NANO MAGIC INC. The following is management's discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying unaudited consolidated financial statements. OVERVIEW PEN develops, commercializes and markets consumer and industrial products enabled by nanotechnology that solve everyday problems for customers in the optical, transportation, military, sports and safety industries. Our primary business is the formulation, marketing and sale of products enabled by nanotechnology including the ULTRA CLARITY brand eyeglass cleaner, CLARITY DEFOGIT brand defogging products and CLARITY ULTRASEAL nanocoating products for glass and ceramics. We also sell an environmentally friendly surface protector, fortifier, and cleaner. Our design center conducts development services for us and for government and private customers and develops and sells printable inks and pastes, thermal management materials, and graphene foils and windows. Our principal operating segments coincide with our different business activities and types of products sold. This is consistent with our internal reporting structure. Our two reportable segments for the three and nine months endedSeptember 30, 2019 were (i) the Product Segment and (ii) the Contract services Segment. For the three and nine months endedSeptember 30, 2018 , the Company operated the same two segments. RESULTS OF OPERATIONS The following comparative analysis on results of operations was based primarily on the comparative consolidated financial statements, footnotes and related information for the periods identified below and should be read in conjunction with the unaudited consolidated financial statements and the notes to those statements that are included elsewhere in this report. The results discussed below are for the three and nine months endedSeptember 30, 2019 and 2018.
4
Comparison of Results of Operations for the Three and Nine Months ended
Revenues: For the three and nine months endedSeptember 30, 2019 and 2018, revenues consisted of the following: Three Months Ended Nine Months Ended September 30, September 30, 2019 2018 2019 2018 Sales: Product segment$ 263,180 $ 383,000 $ 1,088,495 $ 2,445,132 Contract services segment$ 255,171 382,957
839,356 1,131,803
Total segment and consolidated sales
For the three months endedSeptember 30, 2019 , sales from the Product segment were down by$119,820 or 31% as compared to the three months endedSeptember 30, 2018 . For the nine months endedSeptember 30, 2019 revenue from the Product segment was down by$1,356,637 or 55% as compared to the nine months endedSeptember 30, 2018 . For the three months endedSeptember 30, 2019 , sales from the Contract services segment decreased by$127,786 or 33% as compared to the three months endedSeptember 30 . For the nine months endedSeptember 30, 2019 revenue from the Contract services segment decreased by$292,447 or 26%, as compared to the nine months endedSeptember 30, 2018 . Cost of revenues Cost of revenues includes inventory costs, materials and supplies costs, internal labor and related benefits, subcontractor costs, depreciation, overhead and shipping and handling costs incurred and costs related to government and private research contracts in our Contract services segment.
For the three months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2019 2018 2019 2018
Cost of revenues:
Product segment $ 226,091 $ 350,969 $ 783,112 $ 1,806,472
Contract services segment 220,168 290,810 842,521 882,123
Total segment and consolidated
cost of revenues $ 446,259 $ 641,779 $ 1,625,633 $ 2,688,595 Gross profit and gross margin
For the three months endedSeptember 30, 2019 , gross profit decreased 52,086 or 42% as compared to the three months endedSeptember 30, 2018 . For the nine months endedSeptember 30, 2019 , gross profit decreased by$586,122 or 66% as compared to the nine months endedSeptember 30, 2018 .
Gross profit and gross margin by segment are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2019 % 2018 % 2019 % 2018 %
Gross profit:Product segment *$ 37,089 14.1 %$ 32,031 8.4
%
$ 72,092 13.9 % 124,178 16.2 %$ 302,218 15.7 %$ 888,340 24.8 %
* Gross margin % based on respective segments revenues.
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For the three and nine months ended
The erosion in gross margin from the contract research segment for the three and nine endedSeptember 30, 2019 as compared to the three and nine months endedSeptember 30, 2018 was attributable to profit on government contracts in 2018 that was not recurring in 2019. Operating expenses
For the three months endedSeptember 30, 2019 , operating expenses decreased by$60,295 or 15% compared to the three months endedSeptember 30, 2018 . Operating expenses decreased by$390,706 or 28% for the period endedSeptember 30, 2019 , as compared to the nine months endedSeptember 30, 2018 . For the three and nine months endedSeptember 30, 2019 and 2018, operating expenses consisted of the following: Three Months Ended Nine Months Ended September 30, September 30, 2019 2018 2019 2018 Selling and marketing expenses$ 11,812 $ 5,345 $ 38,156 $ 34,121 Salaries, wages and related benefits 57,572 133,044 217,352 488,115 Research and development 10,778 1,850 51,847 12,294 Professional fees 99,371 141,091 265,343 464,331 General and administrative expenses 168,017 126,515 452,649 417,192 Total$ 347,550 $ 407,845 $ 1,025,347 $ 1,416,053
? For the three months ended
increased by
30, 2018. For the nine months ended
expenses increased by
? For the three months ended
benefits decreased by
wages and related benefits decreased by
nine months ended
personnel reductions appropriate to the decline in sales volumes as well as
ongoing efforts to reduce costs.
? For the three months ended
increased by
30, 2018. For the nine months ended
development costs increased by
ended
labels.
? For the three months ended
the prior period due to a reduction in spend related to outside consultants
and legal.
? For the three months ended
expenses increased by
administrative expenses increased by
months ended
general facilities spend necessitated by a change in personnel in 2019. Loss from operations As a result of the factors described above, for the three months endedSeptember 30, 2019 , loss from operations amounted to$(275,458) as compared to loss from operations of$(283,667) for the three months endedSeptember 30, 2018 , a decrease of$8,209 or 3%. For the nine months endedSeptember 30, 2019 , loss from operations amounted to$(723,129) as compared to a loss from operations of$(527,713) for the nine months endedSeptember 30, 2018 , an increased loss
of$195,416 or 37%. 6 Other (income) expense
For the three months endedSeptember 30, 2019 , other income was$42,583 as compared to$25,746 for the three months endedSeptember 30, 2018 an increase of$16,837 or 65%, due primarily to a reduction in interest expense. Other income for the three-month period endedSeptember 30, 2019 decreased$16,258 or 29% as compared to the same period in 2018. For the nine months endedSeptember 30, 2019 other income was$99,106 as compared to$228,472 for the nine months ended 2018, a decrease of$134,160 or 59%, due to a reduction in interest expense offset by a larger reduction in other income generated from forgiveness of
accrued payables. Net loss
As a result of the foregoing, for the three and nine months endedSeptember 30, 2019 , net loss amounted to$(232,875) and$(624,023) as compared to net loss of$(257,921) and$(299,241) for the three and nine months endedSeptember 30, 2018 . For the three-month period the loss decreased by$25,046 or 10%. For the nine-month period the loss increased by$329,576 or 110%. For the three months endedSeptember 30, 2019 and 2018, net (loss) amounted to$(0.04) per common share (basic and diluted), and$(0.08) per common share (basic and diluted), respectively. For the nine months endedSeptember 30, 2019 and 2018, net (loss) amounted to$(0.14) per common share (basic and diluted) and$(0.10) per common share (basic and diluted), respectively.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability of an enterprise to generate adequate amounts of cash
to meet its needs for cash requirements. We had working capital deficit of
The following table sets forth a summary of changes in our working capital from
December 31, 2018 to
September 30, 2019
Change in
Working Percentage
September 30, 2019 December 31, 2018 Capital Change
Working capital:
Total current assets $ 949,930 $ 1,523,447 $ (573,517 ) (37.65 )%
Total current liabilities 1,687,814 2,507,268 (819,455 ) (32.68 )%
Working capital deficit: $ (737,884 ) $ (983,822 ) $ 245,938 ) 25.00 % The decrease in current assets was a due to a reduction in accounts receivable, inventory, and a decrease in prepaid expenses. The decrease in current liabilities is due to a reduction in accounts payable, accrued expenses, and the bank line of credit which has been paid off. Net cash used in operating activities was$677,304 for the nine months endedSeptember 30, 2019 as compared to cash provided of$31,074 for the nine months endedSeptember 30, 2018 , a decrease of$708,378 or 2280%. Net cash provided by operating activities for the nine months endedSeptember 30, 2019 primarily reflected a net loss of$(624,023) adjusted for add-backs of$52,881 and changes in operating assets and liabilities of$(106,162) .
Net cash flow used by investing activities was
7 Net cash provided by financing activities of$483,976 for the nine months endedSeptember 30, 2019 as compared to cash used in financing activities$(61,135) in the same period in 2018. During the nine months endedSeptember 30, 2019 , we paid down the bank line of credit and received proceeds from stock sales of$838,320 .
Future Liquidity and Capital Needs.
Our principal future uses of cash are for working capital requirements, including sales and marketing expenses and reduction of accrued liabilities. Application of funds among these uses will depend on numerous factors including our sales and other revenues and our ability to control costs. Revolving Credit Note InApril 2014 , our subsidiary,PEN Brands LLC entered into a$1,500,000 revolving credit line agreement (the "Revolving Note") withMackinac Commercial Credit, LLC (the "Lender") with draws limited to a borrowing base as defined in the Revolving Note. The unpaid principal balance of this Revolving Note is payable on demand, is secured by all ofPEN Brands LLC's assets, and bears interest computed at a rate of interest (the "Effective Rate") which is equal to 7.0% above the LIBOR Rate, as defined, payable monthly.PEN Brands LLC will pay to Lender a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company may, at any time or from time to time upon three business days' written notice to Lender, prepay the Note in whole provided that if (i) Borrower prepays the Revolving Note in full and terminates the Revolving Note, or (ii) Lender terminates the Revolving Note after default, then Borrower will pay a termination premium equal to 2.0% of the maximum loan amount. OnMay 1, 2015 ,PEN Brands LLC and the Lender entered into an amendment to the Loan and Security Agreement extending the outside maturity date toApril 4, 2016 and permitting advances against an expanded borrowing base. The borrowing base was increased by$450,000 throughOctober 31, 2015 , with this amount reducing by$7,500 monthly thereafter. In addition, the Company guaranteedPEN Brands LLC's obligations to the Lender. OnApril 4, 2016 , the maturity date under the Loan & Security Agreement betweenPEN Brands LLC and the Lender was automatically extended for a one-year renewal term. Without the Lender's consent, so long as the obligation remains outstanding, in addition to other covenants as defined in the Revolving Note,PEN Brands LLC shall not a) merge or consolidate with any other company, except for the combination that closed inAugust 2014 and shall not suffer a change of control; b) make any capital expenditures, as defined, materially affecting the business; c) declare or pay cash dividends upon any of its stock, or distribute any of its property, make any loans, make investments, redeem, retire or acquire any of its stock, d) become liable for the indebtedness of anyone else, as defined, and e) incur indebtedness, other than trade payables. OnApril 3, 2017 ,PEN Brands LLC and the Lender executed a second amendment to the Revolving Note that extended OnApril 3, 2017 ,PEN Brands LLC and the Lender executed a second amendment to the Revolving Note that extended the maturity date toApril 4, 2018 , with a one-year renewal option. The second amendment also changed the interest rate to 3.0% above the Prime Rate, as reported in theWall Street Journal . Under a subsequent amendment, the maturity date was changed
toJuly 3, 2018 .
OnOctober 17, 2017 , pursuant to the terms of the Revolving Note, the gross proceeds of$85,000 in connection with the Asset Purchase agreement were applied to decrease the borrowing base of the Revolving Note. In connection with the sale of fixed assets, the Company amended the Revolving Note to establish a cash collateral account to be no less than$85,000 . Pursuant to this amendment, the Company entered into a loan agreement with two Company directors in the aggregate principal amount of$85,000 in order to fund the cash collateral provision pursuant to the amended loan agreement. The loan bears no interest and is due when cash flow permits, or if earlier, upon the payment or refinancing of the loan from the Lender to PEN Brands. OnMarch 30, 2018 , PEN Brands and the lender entered into the fourth amendment that permits the borrower to request up to three advances of not more than$200,000 each supported by certain qualifying purchase orders. Each purchase order advance to be repaid in not less than 30 days. No subsequent request can be made until any prior purchase order advance has been repaid. Two of the Company's officers and directors have personally guaranteed repayment of purchase order advances. The fourth amendment also changes the maturity date for the loan toJuly 3, 2018 . That date becomes the date for an automatic one-year renewal unless either the lender or the borrower gives notice of non-renewal. Other terms and conditions of the agreement remain the same. 8 OnAugust 8, 2018 , PEN Brands and the lender entered into the fifth amendment with an effective date ofJuly 3, 2018 . The fifth amendment renewed the agreement throughJuly 3, 2019 and provides for an automatic one-year renewal at that time unless it is terminated by either party 60 days in advance. The fifth amendment also limits the amounts that PEN Brands can advance to its parent, and provides that advances based on eligible inventory will reduce monthly by$7,500 per month startingNovember 1, 2018 . OnJanuary 31, 2019 , PEN Brands paid$172,101 to the lender. This payment, and the application of$85,000 in cash collateral held by the lender paid in full the outstanding principal balance, accrued interest and fees due to the lender. The parties also terminated the revolving credit line agreement and note originally executed inApril 2014 that was renewed inAugust 2018 . Equipment Financing OnFebruary 10, 2015 , Nanofilm entered into a promissory note (the "Equipment Note") withKeyBank, N.A. (the "Bank") to borrow up to$373,000 . Nanofilm may obtain one or more advances not to exceed$373,000 . The unpaid principal balance of this Equipment Note is payable in 60 equal monthly installments payments of principal and interest throughJune 10, 2020 . The Equipment Note is secured by certain equipment, as defined in the Equipment Note, and bears interest computed at a rate of interest of 4.35% per annum based on a year of 360 days. OnJune 18, 2019 , PEN Brands entered into an Amendment to the Equipment Note with the Bank. By the amendment, the maturity date of the note was extended untilApril 10, 2022 , the interest rate was raised to 6.29% per year, and the monthly payments were reduced. As ofDecember 31, 2018 ,$73,562 and$60,563 , respectively, were the current and non-current portion due under this note. As ofSeptember 30, 2019 ,$74,106 and$50,919 , were the current and non-current portion due under this note.
Off-Balance Sheet Arrangements
We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder's equity or that are not reflected in our consolidated unaudited financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
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