NANOPHASE TECHNOLOGIES Corp - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES  

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549

Form 10-Q

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: September 30, 2019 

or 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) of the
Securities Exchange Act of 1934

For the transition period from              to             

Commission File Number: 000-22333

Nanophase Technologies Corporation  

(Exact name of registrant as specified in its charter)

1319 Marquette Drive, Romeoville, Illinois 60446 

 (Address of principal executive offices, and zip code)

Registrant’s telephone number, including area code: (630) 771-6708

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 preceding 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 ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☑ 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 “accelerated filer”, “large 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☑

As of November 14, 2019, there were 38,136,792 shares outstanding of common stock, par value $.01, of the registrant.

NANOPHASE TECHNOLOGIES CORPORATION

QUARTER ENDED SEPTEMBER 30, 2019

INDEX 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

NANOPHASE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited Consolidated Condensed)

(in thousands except share and per share data)

See Notes to Consolidated Condensed Financial Statements. 

NANOPHASE TECHNOLOGIES CORPORATION 

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited Consolidated Condensed)

(in thousands except share and per share data)

See Notes to Consolidated Condensed Financial Statements. 

NANOPHASE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY

(Unaudited Consolidated Condensed)

(In thousands except share data)

See Notes to Consolidated Condensed Financial Statements.

NANOPHASE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited Consolidated Condensed)

See Notes to Consolidated Condensed Financial Statements.

 NANOPHASE TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 

(Unaudited Consolidated Condensed) 

(in thousands, except share and per share data or as otherwise noted herein)

(1) Basis of Presentation

The accompanying unaudited consolidated condensed interim financial statements of Nanophase Technologies Corporation (“Nanophase”, “Company”, “we”, “our”, or “us”) reflect all adjustments (consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of our financial position and operating results for the interim periods presented.  All statements include the results from both Nanophase and our wholly-owned subsidiary, Solesence, LLC (“Solésence,” or our “Solésence^® subsidiary”).  Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.   

These financial statements should be read in conjunction with our audited financial statements and notes thereto for the year ended December 31, 2018, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission.

(2) Going Concern / Liquidity

We believe that cash from operations, cash on hand, cash from our May 13, 2019 and November 13, 2019 financings, in addition to unused borrowing capacity, should be adequate to fund our operating plans through 2019, but this is dependent on several things over which we have limited control. Our largest customer, consisting of 64% of revenue for the nine-months ended September 30, 2019, had a revenue decrease of 20% from the same time last year. This decline has limited our flexibility and required us to make cash management a top priority. The growth in our Solésence^® business increased 56% for the nine months ended September 30, 2019 compared to the same time last year. We continue to view Solésence^® as a critical strategic undertaking and may require additional investment in working capital. Our current plan is to continue to invest in Solésence^®-related operating expenses and capital equipment. Given the decline related to our largest customer, as well as our investment in Solésence^®, it is possible that we may need to seek additional funding to address working capital demands within the next twelve months.  We believe that we will be able to secure additional financing, but we do not have any financing commitments in place. However, we may not be able to secure additional financing in a timely manner under commercially reasonable terms, or at all. If we are unable to secure additional financing, we would need to reevaluate the Company’s strategy, including our Solésence^® growth strategy, and lower investment and expenses accordingly. This could impede growth in 2020 and beyond. 

These circumstances raise significant doubt as to the Company’s ability to operate as a going concern under U.S. GAAP. The accompanying financial statements have been prepared on a going concern basis in accordance with U.S. GAAP. As such, no adjustments have been made to the unaudited condensed consolidated financial statements for the recoverability of assets and classification of liabilities that might be necessary should the Company be unable to continue operating as a going concern.

(3) Summary of Significant Accounting Policies

Recently Adopted Financial Accounting Standards

On January 1, 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases, ASU No. 2018-10, Codification Improvements to Topic 842 (Leases) and ASU No. 2018-11, Targeted Improvements to Topic 842 (Leases).  The guidance is intended to increase transparency and comparability among companies for leasing transactions, including a requirement for companies that lease assets to recognize on their balance sheets the assets and liabilities for the rights and obligations created by those leases. The guidance also provides for disclosures that allow the users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases.

The Company adopted the guidance on January 1, 2019 using the modified retrospective method without restatement of comparative periods. As such, periods prior to the date of adoption are presented in accordance with ASC 840 - Leases. The Company utilized the available practical expedient that allowed for the Company to not reassess whether existing contracts contain a lease under the new definition of a lease, lease classification for existing leases and whether previously capitalized initial direct costs would qualify for capitalization under the new guidance.

The adoption of this guidance had a material impact on the Consolidated Condensed Balance Sheet as of September 30, 2019 due to the recognition of equal right-of-use assets and lease liabilities for the Company’s portfolio of operating leases. The right-of-use asset balance was then adjusted by the reclassification of pre-existing accrued rent balances from other line items within the Consolidated Condensed Balance Sheet. The adoption had an immaterial impact to the Consolidated Condensed Statement of Cash Flows and to the Consolidated Condensed Statement of Operations for the three and nine months ended September 30, 2019. The adoption had no impact to the Consolidated Condensed Statement of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2019. Additional information and disclosures required by the new standard are contained in Note 10, Leases.

(4) Description of Business

Nanophase is a skin and sun care focused company that offers engineered materials, formulation development and commercial manufacturing with an integrated family of technologies. We look at our products in three major product categories; Personal Care Ingredients, including sunscreens as active ingredients; Solésence, including full formulations of skin care products, marketed and sold by our wholly-owned subsidiary, Solesence, LLC (“Solésence,” or our “Solésence^® subsidiary”); and Advanced Materials, including  architectural and industrial coating applications, abrasion-resistant additives, plastics additives, medical diagnostics, and a variety of surface finishing technologies (polishing).

We target markets in which we believe practical solutions may be found using our products. We work closely with current and potential customers in these target markets to identify their material and performance requirements and market our materials to various end-use applications manufacturers, and our Solésence^® products to cosmetics and skin care brands. Recently developed technologies have made certain new products possible and opened potential new markets. The patent granted in 2015, for a new type of particle surface treatment (coating) — now called Active Stress Defense™ Technology — became the cornerstone of our product development in personal care.  In addition, through the creation of our Solésence^® subsidiary, we utilize this particle surface treatment to manufacture and sell fully developed solutions to targeted customers in the skin care industry, in addition to the ingredients we have traditionally sold in the personal care area. We are currently in the process of expanding our patented technologies relating to Solesence applications. 

Although our primary strategic focus has been the North American market, we currently sell material to customers overseas and have been working to expand our reach within foreign markets. The Company was incorporated in Illinois on November 25, 1989 and became a Delaware corporation during November 1997. Our common stock trades on the OTCQB marketplace under the symbol NANX.

While product sales comprise the majority of our revenue, we also recognize revenue from other sources from time to time. These activities are not expected to drive the long-term growth of the business. For this reason, we classify such revenue as “other revenue” in our Consolidated Condensed Statements of Operations, as it does not represent revenue directly from the sale of our products.

(5) Revenues

Revenues are recognized at a point in time, typically when control of the promised goods is transferred to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods.

Customers deposits, deferred revenue and other receipts are deferred and recognized when the revenue is realized and earned.  Cash payments to customers are classified as reductions of revenue in the Company’s Consolidated Condensed Statement of Operations. Customer deposits, $344 as of September 30, 2019, have been classified as deferred revenue. At December 31, 2018, customer deposits were immaterial.

On July 31, 2019, we entered into a Joint Development Agreement, with an initial term of ten years, with Sumitomo Corporation of Americas (“SCOA”) to jointly develop certain coated materials for the use in the personal care market. In return for the Company’s exclusive efforts on SCOA’s behalf, SCOA has agreed to pay a commitment fee of $250 and two subsequent payments, of $125 each. The two subsequent payments are contingent upon the achievement of certain performance obligations as defined in the agreement.

If the Company elects to terminate the agreement within the terms allowed and prior to achieving the initial performance obligations, the original $250 must be refunded. As of September 30, 2019, the Company has not yet started fulfilling its performance obligations, and as such, the $250 received is recorded as deferred revenue, split between current and long-term, based on the Company’s estimate of the period over which the performance obligation will be completed. Revenue will be recognized proportionally to the Company’s completion of the performance obligations.

(6) Earnings Per Share

Earnings (Loss) per share is computed using the Treasury Stock Method. Options to purchase approximately 165,000 and 497,000 shares of common stock that were outstanding as of September 30, 2019 for the three and nine months ended September 30, 2019, respectively, were not included in the computation of diluted earnings (loss) per share, as the impact of such shares would be anti-dilutive. Options to purchase approximately 1,119,000 and 820,000 shares of common stock that were outstanding as of September 30, 2018 were not included in the computation of loss per share for the three and nine months ended September 30, 2018, respectively, as the impact of such shares would be anti-dilutive.  

(7) Financial Instruments

We follow the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The fair value framework requires the categorization of assets and liabilities into three levels based upon the assumptions (inputs) used to price the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment.

Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, along with the promissory note with no related borrowings described in Note 8, and any borrowings on the working capital line of credit from Libertyville Bank and Trust and any borrowings under the Master Agreement from Beachcorp, LLC described below in Note 8. The fair values of all financial instruments were not materially different from their carrying values. There were no financial assets or liabilities adjusted to fair value on September 30, 2019 or December 31, 2018.

(8) Notes and Line of Credit

During July 2014 we entered into a bank-issued letter of credit and related promissory note for up to $30 in borrowings to support our obligations under our facility lease agreement. No borrowings have been incurred under this promissory note. Should any borrowings occur in the future, the interest rate would be the prime rate plus 1%, with the bank having the right to “set off” or apply unpaid balances against our checking account if we fail to meet our obligations under any borrowings under the note. It is our intention to renew this note annually, for as long as we need to do so pursuant to the terms of our facility lease agreement. This note was renewed through July 1, 2020.  Because there were no amounts outstanding on the note at any time during 2019 or 2018, we have recorded no related liability on our balance sheet.

On March 22, 2019, we executed a New Business Loan Agreement, dated as of March 4, 2019, with Libertyville Bank and Trust Company, a Wintrust Community Bank (“Libertyville”), our primary bank, which replaces the Line of Credit Agreement with Libertyville having a maturity date of March 4, 2019. The New Business Loan Agreement matures on March 4, 2020. Under the New Business Loan Agreement, Libertyville will provide a maximum of (i) $500 or (ii) two times the sum of (a) 75% our eligible accounts receivables and (b) our cash deposited with Libertyville, whichever is less, of revolving credit to us, collateralized by a senior priority lien on our accounts receivable, inventory, equipment, general intangibles and fixtures. Interest is payable monthly on any advances at a floating interest rate of the prime rate at the time plus 1%. We must have $500 in cash, inclusive of the borrowed amount, at Libertyville on the date of any advance. Advances may only occur at the beginning or end of a fiscal quarter and must be repaid in full within five business days of the advance. As of September 30, 2019, the outstanding balance on this loan was $500. There was no outstanding balance on this loan at December 31, 2018.

On November 16, 2018, we entered into a Business Loan Agreement (the “Master Agreement”) with Beachcorp, LLC. Beachcorp, LLC is managed by Bradford T. Whitmore, who, together with his affiliates Grace Brothers, Ltd. and Grace Investments, Ltd., beneficially owned approximately 53% of our common stock as of May 13, 2019, pursuant to our 2019 financing. The Master Agreement relates to two loan facilities, each evidenced by separate promissory notes, each dated November 16, 2018: a term loan to the Company of up to $500 to be disbursed in a single advance (the “Term Loan”) with a fixed annual interest rate of 8.25%, payable quarterly, accruing from the date of such advance and with principal due on December 31, 2020; and an asset-based revolving loan facility for the Company of up to $2,000 (the “Revolver Facility”), with floating interest accruing at the prime rate plus 3% (8.25% minimum) per year, with a borrowing base consisting of qualified accounts receivable of the Company, and with all principal and accrued interest due March 31, 2020. The Term Loan and Revolver Facility are secured by all the unencumbered assets of the Company and subordinated to Libertyville’s secured interest under the New Business Loan Agreement. The Master Agreement substantially restricts the Company’s ability to incur additional indebtedness during the terms of both the Term Loan and the Revolver Facility. On September 30, 2019, the balance on the term loan was $500 and the balance on the Revolver Facility was $1,103. For the three months and nine months ended September 30, 2019, interest expense was $47 and $140, respectively, compared to the same periods in 2018 of $12 and $32, respectively. For the nine months ended September 30, 2019, $14 was accrued and $126 paid. As Beachcorp, LLC is an affiliate of one of our shareholders, $91 is interest with a related party, of which $77 was paid and $14 was owed. There was a one-time amendment to the credit agreement allowing a 30 day extended Account Receivable eligibility for one of our largest customers. With this amendment, September 30, 2019 borrowings were within the amended credit agreement line, with an additional $233 available. The balance of borrowing base, loan amount, and any excess payments required over the available borrowing base will change as frequently as daily, given the operational nature of the elements of the Revolver Facility.

(9) Inventories

Inventories consist of the following:

(10) Leases

The Company’s operating lease portfolio is comprised of operating leases for office, warehouse space and equipment. Certain of the Company’s leases include one or more options to renew or terminate the lease at the Company’s discretion. The Company regularly evaluates the renewal and termination options and when they are reasonably certain of exercise, includes the renewal or termination option in our lease term.

The adoption of Topic 842 resulted in the Company recognizing operating lease liabilities totaling $2,556 with a corresponding right-of-use (“ROU”) asset of $2,212 based on the present value of the minimum rental payments of such leases. The variance between the ROU asset balance and the lease liability is deferred rent liability that existed prior to the adoption of the ASC 842 and was offset against the ROU asset balance during the adoption. As of September 30, 2019, the ROU asset had a balance of $2,198 which is included in the “Operating lease right-of-use assets” line item of these condensed consolidated financial statements and current and non-current lease liabilities related to the ROU asset of $361 and $2,128 respectively, and are included in the “Current portion of operating lease obligations” and “Long-term portion of operating lease obligations” line items of these condensed consolidated financial statements. The discount rates used for leases accounted for under ASC 842 are based on an interest rate yield curve developed for the leases in the Company’s portfolio.

The office leases contain variable lease payments which consist primarily of rent escalations based on an established index or rate and taxes, insurance, and common area or other maintenance costs, which are paid based on actual costs incurred by the lessor. The Company has elected to utilize the available practical expedient to not separate lease and non-lease components.

Quantitative information regarding the Company’s leases is as follows: 

Supplemental cash flow information related to leases is as follows for the nine months ended September 30, 2019:

The future maturities of the Company’s finance and operating leases as of September 30, 2019 is as follows:

(11) Share-Based Compensation

We follow FASB ASC Topic 718, Compensation – Stock Compensation, in which compensation expense is recognized only for share-based payments expected to vest. We recognized compensation expense related to stock options of $64 and $179 for the three and nine months ended September 30, 2019, respectively, compared to $58 and $146 for the three and nine months ended September 30, 2018, respectively.

As of September 30, 2019, there was approximately $422 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under our stock option plans. That cost is expected to be recognized over a remaining weighted-average period of 1.8 years.

Stock Options and Stock Grants

During the nine months ended September 30, 2019, 36,000 stock options were exercised for $16. During the nine months ended September 30, 2018, 63,999 shares of common stock were issued pursuant to stock option exercises for proceeds of $29.  During the nine months ended September 30, 2019, 547,500 stock options were granted, compared to 570,500 stock options granted during the same period in 2018. During the nine months ended September 30, 2019, 130,500 stock options expired compared to 188,504 for the same period in 2018. For the nine months ended September 30, 2019, 48,600 stock options were forfeited compared to 31,601 for the same period in 2018. We had 3,747,400 stock options outstanding at a weighted average exercise price of $0.64 on September 30, 2019, compared to 3,415,000 stock options outstanding at a weighted average exercise price of $0.67 on December 31, 2018.

No stock options were granted in the three-month periods ending September 30, 2019 and 2018.

The following table illustrates the various assumptions used to calculate the Black-Scholes option pricing model for stock options granted during the three months and nine months periods presented:

As of September 30, 2019, we did not have any unvested restricted stock or performance shares outstanding.

(12) Significant Customers and Contingencies

Revenue from three customers constituted approximately 75%, 5% and 4%, respectively, of our total revenue for the three months ended September 30, 2019. For the nine months ended September 30, 2019, revenue from the same three customers was approximately 64%, 3% and 9%, respectively. Amounts included in accounts receivable on September 30, 2019 relating to these three customers were approximately $1,042, $116 and $122, respectively.  Revenue from these three customers constituted approximately 73%, 4% and 12%, respectively, for the three months ended September 30, 2018. For the nine months ended September 30, 2018, revenue from the same three customers was approximately 73%, 3% and 8%, respectively. Amounts included in accounts receivable on September 30, 2018 relating to these three customers were approximately $1,171, $120 and $388, respectively. The loss of one of these significant customers, a significant decrease in revenue from one or more of these customers, or the failure to attract new customers could have a material adverse effect on our business, results of operations and financial condition.

We currently have exclusive supply agreements with BASF Corporation (“BASF”), our largest customer, that have contingencies outlined which could potentially result in the license of technology and/or the sale of production equipment from the Company to the customer intended to provide capacity sufficient to meet the customer’s production needs. This outcome may occur if we fail to meet certain performance requirements, certain other obligations and/or certain financial condition covenants. The financial condition covenants in one of our supply agreements with BASF “trigger” a technology transfer right (license and equipment sale at BASF’s option) in the event (a) that earnings for the twelve-month period ending with our most recently published quarterly financial statements are less than zero and a minimum of $1 million in total of certain assets of which at least $500 must be in cash, cash equivalents and certain investments, with the balance being composed of certain inventory and receivables, is not maintained or (b) of an acceleration of any debt maturity having a principal amount of more than $10 million. There are certain minimum finished goods inventory requirements with the 2019 amendment to the supply agreement. This agreement also requires Nanophase to maintain certain finished goods inventory levels as “safety stock,” beginning in the first quarter of 2019, and increasing through the third quarter of 2019 to a negotiated level based on agreed demand metrics, in order to maintain the $500 non-cash component discussed above. After September 30, 2019, should our safety stock fall below the prescribed amount of material, the quarter-end cash requirement would revert to $1,000 in cash, cash equivalents, and certain investments. As of September 30, 2019, safety stock did not meet the prescribed amount of material. However, cash, cash equivalents, and eligible accounts receivable exceeded the minimum $1,000 required as of September 30, 2019. The safety stock requirement may be adjusted upon mutual agreement.

Our supply agreements with BASF also “trigger” a technology transfer right in the event of our insolvency, as further defined within the agreements. In the event of an equipment sale, upon incurring a triggering event, the equipment would be sold to the customer at either 115% of the equipment’s net book value or the greater of 30% of the original book value of such equipment, and any associated upgrades to it, or 115% of the equipment’s net book value, depending on the equipment and related products.

Current cash and credit availability should be sufficient (see the description of our New Line of Credit Agreement with Libertyville and the Master Agreement with Beachcorp, LLC (described in Note 8) to operate our business through the balance of 2019. If a triggering event were to occur and BASF elected to proceed with the license and related equipment sale mentioned above, we would receive royalty payments from this customer for products sold using our technology; however, we would lose both significant revenue and the ability to generate significant revenue to replace that which was lost in the near term. Replacement of necessary equipment that could be purchased and removed by the customer pursuant to this triggering event could take in excess of twelve months. Any additional capital outlays required to rebuild capacity would probably be greater than the proceeds from the purchase of the assets as dictated by our agreement with the customer. Similar consequences would occur if we were determined to have materially breached certain other provisions of the supply agreement with BASF. Any such event would also likely result in the loss of many of our key staff and line employees due to economic realities. We believe that our employees are a critical component of our success and it could be difficult to replace them quickly. Given the occurrence of any such event, we might not be able to hire and retain skilled employees given the stigma relating to such an event and its impact on us. Finally, any shortfall in capital needed to operate the business as management intends, including with respect to avoiding this triggering event as described above, may result in a curtailment of certain activities or anticipated investments.

We expect to expend resources on research, development and product testing, and in expanding current capacity or capability for new business. In addition, we may incur significant costs in preparing, filing, prosecuting, maintaining and enforcing our patents and other proprietary rights. We may need additional financing if we were to lose an existing customer or suffer a significant decrease in revenue from one or more of our customers or because of currently unknown capital requirements, new regulatory requirements or the need to meet the cash requirements discussed above to avoid a triggering event under our BASF agreement. Given our expected growth in our Solésence^® business, we may also have temporary working capital demands that we cannot fund with existing capital, while remaining in compliance with the covenants included in our BASF agreement described above. If necessary, we may seek funding through public or private financing and through contracts with governmental entities or other companies. Additional financing may not be available on acceptable terms or at all, and any such additional financing could be dilutive to our shareholders. If we are unable to obtain adequate funds, we may be required to delay, scale-back or eliminate some of our manufacturing and marketing operations or we may need to obtain funds through arrangements on less favorable terms. Such circumstances could raise doubt as to our ability to continue as a going concern. If we obtain funding on unfavorable terms, we may be required to relinquish rights to some of our intellectual property.

On July 31, 2019, we entered into a Joint Development Agreement, with an initial term of ten years, with Sumitomo Corporation of Americas (“SCOA”) to jointly develop certain coated materials for the use in the personal care market. In return for the Company’s exclusive efforts on SCOA’s behalf, SCOA has agreed to pay a commitment fee of $250 and two subsequent payments, of $125 each. The two subsequent payments are contingent upon the achievement of certain performance obligations as defined in the agreement.

If the Company elects to terminate the agreement within the terms allowed and prior to achieving the initial performance obligations, the original $250 must be refunded. As of September 30, 2019, the Company has not yet started fulfilling its performance obligations, and as such, the $250 received is recorded as deferred revenue, split between current and long-term, based on the Company’s estimate of the period over which the performance obligation will be completed. Revenue will be recognized proportionally to the Company’s completion of the performance obligations.

(13) Business Segmentation and Geographical Distribution

Revenue from international sources approximated $34 and $734 for the three and nine months ended September 30, 2019, respectively, compared to $152 and $335 for the three and nine months ended September 30, 2018, respectively. All of this revenue was product revenue.

Our operations comprise a single business segment and all our long-lived assets are located within the United States. We categorize our revenue stream into three main product categories, Personal Care Ingredients, Advanced Materials and Solésence^®. The revenues for the three months and nine months ended September 30, 2019 and 2018, by category, are as follows:

(14) Subsequent Events

On November 13, 2019, we entered into a Securities Purchase Agreement (the “SPA”) with Mr. Whitmore pursuant to which he agreed to purchase a Convertible Note from the Company for $2,000,000 and otherwise including representations, warranties and covenants which are customary for similar transactions.  The transactions contemplated by the SPA are expected to close on November 20, 2019.

Pursuant to the SPA, the Company has agreed to issue a 2% Secured Convertible Promissory Note in the original principal amount of $2,000,000 (the “Convertible Note”), the principal amount of which is payable to the order of Mr. Whitmore and his registered assigns and successors in a single payment on May 15, 2024 (the “Maturity Date”). The principal amount and, at the holder’s option, accrued interest under the Convertible Note is convertible at the holder’s option into additional shares of the Company’s common stock in whole or in part and from time to time up to the Maturity Date at a conversion price of $0.20 per share.

Pursuant to the Convertible Note, we have agreed to reserve sufficient shares of our common stock for the conversion of the Convertible Note. Our Board of Directors has proposed, and has summited to our stockholders for adoption at our 2019 annual meeting, an amendment to our certificate of incorporation to increase the number of authorized shares of common stock (the “Certificate Amendment”). If the Certificate Amendment is adopted by our stockholders and filed with the Delaware Secretary of State, we will be able to reserve a sufficient number of shares for the conversion of the Convertible Note. If the Certificate Amendment is not so filed on or before December 31, 2019, an amount equal to 105% of the outstanding principal amount of the Convertible Note (plus all accrued and unpaid interest, if any) will be immediately due and payable.

If there is a change in control transaction, Mr. Whitmore shall have the right to require the Company or its successor to the Convertible Note, in whole or in part, at a redemption price equal to 105% of the outstanding Principal Amount (plus any accrued interest or applicable late charges) being redeemed.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Dollars are presented in thousands except per share data or unless otherwise stated)

Overview

Nanophase is an advanced materials and applications developer and commercial manufacturer with an integrated family of materials technologies. We produce engineered nano and “non-nano” materials for use in a variety of diverse markets: personal care including sunscreens as active ingredients and in fully formulated cosmetics of our own design, architectural coatings, industrial coating applications, abrasion-resistant additives, plastics additives, medical diagnostics, energy (including solar control) and a variety of surface finishing technologies (polishing) applications, including optics. Finally, we have expanded our offerings beyond active ingredients to include targeted full formulations of skin care products, marketed and sold by our wholly-owned subsidiary, Solesence, LLC (“Solésence,” or our “Solésence® subsidiary”).

We target markets in which we believe practical solutions may be found using our products. We work closely with current and potential customers in these target markets to identify their material and performance requirements and market our materials to various end-use applications manufacturers, and our Solésence® solutions to cosmetics and skin care brands. Recently developed technologies have made certain new products possible and opened potential new markets. For example, we have applied our skills at producing precisely defined nanomaterials to now create and sell larger, “non-nano” material products. Our focus is on customer need where we believe we have an advantage, as opposed to finding uses for one particular technology. We expect growth in end-user (manufacturing customers, including customers of our customers) adoption in 2019 and beyond. Our initiatives in targeted market areas are progressing at differing rates of speed, but we have been broadly moving through testing and development cycles, and in a number of cases believe we are approaching first revenue or next stage revenue with particular customers in the industries referenced above. For example, during 2015 we were granted a patent on a new type of particle surface treatment (coating), which became the cornerstone of our new product development in personal care, with first revenue recognized during 2016. In addition, through the creation of our Solésence® subsidiary, we use this particle surface treatment to manufacture and sell fully developed solutions to targeted customers in the cosmetics and skin care industry, in addition to the additives we have traditionally sold in the personal care area. During 2015 and 2016 we developed and began to sell solutions in the energy management (particularly solar control) industry. We believe that the products that we have designed for this industry remain valuable to the market, although we are currently focusing the greatest part of our business development efforts on building and expanding our Solésence® brand and product suite. We believe that successful introduction of our finished skin care products and materials with manufacturers may lead to follow-on orders for other finished products and materials in their applications. We expect that we will both work more deeply with current customers and attract additional customers, which should help us achieve growth in these markets in 2019 and beyond.

Results of Operations

Total revenue decreased to $3,069 for the three months ended September 30, 2019, compared to $4,022 for the same period in 2018. Total revenue decreased to $10,118 for the nine months ended September 30, 2019 from $11,036 for the same period 2018. A substantial majority of our revenue for both periods was from our largest customers, in particular, sales to our largest customer in personal care and sunscreen applications. Revenue from our top three customers was approximately 75%, 5% and 4%, respectively, of our total revenue for the three months ended September 30, 2019 and approximately 64%, 3% and 9%, respectively, for the nine months ended September 30, 2019. Revenue from these three customers constituted approximately 73%, 4% and 12%, respectively for the three months ended September 30, 2018 and approximately 73%, 3% and 8%, respectively, for the nine months ended September 30, 2018. Product revenue, the primary component of our total revenue, decreased to $3,043 for the three months ended September 30, 2019, compared to $3,998 for the same period in 2018.  The decrease was primarily due to reduced order flow from several of our larger customers, including our largest customer in personal care. Product revenue decreased to $9,797 for the nine months ended September 30, 2019, compared to $10,908 for the same period in 2018. Solésence^® product revenue increased approximately 56% for the nine months ended September 30, 2019 compared to the same period for 2018. The total decrease in product revenue is attributed to order flow from our largest personal care customer.

Other revenue increased to $26 for the three months ended September 30, 2019, compared to $24 for the same period in 2018.  Other revenue increased to $321 for the nine months ended September 30, 2019, compared to $128 for the same period in 2018. Other revenue is typically comprised of royalties and shipping costs paid by customers. For the nine months ended September 30, 2019, other revenue included a unique bulk buyout of $211 in Q1 of 2019.

Cost of revenue generally includes costs associated with commercial production and customer development arrangements.  Cost of revenue decreased to $2,506 for the three months ended September 30, 2019, compared to $2,965 for the same period in 2018. Cost of revenue decreased to $7,839 for the nine months ended September 30, 2019, compared to $8,164 for the same period in 2018. The decrease in cost of revenue was primarily driven by decreased volume coupled with price inflation on materials and manufacturing inefficiencies related to Solésence^® product launches. While we typically pass through costs to our customers, we sometimes cannot pass through 100% of pricing increases on raw materials. Even with pass throughs, our gross margin percentage is negatively impacted by higher material costs. We expect to continue new advanced material development relating to personal care ingredients and for our formulated Solésence^® products during 2019 and beyond.  At current revenue levels, we have generated a positive gross margin, though margins have been impeded by not having enough revenue to efficiently absorb manufacturing overhead. We believe that our current fixed manufacturing cost structure is sufficient to support higher levels of revenue volume.  The extent to which margins may grow, as a percentage of total revenue, will be dependent upon revenue mix, revenue volume, our ability to manage costs and pass commodity market-driven raw materials increases on to customers, and the speed and efficiency with which we are able to scale up production for our Solésence^® products. We expect that product revenue volume increases would result in our fixed manufacturing costs being more efficiently absorbed, which should lead to increased margins.  We expect to continue to focus on reducing controllable variable product manufacturing costs, with potential variability related to the commodity metals markets, but may or may not realize absolute dollar gross margin growth through 2019 and beyond, dependent upon the factors discussed above. 

Research and development expense, which includes all expenses relating to the technology and advanced engineering groups, primarily consists of costs associated with the development or acquisition of new product applications, and finished product formulations for our Solésence^® business.  As an example, we have been, and continue to be, engaged in product development work for our new fully-formulated finished skincare products marketed through Solésence^®.  Much of this work has led to several new products and additional potential new products.  We are also engaged in a series of in-vitro, ex-vivo, and in-vivo tests to determine the efficacy of our Solésence^® products, as well as to provide our customers with support for a consumer claims set.  We are not certain when or if any significant revenue will be generated from the production of the materials described above.

Research and development expense increased to $488 for the three months ended September 30, 2019, compared to $416 for the same period in 2018.  For the nine months ended September 30, 2019 research and development expense decreased to $1,450, compared to $1,513 for the same period in 2018. The primary reasons for this decrease were timing related to outside product testing and evaluation costs related to our Solésence^® products.  We expect quarterly research and development expense to increase during the remainder of 2019.

Selling, general and administrative expense increased to $890 for the three months ended September 30, 2019, compared to $765 for the same period in 2018.  For the nine months ended September 30, 2019, selling, general and administrative expense increased to $2,711, compared to $2,299 for the same period in 2018. Expenses associated with launching the Solésence^® brand contributed to the increase. We expect selling, general and administrative expense to remain at current levels during the remainder of 2019.

Inflation

We believe inflation has not had a material effect on our operations or financial position. However, supplier price increases and wage and benefit inflation, both of which represent a significant component of our costs of operations, may have a material effect on our operations and financial position in 2019 and beyond if we are unable to pass through any applicable increases under our present contracts or through to our markets in general.

Liquidity and Capital Resources

Our cash and cash equivalents amounted to $962 on September 30, 2019, compared to $1,345 on December 31, 2018 and $1,034 on September 30, 2018. The net cash used in our operating activities was $2,161 for the nine months ended September 30, 2019, compared to $921 for the same period in 2018. The net use of cash during the period ended September 30, 2019 was driven primarily by an increase in accounts receivable coupled with a decrease in accounts payables, compared to the same period in 2018 which had significant increases in accounts receivable and inventory with a decrease in accounts payable.  Net cash used in investing activities, specifically capital expenditures, was $523 during the nine months ended September 30, 2019, compared to $115 for the nine months ended September 30, 2018.  Net cash provided by financing activities was $2,301 during the nine months ended September 30, 2019, compared to $115 net cash provided for the same time period for 2018.  We paid $162 for capital lease obligations during the nine months ended September 30, 2019 compared to $114 in the same period in 2018.  On March 22, 2019 we entered a New Business Loan agreement with Libertyville for $500 which replaced the expiring prior year agreement. We paid the outstanding balance for the prior agreement of $300, on January 9, 2018 and had borrowings under our line of credit of $200 on March 30, 2018, which was subsequently repaid on April 4, 2018.  Under the new agreement, we borrowed $500 on March 30, 2019, which was subsequently repaid on April 3, 2019 and we borrowed $500 on September 28, 2019 which was subsequently repaid on October 2, 2019. During the nine months ending September 30, 2019, we drew 19 times from the Master Agreement with Beachcorp, LLC totaling $8,166 with repayment of $7,895. The net borrowings for the nine months ended September 30, 2019 was $271. On May 13, 2019, we sold approximately 4.2 million shares of our common stock to our largest investor for approximately $1,700 in proceeds. No selling commission or other remuneration was paid in connection with this transaction. We have used the proceeds for general corporate purposes. 

Our supply agreements with our largest customer, BASF, contain certain financial covenants which could potentially impact our liquidity.  The most restrictive financial covenants under these agreements require that we maintain a minimum of $1 million in total of certain assets of which at least $500 must be in cash, cash equivalents, and certain investments, with the balance being composed of certain inventory and receivables, and that we not have the acceleration of any debt maturity having a principal amount of more than $10 million, in order to avoid triggering the customer’s potential right to transfer certain technology and equipment to that customer at a contractually-defined price.  We had approximately $962 in cash and approximately $122 in BASF Accounts Receivables over 30 days, totaling $1,084, on September 30, 2019. During March 2019, we entered into a new line of credit, which expires in April 2020.  This supply agreement and its covenants are more fully described in Note 12, and our line of credit is more fully described in Note 8, to our Financial Statements in Part I, Item 1 of this Form 10-Q.  

We believe that cash from operations, proceeds from our May 13, 2019 and November 13, 2019 equity financing, and cash on hand, in addition to unused borrowing capacity should be adequate to fund our operating plans through 2019. Given our expected growth in our Solésence^® business, we are monitoring the temporary working capital demands that this could create, with timing being the most critical variable.  Our actual future capital requirements in 2019 and beyond will depend on many factors, including customer acceptance of our current and potential advanced materials, applications and product, continued progress in research and development activities and product testing programs, the magnitude of these activities and programs, and the costs necessary to increase and expand our manufacturing capabilities and to market and sell our advanced materials, applications and products. Other important issues that will drive future capital requirements will be the development of new markets and new customers as well as the potential for significant unplanned growth with existing customers. Depending on the success of certain projects, we expect that capital spending relating to currently known capital needs for the remainder of 2019 will be between $60 and $100, and we could enter into one or more financing leases to finance these acquisitions, subject to the provisions of our new Line of Credit Agreement with Libertyville and our Master Agreement relating to our business loans with Beachcorp, LLC.  If those projects are delayed or ultimately prove unsuccessful, or if we fail to obtain financing on terms acceptable to us, we would expect our capital spending to be below the lower end of that range.  Similarly, substantial success in business development projects may cause the actual capital investment for the remainder of 2019 to exceed the top of this range. 

Events may arise that require us to seek additional financing. Financing may not be available on acceptable terms or even at all, and any such additional financing could be dilutive to our stockholders. Such financing could be necessitated by such things as the loss of one or more existing customers; a significant decrease in revenue from one or more of our customers; temporary working capital demands resulting from our expected growth in our Solésence^® business that we cannot fund with existing capital; currently unknown capital requirements in light of the factors described above; new regulatory requirements that are outside our control; the need to meet previously discussed cash requirements to avoid a triggering event under our BASF agreement, or various other circumstances coming to pass that we currently do not anticipate.  The failure to have access to sufficient capital to fund our business plans may result in a curtailment or other change in those plans, and under such circumstances, may raise doubt as to our ability to continue as a going concern.  

On September 30, 2019, we had a net operating loss carryforward of approximately $79 million for income tax purposes.  Because we may have experienced “ownership changes” within the meaning of the U.S. Internal Revenue Code in connection with our various prior equity offerings, future utilization of this carryforward may be subject to certain limitations as defined by the Internal Revenue Code.  If not utilized, the carryforward will expire at various dates. $77 million will expire between January 1, 2019 and December 31, 2037, while $2 million does not expire. Under recent changes in the Internal Revenue Code, losses incurred after January 1, 2018 carry forward indefinitely.  As a result of the annual limitation and uncertainty as to the amount of future taxable income that will be earned prior to the expiration of the carryforward, we have concluded that it is likely that a substantial portion of this carryforward will expire before ultimately becoming available to reduce income tax liabilities.  Changes in Illinois state law that began in 2011 will impact net loss carryforward duration and utilization on the state tax level.   

Off−Balance Sheet Arrangements

We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purposes of raising capital, incurring debt or operating our business. We do not have any off-balance sheet arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources.

As more fully described in Note 8 to our Financial Statements, in Part I, Item I of this Form 10-Q, during 2014 we entered into a letter of credit and promissory note for up to $30 supporting our obligations under our facility lease agreement.  No borrowings have been incurred under this promissory note. 

Safe Harbor Provision

We want to provide investors with more meaningful and useful information.  As a result, this Quarterly Report on Form 10-Q (the “Form 10-Q”) contains and incorporates by reference certain “forward-looking statements”, as defined in Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These statements reflect our current expectations of the future results of our operations, performance and achievements. Forward-looking statements are covered under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We have tried, wherever possible, to identify these statements by using words such as “anticipates”, “believes”, “estimates”, “expects”, “plans”, “intends” and similar expressions. These statements reflect management’s current beliefs and are based on information now available to it. Accordingly, these statements are subject to certain risks, uncertainties and contingencies that could cause our actual results, performance or achievements in 2019 and beyond to differ materially from those expressed in, or implied by, such statements. These risks, uncertainties and factors include, without limitation: our ability to be consistently profitable despite the losses we have incurred since our incorporation; a decision by a customer to cancel a purchase order or supply agreement in light of our dependence on a limited number of key customers; the terms of our supply agreements with BASF, which could trigger a requirement to transfer technology and/or sell equipment to that customer; our potential inability to obtain working capital when needed on acceptable terms or at all; our ability to obtain materials at costs we can pass through to our customers, including Rare Earth elements, specifically cerium oxide, as well as high purity zinc; uncertain demand for, and acceptance of, our nanocrystalline materials and Solésence^® products; our manufacturing capacity and product mix flexibility in light of customer demand; our limited marketing experience, including with our suite of Solésence^® products; changes in development and distribution relationships; the impact of competitive products and technologies; our dependence on patents and protection of proprietary information; the resolution of litigation or other legal proceedings in which we may become involved; our ability to maintain an appropriate electronic trading venue for our securities; and the impact of any potential new governmental regulations that could be difficult to respond to or costly to comply with. In addition, our forward-looking statements could be affected by general industry and market conditions and growth rates. Readers of this Quarterly Report on Form 10-Q should not place undue reliance on any forward-looking statements. Except as required by federal securities laws, we undertake no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.  

Disclosure controls

We are responsible for establishing and maintaining disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and (b) accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosures. It should be noted that in designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and that our management necessarily was required to apply its judgment regarding the design of our disclosure controls and procedures.  As of the end of the period covered by this report, we conducted an evaluation, under the supervision (and with the participation) of our management, including our Chief Executive Officer (principal executive officer, and principal financial officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on that evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures were effective at reaching that level of reasonable assurance.

Internal control over financial reporting

The Company’s management, including the CEO (who is also currently acting as both the Company’s principal executive officer and the Company’s principal financial officer), confirm that there was no change in the Company’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

We are not a party to any pending legal proceedings or claims that we believe will result in a material adverse effect on our business, financial condition, or operating results. 

Item 1A. Risk Factors

In addition to the information set forth in this Quarterly Report on Form 10-Q and before deciding to invest in, or retain, shares of our common stock, you also should carefully review and consider the information contained in our other reports and periodic filings that we make with the Securities and Exchange Commission, including, without limitation, the information contained under the caption Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018. Those risk factors could materially affect our business, financial condition and results of operations. Additional risks and uncertainties that we do not currently know about, we currently believe are immaterial or we have not predicted may also harm our business operations or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, results of operations, cash flows or stock price could be materially adversely affected.

In addition to the risk factors previously disclosed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018, investors should consider the following risk factors:

Our Ability to Continue as a Going Concern is in Doubt Absent Obtaining Adequate New Financing

Cash from operations, cash on hand, cash from our May 13, 2019 and November 13, 2019 financing, in addition to unused borrowing capacity, should be adequate to fund our operating plans through 2019. Our largest customer, consisting of 64% of revenue for the nine-months ended September 30, 2019, had a revenue decrease of 20% from the same time last year. This decline has limited our flexibility and required us to make cash management a top priority. The growth in our Solésence^® business increased 56% for the nine-months ended September 30, 2019 compared to the same time last year. We continue to view Solésence^® as a critical strategic undertaking and may require additional investment in working capital. Our current plan is to continue to invest in Solésence^®-related operating expenses and capital equipment. Given the decline related to our largest customer, as well as our growth strategy for Solésence^®, we may need to seek additional funding to address working capital demands within the next twelve months. We believe that we will be able to secure additional financing, but we do not have any additional financing commitments in place as of today. However, we may not be able to secure additional financing in a timely manner under commercially reasonable terms, or at all. If we are unable to secure additional financing, we would need to reevaluate the Company’s strategy, including our Solésence^® growth strategy, and lower investment and expenses accordingly. This could impede growth in 2020 and beyond. 

These circumstances raise significant doubt as to the Company’s ability to operate as a going concern for the next 12 months, and inability to fund our ongoing cash obligations may result in our ceasing to operate, which would result in liquidation of our assets.  In a liquidation of the Company, if we are unable to continue as a going concern, the value realized on our assets would likely be less than our outstanding obligations and, consequently, our stockholders would lose their entire investment.

A Majority of our Common Stock is Controlled by a Single Stockholder

Together with his affiliates Grace Brothers, Ltd. and Grace Investments, Ltd., Bradford T. Whitmore beneficially owned 53% of our common stock as of May 13, 2019.  Therefore, Mr. Whitmore has the legal power, regardless of the votes of our other stockholders, to elect all the members of the Company’s board of directors.  Consequently, our board of directors and management may be strongly influenced by our controlling stockholder, and the interests of our current controlling stockholder may conflict with the interests of other stockholders.

Pursuant to the General Corporation Law of the State of Delaware and our Bylaws, our controlling stockholder is empowered to elect the majority of our board of directors, exercise overall control over our management, determine our policies, sell or, in any other manner, transfer shares representing control over the Company held by him and determine the result of any deliberation of our stockholders, including transactions with related parties, corporate reorganizations, sale of all or substantially all the assets, or delisting our shares from the OTCQB marketplace, as well as to determine the distribution and payment of any future dividends. Our controlling stockholder may have an interest in acquisitions, disposal of assets and partnerships, may seek funding or may take other decisions that could conflict with the interests of other stockholders and which may not result in any improvement in our operating results.

On November 13, 2019, we entered into a Securities Purchase Agreement (the “SPA”) with Bradford T. Whitmore pursuant to which he agreed to purchase a Convertible Note (see below) from the Company for $2,000,000 and otherwise including representations, warranties and covenants which are customary for similar transactions. The transactions contemplated by the SPA are expected to close on November 20, 2019. Together with his affiliates Grace Brothers, Ltd. and Grace Investments, Ltd., Mr. Whitmore beneficially owned approximately 53% of our common stock as of November 13, 2019. Through his affiliate Beachcorp, LLC, Mr. Whitmore is also a substantial lender to the Company under the Business Loan Agreement, dated November 16, 2018 (see Note 8 to our financial statements in Part I of this Quarterly Report on Form 10-Q). The Company did not engage an underwriter for this transaction, and no selling commission or other remuneration was paid in connection with this transaction. We expect to use the proceeds for general corporate purposes.

Pursuant to the SPA, the Company has agreed to issue a 2% Secured Convertible Promissory Note in the original principal amount of $2,000,000 (the “Convertible Note”), the principal amount of which is payable to the order of Mr. Whitmore and his registered assigns and successors in a single payment on May 15, 2024 (the “Maturity Date”). The principal amount of the Convertible Note accrues interest at the rate of 2.0% per year, which interest is payable semi-annually on the 15^th day of May and November, commencing on May 15, 2020. The principal amount and, at the holder’s option, accrued interest under the Convertible Note is convertible at the holder’s option into additional shares of the Company’s common stock in whole or in part and from time to time up to the Maturity Date at a conversion price of $0.20 per share. Assuming the Convertible Note had been converted effective on November 14, 2019, the $2,000,000 principal amount of the Convertible Note would convert into 10,000,000 shares of the Company’s common stock, and such hypothetical conversion of the Convertible Note would have increased Mr. Whitmore’s direct and indirect beneficial ownership to approximately 63% of the Company’s common stock assuming that he directed that all of the shares issued upon such conversion should be issued to him personally.

The obligations under the Convertible Note will be secured by a security interest in all of the Company’s personal property pursuant to a Commercial Security Agreement among Mr. Whitmore, the Company and Solésence, LLC, the Company’s sole subsidiary.

Pursuant to the Convertible Note, we have agreed to reserve sufficient shares of our common stock for the conversion of the Convertible Note. Our Board of Directors has proposed, and has summited to our stockholders for adoption at our 2019 annual meeting, an amendment to our certificate of incorporation to increase the number of authorized shares of common stock (the “Certificate Amendment”). If the Certificate Amendment is adopted by our stockholders and filed with the Delaware Secretary of State, we will be able to reserve a sufficient number of shares for the conversion of the Convertible Note. If the Certificate Amendment is not filed on or before December 31, 2019, an amount equal to 105% of the outstanding principal amount of the Convertible Note (plus all accrued and unpaid interest, if any) will be immediately due and payable.

If there is a change in control transaction, Mr. Whitmore shall have the right to require the Company or its successor to redeem the Convertible Note, in whole or in part, at a redemption price equal to 105% of the outstanding Principal Amount (plus any accrued interest or applicable late charges) being redeemed.

The SPA also amended the Common Stock Purchase Agreement, dated May 13, 2019, between the Company and Mr. Whitmore to add the shares of common stock issuable upon conversion of the Convertible Note to the registration rights granted therein. The Company did not engage an underwriter for this transaction, and no selling commission or other remuneration was paid in connection with this transaction. We expect to use the proceeds for working capital and general corporate purposes. The sale of the Convertible Note to Mr. Whitmore will be exempt from registration pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”), and Rule 506(b) of Regulation D promulgated under the Securities Act because Mr. Whitmore has a preexisting relationship with the Company as its largest stockholder, Mr. Whitmore represented to the Company that he has assets or income sufficient to qualify as an accredited investor, as defined under Regulation D, and the Company did not engage in any general solicitation or general advertising in offering such securities.

The complete text of the SPA is filed as Exhibit 4.1 to this Quarterly Report on Form 10-Q, and this summary is qualified in its entirety by reference to such Exhibit 4.1.

None.

Not applicable.

None. 

Item 6.

Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.