Workhorse Group Inc.: Form 10-Q for the period ended Jun 30, 2024

Overview

We are an American technology company with a vision to pioneer the transition to zero-emission commercial vehicles. Our primary focus is to provide sustainable and cost-effective solutions to the commercial transportation sector. We design and manufacture all-electric trucks, including the technology that optimizes the way these vehicles operate. We are focused on our core competency of bringing our electric delivery vehicle platforms to serve the last mile delivery market.

We continue to seek opportunities to grow the business organically, and by expanding relationships with existing and new customers. We believe we are well positioned to take advantage of long-term opportunities and continue our efforts to bring product innovations to market.

Recent Developments

Going Concern; Financing

As discussed more fully under Note 1, Summary of Business and Significant Accounting Principles; Liquidity, Capital Resources, and Going Concern, above, and Liquidity and Capital Resources; Going Concern, below, our ability to continue as a going concern is contingent upon successful execution of management’s intended plan over the next twelve months to improve the Company’s liquidity and working capital requirements. A vital component of such plan is the consummation of a financing to address these requirements in the short term.

On March 15, 2024, we entered into a securities purchase agreement (the “2024 Securities Purchase Agreement”) with an institutional investor (the “Investor”), under which we agreed to issue and sell, in one or more registered public offerings by the Company directly to the Investor, in multiple tranches over a period beginning on March 15, 2024, senior secured convertible notes (the "2024 Notes") for up to an aggregate principal amount of $139.0 million that are convertible into shares of the Company's Common Stock, par value of $0.001 per share (“Common Stock”) and warrants to purchase shares of Common Stock (the “2024 Warrants”).

During the three months ended June 30, 2024, we issued and sold to the Investor (i) 2024 Notes in the original principal amount of $13.3 million and (ii) 2024 Warrants to purchase up to 3.9 million shares of Common Stock. As of June 30, 2024 we had issued and sold to the Investor (i) 2024 Notes in aggregate original principal amount of $22.3 million and (ii) 2024 Warrants to purchase up to 5.5 million shares of Common Stock pursuant to the 2024 Securities Purchase Agreement (following adjustment in connection with the Company's 1-for-20 Reverse Split).

The 2024 Securities Purchase Agreement provides additional closings as of August 19, 2024 of up to $112.7 million in aggregate principal amount of additional 2024 Notes and, if our share price makes such exercise feasible, the possible receipt of proceeds from the exercise of the corresponding 2024 Warrants pursuant to the 2024 Securities Purchase Agreement. However, we may not realize the full amount available under the 2024 Securities Purchase Agreement. Under the terms of the 2024 Securities Purchase Agreement, our ability to issue and sell additional 2024 Notes to the Investor is restricted if the Investor has not converted previous tranches of 2024 Notes into our Common Stock and sold the shares issued on conversion. Accordingly, the Investor’s ability to make such conversions and sales, and therefore our access to additional liquidity under the 2024 Securities Purchase Agreement, depends on there being a robust public trading market for our Common Stock. Since consummating the Reverse Split of our Common Stock in June 2024, the Nasdaq trading volume of our Common Stock has generally been lower (on a Reverse Split-adjusted basis) than it was before we consummated the Reverse Split. If these conditions continue, the $112.7 million aggregate amount of 2024 Notes we can issue and sell under the 2024 Securities Purchase Agreement may be reduced, and the issuances and sales that we are able to make may be delayed.

If we are not able to complete the additional closings, receive proceeds from the exercise of 2024 Warrants or find another source of liquidity in the immediate future, we may be unable to continue our operations or may need to substantially reduce them. Additional information concerning the 2024 Securities Purchase Agreement, the 2024 Notes, and the 2024 Warrants is set forth in Note 1 and Note 7 to the Condensed Consolidated Financial Statements.

Cost-saving Measures

Another vital component of management’s intended plan over the next twelve months to improve our liquidity and working capital requirements is reducing our operating costs to, among other things, reduce demands on the liquidity that is available to us. Accordingly, in the first and second quarter of 2024 we took the measures described below and started to realize the full benefit of such measures during the second quarter ended June 30, 2024.

• We completed a reduction in force (the “RIF”) pursuant to which we terminated approximately 20% of our total workforce, excluding direct labor. We have not incurred and do not expect to incur material costs in connection with the RIF.
• Each of our executive officers agreed to defer payment of approximately 20% of their cash compensation into the third quarter of 2024.
• On June 6, 2024, the Company completed the previously disclosed divestiture of its Aero business as further described below.

In addition, on April 22, 2024, we furloughed 73 employees at our Union City manufacturing facility without pay, and we have experienced voluntary attrition of personnel, including senior managers of the Company, during and after the second quarter of 2024. We expect the furloughs and voluntary attrition to continue to provide operational savings. We have not incurred, and do not expect to incur, material costs in connection with the furloughs. We are also currently working with certain of our vendors to extend or restructure the payment terms of past due accounts payable balances. The furloughs, salary deferrals and vendor discussions are part of our previously disclosed strategy to reduce costs. During the second quarter of 2024, we started to reinstate certain furloughed employees to fulfill vehicle production requirements for the W56. However, there is still no assurance that all furloughed employees, including key personnel will be available and willing to return to work or that we will be able to replace the employees who departed voluntarily.

Management plans to continue to seek additional opportunities to reduce costs and, in particular, cash expenditures, in a manner intended to minimize their adverse impact on our core operations. There can be no assurance that the measures described above, or any other cost-cutting measures we may implement in the future will be sufficient to address our immediate or longer-term liquidity and working capital needs. Moreover, it is possible that such measures will have an adverse effect on our operations.

Aero Drone Design and Manufacturing Operations

As previously disclosed and discussed above as part of our cost-saving measures, on February 20, 2024, our Board of Directors approved a plan to cease the production operations of our drone design and manufacturing business and transition to only operating as a Drones as a Service business. The decision to cease operation of our drone design and manufacturing product line was not considered a strategic shift having major effects on operations and therefore does not meet the criteria to qualify as a discontinued operation.

On June 6, 2024, we completed the previously disclosed divestiture of our Aero business (the “Aero Divestiture”) to a third party. We expect the Aero Divestiture to provide monthly cost savings of approximately $0.4 million and enhance our ability to concentrate on our commercial electric vehicle truck business. Under the agreement’s earn-out provisions, the Company will receive a portion of the proceeds if the Aero business realizes positive net cash flow but these contingencies are indeterminable at this time. The loss on the sale for this business was $0.7 million of which $0.4 million was included in the Selling, general and administrative expenses and $0.3 million in Cost of sales on the Condensed Consolidated Statements of Operations for three and six months ended June 30, 2024.

Nasdaq Listing Requirements; Reverse Stock Split

As previously disclosed, on September 22, 2023, we received notice from Nasdaq indicating that the closing bid price for our Common Stock had fallen below Nasdaq’s $1.00 minimum bid price requirement (the “Minimum Bid Requirement”) for continued listing for 30 consecutive trading days and, therefore, we were no longer in compliance with the Minimum Bid Requirement. In order for us to regain compliance, the closing bid price of our Common Stock had to be equal to or above the $1.00 minimum bid price for a period of 10 consecutive trading days prior to March 20, 2024. As also previously disclosed, on March 21, 2024, we received written notification from Nasdaq granting our request for a 180-day extension to regain compliance with the minimum bid requirement. After the granting of the extension, the closing bid price of our Common Stock had to be equal to or above the $1.00 minimum bid price for a period of 10 consecutive trading days prior to September 16, 2024.

On June 17, 2024, we effected a 1-for-20 reverse split of our outstanding shares of Common Stock following the 2024 Annual

General Meeting of our stockholders at which our stockholders approved this reverse split. The authorized number of Common

Stock was not affected.

On July 3, 2024, Nasdaq confirmed that we were in compliance with the Minimum Bid Requirement.

Vehicles in Production

We continue to focus on product quality, manufacturing capacity and operational planning, and engineering and design to enable increased deliveries and deployments of our products and future revenue growth. During the first half of 2024, we continued executing our strategic product roadmap for our electric vehicle offerings, including the production of the W4CC, W56 and the development of the W56 208-inch wheelbase vehicle program in both strip chassis and step van variants. We continued to electrify the fleet of vehicles being used in our Stables by Workhorse initiative, which operates FedEx Ground delivery routes in the greater Cincinnati area. The electrification of the fleet provides us with firsthand data on the benefits and challenges of independent fleet operators experience while executing last-mile delivery operations. The initiative also provides valuable insights into how our customers can plan for and manage the transition to EV operations, including how to develop adequate charging infrastructure, training and maintenance services. In addition to our ongoing production ramp in 2024-2025, we intend to continue to generate demand and brand awareness by improving our vehicles’ performance and functionality, and by developing new vehicle programs, including new W56 variants. We expect to continue to benefit from ongoing electrification of the commercial vehicle market and in particular "last mile delivery" sector.

Recent Trends and Market Conditions

We continue to monitor macroeconomic conditions to remain flexible and to optimize and evolve our business as appropriate, and we will have to accurately project demand and infrastructure requirements globally and deploy our production, workforce and other resources accordingly.

Market Demand. Our sales during the first half of 2024 were lower than the prior year period due to slower-than-anticipated industry wide electric vehicle adoption rates and lack of government subsidies and incentives available to our dealers as well as slower than expected roll-out of additional power to electric grids and the resulting effect on roll-outs of electric vehicle charging infrastructure, nationwide. Delayed governmental approvals in certain states and slower than expected proliferation of charging stations across the country have also adversely impacted demand. However, we expect adoption rates to accelerate in 2025, driven by more stringent state and federal emissions requirements and continued government subsidies and incentives that will continue to reduce cost barriers for EV ownership, including the approval for our W56 platform for the California’s Hybrid and Zero-Emission Truck and Bus Voucher Incentive Project (HVIP) program through California Air Resource Board (CARB), providing buyers with an $85,000 base voucher per W56 vehicle purchased. The accelerated adoption rates are related to the enforcement of California’s Advanced Clean Fleets Regulation (“ACF Regulation”), which is contingent upon the Environmental Protection Agency (“EPA”) granting a waiver or determining that a waiver is not necessary. Under the Clean Air Act, California holds the unique authority to request a waiver of preemption, which typically restricts states from setting their own emissions standards for new motor vehicles. The EPA’s role involves a thorough review of comments and an assessment to determine if the criteria for granting a waiver are satisfied. This regulatory landscape is a significant consideration for our operations and strategic planning.

Commodities. Prices for commodities remain volatile, and we expect to experience price increases for base metals and raw materials that are used in batteries for electric vehicles (e.g., lithium, cobalt, and nickel) as well as steel, aluminum and other material inputs. Global demand and differences in output across sectors have generated divergence in price movements across different commodities. We expect the net impact on us overall will be higher material costs.

Supply Chain. We continue to develop relationships with suppliers of key parts, components and raw materials to be used in the manufacture of our products such as batteries, electronics, and vehicle chassis that are sourced from suppliers across the world. As we continue to execute on our new vehicle programs, we will continue to identify supplier relationship and vehicle program synergies which may allow us to take advantage of pricing efficiencies from economies of scale. Where available, we will utilize multiple supply sources for key parts, and we will work to qualify multiple supply sources to achieve pricing efficiencies and minimize potential production risks related to supply chain. As previously disclosed, we are currently working with certain of our vendors to extend or restructure the payment terms of past due accounts payable balances. We are also currently in litigation with one of our battery suppliers, Coulomb Solutions Inc. For more information concerning this matter, see Note15, Commitments and Contingencies to the Condensed Consolidated Financial Statements attached hereto.

Inflation. Inflation continues to impact our operations, resulting from both supply and demand imbalances as economies continue to face constraints as well as the impact on the availability and cost of energy and other commodities as a result of the ongoing conflicts in Ukraine and Israel. We are seeing a near-term impact on our business due to inflationary pressure. In an effort to dampen inflationary pressures, central banks have continued to hold constant high interest rates, which will likely raise the cost of any financing the Company may undertake in the future.

Geopolitical: 2024 is a Presidential election year in the U.S., and our operations and results may be impacted due to uncertainty of the political environment. Election results could affect the support for the adoption of electric vehicles, as well as the availability of government subsidies to fund the adoption of electric vehicles. In addition, recent U.S. Supreme Court decisions that purport to limit the authority of federal executive agencies, including the EPA, may affect our industry in ways we cannot yet predict.

The following section provides a narrative discussion about our financial condition and results of operations. The comments should be read in conjunction with our Condensed Consolidated Financial Statements and related Notes thereto included in Item 1 of this Form 10-Q and in conjunction with our Form 10-K.

Results of Operations

The following table sets forth, for the periods indicated, the components of the Company’s Condensed Consolidated Statements of Operations:

Sales, net of returns and allowances

Sales, net of returns and allowances for the three months ended June 30, 2024 and 2023 were $0.8 million and $4.0 million, respectively. Sales, net of returns and allowances, for the six months ended June 30, 2024 and 2023 were $2.2 million and $5.7 million, respectively. The decrease in sales was primarily due to lower W4 CC vehicle sales compared with the same period a year ago, which was partially offset by an increase in other service revenue generated from operating our Stables by Workhorse route, Drones as a Service before the Aero Divestiture and other service revenue.

Cost of sales

Cost of sales for the three months ended June 30, 2024 and 2023 were $7.3 million and $8.4 million, respectively. The decrease in cost of sales was primarily due to a $4.4 million decrease in costs related to direct materials due to lower sales volume and higher volume of vehicles capitalized into finished goods, a decrease in consulting expenses of $0.5 million and a $0.5 million decrease in employee compensation and related expenses due to lower headcount as result of employee furloughs during the period. The decrease in cost of sales was partially offset by a $2.7 million increase in inventory reserve expenses, and a $1.0 million increase in depreciation expense.

Cost of sales for the six months ended June 30, 2024 and 2023 were $14.7 million and $13.8 million, respectively. The increase in cost of sales was primarily due to a $4.6 million increase in inventory reserve expenses and a $2.0 million increase in depreciation expense which was offset by a $4.4 million decrease in costs related to direct materials and a $1.4 million reversal of warranty expenses previously accrued.

Selling, general and administrative expenses

Selling, general and administrative (“SG&A”) expenses during the three months ended June 30, 2024 and 2023 were $12.1 million and $14.0 million, respectively. The decrease in SG&A expenses was driven by a $2.4 million decrease in employee compensation and related expenses primarily due to lower headcount and a decrease of $0.6 million in marketing expenses during the period, which was partially offset by a $0.2 million increase in depreciation expense and a $0.3 million increase in information technology costs.

SG&A expenses during the six months ended June 30, 2024 and 2023 were $26.2 million and $28.7 million, respectively. The decrease was primarily driven by a $3.4 million decrease in employee compensation and related expenses due to lower headcount. This decrease was partially offset by $0.6 million increase in information technology costs and a $0.4 million increase in depreciation.

Research and development expenses

Research and development (“R&D”) expenses during the three months ended June 30, 2024 and 2023 were $2.0 million and $5.1 million, respectively. The decrease in R&D expenses was primarily driven by a $2.0 million decrease in employee compensation and related expenses due to lower headcount and a $0.8 million decrease in consulting expenses, which was partially offset by a $0.4 million increase in prototype expenses driven by the W56 208 wheel-base program.

R&D expenses during the six months ended June 30, 2024 and 2023 were $5.5 million and $12.3 million, respectively. The decrease in R&D expenses was primarily driven by a $2.6 million decrease in employee compensation and related expenses due to lower headcount, a $1.7 million decrease in prototype expenses related to development expenses for new products which launched in 2023, a $1.5 million decrease in consulting expenses related to the W56 program, and a reduction in other expenses of $0.6 million.

Interest (expense) income, net

Net interest expense for the three months ended June 30, 2024 was $5.2 million compared to net interest income of $0.5 million for the three months ended June 30, 2023. Net interest expense in the current year was driven by a fair value adjustment of $3.6 million and $1.9 million financing fees paid in connection with the 2024 Notes issued during the period.

Net interest expense for the six months ended June 30, 2024 was $6.8 million compared to net interest income $1.1 million for the six months ended June 30, 2023. Net interest expense in the current year was driven by a fair value adjustment of $3.5 million and $2.1 million financing fees paid in connection with the 2024 Notes issued during the period. Net interest income was higher in the prior period as a result of higher cash balances.

Fair value adjustment (loss) and warrants, net

Fair value adjustments for the three and six months ended June 30, 2024 were $0.6 million and $4.4 million respectively, related to the 2024 Warrants under the 2024 Securities Purchase Agreement.

Benefit for income taxes

Benefit for income taxes during the three and six months ended June 30, 2024 and 2023 was zero as all income tax benefits

are reserved.

Liquidity and Capital Resources; Going Concern

We have financed our operations primarily through sales of equity securities and issuance of debt. We have utilized this capital for R&D to fund designing, building and delivering vehicles to customers and for working capital purposes.

We had $2.2 million of sales for the six months ended June 30, 2024. As of June 30, 2024, the Company had $5.3 million in cash and cash equivalents, accounts receivable of $0.8 million, net inventory of $46.5 million and accounts payable of $10.5 million. As of June 30, 2024, the Company had a working capital of $17.8 million, accumulated deficit of $807.0 million, and during the six months ended June 30, 2024 incurred a loss from operations of $44.2 million and used $30.1 million of cash in operating activities.

Our ability to continue as a going concern is contingent upon successful execution of management’s intended plan over the next twelve months to improve our liquidity and working capital requirements. We have made significant progress executing on our revised strategic product roadmap for our electric vehicle offerings, and we expect to generate additional sales within the next twelve months which will help support our operations. Additionally, as previously disclosed, management has reduced its discretionary spend related to non-contracted capital expenditures and, implemented cost-savings measures, including a 20% reduction in force, our executive officers deferring approximately 20% of their cash compensation into the third quarter of 2024, furloughing 73 employees at our Union City manufacturing facility without pay, of which 16 have already been reinstated as of June 30, 2024, and divesting our Aero business. We also experienced voluntary attrition during and after the three months ended June 30, 2024, which has further reduced employee compensation and related costs. As previously disclosed, we are currently working with certain of our vendors to extend or restructure the payment terms of certain past due accounts payable balances. However, if the expected sales are not generated and management is not able to control capital expenditures and other expenses, we will continue to incur substantial operating losses and negative cash flows from operations. There can be no assurance that we will be successful in implementing our plans or acquiring additional funding, that our projections of our future capital needs will prove accurate, or that any additional funding would be sufficient to continue operations in future years.

Our future funding requirements will depend upon many factors, including, but not limited to:

• our ability to produce our current generation of vehicles at required scale and to sell such vehicles to customers;
• our ability to acquire or license other technologies we may seek to pursue;
• our ability to manage our growth and operational expenses; and
• competing technological and market developments.

To the extent revenues from operations are insufficient to meet our liquidity requirements, our ability to continue as a going concern will be dependent on effectively raising capital through private or public placement of our equity securities, including the continued access to the additional closings of, as of August 19, 2024 up to $112.7 million in aggregate principal amount of additional 2024 Notes. However, we may not realize the full amount available under the 2024 Securities Purchase Agreement. Under the terms of the 2024 Securities Purchase Agreement, our ability to issue and sell additional 2024 Notes to the Investor is restricted if the Investor has not converted previous tranches of 2024 Notes into our Common Stock and sold the shares issued on conversion. Accordingly, the Investor’s ability to make such conversions and sales, and therefore our access to additional liquidity under the 2024 Securities Purchase Agreement, depends on there being a robust public trading market for our Common Stock. Since consummating the Reverse Split of our Common Stock in June 2024, the Nasdaq trading volume of our Common Stock has generally been lower (on a Reverse Split-adjusted basis) than it was before we consummated the Reverse Split. If these conditions continue, the aggregate amount of 2024 Notes we can issue and sell under the 2024 Securities Purchase Agreement may be reduced, and the issuances and sales that we are able to make may be delayed.

In addition, if our share price makes such exercise feasible, we may receive proceeds from the exercise of the corresponding 2024 Warrants pursuant to the 2024 Securities Purchase Agreement and use of the ATM Agreement (as further described below), for which there can be no assurance we will be successful in such efforts. We will also rely on debt financing or other sources of capital funding such as through the sale of assets to obtain sufficient financial resources to fund our operating activities. If we are unable to maintain sufficient financial resources, our business, financial condition and results of operations, as well as our ability to continue to develop, produce and market our new vehicle programs and satisfy our obligations as they become due, will be materially and adversely affected. This could affect future vehicle program production and sales. Failure to obtain additional financing will have a material, adverse impact on our business operations. There can be no assurance that we will be able to obtain the financing needed to achieve our goals on acceptable terms or at all. Additionally, any equity or equity-linked financings would likely have a dilutive effect on the holdings of our existing stockholders. Our current level of cash and cash equivalents are not sufficient to execute our business plan. For the foreseeable future, we will incur significant operating expenses, capital expenditures and working capital funding that will deplete our cash on hand.

Our ability to obtain additional financing is extremely limited under current market conditions including the significant amount of capital required, the market price of our stock and potential dilution from the issuance of any additional securities and our ability to maintain compliance with the listing requirements of the Nasdaq Capital Market. If we are unable to identify other sources of funding, we may need to further adjust our operations, including and up to filing a voluntary petition for relief under the Bankruptcy Code. If this were to occur, the value available to our various stakeholders, including our creditors and stockholders, is uncertain and trading prices for our securities may bear little or no relationship to the actual recovery, if any, by holders of our securities in bankruptcy proceedings, if any.

As a result of all of the matters discussed above, including our losses, current liquidity level and our projected capital needs, substantial doubt exists about our ability to continue as a going concern over the next twelve months from the date of issuance of the accompanying Condensed Consolidated Financial Statements. The Condensed Consolidated Financial Statements do not include any adjustments to the carrying amounts and classification of assets, liabilities, and reported expenses that may be necessary if we were unable to continue as a going concern.

Under the ATM Agreement, we may offer and sell shares of our Common Stock having an aggregate sales price of up to $175.0 million, in amounts and at times determined by management. During the six months ended June 30, 2024, we issued 0.5 million shares under the ATM Agreement for net proceeds of $2.7 million. During the year ended December 31, 2023, we issued 89.3 million shares under the ATM Agreement for net proceeds of $62.2 million. As of June 30, 2024 we had approximately $95.6 million available through the issuance of shares of Common Stock under the ATM Agreement. Certain of our other existing financing arrangements, including our 2024 Securities Purchase Agreement, place certain conditions and restrictions on the use of our ATM Program.

Summary of Cash Flows

Cash Flows from Operating Activities

Our cash flows from operating activities are affected by our cash investments to support the business in R&D, manufacturing, SG&A. Our operating cash flows are also affected by our working capital needs to support fluctuations in accounts receivable, inventory, accounts payable and other current assets and liabilities.

During the six months ended June 30, 2024 and 2023, net cash used in operating activities was $30.1 million and $65.8 million, respectively. The decrease in net cash used in operations was primarily attributable to a $21.7 million decrease in spend related to inventory as we slowed our inventory build due to slower than anticipated sales throughout 2023 and the first half of 2024. The decrease is also attributable to a $5.0 million decline in employee compensation and related expenses, excluding non-cash stock-based compensation, resulting from our reduction in force actions.

Cash Flows from Investing Activities

Cash used in investing activities related primarily to capital expenditures to upgrade our production and research and development facilities, were $3.8 million for the six months ended June 30, 2024 and $10.5 million for the six months ended June 30, 2023. The decrease is primarily driven by a decline in spending in tooling and equipment related to our vehicle programs at our Union City, Indiana manufacturing facility.

Cash Flows from Financing Activities

Net cash provided by financing activities during the six months ended June 30, 2024 was $3.3 million, which was primarily attributable to the issuance of Common Stock under our ATM Program offset by the payment of our 2024 Notes.

Net cash provided by financing activities during the six months ended June 30, 2023 was $39.4 million, which was primarily attributable to the issuance of Common Stock under our ATM Program.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Critical Accounting Estimates

A discussion of our critical accounting estimates is contained in the Form 10-K, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Recent Accounting Pronouncements

A description of recently issued and adopted accounting pronouncements is contained in Note 14, Recent Accounting Pronouncements, of the Condensed Consolidated Financial Statements.

For a discussion of our quantitative and qualitative disclosures about market risk, see “Quantitative and Qualitative Disclosures About Market Risks” included in the Form 10-K, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” There have been no material changes to the information provided in the Form 10-K.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q was made under the supervision and with the participation of our management, including our principal executive officer and principal financial officer.

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2024, the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of such date, our disclosure controls and procedures were not effective because of a previously reported material weakness in our internal control over financial reporting, which we describe in Part II, Item 9A of our Form 10-K for the fiscal year ended December 31, 2023.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records in reasonable detail to accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and our receipts and expenditures are being made only in accordance with authorizations of our management and directors and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets could have a material effect on the financial statements.

As disclosed in our Form 10-K, management identified a material weakness in the design of one of our internal controls related to the review of the fair value calculation of the convertible note and warrant liability performed by a third-party valuation expert. The controls were not designed with a level of precision that would detect the use of an inappropriate input that could have a material impact on the valuation.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting, other than the remediation actions described below, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Remediation of the Material Weakness

We have undertaken and are continuing to design and implement remediation measures intended to address the material weakness discussed above. These remediation measures are focused on our precision of review of complex valuation models performed by independent third-party valuation experts we use to value these types of complex financial instruments. The valuation procedures are to be reviewed and approved by responsible management of the Company. Under the supervision of the Audit Committee, we are working to remediate the material weakness and will continue to report regularly to the Audit Committee regarding the status of the implementation activities.

Management’s Conclusion on Internal Control Over Financial Reporting

Based on the results of its evaluation and the material weakness described above, management concluded that the Company’s internal control over financial reporting was not effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with GAAP as of June 30, 2024.

For a detailed discussion of risk factors affecting us, see “Part I – Item 1A. Risk Factors” in the Form 10-K. There have been no material changes in the current period regarding our risk factors.