SBC Medical Group Holdings Inc 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis summarize the significant factors affecting our operating results, financial condition, liquidity, and cash flows for the periods presented below. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report. The forward-looking statements contained herein are based on management’s judgment, assumptions made by management and information currently available to it. Actual results could differ materially from those discussed or implied in the forward-looking statements as a result of various factors, including those described below and elsewhere in this Annual Report, particularly in “Part I, Item 1A. Risk Factors” and the section entitled “Cautionary Note Regarding Forward-Looking Statements.” Unless the context otherwise requires, any reference in this section of this Annual Report to the “Company,” “SBC,” “we,” “us” or “our” refers to Legacy SBC and its consolidated subsidiaries and variable interest entity (“VIE”), prior to the consummation of the Business Combination and to SBC Medical Group Holdings Incorporated, the Combined Entity and its consolidated subsidiaries and VIE following the Business Combination. Overview SBC Medical Group, Inc. (formerly known as SBC Medical Group Holdings Incorporated), a Delaware corporation and subsidiary of the Company (“Legacy SBC”) is a management company headquartered in Irvine, California and Tokyo, Japan, that provides management services to cosmetic treatment centers mainly in Japan. The Company and its subsidiaries are primarily focused on providing comprehensive management services to franchisee clinics, including but not limited to advertising and marketing needs across various platforms (such as social media networks), staff management (such as recruitment and training), booking reservations for franchisee clinic customers, assistance with franchisee employee housing rentals and facility rentals, construction and design of franchisee clinics, medical equipment and medical consumables procurement ( resale ), the provision of cosmetic products to franchisee clinics for resale to clinic customers, licensure of the use of patent-pending and non-patented medical technologies, trademark and brand use, IT software solutions (including but not limited to remote medical consultations), management of the franchisee clinic’s customer rewards program (customer loyalty point program), and payment tools for the franchisee clinics. Our wholly owned subsidiaries, SBC Medical Group Co., Ltd., a Japan corporation (“SBC Medical Sub”), L’Ange Cosmetique Co., Ltd., a Japan corporation (“Lange Sub”), and Shobikai Co., Ltd., a Japan corporation (“Shobikai Sub”), are each designated as a “medical service corporation” in Japan. In Japan, a medical service corporation is a legal entity that provides management service to “medical corporations”. The management services are conducted through franchisor-franchisee contracts and/or service contracts between certain subsidiaries of the Company (SBC Medical Sub, Lange Sub, and Shobikai Sub) and the medical corporations that own all 241 of the treatment centers in Japan. These clinics provide include but are not limited to breast augmentation, liposuction, rejuvenation treatments (including treatment of wrinkles, acne, scars, cellulite, excess fat, discoloration, and signs of aging), laser skin toning and spot removal, eyes double fold surgery, rhinoplasty, treatment of osmidrosis and hyperhidrosis, hair transplants, gynecological formation treatments, laser hair removal, face line surgeries, cosmetical dental procedures, tattoo removal, lasik eye surgery, lateral canthoplasty, brow lift procedures, androgenetic alopecia treatment, and cheek sagging prevention methods. 104 There are currently six medical corporations that the Company’s subsidiaries have entered into franchisor-franchisee contracts and service contracts, consisting of Medical Corporation Shobikai, Medical Corporation Kowakai, Medical Corporation Nasukai, Medical Corporation Aikeikai, Medical Corporation Jukeikai and Medical Corporation Ritz Cosmetic Surgery. In addition, the Company has entered into service contracts since September 2023 with two additional medical corporations, Medical Corporation Association Furinkai and Medical Corporation Association Junikai (collectively with the six franchisee medical corporations, the “Medical Corporations” or “MCs”). All of the Medical Corporations are deemed to be related parties of the Company since relatives of the CEO of the Company are the members (or shain ) of general meetings of members of the Medical Corporations. The CEO of the Company was previously a member of the six franchisee Medical Corporations until he ceased being a member in July 2023. The Company, through SBC Medical Sub, owns equity “deposit” interests (or mochibun ) of the Medical Corporations (except Medical Corporation Association Furinkai and Medical Corporation Association Junikai). Although the Company, through SBC Medical Sub, has an equity “deposit” interest to the rights to receive a distribution of residual assets in proportion to the amount of contribution in certain circumstances as provided in the articles of incorporation of each of the Medical Corporations (except Medical Corporation Association Furinkai and Medical Corporation Association Junikai), the Company or SBC Medical Sub does not have voting control over the corporate actions at general meetings of members (or shain ) of the Medical Corporations per the requirements of the Japanese Medical Care Act. Financial Overview For the years ended December 31, 2024 and 2023, we generated revenues of $205,415,542 and $193,542,423, respectively, we reported net income attributable to SBC Medical Group Holdings Incorporated of $46,614,275 and $39,370,036, respectively, and cash flow provided by operating activities of $20,582,933 and $50,670,322, respectively. As of December 31, 2024, we had retained earnings of $ 189,463,007. Our primary mission is to provide quality comprehensive management services to the Medical Corporations and expand our “Shonan Beauty Clinic” brand. We plan to achieve the mission by maintaining and strengthening our market position and brand in the cosmetic medical treatment management market in Japan, Vietnam, and the United States, and by growing our presence globally. Further information regarding our business is provided in “Part 1, Item 1. Business” of this Annual Report. Results of Operations Comparison of Results of Operations for the Years Ended December 31, 2024 and 2023 The following table summarizes our operating income as reflected in our audited consolidated statements of operations and comprehensive income for the years ended December 31, 2024 and 2023, and presents information regarding amounts and percentage changes during those periods. For the Years Ended December 31, 2024 2023 Variance Amount % of revenue Amount % of revenue Amount % Revenues, net (including net revenues provided to related parties) $ 205,415,542 100.00 % $ 193,542,423 100.00 % $ 11,873,119 6.13 % Cost of revenues 49,365,035 24.03 % 56,238,385 29.06 % (6,873,350 ) (12.22 )% Gross profit 156,050,507 75.97 % 137,304,038 70.94 % 18,746,469 13.65 % Operating expenses 85,746,797 41.74 % 66,643,972 34.43 % 19,102,825 28.66 % Income from operations 70,303,710 34.23 % 70,660,066 36.51 % (356,356 ) (0.50 )% Other income 3,152,107 1.53 % 2,919,269 1.51 % 232,838 7.98 % Income before income taxes 73,455,817 35.76 % 73,579,335 38.02 % (123,518 ) (0.17 )% Income tax expense 26,765,925 13.03 % 35,018,729 18.09 % (8,252,804 ) (23.57 )% Net income 46,689,892 22.73 % 38,560,606 19.93 % 8,129,286 21.08 % Less: net income (loss) attributable to non-controlling interests 75,617 0.04 % (809,430 ) (0.41 )% 885,047 (109.34 )% Net income attributable to SBC Medical Group Holdings Incorporated $ 46,614,275 22.69 % $ 39,370,036 20.34 % $ 7,244,239 18.40 % 105 Revenues, Net Revenues, net generated from different revenue streams consist of the following: For the Years Ended December 31, Variance 2024 2023 Amount % Franchising revenue $ 61,033,032 $ 42,103,380 $ 18,929,652 44.96 % Procurement revenue 54,814,399 53,186,662 1,627,737 3.06 % Management services revenue 53,113,155 72,282,549 (19,169,394 ) (26.52 )% Rental services revenue 16,141,714 7,336,768 8,804,946 120.01 % Others 20,313,242 18,633,064 1,680,178 9.02 % Total $ 205,415,542 $ 193,542,423 $ 11,873,119 6.13 % Revenues, net, increased by 6.13% from $193,542,423 for the year ended December 31, 2023 to $205,415,542 for the year ended December 31, 2024. Japanese Yen (“JPY”) against the U.S. dollar depreciated during the year ended December 31, 2024, compared to the year ended December 31, 2023. The spot rate against the dollar was 156.7890 yen on December 31, 2024 compared to 141.0350 yen on December 31, 2023 and the average rate against the dollar was 151.4405 yen for the year ended December 31, 2024 compared to 140.5261 yen for the same period in 2023. For the years ended December 31, 2024 and 2023, we generated net revenues of $205,415,542 (JPY31,108 million) and $193,542,423 (JPY 27,198 million), respectively. For the years ended December 31, 2024 and 2023, we reported net income of $46,689,892 (JPY7,059 million) and $38,560,606 (JPY 5,419 million), respectively. Overall, the unfavorable impacts of the year-to-year foreign exchange rate changes on net revenues and net income were $15,954,241 and $3,545,053, respectively, for the year ended December 31, 2024. The main reasons for the variance of $11,873,119 in revenues, net per revenue stream are as follows: Franchising Revenue Franchising revenue for the year ended December 31, 2024 increased to $61,033,032 by $18,929,652 or 44.96% from $42,103,380 for the same period in 2023. This increase was mainly due to (i) a change in the billing base of royalty fees from a percentage of sales of MCs to a fixed amount for each clinic of MCs since April 2023 combined with an increase in the number of clinics operated by MCs, (ii) authorizing the six MCs, which are our main recurring customers, to use our patents and trademarks starting from September 2023, and (iii) the business expansion of the MCs, partially offset by the depreciation of JPY. 106 Procurement Revenue The procurement revenue for the year ended December 31, 2024 increased to $54,814,399 by $1,627,737 or 3.06% from $53,186,662 for the same period in 2023. This increase was mainly due to the increase in the demand on medical materials due to the business expansion of MCs, partially offset by the depreciation of JPY. Management Services Revenue The management services revenue for the year ended December 31, 2024 decreased to $53,113,155 by $19,169,394 or 26.52% from $72,282,549 for the same period in 2023. This decrease was mainly due to (i) the discontinuation of clinic operation staff supporting services provided by Shobikai Sub to MCs since the third quarter of 2024, because the Company plans to merge Shobikai Sub with and into Lange Sub and the related business license, held by Shobikai Sub, will be invalid upon the merger, (ii) a significant decline in loyalty program management services revenue compared with 2023, primarily because the charge rate of handling fee decreased from 5% to 4%, and there were more free point redemptions, and (iii) the depreciation of JPY, partially offset by (i) the increase in revenue generated from management consulting services and loyalty program management services provided to two MCs that the Company started to conduct business since September 2023 (Medical Corporation Association Furinkai and Medical Corporation Association Junikai), (ii) the business expansion of MCs and (iii) the increase in the number of the clinics of MCs. Rental Services Revenue The rental services revenue for the year ended December 31, 2024 increased to $16,141,714 by $8,804,946 or 120.01% from $7,336,768 for the same period in 2023. This increase was mainly due to the increased demand for medical equipment from MCs due to the business expansion of MCs, partially offset by the depreciation of JPY. Others The other revenues for the year ended December 31, 2024 increased to $20,313,242 by $1,680,178 or 9.02% from $18,633,064 for the same period in 2023. This increase was mainly due to the business expansion of the subsidiary acquired in April 2023, partially offset by the depreciation of JPY. Cost of Revenues Cost of revenues, for the year ended December 31, 2024, was $49,365,035 compared to $56,238,385 for the same period in 2023. The decrease by $6,873,350 or 12.22% was mainly due to the Company’s effort of the cost reduction for the year ended December 31, 2024, as well as the discontinuation of clinic operation supporting services provided by Shobikai Sub to MCs since the third quarter of 2024, and the Company then terminated the employment of the related staff. As a result, labor cost significantly decreased. Gross Profit Gross profit, for the year ended December 31, 2024, was $156,050,507 compared to $137,304,038 for the same period in 2023. The increase in gross profit by $18,746,469 or 13.65% was mainly due to the increase in franchising revenue with a relatively high gross margin as a result of the factors described above, offset by the decrease in management services revenue as a result of the factors described above. 107 Operating Expenses Operating expenses for the years ended December 31, 2024 and 2023 were as follows: For the Years Ended December 31, Variance 2024 2023 Amount % Salaries and welfare $ 26,843,524 $ 26,847,863 $ (4,339 ) (0.02 )% Depreciation and amortization expense 2,258,364 10,924,452 (8,666,088 ) (79.33 )% Impairment loss on intangible asset 15,058,965 — 15,058,965 100.00 % Consulting and professional service fees 14,555,087 9,481,719 5,073,368 53.51 % Advertising expense 2,782,944 3,367,608 (584,664 ) (17.36 )% Taxes and dues 596,122 1,904,967 (1,308,845 ) (68.71 )% Recruiting expense 1,570,299 2,038,591 (468,292 ) (22.97 )% Lease expense 2,369,666 2,897,683 (528,017 ) (18.22 )% Office, utility and other expenses 6,689,134 8,772,059 (2,082,925 ) (23.74 )% Misappropriation loss — 409,030 (409,030 ) (100.00 )% Stock-based compensation 13,022,692 — 13,022,692 100.00 % Total $ 85,746,797 $ 66,643,972 $ 19,102,825 28.66 % The operating expenses increased to $85,746,797 for the year ended December 31, 2024 by $19,102,825 or 28.66% from $66,643,972 for the same period in 2023.The increase in operating expenses was mainly attributed to the increase in impairment loss on intangible asset, the increase in stock-based compensation, and the increase in consulting and professional service fees, partially offset by the decrease in depreciation and amortization expenses. Depreciation and amortization expense decreased to $2,258,364 by $8,666,088 or 79.33% for the year ended December 31, 2024 from $10,924,452 for the same period in 2023, mainly because the decrease in amortization expense incurred from the intangible assets owned by Cell Pro Japan Co., Ltd. (“Cellpro”), a former subsidiary of the Company, due to the disposal of Cellpro on January 1, 2024. Consulting and professional service fees increased to $14,555,087 by $5,073,368 or 53.51% for the year ended December 31, 2024 from $9,481,719 for the same period in 2023, mainly due to the increase of the professional service fees incurred related to the business combination transaction. 108 Stock-based compensation relates to the warrants issued to the service provider that supported SBC’s listing process. These warrants were issued in November 2022 and became exercisable upon the consummation of business combination with Pono Two Capital, Inc., and the fair value was recognized as an expense. For the year ended December 31, 2024, the Company fully impaired an intangible asset, patent use right, because the estimated cash flows from the use and its eventual disposal of this intangible asset were determined to be negligible. This conclusion was reached through a careful decision-making process and was approved by the Company’s board of directors. Other Income (Expenses) Other income (expenses) for the years ended December 31, 2024 and 2023, were as follows: For the Years ended December 31, Variance 2024 2023 Amount % Interest income $ 19,943 $ 86,748 $ (66,805 ) (77.01 )% Interest expense (28,300 ) (45,292 ) 16,992 (37.52 )% Other income 4,810,008 3,623,332 1,186,676 32.75 % Other expenses (5,463,153 ) (745,519 ) (4,717,634 ) 632.80 % Gain on disposal of subsidiary 3,813,609 — 3,813,609 100.00 % Total $ 3,152,107 $ 2,919,269 $ 232,838 7.98 % Although an unrealized loss was recognized from the Company’s investment in a public entity with readily determinable fair value under other expenses, a gain on disposal of subsidiary was recorded due to the disposal of Cellpro on January 1, 2024. The total other income (expenses) for the year ended December 31, 2024 was $3,152,107, compared to $2,919,269 for the same period in 2023, reflecting only a minor overall fluctuation. Income Tax Expense Income tax expense, for the year ended December 31, 2024, was $26,765,925 compared to $35,018,729 for the same period in 2023. The decrease in income tax expense by $8,252,804 or 23.57% was mainly due to the increase in the deferred tax benefit as no valuation allowance on deferred tax assets of Lange Sub was reserved during the year ended December 31, 2024. It was mainly due to the merger among SBC Medical Sub, Lange Sub and Shobikai Sub, with Lange Sub as the surviving entity after the merger, that expected to be effective in January 2025, resulting in the potential ability of Lange Sub to generate income and utilize the carried forward net operating loss. 109 The effective tax rate for the fiscal year ended December 31, 2024 was 36.44%, a decrease of 11.16% compared to the 47.59% rate for the fiscal year ended December 31, 2023. This decrease was mainly due to a reduction in valuation allowance on deferred tax assets as described in the income tax expense comparison above. Net Income As a result of the foregoing, we reported a net income of $46,689,892 for the year ended December 31, 2024, representing an increase of $8,129,286 from $38,560,606 for the year ended December 31, 2023. Net Income (Loss) Attributable to Non-controlling Interests Net Income attributable to non-controlling interests was $75,617 for the year ended December 31, 2024, as compared to the net loss attributable to non-controlling interests of $809,430 for the year ended December 31, 2023, which was mainly due to the disposal of Cellpro on January 1, 2024. Liquidity and Capital Resources As of December 31, 2024, the Company had $125,044,092 in cash and cash equivalents compared to $103,022,932 as of December 31, 2023. In addition, the Company had $30,260,113 in accounts receivable as of December 31, 2024 compared to $35,113,749 as of December 31, 2023. The Company’s accounts receivable includes balances due from customers for the services and goods provided by the Company and accepted by customers. As of December 31, 2024, the Company’s working capital balance was $123,259,130. In assessing liquidity, management monitors and analyzes the Company’s cash and cash equivalents, ability to generate sufficient future earnings, and operating and capital investment commitments. The Company believes that its current cash and cash equivalents from operations and borrowings from banks will be sufficient to meet its working capital needs for the next 12 months from the date of issuance of the audited financial statements included in this Annual Report. To the extent additional funds are necessary to meet our long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through the incurrence of indebtedness, equity financings or a combination of these potential sources of funds. While we face uncertainties regarding the size and timing of our fundraising, which will be affected by general economic, financial, and other factors that may be beyond our control, we believe that we will be able to continue to meet our current business needs through the use of cash flows generated from operations and stockholder working capital, as needed. The Company evaluates its capital allocation practices with the objective of enhancing shareholder value, while considering performance, the business environment, macroeconomic conditions and other relevant factors. The Company expects to deploy capital for investment opportunities that align with its growth strategy, selectively pursuing prospects in the expanding global medical aesthetics market. 110 Cash Flows for the Years Ended December 31, 2024 and 2023 The following table provides a summary of our cash flows for the years indicated. For the Years ended December 31, Variance 2024 2023 Amount % Net cash provided by operating activities $ 20,582,933 $ 50,670,322 $ (30,087,389 ) (59.38 )% Net cash provided by (used in) investing activities (10,102,410 ) 1,793,631 (11,896,041 ) (663.24 )% Net cash provided by financing activities 22,965,400 6,135,368 16,830,032 274.31 % Effect of changes in foreign currency exchange rate (11,424,763 ) (7,314,383 ) (4,110,380 ) 56.20 % Net change in cash and cash equivalents 22,021,160 51,284,938 (29,263,778 ) (57.06 )% Cash and cash equivalents as of the beginning of the period 103,022,932 51,737,994 51,284,938 99.12 % Cash and cash equivalents as of the end of the period $ 125,044,092 $ 103,022,932 $ 22,021,160 21.38 % Operating Activities Net cash provided by operating activities for the year ended December 31, 2024 was $20,582,933, compared to net cash provided in operating activities of $50,670,322 for the year ended December 31, 2023, reflecting a decrease of $30,087,389. The decrease was mainly due to a decrease in changes in notes payable - related parties of $34.7 million, finance lease receivables – related parties of $22.6 million and accounts payable of $21.8 million, partially offset by an increase in changes in accounts receivable - related parties of $23.8 million and accrued retirement compensation expense – related party of $22.1 million. Investing Activities During the year ended December 31, 2024, net cash used in investing activities of $10,102,410 was mainly the result of payments made on behalf of a related party of $5.6 million, cash paid for acquisition of a subsidiary, net of cash received of $4.2 million, purchase of property and equipment of $2.6 million and purchase of convertible note of $1.7 million, partially offset by repayments from related parties of $6.6 million. During the year ended December 31, 2023, net cash provided by investing activities of $1,793,631 was mainly the result of proceeds from disposal of property and equipment of $8.0 million, sales of short-term investments of $4.1 million, and proceeds from surrender of life insurance policies of 4.0 million, and offset by payments made for the purchase of property and equipment of $8.5 million, purchase of short-term investments of $2.1 million and advances to related parties of $2.3 million. Financing Activities During the year ended December 31, 2024, net cash provided by financing activities of $22,965,400 was the result of proceeds from reverse recapitalization, net of transaction costs of $11.7 million, borrowings from a long-term loan of $6.6 million and borrowings from related parties of $5.5 million. During the year ended December 31, 2023, net cash provided by financing activities of $6,135,368 was the result of borrowings from related parties of $12.3 million and deemed contribution in connection with disposal of property and equipment of $9.6 million and offset by repayments of long-term loans of $8.7 million and repayments to related parties of $7.7 million. 111 Recent Developments Upcoming Changes to Service Fee Structure The Company has decided to revise the fee structure to pursue a long-term growth strategy aimed at expanding and stabilizing the business foundation by creating an environment that can better facilitate the establishment of new clinics by MCs. If the revised fee structure had been applied starting in April 2024, it is estimated that total revenues for fiscal year 2024 would have decreased by approximately 10%. However, the Company expects the impact on total revenues and income from operations for fiscal year 2025 to be offset by the absence of one-time losses that were recorded in fiscal year 2024, which were impairment loss on intangible asset and stock-based compensation. Nevertheless, the ultimate financial impact remains uncertain and will depend on a number of factors, many of which are beyond the Company’s control. Upcoming Insurance Policy Maturing Certain corporate-owned life insurance policies that the Company purchased to insure its CEO and a key officer will mature on March 29, 2025, according to the contract term. The policies of these life insurances were structured so that the surrender value was equivalent to 50% of the initial premium before the maturity of the contract and the initial premium was paid out in a lump sum at the inception of the contract. The surrender value as of the contract mature date agreed to be the initial premium or accumulated initial premium amount considering interest, which is larger. As of December 31, 2024, the insurance policies were recorded at their cash surrender values, included in other assets in the consolidated balance sheets with changes in cash surrender value during the period recorded in selling, general and administrative expenses. The Company expected the maturity of these policies would result in a gain on surrender of life insurance policies of approximately $9.3 million in the first quarter of fiscal year 2025. Misappropriations of Funds In January 2024, before the issuance of the Company’s consolidated financial statements as of December 31, 2023 and for the year then ended, in connection with a routine tax examination of the Company’s income tax returns, the Japanese tax authority discovered misappropriations of Company funds by a former director of general affairs and legal department of L’Ange Cosmetique Co., Ltd., which is a subsidiary of the Company (the “former director”), not a relative of the CEO of the Company or any identified related party, who received kickbacks from multiple vendors of SBC Japan (collectively with the former director, the “participants”) possibly beginning as early as 2012 until the misappropriations were discovered. The former director was suspended immediately upon the discovery and was terminated effective February 23, 2024. The Company has commenced a criminal complaint in Tokyo against the participants, which was accepted by the police on February 25, 2025. 112 Shortly after this discovery, the Company engaged independent legal counsel and forensic consultants to investigate the misappropriations. The investigation, which was completed in March 2024, revealed that the participants had misappropriated approximately JPY632 million ($5.6 million), including consumption tax, from the Company of which the former director received approximately JPY335 million ($3.0 million), between April 2016 and the discovery of the misappropriations in January 2024. The amount misappropriated prior to April 2016 could not be accurately determined because certain data for the period prior to April 2016 was unavailable, the Company does not expect such amount to be material based on current estimates. The Company found no evidence that any other employee of the Company was aware of, or colluded in, the misappropriations of Company funds or that there was any unlawful activity apart from that associated with the participants’ misappropriations of Company funds. The misappropriated amounts, excluding the consumption tax, representing advertising services purchased on behalf of a related-party MC, were originally included in the revenues reported on a net basis. After discovery of the misappropriations, the amounts were reported as a misappropriation loss. For the year ended December 31, 2023, the Company recorded a misappropriation loss of $409,030. Contractual Obligations Lease Agreements The Company has 95 leases classified as operating leases for offices and sublease purposes. As of December 31, 2024, the future maturity of lease liabilities is as follows: Years ending December 31, Lease Payment 2025 $ 4,361,879 2026 712,869 2027 263,412 2028 109,906 2029 109,906 Thereafter 54,950 Total undiscounted lease payments 5,612,922 Less: imputed interest (29,874 ) Total operating lease liabilities $ 5,583,048 Bank and Other Borrowings The Company borrowed loans from various banks and a financial institution for working capital purpose. As of December 31, 2024, future minimum borrowing payments are as follows: Years ending December 31, Principal Repayment 2025 $ 96,824 2026 66,580 2027 6,436,102 2028 — 2029 and thereafter — Total $ 6,599,506 113 Off-Balance Sheet Arrangements (Off-Balance Sheet Transactions) There are no off-balance sheet arrangements as of December 31, 2024 and 2023. Foreign Exchange Rate Risk We are exposed to foreign currency exchange rate fluctuations because our business is primarily conducted in Japan and most of our revenues and costs are denominated in Japanese yen, whereas our reporting currency is U.S. dollar. The weakening of the Japanese yen against the U.S. dollar would have a negative impact on our financial results and vice versa. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates. Some of our accounting policies require a higher degree of judgment than others in their application and require us to make significant accounting estimates. We believe that critical accounting policies as disclosed in this Annual Report reflect the more significant judgements and estimates used in preparation of our consolidated financial statements. The following descriptions of critical accounting policies and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this Annual Report. When reviewing our consolidated financial statements, you should consider our selection of critical accounting policies, the judgments and other uncertainties affecting the application of such policies and the sensitivity of reported results to changes in conditions and assumptions. Revenue Recognition The Company recognizes revenue from franchising services, procurement services, management services and other services under ASC Topic 606, “Revenue from Contracts with Customers”. To determine revenue recognition for contracts with customers, the Company performs the following five steps: (i) identify the contract(s) with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies the performance obligation. Revenue amount represents the invoiced value, net of consumption tax and applicable local government levies, if any. The consumption tax on sales is calculated at 10% of gross sales. The Company does not have significant remaining unfulfilled performance obligations or contract balances. 114 The Company reports revenue on a gross or net basis based on management’s assessment of whether the Company acts as a principal or agent in the transaction. The determination of whether the Company acts as a principal or an agent in a transaction is based on the evaluation of whether (i) the Company is primarily responsible for fulfilling the promise to provide the specified goods or service, (ii) the Company has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer and (iii) the Company has discretion in establishing the price for the specified good or service. If the terms of a transaction do not indicate the Company is acting as a principal in the transaction, then the Company is acting as an agent in the transaction and the associated revenues are recognized on a net basis. The Company recognizes revenue from rental services under ASC Topic 842, “Leases”. The Company currently generates its revenue from the following main sources: Franchising Revenue The Company generates franchising revenue (royalty income) by licensing its intellectual properties, including but not limited to the Company’s brand name (“Shonan Beauty Clinic”), trade name, patents, and trademarks, as a franchisor pursuant to franchise agreements with certain MCs (the “MCs”) in Japan. Prior to April 2023, Franchising Revenue is based on a percentage of sales and recognized at the time when the related sales occurred; since April 2023, it is based on a fixed amount to each clinic of the MCs; since September 2023, it is based on a fixed amount to each MC and a fixed amount to each clinic of the MCs and recognized over time as services are rendered. Procurement Revenue The Company generates procurement revenue by purchasing primarily advertising services and medical materials from qualified vendors on behalf of MCs to maintain brand quality consistency. Procurement revenue is recognized at the point in time upon the delivery of products or over time as services are performed. Occasionally, the Company receives vendor discounts on certain large purchases. It recognizes revenue based on actual payments and will return the over-collection resulting from such discounts to MCs. Management Services Revenue The Company provides loyalty program management services, labor supporting services, function supporting services and management consulting services to MCs. ● Loyalty program management services 115 The Company awards loyalty points on behalf of MCs to MCs’ customers, who earn loyalty points from each qualified purchase made at the loyalty program participating clinics of MCs, in exchange for a handling fee. The revenue is based on a percentage of the related payment amount made by MCs’ customers and is recognized when the loyalty points are awarded. At the time loyalty points are awarded, a MC pays the Company cash in an amount equivalent to the awarded loyalty points, which is recorded as advances from customers. When a MC’s customers redeem the loyalty points, the Company returns the cash back to the MC in an amount equivalent to the redeemed loyalty points. The awarded loyalty points expire if a MC’s customer does not make any additional qualified purchase at a participating clinic within a year. The Company accumulates and tracks the points on behalf of MCs until the loyalty points expire, at which time the Company recognizes an amount equivalent to the expired loyalty points as revenue, which is normally not significant. The Company also awards certain points to MCs’ customers on behalf of MCs for free in order to increase the volume of MC’s sales, from which the Company earns other types of revenues, such as franchising revenue. When a MC’s customers redeem such points, the Company reimburses MC in an amount equivalent to the used free points and records it as a reduction of the revenue recognized. The Company is an agent in the management of loyalty programs, and as a result, revenues are recognized net of the cost of redemptions. ● Labor supporting services The Company generates revenue by dispatching staff to MCs to provide a range of services, primarily including clinic operation, IT, and administrative services, among which, clinic operation service has been fully terminated since October 2024. The Company recognizes the revenue over the time when services are rendered. ● Function supporting services The revenue is derived from providing functional supporting services to MCs, such as accounting and human resources services. The Company recognizes the revenue over the time when services are rendered. ● Management consulting services The Company generates revenue by providing consulting services to MCs in relation to business operations of cosmetic dermatology. The Company recognizes the revenue over the time when services are rendered. Rental Services Revenue The Company generates rental income from operating leases and sales-type leases, which is accounted for under ASC Topic 842. Operating lease revenue is generally recognized on straight-line basis over the terms of the lease agreements and sales-type leases revenue is generally recognized on the lease commitment date. 116 Other Revenues The Company generates other miscellaneous revenues such as accommodation services income, medicine dispensed sales revenue, brokerage services revenue, construction services revenue, pilot training services revenue, interest income, etc. These revenues are recognized when the Company satisfies performance obligations. Long-term Investments in MCs — Related Parties Long-term investments in MCs — related parties represent the payments to obtain equity interests of the MCs in Japan, made by the Company through SBC Japan, a company designated as a MSC in Japan. In accordance with the Japanese Medical Care Act and articles of incorporation of the MCs, which are non-profit organizations, the equity interest holders of MCs are prohibited from receiving any profit distribution from MCs but have the right to receive distribution of the residual assets of the MCs in proportion to the amount of their contribution. As of the balance sheet dates, the investments represent probable future benefit to be realized at the time of dissolution of MCs or the equity interests being sold. The payments made for such investments are classified as investing activities in the consolidated statements of cash flows. The MCs are considered related parties as the relatives of the Chief Executive Officer (“CEO”) of the Company being the Members of the MCs. The investments in MCs — related parties are accounted for using a measurement alternative, under which the investments are measured at cost, less impairment, and adjusted for observable price changes. The Company reviews the investments in MCs for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, especially the investments in Medical Corporation Jukeikai (“MC Jukeikai”) and Medical Corporation Ritz Cosmetic Surgery (“MC Ritz”), which represent the vast majority of the Company’s investments in MCs balance. Impairment Consideration of Investments in MC Jukeikai and MC Ritz Although these two MCs are non-profit entities, their principal operations are providing health care services and they derive primary source of their revenue from the sale of goods and services, rather than the fund contributions. No indicator of impairment was noticed based on the Company’s qualitative assessment of impairment. As the Company provides comprehensive management services to these two MCs, including accounting and bookkeeping services, the Company has access to MCs’ unaudited financial information. In addition to the external market conditions and trends within the MCs’ industry, the Company considered the MCs’ operating performance, such as sales, increase in sales, and net income (loss) when performing its qualitative assessment. As of December 31, 2024, the carrying value of the investments in the two MCs was higher than their net assets, respectively, because the Company acquired the equity interests with the considerations paid higher than the net asset values at the respective purchase dates due to the expected growth and expansion of the MCs. For management’s additional internal analysis purposes, the Company estimates the residual values of the two MCs at dissolution when needed, using the income approach with the discounted cash flow method, which estimates the fair values of the MCs by the present worth of the net economic benefit to be received by MCs. Management applies significant judgment and assumptions related to estimation, including but not limited to the forecasted revenues, the selection of an expected EBITDA margin assumption for the forecast period, forecasted future cash flows, and the discounted rate. The Company currently expects the residual values at the dissolution of the MCs will not be less than the carrying values of the investments in MCs. The management is not aware of any legal or regulatory limitations on the Company’s ability to realize the full amount of proceeds generated from a liquidation of the MCs. 117 Stock Based Compensation The Company accounts for stock-based compensation awards in accordance with ASC Topic 718, “Compensation — Stock Compensation”, under which the Company determines whether stock-based compensation awards should be classified and accounted for as an equity award. There were no liability awards granted during any of the periods stated herein. For all grants of stock-based compensation classified as equity awards, the cost of services received from employees and non-employees in exchange for awards is recognized in the consolidated statements of operations and comprehensive income based on the estimated fair value of those awards on the grant date and amortized on a straight-line basis over the requisite service period or vesting period. The Company records forfeitures and cancellations as they occur. The Company, with the assistance of an independent valuation specialist, determined the fair value of the warrants recognized in the consolidated financial statements using the binomial option pricing model, and the equity value as of the grant date was estimated using 1) income approach with the discounted cash flow valuation method, which requires management to make significant estimates and assumptions related to forecasted revenues and cash flows and the discount rates, and 2) market approach with metrics of publicly traded companies or historically completed transactions of comparable businesses. The Company applied a weighting to the income approach and market approach to determine the fair value. We believe the accounting estimate for valuation of stock-based compensation is a critical accounting estimate because our estimates of fair value of stock-based compensation are based upon assumptions believed to be reasonable, but which are inherently uncertain and, as a result, actual results may differ from estimates. Emerging Growth Company We are an “emerging growth company,” as defined in Section 2(a) of the Securities Act, as modified by the JOBS Act, and we will take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. We have elected not to opt out of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. Smaller Reporting Company Additionally, we are a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. Smaller reporting companies may take advantage of certain reduced disclosure obligations, including, among other things, providing only two years of audited financial statements. We will remain a smaller reporting company until the last day of the fiscal year in which (i) the market value of our common stock held by non-affiliates exceeds $250 million as of the last business day of our second fiscal quarter, or (ii) our annual revenue exceeded $100 million during such completed fiscal year and the market value of our common stock held by non-affiliates exceeds $700 million as of the last business day of our second fiscal quarter. If we continue to be a smaller reporting company at the time we cease to be an emerging growth company, we may continue to rely on exemptions from these certain reduced disclosure requirements that are available to smaller reporting companies. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information otherwise required under this item. 118