SBC Medical Group Holdings Inc: Form 10-Q for the period ended Sep 30, 2024

The following discussion and analysis summarize the significant factors affecting our operating results, financial condition, liquidity, and cash flows for the periods presented below. The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q (this “Quarterly Report”).

Unless the context otherwise requires, any reference in this section of this Quarterly Report to “SBC,” “we,” “us” or “our” refers to SBC Medical Group, Inc. (formerly known as SBC Medical Group Holdings Incorporated) prior to the consummation of the Business Combination and to the Combined Entity and its consolidated subsidiaries following the Business Combination.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report contains forward-looking statements. Forward-looking statements are not historical facts or statements of current conditions, but instead represent only the Company’s beliefs regarding future events and performance, many of which, by their nature, are inherently uncertain and outside of the Company’s control. These forward-looking statements reflect the Company’s current views with respect to, among other things, the Company’s financial performance; growth in revenue and earnings; business prospects and opportunities; and capital deployment plans and liquidity. In some cases, forward-looking statements can be identified by the use of words such as “may,” “should,” “expects,” “anticipates,” “contemplates,” “estimates,” “believes,” “plans,” “projected,” “predicts,” “potential,” or “hopes” or the negative of these or similar terms. The Company cautions readers not to place undue reliance upon any forward-looking statements, which are current only as of the date of this Quarterly Report and are subject to various risks, uncertainties, assumptions, or changes in circumstances that are difficult to predict or quantify. The forward-looking statements are based on management’s current expectations and are not guarantees of future performance. The Company does not undertake or accept any obligation to release publicly any updates or revisions to any forward-looking statements to reflect any change in its expectations or any change in events, conditions, or circumstances on which any such statement is based, except as required by law. Factors that may cause actual results to differ materially from current expectations may emerge from time to time, and it is not possible for the Company to predict all of them; such factors include, among other things, changes in global, regional, or local economic, business, competitive, market and regulatory conditions, and those listed under the heading “Risk Factors” and elsewhere in the Company’s filings with the SEC, which are accessible on the SEC’s website at www.sec.gov (http://www.sec.gov).

Overview

SBC Medical Group, Inc. (formerly known as SBC Medical Group Holdings Incorporated), a Delaware corporation and subsidiary of the Company (“Legacy SBC”) is a management company headquartered in Irvine, California and Tokyo, Japan, that provides management services to cosmetic treatment centers mainly in Japan. The Company and its subsidiaries are primarily focused on providing comprehensive management services to franchisee clinics, including but not limited to advertising and marketing needs across various platforms (such as social media networks), staff management (such as recruitment and training), booking reservations for franchisee clinic customers, assistance with franchisee employee housing rentals and facility rentals, construction and design of franchisee clinics, medical equipment and medical consumables procurement (resale), the provision of cosmetic products to franchisee clinics for resale to clinic customers, licensure of the use of patent-pending and non-patented medical technologies, trademark and brand use, IT software solutions (including but not limited to remote medical consultations), management of the franchisee clinic’s customer rewards program (customer loyalty point program), and payment tools for the franchisee clinics.

Our wholly owned subsidiaries, SBC Medical Group Co., Ltd., a Japan corporation (“SBC Medical Sub”, L’Ange Cosmetique Co., Ltd., a Japan corporation (“Lange Sub”), and Shobikai Co., Ltd., a Japan corporation (“Shobikai Sub”), are each designated as a “medical service corporation” in Japan. In Japan, a medical service corporation is a legal entity that provides management service to “medical corporations”. The management services are conducted through franchisor-franchisee contracts and/or service contracts between certain subsidiaries of the Company (SBC Medical Sub, Lange Sub, and Shobikai Sub) and the medical corporations that own all 224 of the treatment centers in Japan as of September 30, 2024, which operate under the brand name “Shonan Beauty Clinic”. These clinics provide include but are not limited to breast augmentation, liposuction, rejuvenation treatments (including treatment of wrinkles, acne, scars, cellulite, excess fat, discoloration, and signs of aging), laser skin toning and spot removal, eyes double fold surgery, rhinoplasty, treatment of osmidrosis and hyperhidrosis, hair transplants, gynecological formation treatments, laser hair removal, face line surgeries, cosmetical dental procedures, tattoo removal, lasik eye surgery, lateral canthoplasty, brow lift procedures, androgenetic alopecia treatment, and cheek sagging prevention methods.

There are currently six medical corporations that the Company’s subsidiaries have entered into franchisor-franchisee contracts and service contracts, consisting of Medical Corporation Shobikai, Medical Corporation Kowakai, Medical Corporation Nasukai, Medical Corporation Aikeikai, Medical Corporation Jukeikai and Medical Corporation Ritz Cosmetic Surgery. In addition, the Company has entered into service contracts since September 2023 with two additional medical corporations, Medical Corporation Association Furinkai and Medical Corporation Association Junikai (collectively with the six franchisee medical corporations, the “Medical Corporations” or “MCs”). All of the Medical Corporations are deemed to be related parties of the Company since relatives of the CEO of the Company are the members (or shain) of general meetings of members of the Medical Corporations. The CEO of the Company was previously a member of the six franchisee Medical Corporations until he ceased being a member in July 2023. The Company, through SBC Medical Sub, owns equity “deposit” interests (or mochibun) of the Medical Corporations (except Medical Corporation Association Furinkai and Medical Corporation Association Junikai). Although the Company, through SBC Medical Sub, has an equity “deposit” interest to the rights to receive a distribution of residual assets in proportion to the amount of contribution in certain circumstances as provided in the articles of incorporation of each of the Medical Corporations (except Medical Corporation Association Furinkai and Medical Corporation Association Junikai), the Company or SBC Medical Sub does not have voting control over the corporate actions at general meetings of members (or shain) of the Medical Corporations per the requirements of the Japanese Medical Care Act.

For the three months ended September 30, 2024 and 2023, we generated revenues of $53,084,883 and $47,278,685, respectively, we reported net income attributable to SBC Medical Group Holdings Incorporated of $2,832,894 and $8,356,414, respectively. For the nine months ended September 30, 2024 and 2023, we generated revenues of $160,995,005 and $131,192,729, respectively, we reported net income attributable to SBC Medical Group Holdings Incorporated of $40,075,054 and $25,027,776, respectively, and cash flow provided by operating activities of $27,886,231 and $22,753,983, respectively. As of September 30, 2024, we had retained earnings of $182,923,786.

Our primary mission is to provide quality comprehensive management services to the Medical Corporations and expand our “Shonan Beauty Clinic” brand. We plan to achieve the mission by maintaining and strengthening our market position and brand in the cosmetic medical treatment management market in Japan, Vietnam, and the United States, and by growing our presence globally.

Results of Operations

Comparison of Results of Operations for the Three Months Ended September 30, 2024 and 2023

The following table summarizes our operating income as reflected in our unaudited consolidated statements of operations and comprehensive income for the three months ended September 30, 2024 and 2023, and presents information regarding amounts and percentage changes during those periods.

Revenues, Net

Revenues, net generated from different revenue streams consist of the following:

Revenues, net, increased by 12.28% from $47,278,685 for the three months ended September 30, 2023 to $53,084,883 for the three months ended September 30, 2024.

Japanese Yen (“JPY”) against the U.S. dollar slightly depreciated for the three months ended September 30, 2024, compared to the three months September 30, 2023. For the three months ended September 30, 2024 and 2023, we generated net revenues of $53,084,883 (JPY7,908 million) and $47,278,685 (JPY6,718 million), respectively, we reported net income of $2,834,467 (JPY389 million) and $8,057,791 (JPY1,149 million), respectively. Overall, the unfavorable impacts of the period-to-period foreign exchange rate changes on net revenues was $2,570,776 and favorable impact on net income was $108,549, for the three months ended September 30, 2024.

The main reasons for the variance of $5,806,198 in revenues, net per revenue stream are as follows:

Royalty income

Royalty income for the three months ended September 30, 2024 increased to $15,688,528 by $7,081,529, or 82.28%, from $8,606,999 for the same period in 2023. This increase was mainly due to authorizing the six MCs, which are our main recurring customers, to use our patents and trademarks starting from September 2023, as well as the business expansion of the MCs.

Procurement services

The procurement services revenue for the three months ended September 30, 2024 increased to $17,571,299 by $8,611,610, or 96.12%, from $8,959,689 for the same period in 2023. This increase was mainly due to the increased demand on advertising services and medical materials due to the business expansion of MCs.

Management services

The management services revenue for the three months ended September 30, 2024 decreased to $12,110,764 by $10,858,423, or 47.27%, from $22,969,187 for the same period in 2023. This decrease was mainly due to the revenue generated by dispatching staff to MCs to provide clinic operation services were discontinued since September 2024, because the Company plans to merge Shobikai Sub to another subsidiary and the related license, held by Shobikai Sub, to conduct such staff dispatching business will be invalid after the merger.

Rental services

The rental services revenue for the three months ended September 30, 2024 increased to $4.124,774 by $2,786,971, or 208.32%, from $1,337,803 for the same period. This increase was mainly due to the increased demand for medical equipment from MCs due to the business expansion of MCs.

Others

The other revenues for the three months ended September 30, 2024 decreased to $3,589,518 by $1,815,489, or 33.59%, from $5,405,007 for the same period in 2023. This decrease was mainly due to the decrease in demand for leasehold improvement services.

Cost of Revenues

Cost of revenues for the three months ended September 30, 2024 was $9,845,793 compared to $13,780,309 for the same period in 2023. The decrease was mainly due to the discontinuation of clinic operation staff supporting services provide by Shobikai Sub to MCs since September 2024, and the Company then terminated the employment of the related staff. As a result, labor cost significantly decreased.

Gross Profit

Gross profit for the three months ended September 30, 2024 was $43,239,090 compared to $33,498,376 for the same period in 2023. The increase in gross profit by $9,740,714 or 29.08% was mainly due to the increase in royalty income and procurement services with a relatively high gross margin as a result of the factors described above, offset by the decrease in management services revenue as a result of the factors described above.

Operating Expenses

Operating expenses for the three months ended September 30, 2024 and 2023 were as follows:

The operating expenses increased to $29,404,487 for the three months ended September 30, 2024 by $15,929,353, or 118.21%, from $13,475,134 for the same period in 2023. The increase was mainly due to the increase in stock-based compensation, the increase in consulting and professional service fees and the increase in office, utility and other expenses, partially offset by the decrease in depreciation and amortization expenses.

Stock-based compensation relate to the warrants issued to the service provider that supported SBC’s listing process. These warrants were issued in November 2022 and became exercisable upon the consummation of business combination with Pono Two Capital, Inc., and the fair value was recognized as an expense.

Consulting and professional service fees increased by $4,157,001, or 455.20%, to $5,070,231 for the three months ended September 30, 2024 from $913,230 for the same period in 2023, mainly due to the increase of the professional service fees incurred related to the business combination transaction.

Office, utility and other expenses increased by $1,175,844, or 94.40%, to $2,421,455 for the three months ended September 30, 2024 from $1,245,611 for the same period in 2023, mainly due to the insurance expense recognized due to the decrease in the cash surrender values of the corporate-owned life insurance policies and administrative expenses increased in preparation for the listing.

Depreciation and amortization expense decreased by $2,204,482, or 76.30%, to $684,926 for the three months ended September 30, 2024 from $2,889,408 for the same period in 2023, mainly because the decrease in amortization expense incurred from the intangible assets owned by Cell Pro Japan Co., Ltd.(“Cellpro”), a former subsidiary of the Company, due to the disposal of Cellpro on January 1, 2024.

Other Income (Expenses)

Other income (expenses) for the three months ended September 30, 2024 and 2023, were as follows:

In particular, the other income was $65,922 for the three months ended September 30, 2024, as compared to $1,138,869 for the three months ended September 30, 2023, mainly due to the income from the surrender of life insurance policies. The other expense was $795,158 for the three months ended September 30, 2024, as compared to $98,314 for the three months ended September 30, 2023, mainly due to the increase in unrealized loss from the Company’s investment in a public entity with readily determinable fair value.

Income Tax Expense

Income tax expense for the three months ended September 30, 2024 was $10,273,384 compared to $13,012,262 for the same period in 2023. The decrease in income tax expense by $2,738,878 or 21.05% was mainly due to the impact of a temporary increase in listing-related expenses recorded in conjunction with the listing. The decrease was in line with the decrease in income before tax generated by the major operating entities in the three months ended September 30, 2024 as compared with September 30, 2023.

The effective tax rate was 78.38% and 61.76% for the three months ended September 30, 2024 and 2023, respectively. The decrease of 16.62 percentage points was mainly due to the recognition of stock-based compensation of $12,807,455 in the three months ended September 30, 2024 while no such expense was recorded in the three months ended September 30, 2023.

Net Income

As a result of the foregoing, we reported a net income of $2,834,467 for the three months ended September 30, 2024, representing a decrease of $5,223,324 or 64.82% from $8,057,791 for the three months ended September 30, 2023.

Net Income (Loss) Attributable to Non-controlling Interests

Net income attributable to non-controlling interests was $1,573 for the three months ended September 30, 2024, as compared to a net loss attributable to non-controlling interests of $298,623 for the three months ended September 30, 2023, mainly due to the disposal of Cellpro on January 1, 2024.

Comparison of Results of Operations for the Nine Months Ended September 30, 2024, and 2023

The following table summarizes our operating income as reflected in our consolidated statements of operations and comprehensive income for the nine months ended September 30, 2024 and 2023, and presents information regarding amounts and percentage changes during those periods.

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Revenues, Net

Revenues, net generated from different revenue streams consist of the following:

Revenues, net, increased by 22.72% from $131,192,729 for the nine months ended September 30, 2023 to $160,995,005 for the nine months ended September 30, 2024.

Japanese Yen (“JPY”) against the U.S. dollar depreciated during the nine months ended September 30, 2024, compared to the nine months ended September 30, 2023. For the nine months ended September 30, 2024 and 2023, we generated net revenues of $160,995,005 (JPY24,331 million) and $131,192,729 (JPY18,118 million), respectively, we reported net income of $40,142,008 (JPY6,067 million) and $24,330,964 (JPY3,360 million), respectively. Overall, the unfavorable impacts of the period-to-period foreign exchange rate changes on net revenues and net income were $15,184,893 and $3,786,155, respectively, for the nine months ended September 30, 2024.

The main reasons for the variance of $29,802,276 in revenues, net per revenue stream are as follows:

Royalty income

The royalty income for the nine months ended September 30, 2024 increased to $45,425,052 by $19,979,012, or 78.52%, from $25,446,040 for the same period in 2023. This increase was mainly due to (i) a change in the billing base of royalty fees from a percentage of sales of MCs to a fixed amount for each clinic of MCs since April 2023 combined with an increase in the number of clinics operated by MCs, (ii) authorizing the six MCs, which are our main recurring customers, to use our patents and trademarks starting from September 2023, and (iii) the business expansion of the MCs, partially offset by the depreciation of JPY.

Procurement services

The procurement services revenue for the nine months ended September 30, 2024 increased to $44,303,891 by $9,640,957, 27.81%, from $34,662,934 for the same period in 2023. This increase was mainly due to the increase in the demand on medical materials due to the business expansion of MCs, partially offset by the depreciation of JPY.

Management services

The management services revenue for the nine months ended September 30, 2024 decreased to $44,471,031 by $9,222,917, or 17.18%, from $53,693,948 for the same period in 2023. This decrease was mainly due to (i) the discontinuation of clinic operation staff supporting services provided by Shobikai Sub to MCs since September 2024 and (ii) the depreciation of JPY, partially offset by (i) the increase in revenue generated from management consulting services and loyalty program management services provided to two MCs that the Company started to conduct business since September 2023 (Medical Corporation Association Furinkai and Medical Corporation Association Junikai), (ii) the business expansion of MCs and (iii) the increase in the number of the clinics of MCs.

Rental services

The rental services revenue for the nine months ended September 30, 2024 increased to $11,195,888 by $6,514,675, or 139.17%, from $4,681,213 for the same period in 2023. This increase was mainly due to the increased demand for medical equipment from MCs due to the business expansion of MCs, partially offset by the depreciation of JPY.

Others

The other revenues for the nine months ended September 30, 2024 increased to $15,599,143 by $2,890,549, or 22.74%, from $12,708,594 for the same period in 2023. This increase was mainly due to the business expansion of the subsidiary acquired in 2023, partially offset by the depreciation of JPY.

Cost of Revenues

Cost of revenues for the nine months ended September 30, 2024 was $38,816,865 compared to $37,256,066 for the same period in 2023. Even though revenue increased by $29,802,276, or 22.72%, for the nine months ended September 30, 2024 compared to same period in 2023, cost of revenues only increase by $1,560,799 or 4.19% mainly due to the Company’s effort of the cost reduction for the nine months ended September 30, 2024, as well as the revenue generated by providing clinic operation supporting services by Shobikai Sub to MCs were discontinued since September 2024, and the Company then terminated the employment of the related staff. As a result, labor cost significantly decreased.

Gross Profit

Gross profit for the nine months ended September 30, 2024 was $122,178,140 compared to $93,936,663 for the same period in 2023. The increase in gross profit by $28,241,477 or 30.06% was mainly due to the increase in royalty income and procurement services with a relatively high gross margin as a result of the factors described above, offset by the decrease in management services revenue as a result of the factors described above.

Operating Expenses

Operating expenses for the nine months ended September 30, 2024 and 2023 were as follows:

The operating expenses increased to $56,592,092 for the nine months ended September 30, 2024 by $9,326,188, or 19.73%, from $47,265,904 for the same period in 2023. The increase was mainly due to the increase in stock-based compensation and the increase in consulting and professional service fees, partially offset by the decrease in depreciation and amortization expenses.

Stock-based compensation related to the warrants issued to the service provider that supported our listing process. These warrants were issued in November 2022 and became exercisable upon the consummation of business combination with Pono Two Capital, Inc., and the fair value is recognized as an expense.

Consulting and professional service fees increased by $4,378,501, or 74.20%, to $10,279,107 for the nine months ended September 30, 2024 from $5,900,606 for the same period in 2023, mainly due to the increase of the professional service fees incurred related to the business combination transaction.

Depreciation and amortization expense decreased by $6,751,582, or 77.93%, to $1,912,284 for the nine months ended September 30, 2024 from $8,663,866 for the same period in 2023, mainly because the decrease in amortization expense incurred from the intangible assets owned by Cellpro, a former subsidiary of the Company, due to the disposal of Cellpro on January 1, 2024.

Other Income (Expenses)

Other income (expenses) for the nine months ended September 30, 2024 and 2023, were as follows:

In particular, other income was $721,894 for the nine months ended September 30, 2024, as compared to $3,875,723 for the same period in 2023, mainly due to the income from surrender of life insurance policies; other expenses was $2,746,450 for the nine months ended September 30, 2024, as compared to $581,239 for the nine months ended September 30, 2023, mainly due to the unrealized loss from the Company’s investment in a public entity with readily determinable fair value; and gain on disposal of subsidiary was $3,813,609 for the nine months ended September 30, 2024, as compared to nil for the same period in 2023, mainly due to the disposal of Cellpro on January 1, 2024.

Income Tax Expense

Income tax expense, for the nine months ended September 30, 2024, was $27,254,478 compared to $25,683,244 for the same period in 2023. The increase in income tax expense by $1,571,234 or 6.12% was mainly due to an increase in income before tax of the major operating entities as a result of an increase in related-party revenues compared to the same period in 2023.

The effective tax rate was 40.44% and 51.35% for the nine months ended September 30, 2024 and 2023, respectively. The decrease of 10.91 percentage points was mainly due to the $8.7 million enterprise tax paid by the Company in the nine months ended September 30, 2024, which is tax deductible, while only $3 million enterprise tax was paid in the nine months ended September 30, 2023.

Net Income

As a result of the foregoing, we reported a net income of $40,142,008 for the nine months ended September 30, 2024, representing an increase of $15,811,044, or 64.98%, from $24,330,964 for the nine months ended September 30, 2023.

Net Income (Loss) Attributable to Non-controlling Interests

Net income attributable to non-controlling interests was $66,954 for the nine months ended September 30, 2024, as compared to a net loss attributable to non-controlling interests of $696,812 for the nine months ended September 30, 2023, mainly due to the disposal of Cellpro on January 1, 2024.

Liquidity and Sources of Funds

As of September 30, 2024, the Company had $137,393,070 in cash and cash equivalents compared to $103,022,932 as of December 31, 2023. In addition, the Company had $29,779,783 in accounts receivable as of September 30, 2024 compared to $35,113,749 as of December 31, 2023. The Company’s accounts receivable includes balances due from customers for the services and goods provided by the Company and accepted by customers.

As of September 30, 2024, the Company’s working capital balance was $129,679,294. In assessing liquidity, management monitors and analyzes the Company’s cash and cash equivalents, ability to generate sufficient future earnings, and operating and capital investment commitments. The Company believes that its current cash and cash equivalents from operations and borrowings from banks will be sufficient to meet its working capital needs for the next 12 months from the date of issuance of the unaudited financial statements included in this Quarterly Report.

To the extent additional funds are necessary to meet our long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through the incurrence of indebtedness, equity financings or a combination of these potential sources of funds. While we face uncertainties regarding the size and timing of our fundraising, which will be affected by general economic, financial, and other factors that may be beyond our control, we believe that we will be able to continue to meet our current business needs through the use of cash flows generated from operations and stockholder working capital, as needed.

The Company evaluates its capital allocation practices with the objective of enhancing shareholder value, while considering performance, the business environment, macroeconomic conditions and other relevant factors. The Company expects to deploy capital for investment opportunities that align with its growth strategy, selectively pursuing prospects in the expanding global medical aesthetics market.

Cash Flows for the nine months ended September 30, 2024 and 2023

The following table provides a summary of our cash flows for the periods indicated.

Operating Activities

Net cash provided by operating activities for the nine months ended September 30, 2024 was $27,886,231 as compared to the amount of $22,753,983 net cash provided by operating activities for the nine months ended September 30, 2023, reflecting an increase of $5,132,248. The increase was mainly due to an increase in net income of $15.8 million and stock-based compensation of $12.8 million, and increase in changes in accounts receivable - related parties of $25.0 million, customer loans receivable of $12.9 million and accrued retirement compensation expense - related party of $22.1 million, and offset by a decrease in changes in finance lease receivables - related parties of $20.7 million, accounts payable of $17.2 million, notes payable - related parties of $14.0 million, accrued liabilities and other current liabilities of $9.3 million and income tax payable of $17.1 million.

Investing Activities

During the nine months ended September 30, 2024, net cash used in investing activities of $5,554,039 was mainly the result of purchase of property and equipment of $2.0 million, purchase of convertible note of $1.7 million, disposal of subsidiary, net of cash disposed of $0.8 million, and payments made on behalf of a related party of $5.2 million, and offset by repayment from related parties of $6.0 million. During the nine months ended September 30, 2023, net cash provided by investing activities of $8,659,196 was mainly the result of proceeds from disposal of property and equipment of $8.0 million, proceeds from sales of short-term investments of $4.1 million, and proceeds from surrender of life insurance policies of $4.0 million, and offset by purchase of property and equipment of $2.3 million, purchase of short-term investments of $2.1 million, purchase of intangible assets of $1.7 million, purchase of convertible note of $1.0 million, and advances to related parties of $1.0 million.

Financing Activities

During the nine months ended September 30, 2024, net cash provided by financing activities of $11,584,038 was mainly due to the proceeds from recapitalization of Pono Shares net of transaction costs of $11.7 million. During the nine months ended September 30, 2023, net cash provided by financing activities of $6,262,589 was the result of borrowings from related parties of $12.3 million, deemed contribution in connection with disposal of property and equipment of $9.6 million, and offset by repayments of long-term loans of $8.7 million and repayments to related parties of $7.6 million.

Recent Developments

On November 12, 2024, the Company entered into an agreement to acquire 100% equity interest of Aesthetic Healthcare Holdings, a company incorporated in Singapore and principally engaged in medical aesthetics business, with a cash consideration of approximately SGD$7.8 million (equivalent to approximately US$6.0 million). As of the date of this report, the transaction has not yet been completed.

Misappropriations of Funds and Restatements

In January 2024, in connection with a routine tax examination of the Company’s income tax returns, the Japanese tax authority discovered misappropriations of Company funds by a former director of general affairs and legal department of L’Ange Cosmetique Co., Ltd., which is a subsidiary of the Company (the “former director”), not a relative of the CEO of the Company or any identified related party, who received kickbacks from multiple vendors of SBC Japan (collectively with the former director, the “participants”) possibly beginning as early as 2012 until the misappropriations were discovered. The former director was suspended immediately upon the discovery and was terminated effective February 23, 2024. The Company has commenced a criminal complaint in Tokyo against the participants.

Shortly after this discovery, the Company engaged independent legal counsel and forensic consultants to investigate the misappropriations. The investigation, which was completed in March 2024, revealed that the participants had misappropriated approximately JPY632 million ($5.6 million), including consumption tax, from the Company of which the former director received approximately JPY335 million ($3.0 million), between April 2016 and the discovery of the misappropriations in January 2024. The amount misappropriated prior to April 2016 could not be accurately determined because certain data for the period prior to April 2016 was unavailable, the Company does not expect such amount to be material based on current estimates.

The Company found no evidence that any other employee of the Company was aware of, or colluded in, the misappropriations of Company funds or that there was any unlawful activity apart from that associated with the participants’ misappropriations of Company funds. The misappropriated amounts, excluding the consumption tax, representing advertising services purchased on behalf of a related-party MC, were originally included in the revenues reported on a net basis. After discovery of the misappropriations, the amounts were restated as a misappropriation loss.

The Company has restated its previously reported consolidated balance sheets as of December 31, 2022 and 2021, and the related consolidated statements of operations and comprehensive income (loss) and cash flows for the years then ended, based on the results of its investigation and substantive validation procedures. The Company has also restated its previously reported unaudited consolidated balance sheets for the nine months ended September 30, 2023 and 2022 and for the six months ended June 30, 2023 and 2022, and the related unaudited consolidated statements of operations and comprehensive income (loss) and cash flows for the periods then ended.

Contractual Obligations

Lease Agreements

The Company has seventy-two leases classified as operating leases for offices and sublease purposes.

As of September 30, 2024, the future maturity of lease liabilities is as follows:

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Bank and Other Borrowings

The Company borrowed loans from various banks and a financial institution for working capital purpose.

As of September 30, 2024, future minimum borrowing payments are as follows:

Off-Balance Sheet Arrangements (Off-Balance Sheet Transactions)

There are no off-balance sheet arrangements as of September 30, 2024 and December 31, 2023.

Foreign Exchange Rate Risk

We are exposed to foreign currency exchange rate fluctuations because our business is primarily conducted in Japan and most of our revenues and costs are denominated in Japanese yen, whereas our reporting currency is U.S. dollar. The weakening of the Japanese yen against the U.S. dollar would have a negative impact on our financial results and vice versa.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experiences and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates. Some of our accounting policies require a higher degree of judgment than others in their application and require us to make significant accounting estimates. We believe that critical accounting policies as disclosed in this Quarterly Report reflect the more significant judgements and estimates used in preparation of our consolidated financial statements.

The following descriptions of critical accounting policies and estimates should be read in conjunction with our consolidated financial statements and other disclosures included in this Quarterly Report. When reviewing our consolidated financial statements, you should consider our selection of critical accounting policies, the judgments and other uncertainties affecting the application of such policies and the sensitivity of reported results to changes in conditions and assumptions.

Revenue Recognition

The Company recognizes revenue from franchising services, procurement services, management services and other services under ASC Topic 606, “Revenue from Contracts with Customers”.

To determine revenue recognition for contracts with customers, the Company performs the following five steps: (i) identify the contract(s) with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the respective performance obligations in the contract, and (v) recognize revenue when (or as) the Company satisfies the performance obligation. Revenue amount represents the invoiced value, net of consumption tax and applicable local government levies, if any. The consumption tax on sales is calculated at 10% of gross sales. The Company does not have significant remaining unfulfilled performance obligations or contract balances.

The Company reports revenue on a gross or net basis based on management’s assessment of whether the Company acts as a principal or agent in the transaction. The determination of whether the Company acts as a principal or an agent in a transaction is based on the evaluation of whether (i) the Company is primarily responsible for fulfilling the promise to provide the specified goods or service, (ii) the Company has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer and (iii) the Company has discretion in establishing the price for the specified good or service. If the terms of a transaction do not indicate the Company is acting as a principal in the transaction, then the Company is acting as an agent in the transaction and the associated revenues are recognized on a net basis.

The Company recognizes revenue from rental services under ASC Topic 842, “Leases”.

The Company currently generates its revenue from the following main sources:

Franchising Revenue

The Company generates franchising revenue (royalty income) by licensing its intellectual properties, including but not limited to the Company’s brand name (“Shonan Beauty Clinic”), trade name, patents, and trademarks, as a franchisor pursuant to franchise agreements with certain MCs (the “MCs”) in Japan. Prior to April 2023, royalty income is based on a percentage of sales and recognized at the time when the related sales occurred; since April 2023, it is based on a fixed amount to each clinic of the MCs; since September 2023, it is based on a fixed amount to each MC and a fixed amount to each clinic of the MCs and recognized over time as services are rendered.

Procurement Services Revenue

The Company generates procurement services revenue by purchasing primarily advertising services and medical materials from qualified vendors on behalf of MCs to maintain brand quality consistency. Procurement services revenue is recognized at the point in time upon the delivery of products or over time as services are performed. Occasionally, the Company receives vendor discounts on certain large purchases. It recognizes revenue based on actual payments and will return the over-collection resulting from such discounts to MCs.

Management Services Revenue

The Company provides loyalty program management services, labor supporting services, function supporting services and management consulting services to MCs.

• Loyalty program management services

The Company awards loyalty points on behalf of MCs to MCs’ customers, who earn loyalty points from each qualified purchase made at the loyalty program participating clinics of MCs, in exchange for a handling fee. The revenue is based on a percentage of the related payment amount made by MCs’ customers and is recognized when the loyalty points are awarded.

At the time loyalty points are awarded, a MC pays the Company cash in an amount equivalent to the awarded loyalty points, which is recorded as advances from customers. When a MC’s customers redeem the loyalty points, the Company returns the cash back to the MC in an amount equivalent to the redeemed loyalty points. The awarded loyalty points expire if a MC’s customer does not make any additional qualified purchase at a participating clinic within a year. The Company accumulates and tracks the points on behalf of MCs until the loyalty points expire, at which time the Company recognizes an amount equivalent to the expired loyalty points as revenue, which is normally not significant.

The Company also awards certain points to MCs’ customers on behalf of MCs for free in order to increase the volume of MC’s sales, from which the Company earns other types of revenues, such as royalty income. When a MC’s customers redeem such points, the Company reimburses MC in an amount equivalent to the used free points and records it as a reduction of the revenue recognized.

The Company is an agent in the management of loyalty programs, and as a result, revenues are recognized net of the cost of redemptions.

• Labor supporting services

The Company generates revenue by dispatching staff to MCs to provide a range of services, primarily including clinic operation, IT, and administrative services. The Company recognizes the revenue over the time when services are rendered.

• Function supporting services

The revenue is derived from providing functional supporting services to MCs, such as accounting and human resources services. The Company recognizes the revenue over the time when services are rendered.

• Management consulting services

The Company generates revenue by providing consulting services to MCs in relation to business operations of cosmetic dermatology. The Company recognizes the revenue over the time when services are rendered.

Rental Services Revenue

The Company generates rental income from operating leases and sales-type leases, which is accounted for under ASC Topic 842. Operating lease revenue is generally recognized on straight-line basis over the terms of the lease agreements and sales-type leases revenue is generally recognized on the lease commitment date.

Other Revenues

The Company generates other miscellaneous revenues such as medicine dispensed sales revenue, brokerage services revenue, construction services revenue, pilot training services revenue, interest income, etc. These revenues are recognized when the Company satisfies performance obligations.

Long-term Investments in MCs — Related Parties

Long-term investments in MCs — related parties represent the payments to obtain equity interests of the MCs in Japan, made by the Company through SBC Japan, a company designated as a MSC in Japan. In accordance with the Japanese Medical Care Act and articles of incorporation of the MCs, which are non-profit organizations, the equity interest holders of MCs are prohibited from receiving any profit distribution from MCs but have the right to receive distribution of the residual assets of the MCs in proportion to the amount of their contribution. As of the balance sheet dates, the investments represent probable future benefit to be realized at the time of dissolution of MCs or the equity interests being sold. The payments made for such investments are classified as investing activities in the consolidated statements of cash flows. The MCs are considered related parties as the relatives of the Chief Executive Officer (“CEO”) of the Company being the Members of the MCs.

The investments in MCs — related parties are accounted for using a measurement alternative, under which the investments are measured at cost, less impairment, and adjusted for observable price changes. The Company reviews the investments in MCs for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, especially the investments in Medical Corporation Jukeikai (“MC Jukeikai”) and Medical Corporation Ritz Cosmetic Surgery (“MC Ritz”), which represent the vast majority of the Company’s investments in MCs balance.

Impairment Consideration of Investments in MC Jukeikai and MC Ritz

Although these two MCs are non-profit entities, their principal operations are providing health care services and they derive primary source of their revenue from the sale of goods and services, rather than the fund contributions.

No indicator of impairment was noticed based on the Company’s qualitative assessment of impairment. As the Company provides comprehensive management services to these two MCs, including accounting and bookkeeping services, the Company has access to MCs’ unaudited financial information. In addition to the external market conditions and trends within the MCs’ industry, the Company considered the MCs’ operating performance, such as sales, increase in sales, and net income (loss) when performing its qualitative assessment. As of December 31, 2023, the carrying value of the investments in the two MCs was higher than their net assets, respectively, because the Company acquired the equity interests with the considerations paid higher than the net asset values at the respective purchase dates due to the expected growth and expansion of the MCs. The two MCs have been generating net income since the acquisition dates through the year ended December 31, 2022. During the year ended December 31, 2023, as part of their plan of expansion, the MCs opened several new clinics and incurred one-time expenses to set up those clinics and more selling, general, and administrative expenses, such as payroll, rent, and advertising expenses. The net losses incurred by the two MCs for the year ended December 31, 2023 associated with the opening of new clinics are considered temporary. The Company expects that the MCs’ sales will grow gradually over the next few years and that the MCs will be able to generate net income in the next one to two years. As of December 31, 2023, the Company did not observe any other-than-temporary impairment indicators.

For management’s additional internal analysis purposes, the Company estimates the residual values of the two MCs at dissolution when needed, using the income approach with the discounted cash flow method, which estimates the fair values of the MCs by the present worth of the net economic benefit to be received by MCs. Management applies significant judgment and assumptions related to estimation, including but not limited to the forecasted revenues, the selection of an expected EBITDA margin assumption for the forecast period, forecasted future cash flows, and the discounted rate. The Company currently expects the residual values at the dissolution of the MCs will not be less than the carrying values of the investments in MCs. The management is not aware of any legal or regulatory limitations on the Company’s ability to realize the full amount of proceeds generated from a liquidation of the MCs.

Stock-based Compensation

The Company accounts for stock-based compensation awards in accordance with ASC Topic 718, “Compensation — Stock Compensation”, under which the Company determines whether stock-based compensation awards should be classified and accounted for as an equity award. There were no liability awards granted during any of the periods stated herein. For all grants of stock-based compensation classified as equity awards, the cost of services received from employees and non-employees in exchange for awards is recognized in the consolidated statements of operations and comprehensive income based on the estimated fair value of those awards on the grant date and amortized on a straight-line basis over the requisite service period or vesting period. The Company records forfeitures and cancellations as they occur.

The Company, with the assistance of an independent valuation specialist, determined the fair value of the warrants recognized in the consolidated financial statements using the binomial option pricing model, and the equity value as of the grant date was estimated using 1) income approach with the discounted cash flow valuation method, which requires management to make significant estimates and assumptions related to forecasted revenues and cash flows and the discount rates, and 2) market approach with metrics of publicly traded companies or historically completed transactions of comparable businesses. The Company applied a weighting to the income approach and market approach to determine the fair value. We believe the accounting estimate for valuation of stock-based compensation is a critical accounting estimate because our estimates of fair value of stock-based compensation are based upon assumptions believed to be reasonable, but which are inherently uncertain and, as a result, actual results may differ from estimates.

Emerging Growth Company

We are an “emerging growth company,” as defined in Section 2(a) of the Securities Act, as modified by the JOBS Act, and we will take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. We have elected not to opt out of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard.

Smaller Reporting Company

Additionally, we are a “smaller reporting company,” as defined in Item 10(f)(1) of Regulation S-K. Smaller reporting companies may take advantage of certain reduced disclosure obligations, including, among other things, providing only two years of audited financial statements. We will remain a smaller reporting company until the last day of the fiscal year in which (i) the market value of our common stock held by non-affiliates exceeds $250 million as of the last business day of our second fiscal quarter, or (ii) our annual revenue exceeded $100 million during such completed fiscal year and the market value of our common stock held by non-affiliates exceeds $700 million as of the last business day of our second fiscal quarter. If we continue to be a smaller reporting company at the time we cease to be an emerging growth company, we may continue to rely on exemptions from these certain reduced disclosure requirements that are available to smaller reporting companies.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information otherwise required under this item.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report. Based on this evaluation, management concluded that our disclosure controls and procedures were not effective as of September 30, 2024 to provide reasonable assurance that information required to be disclosed in periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Specifically, as previously disclosed, as of the fiscal year ended December 31, 2023, and as described below, we identified material weaknesses in our internal control over financial reporting.

Despite the identified material weaknesses, we believe that our condensed consolidated financial statements and other information contained in this Quarterly Report fairly present, in all material respects, our business, financial condition, and results of operations for the periods presented.

We remain committed to ongoing improvements in our disclosure controls and internal control over financial reporting, as outlined in the remediation plan below.

Material Weakness

A material weakness is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis.

In connection with the discovery of the misappropriations of funds as described in more details under “—Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Misappropriations of Funds and Restatements”, we have identified material weaknesses as of December 31, 2023, which remain un-remediated as of September 30, 2024, in our internal control over financial reporting resulting from our failure to maintain an effective control environment, risk assessment processes and monitoring activities.

Our system of internal control failed to detect the misappropriations of funds due to the following material weaknesses of SBC Medical Group, Inc. (formerly known as SBC Medical Group Holdings Incorporated), a Delaware corporation and subsidiary of the Company:

1. Control Environment. We did not maintain an effective control environment that fully emphasized the establishment of adherence to effective internal control over financial reporting throughout SBC Medical Group, Inc.’s management. We did not give sufficient consideration to the risk of senior management override of internal control. SBC Medical Group, Inc. had not ensured that certain personnel were adequately trained to properly execute critical internal control.

2. Control Activities. We did not effectively implement or maintain control activities, such as ensuring a sufficient functioning of the mechanism of reconciliation of invoices to contracts and multi-level approvals of contracts, invoices and payments. SBC Medical Group, Inc. did not maintain sufficient segregation of duties with respect to certain activities of its former director of the general affairs and legal department at L’Ange Cosmetique Co., Ltd. SBC Medical Group, Inc. did not maintain adequate monitoring and oversight of the activities of our former director permitting the misappropriation of assets by the former director.

3. Risk Assessment. We did not have an effective risk assessment process and the related documentation.

4. Information and Communication. We did not adequately communicate to all employees of the organization information regarding the importance of internal control over financial reporting and employees’ duties and responsibilities, including segregation of duties.

5. Monitoring Activities. We did not maintain effective monitoring controls related to the evaluation and testing of our internal control over financial reporting.

In addition, the Company completed its business combination in September 2024. Prior to the business combination, the Company operated as a private corporation with limited accounting personnel and supervisory resources necessary to support its accounting processes and address its internal control over financial reporting requirements. As a result, the existing internal control are no longer sufficient to meet the post-business combination financial reporting demands, and the Company is actively updating these controls. The design and implementation of internal control over financial reporting in a post-business combination environment has required, and will continue to require, significant time and resources from management and other personnel.

During the process of assessing the Company’s internal control, management identified the following additional material weaknesses in our internal control over financial reporting:

• Lack of well-established procedures to identify, approve and report related party transactions.
• Lack of sufficient financial reporting and accounting personnel to formalize, design, implement and operate key controls over financial reporting process in order to report financial information in accordance with U.S. GAAP and SEC reporting requirements.
• Lack of well-established procedures to ensure all the services provided by subcontractors or vendors are reviewed and verified before the approval of payments.
• Lack of well-established procedures to prevent and detect fraudulent transactions or override of control activities, specifically failure to maintain sufficient segregation of duties with respect to certain activities of its former director of general affairs and legal department of one of its subsidiaries and failure to maintain adequate monitoring and oversight of the work performed by this former director.

Remediation Plan

With respect to the material weaknesses identified in connection with the misappropriations of funds, management has implemented, or is in the process of implementing, the following changes to SBC Medical Group, Inc.’s internal control systems and procedures:

• We established a related party policy in September 2024 to identify, approve, and report related party transactions; and implemented the corresponding procedures since November 2024.
• We will clarify the organization structure and employee positions promoting (i) segregation of duties, (ii) monitoring and oversight, (iii) reconciliation of invoices to contracts and (iv) multi-level approvals of contracts, invoices and payments.
• We will communicate to all employees of the organization information regarding the importance of internal control and employees’ duties and responsibilities, including segregation of duties.

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• We have initiated a project led by our Chief Officer of Internal Control and Internal Audit Office, and aided by outside consultants, to fully document our processes to serve as the basis for activities during 2024 to assess our fraud risks and evaluate and test our internal control over financial reporting.
• We have updated our delegation of authority over our banking activities, and are establishing a treasury function that will improve the segregation of duties surrounding the general manager role to better safeguard cash.

Furthermore, management is fully committed to addressing the control deficiencies that contributed to the material weaknesses in a post-business combination environment. The steps we have already taken in 2024, and those we plan to take in 2025, are as follows:

• We added accounting and finance personnel to strengthen our team. This has allowed us to enhance segregation of duties in the preparation and review of financial reporting, while improving oversight, structure, and reporting lines.
• We have improved our controls related to the preparation and review of complex accounting measurements, the application of GAAP, and our financial statement disclosures. We believe that this will ensure more accurate and timely reporting.
• We have engaged external consultants with expertise in SOX (The Sarbanes-Oxley Act of 2002) compliance to assist us in the design, implementation, and documentation of internal control that address key financial reporting risks. These consultants will also help ensure appropriate evidence of the performance of our controls, including the accuracy and completeness of financial data.

As applicable to each material weakness, the material weaknesses will not be considered remediated until our remediation plans have been fully implemented, the applicable controls operate for a sufficient period of time, and we have concluded, through testing, that the newly implemented and enhanced controls are operating effectively. Under the direction of our Audit Committee, management will continue to enhance corporate oversight at the process level, ensuring proper assignment of authority, responsibility, and accountability. We anticipate completing the implementation of key control enhancements by the end of 2025, which we expect to further strengthen our financial reporting oversight. Furthermore, we believe these efforts will remediate the identified material weakness and substantially improve our internal control over financial reporting.

We have continued the process of, and are focused on, further enhancing effective internal control measures to improve our internal control over financial reporting and to remediate the identified material weakness. We are committed to the continuous improvement of our internal control over financial reporting and will continue to diligently review our internal control over financial reporting. As we continue to evaluate and refine our internal control over financial reporting, we may adjust our remediation plans or take additional steps to address control deficiencies as necessary.

Inherent Limitation on the Effectiveness of Internal Control

The effectiveness of any system of internal control over financial reporting is subject to inherent limitations. These include the exercise of judgment in designing, implementing, and operating controls, as well as the inherent inability to completely eliminate the risk of misconduct or error. Accordingly, while we aim to establish robust controls, any system, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Additionally, the design of our disclosure controls and procedures is impacted by resource constraints and the necessity for management to balance the benefits of potential controls against their associated costs. Moreover, projections of effectiveness into future periods are subject to risks that controls may become inadequate over time due to evolving conditions or diminished compliance. We will continue to monitor and enhance our internal control as necessary or appropriate, but we cannot provide assurance that these improvements will fully eliminate all risks of material misstatement.

Changes in Internal Control over Financial Reporting

Other than the remediation efforts described above, there have been no material changes in our internal control over financial reporting during the three months ended September 30, 2024, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Investing in our Common Stock involves a high degree of risk. These risks are more fully described in the section titled “Risks Related to SBC” included in the Definitive Proxy Statement filed with the SEC on August 12, 2024 (the “Proxy Statement”) in addition to the information in this Quarterly Report. Any of these factors could result in a material adverse effect on our results of operations or financial condition.

There have been no material changes to the risk factors set forth in the Proxy Statement, which are incorporated herein by reference.

The risk factors described or incorporated by reference in this Quarterly Report are not the only risks that we face. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations. If any such risks materialize, it could have a material adverse effect on our business, financial condition, results of operations, and growth prospects and cause the trading price of our Common Stock to decline. We may disclose changes to such risk factors or disclose additional risk factors from time to time in our future filings with the SEC.