Sanara MedTech Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of the financial condition and results of operations of Sanara MedTech Inc. (together with its wholly owned or majority-owned subsidiaries on a consolidated basis, the “Company,” “Sanara MedTech,” “Sanara,” “our,” “us,” or “we”) should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and audited consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2022 and with the unaudited consolidated financial statements and related notes thereto presented in this Quarterly Report on Form 10-Q.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “aims,” “anticipates,” “believes,” “contemplates,” “continue,” “could,” “estimates,” “expects,” “forecast,” “guidance,” “intends,” “may,” “plans,” “possible,” “potential,” “predicts,” “preliminary,” “projects,” “seeks,” “should,” “target,” “will” or “would” or the negative of these words, variations of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Such forward-looking statements are subject to certain risks, uncertainties and assumptions relating to factors that could cause actual results to differ materially from those anticipated in such statements, including, without limitation, the following:

• shortfalls in forecasted revenue growth;
• our ability to implement our comprehensive wound and skincare strategy through acquisitions and investments and our ability to realize the anticipated benefits of such acquisitions and investments;
• our ability to meet our future capital requirements;
• our ability to retain and recruit key personnel;
• the intense competition in the markets in which we operate and our ability to compete within our markets;
• the failure of our products to obtain market acceptance;
• the effect of security breaches and other disruptions;
• our ability to maintain effective internal controls over financial reporting;
• our ability to develop and commercialize new products and products under development, including the manufacturing, distribution, marketing and sale of such products;
• our ability to maintain and further grow clinical acceptance and adoption of our products;
• the impact of competitors inventing products that are superior to ours;
• disruptions of, or changes in, our distribution model, consumer base or the supply of our products;
• our ability to manage product inventory in an effective and efficient manner;
• the failure of third-party assessments to demonstrate desired outcomes in proposed endpoints;
• our ability to successfully expand into wound and skincare virtual consult and other services;
• our ability and the ability of our research and development partners to protect the proprietary rights to technologies used in certain of our products and the impact of any claim that we have infringed on intellectual property rights of others;
• our dependence on technologies and products that we license from third parties;
• the effects of current and future laws, rules, regulations and reimbursement policies relating to the labeling, marketing and sale of our products and our planned expansion into wound and skincare virtual consult and other services and our ability to comply with the various laws, rules and regulations applicable to our business; and
• the effect of defects, failures or quality issues associated with our products.

For a more detailed discussion of these and other factors that may affect our business and that could cause the actual results to differ materially from those anticipated in forward-looking statements, see “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2022, Part II, Item 1A “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Forward-looking statements speak only as of the date on which they are made, and the Company does not assume any obligation to update these forward-looking statements, except to the extent required by applicable securities laws.

OVERVIEW

We are a medical technology company focused on developing and commercializing transformative technologies to improve clinical outcomes and reduce healthcare expenditures in the surgical, chronic wound and skincare markets. Each of our products, services and technologies contributes to our overall goal of achieving better clinical outcomes at a lower overall cost for patients regardless of where they receive care. We strive to be one of the most innovative and comprehensive providers of effective surgical, wound and skincare solutions and are continually seeking to expand our offerings for patients requiring treatments across the entire continuum of care in the United States.

We currently market several products across surgical and chronic wound care applications and have multiple products in our pipeline. On August 1, 2023, we acquired, among other things, the underlying intellectual property of, as well as the rights to manufacture and sell, CellerateRX Surgical Activated Collagen (Powder and Gel) (“CellerateRX Surgical”), our primary product, and HYCOL Hydrolyzed Collagen (Powder and Gel) (“HYCOL”) from Applied Nutritionals, LLC (“Applied”) for human wound care use (for more information regarding this acquisition, see the “Recent Acquisitions” section below). Prior to such time, we had licensed the rights to these products through a sublicense agreement (the “Sublicense Agreement”) with CGI Cellerate RX, LLC (“CGI Cellerate RX”), an affiliate of The Catalyst Group, Inc. (“Catalyst”), both of which are related parties (for additional information regarding related parties, see the section titled “Material Transactions with Related Parties” below). In connection with the asset purchase, Applied assigned its license agreement with CGI Cellerate RX to a wholly owned subsidiary of the Company. We also license certain of our products from Rochal Industries, LLC (“Rochal”) and Cook Biotech Inc.

In July 2021, we acquired certain assets from Rochal, including, among others, intellectual property, four U.S. Food and Drug Administration (“FDA”) 510(k) clearances, rights to license certain products and technologies currently under development, equipment and supplies. As a result of the asset purchase, our pipeline now contains product candidates for mitigation of opportunistic pathogens and biofilm, wound re-epithelialization and closure, necrotic tissue debridement and cell compatible substrates. Since our acquisition of assets from Rochal, we have been developing additional products in our own product pipeline.

In April 2022, we entered into a merger agreement through which Precision Healing Inc. (“Precision Healing”) became a wholly owned subsidiary of the Company. Precision Healing is developing a diagnostic imager and lateral flow assay (“LFA”) for assessing a patient’s wound and skin conditions. This comprehensive wound and skin assessment technology is designed to quantify biochemical markers to determine the trajectory of a wound’s condition to enable better diagnosis and treatment protocol. During the first quarter of 2023, we submitted a 510(k) premarket notification to the FDA for the Precision Healing diagnostic imager. We are evaluating when or if we will submit a 510(k) premarket notification for the Precision Healing LFA.

In July 2022, we entered into a membership interest purchase agreement with Scendia Biologics, LLC (“Scendia”) and Ryan Phillips (“Phillips”) pursuant to which we acquired 100% of the issued and outstanding membership interests in Scendia from Phillips. Since our acquisition of Scendia, we have been selling a full line of regenerative and orthobiologic technologies including (i) TEXAGEN Amniotic Membrane Allograft (“TEXAGEN”), (ii) BiFORM Bioactive Moldable Matrix (“BiFORM”), (iii) ACTIGEN Verified Inductive Bone Matrix (“ACTIGEN”) and (iv) ALLOCYTE Advanced Cellular Bone Matrix (“ALLOCYTE”).

In November 2022, we established a partnership with InfuSystem Holdings, Inc. (“InfuSystem”) focused on delivering a complete wound care solution targeted at improving patient outcomes, lowering the cost of care, and increasing patient and provider satisfaction. The partnership is expected to enable InfuSystem to offer innovative products, including Cork Medical, LLC’s negative pressure wound therapy devices and supplies, and our advanced wound care product line and associated services to new customers.

COMPREHENSIVE VALUE-BASED CARE STRATEGY

In June 2020, we formed a subsidiary, United Wound and Skin Solutions, LLC (“UWSS” or “WounDerm”), to hold certain investments and operations in wound and skincare virtual consult services. Through WounDerm, we plan to offer a comprehensive wound and skincare solution and partner with value-based care providers with the dual goal of lowering the cost to treat wounds while improving clinical outcomes.

Our comprehensive solution consists of four key components: diagnostics, virtual consult services for wound care and dermatology, proprietary efficacious products, and a wound care and dermatology specific electronic medical record (“EMR”) and mobile application. We expect these components will work synergistically to allow clinicians to analyze and treat wound and dermatology conditions more efficiently than the current standard of care:

• Diagnostics – Our proprietary imager and LFA currently under development, which we recently acquired through our acquisition of Precision Healing, are designed to quantify key biomarkers that dictate the trajectory of wound healing and identify deficiencies to aid in treatment. Ultimately, we believe that our diagnostics will lead to treatment algorithms based on the data collected by the Precision Healing technology.
• Virtual Consult Services – Through our exclusive affiliation with Direct Dermatology Inc., we can offer virtual consult services for wound care and dermatology provided by experienced, specialized physicians and clinicians.
• Proprietary Products – We currently offer products for improving patient outcomes by addressing conditions that impact wound healing. We are currently conducting multiple studies to prove the efficacy of our products while developing and exploring new products and opportunities in our six focus areas of (1) debridement, (2) biofilm removal, (3) hydrolyzed collagen, (4) advanced biologics, (5) negative pressure wound therapy products and (6) the oxygen delivery system segment of the wound and skincare market.
• EMR and Mobile Application – Our EMR and mobile application were developed specifically for wound care and dermatology. We are currently developing the capability for the EMR and mobile application to offer wound tracking analytics, recommended treatments and decision support and automated referrals.

We believe that by offering a proprietary comprehensive solution for wound care and dermatology, we will be a value-added partner for providers in value-based care programs, such as Medicare Advantage and other risk-based contracts.

RECENT ACQUISITIONS

Precision Healing

In April 2022, we closed a merger transaction with Precision Healing, pursuant to which Precision Healing became a wholly owned subsidiary of the Company. Precision Healing is developing a diagnostic imager and LFA for assessing a patient’s wound and skin conditions. This comprehensive wound and skin assessment technology is designed to quantify biochemical markers to determine the trajectory of a wound’s condition to enable better diagnosis and treatment protocol.

Pursuant to the merger agreement, among other things, we agreed to (i) pay the holders of Precision Healing common stock and preferred stock closing consideration consisting of 165,738 shares of our common stock, which was issued to accredited investors, and $125,966 in cash, which was paid to stockholders who were not accredited investors, (ii) pay approximately $0.6 million of transaction expenses on behalf of the equity holders of Precision Healing, (iii) assume all outstanding options and warrants of Precision Healing and (iv) pay, subject to the achievement of certain performance thresholds, earnout consideration of up to $10.0 million which is payable in cash or, at our election, is payable to accredited investors in shares of our common stock.

Scendia

In July 2022, we entered into a membership interest purchase agreement by and among the Company, Scendia and Phillips pursuant to which we acquired 100% of the issued and outstanding membership interests in Scendia from Phillips. Scendia provides clinicians and surgeons with a full line of regenerative and orthobiologic technologies. Beginning in early 2022, the Company began co-promoting certain products with Scendia, including: (i) TEXAGEN, (ii) BiFORM, (iii) ACTIGEN and (iv) ALLOCYTE. Prior to the acquisition, Scendia owned 50% of the issued and outstanding membership interests in Sanara Biologics, LLC (“Sanara Biologics”) and the Company owned the remaining 50% of the membership interests. As a result of the acquisition, the Company indirectly acquired all the interests in Sanara Biologics, such that the Company now holds 100% of the issued and outstanding equity interests in Sanara Biologics.

Pursuant to the purchase agreement, the aggregate consideration at closing for the acquisition was $7.6 million, which consisted of (i) a $1.6 million cash payment, subject to certain adjustments, and (ii) 291,686 shares of our common stock, with an agreed upon value of $6.0 million. Pursuant to the purchase agreement, at closing, we withheld 94,798 shares of common stock with an agreed upon value of $1.95 million (the “Indemnity Holdback Shares”), which such Indemnity Holdback Shares were withheld to the extent provided in the purchase agreement to satisfy Phillips’ indemnification obligations and subsequently issued and released to Phillips in July 2023.

In addition to the cash and stock consideration, the purchase agreement provides that Phillips is entitled to receive two potential earnout payments, payable on an annual basis, not to exceed $10.0 million in the aggregate. The earnout consideration is payable to Phillips in cash or, at our election, in up to 486,145 shares of our common stock upon the achievement of certain performance thresholds relating to net revenue attributable to sales of Scendia products during the two-year period following the closing. We made the first earnout payment of approximately $693,000 in cash in August 2023. We expect the second earnout payment to be made in the third quarter of 2024.

Applied Asset Purchase

On August 1, 2023, we entered into an Asset Purchase Agreement (the “Applied Purchase Agreement”) by and among the Company, as guarantor, Sanara MedTech Applied Technologies, LLC, a wholly owned subsidiary of the Company (“SMAT”), Applied, The Hymed Group Corporation (“Hymed” and together with Applied, the “Sellers”), and Dr. George D. Petito (the “Owner”), pursuant to which SMAT acquired certain assets of the Sellers and the Owner, including, among others, the Sellers’ and Owner’s inventory, intellectual property, manufacturing and related equipment, goodwill, rights and claims, other than certain excluded assets, all as more specifically set forth in the Applied Purchase Agreement (collectively, the “Applied Purchased Assets”), and assumed certain Assumed Liabilities (as defined in the Applied Purchase Agreement), upon the terms and subject to the conditions set forth in the Applied Purchase Agreement (such transaction, the “Applied Asset Purchase”). The Applied Purchased Assets include the underlying intellectual property of, as well as the rights to manufacture and sell, CellerateRX Surgical and HYCOL products for human wound care use.

The Applied Purchased Assets were purchased for an initial aggregate purchase price of $15.25 million, consisting of (i) $9.75 million in cash (the “Cash Closing Consideration”), (ii) 73,809 shares of our common stock (the “Stock Closing Consideration”) with an agreed upon value of $3.0 million and (iii) $2.5 million in cash (the “Installment Payments”), to be paid in four equal installments on each of the next four anniversaries of the closing of the Applied Asset Purchase (the “Closing”).

In addition to the Cash Closing Consideration, Stock Closing Consideration and Installment Payments, the Applied Purchase Agreement provides that the Sellers are entitled to receive up to an additional $10.0 million (the “Applied Earnout”), which is payable to the Sellers in cash, upon the achievement of certain performance thresholds relating to SMAT’s collections from net sales of a collagen-based product currently under development. Upon expiration of the seventh anniversary of the Closing, to the extent the Sellers have not earned the entirety of the Applied Earnout, SMAT shall pay the Sellers a pro-rata amount of the Applied Earnout based on collections from net sales of the product, with such amount to be due credited against any Applied Earnout payments already made by SMAT (the “True-Up Payment”). The Applied Earnout, minus the True-Up Payment and any Applied Earnout payments already made by SMAT, may be earned at any point in the future, including after the True-Up Payment is made.

RECENT DEVELOPMENTS

Professional Services Agreement

In connection with the Applied Asset Purchase and pursuant to the Applied Purchase Agreement, effective August 1, 2023, we entered into a professional services agreement (the “Petito Services Agreement”) with the Owner, pursuant to which the Owner, as an independent contractor, agreed to provide certain services to us, including, among other things, assisting with the development of products already in development and assisting with research, development, formulation, invention and manufacturing of any future products (the “Petito Services”). As consideration for the Petito Services, the Owner is entitled to receive: (i) a base salary of $12,000 per month during the term of the Petito Services Agreement, (ii) a royalty payment equal to three percent (3%) of the actual collections from net sales of certain products the Owner develops or co-develops that reach commercialization, (iii) a royalty payment equal to five percent (5%) for the first $50.0 million in aggregate collections from net sales of certain future products and a royalty payment of two and one-half percent (2.5%) on aggregate collections from net sales of certain future products on any amounts exceeding $50.0 million but up to $100.0 million, (iv) $500,000 in cash in the event that 510(k) clearance is issued for any future product accepted by the Company and (v) $1.0 million in cash in the event that a U.S. patent is issued for a certain product; provided that with respect to the incentive payments described in (iv) and (v) of the foregoing, the Owner shall not earn more than $2.5 million.

The Petito Services Agreement has an initial term of three years and is subject to automatic successive one-month renewals unless earlier terminated in accordance with its terms. The Petito Services Agreement may be terminated upon the Owner’s death or disability or by us or the Owner “For Cause” (as defined in the Petito Services Agreement); provided, however, that the base salary described in (i) of the foregoing paragraph shall survive termination through the three-year initial term and the royalty payments and incentive payments described in (ii)-(v) of the foregoing paragraph shall survive termination of the Petito Services Agreement.

Loan Agreement

In connection with the entry into the Applied Purchase Agreement, on August 1, 2023, we, as guarantor, and SMAT, as borrower, entered into a loan agreement (the “Loan Agreement”) with Cadence Bank (the “Bank”) providing for, among other things, an advancing term loan in the aggregate principal amount of $12.0 million (the “Term Loan”). Pursuant to the Loan Agreement, the Bank agreed to make, at any time and from time to time prior to February 1, 2024, one or more advances to SMAT. On August 1, 2023, the Bank made an advance under the Term Loan for $9.75 million, the proceeds of which were used to fund the Cash Closing Consideration for the Applied Asset Purchase. For more information regarding the Loan Agreement, see the “Liquidity and Capital Resources” section below.

COMPONENTS OF RESULTS OF OPERATIONS

Sources of Revenues

Our revenue is derived primarily from sales of our soft tissue repair and bone fusion products to hospitals and other acute care facilities. In particular, the substantial majority of our product sales revenue is derived from sales of CellerateRX surgical powder. Our revenue is driven by direct orders shipped by us to our customers, and to a lesser extent, direct sales to customers through delivery at the time of procedure by one of our sales representatives. We generally recognize revenue when a purchase order is received from the customer and our product is received by the customer.

Revenue streams from product sales and royalties are summarized below for the three and nine months ended September 30, 2023 and 2022.

We recognize royalty revenue from a development and licensing agreement with BioStructures, LLC. We record revenue each calendar quarter as earned per the terms of the agreement which stipulates that we will receive quarterly royalty payments of at least $50,250. Under the terms of the development and license agreement, royalties of 2.0% are recognized on sales of products containing our patented resorbable bone hemostasis. The minimum annual royalty due to us is $201,000 per year through the end of 2023. These royalties are payable in quarterly installments of $50,250. To date, royalties related to this development and licensing agreement have not exceeded the annual minimum of $201,000 ($50,250 per quarter).

Cost of Goods Sold

Cost of goods sold consists primarily of the acquisition costs from the manufacturers of our licensed products, raw material costs for certain components sourced directly by us and all related royalties due as a result of the sale of our products. Our gross profit represents total net revenue less the cost of goods sold, and gross margin represents gross profit expressed as a percentage of total revenue.

Operating Expenses

Selling, general and administrative (“SG&A”) expenses consist primarily of salaries, sales commissions, benefits, bonuses and stock-based compensation. SG&A also includes outside legal counsel fees, audit fees, insurance premiums, rent and other corporate expenses. We expense all SG&A expenses as incurred.

Research and development (“R&D”) expenses include costs related to enhancements to our currently available products and additional investments in our product, services and technologies development pipeline. This includes personnel-related expenses, including salaries and benefits for all personnel directly engaged in R&D activities, contracted services, materials, prototype expenses and allocated overhead, which is comprised of lease expense and other facilities-related costs. We expense R&D costs as incurred. We generally expect that R&D expenses will increase as we continue to support product enhancements and bring new products to market.

Depreciation and amortization expenses include depreciation of fixed assets and amortization of intangible assets that have a finite life, such as product licenses, patents and intellectual property, customer relationships and assembled workforces.

Change in fair value of earnout liabilities represents our measurement of the change in fair value at the balance sheet date of our earnout liabilities that were established at the time of our Precision Healing, Scendia and Applied acquisitions.

Other Expense

Other expense is primarily comprised of losses on equity method investments, interest expense, accretion expense and other nonoperating activities.

RESULTS OF OPERATIONS

Net Revenue. For the three months ended September 30, 2023, we generated net revenue of $16.0 million compared to net revenue of $13.0 million for the three months ended September 30, 2022, a 23% increase from the prior year period. For the nine months ended September 30, 2023, we generated net revenue of $47.3 million compared to net revenue of $30.5 million for the nine months ended September 30, 2022, a 55% increase from the prior year period. The higher net revenue for the three and nine months ended September 30, 2023 were primarily due to increased sales of soft tissue repair products and, to a lesser extent, bone fusion products, as a result of our increased market penetration and geographic expansion, additional revenues as a result of the Scendia acquisition and our continuing strategy to expand our independent distribution network in both new and existing U.S. markets.

During the third quarter of 2022, we began to experience supply issues with the ALLOCYTE product line. During the fourth quarter of 2022 and the nine months ended September 30, 2023, we were unable to fill certain orders for this product, which negatively impacted our sales growth. The supply constraint was caused by significant supplier limits on qualifying eligible donor tissue and supplier necessity to subcontract all processing to secondary suppliers. We have since expanded the ALLOCYTE product line with the release of ALLOCYTE Plus Advanced Viable Bone Matrix (“ALLOCYTE Plus”), which is processed by an alternative supplier with in-house processing capabilities. Our first sales of ALLOCYTE Plus occurred in October 2023. We have a sufficient supply of ALLOCYTE Plus to meet currently expected demand and believe we have measures in place to regularly stock the product in the future.

Cost of goods sold. Cost of goods sold for the three months ended September 30, 2023, was $1.8 million, compared to costs of goods sold of $2.2 million for the three months ended September 30, 2022. Cost of goods sold for the nine months ended September 30, 2023, was $6.1 million, compared to costs of goods sold of $4.0 million for the nine months ended September 30, 2022. The decrease in cost of goods sold for the three months ended September 30, 2023 was primarily due to the elimination of royalty expense on CellerateRX on a consolidated basis as a result of the Applied Asset Purchase. The increase in cost of goods sold for the nine months ended September 30, 2023 was primarily due to higher sales volume as a result of organic sales growth and our acquisition of Scendia. Gross margins were approximately 87% for both nine-month periods ended September 30, 2023 and 2022. The gross margins for the nine months ended September 30, 2023 included lower margins realized on sales of certain Scendia products offset by higher margins realized due to the elimination in consolidation of the CellerateRX royalty expense under the Sublicense Agreement.

Selling, general and administrative expenses. SG&A expenses for the three months ended September 30, 2023, were $13.9 million compared to SG&A expenses of $12.1 million for the three months ended September 30, 2022. SG&A expenses for the nine months ended September 30, 2023, were $40.7 million compared to SG&A expenses of $31.9 million for the nine months ended September 30, 2022. The higher SG&A expenses for the three and nine months ended September 30, 2023 were primarily due to higher direct sales and marketing expenses, which accounted for approximately $1.0 million and $6.8 million, respectively, or 56% and 77%, respectively, of the increases compared to the prior year periods. The higher direct sales and marketing expenses for the three and nine months ended September 30, 2023 were primarily attributable to an increase in sales commissions of $0.7 million and $5.9 million, respectively, as a result of higher product sales. The nine months ended September 30, 2023 also included $0.8 million of increased costs as a result of sales force expansion and operational support. We expect our SG&A expenses to decline as a percentage of net revenues as our sales growth outpaces the costs of sales force expansion and corporate overhead.

Research and development expenses. R&D expenses for the three months ended September 30, 2023, were $1.0 million compared to $1.1 million for the three months ended September 30, 2022. R&D expenses for the nine months ended September 30, 2023, were $3.5 million compared to $2.3 million for the nine months ended September 30, 2022. The higher R&D expenses for the nine months ended September 30, 2023 were primarily due to costs related to the Precision Healing diagnostic imager and LFA. R&D expenses for the three and nine months ended September 30, 2023 also included costs associated with ongoing development projects for our currently licensed products.

Depreciation and amortization expense. Depreciation and amortization expense for the three months ended September 30, 2023, was $1.0 million compared to $0.8 million for the three months ended September 30, 2022. The higher depreciation and amortization expense during the three months ended September 30, 2023 was primarily due to the amortization of intangible assets acquired as part of the Applied Asset Purchase. Depreciation and amortization expense for the nine months ended September 30, 2023, was $2.6 million compared to $1.6 million for the nine months ended September 30, 2022. The higher depreciation and amortization expense during the nine months ended September 30, 2023 was primarily due to the amortization of intangible assets acquired as part of the Precision Healing, Scendia and Applied transactions.

Change in fair value of earnout liabilities. Change in fair value of earnout liabilities was a benefit of $0.7 million for the three months ended September 30, 2023 compared to expense of $0.1 million for the three months ended September 30, 2022. Change in fair value of earnout liabilities was a benefit of $1.5 million for the nine months ended September 30, 2023 compared to an expense of $0.2 million for the nine months ended September 30, 2022. The current year benefits are as a result of a decrease in the estimated fair value of the earnout liabilities established at the time of our Precision Healing and Scendia acquisitions. The decrease in the estimated fair value was due to a change in the discount factor utilized in the valuation models, a decrease in the projected undiscounted amounts to be paid, as well as adjustments to the projected timing of the payments to be made, partially offset by accretion. The prior year period expenses were due to the accretion of the earnout liabilities.

Other expense. Other expense for the three months ended September 30, 2023 was $0.2 million compared to zero for the three months ended September 30, 2022. Other expense for the nine months ended September 30, 2023 was $0.2 million compared to $0.4 million for the nine months ended September 30, 2022. Other expense for the three and nine months ended September 30, 2023 included interest expense, accretion expense and amortization of debt issuance costs related to the Term Loan entered into in conjunction with the Applied Asset Purchase. Other expense for the nine months ended September 30, 2022 included losses from our equity method investment in Precision Healing prior to our acquisition of the remaining interests in April 2022.

Loss before income taxes. We had a loss before income taxes of $1.1 million for the three months ended September 30, 2023, compared to a loss before income taxes of $3.2 million for the three months ended September 30, 2022. For the nine months ended September 30, 2023, we had a loss before income taxes of $4.2 million, compared to a loss before income taxes of $9.8 million for the nine months ended September 30, 2022. The lower loss for the three and nine months ended September 30, 2023 was due to operating expenses increasing at a slower rate than net sales in addition to the benefit recorded as a result of the change in fair value of earnout liabilities.

Income tax benefit. As discussed in Note 12 to the accompanying unaudited consolidated financial statements, we recognized net deferred tax liabilities associated with the Precision Healing merger and the Scendia acquisition. Prior to consideration of these deferred tax liabilities, we had net deferred tax assets in excess of the deferred tax liabilities being recognized, however, a 100% valuation allowance had previously been provided against our net deferred tax assets. As a result of the recording of the net deferred tax liabilities related to the Precision Healing merger and the Scendia acquisition, we reviewed the valuation allowance and determined that it should be reduced by the amount of the deferred tax liabilities that were recognized. This resulted in recognition of an income tax benefit of $1.7 million and $5.8 million in the three and nine months ended September 30, 2022, respectively.

Net loss. For the three months ended September 30, 2023, we had a net loss of $1.1 million, compared to a net loss of $1.5 million for the three months ended September 30, 2022. For the nine months ended September 30, 2023, we had a net loss of $4.2 million, compared to a net loss of $3.9 million for the nine months ended September 30, 2022.

LIQUIDITY AND CAPITAL RESOURCES

Cash on hand at September 30, 2023 was $6.2 million, compared to $9.0 million at December 31, 2022. Historically, we have financed our operations primarily from the sale of equity securities. In February 2023, we entered into a Controlled Equity Offering SM Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co., as sales agent (“Cantor”), pursuant to which we may offer and sell from time to time, to or through Cantor, shares of our common stock having an aggregate offering price of up to $75.0 million.

Sales of the shares, if any, pursuant to the Sales Agreement, may be made in sales deemed to be an “at the market offering” as defined in Rule 415(a)(4) promulgated under the Securities Act of 1933, as amended. Upon delivery of a placement notice and subject to the terms and conditions of the Sales Agreement, Cantor agreed to use commercially reasonable efforts consistent with its normal trading and sales practices, applicable state and federal law, rules and regulations and the rules of The Nasdaq Capital Market to sell the shares from time to time based upon our instructions, including any price, time period or size limits specified by us. We have no obligation to sell any of the shares under the Sales Agreement and may at any time suspend or terminate the offering of our common stock pursuant to the Sales Agreement upon notice to Cantor and subject to other conditions. Cantor’s obligations to sell the shares under the Sales Agreement are subject to satisfaction of certain conditions, including customary closing conditions. Pursuant to the Sales Agreement, we will pay Cantor a commission of 3.0% of the aggregate gross proceeds from each sale of the shares.

During the three months ended September 30, 2023, we did not sell any shares of common stock pursuant to the Sales Agreement. During the nine months ended September 30, 2023, we sold an aggregate of 26,143 shares of common stock for gross proceeds of approximately $1.1 million and net proceeds of approximately $1.0 million pursuant to the Sales Agreement.

We expect our future needs for cash to include funding potential acquisitions, further developing our products, services and technologies pipeline and clinical studies, expanding our sales force, repayment of debt as it becomes due and for general corporate purposes. Based on our current plan of operations, we believe our cash on hand, when combined with expected cash flows from operations and proceeds from the Term Loan discussed above, will be sufficient to fund our growth strategy and to meet our anticipated operating expenses and capital expenditures for at least the next twelve months.

Precision Healing Merger

In November 2020, we entered into agreements to purchase shares of Series A Convertible Preferred Stock (the “Series A Stock”) of Precision Healing for an aggregate purchase price of $600,000. In 2021, we made additional purchases of Series A Stock: $600,000 in February, $500,000 in June, $500,000 in October, and $600,000 in December.

In April 2022, we closed a merger transaction with Precision Healing pursuant to which Precision Healing became our wholly owned subsidiary. Pursuant to the terms of the merger agreement, holders of Precision Healing common stock and preferred stock, other than the Company, were entitled to receive closing consideration, consisting of $125,966 in cash, which was paid to stockholders who were not accredited investors, 165,738 shares of our common stock, which was paid only to accredited investors, and the payment in cash of approximately $0.6 million of transaction expenses of Precision Healing. We recorded the issuance of the 165,738 shares to accredited investors and cash payments to nonaccredited investors based on the closing price per share of our common stock on April 4, 2022, which was $30.75.

Upon the closing of the merger, the outstanding Precision Healing options previously granted under the Precision Healing Inc. 2020 Stock Option and Grant Plan (the “Precision Healing Plan”) converted, pursuant to their terms, into options to acquire an aggregate of 144,191 shares of our common stock with a weighted average exercise price of $10.71 per share. These options expire between August 2030 and April 2031. In addition, outstanding and unexercised Precision Healing warrants converted into rights to receive warrants to purchase (i) 4,424 shares of our common stock with an initial exercise price of $7.32 per share and an expiration date of April 22, 2031, and (ii) 12,301 shares of our common stock with an initial exercise price of $12.05 per share and an expiration date of August 10, 2030. Concurrent with the assumption of the Precision Healing Plan, we terminated the ability to offer future awards under the Precision Healing Plan.

Pursuant to the merger agreement, upon the achievement of certain performance thresholds, the securityholders of Precision Healing, including the holders of options and warrants to purchase Precision Healing common stock and certain persons promised options to purchase Precision Healing common stock, are also entitled to receive payments of up to $10.0 million, which was accounted for as contingent consideration pursuant to Accounting Standards Codification Topic 805, Business Combinations. The earnout consideration is payable in cash or, at our election, is payable to accredited investors in shares of our common stock at a price per share equal to the greater of (i) $27.13 or (ii) the average closing price of our common stock for the 20 trading days prior to the date such earnout consideration is due and payable. Pursuant to the merger agreement, a minimum percentage of the earnout consideration may be required to be issued to accredited investors in shares of our common stock for tax purposes. The amount and composition of the portion of earnout consideration payable is subject to adjustment and offsets as set forth in the merger agreement. We do not anticipate making an earnout consideration payment prior to January 2025.

Scendia Acquisition

In July 2022, we entered into a membership interest purchase agreement by and among the Company, Scendia and Phillips pursuant to which, and in accordance with the terms and conditions set forth therein, we acquired 100% of the issued and outstanding membership interests in Scendia from Phillips.

Pursuant to the purchase agreement, Phillips was entitled to receive closing consideration consisting of (i) approximately $1.6 million of cash, subject to certain adjustments, and (ii) 291,686 shares of our common stock. Pursuant to the purchase agreement, at closing, we withheld the Indemnity Holdback Shares, which Indemnity Holdback Shares were withheld to the extent provided in the purchase agreement to satisfy Phillips’ indemnification obligations and subsequently issued and released to Phillips in July 2023.

In addition to the cash consideration and the stock consideration, the purchase agreement provides that Phillips is entitled to receive two potential earnout payments, payable on an annual basis, not to exceed $10.0 million in the aggregate. The earnout consideration is payable to Phillips in cash or, at our election, in up to 486,145 shares of our common stock upon the achievement of certain performance thresholds relating to net revenue attributable to sales of Scendia products during the two-year period following the closing. We made the first earnout payment of approximately $693,000 in cash in August 2023. We expect the second earnout payment to be made in the third quarter of 2024.

Applied Asset Purchase

On August 1, 2023, we entered into the Applied Purchase Agreement by and among the Company, SMAT, Hymed, Applied and the Owner, pursuant to which SMAT acquired the Applied Purchased Assets and assumed certain Assumed Liabilities upon the terms and subject to the conditions set forth in the Applied Purchase Agreement. The transaction closed on August 1, 2023. The Applied Purchased Assets were purchased for an initial aggregate purchase price of $15.25 million, consisting of (i) $9.75 million in cash, (ii) 73,809 shares of our common stock, with an agreed upon value of $3.0 million and (iii) $2.5 million in cash, to be paid in four equal installments on each of the next four anniversaries of the Closing.

In addition to the Cash Closing Consideration, Stock Closing Consideration and Installment Payments, the Applied Purchase Agreement provides that the Sellers are entitled to receive up to an additional $10.0 million, which is payable to the Sellers in cash, upon the achievement of certain performance thresholds relating to SMAT’s collections from net sales of a collagen-based product currently under development. Upon expiration of the seventh anniversary of the Closing, to the extent the Sellers have not earned the entirety of the Applied Earnout, SMAT shall pay the Sellers the True-Up Payment. The Applied Earnout, minus the True-Up Payment and any Applied Earnout payments already made by SMAT, may be earned at any point in the future, including after the True-Up Payment is made.

Since the closing of the Applied Asset Purchase, we make intercompany royalty payments to SMAT at the same rate as set forth in the Sublicense Agreement. SMAT intends to use the royalties received to repay borrowings under the Term Loan. As described under “Loan Agreement” below, SMAT is required to maintain compliance with certain maintenance covenants and is limited in its ability to distribute or lend cash to the Company without consent of the Bank.

Loan Agreement

In connection with the entry into the Applied Purchase Agreement, on August 1, 2023, we, as guarantor, and SMAT, as borrower, entered into the Loan Agreement with the Bank providing for, among other things, a Term Loan in the aggregate principal amount of $12.0 million, which was evidenced by an advancing promissory note. Pursuant to the Loan Agreement, the Bank agreed to make, at any time and from time to time prior to February 1, 2024, one or more advances to SMAT.

The proceeds of the advances under the Loan Agreement will be used for working capital and for purposes of financing up to one hundred percent (100%) of the Cash Closing Consideration and Installment Payments for the Applied Asset Purchase and related fees and expenses, including any subsequent payments that may be due to the Sellers after the Closing. On August 1, 2023, the Bank, at the request of SMAT, made an advance for $9.75 million. The proceeds from the advance were used to fund the Cash Closing Consideration for the Applied Asset Purchase.

Advances under the Term Loan will begin amortizing in monthly installments commencing on August 5, 2024. All remaining unpaid balances under the Term Loan are due and payable in full on August 1, 2028 (the “Maturity Date”). SMAT may prepay amounts due under the Term Loan. All accrued but unpaid interest on the unpaid principal balance of outstanding advances is due and payable monthly, beginning on September 5, 2023 and continuing monthly on the fifth day of each month thereafter until the Maturity Date. The unpaid principal balance of outstanding advances bears interest, subject to certain conditions, at the lesser of the Maximum Rate (as defined in the Loan Agreement) or the Base Rate, which is for any day, a rate per annum equal to the term secured overnight financing rate (Term SOFR) (as administered by the Federal Reserve Bank of New York) for a one-month tenor in effect on such day plus three percent (3.0%).

The obligations of SMAT under the Loan Agreement and the other loan documents delivered in connection therewith are guaranteed by us and are secured by a first priority security interest in substantially all of the existing and future assets of SMAT.

The Loan Agreement contains customary representations and warranties and certain covenants that limit (subject to certain exceptions) the ability of SMAT and us to, among other things, (i) create, assume or guarantee certain liabilities, (ii) create, assume or suffer liens securing indebtedness, (iii) make or permit loans and advances, (iv) acquire any assets outside the ordinary course of business, (v) consolidate, merge or sell all or a material part of its assets, (vi) pay dividends or other distributions on, or redeem or repurchase, interest in an obligor, including us as guarantor, (vii) cease, suspend or materially curtail business operations or (viii) engage in certain affiliate transactions. In addition, the Loan Agreement contains financial covenants that require SMAT to maintain (i) a minimum Debt Services Coverage Ratio and (ii) a maximum Cash Flow Leverage Ratio, in each case, as defined and calculated according to the procedures set forth in the Loan Agreement. Pursuant to the Loan Agreement, in the event that SMAT fails to comply with the financial covenants described above, we are required to contribute cash to SMAT in an amount equal to the amount required to satisfy the financial covenants. SMAT is limited in its ability to distribute or lend cash to the Company without consent of the Bank.

Pursuant to the Loan Agreement, starting with the three months ended September 30, 2023 and for each quarter thereafter, SMAT will be required to maintain a minimum Debt Service Coverage Ratio (as defined below) of 1.2 to 1.0, which ratio is calculated as of the last day of the applicable fiscal quarter. The “Debt Service Coverage Ratio” is the ratio of (a) the sum of the following during the preceding twelve (12) month period, subject to annualization in certain circumstances: (i) earnings before interest, taxes, depreciation, amortization, stock compensation expense and gains or losses on sales of assets outside the ordinary course of business (“EBITDA”) minus (ii) capital expenditures, minus (iii) cash taxes, minus (iv) dividends and distributions, to (b) the sum of (i) the current portion of long-term debt, (ii) Installment Payments made during the preceding twelve (12) month period and (iii) interest expense during the preceding twelve (12) month period, subject to annualization in certain circumstances. As of September 30, 2023, following a cash contribution from Sanara (as described below), SMAT’s Debt Service Coverage Ratio was 1.3 to 1.0.

The Loan Agreement also requires SMAT to, subject to certain conditions, maintain a maximum Cash Flow Leverage Ratio (as defined below) of not more than (a) 4.5 to 1.0 as of the last day of the fiscal quarter ending on September 30, 2023, (b) 4.0 to 1.0 as of the last day of each fiscal quarter ending on December 31, 2023, and March 31, 2024, (c) 3.5 to 1.0 as of the last day of each fiscal quarter ending on June 30, 2024, and September 30, 2024, and (d) 3.0 to 1.0 as of the last day of each fiscal quarter thereafter. The “Cash Flow Leverage Ratio” is the ratio of all Funded Debt (as defined in the Loan Agreement) to certain multiples of EBITDA during the preceding twelve (12) month period, subject to annualization in certain circumstances. SMAT was in compliance with the financial covenants under the Loan Agreement as of September 30, 2023. Due to the short period of time between the signing of the Loan Agreement and the end of the third quarter, we contributed an immaterial amount of cash to SMAT in order to permit SMAT to be in compliance with the financial covenants under the Loan Agreement. As of September 30, 2023, following a cash contribution from Sanara, SMAT’s Cash Flow Leverage Ratio was 4.5 to 1.0.

The Loan Agreement also contains customary events of default. If such an event of default occurs, the Bank would be entitled to take various actions, including the acceleration of amounts due under the Loan Agreement and actions permitted to be taken by a secured creditor.

Cash Flow Analysis

For the nine months ended September 30, 2023, net cash used in operating activities was $2.4 million compared to $4.9 million used in operating activities for the nine months ended September 30, 2022. The lower use of cash was due to net revenue growth outpacing the growth of our cash operating expenses and timing of cash expenditures for certain accrued payables.

For the nine months ended September 30, 2023, net cash used in investing activities was $10.2 million compared to $3.1 million used in investing activities during the nine months ended September 30, 2022. The higher use of cash used in investing activities during the nine months ended September 30, 2023 was primarily due to cash paid pursuant to the Applied Asset Purchase.

For the nine months ended September 30, 2023, net cash provided by financing activities was $9.8 million as compared to $0.3 million used in financing activities for the nine months ended September 30, 2022. The cash provided by financing activities during the nine months ended September 30, 2023 was due to net loan proceeds of $9.7 million utilized for the Applied Asset Purchase and net proceeds received pursuant to sales of our common stock of $1.0 million, partially offset by the Scendia earnout payment of $0.7 million and the net settlement of equity-based awards, which totaled $0.2 million.

MATERIAL TRANSACTIONS WITH RELATED PARTIES

CellerateRX Surgical Sublicense Agreement

We have an exclusive, world-wide sublicense to distribute CellerateRX Surgical and HYCOL products into the surgical and wound care markets from an affiliate of Catalyst, CGI Cellerate RX, which, prior to the Applied Asset Purchase, licensed the rights to CellerateRX from Applied. Sales of CellerateRX Surgical comprised the substantial majority of our sales during the nine months ended September 30, 2023 and 2022. In January 2021, we amended the term of the Sublicense Agreement to extend the term to May 17, 2050, with automatic successive one-year renewals so long as annual net sales of the licensed products exceed $1.0 million. We pay royalties based on the annual Net Sales of licensed products (as defined in the Sublicense Agreement) consisting of 3% of all collected Net Sales each year up to $12.0 million, 4% of all collected Net Sales each year that exceed $12.0 million up to $20.0 million, and 5% of all collected Net Sales each year that exceed $20.0 million. For the three months ended September 30, 2023 and 2022, royalty expense was a benefit of approximately $9,000 for the three months ended September 30, 2023 due to the reversal of an accrual and $0.4 million of expense, respectively, under the terms of this agreement. For the nine months ended September 30, 2023 and 2022, royalty expense was $1.1 million and $1.2 million, respectively, under the terms of this agreement. Ronald T. Nixon, our Executive Chairman, is the founder and managing partner of Catalyst.

As discussed above, in August 2023, we acquired the underlying intellectual property of, as well as the rights to manufacture and sell, CellerateRX Surgical and HYCOL products from Applied. In connection with this acquisition, Applied assigned its license agreement with CGI Cellerate RX to a wholly owned subsidiary of the Company and no further royalties will be due to Applied thereunder. Since the Closing of the Applied Asset Purchase, Sanara indirectly makes intercompany royalty payments to SMAT at the same rate as set forth in the Sublicense Agreement. These intercompany royalty payments and the offsetting cost of goods sold were eliminated in consolidation effective as of August 1, 2023.

Consulting Agreement

In July 2021, we entered into an asset purchase agreement with Rochal, a related party. Concurrent with the Rochal asset purchase, we entered into a consulting agreement with Ann Beal Salamone pursuant to which Ms. Salamone agreed to provide us with consulting services with respect to, among other things, writing new patents, conducting patent intelligence and participating in certain grant and contract reporting. In consideration for the consulting services to be provided to us, Ms. Salamone is entitled to receive an annual consulting fee of $177,697, with payments to be paid once per month. The consulting agreement has an initial term of three years, unless earlier terminated by us, and is subject to renewal. Ms. Salamone is a director of the Company, is a significant shareholder and the current Chair of the board of directors of Rochal.

Catalyst Transaction Advisory Services Agreement

In March 2023, we entered into a Transaction Advisory Services Agreement (the “Catalyst Services Agreement”) effective March 1, 2023 with Catalyst, a related party. Pursuant to the Catalyst Services Agreement, Catalyst, by and through its directors, officers, employees and affiliates that are not simultaneously serving as directors, officers or employees of the Company (collectively, the “Covered Persons”), agreed to perform certain transaction advisory, business and organizational strategy, finance, marketing, operational and strategic planning, relationship access and corporate development services for us in connection with any merger, acquisition, recapitalization, divestiture, financing, refinancing, or other similar transaction in which we may be, or may consider becoming, involved, and any such additional services as mutually agreed upon in writing by and between Catalyst and us (the “Catalyst Services”).

Pursuant to the Catalyst Services Agreement, we agreed to reimburse Catalyst for (i) compensation actually paid by Catalyst to any of the Covered Persons at a rate no more than a rate consistent with industry practice for the performance of services similar to the Catalyst Services, as documented in reasonably sufficient detail, and (ii) all reasonable out-of-pocket costs and expenses payable to unaffiliated third parties, as documented in customary expense reports, as each of (i) and (ii) is incurred in connection with the Catalyst Services rendered under the Catalyst Services Agreement, with all reimbursements being contingent upon the prior approval of the Audit Committee of our Board of Directors. We incurred $44,032 and $117,018 of costs pursuant to the Catalyst Services Agreement during the three and nine months ended September 30, 2023.

Receivables and Payables

We had outstanding related party receivables totaling $11,032 at September 30, 2023, and $98,548 at December 31, 2022. We had outstanding related party payables totaling $64,747 at September 30, 2023, and $34,036 at December 31, 2022.

IMPACT OF INFLATION AND CHANGING PRICES

Inflation and changing prices have not had a material impact on our historical results of operations. We do not currently anticipate that inflation and changing prices will have a material impact on our future results of operations.

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the unaudited consolidated financial statements and accompanying notes. Although we base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, actual results may differ from the estimates on which our financial statements are prepared at any given point of time. Changes in these estimates could materially affect our consolidated financial position, results of operations or cash flows. Significant items that are subject to such estimates and assumptions include revenue and expense accruals, the fair value measurement of assets and liabilities and the allocation of purchase price to the fair value of assets acquired. Our critical accounting estimates have not significantly changed since December 31, 2022 and are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit to the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and that information is accumulated and communicated to our management, including our principal executive and principal financial officers (whom we refer to in this periodic report as our Certifying Officers), as appropriate to allow timely decisions regarding required disclosure. Our management evaluated, with the participation of our Certifying Officers, the effectiveness of our disclosure controls and procedures as of September 30, 2023, pursuant to Rule 13a-15(b) under the Exchange Act. Based upon that evaluation, our Certifying Officers concluded that, as of September 30, 2023, our disclosure controls and procedures were effective.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Except as provided below, there were no material changes to the Risk Factors disclosed in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022. For more information concerning our risk factors, please see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022.

We may fail to realize all the anticipated benefits of the Applied Asset Purchase, or such benefits may take longer to realize than expected.

We may fail to realize all of the anticipated benefits of the Applied Asset Purchase, including expected operational, research and development and cost synergies, or such benefits may not be achieved within the anticipated timeframe. In addition, in connection with the Applied Asset Purchase, we acquired control of the manufacturing of our CellerateRX Surgical and HYCOL products, which was previously controlled by the Sellers. If we are unable to maintain or replace the Sellers’ manufacturing process, our sales of CellerateRX Surgical and HYCOL products could be jeopardized.

Furthermore, we have incurred significant transaction costs in connection with the Applied Asset Purchase, including payment of certain fees and expenses incurred in connection with the Applied Asset Purchase and the financing of the Applied Asset Purchase, and our future financial results could be impacted if the intangible assets we acquired in the Applied Asset Purchase become impaired. The failure to realize the anticipated benefits of the Applied Asset Purchase or any of our other recent acquisitions could cause an interruption of, or a loss of momentum in, our operations and could result in a material adverse effect on our financial condition, results of operations or cash flows.

Our indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations.

A significant portion of our future cash flow is required to pay interest and principal on our outstanding indebtedness, and we may be unable to generate sufficient cash flow from operations, or have future borrowings available, to enable us to repay our indebtedness or to fund other liquidity needs. Among other consequences, this indebtedness could:

• require us to use a significant percentage of our cash flow from operations for debt service and the satisfaction of repayment obligations, and not for other purposes, such as funding working capital and capital expenditures or making future acquisitions;
• cause our interest expense to increase if there is a general increase in interest rates, because a portion of our indebtedness bears interest at floating rates;
• limit our flexibility in planning for or reacting to changes in our business and limit our ability to exploit future business opportunities; and
• cause us to be more highly leveraged than some of our competitors, which may place us at a competitive disadvantage.

Our outstanding indebtedness is subject to certain operating and financial covenants that restrict our business and financing activities and may adversely affect our cash flow and our ability to operate our business.

The Loan Agreement requires us and SMAT, to maintain compliance with certain operating and financial covenants, which provide that we or SMAT, among other things, may not, subject to certain exceptions:

• create or permit the existence of additional liens on our assets;
• enter into any pledge agreements or arrangements;
• with respect to SMAT, make investments in or provide capital contributions to other entities;
• enter into a merger or consolidation or acquire any assets outside of the ordinary course of business;
• dispose of a material part of our assets or property or enter into any sale-leaseback transactions;
• with respect to SMAT, pay dividends or distributions of our capital stock, without the prior written consent of the Bank;
• make or permit to remain outstanding any loans;
• change the nature of our business;
• enter into transactions with affiliates other than in the ordinary course of business on an arm’s-length basis; or
• amend, modify or obtain or grant a waiver of any provision of any document or instrument evidencing or securing any of our subordinated indebtedness.

In addition, starting with the quarter ending September 30, 2023, SMAT is required to maintain a minimum Debt Service Coverage Ratio of 1.2 to 1.0, which ratio is calculated as of the last day of the applicable fiscal quarter. SMAT is also required to maintain as of the end of each fiscal quarter a maximum Cash Flow Leverage Ratio of not more than (a) 4.5 to 1.0 as of the last day of the fiscal quarter ending on September 30, 2023, (b) 4.0 to 1.0 as of the last day of each fiscal quarter ending on December 31, 2023, and March 31, 2024, (c) 3.5 to 1.0 as of the last day of each fiscal quarter ending on June 30, 2024, and September 30, 2024, and (d) 3.0 to 1.0 as of the last day of each fiscal quarter thereafter.

Further, in the event that SMAT fails to comply with its financial covenants, we are required to contribute cash to SMAT in an amount equal to the amount required to satisfy the financial covenants. During the three months ended September 30, 2023, we contributed an immaterial amount of cash to SMAT to ensure that SMAT was in compliance with the financial covenants under the Loan Agreement as of September 30, 2023. If we are required to make additional cash contributions to SMAT in future periods, we may not have sufficient funds available to fulfill such obligation.

A breach of any of the covenants under our loan agreements, subject to certain cure periods, will result in an event of default, which could cause all of our outstanding indebtedness under the Loan Agreement to become immediately due and payable, and a default interest rate of an additional 5.0% per annum may be applied to the outstanding loan balance. If our indebtedness is accelerated, we cannot be certain that we will have sufficient funds available to pay the accelerated indebtedness or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all.

As a result of the negative covenants contained in the Loan Agreement and the need for cash to pay interest and principal amortization payments required under the Loan Agreement, the Company may not have access to cash it otherwise would have for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes.

Pursuant to the Loan Agreement, SMAT is subject to restrictions on making certain payments, including dividends, other distributions and loans, to the Company. As a result, although SMAT may use its cash to repay the Term Loan, the Company may not have access to cash it otherwise would have for working capital, capital expenditures, acquisitions, general corporate purposes or other purposes.

If our Executive Chairman ceases to serve as the Chairman of the Board of Directors of the Company or SMAT, such event could result in an event of default under the Loan Agreement.

The Loan Agreement provides that if Ron Nixon, our Executive Chairman, ceases to serve as Chairman of the Board of Directors of the Company or SMAT, an event of default will occur under the Loan Agreement, unless a successor, acceptable to the Bank, is elected or appointed within 10 business days of such event. If such an event were to occur and we are unable to find a replacement suitable to the Bank, we would be in default and all of our outstanding indebtedness could become immediately due and payable, and a default interest rate of an additional 5.0% per annum may be applied to the outstanding loan balance.