Notes
to Condensed Consolidated Financial Statements
September
30, 2020
(Unaudited)
Note
1. Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted
accounting principles (“GAAP”) for interim financial information and with the instructions to Rule 8-03 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.
In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments
are of a normal recurring nature. Operating results for the three and nine months ended September 30, 2020 are not necessarily
indicative of the results that may be expected for the fiscal year ending December 31, 2020. The condensed consolidated
balance sheet at December 31, 2019 has been derived from the audited consolidated financial statements. For further information,
refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K relating to Research
Frontiers Incorporated for the fiscal year ended December 31, 2019.
Note
2. Business
Research
Frontiers Incorporated (“Research Frontiers” or the “Company”) operates in a single business segment which
is engaged in the development and marketing of technology and devices to control the flow of light. Such devices, often referred
to as “light valves” or suspended particle devices (SPDs), use colloidal particles that are either incorporated within
a liquid suspension or a film, which is usually enclosed between two sheets of glass or plastic having transparent, electrically
conductive coatings on the facing surfaces thereof. At least one of the two sheets is transparent. SPD technology, made possible
by a flexible light-control film invented by Research Frontiers, allows the user to instantly and precisely control the shading
of glass/plastic manually or automatically. SPD technology has numerous product applications, including SPD-Smart™ windows,
sunshades, skylights and interior partitions for homes and buildings; automotive windows, sunroofs, sun-visors, sunshades, rear-view
mirrors, instrument panels and navigation systems; aircraft windows; museum display panels, eyewear products; and flat panel displays
for electronic products. SPD-Smart light control film is now being developed for, or used in, architectural, automotive, marine,
aerospace and appliance applications.
The
Company has primarily utilized its cash, cash equivalents, and investments generated from sales of
our common stock, proceeds from the exercise of options and warrants, and royalty fees collected to fund its
research and development of SPD light valves, for marketing initiatives, and for other working capital purposes. The Company’s
working capital and capital requirements depend upon numerous factors, including the results of research and development activities,
competitive and technological developments, the timing and cost of patent filings, and the development of new licensees and changes
in the Company’s relationships with its existing licensees. The degree of dependence of the Company’s working capital
requirements on each of the foregoing factors cannot be quantified; increased research and development activities and related
costs would increase such requirements; the addition of new licensees may provide additional working capital or working capital
requirements, and changes in relationships with existing licensees would have a favorable or negative impact depending upon the
nature of such changes. We have incurred recurring losses since inception and expect to continue to incur losses as a result of
costs and expenses related to our research and continued development of our SPD technology and our corporate general and administrative
expenses. Our capital resources and operations to date have been substantially funded through sales of our common stock, exercise
of options and warrants and royalty fees collected. As of September 30, 2020, we had working capital of approximately $5.8
million, cash and cash equivalents of approximately $5.4 million, shareholders’ equity of approximately
$5.9 million and an accumulated deficit of approximately $117.0 million. Our quarterly projected cash flow shortfall,
based on our current operations adjusted for any non-recurring cash expenses for the next 12 months, is approximately $500,000-$600,000
per quarter. Based on our current expectation of our cash flow shortfall for the next 12 months, our working capital would
support our activities for the next 27- 29 months.
In
the event that we are unable to generate sufficient cash from our operating activities or raise additional funds, we may delay,
reduce or curtail our operations or otherwise impede our ongoing business efforts, which could have a material adverse effect
on our business, operating results, financial condition and long-term prospects. The Company may seek to obtain additional
funding through future equity issuances. There can be no assurance as to the availability or terms upon which such financing and
capital might be available. Eventual success of the Company and generation of positive cash flow will be dependent upon the commercialization
of products using the Company’s technology by the Company’s licensees and payments of continuing royalties on account
thereof. To date, the Company has not generated sufficient revenue from its licensees to fund its operations.
Recent
Global Events:
On
March 11, 2020, the World Health Organization declared the novel strain of coronavirus (“COVID-19”) a global pandemic
and recommended containment and mitigation measures worldwide. As a result, the Company expects operations at its facility to
be affected in some capacity, as the COVID-19 virus continues to proliferate and the federal, state and local governments under
which we operate continue to adopt new rules. The Company has put in place enhanced procedures, such as restricting international
and domestic travel, adopting a variety of steps designed to ensure social distancing in our facilities, including working remotely
where available, and increasing our cleaning and sanitizing procedures in our facilities, in an effort to protect its employees
and communities.
Revenues
were negatively impacted in our second and third quarters due to delays in manufacture of products using our technology.
Most of the products using our technology are manufactured by licensees overseas in Europe and Asia who have been similarly affected
by the pandemic. The disruption caused by public health crises, such as COVID-19, could result in lower levels of sale activity
for products using our technology resulting in lower level of royalties owed to us from the sale of these products. The duration
of the potential business disruptions and related financial impact cannot be reasonably estimated at this time, but could materially
adversely affect our business, financial condition, results of operations, and cash flows. The Company increased its allowance
for uncollectible royalty receivables in the second and third quarters of 2020 until the collectability from certain licensees
can be better ascertained in the regions affected by COVID-19.
In
connection with the COVID-19 crisis, Congress passed, and the president signed, the Coronavirus Aid, Relief and Economic Security
Act (“CARES Act”) which, among other things provides relief for businesses impacted by the pandemic. The Company applied
for and received $202,052 in proceeds from the Paycheck Protection Program (“PPP Loan”) made available under the CARES
Act. The PPP Loan is intended to offer businesses hurt by the COVID-19 pandemic economic assistance with the potential for the
principal to be forgiven based on certain expenses incurred during the first 24 weeks after the issuance of the PPP Loan. The
Company estimated that the $194,140 of the PPP Loan principal will be forgiven based on payroll and other expenses incurred through
June 30, 2020. The Company estimated that all of the loan will be forgiven when the additional payroll and other expenses
incurred from July 1, 2020 to September 30, 2020 are included. Consequently, the Company recorded $7,912 and $202,052 as
other income for the three and nine months ended September 30, 2020 representing the PPP loan estimated to be forgiven through
September 30, 2020.
Note
3. Recently Adopted Accounting Pronouncement
Effective
January 1, 2019, the Company adopted the Financial Accounting Standards Board’s Standard, Leases (Topic 842), as
amended. The standard requires all leases to be recorded on the balance sheet as a right of use asset and a lease liability. The
standard provides practical expedients in order to simplify adoption, including the following:
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●
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An
entity need not reassess whether any expired or existing contracts are or contain leases.
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●
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An
entity need not reassess the lease classification for any expired or existing leases. Instead, any leases previously classified
as operating leases will continue to be classified as operating leases, while any leases previously classified as capital
leases will be classified as finance leases.
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●
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An
entity need not reassess initial direct costs for any leases.
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The
Company used the above practical expedients as the transition method in the application of the new lease standard at January 1,
2019. The Company applied a policy election to exclude short-term leases from balance sheet recognition and elected certain practical
expedients at adoption. As permitted, the Company did not reassess whether existing contracts are or contain leases, the lease
classification for any existing leases or the initial direct costs for any existing leases which were not previously accounted
for as leases, are or contain a lease. At adoption on January 1, 2019, an operating lease liability of $1,134,000 and an operating
lease right of use asset of $941,000 were recorded. The operating lease liability was $193,000 more than the operating lease right
of use asset due to unamortized lease incentive from periods prior to the adoption of the new lease standard. There was no cumulative
earnings effect adjustment.
Note
4. Patent Costs
The
Company expenses costs relating to the development, acquisition or enforcement of patents due to the uncertainty of the recoverability
of these items.
Note
5. Revenue Recognition
The
Company recognizes revenue in
accordance with ASC 606 Revenue from Contracts with Customers (Topic 606). The standard provides a single comprehensive
revenue recognition model for all contracts with customers and supersedes existing revenue recognition guidance. The revenue standard
contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The
underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount
that the entity expects to be entitled to in exchange for those goods or services.
ASC
606 follows a five-step approach to determining revenue recognition including: 1) Identification of the contract; 2) Identification
of the performance obligations; 3) Determination of the transaction price; 4) Allocation of the transaction price; and
5) Recognition of revenue.
The
Company determined that its license agreements provide for three performance obligations which include: (i) the Grant of Use to
its Patent Portfolio (“Grant of Use”), (ii) Stand-Ready Technical Support (“Technical Support”) including
the transfer of trade secrets and other know-how, production of materials, scale-up support, analytical testing, etc., and (iii)
access to new Intellectual Property (“IP”) that may be developed sometime during the course of the contract period
(“New Improvements”). Given the nature of IP development, such New Improvements are on an unspecified basis and can
occur and be made available to licensees at any time during the contract period.
When
a contract includes more than one performance obligation, the Company needs to allocate the total consideration to each performance
obligation based on its relative standalone selling price or estimate the standalone selling price if it is not observable. A
standalone selling price is not available for our performance obligations since we do not sell any of the services separately
and there is no competitor pricing that is available. As a consequence, the best method for determining the standalone
selling price of our Grant of Use performance obligation is through a comparison of the average royalty rate for comparable license
agreements as compared to our license agreements. Comparable license agreements must consider several factors including: (i) the
materials that are being licensed, (ii) the market application for the licensed materials, and (iii) the financial terms in the
license agreements that can increase or decrease the risk/reward nature of the agreement.
Based
on the royalty rate comparison referred to above, any pricing above and beyond the average royalty rate would relate to the Technical
Support and New Improvements performance obligations. The Company focuses a significant portion of its time and resources to provide
the Technical Support and New Improvements services to its licensees which further supports the conclusions reached using the
royalty rate analysis.
The
Technical Support and New Improvements performance obligations are co-terminus over the term of the license agreement. For purposes
of determining the transaction price, and recognizing revenue, the Company combined the Technical Support and New Improvements
performance obligations because they have the same pattern of transfer and the same term. We maintain a staff of scientists and
other professionals whose primary job responsibilities throughout the year are: (i) being available to respond to the Technical
Support needs of our licensees, and (ii) developing improvements to our technology which are offered to our licensees as New Improvements.
Since the costs incurred to satisfy the Technical Support and New Improvements performance obligations are incurred evenly throughout
the year, the value of the Technical Support and New Improvements services are recognized throughout the initial contract period
as these performance obligations are satisfied. If the agreement is not terminated at the end of the initial contract period,
it will renew on the same terms as the initial contract for a one-year period. Consequently, any fees or minimum annual royalty
obligations relating to this renewal contract will be allocated similarly to the initial contract over the additional one-year
period.
We
recognize revenue when or as the performance obligations in the contract are satisfied. For performance obligations that are fulfilled
at a point in time, revenue is recognized at the fulfillment of the performance obligation. Since the IP is determined to be a
functional license, the value of the Grant of Use is recognized in the first period of the contract term in which the license
agreement is in force. The value of the Technical Support and New Improvements obligations is allocated throughout the contract
period based on the satisfaction of its performance obligations. If the agreement is not terminated at the end of the contract
period, it will renew on the same terms as the original agreement for a one-year period. Consequently, any fees or minimum annual
royalties (“MAR”) relating to this renewal contract will be allocated similarly over that additional year.
The
Company’s license agreements have a variable royalty fee structure (meaning that royalties are a fixed percentage of sales
that vary from period to period) and frequently include a MAR commitment. In instances when sales of licensed products
by its licensees exceed the MAR, the Company recognizes fee income as the amounts have been earned. Typically, the royalty rate
for such sales is 10-15% of the selling price. While this is variable consideration, it is subject to the sales/usage royalty
exception to recognition of variable consideration in ASC 606 10-55-65 and therefore is not recognized until the subsequent sales
or usage occurs or the MAR period commences.
Because
of the immediate recognition of the Grant of Use performance obligation: (i) the first period of the contract term will generally
have a higher percent allocation of the transaction price under ASC 606 than under the accounting guidance used prior to the adoption
of ASC 606, and (ii) the remaining periods in the year will have less of the transaction price recognized under ASC 606 than under
the accounting guidance used prior to the adoption of ASC 606. After the initial period in the contract term, the revenue for
the remaining periods will be based on the satisfaction of the technical support and New Improvements obligations.
The
Company does not have any contract assets under ASC 606 as of September 30, 2020.
Certain
of the contract fees are accrued by, or paid to, the Company in advance of the period in which they are earned resulting in deferred
revenue. Such excess amounts are recorded as deferred revenue and are recognized into income in future periods as earned.
The
Company operates in a single business segment which is engaged in the development and marketing of technology and devices to control
the flow of light. Our revenue source comes from the licensing of this technology and all of these license agreements have similar
terms and provisions. The majority of the Company’s licensing fee income comes from the activities of several licensees
participating in the automotive market. The Company currently believes that the automotive market will be the largest source of
its royalty income over the next several years. The Company’s royalty income from this market may be influenced by numerous
factors including various trends affecting demand in the automotive industry and the rate of introduction of new technology in
OEM product lines. In addition to these macro factors, the Company’s royalty income from the automotive market could also
be influenced by specific factors such as whether the Company’s SPD-SmartGlass technology appears as standard equipment
or as an option on a particular vehicle, the number of additional vehicle models that SPD-SmartGlass appears on, the size of each
window on a vehicle and the number of windows on a vehicle that use SPD SmartGlass, fluctuations in the total number of vehicles
produced by a manufacturer, and in the percentage of cars within each model produced with SPD-SmartGlass, and changes in pricing
or exchange rates.
As
of September 30, 2020, the Company has four license agreements that are in their initial multiyear term (“Initial
Term”) with continuing performance obligations going forward. The Initial Term of one of these agreements will end
as of December 31, 2021, two will end as of December 31, 2022, and one will end December 31, 2024. The Company currently
expects that all four of these agreements will renew annually at the end of the Initial Term. As of September 30, 2020,
the aggregate amount of the revenue to be recognized upon the satisfaction of the remaining performance obligations for the four
license agreements is $464,265. The revenue for these remaining performance obligations for each of the four
license agreements is expected to be recognized evenly throughout their remaining period of the Initial Term.
Note
6. Fee Income
Fee
income represents amounts earned by the Company under various license and other agreements relating to technology developed by
the Company.
During
the first nine months of 2020, five licensees accounted for 10% or more of fee income of the Company; these licensees accounted
for approximately 18%, 17%, 13%, 12% and 12% of fee income recognized during such period. During the first nine months
of 2019, three licensees accounted for 10% or more of fee income of the Company; these licensees accounted for approximately 43%,
15% and 10% of fee income recognized during such period.
During
the three-month period ended September 30, 2020, six licensees accounted for 10% or more of fee income of the Company;
these licensees accounted for approximately 18%, 15%, 12%, 12%, 11% and 11% of fee income recognized during such
period. During the three-month period ended September 30, 2019, two licensees accounted for 10% or more of fee income of the
Company; these licensees accounted for approximately 53% and 15% of fee income recognized during such period.
Note
7. Stock-Based Compensation
The
Company has granted options/warrants to consultants. GAAP requires that all stock-based compensation be recognized as an expense
in the financial statements and that such costs be measured at the fair value of the award at the date of grant. These awards
generally vest ratably over 12 to 60 months from the date of grant and the Company charges to operations quarterly the current
market value of the options using the Black-Scholes method. During the three and nine months ended September 30, 2020 and 2019,
there were no charges related to options granted to consultants.
During
the nine-month period ended September 30, 2020, the Company did not grant options to employees or directors. During the nine-month
period ended September 30, 2019, the Company granted 233,500 fully vested options to employees and directors and recorded stock-based
compensation of $356,228. All of the options granted to employees during the nine-month period ended September 30, 2019
occurred during the second quarter of 2019. The Company valued these grants using the Black-Scholes option pricing model with
the following assumptions:
Fair
value on grant date
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$
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1.5256
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Expected
dividend yield
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|
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-
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Expected
volatility
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|
|
61
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%
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Risk
free interest rate
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|
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1.84
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%
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Expected
term of the option
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5
years
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There
was no compensation expense recorded relating to restricted stock grants to employees and directors during the three and nine
months ended September 30, 2020 and 2019.
As
of September 30, 2020, there were 882,500 shares available for future grant under our 2019 Equity Incentive Plan, which was approved
by the Company’s shareholders in June 2019.
Note
8. Income Taxes
Since
inception, the Company has incurred losses from operations and as a result has not recorded income tax expense. Benefits related
to net operating loss carryforwards and other deferred tax items have been fully reserved since it was not more likely
than not that the Company would achieve profitable operations and be able to utilize the benefit of the net operating loss carryforwards.
Note
9. Basic and Diluted Loss Per Common Share
Basic
loss per share excludes any dilution. It is based upon the weighted average number of common shares outstanding during the period.
Dilutive loss per share reflects the potential dilution that would occur if securities or other contracts to issue common stock
were exercised or converted into common stock. The Company’s dilutive loss per share equals basic loss per share for the
periods ended September 30, 2020 and 2019, because all potentially dilutive securities (i.e., options and warrants)
were antidilutive in those periods. The number of options and warrants that were not included (because their effect is antidilutive)
was 2,498,251 and 3,381,061 for the three and nine months ended September 30, 2020 and 2019, respectively.
Note
10. Equity
During
the nine months ended September 30, 2020, the Company received $284,207 in proceeds from the exercise of outstanding options and
warrants and issued 83,152 shares of its capital stock in connection with these exercises. In addition, during the nine months
ended September 30, 2020, the Company issued 238,372 shares of its capital stock in connection with the cashless exercise of 450,091
of its outstanding options.
During
the nine months ended September 30, 2019, the Company received $1,170,547 in proceeds from the exercise of outstanding options
and warrants and issued 1,060,718 shares of its capital stock in connection with these exercises. In addition, during the nine
months ended September 30, 2019, the Company issued 363,125 shares of its capital stock in connection with the cashless exercise
of 603,569 of its outstanding options and warrants.
During
the three-month period ended September 30, 2020, there were no exercise of outstanding options. During the three-month period
ended September 30, 2019, the Company received $64,647 in proceeds from the exercise of outstanding options and issued
56,848 shares of its capital stock in connection with these exercises.
The
Company did not sell any equity securities during the three or nine months ended September 30, 2020.
On
or around May 30, 2019, the Company sold to accredited investors a total of 1,276,599 shares of common stock and warrants expiring
May 31, 2024 to purchase 638,295 shares of common stock at an exercise price of $3.384, $3.666 or $4.23 per share depending on
the exercise date. Research Frontiers also sold units to Gauzy, at a price of $1.38 per unit, with each unit comprised of one
share of unregistered common stock and one-half of one warrant. The warrant can be converted into one share of unregistered common
stock at an exercise price of $1.656, $1.794 or $2.07 per share depending on the exercise date. Gauzy received a total of 724,638
shares of unregistered common stock and warrants expiring May 31, 2024 to purchase 362,319 shares of common stock. The aggregate
proceeds from these stock offerings was approximately $4.6 million.
Investors
that participated in the May 30, 2019 offering agreed to amending/clarifying language to the terms of the warrants that they
received in the September 7, 2018 offering. Those investors that received warrants in the September 7, 2018 offering that did
not participate in the May 30, 2019 offering, separately agreed as of June 27, 2019 to the same amending/clarifying language used
in the May 30, 2019 offering. The amending/clarifying language relating to the September 7, 2018 warrants does not allow for a
net cash settlement option for the warrants even if no registered shares of common stock are available upon the exercise of the
warrant. The Company recorded a non-cash expense of $0 and $652,025, respectively, for the three- and nine-month periods ended
September 30, 2019 to mark these warrants to their estimated market value as of their respective amendment/clarification date. The
warrant liability was valued at $1,153,439 (including all valuation adjustments since their issuance) through the date of these
new agreements and amendments and based on the amended warrant terms, the warrant liability was reclassified to equity as of these
dates.
As
of September 30, 2020, there were 1,399,991 warrants outstanding.
Note
11. Leases
The
Company determines if an arrangement is a lease at its inception. This determination generally depends on whether the arrangement
conveys the right to control the use of an identified fixed asset explicitly or implicitly for a period of time in exchange for
consideration. Control of an underlying asset is conveyed if the Company obtains the rights to direct the use of, and to obtain
substantially all of the economic benefits from the use of, the underlying asset. Lease expense for variable leases and short-term
leases is recognized when the obligation is incurred.
The
Company has operating leases for certain facilities, vehicles and equipment with a weighted average remaining lease term of 4.5
years as of September 30, 2020. Operating leases are included in right of use lease assets, other current liabilities and
long-term lease liabilities on the condensed consolidated balance sheet. Right of use lease assets and liabilities are recognized
at each lease’s commencement date based on the present value of its lease payments over its respective lease term. The Company
does not have an established incremental borrowing rate as it does not have any debt. The Company uses the stated borrowing rate
for a lease when readily determinable. When the interest rate implicit in its lease agreements is not readily determinable,
the Company used an interest rate based on the marketplace for public debt. The weighted-average discount rate associated with
operating leases as of September 30, 2020 is 5.5%.
Operating
lease expense for the three months ended September 30, 2020 was approximately $55,000 and approximately $162,000 for the nine
months ended September 30, 2020. The Company has no material variable lease costs or sublease income for the nine months ended
September 30, 2020. Subsequent to the Company’s adoption of the new lease accounting guidance on January 1, 2019, the Company
recorded new right of use lease assets of approximately $900,000 and associated lease liabilities of approximately $1.1 million.
Maturities
of operating lease liabilities as of September 30, 2020 were as follows:
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September
30, 2020
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|
For
the remainder of 2020
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$
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50,690
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|
For the year
ended December 31, 2021
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|
|
207,229
|
|
For the year
ended December 31, 2022
|
|
|
213,320
|
|
For the year
ended December 31, 2023
|
|
|
217,151
|
|
For the year
ended December 31, 2024
|
|
|
221,869
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|
For
the year ended December 31, 2025 and beyond
|
|
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55,874
|
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Total
lease payments
|
|
|
966,133
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|
Less:
imputed lease interest
|
|
|
(114,461
|
)
|
Present
value of lease liabilities
|
|
$
|
851,672
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