NANO MAGIC INC. The following is management's discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying unaudited consolidated financial statements. OVERVIEW PEN develops, commercializes and markets consumer and industrial products enabled by nanotechnology that solve everyday problems for customers in the optical, transportation, military, sports and safety industries. Our primary business is the formulation, marketing and sale of products enabled by nanotechnology including the ULTRA CLARITY brand eyeglass cleaner, CLARITY DEFOGIT brand defogging products and CLARITY ULTRASEAL nanocoating products for glass and ceramics. We also sell an environmentally friendly surface protector, fortifier, and cleaner. Our design center conducts development services for us and for government and private customers and develops and sells printable inks and pastes, thermal management materials, and graphene foils and windows. Our principal operating segments coincide with our different business activities and types of products sold. This is consistent with our internal reporting structure. Our two reportable segments for the three and six months endedJune 30, 2019 were (i) the Product Segment and (ii) the Contract services Segment. For the three and six months endedJune 30, 2018 , the Company operated the
same two segments. RESULTS OF OPERATIONS The following comparative analysis on results of operations was based primarily on the comparative consolidated financial statements, footnotes and related information for the periods identified below and should be read in conjunction with the unaudited consolidated financial statements and the notes to those statements that are included elsewhere in this report. The results discussed below are for the three and six months endedJune 30, 2019 and 2018.
Comparison of Results of Operations for the Three and Six Months ended
Revenues: For the three and six months endedJune 30, 2019 and 2018, revenues consisted of the following: Three Months ended June 30, Six Months ended June 30, 2019 2018 2019 2018 Sales: Product segment$ 383,827 $ 919,557 $ 825,315 $ 2,062,132
Contract services segment$ 267,812 447,896
584,185 748,846
Total segment and consolidated sales
For the three months endedJune 30, 2019 , sales from the Product segment decreased by$535,730 or 58% as compared to the three months endedJune 30, 2018 which was primarily attributable customers lost inMay 2018 for which we were still filling orders that year. For the six months endedJune 30, 2019 revenue from the Product segment decreased by$1,236,817 or 60%, as compared to the six months endedJune 30, 2018 , also attributable to the lost customers. For the three months endedJune 30, 2019 , sales from the Contract services segment decreased by$180,084 or 40% as compared to the three months endedJune 30, 2018 which was primarily attributable to contracts that concluded in 2018. For the six months endedJune 30, 2019 revenue from the Contract services segment decreased by$164,661 or 22%, as compared to the six months endedJune 30, 2018 for the same reason. 4 Cost of revenues Cost of revenues includes inventory costs, materials and supplies costs, internal labor and related benefits, subcontractor costs, depreciation, overhead and shipping and handling costs incurred and costs related to government and private research contracts in our Contract services segment. For the three months endedJune 30, 2019 , cost of revenues decreased by$370,592 or 39% as compared to the three months endedJune 30, 2106 . For the six months endedJune 30, 2019 , cost of revenues decreased by$900,639 or 44%. These changes consisted of the following: Three Months ended June 30, Six Months ended June 30, 2019 2018 2019 2018 Cost of revenues: Product segment$ 374,065 $ 650,816 $ 557,021 $ 1,455,503
Contract services segment 229,097 289,741 622,353 591,313 Total segment and consolidated cost of revenues$ 603,162 $ 940,557 $ 1,179,374 $ 2,046,816 Gross profit and gross margin For the three months endedJune 30, 2019 , gross profit amounted to$81,674 as compared to$426,896 for the three months endedJune 30, 2018 , a decrease of$345,222 or 81%. For the three months endedJune 30, 2019 and 2018, gross margins were 12.5% and 31.2%, respectively. For the six months endedJune 30, 2019 , gross profit amounted to$263,323 as compared to$764,162 for the six months endedJune 30, 2018 , a decrease of$500,839 or 66%. For the six months endedJune 30, 2019 and 2018, gross margins were 18.7% and 27.2%, respectively.
Gross profit and gross margin by segment is as follows:
Three Months Ended June 30, Six Months Ended June 30,
2019 % 2018 % 2019 % 2018 %
Gross profit:
Product segment * $ 9,762 2.5 % 268,741 29.2 % $ 268,294 32.5 % 606,629 29.4 %
Contract services segment * $ 38,715 14.5 % 158,155 35.3 % $ (38,168 ) (6.5 )% 157,533 21.0 %
Total gross profit $ 48,477 7.4 % 426,896 31.2 % 230,126 16.3 % 764,162 27.2 %
* Gross margin % based on respective segments revenues.
For the three months ended
The gross margins from the research development segment for the three months endedJune 30, 2019 was substantially improved as new contracts were awarded in 2019 but not sufficient to bring up the margin for the six month period. Operating expenses For the three months endedJune 30, 2019 , operating expenses were essentially flat, increasing by$7,717 or 1% compared to the three months endedJune 30, 2018 . The same was true for the six months period as operating expenses decreased by$7,615 for the period endedJune 30, 2019 , as compared to the six months endedJune 30, 2018 . For the three and six months endedJune 30, 2019 and 2018, operating expenses consisted of the following: Three Months Ended June 30, Six Months Ended June 30, 2019 2018 2019 2018
Selling and marketing expenses
191,047 159,780 345,237
Research and development 41,024 2,251 41,069 10,444
Professional fees 72,290 150,802 165,972 324,324General and administrative expenses 140,855 143,368
284,632 292,071
Total $ 400,586 $ 474,548 $ 677,797 $ 1,000,852
5
? For the three months ended
increased by
2018 due to an increase in direct sales efforts launched in the second quarter.
For the six months ended
by
sales efforts in the first quarter that were not entirely offset by the
additional efforts in the second quarter.
? For the three months ended
decreased by
2018. For the six months ended
services decreased by
decreases were due to personnel reductions related to our ongoing efforts to
reduce costs.
? For the three months ended
increased by
2018. For the six months ended
increased by
2018. For the three and six months ended
to new packaging to increase the sales channels for our products.
? For the three and six months ended
decreased by
six months ended
to a reduction in the use of outside consultants.
? For the three months ended
decreased by
For the six months ended
decreased by approximately
June 30, 2018 . These reductions were due to ongoing cost control efforts. Loss from operations As a result of the factors described above, for the three months endedJune 30, 2019 , loss from operations amounted to$352,109 as compared to loss from operations of$47,652 for the three months endedJune 30, 2018 , an increase of$304,457 or 639%. For the six months endedJune 30, 2019 , loss from operations amounted to$447,671 as compared to a loss from operations of$244,046 for the six months endedJune 30, 2018 , a difference of$203,625 or 83%. Other (expense) income For the three months endedJune 30, 2019 , other income was$ 9,200 as compared to$26,850 for the three months endedJune 30, 2018 , a decrease of$17,650 or 66%. There was a decrease in interest expense because we paid off the revolving line at the end of January and a reduction in sublease income because ourAustin design center moved to smaller space in early 2019. For the six months endedJune 30, 2019 other income was$56,523 , as compared to a$202,726 , for the six months ended 2018, a decrease of$146,203 , or 72% due to the same factors.
Net loss As a result of the foregoing, for the three and six months endedJune 30, 2019 , net loss amounted to$342,909 and$391,148 as compared to net loss of$20,802 and$41,320 for the three and six months endedJune 30, 2018 . The increase in net loss for the 3-month period was$322,107 or 1548%. For the six-month period there was an increase of$349,828 or 847%. For the three months endedJune 30, 2019 and 2018, net loss amounted to$0.08 per common share (basic and diluted), and$0.01 per common share (basic and diluted), respectively. For the six months endedJune 30, 2019 and 2018, net loss amounted to$0.09 per common share (basic and diluted), and$0.01 per common share (basic and diluted), respectively. 6
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability of an enterprise to generate adequate amounts of cash
to meet its needs for cash requirements. We had working capital deficit of
The following table sets forth a summary of changes in our working capital from
Change in Percentage
June 30, 2019 December 31, 2018 working capital Change
Working capital:
Total current assets $ 1,160,600 $ 1,523,447 $ (362,847 ) (23.82 )%
Total current liabilities 1,806,897 2,507,268 (700,371 ) (27.93 )%
Working capital deficit: $ (646,297 ) $ (983,822 ) $ 337,525 (34.31 )%
The decrease in current assets was attributable to the application of the restricted cash to the pay-off of the revolving credit arrangement and to a reduction in accounts receivable. The reduction in current liabilities reflects the pay-off of the revolving credit arrangement and a decrease in accrued expenses.
Net cash used in operating activities was$382,053 for the six months endedJune 30, 2019 as compared to$376,134 for the six months endedJune 30, 2018 , a change of$5,919 or 2%. Net cash used in operating activities for the six months endedJune 30, 2019 primarily reflected a net loss of ($391,148 ) adjusted for add-backs of$44,099 and changes in operating assets of$(35,004) .
Net cash flow used in investing activities was
Net cash used in financing activities of$348,770 for the six months endedJune 30, 2019 as compared to$378,423 in the same period in 2018. During the six months endedJune 30, 2019 , we paid down the revolving credit arrangement and sold common stock.
Future Liquidity and Capital Needs.
Our principal future uses of cash are for working capital requirements, including reduction of accrued liabilities. Application of funds will depend on numerous factors including our sales and other revenues and our ability to control costs.
Equipment Financing OnFebruary 10, 2015 , PEN Brands entered a$373,000 promissory note (the "Equipment Note") withKeyBank, N.A. (the "Bank"). The unpaid principal balance of this Equipment Note is payable in 60 equal monthly installments payments of principal and interest throughSeptember 10, 2020 . The Equipment Note is secured by certain equipment, as defined in the Equipment Note, and bears interest computed at a rate of interest of 4.35% per annum based on a year of 360 days. AtMarch 31, 2019 , the principal amount due under the Equipment Note amounted to$74,380 . OnJune 18, 2019 , PEN Brands entered into an Amendment to the Equipment Note with the Bank. By the amendment, the maturity date of the note was extended untilApril 10, 2022 , the interest rate was raised to 6.29% per year, and the monthly payments were reduced. amounted to$152,550 . 7
Off-balance Sheet Arrangements
We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder's equity or that are not reflected in our consolidated unaudited financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
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