Notes
to Condensed Consolidated Financial Statements
June
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 six months ended June 30, 2020 are not necessarily indicative
of the results that may be expected for the fiscal year ending December 31, 2020. The condensed consolidated financial statements
as of December 31, 2019 are derived from audited 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 limited 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 June 30, 2020, we had working capital of approximately $6.3 million, cash and cash equivalents of approximately
$5.8 million, shareholders’ equity of approximately $6.3 million and an accumulated deficit of approximately
$116.5 million. Our projected cash flow shortfall based on our current operations adjusted for any non-recurring cash expenses
for the next 12 months is approximately $450,000-500,000 per quarter. Based on our current expectations of our cash flow
shortfall for the next 12 months, our working capital would support our activities for the next 34 months.
In
the event that we are unable to generate sufficient cash from our operating activities or raise additional funds, we may be required
to delay, reduce or severely curtail our operations or otherwise impede our on-going 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.
The Company currently does not have the ability
to assess whether the COVID-19 pandemic is likely to have a material impact on our near-term financial results. Revenues were
negatively impacted in our second quarter 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 quarter 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
estimates that $194,140 of the PPP Loan principal will be forgiven based on payroll and other expenses incurred through June 30,
2020. The Company will also be able to include additional payroll and other expenses incurred after June 30, 2020 until the end
of the 24-week forgiveness calculation period for the PPP Loan (October 2, 2020). Consequently, the Company recorded $194,140 as
other income for the three and six months ended June 30, 2020 representing the portion of the PPP loan estimated to be forgiven
through June 30, 2020. The Company has classified the remaining PPP Loan as a deferred other income liability on its balance sheet.
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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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
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 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 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 June 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 June 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,
2020, one will end as of December 31, 2021, one will end as of December 31, 2022, and one will end as of 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 June 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 $484,148. 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 six months of 2020, five licensees accounted for 10% or more of fee income of the Company; these
licensees accounted for approximately 22%, 17%, 12%, 12% and 12% of fee income recognized during such period. During
the first six months of 2019, three licensees accounted for 10% or more of fee income of the Company; these licensees accounted
for approximately 36%, 15% and 12%, respectively, of fee income recognized during such period.
During the three-month period ended
June 30, 2020, four licensees accounted for 10% or more of fee income of the Company; these licensees accounted for approximately
17%, 17%, 11% and 10%, respectively, of fee income recognized during such period. During the three-month
period ended June 30, 2019, three licensees accounted for 10% or more of fee income of the Company; these licensees accounted
for approximately 43%, 16% and 10%, respectively, 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 six months ended June 30, 2020 and 2019,
there were no charges related to options granted to consultants.
During
the six-month period ended June 30, 2020, the Company did not grant options to employees or directors. During the six-month period
ended June 30, 2019, the Company granted 233,500 fully vested options to employees and directors and recorded stock-based
compensation of $356,228. All of the options granted to employees during the six-month period ended June 30, 2019 occurred during
the second quarter of 2019. The Company valued these grants using the Black-Scholes option pricing model with the following assumptions:
Fair value on grant date
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$
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1.5256
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Expected dividend yield
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0
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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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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 six months
ended June 30, 2020 and 2019.
As
of June 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 June 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 3,441,152
for the three and six months ended June 30, 2020 and 2019, respectively.
Note
10. Equity
During
the six months ended June 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 six months
ended June 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 six months ended June 30, 2019, the Company received $1,105,899 in
proceeds from the exercise of outstanding options and warrants and issued 1,003,870 shares of its capital stock in connection
with these exercises. In addition, during the six months ended June 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 June 30, 2020, the Company received $284,207 in proceeds from the exercise of outstanding
options and issued 83,152 shares of its capital stock in connection with these exercises. In addition, during the three-month
period ended June 30, 2020, the Company issued 81,527 shares of its capital stock in connection with the cashless exercise
of 207,000 of its outstanding options. During the three-month period ended June 30, 2019, the Company received $4,117
in proceeds from the exercise of outstanding options and issued 2,250 shares of its capital stock in connection with these
exercises. In addition, during the three-month period ended June 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.
The Company did not sell any equity securities during the three
or six months ended June 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 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 $404,435 and $652,025, respectively, for the three- and six-month periods ended
June 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 June 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 4.7
years as of June 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 rates implicit in its lease agreements are 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 June 30, 2020 is 5.5%.
Operating
lease expense for the three months ended June 30, 2020 was approximately $54,000 and approximately $107,000 for the six months
ended June 30, 2020. The Company has no material variable lease costs or sublease income for the six months ended June 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 (“ROU”) of approximately $900 thousand and associated lease liabilities of approximately
$1.1 million.
Maturities
of operating lease liabilities as of June 30, 2020 were as follows:
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June 30, 2020
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For the remainder of 2020
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$
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105,721
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For the year ended December 31, 2021
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207,229
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For the year ended December 31, 2022
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213,320
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For the year ended December 31, 2023
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217,151
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For the year ended December 31, 2024
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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
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1,021,164
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Less: imputed lease interest
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(126,654
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)
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Present value of lease liabilities
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$
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894,510
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