CONDENSED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER
30, 2020
(UNAUDITED)
NOTE
1 – ORGANIZATION AND BASIS OF PRESENTATION
Organization
Nano
Magic Inc. (“we”, “us”, “our”, “Nano Magic” or the “Company”), a Delaware
corporation, develops and sells a portfolio of nano-layer coatings, nano-based cleaners, and nano-composite products based on
its proprietary technology, and performs nanotechnology product research and development generating revenues through performing
contract services. On March 3, 2020, we changed our name from PEN Inc. to Nano Magic Inc.
Through
the Company’s wholly-owned subsidiary, Nano Magic LLC, formerly known as PEN Brands LLC, we develop, manufacture and sell
consumer and institutional products using nanotechnology to deliver unique performance attributes at the surfaces of a wide variety
of substrates. These products are marketed internationally directly to consumers and also to retailers and other institutional
customers. On March 31, 2020, PEN Brands LLC changed its name to Nano Magic LLC.
Through
the Company’s wholly-owned subsidiary, Applied Nanotech, Inc., we primarily perform contract research services for the Company
and for governmental and private customers.
Basis
of Presentation
The
accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally
accepted in the United States of America (“US GAAP”) for interim financial information. Accordingly, they do not include
all the information and disclosures required by US GAAP for annual financial statements. In the opinion of management, such statements
include all adjustments (consisting only of normal recurring items) which are considered necessary for a fair presentation of
the unaudited consolidated financial statements of the Company as of September 30, 2020 and for the three and nine months ended
September 30, 2020 and 2019. The results of operations for the three and nine months ended September 30, 2020 are not necessarily
indicative of the operating results for the full year ending December 31, 2020 or any other period. These unaudited condensed
consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related
disclosures of the Company as of December 31, 2019 and for the year then ended, which were filed with the Securities and Exchange
Commission on Form 10-K on May 13, 2020.
Going
Concern
These
consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and
the settlement of liabilities and commitments in the normal course of business. As reflected in the consolidated financial statements
filed with our Form 10-K on May 13, 2020, the Company had losses from operations and net cash used by operations of $1,031,083
and $878,668, respectively, for the year ended December 31, 2019. Furthermore, at September 30, 2020, the Company had an accumulated
deficit of $8,460,248. These factors raise substantial doubt about the Company’s ability to continue as a going concern
within one year after the date that the financial statements are issued. Management cannot provide assurance that the Company
will ultimately achieve profitable operations or become cash flow positive, or raise additional debt and/or equity capital. During
2018 management took measures to reduce operating expenses. During 2019 and the first three quarters of 2020, management closely
monitored costs. In addition, the Company raised equity capital in 2018, 2019 and 2020. These unaudited consolidated financial
statements do not include any adjustments related to the recoverability and classification of assets or the amounts and classification
of liabilities that might be necessary should the Company be unable to continue as a going concern.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use
of Estimates
The
preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates. Significant estimates for the three and nine months ended September 30, 2020 and 2019 include
estimates for allowance for doubtful accounts on accounts receivable, the estimates for obsolete inventory, the useful life of
property and equipment, assumptions used in assessing impairment of long-term assets, estimates of current and deferred income
taxes and deferred tax valuation allowances, the fair value of non-cash equity transactions, and the fair value of equity incentives.
Fair
Value of Financial Instruments and Fair Value Measurements
The
Company adopted the guidance of Accounting Standards Codification (“ASC”) 820 for fair value measurements which clarifies
the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify
the inputs used in measuring fair value as follows:
Level
1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
Level
2-Inputs are quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets
and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or
corroborated by observable market data.
Level
3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants
would use in pricing the asset or liability based on the best available information.
The
carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, loans and lines
of credit, accounts payable, accrued expenses, and other payables approximate their fair market value based on the short-term
maturity of these instruments.
The
Company analyzes all financial and non-financial instruments with features of both liabilities and equity under the Financial
Accounting Standards Board (“FASB”) accounting standard for such instruments. Under this standard, financial and non-financial
assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value
measurement. The Company accounts for no instruments at fair value using level 3 valuation.
ASC
825-10 “Financial Instruments”, allows entities to voluntarily choose to measure certain financial assets and liabilities
at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable,
unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that
instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value
option to any outstanding instruments.
Cash
and Cash Equivalents
For
purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments with a maturity of
three months or less at the purchase date and money market accounts to be cash equivalents.
Accounts
Receivable
Accounts
receivable are presented net of an allowance for doubtful accounts. The Company maintains an allowance for doubtful accounts for
estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowance when
there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances,
the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current
credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. The Company only
grants credit terms to established customers who are deemed to be financially responsible. The expense associated with the allowance
for doubtful accounts is recognized as general and administrative expense.
Inventory
Inventory
is stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out (FIFO) method based on
prices paid for inventory items. This valuation requires us to make judgments, based on currently available information, about
the likely method of disposition, such as sales to individual customers and expected recoverable values.
Property
and Equipment
Property
and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives, which range
from three to ten years. Leasehold improvements are depreciated over the shorter of the useful life or lease term including scheduled
renewal terms. Maintenance and repairs are charged to expense as incurred. When assets are retired or disposed of, the cost and
accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of
disposition. The Company examines the possibility of decreases in the value of these assets when events or changes in circumstances
reflect the fact that their recorded value may not be recoverable.
Impairment
of Long-Lived Assets
In
accordance with ASC Topic 360, the Company reviews long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes an
impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount
of impairment is measured as the difference between the asset’s estimated fair value and its book value. The Company did
not record any impairment charge for the three and nine months ended September 30, 2020 and 2019.
Revenue
Recognition
We
adopted ASC Topic 606, Revenue from Contracts with Customers (“ASC Topic 606”), effective January 1, 2018 using
the modified retrospective method. ASC Topic 606 is a comprehensive revenue recognition model that requires revenue to be recognized
when control of the promised goods or services are transferred to our customers at an amount that reflects the consideration that
we expect to receive. The application of ASC Topic 606 requires us to use significant judgment and estimates. Application of ASC
Topic 606 requires a five-step model applicable to all revenue streams as follows:
Identification
of the contract, or contracts, with a customer
A
contract with a customer exists when (i) we enter into an enforceable contract with a customer that defines each party’s
rights regarding the goods or services to be transferred and identifies the payment terms related to these goods or services,
(ii) the contract has commercial substance and, (iii) we determine that collection of substantially all consideration for goods
or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration.
We apply judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including
the customer’s historical payment experience or, in the case of a new customer, published credit and financial information
pertaining to the customer.
Identification
of the performance obligations in the contract
Performance
obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that
are both capable of being distinct, whereby the customer can benefit from the goods or service either on its own or together with
other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby
the transfer of the goods or services is separately identifiable from other promises in the contract.
When
a contract includes multiple promised goods or services, we apply judgment to determine whether the promised goods or services
are capable of being distinct and are distinct within the context of the contract. If these criteria are not met, the promised
goods or services are accounted for as a combined performance obligation.
Determination
of the transaction price
The
transaction price is determined based on the consideration to which we will be entitled to receive in exchange for transferring
goods or services to our customer. We estimate any variable consideration included in the transaction price using the expected
value method that requires the use of significant estimates for discounts, cancellation periods, refunds and returns. Variable
consideration is described in detail below.
Allocation
of the transaction price to the performance obligations in the contract
If
the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation.
Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation
based on a relative Stand-Alone Selling Price (“SSP,”) basis. We determine SSP based on the price at which the performance
obligation would be sold separately. If the SSP is not observable, we estimate the SSP based on available information, including
market conditions and any applicable internally approved pricing guidelines.
Recognition
of revenue when, or as, we satisfy a performance obligation
We
recognize contract revenue over time and product revenue at a point in time, when the related performance obligation is satisfied
by transferring the promised goods or services to our customer. Contract revenue is recognized based on a cost-to-cost input method.
Disaggregation
of Revenue
For
the three and nine months ended September 30, 2020, total sales in the United States represented approximately 85% and
77% of total consolidated revenues. For the same periods in 2019, sales in the United States represented approximately
87% and 85% of total consolidated revenues. No other geographical area accounted for more than 10% of total sales during
the three and nine months ended September 30, 2020 and 2019.
Principal
versus Agent Considerations
When
another party is involved in providing goods or services to our customer, we apply the principal versus agent guidance in ASC
Topic 606 to determine if we are the principal or an agent to the transaction. When we control the specified goods or services
before they are transferred to our customer, we report revenue gross, as principal. If we do not control the goods or services
before they are transferred to our customer, revenue is reported net of the fees paid to the other party, as agent. Our evaluation
to determine if we control the goods or services within ASC Topic 606 includes the following indicators:
We
are primarily responsible for fulfilling the promise to provide the specified good or service.
When
we are primarily responsible for providing the goods and services, such as when the other party is acting on our behalf, we have
indication that we are the principal to the transaction. We consider if we may terminate our relationship with the other party
at any time without penalty or without permission from our customer.
We
have inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the
customer.
We
may commit to obtaining the services of another party with or without an existing contract with our customer. In these situations,
we have risk of loss as principal for any amount due to the other party regardless of the amount(s) we earn as revenue from our
customer.
The
entity has discretion in establishing the price for the specified good or service.
We
have discretion in establishing the price our customer pays for the specified goods or services.
Contract
Assets
We
capitalize costs and estimated earnings in excess of billings as a contract asset in current assets. At September 30, 2020 and
2019, contract assets totaled $61,334 and $0, respectively.
Contract
Liabilities
Contract
liabilities consist of customer advance payments and billings in excess of revenue recognized. We may receive payments from our
customers in advance of completing our performance obligations. We record contract liabilities equal to the amount of payments
received in excess of revenue recognized, Contract liabilities are recorded under the caption “contract liabilities”
and are reported as current liabilities on our consolidated financial statements when the time to fulfill the performance obligations
under terms of our contracts is less than one year. At September 30, 2020 and 2019, contract liabilities totaled $61,526 and $7,534,
respectively.
Cost
of Sales
Cost
of sales includes inventory costs, materials and supplies costs, internal labor and related benefits, subcontractor costs, depreciation,
overhead and shipping and handling costs incurred.
Shipping
and Handling Costs
Shipping
and handling costs incurred relating to the purchase of inventory are included in inventory which is charged to cost of sales
as products are sold. Shipping and handling costs incurred for product shipped to customers are included in cost of sales. For
the three months ended September 30, 2020 and 2019 shipping and handling costs amounted to $52,687 and $19,707, respectively,
and $103,714 and $65,735 for the nine months ended September 30, 2020 and 2019, respectively.
Research
and Development
Research
and development costs incurred in the development of the Company’s products and under other Company sponsored research and
development projects are expensed as incurred. Costs such as direct labor, direct costs, and other allocated costs incurred to
perform research and development service pursuant to government and private research projects are in included in cost of sales.
Research and development costs incurred in the development of the Company’s products for the three months ended September
30, 2020 and 2019 were $22,383 and $10,778, respectively, and were $53,418 and $51,848 for the nine months ended September
30, 2020 and 2019, respectively, and are included in operating expenses on the accompanying unaudited consolidated statements
of operations.
Advertising
Costs
The
Company participates in various advertising programs. All costs related to advertising of the Company’s products are expensed
in the period incurred. Advertising costs charged to operations for the three months ended September 30, 2020 and 2019 were $1,841
and $0, respectively, and were $4,435 and $1,980 for the nine months ended September 30, 2020 and 2019, respectively, and are
included in sales and marketing on the unaudited consolidated accompanying statements of operations. These advertising expenses
do not in include cooperative advertising and sales incentives which have been deducted from sales.
Federal
and State Income Taxes
The
Company accounts for income tax using the liability method prescribed by ASC 740, “Income Taxes”. Under this method,
deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets
and liabilities using enacted tax rates that will be in effect in the year in which the differences are expected to reverse. The
Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not
that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates
is recognized as income or loss in the period that includes the enactment date.
The
Company follows the accounting guidance for uncertainty in income taxes using the provisions of ASC 740 “Income Taxes”.
Using that guidance, tax positions initially need to be recognized in the financial statements when it is more likely than not
the position will be sustained upon examination by the tax authorities. As of September 30, 2020, and December 31, 2019, the Company
had no uncertain tax positions that qualify for either recognition or disclosure in the financial statements. Tax years that remain
subject to examination are the years ending on and after December 31, 2017. The Company does not expect any significant changes
in its unrecognized tax benefits within twelve months of the reporting date. The Company recognizes interest and penalties related
to uncertain income tax positions in other expense. However, no such interest and penalties were recorded as of September 30,
2020 or December 31, 2019.
Stock-Based
Compensation
Stock-based
compensation is accounted for based on the requirements of the Share-Based Payment Topic of ASC 718 which requires recognition
in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments
over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting
period). The ASC also requires measurement of the cost of employee and director services received in exchange for an award based
on the grant-date fair value of the award. The Company adopted ASU No. 2017-09 in 2018; its adoption did not have a material impact
on its consolidated financial statements.
Pursuant
to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the
“measurement date.” The expense is recognized over the service period of the award. Until the measurement date is
reached, the total amount of compensation expense remains uncertain. The Company initially records compensation expense based
on the fair value of the award at the reporting date.
Loss
Per Share of Common Stock
ASC
260 “Earnings Per Share”, requires dual presentation of basic and diluted earnings per share (“EPS”) with
a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted
EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. Basic net loss per common share is computed by dividing net loss available to common
shareholders by the weighted average number of shares of common shares outstanding during the period. Diluted net loss per common
share is computed by dividing net loss by the weighted average number of shares of common stock, common stock equivalents and
potentially dilutive securities outstanding during each period. Potentially dilutive common shares consist of common stock options
and warrants (using the treasury stock method).
These
common stock equivalents may be dilutive in the future. Potentially dilutive common shares were excluded from the computation
of diluted shares outstanding as they would have an anti-dilutive impact on the Company’s net losses and consisted of the
following:
|
|
September 30, 2020
|
|
|
December 31, 2019
|
|
Stock options
|
|
|
553,170
|
|
|
|
455,502
|
|
Stock warrants
|
|
|
5,443,440
|
|
|
|
2,817,463
|
|
Total
|
|
|
5,996,610
|
|
|
|
3,272,965
|
|
Net
loss per share for each class of common stock is as follows:
Net (loss) income per common shares outstanding:
|
|
Three Months
ended
September 30, 2020
|
|
|
Three Months
ended
September 30, 2019
|
|
|
Nine Months
ended
September 30, 2020
|
|
|
Nine Months
ended
September 30, 2019
|
|
Common stock
|
|
$
|
(0.01
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.11
|
)
|
|
$
|
(0.16
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock
|
|
|
7,487,260
|
|
|
|
5,330,289
|
|
|
|
7,255,244
|
|
|
|
4,483,175
|
|
Total weighted average shares outstanding
|
|
|
7,487,260
|
|
|
|
5,330,289
|
|
|
|
7,255,244
|
|
|
|
4,483,175
|
|
Segment
Reporting
The
Company uses “the management approach” in determining reportable operating segments. The management approach considers
the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions
and assessing performance as the source for determining the Company’s reportable segments. The Company’s chief operating
decision maker is the President and CEO of the Company, who reviews operating results to make decisions about allocating
resources and assessing performance for the entire Company. The Company classified the reportable operating segments into (i)
the development, manufacture and sale of consumer and institutional products using nanotechnology to deliver unique performance
attributes at the surfaces of a wide variety of substrates (the “Product segment”) and (ii) nanotechnology design
and development services for our future products and for government and private entities (the “Contract services segment”).
Leases
The
Company adopted ASC 842 on January 1, 2019 using the modified retrospective basis and did not adjust comparative periods as permitted
under Accounting Standards Update (“ASU”) 2018-11. ASC 842 supersedes nearly all existing lease accounting guidance
under U.S. GAAP issued by the Financial Accounting Standards Board (“FASB”) including ASC Topic 840, Leases. ASC 842
requires that lessees recognize Right-of-Use (ROU) assets and lease liabilities calculated based on the present value of lease
payments for all lease agreements with terms that are greater than twelve months. ASC 842 distinguishes leases as either a finance
lease or an operating lease that affects how the leases are measured and presented in the statement of operations and statement
of cash flows.
For
operating leases, we calculated ROU assets and lease liabilities based on the present value of the remaining lease payments as
of the date of adoption using the IBR as of that date. On the date of adoption, operating lease liabilities and right-of-use assets
totaled $400,327. As per the definition of ASC 842 as of September 30, 2020 , we had finance lease assets totaling $94,855 with related liabilities
of $72,050.
The
FASB issued practical expedients and accounting policy elections that the Company has applied as described below.
Practical
Expedients
ASC
842 provides a package of three practical expedients that must be adopted together and applied to all lease agreements. The Company
elected the package of practical expedients as follows for all leases:
Whether
expired or existing contracts contain leases under the new definition of a lease.
Because
the accounting for operating leases and service contracts was similar under ASC 840, there was no accounting reason to separate
lease agreements from service contracts in order to account for them correctly. The Company reviewed existing service contracts
to determine if the agreement contained an embedded lease to be accounted for on the balance sheet under ASC 842.
Lease
classification for expired or existing leases.
Leases
that were capital leases under ASC 840 are accounted for as financing leases under ASC 842 while leases that were operating leases
under ASC 840 are accounted for as operating leases under ASC 842.
Whether
previously capitalized initial direct costs would meet the definition of initial direct costs under the new standard guidance.
The
definition of initial direct costs is more restrictive under ASC 842 than under ASC 840. Entities that do not elect the practical
expedient are required to reassess capitalized initial direct costs under ASC 840 and record an equity adjustment for those that
are not capitalizable under ASC 842.
Accounting
Policy Elections
Lease
Term
The
Company calculates the term for each lease agreement to include the noncancelable period specified in the agreement together with
(1) the periods covered by options to extend the lease if the Company is reasonably certain to exercise that option, (2) periods
covered by an option to terminate if the Company is reasonably certain not to exercise that option and (3) period covered by an
option to extend (or not terminate) if controlled by the lessor.
The
assessment of whether the Company is reasonably certain to exercise an option to extend a lease requires significant judgement
surrounding contract-based factors, asset-based factors, entity-based factors and market-based factors.
Lease
Payments
Lease
payments consist of the following payments (as applicable) related to the use of the underlying asset during the lease term:
|
●
|
Fixed
payments, including in substance fixed payments, less any lease incentives paid or payable to the lessee
|
|
|
|
|
●
|
Variable
lease payments that depend on an index or a rate, such as the Consumer Price Index or a market interest rate, initially measured
using the index or rate at the commencement date of January 1, 2019.
|
|
|
|
|
●
|
The
exercise price of an option to purchase the underlying asset if the lessee is reasonably certain to exercise that option.
|
|
|
|
|
●
|
Payments
for penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease.
|
|
|
|
|
●
|
Fees
paid by the lessee to the owners of a special-purpose entity for structuring the transaction
|
|
|
|
|
●
|
For
a lessee only, amounts probable of being owed by the lessee under residual value guarantees
|
Incremental
Borrowing Rate
The
ROU asset and related lease liabilities recorded under ASC 842 are calculated based on the present value of the lease payments
using (1) the rate implicit in the lease or (2) the lessee’s IBR, defined as the rate of interest that a lessee would have
to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.
Recently
Issued Accounting Pronouncements
Financial
Instruments — Credit Losses (Topic 326)
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments (“ASU 2016-13”). This standard prescribes an impairment model (known as the current expected
credit loss (“CECL”) model) that is based on expected losses rather than incurred losses. Under the new guidance,
an entity recognizes as an allowance its estimate of expected credit losses, which is intended to result in the timely recognition
of losses. Under the CECL model, entities will estimate credit losses over the entire contractual term of the instrument from
the date of initial recognition of the financial instrument.
Measurement
of expected credit losses is to be based on relevant forecasts that affect collectability. The scope of financial assets within
the CECL methodology is broad and includes trade receivables from certain revenue transactions and certain off-balance sheet credit
exposures. Different components of the guidance require modified retrospective or prospective adoption. ASU 2016-13 is effective
for the annual reporting period beginning on or after December 15, 2020. The Company adopted this standard January 1, 2020 and
there was no material impact.
Except
for our accounting policies for allowance for doubtful accounts as a result of adopting ASU 2016-13, there have been no changes
to our significant accounting policies described in Note 2 to our Annual Report on Form 10-K for the year ended December 31, 2019,
that have had a material impact on our Consolidated Financial Statements and related notes.
Reclassifications
Certain
accounts and financial statement captions in the prior periods have been reclassified to conform to the current period financial
statements.
NOTE
3 – CORRECTION OF IMMATERIAL ERRORS
During
the fourth quarter of 2019, the Company identified errors in accounting for revenues and cost of revenues resulting in immaterial
correction of errors in previously issued consolidated financial statements. Each of these errors affected periods beginning prior
to 2018 through December 31, 2019. In accordance with Staff Accounting Bulletin (SAB) No. 99, Materiality, and SAB No.
108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,
management evaluated the materiality of the errors from qualitative and quantitative perspectives, and concluded that while the
errors did not, individually, or in the aggregate, result in a material misstatement of the previously issued consolidated financial
statements, correcting these errors in the fourth quarter ended December 31, 2019 would have been material to that quarter.
The
adjustments cumulatively impacted the following balances for the nine months ended September 30, 2019 :
|
|
As Reported
|
|
|
Adjustment
|
|
|
As Corrected
|
|
Product revenues
|
|
$
|
1,088,495
|
|
|
$
|
86,499
|
a
|
|
$
|
1,174,994
|
|
Contract revenues
|
|
|
839,356
|
|
|
|
(129,158
|
)b
|
|
|
710,198
|
|
Cost of product revenues
|
|
|
783,112
|
|
|
|
47,478
|
c
|
|
|
830,590
|
|
Cost of contract revenues
|
|
|
842,521
|
|
|
|
(120,185
|
)d
|
|
|
722,336
|
|
Gross profit
|
|
|
302,218
|
|
|
|
30,048
|
e
|
|
|
332,266
|
|
Operating expenses
|
|
|
1,025,347
|
|
|
|
61,394
|
f
|
|
|
1,086,741
|
|
Other income (expense)
|
|
|
99,106
|
|
|
|
(72,707
|
)d
|
|
|
26,399
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss)
|
|
|
(624,023
|
)
|
|
|
(104,053
|
)g
|
|
|
(728,076
|
)
|
Net (loss) per common share
|
|
$
|
(0.14
|
)
|
|
$
|
(0.02
|
)h
|
|
$
|
(0.16
|
)
|
References
to above adjustments
a.
|
This
accounts for a reclassification of $86,499 in revenues from contract revenues to product revenues booked on the Company’s
wholly-owned subsidiary, Applied Nanotech, Inc.,
|
b.
|
With
the proper recognition of contract services revenues with the adoption of ASC Topic 606, in-progress contract revenue was
determined to be overstated in the second quarter and third quarter of 2019 by $29,651 and $13,008, respectively. This, along
with the reclassification in point (a) above, comprises the total adjustment of $129,158.
|
c.
|
This
accounts for the reclassification $47,478 from cost of contract revenues to cost of product revenues in line with the reclassification
of segmented revenues in point (a) above.
|
d.
|
This
accounts for the reclassification of sublease income totaling $72,707 for the nine months ending September 30, 2019 from other
income to cost of contract revenues, plus $47,478 in cost of contact revenues reclassified to cost of product revenues as
per point (c) above.
|
e.
|
This
accounts for the net impact of the reclassification of sublease income of $72,707 in point (d) above, offset by the overstatement
of contract services revenues of $42,659 outlined in point (b) above.
|
f.
|
The
$61,394 adjustment represents $39,394 booked for year-to-date compensation expense from options granted to an executive in
the second quarter of 2019 plus $22,000 for the accrual of audit fees performed in the first quarter of 2019 not previously
recorded in the period.
|
g.
|
Net
loss was understated by $104,053 for the nine months ending September 30, 2019, due to $42,659 in overstated contract services
revenues outlined in point (b) above plus $61,394 in understated expenses outlined in point (f) above.
|
h.
|
Net
(loss) per common share for the nine months ended September 30, 2019 resulting from the adjustments as outlined above has
been corrected to $0.16 per share from the previously reported number of $0.14 per share.
|
NOTE
4 – ACCOUNTS RECEIVABLE
At
September 30, 2020 and December 31, 2019, accounts receivable consisted of the following:
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
Accounts
receivable
|
|
$
|
533,023
|
|
|
$
|
164,960
|
|
Less:
allowance for doubtful accounts
|
|
|
(13,645
|
)
|
|
|
(13,670
|
)
|
Accounts
receivable, net
|
|
$
|
519,378
|
|
|
$
|
151,290
|
|
NOTE
5 – INVENTORY
At
September 30, 2020 and December 31, 2019, inventory consisted of the following:
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
Raw
materials
|
|
$
|
857,014
|
|
|
$
|
663,932
|
|
Work-in-progress
|
|
|
-
|
|
|
|
-
|
|
Finished
goods
|
|
|
322,123
|
|
|
|
335,762
|
|
|
|
$
|
1,179,137
|
|
|
$
|
999,694
|
|
Less:
reserve for obsolescence
|
|
|
(425,052
|
)
|
|
|
(577,072
|
)
|
Inventory,
net
|
|
$
|
754,085
|
|
|
$
|
422,622
|
|
NOTE
6 - PROPERTY AND EQUIPMENT
Property
and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives, which range
from three to ten years. Leasehold improvements are depreciated over the shorter of the useful life or lease term including scheduled
renewal terms. Maintenance and repairs are charged to expense as incurred. When assets are retired or disposed of, the cost and
accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in other income or expense
in the year of disposition. The Company examines the possibility of decreases in the value of these assets when events or changes
in circumstances reflect the fact that their recorded value may not be recoverable.
NOTE
7 – OPERATING AND FINANCE LEASE RIGHT-OF-USE ASSETS
Leasing
Transactions
The
Company’s leased assets include offices, production and research and development facilities. Our current lease portfolio
has remaining terms from less than one-year up to seven years. Many of these leases contain options under which we can extend
the term for several years. Renewal options are excluded from our calculation of lease liabilities unless we are reasonably assured
to exercise the renewal option. Our lease agreements do not contain residual value guarantees or material restrictive covenants.
On
September 20, 2017, the Company entered into a three-year lease agreement for 26,063 square feet of office space in Brooklyn Heights,
Ohio beginning September 20, 2017 and ended September 20, 2020. Monthly lease payments amount to $8,688.
On
December 10, 2018, we entered into a five-year lease agreement for 3,742 square feet of space for the design facility in Austin,
Texas, beginning January 2019 and ending February 29, 2024. Monthly lease payments start at $3,472 per month, increasing
3% each year.
On
June 21, 2019, we leased approximately 1,200 square feet of office space in Bingham Farms, Michigan for nine months for a sales
office. Monthly payments are $1,529 per month. The lease has been extended through December 31, 2020.
Effective
May 31, 2020, we entered into a lease for a 29,220 square foot building in Madison Heights, Michigan. The occupancy date and rent
commencement date is October 1, 2020. By that date, the landlord, Magic Research LLC, is required to have completed tenant
improvements to accommodate our office and manufacturing needs. When we are established in the new facility, we expect to vacate
our facility in Brooklyn Heights, Ohio as our lease there expires in September 2020. The new lease has a term of seven years with
a renewal option at the end of the initial term for an additional 3-year term, and a second renewal option thereafter for an additional
5-year term. As the sole tenant, we are responsible for all taxes, ordinary maintenance, snow removal and other ordinary operating
expenses. Rent is $6.50 per square foot, increasing by $0.25 per year. During the first three years we also have the right to
buy up to a 49% interest in Magic Research LLC for a price equal to 49% of the contributions received from other members. See
Note 10, Stockholders’ Equity, for a description of the warrants issued to the landlord in connection with this lease. The
fair value of these warrants totaling $311,718 were recorded as initial direct costs of obtaining the lease and are included in
other assets on the accompanying balance sheet. See Note 9, Related Party Transactions, for information about Tom J. Berman and
Ronald J. Berman’s role in management and economic participation in the landlord.
Operating leases are reflected on our balance sheet within operating
lease ROU assets and the related current and non-current lease liabilities. Leases with terms of less than twelve months have been
classified as current ROU assets, whereas the lease with a remaining term of more than twelve months has been classified as a non-current
ROU asset. ROU assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation
to make lease payments arising from lease agreement. Operating lease ROU assets and liabilities are recognized at the commencement
date, or the date on which the lessor makes the underlying asset available for use, based upon the present value of the lease payments
over the respective lease term. Lease expense is recognized on a straight-line basis over the lease term, subject to any changes
in the lease or expectation regarding the terms. Variable lease costs such as common area maintenance, property taxes and insurance
are expensed as incurred.
On August 11, 2020, we entered into a finance
lease for furniture that will be used in the new Michigan facility. We financed $60,684 over a period of 36 months and are required
to make monthly payments of $1,972 during that time.
On September 24, 2020, we entered into
a finance lease with Raymond Leasing Corporation for a forklift. The lease term is 36 months with monthly payments of $425.
Balance
Sheet
Supplemental
balance sheet information related to leases was as follows:
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
Operating
Leases
|
|
|
|
|
|
|
|
|
Total
operating lease ROU assets
|
|
$
|
1,110,332
|
|
|
$
|
257,523
|
|
|
|
|
|
|
|
|
|
|
Operating
lease liabilities (current)
|
|
|
131,084
|
|
|
|
131,835
|
|
Operating
lease liabilities (noncurrent)
|
|
|
1,119,641
|
|
|
|
136,624
|
|
Total
operating lease liabilities
|
|
$
|
1,250,725
|
|
|
$
|
268,459
|
|
|
|
September 30, 2020
|
|
|
December 31, 2019
|
|
Finance Leases
|
|
|
|
|
|
|
|
|
Total finance lease assets
|
|
$
|
94,855
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Finance lease liabilities (current)
|
|
|
23,000
|
|
|
|
-
|
|
Finance lease liabilities (noncurrent)
|
|
|
49,050
|
|
|
|
-
|
|
Total finance lease liabilities
|
|
$
|
72,050
|
|
|
$
|
-
|
|
Income
Statement
Supplemental
income statement information related to leases was as follows:
|
|
September 30, 2020
|
|
|
September 30, 2019
|
|
Operating Lease Costs
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
$
|
136,884
|
|
|
$
|
95,113
|
|
Cost of contract services
|
|
|
34,755
|
|
|
|
34,755
|
|
Variable lease costs
|
|
|
31,703
|
|
|
|
40,244
|
|
Sublease income
|
|
|
(41,220
|
)
|
|
|
(72,707
|
)
|
Net operating lease cost
|
|
$
|
162,122
|
|
|
$
|
97,405
|
|
Costs related to the Finance leases were
immaterial to the quarter.
NOTE
8 – NOTES PAYABLE
On
February 10, 2015, Nano Magic LLC (then named Nanofilm) entered into a promissory note (the “Equipment Note”) with
KeyBank, 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
through June 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. At December 31, 2019, the principal amount due
under the Equipment Note amounted to $115,926. Due to the slowdown caused by the COVID-19 pandemic, KeyBank agreed in April 2020
that we would not be required to make scheduled payments in April, May and June. The amount that would have been paid will be
added to the final scheduled loan payment. As of September 30, 2020, $43,795 and $52,958, represent the current and non-current
portion due under this note.
In
June and November 2015, in connection with a severance package offered to four employees, the Company entered into four promissory
note agreements with the four employees which obligate the Company to pay these employees accrued and unpaid deferred salary in
an aggregate amount of $51,808. The principal amounts due under these notes shall bear interest at the minimum rate of interest
applicable under the internal revenue code (approximately 3.0% at December 31, 2019). As of September 30, 2020, principal and
interest payable under three of these notes aggregating $37,458 are due in 2025 and are included in non-current notes payable.
January
2017, the Company issued a promissory note in the principal amount of $17,425 to a departing employee representing the amount
of his accrued and unpaid salary. The note does not bear interest and is due in January 2027, and is included in non-current notes
payable.
On
May 8, 2020, we obtained a loan from Fifth Third Bank for $130,900 under the Small Business Administration Paycheck Protection
Program. The loan bears interest at 1.00% and is payable in monthly installments of principal and interest in the amount of $7,330.
We do not expect to make payments as long as our forgiveness application is filed not later than September 1, 2021.
On
September 1, 2020, we entered an agreement with NOWaccount Network Corporation for the sale of accounts receivable due from a
specific customer of ours. Subject to certain limits, we will receive a payment equal to 95% of the amount of the invoice upon
shipment of the product and sale of the account.
NOTE
9 – RELATED PARTY TRANSACTIONS
Apart
from Board fees paid to all of our directors, we paid the following amounts as compensation to our directors:
|
|
Three Months ended September 30,
|
|
|
Nine Months ended September 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Ronald J. Berman
|
|
$
|
39,000
|
|
|
|
26,257
|
|
|
|
176,700
|
|
|
|
82,392
|
|
Tom J. Berman
|
|
$
|
75,764
|
|
|
|
37,500
|
|
|
|
165,764
|
|
|
|
37,500
|
|
Jeanne M Rickert
|
|
$
|
3,000
|
|
|
|
3,000
|
|
|
|
9,000
|
|
|
|
9,000
|
|
Scott E. Rickert
|
|
$
|
3,000
|
|
|
|
3,000
|
|
|
|
9,000
|
|
|
|
9,000
|
|
Ron
Berman and Tom Berman each have a 2.08% ownership interest in Magic Research LLC, the landlord for the facility we leased in Michigan
effective May 31, 2020. The manager of Magic Research LLC is Magic Research Management LLC; Ron Berman and Tom Berman are two
of its three co-managers. Compensation from Magic Research LLC to Magic Research Management LLC is $10,000 per year to oversee
the recordkeeping, tax return preparation, oversight of tenant improvements and other operating costs for the landlord.
Ron
Berman and Tom Berman share ownership of PEN Comeback Management, LLC that is the sole voting member of PEN Comeback, LLC, PEN
Comeback 2, LLC and Magic Growth, LLC.
NOTE
10 - STOCKHOLDERS’ EQUITY
Description
of Preferred and Common Stock
Effective
July 2, 2020, the Company amended and restated its Certificate of Incorporation to (i) eliminate the Company’s Class B common
stock and Class Z common stock and related provisions, and to rename as “common stock” the Company’s Class A
common stock, and (ii) increase the number of authorized shares of common stock from 7,200,000 to 30,000,000.
Preferred
Stock
The
preferred stock may be issued in one or more series. The Company’s board of directors are authorized to issue the shares
of preferred stock in such series and to fix from time to time before issuance thereof the number of shares to be included in
any such series and the designation, powers, preferences and relative, participating, optional or other rights, and the qualifications,
limitations or restrictions thereof, of such series.
Common
Stock
The
rights of each share of common stock are the same with respect to dividends, distributions and rights upon liquidation. Common
stock has a par value of $0.0001 per share. Holders of common stock are entitled to one vote per share in the election of directors
and other matters submitted to a vote of the stockholders.
Issuances
of Common Stock
Sales
of Common Stock and Derivative Equity Securities
On
January 22, 2020, we sold 198,530 shares of common stock in a private placement to PEN Comeback 2 at a per share price of $0.65
for aggregate proceeds of $129,044. At the same time the investor bought 198,516 warrants to purchase up to 198,516 additional
shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires four years from date of issue. Aggregate
proceeds from the sales of the warrants were $5,955.
On
February 24, 2020, we sold 205,883 shares of common stock in a private placement to PEN Comeback 2 at a per share price of $0.65
for aggregate proceeds of $133,824. At the same time the investor bought 205,868 warrants to purchase up to 198,516 additional
shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires four years from date of issue. Aggregate
proceeds from the sales of the warrants were $6,176.
On
March 24, 2020, in a private placement to PEN Comeback 2, we sold 551,600 shares of common stock and committed to issue an additional
242,518 shares when we have additional authorized shares. That occurred on July 2, 2020, and the shares were issued. Proceeds,
at a per share price of $0.65, were $516,177. At the same time the investor bought 794,110 warrants to purchase up to 794,110
additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires four years from date of issue.
Aggregate proceeds from the sale of the warrants were $23,823.
On
March 26, 2020, in a private placement to the same investor we committed to issue 36,765 shares when we have additional authorized
shares and accepted $.65 per share for proceeds of $23,897. The additional shares were authorized on July 2, 2020 and the shares
were issued. Also on March 26, 2020 the investor bought 36,758 warrants to purchase up to 36,780 additional shares at a warrant
exercise price of $1.50. The right to purchase warrant shares expires four years from date of issue. Aggregate proceeds from the
sale of the warrants were $1,103.
On
July 13, 2020, Nano Magic Inc. sold to Magic Growth, LLC 388,462 shares of common stock for proceeds of $485,578 and warrants
to purchase up to 388,450 shares of common stock for proceeds of $19,422. The warrants are exercisable at any time during the
four years after date of issue at a warrant exercise price of $2.00 per share. The stock and warrants were sold in a private placement
exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended. PEN Comeback Management, LLC, owned
by Tom J. Berman and Ronald J. Berman, is the sole voting member of Magic Growth, LLC.
On August 12, 2020, Nano Magic Inc. sold to
Magic Growth, LLC 461,539 shares of common stock for proceeds of $576,922 and warrants to purchase up to 461,525 shares
of common stock for proceeds of $23,079. The warrants are exercisable at any time during the four years after date of issue
at a warrant exercise price of $2.00 per share. The stock and warrants were sold in a private placement exempt from registration
under Section 4(a)(2) of the Securities Act of 1933, as amended.
On
September 14, 2020, Nano Magic Inc. sold to Magic Growth, LLC 130,770 shares of common stock for proceeds of $163,463 and warrants
to purchase up to 130,750 shares of common stock for proceeds of $6,537. The warrants are exercisable at any time during the four
years after date of issue at a warrant exercise price of $2.00 per share. The stock and warrants were sold in a private placement
exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended.
For the three months ended September
30, 2020, 130,770 shares of common stock were sold for $163,463, and we issued 279,823 shares of common stock to fulfill
the subscription payable that was on our books at June 30, 2020. During this three month period we also issued 130,750 warrants
for proceeds of $6,537. For the nine months ended September 30, 2020, we issued an aggregate of 2,216,067 shares of common stock
and 2,625,977 warrants.
Common
Stock Issued for Services
On
February 12, 2020, we issued an aggregate of 21,048 shares of common stock to our directors as compensation to them for service
on our Board. These shares were valued on that date at $0.57 per share based on the quoted price of the stock for a total value
of $12,000.
Warrants
issued to Landlord
In
connection with the lease for the facility in Michigan effective May 31, 2020, we issued the landlord warrants to purchase up
to 410,000 shares of our common stock at a warrant exercise price of $1.50 per share. The warrants are exercisable after we have
additional authorized shares of stock until the fourth anniversary of the date of the lease. The fair value of the warrants at
the date of issuance was $311,718 and is included in the calculation of right-of-use assets.
Stock
Options
Stock
options outstanding are to purchase common stock. Stock options outstanding at September 30, 2020 are 553,170, reflecting a grant
of 100,000 under the 2015 Equity Incentive Plan made in the first nine months of 2020, and the expiration of 2,332 options during
the same period. No options were exercised during the period.
|
|
Number of
Options
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Remaining
Contractual
Term
(Years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Balance Outstanding December 31, 2019
|
|
|
455,502
|
|
|
$
|
1.24
|
|
|
|
4.22
|
|
|
$
|
585,000
|
|
Granted
|
|
|
100,000
|
|
|
|
0.65
|
|
|
|
3.60
|
|
|
|
120,000
|
|
Expired
|
|
|
(2,332
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Balance Outstanding September 30, 2020
|
|
|
553,170
|
|
|
$
|
0.90
|
|
|
|
3.47
|
|
|
$
|
499,201
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, September 30, 2020
|
|
|
228,170
|
|
|
$
|
1.36
|
|
|
|
3.48
|
|
|
$
|
310,451
|
|
Warrants
As
of September 30, 2020, there were outstanding and exercisable warrants to purchase 5,443,440 shares of common stock with a weighted
average exercise price of $1.59 per share and a weighted average remaining contractual term of 37.15 months. As of September 30,
2020, there was no intrinsic value for exercisable warrants.
2015
Equity Incentive Plan
On
November 30, 2015, the Board of Directors authorized the 2015 Equity Incentive Plan (the “Plan”), which reserved 111,111
shares of common stock. If any share of common stock that has been granted pursuant to a stock option ceases to be subject to
a stock option, or if any forfeiture or termination affects shares of common stock that are the subject to any other stock-based
award, the shares are again available for future grants and awards under the Plan. The Plan’s purpose is to enable the Company
to offer its employees, officers, directors and consultants an opportunity to acquire a proprietary interest in the Company for
their contributions. On December 31, 2019, we issued an aggregate of 102,500 shares to employees in settlement of accrued salaries
totaling $66,615. On January 31, 2020 we granted an option to purchase 100,000 shares to a senior member of the sales team with
vesting tied directly to 2020 sales goals.
NOTE
11 - COMMITMENTS AND CONTINGENCIES
Stock
Appreciation Rights
If
the Company completes an IPO, the value of stock appreciation rights calculated based on the IPO formula may cause a material
increase in the value of the liability (See Note 13).
Litigation
The
Company may be, from time to time, subject to various administrative, regulatory, and other legal proceedings arising in the ordinary
course of business. We are not currently a defendant in any proceedings. Our policy is to accrue costs for contingent liabilities,
including legal proceedings or unasserted claims that may result in legal proceedings, when a liability is probable and the amount
can be reasonably estimated. As of September 30, 2020, the Company has not accrued any amount for litigation contingencies.
NOTE
12 – CONCENTRATIONS
Concentrations
of Credit Risk
Financial
instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable
and cash deposits and investments in cash equivalent instruments.
Customer
Concentrations
For
the nine months ended September 30, 2020 and 2019, four customers represented 47% and two different customers
represented 31% of product revenues respectively. For the contract revenues segment, two customers accounted for 18%
of revenues for the nine months ended September 30, 2020. For the nine months ending September 30, 2019, one of those same
customers accounted for 46% of revenues and another customer accounted for 39% of revenues.
In
the product segment, two of these customers amounted to 68% of the accounts receivable balances at September 30, 2020.
A reduction in sales from or loss of such customers would have a material adverse effect on our results of operations and financial
condition.
Geographic
Concentrations of Sales
For the three and nine months ended September
30, 2020, total sales in the United States represented approximately 85% and 77% of total consolidated revenues. For the same
periods in 2019, sales in the United States represented approximately 87% and 85% of total consolidated revenues. No other geographical
area accounted for more than 10% of total sales during the three and nine months ended September 30, 2020 and 2019.
Vendor
Concentrations
For
the nine months ended September 30, 2020, two vendors represented 53% of inventory purchases. None of those vendors
represented greater than 10% of inventory purchases for the nine months ended September 30, 2019.
NOTE
13 – STOCK APPRECIATION PLAN
From
1, 1988, until December 31, 1997, when the plan was terminated, Nano Magic LLC had in place a Stock Appreciation Rights Plan A
(the “Plan”), intended to provide employees, directors, members of a technical advisory board and certain independent
contractors selected by the Board with equity-like participation in the growth of Nano Magic LLC. The maximum number of stock
appreciation rights that could be granted by the Board was 1,000,000.
There
were 235,782 fully vested stock appreciation rights (“SARS”) outstanding under the terms of the Plan at September
30, 2020 and December 31, 2019. The SARS unit value is based on the book value of the Company as of the last fiscal year end multiplied
by a SARS multiplier stipulated in the SARS plan. However, in the event of an initial public offering (“IPO”) of Nano
Magic LLC, the SARS are redeemable based on a value equal to offering price of the stock in an IPO times the total outstanding
shares of the Company just subsequent to the completion of the IPO, multiplied by the SARS multiplier. The SARS multiplier is
to be adjusted, as the Board determines, to reflect changes in the capitalization of Nano Magic LLC. Generally, the SARS are redeemable
in cash, at their then fair value as computed pursuant to the Plan, in the event of termination of employment or business relationship,
death, permanent and total disability, or sale of Nano Magic Brands (as defined). Upon an IPO, SARS are to be redeemed by applying
70% of the redemption value to purchase common shares, with the remaining 30% being distributed in cash to the participant.
The
business combination completed in August 2014 did not qualify as an IPO under the Plan; however, a future underwritten registered
offering may qualify.
The
accrued redemption value associated with the stock appreciation rights amounted to $42,823, at September 30, 2020 and December
31, 2019. If the Company completes an IPO, the value of SARS calculated based on the IPO formula may cause a material increase
in the value of the liability.
NOTE
14– SEGMENT REPORTING
The
Company’s principal operating segments coincide with the types of products to be sold. The products from which revenues
are derived are consistent with the reporting structure of the Company’s internal organization. The Company’s two
reportable segments for the three and nine months ended September 30, 2020 and 2019 were the Product segment and ii) the Contract
services segment (formerly the research and development segment). The Company’s chief operating decision-maker has been
identified as the President and CEO, who reviews operating results to make decisions about allocating resources and assessing
performance for the entire Company. Segment information is presented based upon the Company’s management organization structure
as of September 30, 2020 and the distinctive nature of each segment. Future changes to this internal financial structure may result
in changes to the reportable segments disclosed. There are no inter-segment revenue transactions and, therefore, revenues are
only to external customers. As the Company primarily generates its revenues from customers in the United States, no geographical
segments are presented.
Segment
operating profit is determined based upon internal performance measures used by the chief operating decision-maker. The Company
derives the segment results from its internal management reporting system. The accounting policies the Company uses to derive
reportable segment results are the same as those used for external reporting purposes. Management measures the performance of
each reportable segment based upon several metrics, including net revenues, gross profit and operating loss. Management uses these
results to evaluate the performance of, and to assign resources to, each of the reportable segments. The Company manages certain
operating expenses separately at the corporate level and does not allocate such expenses to the segments. Segment income from
operations excludes interest income/expense and other income or expenses and income taxes according to how a particular reportable
segment’s management is measured. Management does not consider impairment charges, and unallocated costs in measuring the
performance of the reportable segments.
Segment
information available with respect to these reportable business segments for the three and nine months ended September 30, 2020
and 2019 was as follows:
|
|
Three Months Ended September
30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2020
|
|
|
2019
|
|
|
2020
|
|
|
2019
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
983,628
|
|
|
$
|
302,294
|
|
|
$
|
2,133,407
|
|
|
$
|
1,174,994
|
|
Contract services segment
|
|
|
117,219
|
|
|
|
203,049
|
|
|
|
568,098
|
|
|
|
710,198
|
|
Total segment and consolidated revenues
|
|
$
|
1,100,847
|
|
|
$
|
505,343
|
|
|
$
|
2,701,505
|
|
|
$
|
1,885,192
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
541,272
|
|
|
$
|
241,694
|
|
|
$
|
1,364,870
|
|
|
$
|
830,590
|
|
Contract services segment
|
|
|
132,663
|
|
|
|
191,065
|
|
|
|
454,566
|
|
|
|
722,336
|
|
Total segment and consolidated cost of revenues
|
|
$
|
673,935
|
|
|
$
|
432,759
|
|
|
$
|
1,819,436
|
|
|
$
|
1,552,926
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
442,356
|
|
|
$
|
60,600
|
|
|
$
|
768,536
|
|
|
$
|
344,404
|
|
Contract services segment
|
|
|
(15,444
|
)
|
|
|
11,984
|
|
|
|
113,532
|
|
|
|
(12,138
|
)
|
Total segment and consolidated gross profit
|
|
$
|
426,912
|
|
|
$
|
72,584
|
|
|
$
|
882,069
|
|
|
$
|
332,266
|
|
Gross margin:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
|
45.0
|
%
|
|
|
20.0
|
%
|
|
|
36.0
|
%
|
|
|
29.3
|
%
|
Contract services segment
|
|
|
-13.2
|
%
|
|
|
5.9
|
%
|
|
|
20.0
|
%
|
|
|
-1.7
|
%
|
Total gross margin
|
|
|
38.8
|
%
|
|
|
14.4
|
%
|
|
|
32.7
|
%
|
|
|
17.6
|
%
|
Segment operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
311,924
|
|
|
$
|
243,704
|
|
|
$
|
986,887
|
|
|
$
|
661,652
|
|
Contract services segment
|
|
|
39,981
|
|
|
|
46,420
|
|
|
|
118,085
|
|
|
|
161,057
|
|
Total segment operating expenses
|
|
$
|
351,905
|
|
|
$
|
290,123
|
|
|
$
|
1,104,973
|
|
|
$
|
822,708
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
130,432
|
|
|
$
|
(183,104
|
)
|
|
$
|
(218,351
|
)
|
|
$
|
(317,248
|
)
|
Contract services segment
|
|
|
(55,425
|
)
|
|
|
(34,436
|
)
|
|
|
(4,553
|
)
|
|
|
(173,195
|
)
|
Total segment income (loss)
|
|
|
75,007
|
|
|
|
(217,540
|
)
|
|
|
(222,904
|
)
|
|
|
(490,443
|
)
|
Unallocated costs
|
|
|
(185,387
|
)
|
|
|
(77,123
|
)
|
|
|
(545,179
|
)
|
|
|
(264,032
|
)
|
Total consolidated income (loss) from operations
|
|
$
|
(110,380
|
)
|
|
$
|
(294,663
|
)
|
|
$
|
(768,083
|
)
|
|
$
|
(754,475
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
-
|
|
Depreciation and amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
33,922
|
|
|
$
|
13,972
|
|
|
$
|
41,150
|
|
|
$
|
40,321
|
|
Contract services segment
|
|
|
(834
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total segment depreciation and amortization
|
|
|
33,088
|
|
|
|
13,972
|
|
|
|
41,150
|
|
|
|
40,321
|
|
Unallocated depreciation
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total consolidated depreciation and amortization
|
|
$
|
33,088
|
|
|
$
|
13,972
|
|
|
$
|
41,150
|
|
|
$
|
26,416
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital additions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
41,919
|
|
|
$
|
-
|
|
|
$
|
46,514
|
|
|
$
|
-
|
|
Contract services segment
|
|
|
-
|
|
|
|
2,482
|
|
|
|
-
|
|
|
|
2,482
|
|
Total segment capital additions
|
|
|
41,919
|
|
|
|
2,482
|
|
|
|
46,514
|
|
|
|
2,482
|
|
Unallocated capital additions
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total consolidated capital additions
|
|
$
|
41,919
|
|
|
$
|
2,482
|
|
|
$
|
46,514
|
|
|
$
|
2,482
|
|
|
|
September 30, 2020
|
|
|
September 30, 2019
|
|
Segment total assets:
|
|
|
|
|
|
|
|
|
Product segment
|
|
$
|
3,569,298
|
|
|
$
|
862,810
|
|
Contract services segment
|
|
|
244,101
|
|
|
|
96,697
|
|
Corporate
|
|
|
452,289
|
|
|
|
9,645
|
|
Total consolidated total assets
|
|
$
|
4,265,688
|
|
|
$
|
969,152
|
|