Note 7. Preferred Stock and Notes Payable

Debt consists of following as of September 30, 2026:

 Schedule of Debt

On June 2, 2026, the Company entered into a Securities Purchase Agreement (the “June 2026 Securities Purchase Agreement”) with Streeterville Capital, LLC (the “Investor”), providing for the issuance and sale by the Company, and the purchase by the Investor, of (i) 250 shares (the “Preferred Shares”) of the Company’s Series A Preferred Stock, par value $0.01 per share (the “Series A Preferred Stock”), at an issued value of $10,000 per share and a stated value of $12,000 per share, for aggregate gross proceeds of $2,500,000; (ii) a Secured Promissory Note A-1 in an original principal amount of $2,720,000 (the “Note A-1”); and (iii) a Secured Promissory Note B in an original principal amount of $5,000,000 (the “Note B” and together with the Note A-1, the “Notes”). The transactions contemplated by the Securities Purchase Agreement (collectively, the “Transaction”) closed on June 3, 2026 (the “Closing Date”). At closing, the Company received $10,000,000 from the Investor, $5,000,000 of which was deposited into a bank account owned by a wholly owned subsidiaries of the Company as cash collateral for the Notes (the “Cash Collateral Account”). The $5,000,000 amount is classified as restricted cash on the condensed consolidated balance sheet. The obligations under the Notes are secured by substantially all of the assets of the Company, other than its intellectual property assets, and are guaranteed by certain of the Company’s subsidiaries. The Company intends to utilize the $5,000,000 of proceeds from the closing of the Transaction, along with any proceeds later released from the Cash Collateral Account, for general corporate purposes, including research and development activities, capital expenditures and working capital. The Company agreed to pay the placement agents for financing a fee of 7.0% of the gross proceeds received by the Company in connection with the Transaction.

If the aggregate outstanding balance of the Note A-1 or the aggregate number of outstanding Preferred Shares is reduced by $2,000,000, the Company will have the right to exchange up to $1,000,000, plus interest (or, if less than $1,000,000, the entire remaining amount of the Note B, or such other amount as the parties mutually agree), of the Note B for a new secured note in the same form and having the same terms as the Note A-1 (each, a “Note Exchange”). Upon the completion of each Note Exchange, an amount of cash equal to the amount of the Note B exchanged in such Note Exchange will be released from the Cash Collateral Account to the Company. The Note A-1 will accrue payment-in-kind (PIK) interest at a rate of 8% per annum, which will be added to the outstanding principal balance of the Note A-1, and will mature 18 months following the Closing Date.

The Note B will bear interest at 5% per annum and will mature 18 months following the Closing Date. The Notes can be prepaid by the Company in whole or in part at any time, subject to a 10% prepayment premium on any principal amounts prepaid. Beginning six months after the Closing Date, the Investor may redeem up to $250,000 of the principal amount of the Note A-1 each calendar month. In addition, on any trading day when the Company’s common stock trades at a price that is at least 15% greater than the “Minimum Price” as defined under Nasdaq Stock Market LLC Rule 5635(d), the Investor may redeem an additional principal amount of the Notes equal to 5% of the trading volume of the Company’s common stock on such trading day. The Company will be subject to customary covenants while the Notes remain outstanding. The Notes also contain customary events of default, the occurrence of which would permit the Investor to accelerate the obligations under the Notes and exercise remedies against any collateral (including amounts on deposit in the Cash Collateral Account) or guarantees in respect of the Notes. In addition, following the occurrence of an event of default, the interest rate of each Note would increase to the lesser of 15% per year or the maximum rate permitted by applicable law.

Broker fees totaling $350,000 were allocated between the preferred stock and Note A-1 based on their values. Issuance costs, which primarily include legal fees totaling $292,310, were allocated between the preferred stock and Note A-1 and Note B based on the face value of each financial instrument and will be amortized over the life of the instruments. The original issuance discount associated with Note A-1 was recorded as a contra-liability to be amortized over the life of the note.

Interest expense consistent of following for nine months ended September 30:

 Schedule of Interest Expense

Permanent Equity Classification

The Company classified the 250 shares of Series A Preferred Stock as permanent stockholders’ equity as of the Closing Date. Under ASC 480-10-S99-3A, an equity instrument must be classified outside of permanent equity if it is redeemable upon the occurrence of an event not solely within the control of the issuer. On July 29, 2026, the Company and the Investor executed an Irrevocable Waiver and Covenant Not to Exercise Redemption Rights (the “Waiver”), effective as of June 2, 2026, under which the Investor irrevocably waived the default redemption right under Section 12(b)(i) of the Certificate of Designation with respect to all events of default. The Waiver is a Type 1 recognized subsequent event under ASC 855-10-25-1 that provides evidence of conditions existing at the June 3, 2026 closing date and confirms the permanent-equity classification applied as of that date. Accordingly, because the Series A Preferred Stock is not redeemable upon an event outside the Company’s control, it is classified as permanent stockholders’ equity in accordance with ASC 480-10-S99-3A.

The Series A Preferred Stock accrues a preferred return at a rate of 8% per annum on its stated value, compounded daily. The preferred return is payable quarterly, either in cash or, at the Company’s election, through the issuance of additional shares of Series A Preferred Stock. The number of additional shares is determined by dividing the accrued and unpaid preferred return by the $10,000 per-share purchase price. Fractional shares are not issued, and the portion of the preferred return that otherwise would result in the issuance of a fractional  share is payable in cash.

In the event of a voluntary or involuntary liquidation, dissolution or winding up of the Company, each outstanding share of Series A Preferred Stock is entitled to receive, before any distribution to holders of common stock, an amount equal to its stated value plus any accrued and unpaid preferred return. After payment of this liquidation preference, the holders of Series A Preferred Stock do not participate in any remaining distributions.

Restricted Cash

At September 30, 2026, approximately $5.0 million was held in a restricted collateral account at Lakeside Bank in the name of a wholly owned subsidiary of the Company in connection with the Note B. This amount is classified as restricted cash on the condensed consolidated balance sheet and is included in cash, cash equivalents and restricted cash in the condensed consolidated statements of cash flows.

Note B Amendment

On July 14, 2026, effective as of June 2, 2026, the Company and the Investor amended the Note B to remove its limited redemption feature - the feature permitting the Investor to redeem principal based on the trading volume of the Company’s common stock on days the stock trades at or above 115% of the Nasdaq Minimum Price. As a result, that feature applies only to the Note A-1, and no derivative liability was recorded in connection with the Note B.

Embedded Derivative Liability Note A-1 Limited Redemption

The Note A-1 contains a limited redemption feature that permits the Investor, beginning six months after closing, to redeem Note A-1 principal on any trading day on which the Company’s common stock trades at or above 115% of the Nasdaq Minimum Price, in an amount up to 5% of the cumulative daily dollar trading volume in aggregate across the outstanding Notes. The Company determined that this feature is not clearly and closely related to the debt host and meets the definition of a derivative. The feature has been bifurcated and is recorded as a derivative liability measured at fair value, with changes in fair value recognized in the condensed consolidated statements of operations as “Change in fair value of derivative liability.”

The fair value of the bifurcated derivative was $130,156 at the June 3, 2026 closing date and $34,809 at September 30, 2026, resulting in a gain of $67,866 and $45,679 recognized during the nine months and three months ended September 30, 2026, respectively. Fair value was determined using a Monte Carlo simulation model classified within Level 3 of the fair value hierarchy. Significant inputs at September 30, 2026 included a common stock price of $1.38, a redemption trigger price of $2.461 (115% of the $2.14 Nasdaq Minimum Price), annualized volatility of 53.46%, a risk-free rate of 4.5%, and normalized average daily trading volume of 68,482 shares. At the June 3, 2026 closing date, the corresponding inputs included a common stock price of $2.10, annualized volatility of 22.84%, and normalized average daily trading volume of 41,177 shares.

The following table reconciles the derivative liability for the redemption feature of the A-1 Note, which is measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

Schedule of Fair Value on Recurring Basis Using Significant Unobservable Inputs 

Conversion of a Portion of the A-1 Secured Promissory Note into Series B Preferred Stock

On September 28, 2026, the Company entered into an exchange agreement with Streeterville Capital, LLC pursuant to which the Company exchanged $1.2 million of the outstanding principal amount of its Secured Promissory Note A-1 (the “Note A-1”) for 120 newly issued shares of Series B Preferred Stock, par value $0.01 per share (the “Series B Preferred Stock”). The Series B Preferred Stock was issued at a conversion price of $10,000 per share and has a stated value of $12,000 per share. The transaction was undertaken, in part, to increase the Company’s stockholders’ equity in support of compliance with the minimum stockholders’ equity requirement under Nasdaq Listing Rule 5550(b)(1).

The Series B Preferred Stock provides for an annual preferred return of 8% of stated value, compounded daily and payable quarterly, at the Company’s election, in cash or additional shares of Series B Preferred Stock issued at $10,000 per share. The Series B Preferred Stock does not have voting rights, except with respect to amendments that materially and adversely affect the rights or preferences of the Series B Preferred Stock and is not convertible into common stock. Upon a liquidation, dissolution or winding up of the Company, the Series B Preferred Stock ranks pari passu with the Company’s Series A Preferred Stock and senior to the Company’s common stock.

Holders of the Series B Preferred Stock do not have the right to require redemption of their shares. The Company may redeem the shares, solely at the discretion of its Board of Directors, at 110% of the applicable liquidation amount, plus any accrued and unpaid preferred return. The occurrence of an event of default may increase the stated value of the Series B Preferred Stock but does not provide the holder with a right to require cash redemption. Based on these terms, the Company determined that the Series B Preferred Stock is not mandatorily redeemable and is not redeemable upon an event outside the Company’s control. Accordingly, the Series B Preferred Stock is classified within permanent stockholders’ equity under ASC 480-10-S99-3A.

The exchange was accounted for as a partial extinguishment of the Note A-1 under ASC 470-50. The Company measured the Series B Preferred Stock issued at its estimated fair value of $1.2 million, based on the negotiated exchange price of $10,000 per share. Because the Series B Preferred Stock is a newly created class of preferred stock for which no active market exists, the Company considered the negotiated, arm’s-length exchange price to be the best available evidence of fair value.

The following table summarizes the amounts recognized in connection with the exchange:

 Schedule of Amounts Recognized in Connection with the Exchange

The net carrying amount of the Note A-1 extinguished included $1.2 million of principal, net of approximately $202,000 of related unamortized debt discount and issuance costs. The Company allocated the unamortized discount and issuance costs and the embedded derivative liability between the extinguished and continuing portions of the Note A-1 based on the relative principal amounts subject to the exchange. The resulting loss on extinguishment of approximately $167,643 was recognized within other income (expense) in the condensed consolidated statements of operations for the three and nine months ended September 30, 2026. Note A-1-extinguishment gains and losses are recognized currently in income and identified separately rather than deferred or amortized.

Immediately before the exchange, the Company remeasured the embedded derivative associated with the Note A-1’s limited redemption feature to its September 28, 2026 fair value of approximately $62,290. The decrease from its June 30, 2026 fair value of approximately $107,969 resulted in a gain of approximately $45,679, which was recognized within “Change in fair value of derivative liability” in the condensed consolidated statements of operations. In connection with the partial extinguishment, approximately $27,481 of the derivative liability was derecognized, and the remaining derivative liability of approximately $34,809 continued to be recognized in connection with the outstanding portion of the Note A-1.

The Company recorded approximately $1.2 million within stockholders’ equity for the Series B Preferred Stock issued, consisting of approximately $1 of par value and approximately $1.2 million of additional paid-in capital. Net impact after issuance costs was $1,131,658.

The preferred return on the Series B Preferred Stock does not affect net loss until declared or otherwise settled. However, the preferred return accumulated during each reporting period, whether or not declared, is deducted from net loss in determining net loss available to common stockholders and basic and diluted net loss per common share. Any preferred return paid through the issuance of additional Series B Preferred Stock will be reflected as a noncash financing activity.

As of September 30, 2026, 120 shares of Series B Preferred Stock were issued and outstanding, with an aggregate stated value of $1.44 million and an aggregate carrying amount of approximately $1.1 million.