. As such, the Company recognized the assets and liabilities of Quasuras, acquired in the merger, at their historical carrying amounts. Prior to the acquisition of Quasuras and, since at least 2002, the Company was a shell company, as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934 (the Exchange Act). In June 2017, the Company changed its name from Bear Lake Recreation, Inc. to Modular Medical, Inc. The Company is a development stage medical device company focused on the design, development and eventual commercialization of an innovative insulin pump using modernized technology to increase pump adoption in the diabetes marketplace. Through the creation of a novel two-part patch pump, our MODD1 product candidate, or MODD1, the Company seeks to fundamentally alter the trade-offs between cost and complexity and access to the higher standards of care that presently available insulin pumps provide. By simplifying and streamlining the user experience from introduction, prescription, reimbursement, training and day-to-day use, we seek to expand the wearable insulin delivery device market beyond the highly motivated “super users” and expand the category into the mass market. The product candidate seeks to serve both the type 1 and the rapidly growing, especially in terms of device adoption, type 2 diabetes markets. In February 2022, the Company completed a public offering of its equity securities, and its common stock was approved to list on the Nasdaq Capital Market under the symbol “MODD” and began trading there on February 10, 2022. Liquidity and Going Concern The Company expects to continue to incur operating losses for the foreseeable future and incur cash outflows from operations as it continues to invest in the development and subsequent commercialization of its product. The Company expects that its research and development and general and administrative expenses will continue to increase, and, as a result, it will eventually need to generate significant revenue to achieve profitability. The Company’s expected operating losses and cash burn raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that these financial statements are issued. These consolidated financial statements do not include any adjustments that might result from this uncertainty. Implementation of the Company’s plans and its ability to continue as a going concern will depend upon the Company’s ability to raise additional capital, through the sale of additional equity or debt securities, to support its future operations. There can be no assurance that such additional capital, whether in the form of debt or equity financing, will be sufficient or available and, if available, that such capital will be offered on terms and conditions acceptable to the Company. In May 2022 and May 2023, the Company completed offerings of its common stock and warrants. The Company’s operating needs include the planned costs to operate its business, including amounts required to fund working capital and capital expenditures. The Company’s future capital requirements and the adequacy of its available funds will depend on many factors, including the Company’s ability to successfully commercialize its product, competing technological and market developments, and the need to enter into collaborations with other companies or acquire other companies or technologies to enhance or complement its product offering. If the Company is unable to secure additional capital, it may be required to curtail its research and development initiatives and take additional measures to reduce costs in order to conserve its cash. Basis of Presentation The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company’s fiscal year ends on March 31 of each calendar year. Each reference to a fiscal year in these notes to the consolidated financial statements refers to the fiscal year ended March 31 of the calendar year indicated (for example, fiscal 2023 refers to the fiscal year ending March 31, 2023). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Quasuras. All significant intercompany transactions and balances have been eliminated in consolidation. F- 8 Reverse Stock Split On November 24, 2021, the Company filed a certificate of amendment to its amended and restated certificate of incorporation with the Secretary of State of the State of Nevada to effect a 1-for-3 reverse stock split of the Company’s shares of common stock. Such amendment and ratio were previously approved by a majority of the Company’s stockholders and the board of directors. As a result of the reverse stock split, which was effective November 29, 2021, every three shares of the Company’s pre-reverse split outstanding common stock were combined and reclassified into one share of common stock. Proportionate voting rights and other rights of common stockholders were not affected by the reverse stock split. Any fractional shares of common stock resulting from the Reverse Split were rounded up to the nearest whole share. All stock options outstanding and common stock reserved for issuance under the Company’s equity incentive plans and warrants outstanding immediately prior to the reverse stock split were adjusted by dividing the number of affected shares of common stock by three and, as applicable, multiplying the exercise price by three, as a result of the reverse stock split. All share numbers, share prices, exercise prices and per share amounts have been adjusted, on a retroactive basis to reflect this 1-for-3 reverse stock split. Use of Estimates The preparation of the accompanying consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Estimates may include those pertaining to accruals, stock-based compensation and income taxes. Actual results could differ from those estimates. Reportable Segment The Company operates in one business segment and uses one measurement of profitability for its business. Research and Development The Company expenses research and development expenditures as incurred. General and Administrative General and administrative expenses consist primarily of payroll and benefit costs, rent, stock-based compensation, legal and accounting fees, and office and other administrative expenses. Concentration of Credit Risk Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of cash. The Company maintains its cash at a high credit quality financial institution within the United States, which is insured by the Federal Deposit Insurance Corporation (FDIC) up to limits of approximately $ 250,000 . No reserve has been made in the financial statements for any possible loss due to financial institution failure. Risks and Uncertainties The Company is subject to risks from, among other things, competition associated with the industry in general, other risks associated with financing, liquidity requirements, rapidly changing customer requirements, limited operating history and the volatility of public markets. Recent Economic Disruptions The global outbreak of the coronavirus disease 2019 (COVID-19) was declared a pandemic by the World Health Organization and a national emergency by the U.S. government in March 2020. This negatively affected the U.S. and global economy, disrupted global supply chains, significantly restricted travel and transportation, resulted in mandated closures and orders to “shelter-in- place” and created significant disruption of the financial markets. While the U.S. national emergency expired in May 2023 and substantially all closures and “shelter-in-place” orders have ended, there can be no assurance that the COVID-19 pandemic will not impact the Company’s operational and financial performance in the future, as the duration and spread of the pandemic and related actions taken by U.S. and foreign government agencies to prevent disease spread are uncertain, out of our control, and cannot be predicted. The continued spread of COVID-19 has also led to disruption and volatility in the global capital markets. The Russian invasion of Ukraine in February 2022 has led to further economic disruptions. Mounting inflationary cost pressures and recessionary fears have negatively impacted the global economy. Since mid-2022, the U.S. Federal Reserve has addressed elevated inflation by increasing interest rates, as inflation remains elevated. While the Company was recently able to access the capital markets, in the future, the Company may be unable to access the capital markets, and additional capital may only be available to the Company on terms that could be significantly detrimental to its existing stockholders and to our business. F- 9 Cash and Cash Equivalents Cash and cash equivalents include cash on hand and cash in demand deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less. Property and Equipment Property and equipment are recorded at historical cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally three to five years . Depreciation is recorded in operating expenses in the consolidated statements of operations. Leasehold improvements and assets acquired through capital leases are amortized over the shorter of their estimated useful life or the lease term, and amortization is recorded in operating expenses in the consolidated statements of operations. Construction-in-process includes machinery and equipment and is stated at cost and not depreciated. Depreciation on construction-in-process commences when the assets are ready for their intended use and placed into service. Fair Value of Financial Instruments The Company measures the fair value of financial instruments using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels: ● Level 1 inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets. ● Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. ● Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement. Due to their short-term nature, the carrying values of cash equivalents, accounts payable and accrued expenses, approximate fair value. Debt Modifications and Extinguishments When the Company modifies or extinguishes debt, it does so in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 470-50, Debt— Modifications and Extinguishments, which requires modification to debt instruments to be evaluated to assess whether the modifications are considered “substantial modifications.” A substantial modification of terms shall be accounted for like an extinguishment. Based on the guidance relied upon and the analysis performed, if the Company believes the embedded conversion feature has no fair value on the date of issuance (measurement date) and the embedded conversion feature has no beneficial conversion feature, the embedded conversion feature does not meet the criteria in ASC 470-50-40-10 or 470-20-25 and the issuance of the convertible note payable is considered a modification, and not an extinguishment that would require the recognition of a gain or loss. If the Company determines the change in terms meet the criteria for substantial modification under ASC 470 it will treat the modification as extinguishment and recognize a loss from debt extinguishment. Leases The Company’s right-of-use assets consist of leased assets recognized in accordance with FASB ASC No. 842, Leases , which requires lessees to recognize a lease liability and a corresponding lease asset for virtually all lease contracts. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and the lease liability represents the Company’s obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on the consolidated balance sheets and are expensed on a straight-line basis over the lease term in the consolidated statement of operations and comprehensive loss. The Company determines the lease term by agreement with the lessor. In cases where the lease does not provide an implicit interest rate, the Company uses the Company’s incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. Stock-Based Compensation The Company recognizes stock-based compensation for stock options granted to employees and non-employees on a straight-line basis over the requisite service period, usually the vesting period, based on the grant-date fair value. The Company estimates the value of stock options on the date of grant using the Black-Scholes pricing model. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the option price, as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and projected stock option exercise behaviors. F- 10 Per-Share Amounts Basic net loss per share is computed by dividing loss for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share gives effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of incremental shares of common stock issuable upon the exercise of stock options and exercise of warrants. The following table sets forth securities outstanding which were excluded from the computation of diluted net loss per share as their inclusion would be anti-dilutive: March 31, 2023 2022 Options to purchase common stock 2,481,090 1,650,705 Common stock warrants 7,565,588 4,779,072 Total 10,046,678 6,429,777 Reclassifications Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations or cash flows. Income Taxes The Company determines deferred tax assets and liabilities based upon the differences between the financial statement and tax bases of the Company’s assets and liabilities using tax rates in effect for the year in which the Company expects the differences to affect taxable income. A valuation allowance is established for any deferred tax assets for which it is more likely than not that all or a portion of the deferred tax assets will not be realized. Based on the available information and other factors, management believes it is more likely than not that its federal and state net deferred tax assets will not be fully realized, and the Company has recorded a full valuation allowance. The Company accounts for uncertain tax positions in accordance with FASB ASC Topic 740, Income Taxes . When tax returns are filed, it is likely that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the consolidated financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest associated with unrecognized tax benefits is classified as interest expense and penalties are classified in general and administrative expenses in the consolidated statements of operations. The Company files U.S. federal and state income tax returns in jurisdictions with varying statutes of limitations. The Company’s historical net operating loss and credit carryforwards may be adjusted by the federal and state tax authorities until the statute closes on the year in which such tax attributes are utilized. Comprehensive Loss Comprehensive loss represents the changes in equity of an enterprise, other than those resulting from stockholder transactions. Accordingly, comprehensive loss may include certain changes in equity that are excluded from net loss. For the years ended March 31, 2023 and 2022, the Company’s comprehensive loss was the same as its net loss. F- 11 Recently Issued Accounting Pronouncement In June 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses . This ASU added a new impairment model (known as the current expected credit loss (CECL) model) that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes an allowance for its estimate of expected credit losses and applies to most debt instruments, trade receivables, lease receivables, financial guarantee contracts, and other loan commitments. The CECL model does not have a minimum threshold for recognition of impairment losses and entities will need to measure expected credit losses on assets that have a low risk of loss. This update is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years for smaller reporting companies. The adoption of this ASU is not expected to have a material impact on the Company’s results of operations and financial position. NOTE 2 – CONSOLIDATED BALANCE SHEET DETAIL March 31, 2023 2022 Property and equipment, net: Machinery and equipment $ 820,058 $ 230,947 Computer equipment and software 65,890 52,114 Construction-in-process 1,002,726 — Leasehold improvements 25,298 139,197 Office equipment 63,393 63,298 1,977,365 485,556 Less: accumulated depreciation and amortization ( 256,054 ) ( 249,597 ) Total property and equipment, net $ 1,721,311 $ 235,959 March 31, 2023 2022 Accrued Expenses Accrued wages and bonus $ 267,316 $ 457,891 Other 71,382 67,000 $ 338,698 $ 524,891 NOTE 3 – LEASES W. Bernardo Drive, San Diego, CA The 39 -month lease term commenced April 1, 2020, and the lease provides for an initial monthly rent of approximately $ 12,400 annual rent increases of approximately 3 %. In addition to the minimum lease payments, the Company is responsible for property taxes, insurance and certain other operating costs. A discount rate of 11 %, which approximated the Company’s incremental borrowing rate, was used to measure the lease asset and liability. The Company obtained a right-of-use asset of $ 270,950 in exchange for its obligations under the operating lease. The landlord also provided a lease incentive of approximately $ 139,000 , which was paid to the Company in June 2020, for the Company to make improvements to the leased space. In addition, the Company paid a $ 100,000 security deposit. Thornmint Road, San Diego, CA The 48 -month lease term commenced February 1, 2023, and the lease provides for an initial base monthly rent of $ 36,000 with annual rent increases of approximately 4 %. In addition to the minimum lease payments, the Company is responsible for property taxes, insurance and other certain operating costs. A discount rate of 8 %, which approximated the Company’s incremental borrowing rate, was used to measure the lease asset and liability. The Company obtained a right-of-use asset of $ 1,560,101 in exchange for its obligations under the operating lease. Future minimum payments under the facility operating leases, as of March 31, 2023, are listed in the table below. Fiscal year ending March 31, 2024 $ 462,008 2025 452,275 2026 470,366 2027 404,951 Total future lease payments 1,789,600 Less: Imputed interest ( 244,409 ) Present value of lease liabilities $ 1,545,191 Cash paid for amounts included in the measurement of lease liabilities was $ 230,028 and $ 153,432 for the years ended March 31, 2023 and 2022, respectively. Rent expense was $ 237,425 and $ 107,820 for the years ended March 31, 2023 and 2022, respectively. F- 12 NOTE 4 – PPP NOTE In April 2020, the Company received a $ 368,780 unsecured loan (the PPP Note) under the Paycheck Protection Program (the PPP), which was established under the U.S. government’s Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). The PPP Note to the Company was made through Silicon Valley Bank (the Lender), and the Company entered into a U.S. Small Business Administration Paycheck Protection Program Note with the Lender evidencing the PPP Note. The full amount of the PPP Note was due in April 2022 and interest accrued on the outstanding principal balance of the PPP Note at a fixed rate of 1.0 % per annum, which was deferred for 10 months after the covered period during which the Company used the proceeds. In May 2021, the Lender and the U.S. Small Business Administration notified the Company that the outstanding principal and accrued interest for the PPP Note was forgiven in full. The Company accounted for the forgiveness of the PPP Note in accordance with ASC Topic 470, and the amount forgiven was recorded as a gain on extinguishment and recognized in the other income line of the consolidated statements of operations. NOTE 5 – CONVERTIBLE PROMISSORY NOTES From February through April 2021, the Company sold $ 2,310,000 of convertible promissory notes (each an Original Note and, collectively, the Original Notes), at par in a private placement transaction effected pursuant to an exemption from the registration requirements under the Securities Act of 1933, as amended. Effective April 30, 2021, pursuant to a revocation and replacement agreement between each holder of an Original Note and the Company (the Revocation Agreement), the $ 2,310,000 of Original Notes and accrued interest thereon as of April 30, 2021 were replaced with $ 2,360,550 aggregate principal amount of Notes and 2021 Warrants (as defined below). The Company accounted for the replacement of the Original Notes in accordance with ASC 470 and recorded a loss on extinguishment of $ 1,321,450 and interest expense of $ 70,647 for unamortized debt issuance costs as of April 30, 2021. During the three months ended June 30, 2021, pursuant to a securities purchase agreement by and between the Company and each investor (the SPA), the Company sold to investors $ 4,250,000 aggregate principal amount of convertible promissory notes (the Notes) and warrants to purchase shares of its common stock (the 2021 Warrants). The Notes were unsecured obligations of the Company with each Note having a stated maturity date of 12 months from its issue date and accrued interest at a rate of 12 % per annum, payable on maturity. If the Company completed an offering of its common stock or other securities in excess of $ 12,000,000 of gross proceeds (a Qualified Capital Raise, as defined in the Notes), each Note holder would be required to convert its Adjusted Note Amount (as defined below) into the securities of such Qualified Capital Raise. Adjusted Note Amount equals the product of (i) the sum of all outstanding principal plus accrued interest on a Note, multiplied by (ii) 1.25. In connection with the issuance of the Notes, the Company issued the 2021 Warrants to purchase in the aggregate 767,796 shares of its common stock at an initial exercise price of $ 24.00 per share. The fair value of the 2021 Warrants was $ 3,700,632 , of which $ 2,379,182 was recorded as a debt discount and amortized to interest expense, and $ 1,321,450 was recorded as a loss on debt extinguishment. The Company calculated the fair value of the Warrants utilizing the Black-Scholes valuation model with the following assumptions: volatility of 88.98 %, risk-free interest rate of 0.86 %, a term of 5.75 years and a dividend yield of zero . Upon the closing of a public offering in February 2022, which was a Qualified Capital Raise, in accordance with their terms, the Notes converted into 1,511,276 shares of common stock and the holders of the Notes received an additional 1,511,276 common stock purchase warrants with an exercise price of $ 6.60 per share. In addition, as a result of the February 2022 equity offering, the exercise price of the 767,796 outstanding 2021 Warrants was reduced to $ 6.00 per share. F- 13 NOTE 6 – PROMISSORY NOTE In October 2021, the Company issued a secured promissory note (the Bridge Note) to Manchester Explorer, L.P. (Explorer) that provided the Company with a $ 3,000,000 revolving credit facility with all amounts being drawn down by the Company thereunder being due and payable, subject to acceleration in the event of a default, on March 15, 2022 (the Maturity Date). Interest at the rate of 12 % was payable on each drawn down without regard to the draw down date or the date when interest is paid. During fiscal 2022, the Company made draws on the Bridge Note of $ 2,100,000 and incurred interest charges of $ 252,000 . In February 2022, subsequent to the completion of the 2022 Offering (see Note 7), the Bridge Note and accrued interest was paid in full. NOTE 7 – STOCKHOLDERS’ EQUITY February 2022 Public Offering On February 9, 2022, the Company entered into an underwriting agreement with Oppenheimer & Co. Inc., who acted as the representative of the several underwriters (the Underwriters), in a firm commitment underwritten public offering (the 2022 Offering) pursuant to which, on February 14, 2022, the Company sold to the Underwriters an aggregate of 2,500,000 shares of the Company’s common stock and 2,500,000 warrants (the Offering Warrants and, collectively with the shares of common stock, the Units), each to purchase one share of common stock. The price to the public in the 2022 Offering was $ 6.00 per Unit, before underwriting discounts and commissions. The common stock and the Offering Warrants comprising the Units were immediately separable upon issuance and were issued separately. The Offering Warrants were exercisable immediately, have an exercise price of $ 6.60 per share and expire on February 14, 2027 . The gross proceeds from the 2022 Offering were $ 15,000,000 , before deducting approximately $ 1,465,000 of underwriting discounts and commissions and other offering expenses. Placements of Common Stock and Warrants On May 2, 2022, the Company entered into a securities purchase agreement (the Purchase Agreement) with an institutional investor, pursuant to which the Company sold, in a registered direct offering, which closed on May 5, 2022, an aggregate of 449,438 shares (the Shares) of the Company’s common stock, par value $ 0.001 per share, at a purchase price per Share of $ 4.45 and pre-funded warrants (the Pre-Funded Warrants) to purchase an aggregate of 1,348,314 shares of common stock at a purchase price per Pre-Funded Warrant of $ 4.44 . The Pre-Funded Warrants will be exercisable immediately on the date of issuance at an exercise price of $ 0.01 per share and may be exercised at any time until all of the Pre-Funded Warrants are exercised in full. In a concurrent private placement under the Purchase Agreement, the Company issued to the Investor warrants (the Private Placement Warrants) to purchase an aggregate of 1,438,202 shares of common stock at an exercise price of $ 6.60 per share. The Private Placement Warrants will be exercisable beginning on the six-month anniversary of the date of issuance (the Initial Exercise Date) and will expire on the five-year anniversary of the Initial Exercise Date. In October 2021, the Company sold 30,864 shares of common stock to two officers, its i) chief executive officer and ii) the chairman of the Company’s board of directors (the Board), president, chief financial officer and treasurer, at a purchase price of $ 8.10 per share, for gross proceeds of approximately $ 250,000 . Issuances of Common Stock and Warrants During the years ended March 31, 2023 and 2022, the Company issued 11,264 and 90,000 shares of common stock to service providers, respectively, with fair values of approximately $ 21,727 and $ 594,400 , respectively. F- 14 Warrants As of March 31, 2023, the Company had the following warrants outstanding: Number of Exercise Type Shares Prices Expiration Dates Common stock 1,348,314 $ 0.01 — Common stock 767,796 $ 6.00 January - February 2027 Common stock 4,011,276 $ 6.60 February 2027 Common stock 1,438,202 $ 6.60 November 2027 Total 7,565,588 As of March 31, 2022, the Company had the following warrants outstanding: Number of Exercise Type Shares Prices Expiration Dates Common stock 767,796 $ 6.00 January - February 2027 Common stock 4,011,276 $ 6.60 February 2027 Total 4,779,072 NOTE 8 – STOCK-BASED COMPENSATION Amended 2017 Equity Incentive Plan In October 2017, the Company’s Board approved the 2017 Equity Incentive Plan (the Plan) with 1,000,000 shares of common stock reserved for issuance. In January 2020 and August 2021, the Board approved increases in the number of shares reserved for issuance under the Plan by 333,334 and 1,333,334 shares, respectively. In January 2023, the Company’s stockholders approved an increase in the number of shares reserved for issuance under the Plan by an additional 2,000,000 shares. Under the Plan, eligible employees, directors and consultants may be granted a broad range of awards, including stock options, stock appreciation rights, restricted stock, performance-based awards and restricted stock units. The Plan is administered by the Board or, in the alternative, a committee designated by the Board. Stock-Based Compensation Expense The expense relating to stock options is recognized on a straight-line basis over the requisite service period, usually the vesting period, based on the grant date fair value. The unamortized compensation cost, as of March 31, 2023, was $ 3,268,600 related to stock options and is expected to be recognized as expense over a weighted-average period of approximately two years . During the year ended March 31, 2023, the Company granted options to purchase 1,006,074 shares of its common stock to employees, directors and consultants. The options had 10 -year terms and 123,407 options vested immediately when granted. F- 15 The weighted-average grant date fair value of stock options granted during the years ended March 31, 2023 and 2022 was $ 2.85 and $ 10.28 , respectively. The following assumptions were used in the fair-value method calculations: Year Ended March 31, 2023 2022 Risk-free interest rates 2.82 % - 4.06 % 0.8 % - 2.42 % Volatility 83 % - 223 % 89 % - 370 % Expected life (years) 5.0 - 5.7 5.0 - 6.2 Dividend yield — — The fair values of options at the grant date were estimated utilizing the Black-Scholes valuation model, which includes simplified methods to establish the fair term of options. The expected volatility is based on the historical volatility of the Company’s stock price. The risk-free interest rate was derived from the Daily Treasury Yield Curve Rates, as published by the U.S. Department of the Treasury as of the grant date for terms equal to the expected terms of the options. A dividend yield of zero was applied because the Company has never paid dividends and has no intention to pay dividends in the foreseeable future. The Company accounts for forfeitures as they occur. A summary of stock option activity under the Plan is presented below: Options Outstanding Shares Available for Grant Number of Shares Weighted Average Exercise Price Balance at March 31, 2021 136,082 1,197,252 $ 5.25 Additional shares authorized under the Plan 1,333,334 — — Options granted ( 827,427 ) 827,427 10.39 Share awards ( 26,497 ) — — Options cancelled and returned to the Plan 373,974 ( 373,974 ) 10.73 Balance at March 31, 2022 989,466 1,650,705 6.58 Additional shares authorized under the Plan 2,000,000 — — Options granted ( 1,006,074 ) 1,006,074 3.15 Share awards ( 26,789 ) — — Options cancelled and returned to the Plan 175,689 ( 175,689 ) 6.48 Balance at March 31, 2023 2,132,292 2,481,090 $ 5.19 There were no stock options exercised during the years ended March 31, 2023 and 2022. The Company issued 26,789 shares to its non-employee directors under the Company’s outside director compensation plan and approximately $ 86,048 was recorded as stock-based compensation expense for these share awards during the year ended March 31, 2023. The following table summarizes the range of outstanding and exercisable options as of March 31, 2023: Options Outstanding Options Exercisable Weighted Average Remaining Weighted Weighted Contractual Average Average Aggregate Number Life Exercise Number Exercise Intrinsic Range of Exercise Price Outstanding (in Years) Price Exercisable Price value $ 1.44 – $3.95 982,358 7.78 $ 2.05 531,797 $ 2.04 $ 319 $ 4.18 - $7.51 969,600 8.05 5.46 572,600 6.32 — $ 8.61 - $17.70 529,132 8.25 10.53 379,634 10.49 — 2,481,090 7.99 $ 5.19 1,484,031 $ 5.87 $ 319 The intrinsic value per share is calculated as the excess of the closing price of the common stock on the Company’s principal trading market over the exercise price of the option at March 31, 2023. F- 16 NOTE 9 – INCOME TAXES The income tax provision consisted of the following: Year Ended March 31, 2023 2022 Current portion: Federal $ — $ — State 1,600 1,600 1,600 1,600 Deferred portion: Federal ( 2,933,000 ) ( 4,109,000 ) State ( 1,467,000 ) ( 1,300,000 ) ( 4,400,000 ) ( 5,409,000 ) Change in valuation allowance 4,400,000 5,409,000 Provision for income taxes $ 1,600 $ 1,600 At March 31, 2023, the Company had net operating loss carryforwards (NOLs) of approximately $ 29,500,000 for federal income tax purposes and $ 36,600,000 for state income tax purposes. These NOLs are available to reduce future taxable income and will expire at various times from 2037 through 2043, except federal NOLs from fiscal 2018 and later, which will never expire. The Company also had federal research and development tax credit carryforwards of approximately $ 1,300,000 , which will begin expiring at various times from 2038 through 2042, and state research and development credits of approximately $ 400,000 , which do not have an expiration date. A reconciliation of income taxes provided at the federal statutory rate to the actual income tax provision is as follows: Year Ended March 31, 2023 2022 Federal statutory rate ( 21 )% ( 21 )% State tax rate, net of federal benefit ( 6 )% ( 7 )% Research and development tax credits ( 6 )% ( 2 )% Change in valuation allowance 29 % 30 % Other 4 % — % Effective income tax rate — % — % The losses before income tax provision for the years ended March 31, 2023 and 2022 were solely attributable to US operations. Significant components of the Company’s deferred tax assets and liabilities were: March 31, 2023 2022 Net operating loss carryforwards $ 8,742,000 $ 7,731,000 Stock-based compensation expense 2,587,000 1,824,000 Property and equipment 105,000 80,000 Reserves, accruals & other 1,841,000 ( 104,000 ) Research and development tax credits 1,658,000 988,000 Total deferred tax assets 14,933,000 10,519,000 Section 179 assets ( 111,000 ) ( 97,000 ) Total deferred tax liabilities ( 111,000 ) ( 97,000 ) Less: valuation allowance ( 14,822,000 ) ( 10,422,000 ) Deferred tax assets, net $ — $ — F- 17 Based on the available information and other factors, management believes it is more likely than not that the net deferred tax assets at March 31, 2023 and 2022, will not be fully realizable. Accordingly, management has recorded a full valuation allowance against its net deferred tax assets at March 31, 2023 and 2022. Management has evaluated and concluded that there were no material uncertain tax positions requiring recognition in the Company’s consolidated financial statements at March 31, 2023 and 2022. The Company does not expect any significant changes in its unrecognized tax benefits within twelve months of the reporting date. NOTE 10 – ROYALTY AGREEMENT In July 2017, the Company entered into a royalty agreement with its founder, then-chief executive officer, president and major shareholder (the Founder). Pursuant to the agreement, the Founder assigned and transferred all of his rights in the intellectual property of Quasuras in return for future royalty payments on the Company’s product. The Company is obligated to make royalty payments under the agreement to the Founder on any sales of the royalty product sold or otherwise commercialized by the Company equal to (a) $ 0.75 on each sale of a royalty product or (b) 5 % of the gross sale price of the royalty product, whichever is less. The royalty payments will cease, and the agreement will terminate, at such time as the total sum of royalty payments actually paid to the Founder, pursuant to the agreement, reaches $ 10,000,000 . The Company has the option to terminate the agreement at any time upon payment, to the Founder, of the difference between total royalty payments actually made to him to date and the sum of $ 10,000,000 . All payments of the royalties, if due, for the preceding quarter, will be made by the Company to the Founder within 30 days after the end of each calendar quarter. NOTE 11 – COMMITMENTS AND CONTINGENCIES Litigations, Claims and Assessments In the normal course of business, the Company may be involved in legal proceedings, claims and assessments arising in the ordinary course of business. The Company records legal costs associated with loss contingencies as incurred and accrues for all probable and estimable settlements. Indemnification In the ordinary course of business, the Company enters into contractual arrangements under which it may agree to indemnify the counterparties from any losses incurred relating to breach of representations and warranties, failure to perform certain covenants, or claims and losses arising from certain events as outlined within the particular contract, which may include, for example, losses arising from litigation or claims relating to past performance. Such indemnification clauses may not be subject to maximum loss clauses. The Company has also entered into indemnification agreements with its officers and directors. No amounts were reflected in the Company’s consolidated financial statements for the years ended March 31, 2023 and 2022 related to these indemnifications. The Company has not estimated the maximum potential amount of indemnification liability under these agreements due to the limited history of prior claims and the unique facts and circumstances applicable to each particular agreement. To date, the Company has not made any payments related to these indemnification agreements. Purchase Obligations The Company’s primary purchase obligations include purchase orders for machinery and equipment. At March 31, 2023, the Company had outstanding purchase orders for machinery and equipment and related expenditures of approximately $ 833,000 . NOTE 12 – RELATED PARTY TRANSACTIONS Manchester Management Company, LLC (MMC), as the general partner of Explorer, combined with the holdings of its affiliates, JEB Partners LP, James Besser and Morgan Frank, owned approximately 25 % of the Company’s outstanding shares of common stock as of March 31, 2023. Mr. Besser is the Company’s chief executive officer and a managing member of MMC. Mr. Frank is one of our directors and serves as the portfolio manager of Explorer and as a managing member of MMC. The daughter of the Founder is an employee of the Company. During the years ended March 31, 2023 and 2022, the Company paid her $ 201,275 and $ 169,589 , respectively, which includes the aggregate grant date fair value, as determined pursuant to FASB ASC Topic 718, of stock options granted to her. In May 2021, a member of the Board purchased $ 200,000 aggregate principal amount of Notes (the Director Note). On February 14, 2022, in connection with the Offering, the Director Note and $ 18,805 of accrued interest thereon were converted into 45,586 shares of common stock and 45,586 Offering Warrants. In February 2021, Explorer, which is represented by Mr. Frank, and the Founder (the Related Party Holders) purchased $ 1,000,000 and $ 100,000 , aggregate principal amount of the Original Notes, respectively. Effective April 30, 2021, the Related Party Holders entered into revocation agreements with the Company pursuant to which their aggregate principal amount of Original Notes and accrued interest were replaced with Notes. On February 14, 2022, the Related Party Holders held Notes in an aggregate principal amount of $ 1,026,630 and $ 102,663 , respectively, with $ 97,881 and $ 9,788 of interest payable thereon. In connection with the Offering, the Related Party Holders received 234,274 and 23,429 shares of common stock, respectively, and 234,274 and 23,429 Offering Warrants, respectively. F- 18 NOTE 13 – SUBSEQUENT EVENT On May 15, 2023, the Company entered into an underwriting agreement (the Underwriting Agreement) with Newbridge Securities Corporation (the Underwriter), with respect to the issuance and sale in a firm commitment underwritten offering (the 2023 Offering) by the Company of units of its securities for aggregate gross proceeds of approximately $ 9,400,000 , before deducting underwriting discounts and commissions and other offering expenses. The Company sold 8,816,900 shares of its common stock and warrants to purchase 4,408,450 shares of its common stock. The securities were sold as a unit, with each unit consisting of two shares of common stock of the Company and one warrant (the 2023 Warrant) to purchase one share of common stock, at a public offering price of $ 2.13 per unit. The 2023 Warrants were immediately separable and exercisable, had a per share exercise price of $ 1.22 and expire five years from the date of issuance. The 2023 Offering closed on May 18, 2023. Pursuant to the Underwriting Agreement, the Company granted the Underwriter a 30-day option to purchase up to an additional 1,322,534 shares of common stock and an additional 661,267 of the 2023 Warrants to cover over-allotments, if any. On May 25, 2023, the Underwriter exercised in full this option and purchased the additional securities for aggregate gross proceeds to the Company of approximately $ 1,400,000 , before deducting underwriting discounts and commissions and other offering expenses. The Underwriter was paid a cash fee of 7.0 % of the aggregate gross proceeds of the Offering and reimbursed certain out-of-pocket expenses of $ 125,000 . Pursuant to the Underwriting Agreement, the Company issued to the Underwriter a five-year warrant to purchase 709,760 shares of common stock a per share exercise price of $ 1.22 . The Underwriting Agreement contains customary representations, warranties and agreements by the Company, customary conditions to closing, indemnification obligations of the Company and the Underwriter, including for liabilities under the Securities Act of 1933, as amended, other obligations of the parties and termination provisions. In addition, pursuant to the terms of the Underwriting Agreement and related “lock-up” agreements, the Company, each director and executive officer of the Company, and certain stockholders have agreed with the Underwriter not to offer for sale, issue, sell, contract to sell, pledge or otherwise dispose of any of our common stock or securities convertible into common stock for a period of 90 days after May 17, 2023. F- 19 ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.