NOCOPI TECHNOLOGIES INC/MD/ - Quarter Report: 2022 September (Form 10-Q)

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

(Mark One)

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022

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: 000-20333

NOCOPI TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

480 Shoemaker Road, Suite 104, King of Prussia, PA 19406

(Address of principal executive offices) (Zip Code)

(610) 834-9600

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None.

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 (§232.405 of this chapter) 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 “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 checkmark 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 Securities Act. ☐

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 9,251,178 shares of common stock, par value $0.01, as of November 1, 2022.

NOCOPI TECHNOLOGIES, INC.

INDEX

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

Nocopi Technologies, Inc.

Statements of Comprehensive Income*

(unaudited)

*See accompanying notes to these financial statements.

Nocopi Technologies, Inc.

Balance Sheets*

(unaudited)

*See accompanying notes to these financial statements.

Nocopi Technologies, Inc.

Statements of Cash Flows*

(unaudited)

*See accompanying notes to these financial statements.

Nocopi Technologies, Inc.

Statements of Stockholders’ Equity*

For the Periods December 31, 2021 through September 30, 2022 and December 31, 2020 through September 30, 2021

(unaudited)

* See accompanying notes to these financial statements.

NOCOPI TECHNOLOGIES, INC.

NOTES TO FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Financial Statements

The accompanying unaudited condensed financial statements have been prepared by Nocopi Technologies, Inc. (our “Company”). These statements include all adjustments (consisting only of normal recurring adjustments) which management believes necessary for a fair presentation of the statements and have been prepared on a consistent basis using the accounting policies described in Note 2 Significant Accounting Policies included in the Notes to Financial Statements included in our Company’s Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission on March 30, 2022, as amended on April 29, 2022 (the “2021 Annual Report”). Certain financial information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although our Company believes that the accompanying disclosures are adequate to make the information presented not misleading. The Notes to Financial Statements included in the 2021 Annual Report should be read in conjunction with the accompanying interim financial statements. The interim operating results for the three months and nine months ended September 30, 2022 may not be necessarily indicative of the operating results expected for the full year.

A novel strain of coronavirus, COVID-19, that was first identified in Wuhan, China in December 2019 has surfaced in many countries around the world including the United States. Many countries continue to experience reoccurrences of COVID-19 to the current date. The World Health Organization has declared COVID-19 to constitute a global pandemic. Certain state and local governments reacted by placing significant restrictions on businesses including a closure in Pennsylvania of non-essential businesses that was announced on March 20, 2020. While most Pennsylvania businesses have been allowed to reopen, often at limited capacity and with certain restrictions, as of the current date, there can be no assurances that future closures will be avoided. A requirement to close our Company for a considerable period of time could result in a negative impact on our Company’s financial condition and results of operations. Additionally, as our Company imports certain raw materials from China, if an extended disruption of the supply of these raw materials were to occur, such as the vessel delays resulting from the congestion experienced in certain Chinese ports due to a COVID-19 outbreak in the second quarter of 2021 and continuing to the present time, our ability to produce products for sale to our customers could be negatively impacted. Additionally, certain of the Company’s licensees in the entertainment and toy products market who utilize printers in China to produce their products have been affected by the COVID-19 related cargo surge beginning in the third quarter of 2021 and continuing to the present time at major Chinese and United States ports as well as the world-wide container shortage resulting in significantly higher shipping costs, and have responded by deferring or scaling back production of their orders and, in some cases, rescheduling the shipping of completed orders. Such deferrals may affect the number and value of orders placed by the Company’s licensed printers in the entertainment and toy products market. Further, restrictions on our customers and licensees in areas affected by the COVID-19 could adversely affect our results of operations and financial condition. Our Company’s operating results for the first nine months of 2022 are reflective of the effects of the ongoing cargo surge as well as lockdowns in certain Chinese cities that are continuing to the present time, including the two month lockdown in Shanghai during the first half of 2022 that continues to affect businesses and production in those areas. As the COVID-19 pandemic continues to spread with the Omicron variants including BA.5, currently the most dominant variant, as well as other recently identified variants and sub-variants including BA4.6, BQ.1 and BQ.1.1, any future financial impact cannot be reasonably estimated at this time. We cannot predict the scope or magnitude of the negative effect that may result from the impact of the COVID-19 pandemic on the Company’s financial condition and results of operations. Our Company’s results of operations were negatively affected in earlier periods in part as a result of a significant increase in the cost of raw materials utilized by our Company in the manufacture of certain of its products as a result of price increases related to the impact of the ongoing COVID-19 pandemic on the availability and supply of these raw materials. While prices of these raw materials have declined at the present time, there can be no assurances that raw material prices will remain at current levels or decrease to pre-COVID-19 pandemic levels in future periods. As the COVID-19 pandemic continues to spread both in its original form and in the recently identified variants of COVID-19 along with the potential re-imposition of COVID-19 restrictions that may be considered by federal, state and local governments, any future financial impact cannot be reasonably estimated at this time.

Our Company follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 220 in reporting comprehensive income (loss). Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Since our Company has no items of other comprehensive income (loss), comprehensive income (loss) is equal to net income (loss).

Note 2. Revenues

Our Company follows ASU 214-09, Revenue from Contracts with Customers (“Topic 606”), using the modified retrospective method. The adoption of the guidance affected our recognition of revenue from licenses and royalties. Since its adoption in 2018, we recognize revenue from licensees and royalties at a point in time when the term begins. During the third quarter of 2022, we negotiated an amendment to a license agreement with a licensee that provides for a five year extension to the license agreement that contains guaranteed royalties payable in installments over the term of the amendment to the license agreement. Since the performance obligation is to grant the license for the use of certain patented ink technology as it exists at the time that it is granted, the promise to grant the license is a performance obligation satisfied at a point in time in accordance with Topic 606. In accordance with Topic 606, we recorded $241,000 net of imputed interest of licenses, royalties and fees and $16,900 of selling expenses in the third quarter and first nine months of 2022 related to the amendment to the license agreement. The related receivable and payable are recorded as other assets and other liabilities on the balance sheet.

Note 3. Stock Based Compensation

Our Company follows FASB ASC 718, Compensation – Stock Compensation, and uses the Black-Scholes option pricing model to calculate the grant-date fair value of an award. At September 30, 2022, our Company did not have an active stock option plan. There was no unrecognized portion of expense related to stock option grants at September 30, 2022.

Note 4. Line of Credit

In November 2018, our Company negotiated a $150,000 revolving line of credit with a bank to provide a source of working capital, if required. The line of credit is secured by all the assets of our Company and bears interest at the bank’s prime rate for a period of one year and its prime rate plus 1.5% thereafter. The line of credit is subject to an annual review and quiet period. There have been no borrowings under the line of credit since its inception.

Note 5. Stockholders’ Equity

On August 25, 2022 our Company filed Articles of Amendment to its Articles of Incorporation with the State Department of Assessments and Taxation of the State of Maryland to effect a one-for-ten (1:10) reverse stock split of our Company’s common stock, par value $0.01 per share (the “Reverse Stock Split”). The August 25, 2022 Articles of Amendment become effective as of 12:01 a.m. Eastern Standard Time on September 2, 2022 (the “Effective Time”). At the Effective Time, every ten shares of common stock of our Company that were issued and outstanding immediately prior to the Effective Time were changed into one issued and outstanding share of common stock of our Company. The Reverse Stock Split did not affect any stockholder’s ownership percentage of our Company’s shares, except to the limited extent that the Reverse Stock Split resulted in any stockholder owning a fractional share. No fractional shares were issued in connection with the Reverse Stock Split. Each stockholder who would otherwise have been entitled to receive a fraction of a share of our Company’s common stock instead received one whole share of common stock. There was no change to the number of authorized shares or the par value per share. Unless we indicate otherwise, all information in this Quarterly Report on Form 10-Q gives pro forma effect to the Reverse Stock Split and the corresponding adjustment of all common stock price per share and common stock warrant price data.

On August 1, 2022 our Company entered into a stock purchase agreement in connection with a private placement for total gross proceeds of $3.5 million. The stock purchase agreement provided for the issuance of an aggregate of 2,500,000 shares of our Company’s common stock to two investors at a purchase price of $1.40 per share. To enable the private placement transaction, our Company’s Board of Directors approved the Reverse Stock Split. On September 13, 2022, the sale pursuant to the stock purchase agreement closed. No placement fees or commissions were paid in connection with this transaction.

During the second quarter of 2021, holders of the remaining 14,137 warrants that had been outstanding exercised their options to purchase a total of 14,137 shares of our Company’s common stock at $0.20 per share. The warrants were granted in 2014 to two individuals who acquired convertible debentures from the Company in 2014. The warrants were exercisable two years after issuance and expire seven years after issuance. The fair value of the warrants was determined using the Black-Scholes pricing model. The relative fair value of the warrants was recorded as a discount to the notes payable with an offsetting credit to additional paid-in capital since our Company determined that the warrants were an equity instrument in accordance with FASB ASC 815. The debt discount related to the warrant issuances was accreted through interest expense over the term of the notes payable. At September 30, 2022, our Company had no warrants outstanding.

Note 6. Income Taxes

There is no provision for federal income taxes for the three months ended September 30, 2022 due to the availability of net operating loss carryforwards. There is no income tax benefit for the losses for the nine months ended September 30, 2022 because our Company has determined that the realization of the next deferred tax asset is not assured. There is no provision for federal income taxes for the three and nine months ended September 30, 2021 due to the availability of net operating loss carryforwards. Our Company has established a valuation allowance for the entire amount of benefits resulting from our Company’s net operating loss carryforwards because our Company has determined that the realization of the net deferred tax asset is not assured.

The components for state income tax expense resulting from the limitation on the use of net operating losses are:

There was no change in unrecognized tax benefits during the period ended September 30, 2022 and there was no accrual for uncertain tax positions as of September 30, 2022.

Tax years from 2019 through 2021 remain subject to examination by U.S. federal and state jurisdictions.

Note 7. Earnings (Loss) per Share

In accordance with FASB ASC 260, Earnings per Share, basic earnings (loss) per common share is computed using net earnings (loss) divided by the weighted average number of common shares outstanding for the periods presented. Diluted earnings (loss) per share are computed using weighted average number of common shares plus dilutive common share equivalents outstanding during the period. Since our Company did not have any common stock equivalents outstanding as of September 30, 2022 and 2021, basic and diluted earnings (loss) per share were the same.

Note 8. Major Customer and Geographic Information

Our Company’s revenues, expressed as a percentage of total revenues, from non-affiliated customers that equaled 10% or more of our Company’s total revenues were:

Our Company’s non-affiliate customers whose individual balances amounted to more than 10% of our Company’s net accounts receivable, expressed as a percentage of net accounts receivable, were:

Our Company performs ongoing credit evaluations of its customers and generally does not require collateral. Our Company also maintains allowances for potential credit losses. The loss of a major customer could have a material adverse effect on our Company’s business operations and financial condition.

Our Company’s revenues by geographic region are as follows:

Note 9. Leases

Our Company conducts its operations in leased facilities under a non-cancelable operating lease expiring in 2024.

Due to the adoption of the new lease standard under the optional transition method which allows the entity to apply the new lease standard at the adoption date, our Company has capitalized the present value of the minimum lease payments commencing January 1, 2019, using an estimated incremental borrowing rate of 6.5%. The minimum lease payments do not include common area annual expenses which are considered to be non-lease components.

As of January 1, 2019 the operating lease right-of-use asset and operating lease liability amounted to $241,100 with no cumulative-effect adjustment to the opening balance of accumulated deficit.

There are no other material operating leases. Our Company has elected not to recognize right-of-use assets and lease liabilities arising from short-term leases.

Total lease expense under operating leases for the three and nine months ended September 30, 2022 was $13,300 and $40,000, respectively. Total lease expense under operating leases for the three and nine months ended September 30, 2021 was $13,300 and $40,000, respectively.

Maturities of lease liabilities are as follows:

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Information

This report on Form 10-Q contains, and our officers and representatives may from time to time make, "forward-looking statements" within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as: "anticipate," "intend," "plan," "goal," "seek," "believe," "project," "estimate," "expect," "strategy," "future," "likely," "may," "should," "will" and similar references to future periods. Examples of forward-looking statements include, among others, statements we make regarding:

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.

The following discussion and analysis should be read in conjunction with our condensed financial statements, included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management. This information should also be read in conjunction with our audited historical financial statements which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the Securities and Exchange Commission on March 30, 2022, as amended on April 29, 2022.

Background Overview

Nocopi Technologies, Inc. develops and markets specialty reactive inks for applications in the large educational and toy products market. We also develop and market technologies for document and product authentication, which we believe can reduce losses caused by fraudulent document reproduction or by product counterfeiting and/or diversion. We derive our revenues primarily from licensing our technologies on an exclusive or non-exclusive basis to licensees who incorporate our technologies into their product offering and from selling products incorporating our technologies to the licensees or to their licensed printers.

Unless the context otherwise requires, all references to the “Company,” “we,” “our” or “us” and other similar terms means Nocopi Technologies, Inc., a Maryland corporation.

Effects of COVID-19

To serve our customers while also providing for the safety of our employees and service providers, we have adapted various steps to protect our employees. Any employee who is uncomfortable coming into our facilities may choose not to come in. We have a large enough facility to enable all of our employees to social distance and we follow Centers for Disease Control and Prevention (CDC) guidelines. Our production employees work with chemicals and they have always used masks, respirators, etc., even before COVID-19. As a result, we continue to maintain the same level of productivity and effectiveness as prior to the COVID-19 pandemic.

The impact of COVID-19 on our Company had little effect on the financial results during the first six months of 2021 as the shortage of raw materials used in certain of our Company’s products experienced throughout 2020 as a consequence of the COVID-19 pandemic and the resultant price increases were at least temporarily eased, though still higher than pre-pandemic levels, so our Company’s gross margins on those products returned to similar levels as were experienced before the inception of the COVID-19 pandemic; however, in the third quarter of 2021, certain of the Company’s licensees in the entertainment and toy products market who utilize printers in China to produce their products have been adversely affected by the cargo surge related to congestion experienced in certain Chinese ports due to a COVID-19 outbreak that began in the second quarter of 2021. The cargo surge continues to the present time, now adversely affecting major United States ports. The world-wide cargo surge along with a container shortage resulted in significantly higher shipping costs during the third quarter of 2021. Certain of our Company’s licensees in the entertainment and toy products market have responded by deferring or scaling back production and size of future orders, and, in some cases, rescheduling the shipping of completed orders. Ink orders from our Company’s licensed printers in China fell significantly in the third quarter of 2021 compared to earlier periods. These supply chain disruptions are being experienced by many businesses including our Company’s licensees. A continuance of these supply chain disruptions may negatively impact the number and value of orders placed by our Company’s licensed printers in the entertainment and toy products market with a resultant negative impact on our Company’s results of operations and cash flow in future periods.

To date, we have not suffered a drop off in total earned royalties in the entertainment and toy products market as a result of COVID-19 as retail demand continues to be strong for the products marketed by our licensees in the entertainment and toy products market; however, during the third quarter of 2021, reflecting the significantly higher shipping costs caused by the COVID-19 related cargo surge at major China and United States ports and the world-wide container shortage, ink orders from the printers of our licensees in the entertainment and toy products market were significantly below historical levels. We continue to experience a negative impact on revenues in our smaller anti-counterfeiting and anti-diversion products market due to reduced production activity at certain printing facilities that utilize these technologies and anticipate that these conditions may continue for a period of time. We continue to retain licensing revenues at historical levels in the entertainment and toy products market through the current date despite the downturns in the overall economy. While the products of our licensees in the larger entertainment and toy products market are sold by both large and smaller retailers, some of whom remain open, and are also available for purchase online, we believe that revenues may not continue to be achieved at levels experienced to the current date due to the negative economic conditions that are expected to continue over the balance of the year and beyond as a result of COVID-19. A slowdown in overall consumer spending may affect the sales of products marketed by our licensees. Our major licensees in the entertainment and toy products market are large, well-known businesses in this market with whom we believe our long-term relationship will not be adversely affected by the current COVID-19 pandemic.

Results of Operations

Our Company’s revenues are derived from (a) royalties paid by licensees of our technologies, (b) fees for the provision of technical services to licensees and (c) from the direct sale of (i) products incorporating our technologies, such as inks, security paper and pressure sensitive labels, and (ii) equipment used to support the application of our technologies, such as ink-jet printing systems. Royalties consist of guaranteed minimum royalties payable by our licensees in certain cases and additional royalties which typically vary with the licensee’s sales or production of products incorporating the licensed technology. Service fees and sales revenues vary directly with the number of units of service or product provided.

Our Company recognizes revenue on its lines of business as follows:

We believe that, as fixed cost reductions beyond those we have achieved in recent years may not be achievable, our operating results are substantially dependent on revenue levels. Because revenues derived from licenses and royalties carry a much higher gross profit margin than other revenues, operating results are also substantially affected by changes in revenue mix.

Both the absolute amount of our Company’s revenues and the mix among the various sources of revenue are subject to substantial fluctuation. We have a relatively small number of substantial customers rather than a large number of small customers. Accordingly, changes in the revenue received from a significant customer can have a substantial effect on our Company’s total revenue, revenue mix and overall financial performance. Such changes may result from a substantial customer’s product development delays, engineering changes, changes in product marketing strategies, production requirements and the like. In addition, certain customers have, from time to time, sought to renegotiate certain provisions of their license agreements and, when our Company agrees to revise such terms, revenues from the customer may be affected.

Revenues for the third quarter of 2022 were $685,900 compared to $312,500 in the third quarter of 2021, an increase of $373,400, or approximately 119%. Revenues in the third quarter of 2022 included, in accordance with ASU 214-09, Revenue from Contracts with Customers (“Topic 606”), revenue of $241,000 representing the present value of guaranteed royalty payments that will be payable over a five-year period beginning in the fourth quarter of 2022 as a result of an amendment to a license agreement with a licensee that provides for a five year extension to the license agreement beginning in October 2022. Since the performance obligation is to grant the license for the use of certain patented ink technology as it exists at the time that it is granted, the promise to grant the license is a performance obligation satisfied at a point in time in accordance with Topic 606. Prior to 2018, we recognized revenue from licenses and royalties on a straight-line basis over the term of the related license agreement. Licenses, royalties and fees increased by $226,100, or approximately 102%, to $448,600 in the third quarter of 2022 from $222,500 in the third quarter of 2021. The increase in licenses, royalties and fees in the third quarter of 2022 compared to the third quarter of 2021 is due primarily to higher royalties from our Company’s licensees in the entertainment and toy products market due to ongoing strong retail demand for these products offset in part by lower revenues from our licensees in the security markets. We cannot assure you that the marketing and product development activities of our Company’s licensees or other businesses in the entertainment and toy products market will produce a significant increase in revenues for our Company, nor can the timing of any potential revenue increases be predicted, particularly given the uncertain economic conditions being experienced worldwide as a result of the COVID-19 pandemic that is continuing to negatively impact all worldwide economies along with the massive international supply chain disruptions currently being experienced. The products marketed by the Company’s major licensees in the entertainment and toy products markets are produced in China. Trans-Pacific ocean shipping has been negatively affected by container shortages and port delays both in the United States and China.

Product and other sales increased by $147,300, or approximately 164%, to $237,300 in the third quarter of 2022 from $90,000 in the third quarter of 2021. Sales of ink increased in the third quarter of 2022 compared to the third quarter of 2021 due primarily to higher ink shipments to the third party authorized printer used by one of our Company’s major licensees in the entertainment and toy products market. In the third quarter of 2022, our Company derived revenues of approximately $648,300 from our licensees and their authorized printers in the entertainment and toy products market compared to revenues of approximately $257,000 in the third quarter of 2021.

For the first nine months of 2022, revenues were $1,539,600, representing an increase of $101,800, or approximately 7%, from revenues of $1,437,800 in the first nine months of 2021. Licenses, royalties and fees increased by $202,800, or approximately 37%, to $755,700 in the first nine months of 2022 from $552,900 in the first nine months of 2021. The increase in licenses, royalties and fees is due primarily to higher royalties from our Company’s licensees in entertainment and toy products market including $241,000 representing the present value of guaranteed royalty payments that will be payable over a five-year period beginning in the fourth quarter of 2022 as a result of an amendment to a license agreement with a licensee that provides for a five year extension to the license agreement beginning in October 2022 described above offset in part by lower revenues from certain of our Company’s licensees in the security markets which continue to be negatively affected by the COVID-19 pandemic and the variants of COVID-19 that have recently been identified. We cannot assure you that the marketing and product development activities of our Company’s licensees or other businesses in the entertainment and toy products market will produce a significant increase in revenues for our Company, nor can the timing of any potential revenue increases be predicted, particularly given the uncertain economic conditions being experienced worldwide as a result of the COVID-19 pandemic that is continuing to negatively impact all worldwide economies along with recently identified variants of the COVID-19 virus.

Product and other sales decreased by $101,000, or approximately 11%, to $783,900 in the first nine months of 2022 from $884,900 in the first nine months of 2021. Sales of ink decreased in the first nine months of 2022 compared to the first nine months of 2021 due primarily to lower ink shipments to the third party authorized printer used by one of our Company’s major licensees in the entertainment and toy products market along with lower ink shipments to our Company’s licensees in the retail receipt and document fraud market. Our Company derived revenues of approximately $1,426,100 from licensees and their authorized printers in the entertainment and toy products market in the first nine months of 2022 compared to revenues of approximately $1,279,700 in the first nine months of 2021.

Our Company’s gross profit increased to $493,500 in the third quarter of 2022, or approximately 72% of revenues, from $209,200 in the third quarter of 2021 or approximately 67% of revenues. Licenses, royalties and fees have historically carried a higher gross profit than product and other sales. Such other sales generally consist of supplies or other manufactured products which incorporate our Company’s technologies or equipment used to support the application of its technologies. These items (except for inks which are manufactured by our Company) are generally purchased from third-party vendors and resold to the end-user or licensee and carry a lower gross profit than licenses, royalties and fees. The higher gross profit in the third quarter of 2022 compared to the third quarter of 2021 results primarily from higher gross revenues from licenses, royalties and fees and product and other sales.

For the first nine months of 2022, gross profit was $979,800, or approximately 64% of revenues, compared to $880,400, or approximately 61% of revenues in 2021. The lower gross profit in the first nine months of 2022 compared to the first nine months of 2021 results primarily from lower revenues from product and other sales offset in part by higher revenues from licenses, royalties and fees in the first nine months of 2022 compared to the first nine months of 2021.

As the variable component of cost of revenues related to licenses, royalties and fees is a low percentage of these revenues and the fixed component is not substantial, period to period changes in revenues from licenses, royalties and fees can significantly affect both the gross profit from licenses, royalties and fees as well as overall gross profit. The gross profit from licenses, royalties and fees increased to approximately 90% in the third quarter of 2022 compared to approximately 87% in the third quarter of 2021 and to approximately 83% of revenues from licenses, royalties and fees in the first nine months of 2022 from approximately 77% in the first nine months of 2021.

The gross profit, expressed as a percentage of revenues, of product and other sales is dependent on both the overall sales volumes of product and other sales and on the mix of the specific goods produced and/or sold. The gross profit from product and other sales increased to approximately 38% of revenues in the third quarter of 2022 compared to approximately 17% of revenues in the third quarter of 2021. For the first nine months of 2022, the gross profit, expressed as a percentage of revenues, decreased to approximately 45% of revenues from product and other sales compared to approximately 51% of revenues from product and other sales in the first nine months of 2021. The increase in gross profit from product and other sales in the third quarter of 2022 compared to the third quarter of 2021 is due primarily to higher ink shipments to the third party authorized printer used by two of our Company’s major licensees in the entertainment and toy products market. The decrease in gross profit from product and other sales in the first nine months of 2022 compared to the first nine months of 2021 is due primarily to lower ink shipments to a third party authorized printers used by one of our Company’s major licensees in the entertainment and toy products market.

Research and development expenses decreased in the third quarter of 2022 to $23,900 from $44,000 in the third quarter of 2021 and to $95,900 in the first nine months of 2022 from $134,300 in the first nine months of 2021 due primarily to lower employee related expenses in the third quarter and first nine months of 2022 compared to the third quarter and first nine months of 2021.

Sales and marketing expenses increased in the third quarter of 2022 to $88,900 from $56,900 in the third quarter of 2021. Sales and marketing expenses increased in the first nine months of 2022 to $230,400 from $214,000 in the first nine months of 2021. The increase is due primarily to higher commission expense on the higher level of sales in the third quarter and first nine months of 2022 compared to the third quarter and first nine months of 2021.

General and administrative expenses increased in the third quarter and first nine months of 2022 to $180,200 and $964,600, respectively, from $122,300 and $385,500, respectively, in the third quarter and first nine months of 2021 due primarily to significantly higher professional fees and public company expense in the third quarter and first nine months of 2022 compared to the third quarter and first nine months of 2021.

Income taxes in the third quarter and first nine months of 2021 resulted from limitations placed on income tax net operating loss deductions by the Commonwealth of Pennsylvania.

The net income of $206,500 in the third quarter of 2022 compared to net income of $1,100 in the third quarter of 2021 resulted primarily from a higher gross profit on a higher level of licenses, royalties and fees offset in part by higher cost of revenues and higher operating expenses in the third quarter of 2022 compared to the third quarter of 2021. The net loss of $293,900 in the first nine months of 2022 compared to net income of $158,400 in the first nine months of 2021 resulted primarily higher operating expenses in the first nine months of 2022 offset in part by a higher gross profit on a higher level of licenses, royalties and fees in the first nine months of 2022 compared to the first nine months of 2021.

Plan of Operation, Liquidity and Capital Resources

During the first nine months of 2022, our Company’s cash increased to $5,355,700 at September 30, 2022 from $1,846,700 at December 31, 2021. During the first nine months of 2022, our Company generated $9,800 from its operating activities, received $3,500,000 upon the sale of 2.5 million shares of its common stock and used $800 for capital expenditures.

During the first nine months of 2022, our Company’s revenues increased approximately 7% primarily as a result of higher license and royalty revenues due primarily to the five year license extension with one of our Company’s licensees in the entertainment and toy products market.

Additionally, our Company’s total overhead expenses increased in the nine months of 2022 to $1,290,900 compared to $733,800 in the first nine months of 2021. As a result of these factors, our Company sustained a net loss of $293,900 in the first nine months of 2022 compared to net income of $158,400 in the first nine months of 2021. Our Company’s total overhead expenses increased in the first nine months of 2022 compared to the first nine months of 2021 and our Company’s net interest income increased in the first nine months of 2022 compared to the first nine months of 2021. Our Company had positive operating cash flow of $9,800 during the first nine months of 2022 and at September 30, 2022, had positive working capital of $6,420,000 and stockholders’ equity of $6,711,400. For the full year of 2021, our Company had net income of $49,400 and had positive operating cash flow of $512,700. At December 31, 2021, our Company had working capital of $3,197,500 and stockholders’ equity of $3,505,300.

In November 2018, our Company negotiated a $150,000 revolving line of credit (“Line of Credit”) with a bank to provide a source of working capital, if required. The Line of Credit is secured by all the assets of our Company and bears interest at the bank’s prime rate for a period of one year and its prime rate plus 1.5% thereafter. The Line of Credit is subject to an annual review and quiet period. There have been no borrowings under the Line of Credit since its inception. We may need to obtain additional capital in the future to further support the working capital requirements associated with our existing revenue base and to develop new revenue sources. We cannot assure you that we will be successful in obtaining such additional capital, if needed. We continue to maintain a cost containment program including curtailment, where possible, of discretionary research and development and sales and marketing expenses.

Our plan of operation for the twelve months beginning with the date of this quarterly report consists of concentrating available human and financial resources to continue to capitalize on the specific business relationships our Company has developed in the entertainment and toy products market. This includes two licensees that have been marketing products incorporating our Company’s technologies since 2012. These two licensees maintain a significant presence in the entertainment and toy products market and are well known and highly regarded participants in this market. We anticipate that these two licensees will expand their current offerings that incorporate our technologies and will introduce and market new products that will incorporate our technologies available to them under their license agreements with our Company. We will continue to develop various applications for these licensees. In October 2022, the Company completed an Amended and Restated License Agreement commencing in July 2023 with one of these two licensees that provides for a new five-year license term requiring minimum guaranteed royalty payments of no less than $520,000 each year of the term. We also plan to expand our licensee base in the entertainment and toy market. We currently have additional licensees marketing or developing products incorporating our technologies in certain geographic and niche markets of the overall entertainment and toy products market.

Our Company maintains its presence in the retail loss prevention market and believes that revenue growth in this market can be achieved through increased security ink sales to its licensees in this market. We will continue to adjust our production and technical staff as necessary and, subject to available financial resources, invest in capital equipment needed to support potential growth in ink production requirements beyond our current capacity. Additionally, we will pursue opportunities to market our current technologies in specific security and non-security markets. There can be no assurances that these efforts will enable our Company to generate additional revenues and positive cash flow.

Our Company has received, and may in the future seek, additional capital in the form of debt, equity or both, to support our working capital requirements and to provide funding for other business opportunities. Beyond the Line of Credit, we cannot assure you that if we require additional capital, that we will be successful in obtaining such additional capital, or that such additional capital, if obtained, will enable our Company to generate additional revenues and positive cash flow.

As previously stated, we generate a significant portion of our total revenues from licensees in the entertainment and toy products market. These licensees generally sell their products through retail outlets. In the future, such sales may be adversely affected by changes in consumer spending that may occur as a result of an uncertain economic environment throughout the balance of 2022 and beyond due to the ongoing COVID-19 pandemic and its effect on the global economy, geopolitical instability including the Russia-Ukraine war and the supply chain disruptions related to both as well as the record inflation and significantly higher interest rates currently being experienced in the United States, along with the probability of an economic recession both in the United States and globally. As a result, our revenues, results of operations and liquidity may be further negatively impacted.

Contractual Obligations

As of September 30, 2022, there were no material changes in our contractual obligations from those disclosed in our Annual Report on Form 10-K filed with the SEC on March 30, 2022, as amended on April 29, 2022, other than those appearing in the notes to the financial statements appearing elsewhere in this Quarterly Report on Form 10-Q.

Recently Adopted Accounting Pronouncements

As of September 30, 2022, there were no recently adopted accounting standards that had a material effect on our Company’s financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. The amendments in this Update affect loans, debt securities, trade receivables, and any other financial assets that have the contractual right to receive cash. The ASU requires an entity to recognize expected credit losses rather than incurred losses for financial assets. For public entities, the amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. ASU No. 2019-10 extends the effective dates for two years for smaller reporting companies and nonpublic companies.

In August 2020, the FASB issued ASU No. 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40), Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The amendments in this Update affect entities that issue convertible instruments and/or contracts in an entity’s own equity. For convertible instruments, the instruments primarily affected are those issued with beneficial conversion features or cash conversion features because the accounting models for those specific features are removed. However, all entities that issue convertible instruments are affected by the amendments to the disclosure requirements in this Update. For contracts in an entity’s own equity, the contracts primarily affected are freestanding instruments and embedded features that are accounted for as derivatives under the current guidance because of failure to meet the settlement conditions of the derivatives scope exception related to certain requirements of the settlement assessment. The Board simplified the settlement assessment by removing the requirements (1) to consider whether the contract would be settled in registered shares, (2) to consider whether collateral is required to be posted, and (3) to assess shareholder rights. Those amendments also affect the assessment of whether an embedded conversion feature in a convertible instrument qualifies for the derivatives scope exception. Additionally, the amendments in this Update affect the diluted EPS calculation for instruments that may be settled in cash or shares and for convertible instruments. The amendments in this Update are effective for public business entities that meet the definition of a Securities and Exchange Commission (SEC) filer, excluding entities eligible to be smaller reporting companies as defined by the SEC, for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Board specified that an entity should adopt the guidance as of the beginning of its annual fiscal year. The Board decided to allow entities to adopt the guidance through either a modified retrospective method of transition or a fully retrospective method of transition.

Off-Balance Sheet Arrangements

Our Company does not have any off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not Applicable

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures. Our Company’s management, with the participation of our Company’s Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of our Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2022. Based on this evaluation, our Company’s Principal Executive Officer and Principal Financial Officer concluded that, as of September 30, 2022, our Company’s disclosure controls and procedures were effective, in that they provide reasonable assurance that information required to be disclosed by our Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to our Company’s management, including our Company’s Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitation on Effectiveness of Controls. While our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance that their respective objectives will be met, we do not expect that our disclosure controls and procedures or our internal control over financial reporting are or will be capable of preventing or detecting all errors and all fraud. Any control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

None

Item 1A. Risk Factors.

Not applicable

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

The shares of common stock were issued in reliance on the exemption from registration contained in Section 4(a)(2) of the Securities Act of 1933, as amended, and by Rule 506 of Regulation D promulgated thereunder as a transaction by an issuer not involving any public offering.

Item 3. Defaults Upon Senior Securities.

None

Item 4. Mine Safety Disclosures.

Not applicable

Item 5.  Other Information.

None 

Item 6.  Exhibits.

(a) Exhibits

The following exhibits are included herein:

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.

EXHIBIT INDEX

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