iSpecimen Inc.: Form 10-Q for the period ended Jun 30, 2023

References in this report (the “Quarterly Report”) to “we,” “us” or the “Company” refer to iSpecimen Inc. The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the financial statements and the notes thereto contained elsewhere in this Quarterly Report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties.

Special Note Regarding Forward-Looking Statements

This Quarterly Report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are not historical facts and involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. All statements, other than statements of historical fact included in this Quarterly Report including, without limitation, statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding the Company’s financial position, business strategy and the plans and objectives of management for future operations, are forward-looking statements. Words such as “expect,” “believe,” “anticipate,” “intend,” “estimate,” “seek” and variations and similar words and expressions are intended to identify such forward-looking statements. Such forward-looking statements relate to future events or future performance, but reflect management’s current beliefs, based on information currently available. A number of factors could cause actual events, performance, or results to differ materially from the events, performance and results discussed in the forward-looking statements. For information identifying important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements, please refer to the “Risk Factors” section of Amendment No. 1 to the Company’s Annual Report on Form 10-K/A filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 30, 2023. The Company’s securities filings can be accessed on the EDGAR section of the SEC’s website at www.sec.gov (http://www.sec.gov). Except as expressly required by applicable securities law, the Company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Overview

We were incorporated in 2009 under the laws of the state of Delaware. Our mission is to accelerate life science research and development via a single global marketplace platform, the iSpecimen Marketplace, which connects researchers to subjects, specimens, and associated data. We are headquartered in Lexington, Massachusetts. We operate as one operating and reporting segment.

The iSpecimen Marketplace is an automated search and request platform for researchers seeking human biospecimens, and a full suite of fulfillment and management tools for biospecimen providers. The platform taps into information management systems found in biobanks and laboratories for specimen data, and electronic Medical Records to gain insights into the patient populations to support specimen collections directly from research subjects.

Researchers can search this data using our intuitive web-based user interface to obtain specimens more efficiently. They can instantly find the specific specimens they need for their studies, request quotes for these specimens or for custom collections directly from research subjects, place orders, and track and manage their specimens and associated data across projects.

Biospecimen providers also gain efficiencies using the iSpecimen Marketplace, not only because the platform provides instant access to a large researcher base, but because the technology orchestrates the bioprocurement workflow from specimen request to fulfillment. Specimen providers can access intuitive dashboards to view requests, create proposals, and track and manage their orders.

Finally, the platform helps with administrative and reporting functions for researchers, suppliers, and our internal personnel, including user and compliance management.

The iSpecimen Marketplace is composed of four major functional areas: search, fulfillment, data, and administrative reporting. We continue to invest in the evolution of these areas to improve engagement with the platform and liquidity across it. Our core business objective is to retain and grow both researcher and supplier usage of our platform to support biospecimen procurement, as well as to position the Company to explore other adjacent business opportunities that can benefit from the use of the iSpecimen Marketplace.

The iSpecimen Marketplace currently supports the supply chain management and bioprocurement process for specimens and associated data. We generate revenue by procuring various specimens from hospitals, laboratories, and other supply sites, which comprise our global network, and delivering them to our medical research customers using our proprietary software. Costs paid to acquire specimens from hospitals and laboratories generally vary depending upon the sample type, collection requirements, and data provided. We generally operate in a “just in time” fashion, meaning we procure specimens from our suppliers and distribute specimens to our customers after we obtain an order for specimens from a research client. Generally, we do not speculatively purchase and bank samples in anticipation of future, unspecified needs. We believe our approach offers many advantages over a more traditional inventory-based supplier business model. In a fast-paced industry where personalized and precision medicine are growing at extraordinary rates, having access to hundreds of biorepositories to source supplies of biospecimens, rather than being limited to sourcing such biospecimens from a limited number of biorepositories under our management, substantially reduces the risks associated with a limited source of supply and provides us with the ability to avoid many of the operational constraints inherent in an industry where inventory turnover and cash conversion cycles can be lengthy.

Impact of the Current Economy

The Company’s financial performance is subject to global economic conditions and their impact on levels of spending by our customer research organizations, particularly discretionary spending for procurement of specimens used for research. Economic recessions may have adverse consequences across industries, including the health and bio-specimen industries, which may adversely affect our business and financial condition. We increased our allowance for doubtful accounts in accounts receivables by $261,610 during the six months ended June 30, 2023 due to a few boutique life sciences customers that have filed for bankruptcy. We have enhanced procedures related to our credit check process for new and existing customers in fiscal year 2023 to mitigate the risk to future collectability of receivables.

Changes in general market, economic and political conditions in domestic and foreign economies or financial markets, including fluctuation in stock markets resulting from, among other things, trends in the economy and inflation, as are being currently experienced, may result in a reduction in researchers’ demand for specimens due to the research organization’s inability to obtain funding.

To further address the current market conditions, the Company has taken steps, which include but are not limited to, reevaluating its pricing in order to be more competitive, creating campaigns to highlight and fast-track high demand items, and enhancing internal team communications to accelerate the sales cycle.

We believe that our business will continue to be resilient through a continued economic downturn or recession, or slowing or stalled recovery therefrom, and that we have the liquidity to address our financial obligations and alleviate possible adverse effects on our business, financial condition, results of operations or prospects.

Impact of the Russian-Ukrainian War on Our Operations

Our business was negatively impacted during the first half of 2022 by the ongoing war between Russia and Ukraine. At the start of the war, we had approximately $1 million of purchase orders that were slated to be fulfilled by our supply network in Ukraine and Russia. This supply network was shut down at the start of the war. Ukrainian suppliers were disabled due to war conditions and evacuations and some of our Russian suppliers were disabled by sanctions. While we mobilized to shift these purchase orders to other suppliers in the network, the process of getting specimen collections from other supply sites took time, which caused a delay in the fulfillment of such purchase orders. Alternate suppliers do not have the same favorable unit economics or specimen collection rates, and this impacted our margins. Additionally, key resources were diverted from operations to resolving the re-fulfillment issues caused by the conflict.

As of June 30, 2023, our supply sites in Russia that had not been under sanctions were accessible and our supply sites in Ukraine were mostly reopened. However, logistics and transportation of specimens out of the country of Ukraine remains challenging and not as economically feasible as they were prior to the beginning of the war. Due to the uncertainty caused by the ongoing war, Ukrainian and Russian suppliers may again become inaccessible to us. Therefore, as long as the uncertainty continues, our policy is to ensure at a purchase order level that an order is not solely sourced from the two countries. The short and long-term implications of the war are difficult to predict as of the filing date of this report. The imposition of more sanctions and counter sanctions may have an adverse effect on the economic markets generally and could impact our business and the businesses of our supply partners, especially those in Ukraine and Russia. Because of the highly uncertain and dynamic nature of these events, it is not currently possible to estimate the impact of the war on our business and the companies from which we obtain supplies and distribute specimens.

Known Trends, Demands, Commitments, Events or Uncertainties Impacting Our Business

Chief Executive Officer Initiatives

Under the direction of Ms. Curley, our Chief Executive Officer, the Company’s mission to accelerate life sciences research and development, pursuant to a single global marketplace platform, remains unchanged from that of prior management. Ms. Curley continues to review the Company’s structure, processes, and resources to evaluate and identify areas for improvement, and has been focused on creating and ensuring a runway for growth and scale for our business. The focus of our activities is directed at increasing our revenue in the second half of 2023 with new revenue enhancement initiatives that are underway and increasing our cross-functional team communications to help improve execution.

One of our key new revenue enhancement initiatives is to identify, through sequencing runs, high value cancer patients which possess specific mutations in donor FFPE blocks. We have invested in active repetitive screening to create a virtual inventory available for our research customers in areas of high value. This initiative is extremely valuable, not only to our business, but we believe, for the entire industry. The power of our supplier network makes this initiative possible and when paired with the search functionality of our proprietary iSpecimen Marketplace, it provides an easier solution than what currently exists in our industry. We have successfully launched our first pilot and anticipate a modest level of revenue from this initial sequencing run, starting at the end of the third quarter of 2023. This is the first of several sequencing runs we anticipate performing throughout 2023 for this initiative.

Ms. Curley has also reviewed our technology roadmap and has been green-lighting projects to accelerate development timelines. We are committed to investing in and developing our technology. In the six months ended June 30, 2023, we capitalized approximately $2,732,000 of internally developed software costs with plans to invest at lower levels for the remainder of the year. We anticipate that these investments will increase revenue opportunities and result in operational efficiencies, positively impacting our liquidity, capital resources and results of operations in the future with a less than two-year rate of return on the investment.

We have identified and are addressing opportunities to match specimen requests more effectively to the inventory and capabilities of our supplier network. We believe that during the second half of 2023, this will result in an increase in the utilization rate of our supplier network, which currently is heavily skewed toward the top 10-15% of our suppliers. Our initiative designed to reduce or eliminate supplier concentration is underway. We expect the re-leveling of our network will result in higher match rates, market depth and improved time-to-match.

Our iSpecimen Marketplace Onsite Program, which offers additional support to our biospecimen provider partners, is underway and we have begun to appoint iSpecimen Marketplace Onsite coordinators, whose responsibility is to field all requests made by the provider partner and submit proposals on behalf of the provider partner, resulting in streamlined sample-related management and reducing strain on existing staff and product pipelines.

Market Conditions

In order to address a downturn in the industry that impacted our financial results during the three months ended June 30, 2023, we have revised our sales approach as detailed below, which we believe, will put us in a better position, to obtain favorable results faster for the remainder of 2023 and also recognize revenue more in line with historical levels. The majority of our customers are economically impacted by the availability of funding. We believe that the reduction in revenue in the second quarter was a result of the potential of a global economic slowdown at the end of the first quarter and that uncertainty negatively impacted on the equity markets for our industry. These economic challenges negatively impacted spending by our customers, having a direct effect on our revenue results for the second quarter of 2023. Specifically, in the second quarter of 2023, we experienced a substantial decline in the receipt of purchase orders from our customers. Due to this decline in purchase orders from customers, we also experienced a lower backlog of purchase orders compared to prior quarters. This adversely impacted on our ability to fulfill orders and generated lower levels of revenue in the second quarter of 2023.

During the second quarter of 2023 we focused on launching several new initiatives with the express purpose of increasing our success rates for converting quotes to secured purchase orders, with the goal of reinstating our fulfillment of orders to the levels achieved in quarters prior to the second quarter of 2023. By the end of the second quarter of 2023, we began to see the results of those efforts as evidenced by an increase in the level of our backlog compared to the beginning of the second quarter of 2023. Based on the increase in our backlog by the end of the second quarter, we believe that this downturn in revenue for the second quarter of 2023 represents a temporary downturn and that we have taken the required actions to address these issues which, we believe, will allow us to achieve better results for the third quarter of 2023 and beyond.

Mitigating Concentration Risks – Cash

As of December 31, 2022, we maintained all of our cash with one financial institution and our cash balance with this financial institution was in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limit. If this bank fails in the future, we may not be able to immediately (or ever) recover our cash in excess of the FDIC insured limits which would adversely impact our operating liquidity and could negatively impact our operations, results of operations and financial performance.

Since the March 2023 failure and FDIC takeover of Silicon Valley Bank and the inability of its customers to readily access their cash deposits, there has been a heightened risk and greater focus on the potential failures of other banks in the future. In order to reduce the risks associated with maintaining all of our cash at a single bank, we have diversified our holdings by purchasing U.S Treasury bills at a different financial institution. As of June 30, 2023, we had a balance of approximately $6.2 million of U.S. Treasury bills at a financial institution that is different from where our cash is held. The Company will continue to assess other opportunities to ensure the safeguarding of our assets.

Components of Our Results of Operations

Revenue

We generate revenue by procuring various specimens from hospitals, laboratories, and other supply sites for our medical research customers using our proprietary software, the iSpecimen Marketplace, to identify, locate, and ultimately validate the required specimens to our customers’ requested specifications. The Company’s performance obligation is to procure a specimen meeting the customer specification(s) from a supplier, on a “best efforts” basis, for our customer at the agreed price per specimen as indicated in the customer contract with the Company. We do not currently charge suppliers or customers for the use of our proprietary software. Each customer will execute a material and data use agreement with the Company or agree to online purchase terms, each of which includes terms such as specimen and data use, shipment terms, payment, and cancellation terms. These are then supplemented by purchase orders that specify specimen requirements including detailed inclusion/exclusion criteria, quantities to be collected, and pricing. Collectively, these customer agreements represent the Company’s contracts with its customer. Generally, contracts have fixed unit pricing. For certain specimen orders, a refundable customer deposit may be required prior to order fulfillment depending on project set-up requirements, presented as deferred revenue. The Company expects to recognize the deferred revenue within the next twelve months.

We recognize revenue over time, as we have created an asset with no alternative use and we have an enforceable right to payment for performance completed to date. At contract inception, we review a contract and related order upon receipt to determine if the specimen ordered has an alternative use to us. Generally, specimens ordered do not have an alternative future use to us and our performance obligation is satisfied when the related specimens are accessioned. We use an output method to recognize revenue for specimens with no alternative future use. The output is measured based on the number of specimens accessioned.

Customers are typically invoiced upon shipment. Depending on the quantity of specimens ordered, it may take several accounting periods to completely fulfill a purchase order. In other words, there can be multiple invoices issued for a single purchase order, reflecting the specimens being accessioned over time. However, specimens are generally shipped as soon as possible after they have been accessioned.

Cost of Revenue

Cost of revenue primarily consists of the purchase price to acquire specimens from hospitals and laboratories, inbound and outbound shipping costs, supply costs related to samples, payment processing and related transaction costs, and costs paid to the supply sites to support sample collections. Shipping costs upon receipt of products from suppliers are recognized in cost of revenue.

Technology

Technology costs include payroll and related expenses for employees involved in the development and implementation of our technology, software license and system maintenance fees, outsourced data center costs, data management costs, depreciation and amortization, and other expenses necessary to support technology initiatives. Collectively, these costs reflect the efforts we make to offer a wide variety of products and services to our customers. Technology and data costs are generally expensed as incurred.

A portion of technology costs are related to research and development. Costs incurred for research and development are expensed as incurred, except for software development costs that are eligible for capitalization. Research and development costs primarily include salaries and related expenses, in addition to the cost of external service providers.

Sales and Marketing

Sales and marketing costs primarily consist of payroll and related expenses for personnel engaged in marketing and selling activities, including salaries and sales commissions, travel expenses, public relations, and social media costs, ispecimen.com website development and maintenance costs, search engine optimization fees, advertising costs, direct marketing costs, trade shows and events fees, marketing and customer relationship management software, and other marketing-related costs.

Supply Development

We have agreements with supply partners that allow us to procure specimens from them and distribute these samples to customers. Supply development costs primarily include payroll and related expenses for personnel engaged in the development and management of this supply network, related travel expenses, regulatory compliance costs to support the network, and other supply development and management costs.

Fulfillment

Fulfillment costs primarily consist of those costs incurred in operating and staffing operations and customer service teams, including costs attributable to assess the feasibility of specimen requests, creating and managing orders, picking, packaging, and preparing customer orders for shipment, responding to inquiries from customers, and laboratory equipment and supplies.

General and Administrative

General and administrative expenses primarily consist of costs for corporate functions, including payroll and related expenses for human resources, legal, finance, and executive teams, associated software licenses, facilities, and equipment expenses, such as depreciation and amortization expense and rent, outside legal expenses, insurance costs, and other general and administrative costs.

Financial Operations Overview and Analysis for the Three and Six Months Ended June 30, 2023 and 2022 (Unaudited)

Comparison of the Three Months Ended June 30, 2023 and 2022

Revenue

Revenue decreased by approximately $714,000, or 31%, from approximately $2,339,000 for the three months ended June 30, 2022 to approximately $1,625,000 for the three months ended June 30, 2023. This was primarily due to a decrease of 2,322, or 33%, in specimen count from 7,004 specimens in the three months ended June 30, 2022 to 4,682 specimens in the three months ended June 30, 2023. The effect of the decrease in specimen count was offset by a change in the specimen mix which caused the average selling price per specimen to increase by $13, or 4%, from approximately $334 in the three months ended June 30, 2022 to $347 in the three months ended June 30, 2023.

Cost of Revenue

Cost of revenue decreased by approximately $146,000, or 15%, from approximately $1,000,000 for the three months ended June 30, 2022 to approximately $854,000 for the three months ended June 30, 2023, which was attributable to a 33% decrease in the number of specimens accessioned for the current period compared to the same period in the prior year, offset by a $40 or 28% increase in the average cost per specimen.

Technology

Technology expenses increased by approximately $207,000, or 33% from approximately $636,000 for the three months ended June 30, 2022 to approximately $843,000 for the three months ended June 30, 2023. The increase was related to increases in headcount and payroll and related expenses of approximately $75,000, amortization of internally developed software of approximately $234,000, offset by decreases in professional fees unrelated to internally developed software of approximately $99,000 and in general and administrative expenses of approximately $3,000.

Sales and Marketing Expenses

Sales and marketing expenses increased by approximately $27,000, or 3%, from approximately $951,000 for the three months ended June 30, 2022 to approximately $978,000 for the three months ended June 30, 2023. The increase was attributable to increases due to hiring more sales personnel, professional fees of approximately $72,000, payroll and related expenses of approximately $58,000, travel expenses of approximately $6,000, offset by a decrease in external marketing expenses of approximately $109,000.

Supply Development

Supply development expenses increased by approximately $49,000, or 20%, from approximately $242,000 for the three months ended June 30, 2022 to approximately $291,000 for the three months ended June 30, 2023. The increase was primarily attributable to increases in professional fees of approximately $104,000, offset by decreases in payroll and related expenses of approximately $53,000, and travel expenses of approximately $2,000.

Fulfillment

Fulfillment costs decreased by approximately $57,000, or 11%, from approximately $520,000 for the three months ended June 30, 2022 to approximately $463,000 for the three months ended June 30, 2023. The decrease was primarily attributable to decreases in payroll and related expenses of approximately $69,000 for personnel engaged in pre-sales feasibility assessments and post-sales fulfillment activities, offset by an increase in operating expenses of approximately $12,000.

General and Administrative Expenses

General and administrative expenses increased by approximately $183,000, or 12%, from approximately $1,575,000 for the three months ended June 30, 2022 to approximately $1,758,000 for the three months ended June 30, 2023. The increase was attributable to increases in directors’ and officers’ insurance of approximately $157,000, professional fees of approximately $123,000, depreciation expenses of $33,000, advertising expense of approximately $15,000, utilities and facilities expenses of approximately $4,000, offset by decreases in payroll and related expenses of approximately $125,000, and travel expense of approximately $24,000.

Other Income (Expense), Net

Other income (expense), net, increased by approximately $100,000, or 459%, from approximately $22,000 of other expense net, for the three months ended June 30, 2022 to approximately $78,000 of other income, net, for the three months ended June 30, 2023. The increase in other income (expense), net, was attributable to increases in interest income of approximately $97,000, and a decrease in interest expense of approximately $39,000, offset by an increase in other expense of approximately $36,000.

Comparison of the Six Months Ended June 30, 2023 and 2022

Revenue

Revenue decreased by approximately $282,000, or 6%, from approximately $4,857,000 for the six months ended June 30, 2022 to approximately $4,575,000 for the six months ended June 30, 2023. This was primarily due to a decrease in average selling price per specimen of $64, or 16%, from approximately $407 in the six months ended June 30, 2022 to $343 in the six months ended June 30, 2023. The decrease in average selling price per specimen was offset by an increase of 1,383, or 12%, in specimen count from 11,928 specimens in the six months ended June 30, 2022 to 13,311 specimens in the six months ended June 30, 2023.

Cost of Revenue

Cost of revenue decreased by approximately $165,000, or 8%, from approximately $2,166,000 for the six months ended June 30, 2022 to approximately $2,001,000 for the six months ended June 30, 2023, which was attributable to a 17% decrease in the average cost per specimen impacted by the specimen mix during the six month period ended June 30, 2023 over the same period in 2022, offset by a 12% increase in the number of specimens accessioned during the six months ended June 30, 2023 over the same period in the prior year.

Technology

Technology expenses increased by approximately $515,000, or 44%, from approximately $1,163,000 for the six months ended June 30, 2022 to approximately $1,678,000 for the six months ended June 30, 2023. The period over period increase was related to increases in

payroll and related expenses of approximately $178,000 and in amortization of approximately $402,000, offset by decreases in general operating expense of approximately $39,000 and professional fees of approximately $26,000.

Sales and Marketing Expenses

Sales and marketing expenses increased approximately $327,000, or 19%, from approximately $1,698,000 for the six months ended June 30, 2022 to approximately $2,025,000 for the six months ended June 30, 2023. The period over period increase was primarily attributable to an increase in payroll and related expenses of approximately $372,000, and an increase in general operating expenses related to sales and marketing of approximately $168,000, offset by a decrease in external marketing expense of approximately $213,000.

Supply Development

Supply development expenses increased approximately $191,000, or 45%, from approximately $424,000 for the six months ended June 30, 2022 to approximately $615,000 for the six months ended June 30, 2023. The period over period increase was primarily attributable to increases in professional fees of approximately $263,000 and general supply development expenses of approximately $6,000, offset by a decrease in payroll and related expenses of approximately $78,000.

Fulfillment

Fulfillment costs decreased approximately $72,000, or 7%, from approximately $964,000 for the six months ended June 30, 2022 to approximately $892,000 for the six months ended June 30, 2023. The decrease was primarily attributable to a decrease in payroll and related expenses of approximately $86,000 for personnel engaged in pre-sales feasibility assessments and order fulfillment, offset by an increase in general operating expenses related to fulfillment of approximately $14,000.

General and Administrative Expenses

General and administrative expenses increased approximately $84,000, or 2%, from approximately $3,386,000 for the six months ended June 30, 2022 to approximately $3,470,000 for the six months ended June 30, 2023. The period over period increase was attributable to increases in professional fees of approximately $164,000, directors’ and officers’ insurance of approximately $72,000, and depreciation expense of approximately $67,000, offset by decreases in compensation costs of approximately $135,000, software costs of approximately $81,000, and general operating expenses of approximately $3,000.

Other Income (Expense), net

Other income (expense), net, increased by approximately $236,000, or 500%, from approximately $47,000 of other expense net, for the six months ended June 30, 2022 to approximately $189,000 of other income, net, for the six months ended June 30, 2023. The increase in other income (expense), net, was attributable to increases in interest income of approximately $199,000, and a decrease in interest expense of approximately $73,000, offset by an increase in other expense of approximately $36,000.

Liquidity and Capital Resources

In November 2022, we paid off the outstanding principal balance of $3,500,000 and outstanding interests on our Term Loan. As of December 31, 2022, we had a balance of cash and cash equivalents of approximately $15,309,000. During the six months ended June 30, 2023, to reduce the risks associated with maintaining all our cash at a single bank, we diversified our cash into investments by purchasing U.S. Treasury bills with maturities ranging from one to six months. The U.S. Treasury bills have been classified as available-for-sale securities. As of June 30, 2023, we had a balance of cash and cash equivalents of approximately $2,000,000 and available-for-sale securities of approximately $6,200,000, with a sum of both classifications totaling approximately $8,200,000. We also had working capital of approximately $8,100,000 as of June 30, 2023, and no longer have any debt that could decrease our liquidity.

Since inception, we have relied upon raising capital to finance our operations. In the six months ended June 30, 2023, we invested approximately $2.7 million of cash on developing our Marketplace technology to bring it closer to revenue feasibility. We intend to continue to use our existing cash to further develop our technology, grow our supply network, increase our marketing and sales presence, scale our operations, and for working capital and general corporate purposes.

We believe our cash and cash equivalents, along with our available-for-sale securities, together with the anticipated cash flow from operations will be sufficient to meet our working capital, and capital expenditure requirements for at least the next 12 months. The liquidity we derive from cash flows from operations is, to a large degree, predicated on our ability to process our unbilled receivables and collect our receivables in a timely manner. In the event that revenue during the next 12 months continues to fall short of our projections or if our plans or assumptions change, including if inflation begins to have a greater impact on our business or if we decide to move forward with any activities that require more outlays of cash than originally planned, we may need to raise additional capital sooner than expected.

Our ability to obtain capital to implement our growth strategy over the longer term will depend on our future operating performance, financial condition and, more broadly, on the availability of equity and debt financing. Capital availability will be affected by prevailing conditions in our industry, the global economy, the global financial markets, and other factors, many of which are beyond our control. Specifically, as a result of recent volatility and weakness in the public markets, due to, among other factors, uncertainty in the global economy and financial markets, it may be much more difficult to raise additional capital, if and when it is needed, unless the public markets become less volatile and stronger at such time that we seek to raise additional capital. In addition, any additional debt service requirements we take on could be based on higher interest rates and shorter maturities and could impose a significant burden on our results of operations and financial condition, and the issuance of additional equity securities could result in significant dilution to stockholders.

Cash Flows

Operating Activities

For the six months ended June 30, 2023, net cash used in operating activities was approximately $4,519,000 which consisted of a net loss of approximately $5,915,000 offset by non-cash charges of approximately $1,420,000, which included $935,000 related to amortization of internally developed software, $245,000 in stock-based compensation, $262,000 in bad debt expense, and $76,000 related to depreciation and amortization of property and equipment, offset by $98,000 of amortization of discount on available-for-sale securities. Total changes in assets and liabilities of approximately $23,000 were attributable to a $122,540 increase in accounts receivable, a $679,143 decrease in accounts payable, a $649,000 decrease in accrued expenses, a $77,872 decrease in operating lease liability, a $42,734 decrease in deferred revenue, offset by a $1,229,433 decrease in accounts receivables-unbilled, a $112,665 decrease in prepaid expenses and other current assets, a $77,577 decrease in right-of-use asset, and a $128,541 decrease in tax credit receivable.

For the six months ended June 30, 2022, net cash used in operating activities was approximately $3,354,000, which consisted of a net loss of approximately $4,991,000 offset by non-cash charges of approximately $1,232,000, which included $533,000 related to amortization of internally developed software, $414,000 in stock-based compensation, $270,000 in bad debt expense, $9,000 related to depreciation and amortization of property and equipment, and $6,000 of amortization of discount on the Term Loan with the Lender. Total changes in assets and liabilities of approximately $405,000 were attributable to a $475,000 decrease in accounts receivable-unbilled, a $1,073,000 decrease in accounts receivable, partially offset by a $400,000 decrease in accounts payable, a $376,000 decrease in accrued expenses, a $320,000 decrease in deferred revenue, and a $48,000 increase in prepaid expenses and other current assets.

Investing Activities

Net cash used in investing activities was approximately $8,856,000 and $777,000 for the six months ended June 30, 2023 and 2022, respectively. Net cash used in investing activities for the six months ended June 30, 2023 consisted of $2,731,507 of capitalization of internally developed software, $7,642,929 of purchase of available-for-sale securities, and $13,745 of purchases of property and equipment, offset by $1,532,000 of proceeds from sale and maturities of available-for-sale securities. Net cash used in investing activities for the six months ended June 30, 2022 consisted of $777,181 of capitalization of internally developed software.

Financing Activities

Net cash provided by financing activities was approximately $71,000 and $83,000 for the six months ended June 30, 2023 and 2022, respectively. Net cash provided by financing activities for the six months ended June 30, 2023 consists of $71,000 received from the exercise of stock options. Net cash provided by financing activities for the six months ended June 30, 2022 consists of $77,000 received from the exercise of stock options and $6,250 proceeds from issuance of common stock in exchange for services.

Effects of Inflation and Supply Chain Shortages

Our operations are heavily reliant on specimen availability, and as a result, we often receive more requests than we can fulfill. While the Company is subject to these types of supply chain constraints that are specific to the specimen industry, we have not been affected by the more common supply chain issues currently affecting the economy, specifically surrounding transportation. Due to the small size of the packages that we ship, our carriers were able to continue making timely deliveries during the six months ended June 30, 2023.

We have experienced negative effects of inflation in certain areas of our business due to the high rates of inflation in the world’s current economy. This inflation is affecting employee salaries, which account for a significant portion of our operating costs. Additionally, the costs of supplies have been affected by inflation; however, these costs are not significant to the Company’s results.

Inflation has not had a significant impact on the cost of specimens due to our long-term contracts maintained with vendors, which include revenue sharing plans.

Non-GAAP Financial Measure

To supplement our financial statements, which are prepared and presented in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), we use adjusted earnings before interest, taxes, depreciation, and amortization (“Adjusted EBITDA”), a non-GAAP financial measure, to understand and evaluate our core operating performance. This non-GAAP financial measure, which may be different than similarly titled measures used by other companies, is presented to enhance investors’ overall understanding of our financial performance and should not be considered a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP.

We define our non-GAAP financial measure of Adjusted EBITDA as net loss, excluding income tax benefit, depreciation and amortization, stock-based compensation expense and interest expense.

We believe that Adjusted EBITDA provides useful information about our financial performance, enhances the overall understanding of our past performance and future prospects, and allows for greater transparency with respect to a key metric used by our management for financial and operational decision-making. We believe that Adjusted EBITDA helps identify underlying trends in our business that otherwise could be masked by the effect of the expenses that we exclude in Adjusted EBITDA. In particular, we believe the exclusion of the change in fair value of derivative liabilities on the bridge notes and convertible notes provides a useful supplemental measure in evaluating the performance of our operations and provides better transparency into our results of operations.

We are presenting the non-GAAP measure of Adjusted EBITDA to assist investors in seeing our financial performance through the eyes of management, and because we believe this measure provides an additional tool for investors to use in comparing our core financial performance over multiple periods with other companies in our industry.

Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of Adjusted EBITDA compared to net loss, the closest comparable GAAP measure. Some of these limitations are that:

• Adjusted EBITDA excludes certain recurring, non-cash charges such as depreciation of leasehold improvements, property and equipment and amortization of internally developed software and, although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;
• Adjusted EBITDA excludes stock-based compensation expense which has been, and will continue to be for the foreseeable future, significant recurring expenses in our business and an important part of our compensation strategy; and
• Adjusted EBITDA excludes amortization of debt issuance costs and discounts on convertible notes which are components of interest expense.

The following table presents a reconciliation of Adjusted EBITDA to net loss, the most comparable GAAP financial measure, for each of the periods presented:

Critical Accounting Policies

We have chosen accounting policies that we believe are appropriate to accurately and fairly report our operating results and financial condition in conformity with GAAP. We apply these accounting policies in a consistent manner. Our significant accounting policies are discussed in Note 2, “Summary of Significant Accounting Policies,” in our financial statements included in Amendment No. 1 to our Annual Report on Form 10-K/A for the year ended December 31, 2022.

The application of critical accounting policies requires that we make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. These estimates and assumptions are based on historical experience and other market-specific or other relevant assumptions that we believe to be reasonable under the circumstances. We evaluate these estimates and assumptions on an ongoing basis. If actual results ultimately differ from previous estimates, the revisions are included in results of operations in the period in which the actual amounts become known. The critical accounting policies that involve the most significant management judgments and estimates used in preparation of our financial statements or are the most sensitive to change from outside factors, are discussed in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Amendment No. 1 to the Company’s Annual Report on the Form 10-K/A for the year ended December 31, 2022. There have been no material changes in our critical accounting policies and procedures during the six months ended June 30, 2023.

JOBS Act Transition Period

On April 5, 2012, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies.

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 will adopt the new or revised standard at the time private companies adopt the new or revised standard and will do so until such time that we either (i) irrevocably elect to “opt out” of such extended transition period or (ii) no longer qualify as an emerging growth company.

We are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, as an “emerging growth company,” we intend to rely on certain of these exemptions, including without limitation, (i) providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002 and (ii) complying with any requirement that may be adopted by the PCAOB regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. We will remain an “emerging growth company” until the earliest of (i) the last day of the fiscal year in which we have total annual gross revenues of $1.235 billion or more; (ii) December 31, 2026; (iii) the date on which we have issued more than $1 billion in nonconvertible debt during the previous three years; or (iv) the date on which we are deemed to be a large accelerated filer under the rules of the SEC.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in our Exchange Act reports 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 or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the fiscal quarter ended June 30, 2023, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. These controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in the reports that we file or submit under the Exchange Act 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 principal executive officer and principal financial and accounting officer, in a manner to allow timely decisions regarding required disclosures. Based on this evaluation, management has concluded that our disclosure controls and procedures were not effective as of June 30, 2023 due to the following material weakness in internal control over financial reporting:

• The Company did not design and maintain adequate controls to maintain appropriate documentation for the tax exempt status of its customers, calculate and collect sales tax at point of sale, and subsequently report and remit in a timely manner to the relevant tax jurisdictions sales tax obligations.

Notwithstanding the existence of the material weakness described above, management believes that the condensed financial statements included in this Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows as of and for the periods presented, in conformity with GAAP.

Management’s Plan for Remediation

The material weakness described above was identified as a result of an entity-wide risk assessment process that commenced in the quarter ended June 30, 2023. The Company is in the process of implementing a remediation plan to improve our internal control over financial reporting and to remediate the related control deficiencies that led to the material weakness. In response to these deficiencies, management, with the oversight of the Audit Committee of the Board of Directors, has identified and implemented steps to remediate the material weakness.

The Company began implementing the remediation plan during the second quarter of fiscal 2023. The following remedial measures are designed to address the material weakness and to continue to improve our internal control over financial reporting.

• We have engaged external tax advisors to complement internal resources and efforts and provide support in assessing the appropriate sales tax treatment associated with the Company’s products for all prior years in which the Company had generated revenue, will implement a sales tax software platform solution for the calculation, collection, and remittance of sales tax for all non-exempt future sales, and assist with the collection and tracking of Voluntary Disclosure Agreements received from states where a potential tax liability may exist.
• We will design and implement enhanced policies, procedures and controls related to the calculation, collection, and remittance of sales tax to relevant jurisdictions.
• We will train appropriate personnel in the effective design and execution of our enhanced policies, procedures, and controls, including the importance of the ongoing, consistent effective execution of such procedures and controls.

We are committed to the remediation of the material weakness and expect to successfully implement enhanced control processes. However, as we continue to evaluate, and work to improve our internal control over financial reporting, management may determine that additional measures to address control deficiencies or modifications to the remediation plan are necessary. Therefore, we cannot assure you when we will be able to fully remediate such weakness, nor can we be certain that additional actions will not be required or what the costs may be of any such additional actions. Moreover, we cannot assure you that additional material weaknesses will not arise in the future.

Changes in Internal Control Over Financial Reporting

We are in the process of implementing certain changes to our internal controls to remediate the material weakness described above. Except as noted above, there were no changes in the Company’s internal control over financial reporting during the three months ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Other than as described below, there have been no material changes with respect to risk factors previously disclosed in Amendment No. 1 to the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2022, filed with the SEC on March 30, 2023.

We have identified a material weakness in our internal controls over financial reporting that may cause us to fail to meet our reporting obligations or result in material misstatements of our financial statements. If we fail to remediate a material weakness or if we otherwise fail to establish and maintain effective control over financial reporting, our ability to accurately and timely report our financial results could be adversely affected.

We are required to comply with the SEC’s rules implementing Sections 302 and 404 of the Sarbanes-Oxley Act, which requires management to certify financial and other information in our quarterly and annual reports and provide an annual management report on the effectiveness of our controls over financial reporting. Although we are required to disclose changes made in our internal controls and procedures on a quarterly basis, we are not required to make our first annual assessment of our internal controls over financial reporting pursuant to Section 404 until the later of (i) the year following our first annual report required to be filed with the SEC or (ii) the date we are no longer an emerging growth company. This assessment needs to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on the effectiveness of our internal control over financial reporting, provided that our independent registered public accounting firm is not required to attest to the effectiveness of our internal control over financial reporting until our first annual report required to be filed with the SEC, following the later of the date we are deemed to be an “accelerated filer” or a “large accelerated filer,” each as defined in the Exchange Act, or the date we are no longer an emerging growth company, as defined in the JOBS Act. We could be an emerging growth company for up to five years after the date of our initial public offering.

A material weakness is 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 the second quarter of 2023, the Company engaged external tax consultant advisors to complement internal resources and efforts to provide support in assessing the Company’s tax liability associated with products for all prior years in which the Company had generated revenue, to assist with the collection and tracking of VDAs where a potential tax liability may exist and to assist with the implementation of a sales tax software platform solution for the calculation, collection, and remittance of sales tax for all non-exempt future sales. From the Company’s inception through present, the Company now believes it is probable that a sales tax liability existed for certain of its sales of products to certain of its customers; however, due to the complexity and uncertainty around the application of these rules by taxing authorities, results may vary materially from the Company’s expectations. Currently, the Company does not have sufficient information to reasonably estimate a minimum or maximum amount of the sales tax liability as of the date of this report. The Company is also in the process of identifying where there may be a need to file VDAs with relevant taxing jurisdictions regarding its failure to collect and remit sales tax obligations. As of June 30, 2023, the Company had not recorded an accrual for the probable sales tax liability nor the interest and penalties likely to be imposed by the taxing jurisdictions for the current and prior reporting periods in the financial statements. The Company will record a liability when the amount of the liability becomes reasonably estimable.

We also may identify future material weaknesses in our internal controls over financial reporting or fail to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, and we may be unable to accurately report our financial results, or report them within the timeframes required by law or stock exchange regulations. We cannot assure that additional material weaknesses will not exist or otherwise be discovered, any of which could adversely affect our reputation, financial condition and results of operations.