SANUWAVE Health, Inc. 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes appearing elsewhere in this report, and together with our audited consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as of and for the year ended December 31, 2022 included in our Annual Report on Form 10-K, filed with the SEC on March 31, 2023 (the “2022 Annual Report”). Executive Summary We continued to realize significant revenue growth during the three and nine months ended September 30, 2023, as compared to the same periods in 2022. Revenue for the three months ended September 30, 2023, totaled $5.0 million, an increase of 19%, as compared to $4.2 million for the same period of 2022. Revenue for the nine months ended September 30, 2023, totaled $13.4 million, an increase of 19%, as compared to $11.2 million for the same period of 2022. Net loss for the three months ended September 30, 2023, was $23.7 million, or $0.03 per basic and diluted share, compared to a net loss of $1.1 million, or $0.00 per basic and diluted share, for the same period in 2022. The increase in our net loss for the three months ended September 30, 2023, was primarily due to continued losses on the fair value of our derivatives, which totaled $19.3 million of expense in the period. For the three months ended September 30, 2023, our operating loss totaled $0.5 million, which is an improvement of $2.0 million compared to 2022. Net loss for the nine months ended September 30, 2023, was $44.0 million, or $0.06 per basic and diluted share, compared to a net loss of $4.6 million, or $0.01 per basic and diluted share, for the same period in 2022. The increase in our net loss for the nine months ended September 30, 2023, was primarily due to continued losses on the fair value of our derivatives, which totaled $29.9 million of expense in the period. For the nine months ended September 30, 2023, our operating loss totaled $1.6 million, which is an improvement of $5.9 million compared to the same period in 2022, which aligns with our initiative to drive profitable growth and manage spend through 2023. Merger Agreement with SEPA On August 23, 2023, we entered into an Agreement and Plan of Merger (the “ Merger Agreement ”) by and among SEP Acquisition Corp., a Delaware corporation (“ SEPA ”), SEP Acquisition Holdings Inc., a Nevada corporation, and a wholly owned subsidiary of SEPA (“ Merger Sub ”). Pursuant to the terms of the Merger Agreement, a business combination between the Company and SEPA (the “ Merger ”) will be affected. More specifically, and as described in greater detail below, at the effective time of the Merger (the “ Effective Time ”): • Merger Sub will merge with and into the Company, with the Company being the surviving company following the merger. • Each issued and outstanding share of the Company common stock will automatically be converted into Class A common stock of SEPA, par value $0.0001 per share, at the Conversion Ratio (as defined in the Merger Agreement); and • Outstanding Company convertible securities of the Company will be assumed by SEPA and will be converted into the right to receive Class A Common Stock of SEPA. Pursuant to the terms of the Merger Agreement, the holders of (i) Company common stock, (ii) options to purchase Company common stock, (iii) warrants to purchase Company common stock, and (iv) convertible promissory notes, collectively will be entitled to receive 7,793,000 shares of Class A Common Stock of SEPA. Out-of-the-money options and out-of-the-money warrants will be assumed by SEPA and converted into options or warrants, respectively, exercisable for shares of Class A Common Stock based on the Conversion Ratio; however, such out-of-the-money options and out-of-the-money warrants shall not be reserved for issuance from the Merger Consideration. The Merger Agreement contains certain conditions to Closing, including the following: • holders of 80% or more of the Company’s convertible notes with a maturity date occurring after the date of the Closing (the “ Closing Date ”), measured by number of shares of our common stock into which such convertible notes may be converted, agreeing to convert their convertible notes into shares of common stock immediately prior to the Effective Time. • holders of 80% or more of the Company’s warrants that would be outstanding on the Closing Date, measured by number of shares of our common stock subject to all such warrants in the aggregate, agreeing to convert their warrants into shares of common stock immediately prior to the Effective Time. • SEPA having, at the Closing, at least $12,000,000 in cash and cash equivalents, including funds remaining in the trust account (after giving effect to the completion and payment of any redemptions) and the proceeds of any private placement in SEPA. As of the date of this Quarterly Report on Form 10-Q, the holders of approximately 95% of our outstanding warrants covered by the preceding covenant and 100% of our outstanding convertible notes covered by the preceding covenant have committed to exchange such warrants and convertible notes for an aggregate of 1,122,677,498 shares and 280,812,105 shares, respectively, of our common stock immediately prior to the Closing. 18 Table of Contents Non-GAAP Financial Measures Throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, we present certain financial measures that facilitate management's review of the operational performance of the Company and as a basis for strategic planning; however, such financial measures are not presented in our financial statements prepared in accordance with accounting principles generally accepted in the United States (U.S.) (U.S. GAAP). These financial measures are considered "non-GAAP financial measures" and are intended to supplement, and should not be considered as superior to, or a replacement for, financial measures presented in accordance with U.S. GAAP. The Company uses Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) and Adjusted EBITDA to assess its operating performance. Adjusted EBITDA is Earnings before Interest, Taxes, Depreciation and Amortization adjusted for the change in fair value of derivatives and any significant non-cash or non-recurring one-time charges. EBITDA and Adjusted EBITDA should not be considered as alternatives to net income as a measure of financial performance or any other performance measure derived in accordance with GAAP, and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. These non-GAAP financial measures are presented in a consistent manner for each period, unless otherwise disclosed. The Company uses these measures for the purpose of evaluating its historical and prospective financial performance, as well as its performance relative to competitors. These measures also help the Company to make operational and strategic decisions. The Company believes that providing this information to investors, in addition to GAAP measures, allows them to see the Company’s results through the eyes of Management, and to better understand its historical and future financial performance. These non-GAAP financial measures are also frequently used by analysts, investors, and other interested parties to evaluate companies in our industry, when considered alongside other GAAP measures. EBITDA and Adjusted EBITDA have their limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are that EBITDA and Adjusted EBITDA: • Do not reflect every expenditure, future requirements for capital expenditures or contractual commitments. • Do not reflect all changes in our working capital needs. • Do not reflect interest expense, or the amount necessary to service our outstanding debt. As presented in the GAAP to Non-GAAP Reconciliations section below, our non-GAAP financial measure excludes the impact of certain charges that contribute to our net loss (Non-GAAP Adjustments). Three months ended September 30, Nine months ended September 30, (in thousands) 2023 2022 2023 2022 Net (Loss)/Income $ (23,700 ) $ (1,139 ) $ (44,042 ) $ (4,596 ) Non-GAAP Adjustments: Interest expense 3,845 3,821 12,504 9,972 Depreciation and amortization 266 235 780 681 EBITDA (19,589 ) 2,917 (30,758 ) 6,057 Non-GAAP Adjustments for Adjusted EBITDA: Change in fair value of derivative liabilities 19,325 (5,252 ) 29,943 (16,597 ) Other non-cash or one-time charges: Release of historical accrued employee compensation expenses - - (1,250 ) - Shares for Services - - 224 888 Loss on issuance of debt - - - 3,434 Loss on extinguishment of debt - 86 - 297 Adjusted EBITDA $ (264 ) $ (2,249 ) $ (1,841 ) $ (5,921 ) 19 Table of Contents Results of Operations For the Three Months Ended For the Nine Months Ended September 30, Change September 30, Change (in Thousands) 2023 2022 $ % 2023 2022 $ % Revenues: Total Revenue $ 4,953 $ 4,166 $ 787 19 % $ 13,404 $ 11,242 $ 2,162 19 % Cost of Revenues 1,412 1,157 255 22 % 3,876 3,141 735 23 % Gross Margin 3,541 3,009 532 18 % 9,528 8,101 1,427 18 % Gross Margin Percentage 71 % 72 % -1 % 71 % 72 % -1 % Operating Expenses: General and administrative 2,681 3,498 (817 ) -23 % 6,678 9,484 (2,806 ) -30 % Selling and marketing 1,039 1,650 (611 ) -37 % 3,430 5,037 (1,607 ) -32 % Research and development 165 157 8 5 % 436 494 (58 ) -12 % Depreciation and amortization 187 189 (2 ) -1 % 563 575 (12 ) -2 % Operating Loss (531 ) (2,485 ) 1,954 -79 % (1,579 ) (7,489 ) 5,910 -79 % Other Income (Expense), net (23,169 ) 1,346 (24,515 ) nm (42,463 ) 2,893 (45,356 ) nm Net Loss $ (23,700 ) $ (1,139 ) (22,561 ) nm $ (44,042 ) $ (4,596 ) (39,446 ) nm nm - Not Meaningful Revenues and Gross Margin Revenues for the three month-period ended September 30, 2023, were $5.0 million compared to $4.2 million for the same period of 2022, an increase of $0.8 million, or 19%. The increase was primarily driven by the continued increased sales of our UltraMIST® system. The increase in revenues was due to an increase in the average selling price of our consumables and parts revenue of 9% year over year, and the remainder of the growth in the number of consumables and systems sold year over year. Gross margin as a percentage of revenue decreased to 71% during the three months ended September 30, 2023, from 72% in the same period of 2022. Revenues for the nine months ended September 30, 2023, were $13.4 million compared to $11.2 million for the same period of 2022, an increase of $2.2 million, or 19%. Gross margin as a percentage of revenue decreased to 71% for the nine months ended September 30, 2023, from 72% in the same period in 2022. General and Administrative Expenses General and administrative expenses decreased $0.8 million or 23% for the three months ended September 30, 2023, compared with the same period of 2022. The decrease for the three months ended September 30, 2023, was primarily due to cost savings activities. General and administrative expenses decreased $2.8 million or 30% for the nine months ended September 30, 2023, compared to the same period in 2022. This decrease was primarily due to continued cost management activities and restructuring activities. Selling and Marketing Expenses Selling and marketing expenses decreased by $0.6 million or 37% for the three months ended September 30, 2023, as compared with the same period of 2022. Selling and marketing expenses decreased by $1.6 million or 32% for the nine months ended September 30, 2023, as compared with the same period of 2022. The decreases were primarily due to a reduction in sales headcount during 2023 and other cost management activities. Research and Development Expenses Research and development expenses increased slightly or 5% for the three months ended September 30, 2023, as compared with the same period of 2022. Research and development expenses as a percentage of revenue decreased from 4% during the three months ended September 30, 2022, to 3% for the same period in 2023. The decrease was primarily due to improved cost management in 2023. Research and development expenses decreased $58 thousand or 12% for the nine months ended September 30, 2023, as compared with the same period of 2022. Research and development expenses as a percentage of revenue decreased from 4% during the nine months ended September 30, 2022, to 3% for the same period in 2023. The decrease was primarily due to improved cost management in 2023. 20 Table of Contents Other (Expense)/Income, net For the three months ended September 30, Change For the nine months ended September 30, Change 2023 2022 $ % 2023 2022 $ % Interest expense $ (3,845 ) $ (3,821 ) $ (24 ) 1 % $ (12,504 ) $ (9,972 ) $ (2,532 ) 25 % Change in fair value of derivatives (19,325 ) 5,252 (24,577 ) -468 % (29,943 ) 16,597 (46,540 ) -280 % Loss on issuance of debt - - - nm - (3,434 ) 3,434 nm Loss on extinguishment of debt - (86 ) 86 nm - (297 ) 297 nm Other expense 1 1 - nm (16 ) (1 ) (15 ) nm Other (expense)/income, net $ (23,169 ) $ 1,346 $ (24,515 ) -1821 % $ (42,463 ) $ 2,893 $ (45,356 ) -1568 % nm - not meaningful Other expense, net increased by $24.5 million to $23.2 million for the three months ended September 30, 2023, as compared to the same period for 2022. Other expense, net increased $45.4 million to $42.5 million for the nine months ended September 30, 2023, as compared to the same period for 2022. These increases were primarily due to increased convertible promissory notes and ABS Promissory Notes outstanding from the transactions executed during 2022 and 2023 and continued losses recognized for the change in fair value of warrants and their embedded conversion liabilities. Liquidity and Capital Resources Since inception, we have incurred losses from operations each year. As of September 30, 2023, we had an accumulated deficit of $238.3 million. Historically, our operations have primarily been funded from the sale of capital stock, notes payable, and convertible debt securities. The recurring losses from operations, the events of default on our notes payable, and dependency upon future issuances of equity or other financing to fund ongoing operations have raised substantial doubt as to our ability to continue as a going concern for a period of at least twelve months from the filing of this Form 10-Q. We expect to devote substantial resources for the commercialization of UltraMIST and PACE systems which will require additional capital resources to remain a going concern. Management’s plans are to obtain additional capital in 2023 or early 2024 primarily through the closure of the Merger, which is expected to add approximately $12 million of additional capital and funding to the Company. We could alternatively obtain capital through the conversion of outstanding warrants, issuance of common or preferred stock, securities convertible into common stock, or secured or unsecured debt. These possibilities, to the extent available, may be on terms that result in significant dilution to our existing stockholders. In addition, there can be no assurances that our plans to obtain additional capital will be successful on the terms or timeline we expect, or at all. If these efforts are unsuccessful, we may be required to significantly curtail or discontinue operations or, if available, obtain funds through financing transactions with unfavorable terms. Statement of Cash Flows For the nine months ended September 30, (in Thousands) 2023 2022 Cash flows used by operating activities $ (3,253 ) $ (13,176 ) Cash flows (used by) provided by investing activities $ (156 ) $ 1,022 Cash flows provided by financing activities $ 3,356 $ 12,664 Cash used in operating activities during the nine months ended September 30, 2023, totaled $3.3 million as compared to $13.2 million in the previous period. This improvement in cash used in operations aligns with our approach to drive profitable growth and manage costs. Cash provided by financing activities of $3.4 million for the nine months ended September 30, 2023, was primarily due to new bridge notes payable and convertible lending activities to fund operations. Cash provided by financing activities for the nine months ended September 30, 2022, consisted primarily of $5.0 million received from our senior lender. Critical Accounting Policies and Estimates We have used various accounting policies to prepare the condensed consolidated financial statements in accordance with U.S. GAAP. Our significant accounting policies are disclosed in Note 4 to the consolidated financial statements in Part II Item 8. “Financial Statements and Supplementary Data” in our Annual Report on Form 10-K filed with the SEC on March 31, 2023. 21 Table of Contents The preparation of the condensed consolidated financial statements, in conformity with U.S. GAAP, requires us to use judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. These estimates reflect our best judgment about economic and market conditions and the potential effects on the valuation and/or carrying value of assets and liabilities based upon relevant information available. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The following accounting policies and estimates are deemed critical: Litigation Contingencies We may be involved in legal actions involving product liability, intellectual property and commercial disputes, tax disputes, and governmental proceedings and investigations. The outcomes of these legal actions are not completely within our control and may not be known for prolonged periods of time. In some actions, the enforcement agencies or private claimants seek damages that could require significant expenditures or result in lost revenues or limit our ability to conduct business in the applicable jurisdictions. Estimating probable losses from our litigation and governmental proceedings is inherently difficult, particularly when the matters are in early procedural stages, with incomplete scientific facts or legal discovery; involve unsubstantiated or indeterminate claims for damages; potentially involve penalties, fines, or punitive damages; or could result in a change in business practice. The Company records a liability in the condensed consolidated financial statements for loss contingencies when a loss is known or considered probable, and the amount may be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible but not known or probable, and may be reasonably estimated, the estimated loss or range of loss is disclosed. Our significant legal proceedings are discussed in Note 11 to the condensed consolidated financial statements. Derivative Liabilities from Embedded Conversion Options and Warrants The Company classified certain convertible instruments as having embedded conversion options which qualified as derivative financial instruments to be separately accounted for. The Company also determined that certain warrants also qualified as derivative financial instruments. Various valuations models were used to estimate the fair value of these derivative financial instruments that are classified as derivative liabilities on the condensed consolidated balance sheets. The models include subjective input assumptions that can materially affect the fair value estimates and as such are subject to uncertainty. The material assumptions for the selected subjective inputs have not changed for the reporting period, except for the expected volatility, which is estimated based on the actual volatility during the most recent historical period equal to the remaining life of the instruments. Valuation of Intangible Assets and Goodwill When we acquire a business, the assets acquired, and liabilities assumed are recorded at their respective fair values on the acquisition date. Goodwill is the excess of the purchase price over the estimated fair value of net assets of acquired businesses. Intangible assets primarily include patents, trademarks, and customer relationships. Determining the fair value of intangible assets acquired as part of a business combination requires us to make significant estimates. These estimates include the amount and timing of projected future cash flows of each project or technology, the discount rate used to discount those cash flows to present value, and the assessment of the asset’s life cycle. The estimates could be impacted by legal, technical, regulatory, economic, and competitive risks. The test for impairment of goodwill requires us to make several estimates to determine the fair value of the goodwill. Our estimates associated with the goodwill impairment test are considered critical due to the amount of goodwill recorded on our condensed consolidated balance sheets and the judgment required in determining fair value. We assess the impairment of goodwill at the consolidated level annually. We also test definite-lived intangible assets for impairment when an event occurs, or circumstances change that would indicate the carrying amount of the assets or asset group may be impaired. Our assessment for goodwill and intangible assets impairment is based on future cash flows that require significant judgment with respect to future revenue and expense growth rates and other assumptions and estimates. We use estimates that are consistent with the highest and best use of the assets based on a market participant’s view of the assets being evaluated. Actual results may differ from our estimates due to several factors including, among others, changes in competitive conditions, regulatory changes, results of clinical trials, and changes in worldwide economic conditions. Segment and Geographic Information We have determined that we have one operating segment. Our revenues are generated from sales primarily in the United States. International sales include sales in Europe, Canada, the Middle East, Central America, South America, Asia, and Asia/Pacific. All significant expenses are generated in the United States and all significant assets are in the United States. Effects of Inflation Our assets are, to an extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation, which has increased, affects expenses such as employee compensation, office space leasing costs and research and development charges, which may not be readily recoverable. To the extent inflation results in rising interest rates and has other adverse effects on the market, it may adversely affect our consolidated financial condition and results of operations. 22 Table of Contents Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide the information required under this item.