Unaudited Interim Financial Information

The unaudited interim financial statements and related notes have been prepared in accordance with U.S. GAAP for interim financial information, within the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Certain information and disclosures normally included in the annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. The unaudited interim financial statements have been prepared on a basis consistent with the audited financial statements and in the opinion of management, reflect all adjustments, consisting of only normal recurring adjustments, necessary for the fair presentation of the results for the interim periods presented and of the financial condition as of the date of the interim balance sheet. The financial data and the other information disclosed in these notes to the interim financial statements related to the three and six month periods are unaudited. Unaudited interim results are not necessarily indicative of the results for the full fiscal year. These unaudited interim financial statements should be read in conjunction with the financial statements of the Company for the year ended December 31, 2022 and notes thereto that are included in the Company’s Registration Statement filed with the SEC on June 5, 2023.

AZITRA, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three and Six Months Ended June 30, 2023 and 2022

Cash and Cash Equivalents

Cash and Cash Equivalents

For purposes of the balance sheets and statements of cash flows, the Company considers all cash on hand, demand deposits and all highly liquid investments with original maturities of three months or less to be cash equivalents.

Accounts Receivable

Accounts Receivable

The Company carries its accounts receivable at cost less an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts based on a history of past write-offs, collections and current conditions. There was no allowance for doubtful accounts at June 30, 2023 and December 31, 2022. Accounts receivable are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received.

Right of Use Assets

Right of Use Assets

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (“Topic 842”). ASU 2016-02 requires lessees to present right-of-use (“ROU”) assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. See Note 2 – Recently Adopted Accounting Pronouncements.

In calculating the effect of ASU 2016-02, the Company elected the transition method thereby not restating comparable periods. The Company elected to account for non-lease components as part of the lease component to which they relate. Lease accounting involves significant judgments, including making estimates related to the lease term, lease payments, and discount rate. In accordance with the guidance, the Company recognized ROU assets and lease liabilities for all leases with a term greater than 12 months.

The Company has operating leases for buildings. Currently, the Company has 3 operating leases with a ROU asset and lease liability totaling $1,418,502 as of January 1, 2022. The basis, terms and conditions of the leases are determined by the individual agreements. The Company’s option to extend certain leases ranges from 36 – 52 months. All options to extend have been included in the calculation of the ROU asset and lease liability. The leases do not contain residual value guarantees, restrictions, or covenants that could incur additional financial obligations to the Company. There are no subleases, sale-leaseback, or related party transactions.

At June 30, 2023, the Company had operating right-of-use assets with a net value of $976,959 and current and long-term operating lease liabilities of $298,047 and $693,609, respectively.

Deferred Patent Costs

Deferred Patent Costs

Deferred patent costs represent legal and filing expenses incurred related to the submission of patent applications for patents pending approval. These deferred costs will begin to be amortized over their estimated useful lives upon the formal approval of the patent. If the patent is not approved, the costs associated with the patent will be expensed in the year the patent was rejected. No impairment losses relating to deferred patent costs were recorded in the three and six months ended June 30, 2023 or 2022.

Convertible Debt and Warrant Accounting

Convertible Debt and Warrant Accounting

Warrants

The Company accounts for warrants as either equity-classified or liability-classified instruments based on an assessment of the warrant’s specific terms and applicable authoritative guidance in ASC 480, Distinguishing Liabilities from Equity (“ASC 480”) and ASC 815, Derivatives and Hedging (“ASC 815”). The assessment considers whether the warrants are freestanding financial instruments pursuant to ASC 480, meet the definition of a liability pursuant to ASC 480, and whether the warrants meet all of the requirements for equity classification under ASC 815, including whether the warrants are indexed to the Company’s own common stock, among other conditions for equity classification. This assessment, which requires the use of professional judgment, is conducted at the time of warrant issuance and as of each subsequent quarterly period end date while the warrants are outstanding.

For issued warrants that meet all of the criteria for equity classification, the warrants are required to be recorded as a component of additional paid-in capital at the time of issuance. For issued warrants that do not meet all the criteria for equity classification, the warrants are required to be recorded at their initial fair value on the date of issuance, and each balance sheet date thereafter. Changes in the estimated fair value of the warrants are recognized as a non-cash gain or loss on the statements of operations under Other Income/loss.

Convertible debt

When the Company issues debt with a conversion feature, it first assesses whether the debt should be accounted for in accordance with ASC 480 – Distinguishing Liabilities from Equity. If the debt does not meet the criteria of an ASC 480 liability, the note’s conversion features require bifurcation in accordance with ASC 815 – Derivatives and Hedging. If the Company determines the embedded conversion feature requires bifurcation in accordance with ASC 815, the Company also considers if it can elect the fair value option. If the fair value option is elected, the Company records the note at its initial fair value with any subsequent changes in fair value recorded in earnings. As noted in Note 7, the Company has elected the fair value option for the 2022 Convertible Notes and will record the notes at their initial fair values with any subsequent changes in fair value recorded in earnings. The Convertible Notes were converted into the Company’s common stock on the Closing Date of the Company’s IPO.

Revenue

Revenue

The Company follows the five steps to recognize revenue from contracts with customers under ASC 606, Revenue from Contracts with Customers (“ASC 606”), which are:

	●	Step 1: Identify the contract(s) with a customer

	●	Step 2: Identify the performance obligations in the contract

	●	Step 3: Determine the transaction price

AZITRA, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three and Six Months Ended June 30, 2023 and 2022

	●	Step 4: Allocate the transaction price to the performance obligations in the contract

	●	Step 5: Recognize revenue when (or as) a performance obligation is satisfied

The Company generates service revenue through a joint development agreement with a research partner. The Company recognizes revenue related to the research and development aspects of the agreement over time using the input method as work is performed on the contract.

The Company also generates grant revenue, which represents monies received on contracts with various federal agencies and nonprofit research institutions for general research conducted by the Company to further their product development and are therefore considered contributions to the Company. The contracts are generally for periods of one year or more and can be cancelled by either party. The Company concluded that the grant arrangements do not meet the criteria to be treated as a collaborative arrangement under FASB ASC Topic 808 as the Company is the only active participant in the arrangement. The grant arrangements also do not meet the criteria for revenue recognition under Topic 606, as the U.S. Government would not meet the definition of a customer.

Amounts earned under these grant contracts are recorded as a reduction to research and development expense when eligible expenses are incurred and the right to payment is realizable or realized and earned. The Company believes this policy is consistent with Topic 606, to ensure that recognition reflects the transfer of promised goods or services to customers in an amount that reflects the consideration that the Company expects to be entitled to in exchange for those goods or services, even though there is no exchange as defined in Topic 606. Additionally, the Company has determined that the recognition of amounts received as costs are incurred and amounts become realizable is analogous to the concept of transfer of control of a service over time under Topic 606.

Receipts of grant awards in advance, which are payable back to the funding agency if not used in accordance with conditions in the grants related to allowable costs or receipt of funding from research partners related to service revenue arrangements before work is performed on the contract, are classified as contract liabilities in the accompanying balance sheets.

Stock-Based Compensation

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC 718, Compensation-Stock Compensation (ASC 718). ASC 718 requires employee stock options and rights to purchase shares under stock participation plans to be accounted for at fair value. ASC 718 requires that compensation costs related to share-based payment transactions be recognized as operating expenses in the financial statements. Under this method, compensation costs for all awards granted or modified are measured at estimated fair value at date of grant and are included as compensation expense over the vesting period during which an employee provides service in exchange for the award. For awards with a performance condition that affects vesting, the Company recognizes compensation expense when it is determined probable that the performance condition will be achieved.

The Company uses a Black-Scholes option pricing model to determine fair value of its stock options. The Black-Scholes model includes various assumptions, including the value of the underlying common stock, the expected life of stock options, the expected volatility and the expected risk-free interest rate. These assumptions reflect the Company’s best estimates, but they involve inherent uncertainties based on market conditions generally outside of the control of the Company. As a result, if other assumptions had been used, stock-based compensation cost could have been materially impacted. Furthermore, if the Company uses different assumptions for future grants, stock-based compensation cost could be materially impacted in future periods.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of ASC 718 as updated by Accounting Standards Update (ASU) No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of ASC 718 to include share-based payment transactions to non-employees.

AZITRA, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For The Three and Six Months Ended June 30, 2023 and 2022

The following assumptions are used in valuing options issued using the Black-Scholes option pricing model:

Expected Volatility. The expected volatility of the Company’s shares is estimated based on the Company’s external valuation.

Expected Term. The expected term of options is estimated using the simplified method which is based on the vesting period and contractual term for each grant, or for each vesting-tranche for awards with graded vesting.

Underlying Common Stock Value. The underlying common stock value of the Company’s shares is estimated by a third-party valuation expert.

Risk-free Interest Rate. The Company bases the risk-free interest rate on the implied yield available on a U.S. Treasury note with terms equal to the expected term of the underlying grant.

Dividend Yield. The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has not paid dividends on Common stock in the past nor does it expect to pay dividends on Common stock in the near future. As such, the Company uses a dividend yield percentage of zero

Fair Value Measurements

Fair Value Measurements

The Company carries certain liabilities at fair value on a recurring basis. A fair value hierarchy that consists of three levels is used to prioritize the inputs to fair value valuation techniques:

	●	Level 1 – Inputs are based upon observable or quoted prices for identical instruments traded in active markets.

	●	Level 2 – Inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

	●	Level 3 – Inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

Financial Instruments

Financial Instruments

The Company’s financial instruments are primarily comprised of accounts receivable, accounts payable, accrued liabilities, and long-term debt. For accounts receivable, accounts payable and accrued liabilities, the carrying amount approximates fair value due to the short-term maturities of such instruments. The estimated fair value of the Company’s long-term debt approximates carrying value.