FLEXPOINT SENSOR SYSTEMS INC - Quarter Report: 2019 September (Form 10-Q)

NOTE 2 – GOING CONCERN

The Company continues to accumulate significant operating losses and has an accumulated deficit of $28,713,497 at September 30, 2019.  These factors raise substantial doubt about the Company’s ability to continue as a going concern.  The financial statements do not include any adjustments that might result from the outcome of these uncertainties.

Management is seeking additional funding to provide operating capital for its operations until such time as revenues are sufficient to sustain our level of operations.  However, there is no assurance that additional funding will be available on acceptable terms, if at all.

NOTE 3 – DERIVATIVE INSTRUMENTS

The derivative liability as of September 30, 2019, in the amount of $811,551 has a Level 3 fair value classification.

The following table provides a summary of changes in fair value of the Company’s Level 3 financial liabilities as of September 30, 2019 and December 31, 2018:

During the year ended 2018 and the nine-month period ended September 30, 2019, the Company issued convertible promissory notes which are convertible into common stock. Due to the Company’s lack of authorized shares

12

necessary to settle all convertible instruments, in accordance with ASC 815-40-25, the Company determined that the conversion features related to these notes are derivative to settle all convertible instruments.  The accounting treatment of derivative financial instruments requires that the Company record fair value of the derivatives as of the inception date of debenture and to fair value as of each subsequent reporting date.

At September 30, 2019, the Company marked to market the fair value of the derivatives and determined a fair value of $811,551. The Company recorded a loss from change in fair value of derivatives of $440,367 for the nine-month period ended September 30, 2019.  The fair value of the embedded derivatives was determined using binomial lattice model based on the following assumptions: (1) dividend yield of 0%, (2) expected volatility of 112.28% to 155.86%, (3) weighted average risk-free interest rate of 1.88% to 2.50% (4) expected life of 0.50 to 1.50 years, and (5) the quoted market price of the Company’s common stock at each valuation date.

In accordance ASC 840-15-25, the Company has implemented a sequencing policy with respect to all outstanding convertible instruments. The Company evaluates its contracts based upon earliest issuance date.

As of September 30, 2019, liabilities measured at fair value on a recurring basis are summarized as follows:

NOTE 4 – CONVERTIBLE NOTES PAYABLE

Convertible Note Payable

At September 30, 2019 there are notes outstanding with principal balances which total $930,000. Of the notes, $890,000 are convertible notes bearing a 10% annual rate of interest (with a 15% default rate) and are convertible into shares of common stock at the rate of $0.06 to $0.07 per share.  $40,000 is a convertible note entered into on August 8, 2011 with a former Company Director, at a rate of $0.20 per share.  That note was due on December 31, 2015, and bears a default interest rate of 10%.

On May 28, 2019 the Company issued 3,650,000 shares of restricted common stock to Empire Fund Managers and 3,200,000 shares of restricted common stock to Compass Equity Partners, LLC in consideration for two convertible notes in the amount of $300,000 and $110,574 of accrued but unpaid interest.  The Company recognized a gain on extinguishment of debt of $90,325 as a result of this transaction.  See Note 6.

On January 31, 2019, the Company entered into a convertible note for up to $100,000 from a third party.  The note has an annual interest rate of 10% and is secured by the Company’s equipment.  The note has a conversion feature for restricted common shares at $0.05 per share and a maturity date of August 31, 2018.  At September 30, 2019 the Company had drawn $100,000 against this note.

Convertible Note Payable - Related Party

At September 30, 2019 there are notes outstanding with two directors of the Company with balances of $164,257 and $54,256, respectively.  The notes bear an 8% annual rate of interest with a 12% default rate.  There are $50,000 in notes to the first officer that had due dates of December 31, 2016 and December 31, 2017, and on which interest is being calculated at the default rate.  Notes of $37,257 and $27,256 have due dates of December 31, 2018 and on which interest is being calculated at the default rate.  The remaining $77,000 and $27,000 notes have due dates of December 31, 2019.  

Additionally, in May 2019, the Company converted the $39,000 payable to two directors into convertible notes payable in the amounts of $22,000 and $17,000.  The notes bear interest at the rate of 8%, have a default rate of 12%, are convertible into shares of common stock at a conversion price of $0.06 per share, and have a termination date of December 31, 2019.  There is a debt discount of $12,019 on the balance sheet related to these notes that is being amortized over their respective terms.

All of the convertible notes issued to directors are convertible into shares of common stock with notes totaling $114,513 at the rate of $0.07 per share and notes totaling $104,000 at the rate of $0.06 per share.

13

NOTE 5 – STOCK OPTION PLANS

On August 25, 2005, the Board of Directors of the Company approved and adopted the 2005 Stock Incentive Plan (the Plan). The Plan became effective upon its adoption by the Board and will continue in effect for ten years, unless terminated.  This plan was approved by the stockholders of the Company at their annual meeting of shareholders on November 22, 2005. Under the Plan, the exercise price for all options issued will not be less than the average quoted closing market price of the Company’s trading common stock for the thirty day period immediately preceding the grant date plus a premium of ten percent.  The maximum aggregate number of shares that may be awarded under the plan is 2,500,000 shares.  The Company continues to utilize the Black-Scholes option-pricing model for calculating the fair value of the options granted as defined by ASC Topic 718, which is an acceptable valuation approach under ASC 718. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock.

On August 24, 2015, the Board of Directors approved the issuance of options to purchase 2,185,000 shares of the Company’s common stock.  Of the total issued, 1,960,000 options were issued to replace options held by directors and employees which were to expire and 225,000 options were issued to new employees.  Of the options issued, 640,000 have an option price of $0.14 per share, 500,000 have an option price of $0.15 per share, 995,000 have an option price of $0.20 per share, and 50,000 have an option price of $0.25 per share.  Options issued as replacement shall have immediate vesting terms. Options which are not replacements shall vest over a two year four month period in equal installments on the last day of 2015, 2016 and 2017, respectively.  We relied on an exemption from the registration requirements provided by Section 4(a)(2) of the Securities Act.

Projected data related to the expected volatility and expected life of stock options is based upon historical and other information, and notably, the Company's common stock has limited trading history. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore, the existing valuation models do not provide a precise measure of the fair value of the Company's employee stock options.  Between August 25, 2005 and December 31, 2015, the Company granted options to employees to purchase an aggregate 3,096,000 shares of common stock at exercise prices ranging from $0.14 to $2.07 per share.  The options vest over three years and expire 10 years from the date of grant.  The Company used the following assumptions in estimating the fair value of the options granted:

·

Market value at the time of issuance – Range of $0.14 to 2.07

·

Expected term – Range of 3.7 years to 10.0 years

·

Risk-free interest rate – Range of 1.60% to 4.93%

·

Dividend yield – 0%

·

Expected volatility – 200% to 424%

·

Weighted-average fair value - $0.16 to $2.07

All of the options were fully vested at December 31, 2018. As a result there was no stock-based compensation expenses recorded for the three and nine months ended September 30, 2019.  The Company recognized no stock-based compensation expense for the three and nine month periods ended September 30, 2018. There were 2,185,000 and 2,185,000 employee stock options outstanding at September 30, 2019 and December 31, 2018, respectively.  

A summary of all employee options outstanding and exercisable under the plan as of September 30, 2019, and changes during the three months then ended is set forth below:

14

NOTE 6 – CAPITAL STOCK

Preferred Stock – There are 1,000,000 shares of preferred stock with a par value of $0.001 per share authorized.  At September 30, 2019 and December 31, 2018, there were no shares of preferred stock issued or outstanding.

Common Stock – There are 100,000,000 shares of common stock with a par value of $0.001 per share authorized.  At the annual meeting of stockholders held December 28, 2018, the shareholders approved increasing the number of authorized shares to 200,000,000.  The amendment to the Articles of Incorporation affecting such change was filed with the State of Delaware on October 11, 2019.  During the nine months ended September 30, 2019 the Company issued 6,850,000 shares to fulfill its obligations under two notes which totaled $300,000 and accrued but unpaid interest which totaled $110,574.  The notes had a conversion price of $0.06 per share.  The Company recorded a gain on the extinguishment of debt of $90,325, which amount was accrued interest forgiven by the note holder.  

NOTE 7 – COMMITMENTS AND CONTINGENCIES

The Company currently occupies manufacturing facility in Draper, Utah.  The lease on the facility expired on December 31, 2014, at which time the Company entered into a three year extension which expired on December 31, 2017.  The lease provides that on the expiration of the lease on December 31, 2017 the lease became a month to month lease at a monthly lease rate ($9,600), plus an increase of 10% on the anniversary date of each succeeding year.  The Company is paying a lease rate of $11,520 per month in 2019.  

On July 22, 2019, the Company entered into a settlement agreement with its landlord wherein the Company agreed to pay $55,000 in settlement of all past liabilities, obtaining a full release from the landlord upon the payment being made.  The Company recognized a $57,320 gain on forgiveness of debt related to this settlement agreement.

NOTE 8 – RELATED PARTY TRANSACTIONS

At September 30, 2019 there was $1,031 payable to the Chief Executive Officer of the Company.   At December 31, 2018, the Company had amounts of $10,000 payable to its Chief Executive Officer and $10,000 payable to a director for funds loaned the Company to pay of various operating expenses of the business.

In May 2019, the Company converted the amounts payable to officers to convertible notes issued notes to officers in the amounts of the amount of $22,000 and $17,000.  The notes bear interest at the rate of 8% per annum with a default rate of 12%, are convertible into shares of common stock at $0.06 per share, and have a termination date of December 31, 2019.

At September 30, 2019 and December 31, 2018, the Company had outstanding notes payable to an officer in the amount of $167,257 and $147,257, respectively, and outstanding notes payable to a director in the amount of $54,256 and $32,256 respectively.

NOTE 9 – SUBSEQUENT EVENTS

At the annual meeting of stockholders held December 28, 2018, the shareholders approved increasing the number of authorized shares to 200,000,000.  The amendment to the Articles of Incorporation affecting such change was filed with the State of Delaware on October 11, 2019.

15

In this quarterly report references to “Flexpoint", "the Company," “we,” “us,” and “our” refer to Flexpoint Sensor Systems, Inc. and its subsidiaries.

FORWARD LOOKING STATEMENTS

The U.S. Securities and Exchange Commission (“SEC”) encourages reporting companies to disclose forward-looking information so that investors can better understand future prospects and make informed investment decisions.  This report contains these types of statements. Words such as “may,” “expect,” “believe,” “anticipate,” “estimate,” “project,” or “continue” or comparable terminology used in connection with any discussion of future operating results or financial performance identify forward-looking statements.  You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this report.  All forward-looking statements reflect our present expectation of future events and are subject to a number of important factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE OVERVIEW

Flexpoint Sensor Systems, Inc. is a company engaged principally in improving its unique sensor technology, expanding its suite of products, developing new sensor applications, obtaining financing and seeking long-term sustainable manufacturing contracts.  Our operations have not yet commenced to a commercially sustainable level and include designing, engineering, manufacturing and selling sensor technology and products featuring our Bend Sensor^® technology and equipment.

On August 20, 2019 the Company announced the development of the world’s first digital bend sensor capable of automatically compensating for changes in the environment, thus guaranteeing consistent performance across temperature and humidity variables. Easily integrated into multiple applications, the data gathered by the sensor will be digitally converted and transmitted, enhancing performance.

The Bend Sensor has traditionally been offered in analog form, but most engineers prefer sensors with digital interfaces such as accelerometers. More attractive to online catalog distributors, Flexpoint’s Digital Bend Sensor (DBS) has an intuitive nature, is more easily integrated with existing products, simplifies design and more importantly, reduces time to market.  

The Company feels that with the ease and simplicity of the digital bend sensor technology, the soon to be released product will bring new opportunities and create various additional applications for Flexpoint’s Bend Sensor Technology.

On July 25, 2019  the Company announced that they had filed a provisional patent for the new “Swell Sensor” designed to detect and stop a Lithium ion or Lithium Polymer battery from charging or discharging, preventing a thermal runway; one of the major ways battery fires occur.

Li-ion and Li-polymer batteries are used today in everything from phones to electric cars. Flexpoint’s technology included in the provisional patent provides a method to protect these batteries, their products and those who use them every day, measuring the expansion or swelling of the battery effectively stopping a potentially dangerous state.

Batteries become over heated, over charged, or simply fail due to old age. When this occurs, it’s possible for the inner cells of the battery to outgas a flammable electrolyte mixture, causing the battery to swell. The Flexpoint Sensor addresses the swollen battery effect, as batteries are designed to contain as a failsafe the measure of out gassing. The Flexpoint Swell Sensor detects the condition, effectively shutting down the short circuit.  Without this type of detection, some batteries can eventually reach temperatures over 1000º F. Designed to detect the dangerous expansion and stop a Lithium ion or Lithium polymer battery from charging or discharging, the Flexpoint battery expansion sensor was created to prevent thermal runaway—how most battery fires occur. The battery expansion sensor can detect a swollen battery and take appropriate action, effectively shutting it down and sending a notice to the user that the battery is no longer safe.

16

The Company is currently collaborating with three Fortune 100 companies involving the battery expansion sensor. The overall testing phases range from six to nine months. With confidentiality agreements in place, Flexpoint is now in development with these and other companies to integrate the Battery Expansion Sensor (BXS) into their products.

Flexpoint Sensor Systems, Inc. has designed a low cost, viable solution.

During a conference call announcing second quarter operating results representatives of the Company announced that with the agreements that had been signed and the projects they were pursuing, it was transitioning from a development company to a sales and marketing company.  This represents a significant change for the Company. The Company is now profitable and continues to negotiate additional significant orders with major revenue potential as the bend sensor gains global awareness.

On June 20, 2019 the Company announced our exclusive development and licensing agreement with Audio Technology company subVo, LLC introducing a new wave of near perfect sound reproduction for everyday smart and slim devices. Tracking movement in real time, the Bend Sensor® used in the subVo® system knows the exact position of the cone at any given moment, allowing for the amplifier to calibrate, correct, and produce near-perfect sound reproduction, with zero lag time. The Bend Sensor® provides low distortion, flat frequency response, and fast impulse response. In addition to the licensing agreement the company received income for the previous work for the design and development of the system.

The Flexpoint Bend Sensor® technology will be utilized in subVo’s KlaraT® speaker compensation technology and software algorithm. The sensor, when added to, or printed directly onto the diaphragm of a speaker, enables perfect synergistic motion, sensing precise movements throughout the audible spectrum. The Bend Sensor works with the KlaraT proprietary software, allowing the feedback control and speaker protection algorithms to push speakers to their limits, without distortion or damage. This combined with the auto-calibration algorithm will remove all variability due to tolerances incurred in the manufacturing process, saving time and ultimately cost.  The KlaraT calibration compensates for changes in temperature, humidity, and wear of the speaker itself over time.

On October 18, 2018, the Company announced it had signed a five year manufacturing and supply agreement with Counted LLC.  Counted LLC conceived of a medication delivery monitoring system and dispensing monitoring system.  Flexpoint designed and produced the monitoring system with Flexpoint features, Flexpoint technology and Flexpoint designed electronics to track and report the dispensing of medications in real time.  The information has the potential to be transmitted to physicians, pharmacists and government agencies.  Prototypes have been built and successfully tested with additional production and testing continuing through 2018 and the first quarter of 2019.  The Company expects that commercial production will begin in the late third quarter of 2019, increasing throughout the balance of 2019 and beyond.

In the rapidly growing and emerging wearables space, Flexpoint has recently received additional purchase orders from multiple glove manufacturers across various market sub-segments, including medical, gaming and virtual reality. The “speed to market” commercialization plans of these companies are driving this increased order volume.  Flexpoint is aggressively going after this evolving market, and expects this pattern to continue and dramatically increase throughout 2019.  In aggregate, Bend Sensor^® wearables order volumes are expected to number in the tens of thousands in 2019.  The wearables market segment is clearly one where our technology is easily adapted and truly illustrates our technological differentiation.  Flexpoint’s willingness and ability to customize sensors for these innovative companies and deliver them at a competitive price point allows us to deliver real value to our customers.

These ground-breaking glove systems, combined with unique, leading edge software applications, also adapt to a wide range of other applications, including health rehabilitation, unmanned systems control, smartphone interaction and professional training across multiple industries.  In addition to producing an array of Bend Sensors^®, the Company is under agreement to supply integrated assemblies comprised of multiple sensor types and associated electronics.

In the VR/VA marketspace, orders of increasing size and frequency were received during the fourth quarter of 2018 and in the first quarter of 2019 from Manus VR and Neofect as they strive to fulfill production orders.  Flexpoint also received orders from other global VR/AR customers during the quarter.

Finalizing long-term, constant revenue generating production contracts with our existing and other customers remains our greatest challenge because our on-going business is dependent on the types of revenues and cash flows generated by such contracts. Cash flow and cash requirement risks are closely tied to and are dependent upon our

17

ability to attract significant long-term production contracts.  We must continue to obtain funding to operate and expand our operations so that we can deliver our unique Bend Sensor^® and Bend Sensor^® related technologies and products to the market.  Management believes that even though we are making positive strides forward with our business plan we will need to raise additional operating capital.

LIQUIDITY AND CAPITAL RESOURCES

Currently our revenue is primarily from product licensing, development, manufacturing and recurring sales with additional contributions to income from design contract, testing and limited production services for prototypes and samples, and is currently at a level to support our operations.  We believe, based upon current orders and projected orders over the next twelve months, that we could be producing sensors under long-term contracts in the future that will help support our existing operations and potential future growth. Management recognizes such contracts usually go through a long negotiation process and there can be no guarantee that we will be successful in our negotiations or that such contracts will be sufficient to support our current operations in the near future.

For the twelve months previous to this quarter we have relied on the proceeds of convertible loans from existing shareholders and private placements of our common stock.  During 2018 and the first nine months of 2019, the Company secured additional financing to fund its operations by issuing convertible notes to First Equity Holdings Corp. and officers.  The balances of all notes have a combined total of $1,136,494, net of debt discounts of $12,019, as of September 30, 2019. The notes have an annual interest rate of 8% to 10% and default rates of 12% to 15%, have various maturity dates, and are secured by the Company’s business assets.

Management believes that our current cash burn rate is approximately $60,000 per month and that proceeds from additional convertible notes and estimated revenues for manufacturing, production, engineering design and prototype products will be sufficient to fund the next twelve months of operations.  Our auditors have expressed doubt about our ability to continue as a going concern and that we may not realize significant revenue or become profitable within the next twelve months. We will require additional financing to fund our short-term cash needs. We will have to rely on additional debt financing, loans from existing shareholders and private placements of common stock for additional funding. Based upon our current purchase orders and anticipated purchase orders over the next twelve months our projected revenues by the end of 2019 are anticipated to cover our projected operating expenses, based on our current burn rate. However, we cannot assure you that we will be able to obtain short-term financing, or that sources of such financing, if any, will continue to be available, and if available, that they will be on terms favorable to us. Nor is there any guarantee that the projected volume of purchase orders will meet the volumes that we anticipate.

As we enter into new agreements, we must ensure that those agreements provide adequate funding for any pre-production research and development and manufacturing costs. If we are successful in establishing agreements with adequate initial funding, management believes that our operations for the long term will be funded by revenues, licensing fees and/or royalties related to these agreements. However, we have formalized only a few agreements during the past four years and there can be no assurance that the agreements will generate sufficient revenues or be profitable in the future or that a desired technological application will be successful enough to produce the volumes and profits necessary to fund our operations.  

FINANCIAL OBLIGATIONS AND CONTINGENT LIABILITIES

Our principal commitments at September 30, 2019 consisted of our operating lease of $11,520 per month, and total liabilities of $3,666,932, which includes $1,136,494 of convertible notes payable, net of discounts of $12,019.  Accrued liabilities at September 30, 2019, were $1,530,065 and were related to payroll, payroll tax liabilities, accrued professional expenses, accrued insurance expense, accrued interest expense on notes and accrued paid time off.  

During the nine months ending September 30, 2019, the Company has raised an additional $100,000 in operating capital through the issuance of a short-term note.  On January 31, 2019, the Company entered into this convertible note for up to $100,000 from a third party.  The note has an annual interest rate of 10% and a default rate of 15% annually.  The note is secured by the Company’s equipment.  The note has a conversion feature for restricted common shares at $0.05 per share and a maturity date of August 31, 2019. As of September 30, 2019 the Company had drawn the full $100,000 on the note.

18

During the year ended 2018 and the nine-month period ended September 30, 2019, the Company issued convertible promissory notes which are convertible into common stock. Due to the Company’s lack of authorized shares necessary to settle all convertible instruments, we determined that the conversion features related to these notes are derivative instruments.  At September 30, 2019, the Company determined a fair value of $811,551 for the derivative instruments. The Company recorded a loss from change in fair value of derivatives of $440,367 for the nine-month period ended September 30, 2019.

The Company has a few major customers who represent a significant portion of revenue and accounts receivable. During the nine months ended September 30, 2019, two customers represented 86% of sales and two other customers represented 89% of accounts receivable.  The Company has a strong ongoing relationship with this customer with scheduled delivery extending through the year and does not believe this concentration poses a significant risk, as their products are based entirely on the Company’s technologies.

OFF-BALANCE SHEET ARRANGEMENTS

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.

CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates of particular significance in our financial statements include goodwill and the annual tests for impairment of goodwill and long-lived assets and valuing stock option compensation.  

The Company's goodwill represents the excess of its reorganization value over the fair value of the net assets upon emergence from bankruptcy. Goodwill is not amortized, therefore we test our goodwill for impairment annually or when a triggering event occur using a fair value approach. A fair value based test is applied at the overall Company level. The test compares the fair value of the Company to the carrying value of its nets assets. The test requires various judgments and estimates. During 2018 and for the nine months ended September 30, 2019, the Company recorded no impairment charge to reduce the carrying value of the goodwill to its estimated fair value. As part of the impairment testing performed at December 31, 2018, the Company considered factors such as the global market volatility, variables in the economy, and the overall uncertainty in the markets which has resulted in a decline in the market price of the Company's stock price and market capitalization for a sustained period, as indicators for potential goodwill impairment.

We test long-lived assets for impairment annually or when a triggering event occurs. Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets. The amount of impairment is measured using a discounted-cash-flows model considering future revenues, operating costs and risk-adjusted discount rate and other factors. The analysis compares the present value of projected net cash flows for the remaining current year and next two years against the carrying value of the long-lived assets. If the carrying values of the long-lived assets exceed the present value of the discounted projected revenues an impairment expense would be recognized in the period and the carrying value of the assets would be adjusted accordingly. Impairment tests are conducted on an annual basis and, should they indicate a carrying value in excess of fair value, a charge may be required.

Financial accounting standards require that recognition of the cost of employee services received in exchange for stock options and awards of equity instruments be based on the grant-date fair value of such options and awards and is recognized as an expense in operations over the period they vest. The fair value of the options we have granted is estimated at the date of grant using the Black-Scholes American option-pricing model. Option pricing models require the input of highly sensitive assumptions, including expected stock volatility. Also, our stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate.  Management believes the best input assumptions available were used to value the options and that the resulting option values are reasonable. For the nine month periods ended September 30, 2019 and 2018 we recognized $0 and $0, respectively, of stock-based compensation expense for our stock options and there is no additional unrecognized compensation cost related to employee stock options at the current time.

19

RESULTS OF OPERATIONS

The Company continues to concentrate its marketing resources on a limited number of customers that have the greatest potential to generate the most short-term revenue while still building relationships with our larger customers. Management believes this approach has the highest potential to bring long-term commercially viable products to market and will provide sustainable cash flow to fund the Company's operations in the future. Currently, overall revenues are not sufficient to sustain our operations.  Management anticipates that revenues will increase as we continue to execute our long-term business plan and cultivate larger customer bases with our existing product offering. However, until a long-term production contract is in place there is no guarantee that our current customer base will order in sufficient volumes to sustain our operations. Therefore, management continues to work with larger companies and industries and is hopeful that in the near future we will sign a long-term licensing or manufacturing contract.

We received revenue from repeat orders from our existing customers, design contract, and development engineering. Revenue is recognized using the ASC 606 five step detailed in Note 1 to the financial statements.  Revenue from the sale of a product is recorded at the time of shipment to the customer.  Revenue from the license agreement was recognized in the period the agreement was concluded, as it is a right of use license and the Company has no further obligations to perform under the terms of the agreement.  Revenue from research and development engineering contracts is recognized as the services are provided and accepted by the customer. Revenue from contracts to license technology to others is deferred until all conditions under the contract are met and then the sale is recognized as licensing royalty revenue over the remaining term of the contract.

The following discussions are based on the consolidated operations of Flexpoint Sensor Systems, Inc. and should be read in conjunction with our unaudited financial statements for the three and nine months ended September 30, 2019 and 2018, included in Part I, Item 1, above, and the audited financial statements included in the Company’s annual report on Form 10-K for the years ended December 31, 2018 and 2017.

THREE MONTH PERIODS ENDED SEPTEMBER 30, 2019 AND 2018:

For the three months ending September 30, 2019 revenue was $54,209, a decrease of $17,999 when compared to the same period in 2018. A customer who placed $40,000 in orders in 2018 did not place orders in 2019, as their project has not yet moved to commercialization.  The majority of the revenue for this period came from product manufacturing and recurring sales, product engineering services, prototype and pre-production products.

Of the $222,157 and $205,046 total operating costs and expense for the three months ending September 30, 2019 and 2018, respectively, $60,498 and $73,873 were for direct research and development cost, respectively. For the three months ended September 30, 2019, total operating expenses increased by $17,111 when compared to the same period in 2018, due primarily to higher consulting fee expense in 2019.  

Other expense for the three month period ended September 30, 2019 was $173,665, a $183,900 increase compared to the same period in 2018.  The increase is attributable to a loss of $151,673 on the change in fair value of derivative liabilities recorded in 2019, interest expense of $79,324 and a $57,320 gain on forgiveness of debt realized from the settlement of debt with the owner of the building we rent on a month-to-month basis, while in 2018 a gain of $88,606 on derivatives was recognized..

Net loss of $341,613 was realized for the three months ended September 30, 2019.  A net loss of $122,603 was realized for the three month period ended September 30, 2018.

20

NINE MONTH PERIODS ENDED SEPTEMBER 30, 2019 AND 2018:

For the nine months ending September 30, 2019 revenue was $691,250, an increase of $488,620 when compared to the same period in 2018. The majority of the revenue for the increase for this period came from the $450,000 revenue recognized for the license agreement entered into.  Production product was $46,955 higher in 2019 than 2018 as we continue to receive reorders in higher quantities from existing customers.

Of the $663,407 and $642,678 total operating costs and expense for the nine months ending September 30, 2019 and 2018, respectively, $213,956 and $237,678 were for direct research and development cost, respectively. For the nine months ended September 30, 2019, total operating expenses increased by $20,724 when compared to the same period in 2018, due primarily to an increase in administrative expense.

Other income (expense) for the nine month period ended September 30, 2019 was $(528,793), a $584,383 decrease compared to the same period in 2018.  The decrease is primarily attributable to the loss of $440,367 on the change in fair value of derivative recorded in 2019 while in 2018 a gain of $291,446 on derivative was recognized.

A net loss of $500,950 was realized for the nine months ended September 30, 2019.  A net loss of $384,458 was realized for the nine month period ended September 30, 2018.

The chart below represents a summary of our condensed consolidated balance sheets at September 30, 2019 and December 31, 2018.

Cash and cash equivalents increased by $187,901 at September 30, 2019 compared to December 31, 2018. The increase in cash is due to the $450,000 payment received under a license agreement, collection of accounts receivable and proceeds of $100,000 from convertible notes. Our non-current assets decreased at September 30, 2019 due to the amortization of long-lived assets.

Total liabilities increased by $360,318 at September 30, 2019.  The increase was due primarily to the increase in derivative liabilities and accrued liabilities, along with $100,000 received from a new convertible note, offset by the conversion of $300,000 of convertible notes and $110,574 of accrued interest into shares of restricted common.

INFLATION

We do not expect the impact of inflation on our operations to be significant for the next twelve months.

21

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable to smaller reporting companies.

ITEM 4.  CONTROLS AND PROCEDURES

(a)

Disclosure Controls and Procedures

As of the end of the period covered by this quarterly report we carried out an evaluation of the effectiveness of our disclosure controls and procedures under the supervision and with the participation of our Chief Executive Officer, who also serves as our Principal Financial Officer.  Our controls and procedures are designed to allow information required to be disclosed in our reports to be recorded, processed, summarized and reported within the specified periods, and accumulated and communicated to management to allow for timely decisions regarding required disclosure of material information.  Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.  Based upon the evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures were not effective at that reasonable assurance level as of the end of the nine-month period ended September 30, 2019.  

The material weaknesses relate to the limited number of persons responsible for the recording and reporting of financial information, the lack of separation of financial reporting duties, and the limited size of our management team in general. We are in the process of evaluating methods of improving our internal control over financial reporting, including the possible addition of financial reporting staff and the increased separation of financial reporting responsibility, and intend to implement such steps as are necessary and possible to correct these material weaknesses

(b)

Changes in Internal Control over Financial Reporting

There have been no changes in internal control over financial reporting during the nine months of 2019 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 1A.  RISK FACTORS

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and, as such, are not required to provide the information under this Item.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On May 28, 2019 the Company issued 3,650,000 shares of restricted common stock to Empire Fund Managers and 3,200,000 shares of restricted common stock to Compass Equity Partners, LLC in consideration for two convertible notes and accrued but unpaid interest totaling $410,574.   We relied on an exemption from the registration requirements provided by Section 4(a) (2) of the Securities Act.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

22

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.  OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Part I Exhibits