Nexalin Technology, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2023. The unaudited consolidated statements include Nexalin Technology, Inc. and its wholly owned subsidiary. The company is a smaller reporting company and emerging growth company.
Business Context
Nexalin develops non-invasive neurostimulation devices for mental-health and cognitive conditions. Gen-1 devices continue to generate limited licensing and electrode-related revenue, but the company is not pursuing new U.S. Gen-1 sales pending regulatory decisions. Gen-2 and Gen-3 devices use a 15-milliamp waveform and remain subject to regulatory clearance for U.S. commercialization.
In May 2023, the company formalized a Hong Kong joint venture with Wider Come Limited for development, marketing, sales and distribution in China and the broader Asia-Pacific region. Nexalin owns 48%, invested $96,000 during the quarter, and accounts for the investment under the equity method. The joint venture had no operating activity through September 30, 2023.
Key Financial Metrics
| Metric | Three Months Ended September 30, 2023 | Three Months Ended September 30, 2022 | Nine Months Ended September 30, 2023 | Nine Months Ended September 30, 2022 |
|---|---|---|---|---|
| Revenue | $24,113 | $545,323 | $90,212 | $1,282,933 |
| Gross profit | $20,140 | $358,025 | $69,755 | $926,588 |
| Gross margin | 84% | 66% | 77% | 72% |
| Operating expenses | $2,435,677 | $651,219 | $4,141,578 | $2,040,002 |
| Loss from operations | $(2,415,537) | $(293,194) | $(4,071,823) | $(1,113,414) |
| Net loss | $(2,297,189) | $(135,401) | $(3,868,040) | $(968,139) |
| Basic and diluted loss per share | $(0.31) | $(0.03) | $(0.53) | $(0.19) |
Revenue declined 96% year over year in the third quarter and 93% for the first nine months, primarily because of reduced device sales through the China distribution network. Nine-month 2023 revenue included $9,600 of device sales, $62,566 of licensing fees, $16,679 of equipment revenue and $1,367 of other revenue. No royalty revenue was recorded in the nine-month period.
Operating expenses increased 274% in the quarter and 103% year to date. The increases primarily reflected research and development activity for Gen-2 and Gen-3, public-company costs, additional personnel, insurance, travel and $1.5 million of non-employee stock compensation recorded in research and development. The company issued 150,000 shares to affiliates of Wider and recognized an additional obligation for 150,000 shares, resulting in approximately $1.5 million of stock-based compensation expense.
Cash Flow, Liquidity and Debt
- Cash and cash equivalents were $361,397 at September 30, 2023, compared with $162,743 at December 31, 2022.
- Short-term investments were $3,575,805, down from $6,831,192 at year-end 2022. These investments consisted of U.S. Treasury notes.
- Working capital was $3,066,274 at September 30, 2023, compared with $5,476,476 at December 31, 2022.
- Operating activities used $2,831,354 of cash during the first nine months of 2023, compared with $1,309,242 in the prior-year period.
- Investing activities provided $3,230,008, primarily from sales of short-term investments of $32.7 million, partially offset by purchases of $29.3 million, a $96,000 joint-venture investment and approximately $74,000 of patent purchases.
- Financing activities used $200,000, reflecting repayment of the officer loan. No equity financing proceeds were reported in the 2023 period.
- Total liabilities were $1,197,075, including a $500,000 note payable. The note was issued in 2017, matured in 2017 and was in default at September 30, 2023. The company also had $606,891 of accrued expenses, including $336,000 of accrued settlement liabilities.
Material Changes and Unusual Items
- Revenue and gross profit declined substantially because 2022 included significant China device sales, including $520,000 in the third quarter and $1.16 million in the first nine months.
- Gross margin improved because 2023 revenue consisted primarily of higher-margin licensing fees rather than device sales.
- The company recognized a $180,593 gain on sales of short-term investments during the first nine months of 2023 and a $82,943 gain during the third quarter.
- Comprehensive loss included unrealized losses on short-term investments of $35,513 for the first nine months and $32,289 for the quarter.
- Shares outstanding increased to 7,436,562 at September 30, 2023 from 7,286,562 at December 31, 2022. The company had 2,662,250 outstanding warrants with a $4.15 exercise price.
- The company repaid the $200,000 officer loan in March 2023 and paid accrued interest in April 2023.
Outlook, Risks and Contingencies
Management expects continued operating losses and negative operating cash flow while it funds product development, clinical work, regulatory activities, commercialization infrastructure and public-company expenses. Management stated that it does not believe existing cash is sufficient for the twelve months following issuance of the financial statements and that substantial doubt exists regarding the company’s ability to continue as a going concern. The company expects to require additional capital, revenue from the joint venture and U.S. regulatory approval to execute its business plan.
A pre-submission document for a Gen-3 510(k) process was filed with the FDA in January 2023. The company received FDA comments, held a formal meeting on May 9, 2023 and filed meeting minutes on May 16, 2023. No additional FDA comments had been received as of the filing. FDA clearance or approval remains uncertain, and the company’s devices are not authorized for all intended U.S. uses.
The company received a Nasdaq deficiency notice for trading below the $1.00 minimum bid price. It failed to regain compliance by November 6, 2023, and Nasdaq also determined that it did not meet the $5 million stockholders’ equity requirement for an additional compliance period. The company appealed to the Nasdaq Hearings Panel; trading remained stayed during the appeal process. Delisting could materially reduce liquidity, impair access to capital and adversely affect the stock price.
Management identified material weaknesses in internal control over financial reporting, including inadequate segregation of duties and insufficient information-technology access controls. Management concluded that disclosure controls and procedures were not effective as of September 30, 2023 and plans to engage an outside firm and implement enhanced controls.
Contingencies include a California Employment Development Department matter for which approximately $300,000 has been accrued, a settlement with the University of Arizona for approximately $69,000 agreed in October 2023, and an employment-related lawsuit scheduled for trial in March 2024. Management could not estimate the potential loss from the lawsuit.
Investor Verification Checklist
- Verify the company’s ability to fund operations for the next twelve months and the timing, terms and dilution effects of any future financing.
- Monitor FDA feedback, 510(k) or PMA progress, clinical-trial results and the timing of any U.S. commercial authorization for Gen-2 or Gen-3.
- Confirm the status of the Nasdaq appeal and whether the company satisfies the minimum bid-price and stockholders’ equity requirements.
- Assess the financial performance, funding obligations and revenue prospects of the Wider joint venture, which had no activity through September 30, 2023.
- Review the $500,000 defaulted note, accrued settlement liabilities and other legal contingencies.
- Evaluate customer and geographic concentration: three customers represented 70% of third-quarter revenue and 55% of nine-month revenue, while China revenue fell sharply from the prior year.
- Track remediation of the disclosed material weaknesses in financial reporting and information-technology controls.