Nano Magic Inc. - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2019;

or

For the transition period from _____________ to _____________

COMMISSION FILE NO. 1-11602

Nano Magic Inc.

(Exact name of registrant as specified in its charter)

750 Denison Court, Bloomfield Hills, MI 48302

(Address of principal executive office, including Zip Code)

Registrant’s telephone number, including area code: (844) 273-6462

Securities registered pursuant to Section 12(b) of the Exchange Act:

Securities registered pursuant to Section 12(g) of the Exchange Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes [  ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

The aggregate market value of the Common Stock held by non-affiliates of the Registrant, based upon the closing price of the Class A Common Stock on the OTCQB system on June 30, 2019 of $1.25, was approximately $1,125,970.

As of April 20, 2020, the registrant had 7,199,941 shares of Class A Common Stock issued and outstanding.

Documents Incorporated by Reference: No documents are incorporated by reference into this annual report on Form 10-K.

NANO MAGIC INC.

FORM 10-K

TABLE OF CONTENTS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (this “Report”) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which includes information about us and our industry that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this Report regarding our strategy, future operations, future financial position, future net sales, projected expenses, prospects and plans and objectives of management are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievement to be materially different from those expressed or implied by the forward-looking statements. Among these risks are those associated with the novel strain of the coronavirus (“COVID-19”) which has caused significant economic and financial disruptions and the fact that we have experienced recurring losses from operations, limited cash flows from operations, and an accumulated deficit during the periods reported which raise substantial doubt about our ability to continue as a going concern. These are not, however, the only material risks that we face. These risks, along with others, and their impacts on our business are discussed in more detail throughout this Report.

In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “potential,” “continue,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Actual events or results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors. There may be other factors that cause our actual results to differ materially from the forward-looking statements.

These forward-looking statements represent our estimates and assumptions only as of the date of this report. Unless required by U.S. federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made or to conform these statements to actual results.

PART I

Item 1. Business

Nano Magic Inc., a Delaware corporation (“we”, “us”, “our”, “Nano Magic” or the “Company”), formerly PEN Inc., develops, commercializes and markets consumer and industrial products powered by nanotechnology. We are recognized for the surface cleaning products manufactured and sold by our wholly-owned subsidiary Nano Magic LLC (formerly PEN Brands LLC). These include the ULTRA CLARITY brand eyeglass cleaner, our defogging products and nanocoating products for glass and ceramics. We have historically sold our consumer products directly to opticians, ophthalmologists and small optical retailers and we will continue to do so, even as we are currently working to expand our consumer sales through e-commerce and the development of Nano Magic-branded consumer products to sell into big box retailers and direct-to-consumer sales. We also develop and sell printable inks and pastes, thermal management materials, and graphene foils and windows through our other wholly-owned subsidiary, Applied Nanotech, Inc. (“Applied Nanotech”). Applied Nanotech also holds our Innovation and Technology Center in Austin, Texas that, in addition to performing product development work for our business, engages in contract research and development work for government and private customers.

We were formed in 2014 as the successor to Applied Nanotech Holdings Inc. (“Applied Nanotech Holdings”). Applied Nanotech Holdings was formed in 1989 and, in the combination that created us, acquired by Nanofilm, Ltd. Our principal operating segments coincide with our different business activities, which is consistent with our internal reporting structure. Our two reportable segments for the years ended December 31, 2019 and 2018 were (i) the Product segment and (ii) the Contract Services segment

Product Segment

In our Product segment, revenue is based on the retail and institutional sale of specialty products utilizing nanotechnology to deliver unique performance attributes. We have a strong focus on understanding surfaces and our products for surfaces can be used on a wide variety of substrates. Our consumer products are sold as liquids, gels, foam and as wet and dry towelettes. Institutional coating products are typically sold in liquid form enabling application by a variety of common commercial techniques We rely on intellectual property including trade secret formulations to protect our proprietary technology.

We have multiple product technology platforms that offer solutions to common surface problems such as ease of cleaning, preventing fogging, preventing accumulation of dirt or grime, improving resistance to scuffing and wear and surface protection. All our products have some “nano” characteristic about them – whether it is being active at the molecular level, incorporation of submicron-particles, or creating very thin, self-assembling coatings that are 20 nanometers or less in thickness.

Our consumer products are primarily customized cleaning and de-fogging treatments. With respect to our consumer products, we strive to create segment leading brands that are sustainable, of high quality, and that are both easy and safe to apply. Our products can be used on eyeglasses, extreme sport and safety glasses and goggles, electronic screens, windshields, windows, mirrors, shower doors, and other similar clear surfaces along with the cleaning of everyday household surfaces.

Industrial products include a family of coating liquids that create nano-thin, strongly-bound, invisible, “forcefield”-like coatings on surfaces used for glass and ceramic surfaces and a series of clear coatings for plastics incorporating submicron sized particles to improve abrasion resistance and wear resistance without sacrificing transparency. We manufacture our formulations internally to protect our technology and strive to maintain the highest quality for the products that we and our commercial partners bring to the marketplace.

Our surface treating products include:

In addition to our surface treatment products, we sell metallic inks and pastes to a variety of customers around the world. The submicron particles in our formulations are compatible with the nozzles used in digital printing, including 3D printing. Certain of our products based on nano-copper are available only outside Asia under agreements with our former research partner Ishihara Chemical Company, Ltd., that has exclusive rights in Asia to patents developed under research contracts with them. Other copper products that we sell are available worldwide.

In the medical field, our thin carbon foil made of layers of graphene is sold for use in cyclotron accelerators that produce nuclear pharmaceuticals used by the medical field in Positron Emission Tomography (PET) imaging.

We believe that products powered by nanotechnology can tackle and solve big, global problems in selected growing markets. We have three primary areas of new product focus:

In 2016, we introduced a hygienic product into the institutional market that creates surfaces unfriendly to germs. Several patent applications related to the formulation have been issued. The product is safe for use on many surfaces, both natural and man-made. After application, the product continues to fortify and protect, keeping a clean and healthy surface. We are preparing a modified version of that product for a broader market launch with enhanced features. We are working to accomplish the product launch in 2020, but the timing is uncertain and there are regulatory approvals required that may delay commercial sales.

We believe that our manufacturing capacity is adequate to enable us to fill orders for the new product. We have ingredients on hand for initial production. However, some of the raw materials and bottles used to produce certain of our liquid products, including our new surface product, are used to produce hand sanitizer and other cleaning products that are currently in high demand due to the COVID-19 pandemic. Further, some of our raw materials and packaging have become harder to find. Please refer to the paragraph below under the heading “Impact of COVID-19” for a more detailed discussion of these matters.

Marketing and Distribution

We sell our consumer products directly to retailers in the United States. Historically we have relied heavily on outside agents and distributors and sold to some of the leading optical retailers. We lost many of those customers in 2018 due to certain delays in shipping customer orders, but we have continued direct sales to opticians and ophthalmologists. We have also increased our emphasis on internal sales efforts, both direct-to-consumer sales, including internet sales, and sales to big box retailers. Sales to big box retailers include private label products under the retailers’ names. Our industrial coating products, inks and pastes, and graphene foil products are sold directly to institutional and industrial customers. Some of our products are used on our customer’s branded products.

Manufacturing Operations

We manufacture, pack and label liquids and towelettes as well as specialty surface coatings at our 26,000-square foot facility in Brooklyn Heights, Ohio. Metallic inks and pastes and the graphene windows are made at our Innovation and Technology Center in Austin, Texas. We are currently subject to certain limitations on our operations due to the COVID-19 pandemic. Certain of our products, however, have been deemed essential under the new regulations and, as a result, some of our operations have been allowed to continue. This uneven impact across our business has caused increased uncertainty and unpredictability both in our operations and results.

Intellectual Property and Proprietary Rights

Our nanotechnology expertise and the related intellectual property used in our current products is specialized in the areas of surface science, molecular self-assembly, transparent composites, surfactants, sub-micron metallic inks and pastes and graphene foils. The intellectual property developed from this work is protected with a combination of selective patents and primarily by trade secrets. This intellectual property strategy is like that used by leading companies in the fragrance and flavors industry. No single patent is significant to any of our commercial products. Please refer to the section entitled “Intellectual Property Rights” in this Item 1 for a more detailed discussion of these matters.

Competition

Products sold into the optical segment, which has historically been our core sales channel, have a small number of significant competitors. Our products are known to be the “benchmark” products in these segments and generally outperform those of our competitors. Some of our products in these segments do compete for certain customers or certain applications against lower-priced, traditional materials. Most of the companies selling products into these market segments are privately-held, U.S. packaging or catalog companies. Examples in the U.S. include Hilco Accessories, California Accessories, and Amcon Laboratories. Internationally, the catalog company, Prosben, Inc., from the Peoples Republic of China is a competitor. In the nano-coating products area or the anti-fog product line we are not aware of any competitive products that we believe match our product performance or processing characteristics.

Products sold into the hygienic, germ-unfriendly market have a diverse variety of potential competitors. Potential competitors fall into the general category of germ-killing cleaners, known as disinfectants. These disinfectants rely on the use of government-approved pesticides as their active ingredient. Examples include bleach, benzalkonium chloride, and alcohols. All disinfectant products require the use of protective gloves and masks for their safe use. Examples in the U.S. include the Clorox Company, GOJO Industries, Inc., and Reckitt Benckiser, Inc. Since our products do not include germ-killing pesticides and do not require protective clothing, it is unclear how customers will perceive our products as compared to these potential competitors.

Most inks and pastes sold in commercial quantities today are manufactured and sold by large multinational chemical companies. For example, the two largest suppliers of silver inks and pastes for solar cell production are DuPont and Ferro. We are unable to compete directly with companies of that size in established silver ink markets. The use of metallic inks in 2D and 3D printing is just developing. Because silver is expensive, other metals are preferred for these applications. Numerous other companies are working with other technologies for the commercial use of conductive inks and pastes.

Backlog

Sales are primarily made under purchase orders for delivery of products. We do not believe that a backlog as of any date is indicative of future results. Some agreements give customers the right to purchase a specific quantity of products during a specified period, but these agreements do not obligate the customers to purchase any minimum quantity. The quantities purchased by the customer, as well as the shipment schedules, are frequently revised during the agreement term to reflect changes in the customer’s needs. Because of our relatively small size, a customer’s delay of a product shipment can make a difference in the results for an accounting period.

Geographical Information

All long-lived assets are in the United States.

Sources and availability of raw materials and the names of principal suppliers

We use third-party suppliers in the United States to obtain substantially all raw materials, components and packaging products. As is customary in our industry, historically we have not had long-term or exclusive agreements with third-party suppliers and have generally made purchases through purchase orders. In the last quarter of 2018 and first quarter of 2019 we terminated most of our outside contract and toll manufacturing, bringing our manufacturing back in house. We believe that we have good relationships with our suppliers.

Apart from the disruption affecting all manufacturing businesses as a result of the COVID-19 pandemic, some of the raw materials and bottles used to produce our liquid products, including the new surface product, are used to produce hand sanitizer and other cleaning product that are in high demand and some of our raw materials and packaging have become harder to find due to the COVID-19 pandemic. If shortages continue, we may not be able to obtain adequate supply. Moreover, when the material is available, the price can be substantially higher which will probably adversely impact our profit margin even if we can implement some price increases. In addition, disruption of our operations and the likelihood of shipment delays could have a material adverse effect on our business, prospects, results of operations, financial condition or cash flows.

Key Customers

A limited number of key customers historically accounted for a substantial portion of our commercial revenue. Delays in shipping customer orders caused several major customers to advise us in May 2018 that they would stop buying our products. Two customers accounted for 51% of the Company’s total product revenue in 2018. No customers represented greater than 10% of total product revenue in 2019 as a result of this lost business.

Impact of COVID-19

In December 2019, COVID-19 was first reported in Wuhan, China. Less than four months later, on March 11, 2020, the World Health Organization declared COVID-19 a pandemic. Restrictions imposed by Federal, state and local governments have affected operations of our business and those of our vendors and customers as well as logistics for shipping and receiving supplies and shipping our products. 

Apart from the disruption affecting all manufacturing businesses, some of the raw materials and bottles used to produce our liquid products, including our new surface product described above, are used to produce hand sanitizer and other cleaning products that are in high demand. As a result, some of our raw materials and packaging have become harder to find due to the COVID-19 pandemic. If shortages continue, we may not be able to obtain adequate supply. Moreover, when the material is available, the price can be substantially higher which will probably adversely impact our profit margin even if we can implement some price increases. The increased use of face masks and other personal protective equipment as a result of the pandemic has created additional demand for our antifog product.

Whether these effects on businesses and our customers generally, and on our business in particular, will continue, whether the effects noted will change with a continuation of government restrictions or changes in government restrictions over time, or from other effects of the COVID-19 pandemic is unknown.

Contract Services Segment

Our Contract services segment functions as the Innovation and Technology Center for our new products as well as performing work for government agencies and private strategic partners. Formerly called the research and development segment, this segment has moved away from areas of research that do not involve product development, especially government contracts that require us to fund part of the research cost. This segment is now involved in proof of concepts and prototypes for proposed Nano Magic products and development work under contract for government and private entities. In work on products for Nano Magic we focus only on submicron size particles, not smaller nanoparticles that are subject to much greater government regulation. Our work generally falls under one of three technology platforms:

Much of our contract product development work is done under government contracts. Government contracts frequently limit profit on work done. With private development contracts, there is a relationship between revenues received under the contract and rights granted to the licensee under the contract. Our short-term goal when we work for others is to cover all out of pocket costs and contribute to our overall overhead. Our long-term goal is to become a trusted supplier of products to our development partners.

We continue to focus on stabilizing our financial situation and operating this segment at break-even based on revenues from our development activities.

Nanoelectronics Applications – Inks and Pastes

Metallic Inks & Pastes

Copper Inks - As flexible electronics grow, soldering is disappearing. New digital and additive manufacturing processes allow industries to move from the design process directly to the production line. We believe that only submicron particles are capable of producing inks that are compatible with the nozzles used in digital printing.

Other metallic inks – Our technology and development work in conductive inks also resulted in conductive inks and pastes using nickel, silver, and aluminum rather than copper. Research partners who funded some of our work using silver and aluminum have exclusive rights to certain products for solar applications. We are not restricted in using products for other applications, and we can sell into the solar field our products that do not infringe those specific patents.

Technical Inks Printing Solution (TIPS)

Conductive inks have the potential to revolutionize many types of electronics manufacturing. Our strategy is to provide a comprehensive solution for end users not just by developing inks, but assisting in the process from start to finish. We call this our Technical Inks Printing Solution. We have also formed relationships with hardware manufacturers with the goal of providing seamless integration into high volume manufacturing for companies wishing to use conductive inks in their manufacturing processes. In addition to traditional 2D printing applications, we developed a multifunctional copper ink for 3D printing applications, the fastest growing segment of printed electronics.

We also build on our expertise in inks and pastes to work with potential customers to develop inks to their specifications for their products in development. Product sales typically come from repeat business or from customer inquiries in our areas of expertise.

Sensors

Our approach to sensor technology offers the unique advantage of recognizing and sometimes measuring materials at the molecular level. Our competition in the sensor area will come from a variety of technologies and companies depending on the purpose and use of the sensor. The areas where we are currently active are described below.

Hydrogen and Methane Sensors. Hydrogen sensors were initially targeted for use in fuel cells for automobiles and for remote monitoring of large power transformers. We developed a hydrogen sensor for use in the measurement of hydrogen in power transformer products. Currently, we are not aware of commercial interest in hydrogen sensors.

Methane gas detectors that we developed for use in the natural gas industry under funding from the Northeast Gas Association have achieved UL 1484 certification for Residential Gas Detectors. In 2018, the Northeast Gas Association completed a field test and reliability study of these sensors. The results have led to further work to improve the performance of these detectors beyond the UL 1484 standards. Northeast Gas Association has told us that they have a commercialization partner. Following that, in 2020 we reached agreement with the Northeast Gas Association to license to our background intellectual property pursuant to which we will be entitled to a percentage of revenue from any commercial sales through March 31, 2028.

Submicron Particle Formulations and Materials for Health and Safety Applications

Using our experience with metallic inks and our prior work with carbon nanotube composites we developed a new graphene foil that is used by institutional customers who make nuclear pharmaceuticals. We have developed mountings for the foil and have developed foils that include both carbon nanotubes and graphene for longer life in cyclotron applications. We are also working to develop targets to be used by customers in this industry.

Key Customers

Related to the Company’s contract services revenue, three customers accounted for 99% and 67% of contract services revenue in 2019 and 2018, respectively. Two of those customers are government entities.

Intellectual Property Rights

An important part of our overall business and product development strategy is to protect our intellectual property and, when appropriate, we seek patent protection for our products and proprietary technology. Historically, we made filings in the United States and selected foreign jurisdictions. Beginning in 2014, as a cost saving measure, we became much more selective in filing patents and reduced the number of jurisdictions where we act to protect our rights. This practice exposes us to some risk that certain items of intellectual property that we develop may not be protected and, as a result, we could lose the benefit of exclusivity from applications using that intellectual property. Still, our patent portfolio consists of approximately 20 patents, including issued patents and patent applications pending before foreign and United States Patent and Trademark Offices. Trade secret protection is also important to our products.

The patenting of technology-related products and processes involves uncertain and complex legal and factual questions. The legal standards change from time to time, and administrative and court interpretations are not always consistent in one jurisdiction, or across different jurisdictions. Therefore, there is no assurance that our pending United States and foreign applications will issue, or what scope of protection any issued patents will provide, or whether any such patents ultimately will be upheld as valid by a court of competent jurisdiction in the event of a legal challenge. Interference proceedings, to determine priority of invention, also could arise in any of our pending patent applications. The costs of such proceedings would be significant and an unfavorable outcome could result in the loss of rights to the invention at issue in the proceedings. If we fail to obtain patents, there can be no assurance that we can protect our rights in the technology, or that others will not independently develop substantially equivalent proprietary products and techniques, or otherwise gain access to our technology.

Competitors have filed applications for, or have been issued, patents, and may obtain additional patents and proprietary rights relating to products or processes used in, necessary to, competitive with, or otherwise related to, our patents. The scope and validity of these patents, and the extent to which we may be required to obtain licenses under these patents or under other proprietary rights and the cost and availability of licenses is unknown. This may limit our ability to use and to license our technology. Litigation concerning these or other patents could be protracted and expensive. If suit were brought against us for patent infringement, we could potentially challenge the validity of the other patent but would need to overcome a presumption of validity. If we were found to infringe and the patent was held valid (or was unchallenged), there could be no assurance that the prevailing party would grant us a license. Even if a license were available, the payments that would be required would be unknown and could materially reduce the value of our interest in the affected products.

We also rely upon unpatented trade secrets. No assurance can be given that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technology or that we can meaningfully protect our rights to our unpatented trade secrets.

We require our employees, directors, consultants, outside scientific collaborators, sponsored researchers, and other advisors to execute confidentiality agreements upon the commencement of employment or consulting relationships with us. These agreements provide that all confidential information developed or made known to the individual through the relationship is to be kept confidential and not disclosed to third parties except in specific circumstances. In the case of employees and some consultants, the agreements provide that all inventions conceived by the individual while working for us will be our property. There is no assurance, however, that these agreements will provide sufficient protection for our trade secrets in the event of unauthorized use or disclosure of such information.

Government Contracts

A portion of our revenue in the Contract services segment consists of reimbursement of expenditures under U.S. government contracts. Our revenue from government contracts was $743,665 and $1,085,639 for the years ended December 31, 2019 and 2018, respectively. These reimbursements represented all or a portion of the costs associated with such contracts. As of December 31, 2019, we had several government contracts in process that had approximately $545,817 of revenue yet to be recognized. Government contracts are subject to delays and risk of cancellation. Also, in the ordinary course of business, government contractors generally are subject to audits and reviews by government agencies. These audits and reviews involve review of a contractor’s performance on its contracts, as well as its pricing practices, the costs incurred and compliance with all laws, regulations and standards. We have been audited by the government, with no material changes, and we do not expect the results of any government audit to have a significant effect on our operations or our financial statements.

Research and Development

Research and development drive our new products and improvement of existing products. Research and development costs incurred in the development of the Company’s products was $68,539 for the year ended December 31, 2019. Research and development costs were $60,848 for 2018. This represented approximately 5.1% and 5.6% of our total operating costs in each of those years. The ability to engineer product performance using nanotechnology is one of the ways we distinguish our products in marketing and sales of our products. Product research and development work includes branding and packaging, development and refinement of formulas, engineering of liquid formulas that can be applied both by hand and by machine, optimization for a variety of performance characteristics, testing and characterization, and work on manufacturing processes and techniques both for producing the product, and for a customer’s use of the product.

Compliance with Laws and Regulations

Our operations must satisfy governmental safety standards. Applicable safety standards are established by the U.S. Occupational Safety and Health Administration (“OSHA”), pollution control standards by the U.S. Environmental Protection Agency (“EPA”) and other state and local regulations, including foreign regulation for products manufactured or shipped outside the U.S. Some of our research work, and products developed may also be subject to regulation under the Radiation Control for Health and Safety Act administered by the Center for Devices and Radiological Health (“CDRH”) of the U.S. Food and Drug Administration. We take these requirements into account in product development. Cost of compliance with these regulations has not been significant in the past and we do not expect it to be material in the future.

OSHA, the EPA, the CDRH and other governmental agencies, both in the United States, the states where we or our customers sell products, and foreign countries, may adopt additional rules and regulations that may affect us and products using our technology. The cost of compliance with these regulations has not been significant to us in the past and is not expected to be material in the future. Changing regulations can affect our customers, and we have in the past, and may be required in the future, to reformulate or change packaging to address regulatory issues. This can affect timing of sales which may be significant in an accounting period.

Our commercial products do not require any government approvals. The modified version of our hygienic product that we are working to launch in 2020 is expected to require some regulatory approval from the EPA depending, in part, on what claims are made regarding its efficacy.

Employees

As of December 31, 2019, we had 12 full-time employees. We do not anticipate the need to hire significant additional employees to support our existing business. If product sales increase, or we begin to see commercial sales of new products, we may hire additional employees in sales, marketing and production. We are not subject to any collective bargaining agreements, and we consider our relations with our employees to be good.

Available Information

General information about the Company can be found on our website, located at www.nanomagic.com.

Item 1A. Risk Factors

As a smaller reporting company, we are not required to provide disclosure under this item. There are, however, risks associated with any investment in our securities, and we have identified material risks as appropriate in this Report. We encourage you to refer to the section titled “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this Report.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties.

We lease facilities in four locations. Our headquarters is in leased space in Bloomfield Hills, Michigan. Our leased space in Austin, Texas is used primarily by our Contract services segment and to produce our printable inks and pastes, thermal management materials, and graphene foils and window. Leased office, warehouse, manufacturing and laboratory space in Brooklyn Heights, Ohio is used by our Product segment to produce our coatings products. In 2019, we also leased space for a sales office in Bingham Farms, Michigan. These facilities are adequate for our current needs.

Item 3. Legal Proceedings.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our Class A common stock, $0.0001 par value, trades on the OTCQB system under the symbol “PENC”. The following table sets forth, on a per share basis for the periods indicated, the high and low sale prices for the common stock as reported by that system. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.

As of April 20, 2020, the closing sale price for our Class A common stock as reported on the OTCQB system was $1.70 per share. As of that date, there were approximately 357 shareholders of record for our Class A common stock. This does not include beneficial owners holding Class A common stock in street name in brokerage accounts. As of our last record of total shareholders, including those holding stock in street name, there were approximately 3,460 shareholders.

Trading Suspension

On April 30, 2020, the SEC issued an Order of Suspension of Trading (the “Order”) of our common stock for the 10-day period from May 1, 2020 to May 14, 2020. A trading suspension is not an enforcement action and is not a finding of wrongdoing by the SEC. In the Order, the SEC raised questions regarding the accuracy and adequacy of publicly available information in the marketplace concerning the Company since at least February 24, 2020, relating to publicly available information concerning the Company, including (a) information in the marketplace claiming that the Company has a patent for a disinfectant that kills “coronavirus” and (b) a statement made by the Company on April 7, 2020 regarding the Company’s involvement in the fight against COVID-19. With the assistance of outside counsel, Dickinson Wright, we have notified the SEC that we do not believe the SEC should have ordered a trading suspension and we believe that all disclosures by the Company in the marketplace are accurate and adequate.

On May 6, 2020, we, through Dickinson Wright, filed with the SEC a Petition to Terminate Trading Suspension (“Petition”). On May 7, 2020, Dickinson Wright filed with the SEC a Motion for Expedited Consideration of Petition to Terminate Trading Suspension. In our Petition, we informed the SEC that neither the Company, nor its officers or directors were the source of the “information in the marketplace” cited by the SEC. The Company believes that the “information” to which the SEC refers is information that may have been posted by third parties on internet message boards. The Company cautions investors to rely only on information released by the Company in its current and periodic reports filed with the SEC, and in press releases that the Company, from time to time, may issue. The Company has a policy of not communicating on internet message boards and a policy of not communicating with persons seeking to obtain information from the Company outside of the Company’s public filings and official statements. The Company at no time and in no medium has communicated or published information claiming that “the Company has a patent for a disinfectant that kills ‘coronavirus.’” The Company has no knowledge of the source of such information entering the marketplace. The Company’s practice is to cooperate with non-public inquiries conducted by regulators. The Company does have four issued patents – two issued in April 2017, one issued in November 2018, and one issued in October 2019 – relating to the Company’s work in disinfectants. The testing on the Company’s formulations for the four patents all occurred prior to the filing in 2015 of the patent applications.

Cash Dividends

We have never paid cash dividends on our common stock, have no plans to pay any dividends, and it is unlikely that we will pay any dividends in the foreseeable future. We currently intend to invest future earnings, if any, to finance expansion of our business. Any payment of cash dividends in the future will be dependent upon our earnings, financial condition, capital requirements, and other factors determined by our board of directors.

Recent Sales of Unregistered Securities

On January 31, 2019, we sold 325,581 shares of Class A common stock in a private placement to PEN Comeback, LLC (“PEN Comeback”) at a per share price of $0.40 for aggregate proceeds of $130,232. At the same time PEN Comeback bought warrants to purchase up to 325,581 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that Nano Magic shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the warrants were $9,768.

On March 22, 2019, we sold 232,558 shares of Class A common stock in a private placement to PEN Comeback at a per share price of $0.40 for aggregate proceeds of $93,023. At the same time the investor bought warrants to purchase up to 325,581 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that Nano Magic shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the warrants were $6,977.

On April 3, 2019, we issued an aggregate of 18,180 shares of our Class A common stock to five of our directors as compensation to them for service on our Board. The shares were valued at $0.55 per share based on the quoted price of the stock for a total value of $10,000. On that date the Board also granted to our President an option to purchase up to 550,000 shares of our Class A common stock at a price of $0.55 per share. Under that option, the right to purchase 50,000 shares vested on the date of grant, the right to purchase up to 75,000 shares vested on December 31, 2019, the right to purchase 100,000 shares will vest on June 30, 2020, and the right to purchase up to 125,000 shares will vest on December 31, 2020. In addition, two tranches entitling him to purchase 100,000 shares vest only if he reaches the cap for cash payments under the bonus program created under his employment agreement. The bonus cap under Mr. Berman’s employment agreement was not reached in 2019 and that tranche will never vest, but the tranche for 2020 may vest in the future. All rights to purchase have a term of 5 years from date of vesting.

On April 24, 2019, we issued an aggregate of 19,998 shares of Class A common stock to our directors as compensation to them for service on our Board. These shares were valued on that date at $0.60 per share based on the quoted price of the stock for a total value of $12,000.

On May 10, 2019, we sold 523,266 shares of Class A common stock in a private placement to PEN Comeback at a per share price of $0.40 for aggregate proceeds of $209,302. At the same time the investor bought warrants to purchase up to 523,266 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that Nano Magic shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the warrants were $15,698.

On June 27, 2019, we sold 441,860 shares of Class A common stock in a private placement to PEN Comeback at a per share price of $0.40 for aggregate proceeds of $176,744. At the same time the investor bought warrants to purchase up to 441,860 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that Nano Magic shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the warrants were $13,256.

On July 24, 2019, we issued an aggregate of 18,750 shares of Class A common stock to our directors as compensation to them for service on our Board. These shares were valued on that date at $0.64 per share based on the quoted price of the stock for a total value of $12,000.

On September 6, 2019, we sold 216,912 shares of Class A common stock in a private placement to PEN Comeback 2, LLC (“PEN Comeback 2”) at a per share price of $0.65 for aggregate proceeds of $140,993. At the same time the investor bought 216,906 warrants to purchase up to 216,906 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 $6,507.

On October 9, 2019, we sold an additional 88,235 shares of Class A common stock in a private placement to PEN Comeback 2 at a per share price of $0.65 for aggregate proceeds of $57,353. At the same time the investor bought 88,235 warrants to purchase up to 88,235 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 $2,647.

On October 23, 2019, we issued an aggregate of 23,331 shares of Class A common stock to our directors as compensation to them for service on our Board and its committees. These shares were valued on that date at $0.60 per share based on the quoted price of the stock for a total value of $14,000.

On October 31, 2019, we sold an additional 165,441 shares of Class A common stock in a private placement to PEN Comeback 2 and 15,384 shares of Class A common stock to the Rickert Family, Limited Partnership, all at a per share price of $0.65 for aggregate proceeds of $117,537. At the same time PEN Comeback 2 bought 165,441 warrants to purchase up to 165,441 additional shares and the partnership bought 13 warrants to purchase up to 13 additional shares, all 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 $4,963.

On December 10, 2019, we sold an additional 272,059 shares of Class A common stock in a private placement to PEN Comeback 2 at a per share price of $0.65 for aggregate proceeds of $176,838. At the same time the investor bought 272,055 warrants to purchase up to 272,055 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 $0.03 per warrant for an aggregate of $8,162.

On December 18, 2019, we issued an aggregate of 20,688 shares of Class A common stock to our directors as compensation to them for service on our Board. These shares were valued on that date at $0.58 per share based on the quoted price of the stock for a total value of $12,000.

The issuances of all shares described in this section were exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(a)(2).

Issuer Purchases of Equity Securities

Neither we nor any of our affiliates have engaged in any purchases of our equity securities during the periods discussed in this Report.

Equity Compensation Plan Information

The table below sets out as of December 31, 2019 the number of securities to be issued upon the exercise of outstanding options, warrants and rights (column (a)), the weighted average exercise price of those options, warrants and rights (column (b)), and the number of securities remaining available for future issuance under the plan (other than the securities to be issued upon the exercise of the outstanding options, warrants and rights) (column (c)).

Item 6. Selected Financial Data

As a smaller reporting company, we are not required to provide disclosure under this item.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation.

The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements.

OVERVIEW

Nano Magic develops, commercializes and markets consumer and industrial products powered by nanotechnology that solve everyday problems for customers in the optical, transportation, military, sports and safety industries. Our primary business is the formulation, marketing and sale of products powered by nanotechnology including the ULTRA CLARITY brand eyeglass cleaner, our defogging products and nanocoating products for glass and ceramics. We have historically sold our consumer products directly to opticians and ophthalmologists and small optical retailers and we will continue to do so, even as we are now working to expand our consumer sales by e-commerce and developing Nano Magic-branded consumer products to sell into big box retailers and direct-to-consumer sales. We also develop and sell printable inks and pastes, thermal management materials, and graphene foils and windows. Our Innovation and Technology Center conducts development services for us and for government and private customers.

In December 2019, a novel strain of coronavirus disease (“COVID-19”) was first reported in Wuhan, China. Less than four months later, on March 11, 2020, the World Health Organization declared COVID-19 a pandemic. Restrictions imposed by Federal, state and local governments have affected operations of our business and those of our vendors and customers as well as logistics for shipping and receiving supplies and shipping our products.

Apart from the disruption affecting all manufacturing businesses, some of the raw materials and bottles used to produce our liquid products are used to produce hand sanitizer and other cleaning product that are in high demand and some of our raw materials and packaging have become harder to find due to the COVID-19 pandemic. If shortages continue, we may not be able to obtain adequate supply. Moreover, when the material is available, the price can be substantially higher which will probably adversely impact our profit margin even if we can implement some price increases. The increased use of face masks and other personal protective equipment as a result of the pandemic has created additional demand for our antifog product.

Our principal operating segments coincide with the types of products to be sold. The Company’s two reportable segments for the years ended December 31, 2019 and 2018 were (i) the Product segment and (ii) the Contract services segment.

RESULTS OF OPERATIONS

The following comparative analysis on results of operations was based primarily on the comparative consolidated financial statements, footnotes and related information for the periods identified below and should be read in conjunction with the consolidated financial statements and the notes to those statements that are included elsewhere in this report. The results discussed below are for the years ended December 31, 2019 and 2018.

Comparison of Results of Operations for the Year Ended December 31, 2019 and 2018

Revenues

For the years ended December 31, 2019 and 2018, revenues consisted of the following:

For the year ended December 31, 2019, sales from the Product segment decreased by $1,631,019, or 51%, as compared to the year ended December 31, 2018. This was primarily attributable to the loss of large retail optical chains as customers in 2018 that reduced the sales volume of our optical cleaners in 2019. We are working to increase sales through other distribution channels and to place products with other retailers, but we anticipate it will take time to rebuild revenue.

For the year ended December 31, 2019, revenues of our Contract services segment decreased by $433,726 or 33% as compared to the year ended December 31, 2018, due primarily to the completion of research projects that were not replaced with new projects. We have submitted proposals for funding of other projects and expect, in the ordinary course of business, that some of those proposals will be funded and new contracts will replace those that have been concluded.

Cost of revenues

Cost of revenues includes inventory costs, materials and supplies costs, internal labor and related benefits, subcontractor costs, depreciation, overhead and shipping and handling costs incurred including costs related to government and private contracts in our Contract services segment.

For the year ended December 31, 2019, cost of revenues decreased by $1,336,425, or 39%. These consisted of the following:

Gross profit and gross margin

For the year ended December 31, 2019, gross profit amounted to $323,901 as compared to $1,048,785 for the year ended December 31, 2018, a decrease of $724,884, or 69%. The decrease was due to significant reduction in sales volume that negatively impacted margin. For the years ended December 31, 2019 and 2018, gross margins were 13.3% and 23.3%, respectively.

Gross profit and gross margin by segment and totals are as follows:

Operating expenses

For the year ended December 31, 2019, operating expenses increased by $326,597, or 27%. For the years ended December 31, 2019 and 2018, respectively, operating expenses consisted of the following:

Loss from operations

As a result of the factors described above, for the year ended December 31, 2019, loss from operations amounted to $1,031,083 as compared to a loss from operations of $40,393 for the year ended December 31, 2018, a difference of $990,690 or 2453%.

Other income

For the year ended December 31, 2019, total other income amounted to $66,096 as compared to other income of $62,465 for the year ended December 31, 2018, an increase of $3,641, or 6%. Interest expense was down due to the pay-off of the revolving credit facility in January 2019. Additionally, 2018 accounted for the one-time write-off of an account payable and certain related accruals and the reversal of a portion of a litigation reserve which was settled for less than the amount reserved.

Net loss

As a result of the foregoing, for the year ended December 31, 2019, our net (loss) amounted to $(964,987) as compared to a net income of $22,072 for the year ended December 31, 2018, a change of $(987,059) or -4472%.

For the years ended December 31, 2019 and 2018, net loss amounted to $(0.21) per common share (basic and diluted), and a net income of $0.01 per common share (basic and diluted), respectively.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is the ability of an enterprise to generate adequate amounts of cash to meet its needs for cash requirements. We had a working capital deficit of $673,040 and unrestricted cash of $216,801 as of December 31, 2019.

The following table sets forth a summary of changes in our working capital from December 31, 2018 to December 31, 2019:

Reductions on current assets and current liabilities reflect the smaller size of the business. At the same time, working capital was substantially improved as we reduced accounts payable and other accrued expenses and paid off the revolving credit line.

This working capital deficit raises substantial doubt about our ability to continue as a going concern within one year after the date that the financial statements are issued. Management cannot provide assurance that we will ultimately achieve profitable operations or become cash flow positive or raise additional debt and/or equity capital. Our principal future uses of cash are for working capital requirements, including sales and marketing expenses, legal and other professional fees, capital expenditures and reduction of accrued liabilities. These uses will depend on numerous factors including our sales and other revenues, and our ability to control costs. Recently, we have financed our working capital needs primarily through sales of equity securities. Over the past year we have continued to focus closely on all expenditures, at the same time working to increase sales and revenue. We will continue to look for opportunities to raise funds while minimizing dilution and, as funds permit, to increase the marketing of our products. There has been a slow-down in business activity as a result of the COVID-19 pandemic, but the severity of the disruption and the length of the slow-down and timing of recovery are unknown. This, along with the specific factors noted elsewhere, could further strain our liquidity and create a greater need for working capital.

Our consolidated financial statements included elsewhere in this Report have been prepared in conformity with accounting principles generally accepted in the United States of America, or U.S. GAAP, which contemplate our continuation as a going concern and the realization of assets and satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the consolidated financial statements do not necessarily purport to represent realizable or settlement values. The consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

Net cash used by operating activities was $878,668 for the year ended December 31, 2019 as compared to net cash provided by operating activities of $155,886 for the year ended December 31, 2018, a change of $(1,034,554), or -664%.

Net cash used in investing activities was $(11,361) for the year ended December 31, 2019 as compared to $(3,916) for the year ended December 31, 2018. Additions in 2019 were mostly related to computer equipment and peripherals.

Net cash provided by financing activities was $810,332 for the year ended December 31, 2019 as compared to net cash used in financing activities of $(78,767) for the year ended December 31, 2018. During the year ended December 31, 2019, we used $508,859 to pay-off a line of credit and repaid other debt in the amount of $18,199, and received $1,169,773 in net proceeds from the sale of securities. During the year ended December 31, 2018, we paid down $374,735 more than we received under the line of credit and received $344,944 in net proceeds from the sale of securities.

CRITICAL ACCOUNTING POLICIES

Our critical accounting policies are included in Note 2 - Significant Accounting Policies of our consolidated financial statements included within this Report.

RECENT ACCOUNTING PRONOUNCEMENTS

Our recently issued accounting standards are included in Note 2 - Significant Accounting Policies of our consolidated financial statements included within this Report.

OFF-BALANCE SHEET ARRANGEMENTS

We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not Applicable.

Item 8. Financial Statements and Supplementary Data.

NANO MAGIC INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2019 and 2018

TABLE OF CONTENTS

Report of Independent Registered Public Accounting Firm

To the Audit Committee
Nano Magic Inc. and Subsidiaries

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheet of Nano Magic Inc. and Subsidiaries (the “Company”) as of December 31, 2019, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the year ended December 31, 2019, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and the results of its operations and its cash flows for the year ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

We also audited the adjustments described in Note 3 that were applied to restate the 2018 financial statements. In our opinion, such adjustments are appropriate and have been properly applied. 

Change in Accounting Principle

As discussed in Note 2 to the consolidated financial statements, the Company adopted Accounting Standards Update 2018-11, Leases, (Topic 842), effective January 1, 2019.

Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has recurring losses from operations, limited cash flows from operations, and an accumulated deficit. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

We have served as the Company’s auditor since 2019.

/s/ UHY LLP

Sterling Heights, Michigan

May 13, 2020

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Nano Magic Inc. and Subsidiaries (formerly known as PEN Inc. and Subsidiaries)

Opinion on the Financial Statements

We have audited, before the effects of the adjustments for the correction of immaterial errors described in Note 3, the consolidated balance sheet of Nano Magic Inc. and Subsidiaries (formerly known as PEN Inc. and Subsidiaries) (“the Company”) as of December 31, 2018, and the related consolidated statements of operations, changes in stockholders’ deficit and cash flows for the year then ended, and the related notes (collectively referred to as the financial statements). In our opinion, except for the errors described in Note 3, the 2018 financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

We were not engaged to audit, review, or apply any procedures to the adjustments for the correction of the errors described in Note 3 and, accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have been properly applied. Those adjustments were audited by UHY LLP. (The 2018 financial statements before the effects of the adjustments discussed in Note 3 are not presented herein.)

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses, has a stockholders’ deficit and has a working capital deficit. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with regard to these matters are described in Note 1. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We served as the Company’s auditor from December 2018 through January 2020.

NANO MAGIC INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

NANO MAGIC INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

NANO MAGIC INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT

FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018

(Audited)

See accompanying notes to consolidated financial statements.

NANO MAGIC INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

The following table provides a reconciliation of cash and restricted cash reported within the consolidated balance sheet that sum to the total of the same such amounts shown in the consolidated statement of cash flows:

See accompanying notes to consolidated financial statements.

NANO MAGIC INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2019 AND 2018

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 primarily to customers in the optical industry. 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 and Principles of Consolidation

The Company’s consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Applied Nanotech, Inc. and Nano Magic LLC. All significant intercompany accounts and transactions have been eliminated in consolidation.

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, 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, the Company had an accumulated deficit, a stockholders’ deficit and a working capital deficit of $7,689,545, $446,856 and $673,040, respectively, at December 31, 2019 and $6,724,558, $837,585, and $1,034,965 at December 31, 2018. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements are issued. Management cannot provide assurance that the Company will ultimately achieve profitable operations, become cash flow positive or raise additional capital. During 2018 management took measures to reduce operating expenses and continued to closely monitor costs in 2019. In addition, the Company raised equity capital in 2018, 2019 and 2020. These 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 accounting principles generally accepted in the United States of America (“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 years ended December 31, 2019 and 2018 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 items 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, Cash Equivalents and Restricted Cash

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.

Investments

Investments consist of long-term certificates of deposit. The certificate of deposit held at December 31, 2019 and 2018 matures in May 2021 and carries interest at a rate of 2.29% per year.

Accounts Receivable

The Company recognizes an allowance for losses on accounts receivable in an amount equal to the estimated probable losses net of recoveries. The allowance is based on an analysis of historical bad debt experience, current receivables aging, and expected future write-offs, as well as an assessment of specific identifiable customer accounts considered at risk or uncollectible. 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 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.

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 year ended December 31, 2019 and 2018.

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 cumulative impact of this adoption for open contracts as of January 1, 2018 was $159,396; this affected December 31, 2017 retained earnings. 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 years ended December 31, 2019 and 2018, total sales in the United States represent approximately 83% and 93% of total consolidated revenues, respectively. No other geographical area accounted for more than 10% of total sales during the years ended December 31, 2019 and 2018.

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 December 31, 2019 and 2018, contract assets totaled $15,525 and $16,486, 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 December 31, 2019 and 2018, contract liabilities totaled $162,123 and $95,610, 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 years ended December 31, 2019 and 2018 shipping and handling costs amounted to $94,431 and $110,761, 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 years ended December 31, 2019 and 2018 were $68,539 and $60,846, respectively, and are included in operating expenses on the accompanying 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 years ended December 31, 2019 and 2018 were $4,969 and $779, respectively, and are included in selling and marketing on the consolidated accompanying statements of operations. These advertising expenses do not 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 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 December 31, 2019 or 2018.

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.

Earnings (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. As of December 31, 2018, 37,778 contingently issuable common shares that were issuable based on certain market conditions (see Note 11) were not included in the potential dilutive shares in calculating the diluted EPS. Additionally, 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 income (loss) and consisted of the following:

Additionally, there are an unknown quantity of common stock equivalents that result from a potential conversion of stock appreciation rights (See Note 16).

Net income (loss) per share for each class of common stock is as follows:

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 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 and sales of products developed for third parties (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. We do not have finance leases as per the definition of ASC 842 as of December 31, 2019.

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:

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 leases as a result of adopting ASC 842, 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. None of the reclassifications, excluding the correction disclosed in Note 3 below, had any impact on the net loss reported in 2018.

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 balance sheet items as of December 31, 2018: