UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 20172018

 

[  ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

COMMISSION FILE NO. 1-11602

 

PEN INC.

(Exact name of registrant as specified in its charter)

 

Delaware 47-1598792
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

701 Brickell Ave., Suite 1550  
Miami, FL 33131
(Address of principal executive offices) (Zip Code)

 

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

 

Former name or former address, if changed since last report:Not applicable.

 

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. [X][  ] Yes [  ][X] No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] 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.

 

Large accelerated filer [  ]Accelerated filer [  ]
  
Non-accelerated filer [  ] (Do not check if a smaller reporting company)Smaller reporting company [X]

 

Emerging growth company [  ]

 

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

 

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

As of November 13, 2017,May 9, 2019, the registrant had 1,686,4864,375,576 shares of Class A common stock, par value $.0001 per shareCommon Stock (including 37,778 shares that are subject to forfeiture) and 1,420,176 shares of Class B common stock, par value $.0001 per share, issued and outstanding..

 

 

 

 
 

 

PEN INC.

 

INDEX

 

  Page
Part I. Financial Information 
   
 Item 1. Financial StatementsF-1
   
 Consolidated Balance Sheets—September 30, 20172018 (unaudited) and December 31, 20162017F-1
   
 Consolidated Statements of Operations—Three and Nine Months Ended September 30, 2018 and 2017 and 2016 (unaudited)F-2
   
 Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2018 and 2017 and 2016 (unaudited)F-3
   
 Condensed Notes to Unaudited Consolidated Financial StatementsF-4
   
 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations4
   
 Item 3. Quantitative and Qualitative Disclosures about Market Risk9
   
 Item 4. Controls and Procedures109
   
Part II. Other Information 
   
 Item 1. Legal Proceedings1110
   
 Item 1A. Risk Factors1110
   
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds10
Item 3. Defaults Upon Senior Securities11
   
 Item 3. Defaults Upon Senior Securities4. Mine Safety Disclosures11
   
 Item 4. Mine Safety Disclosures5. Other Information11
   
 Item 5. Other Information6. Exhibits11
   
Item 6. Exhibits11
Signatures12

2

FORWARD-LOOKING STATEMENTS

 

This Form 10-Q contains certain forward-looking statements that we believe are within the meaning of the federal securities laws. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements, including the statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding our strategy, future operations, future expectations or future estimates, financial position and objectives of management. Those statements in this Form 10-Q containing the words “believes,” “anticipates,” “plans,” “expects” and similar expressions constitute forward-looking statements, although not all forward-looking statements contain such identifying words. These forward-looking statements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions relating to our operations, results of operations, competitive factors, shifts in market demand and other risks and uncertainties.

 

Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate and actual results may differ from those indicated by the forward-looking statements included in this Form 10-Q. In light of the significant uncertainties inherent in the forward-looking statements included in this Form 10-Q, you should not consider the inclusion of such information as a representation by us or anyone else that we will achieve such results. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.

 

3
 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

PEN INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

  September 30,2017  December 31, 2016 
  (unaudited)    
ASSETS      
CURRENT ASSETS:        
Cash $73,927  $189,128 
Accounts receivable, net  819,306   722,845 
Accounts receivable - related party  14,226   10,474 
Inventory  1,133,502   1,035,499 
Prepaid expenses and other current assets  42,314   75,080 
Total Current Assets  2,083,275   2,033,026 
         
OTHER ASSETS:        
Property, plant and equipment, net  400,778   709,627 
Other assets  89,325   51,078 
Total Other Assets  490,103   760,705 
         
Total Assets $2,573,378  $2,793,731 
         
LIABILITIES AND STOCKHOLDERS’ DEFICIT        
         
CURRENT LIABILITIES:        
Bank revolving line of credit $689,232  $979,688 
Current portion of notes payable  79,979   90,449 
Accounts payable  1,606,816   1,078,527 
Accounts payable - related parties  20,887   52,887 
Deferred revenue  70,180   - 
Accrued expenses  649,331   904,166 
         
Total Current Liabilities  3,116,425   3,105,717 
         
LONG-TERM LIABILITIES:        
Notes payable, net of current portion  227,397   266,110 
         
Total Long-Term Liabilities  227,397   266,110 
         
Total Liabilities  3,343,822   3,371,827 
         
Commitments and Contingencies (See Note 11)        
         
STOCKHOLDERS’ DEFICIT:        
Preferred stock, $0.0001 par value, 20,000,000 shares authorized; no shares issued and outstanding  -   - 
Class A common stock: $0.0001 par value, 7,200,000 shares authorized; 1,648,708 and 1,367,431 issued and outstanding at September 30, 2017 and December 31, 2016, respectively  165   136 
Class B common stock: $0.0001 par value, 2,500,000 shares authorized; 1,420,176 and 1,402,104 issued and outstanding at September 30, 2017 and December 31, 2016, respectively  142   140 
Class Z common stock: $0.0001 par value, 300,000 shares authorized; 0 and 262,631 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively  -   26 
Additional paid-in capital  5,480,924   5,321,769 
Accumulated deficit  (6,251,675)  (5,900,167)
         
Total Stockholders’ Deficit  (770,444)  (578,096)
         
Total Liabilities and Stockholders’ Deficit $2,573,378  $2,793,731 

  September 30, 2018  December 31, 2017 
   (unaudited)     
ASSETS        
CURRENT ASSETS:        
Cash $114,321  $138,296 
Restricted cash $85,000  $95,003 
Accounts receivable, net  220,556   607,632 
Accounts receivable - related party  -   14,226 
Inventory  969,174   733,979 
Prepaid expenses and other current assets  66,617   162,246 
Total Current Assets  1,455,668   1,751,382 
Property, plant and equipment, net  344,289   388,777 
Other assets  35,706   41,116 
Total Assets $1,835,663  $2,181,275 
         
LIABILITIES AND STOCKHOLDERS’ DEFICIT        
         
CURRENT LIABILITIES:        
Accounts payable $1,319,659  $1,383,514 
Accounts payable - related parties  19,887   19,887 
Accrued expenses and other current liabilities  947,774   649,974 
Customer deposits  20,428   169,970 
Bank revolving line of credit  531,787   563,218 
Current portion of notes payable  82,498   96,533 
Advances from related parties  140,000   115,000 
Deferred revenue  -   98,381 
Total Current Liabilities  3,062,033   3,096,477 
Notes payable, net of current portion  140,134   180,803 
Total Liabilities  3,202,167   3,277,280 
         
Commitments and Contingencies (See Note 11)        
         
STOCKHOLDERS’ DEFICIT:        
Preferred stock, $0.0001 par value, 20,000,000 shares authorized; no shares issued and outstanding  -   - 
Class A common stock: $0.0001 par value, 7,200,000 shares authorized; 1,662,808 and 1,653,322 issued and outstanding at September 30, 2018 and December 31, 2017, respectively  166   165 
Class B common stock: $0.0001 par value, 2,500,000 shares authorized; 1,436,052 and 1,423,252 issued and outstanding at September 30, 2018 and December 31, 2017, respectively  144   142 
Class Z common stock: $0.0001 par value, 300,000 shares authorized; 0 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively  -   - 
Additional paid-in capital  5,519,664   5,490,925 
Accumulated deficit  (6,886,478)  (6,587,237)
Total Stockholders’ Deficit  (1,366,504)  (1,096,005)
Total Liabilities and Stockholders’ Deficit $1,835,663  $2,181,275 

 

See accompanying condensed notes to unaudited consolidated financial statements.

 

F-1
 

 

PEN INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2017  2016  2017  2016 
  (unaudited)  (unaudited)  (unaudited)  (unaudited) 
REVENUES:                
                 
Products (including related party sales of $26,093 and $52,328 and $138,004, and $148,624 for the three and nine months ended September 30, 2017 and 2016, respectively) $1,772,960  $1,781,755  $5,523,785  $5,391,305 
Contract services  255,301   225,083   723,435   804,522 
                 
Total Revenues  2,028,261   2,006,838   6,247,220   6,195,827 
                 
COST OF REVENUES:                
Products  1,121,039   1,116,987   3,237,221   3,175,629 
Contract services  274,240   258,768   787,443   864,905 
                 
Total Cost of Revenues  1,395,279   1,375,755   4,024,664   4,040,534 
                 
GROSS PROFIT  632,982   631,083   2,222,556   2,155,293 
                 
OPERATING EXPENSES:                
Selling and marketing expenses  20,933   57,942   257,803   177,274 
Salaries, wages and related benefits  253,615   375,794   820,051   1,241,033 
Research and development  82,544   71,921   297,697   236,534 
Professional fees  135,261   118,818   536,284   364,450 
General and administrative expenses  188,760   242,380   653,008   738,909 
                 
Total Operating Expenses  681,113   866,855   2,564,843   2,758,200 
                 
LOSS FROM OPERATIONS  (48,131)  (235,772)  (342,287)  (602,907)
                 
OTHER (EXPENSE) INCOME:                
Interest expense  (20,124)  (26,000)  (54,038)  (82,270)
Loss on disposal of fixed assets  (122,050)  -   (122,050)  - 
Other income, net  65,575   50,870   166,867   228,649 
                 
Total Other (Expense) Income  (76,599)  24,870   (9,221)  146,379 
                 
NET LOSS $(124,730) $(210,902) $(351,508) $(456,528)
                 
NET LOSS PER COMMON SHARE:                
Basic $(0.04) $(0.07) $(0.12) $(0.15)
Diluted $(0.04) $(0.07) $(0.12) $(0.15)
                 
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:                
Basic  3,062,759   3,020,062   3,051,826   3,006,837 
Diluted  3,062,759   3,020,062   3,051,826   3,006,837 

  For the Three Months Ended  For the Nine Months Ended 
  September 30,  September 30, 
  2018  2017  2018  2017 
  (unaudited)  (unaudited)  (unaudited)  (unaudited) 
REVENUES:            
Products (including related party sales of $0 for the three and nine months ended September 30, 2018 and $26,093 and $138,004 for the three and nine months ended September 30, 2017) $383,000  $1,772,960  $2,445,132  $5,523,785 
Contract services  382,957   255,301   1,131,803   723,435 
                 
Total Revenues  765,957   2,028,261   3,576,935   6,247,220 
                 
COST OF REVENUES:                
Products  350,969   1,121,039   1,806,472   3,237,221 
Contract services  290,810   274,240   882,123   787,443 
                 
Total Cost of Revenues  641,779   1,395,279   2,688,595   4,024,664 
                 
GROSS PROFIT  124,178   632,982   888,340   2,222,556 
                 
OPERATING EXPENSES:                
Selling and marketing expenses  5,345   20,933   34,121   257,803 
Salaries, wages and related benefits  133,044   253,615   488,115   820,051 
Research and development  1,850   82,544   12,294   297,697 
Professional fees  141,091   135,261   464,331   536,284 
General and administrative expenses  126,515   188,760   417,192   653,008 
                 
Total Operating Expenses  407,845   681,113   1,416,053   2,564,843 
                 
INCOME (LOSS) FROM OPERATIONS  (283,667)  (48,131)  (527,713)  (342,287)
                 
OTHER (EXPENSE) INCOME:                
Interest expense  (29,480)  (20,124)  (72,092)  (54,038)
Loss on disposal of fixed assets  -   (122,050)  -   (122,050)
Other income, net  55,266   65,575   300,564   166,867 
                 
Total Other (Expense) Income  25,746   (76,599)  228,472   (9,221)
                 
NET INCOME (LOSS) $(257,921) $(124,730) $(299,241) $(351,508)
                 
NET INCOME (LOSS) PER COMMON SHARE:                
Basic $(0.08) $(0.04) $(0.10) $(0.12)
Diluted $(0.08) $(0.04) $(0.10) $(0.12)
                 
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:                
Basic  3,091,457   3,062,759   3,098,860   3,051,826 
Diluted  3,091,457   3,062,759   3,098,860   3,051,826 

 

See accompanying condensed notes to unaudited consolidated financial statements.

 

F-2
 

 

PEN INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

  For the Nine Months Ended 
  September 30, 
  2017  2016 
  (unaudited)  (unaudited) 
CASH FLOWS FROM OPERATING ACTIVITIES        
Net loss $(351,508) $(456,528)
Adjustments to reconcile net loss to net cash provided by operating activities:        
Change in inventory obsolescence reserve  50,390   34,184 
Bad debt expense  -   12,034 
Depreciation and amortization expense  100,325   136,598 
Amortization of deferred lease incentives  5,346   9,623 
Gain on sale of property and equipment, net  (527)  (21,866)
Gain on settlement of accounts payable  -   (33,511)
Gain on settlement of accrued salary  -   (36,973)
Loss on disposal of property and equipment  122,050   - 
Stock-based compensation  140,160   151,856 
Change in operating assets and liabilities:        
Accounts receivable  (96,461)  452,113 
Accounts receivable - related party  (3,752)  (28,352)
Inventory  (148,393)  (212,461)
Prepaid expenses and other assets  (5,481)  76,634 
Accounts payable  545,714   41,557 
Accounts payable - related parties  (32,000)  14,823 
Accrued expenses  (112,462)  70,420 
Deferred revenue  70,180   (21,692)
         
NET CASH PROVIDED BY OPERATING ACTIVITIES  283,581   188,459 
         
CASH FLOWS FROM INVESTING ACTIVITIES        
Proceeds from sales of property and equipment  87,000   21,866 
Purchases of property, plant and equipment  -   (4,000)
         
NET CASH PROVIDED BY INVESTING ACTIVITIES  87,000   17,866 
         
CASH FLOWS FROM FINANCING ACTIVITIES        
Proceeds from bank lines of credit  4,964,067   5,193,000 
Repayment of bank lines of credit  (5,383,241)  (5,522,951)
Repayment of bank loans  (56,138)  (55,785)
Proceeds from sale of common stock  -   50,000 
Payment of issuance costs related to sale of common stock  -   (2,000)
Repayment of loan to third party  (10,470)  (4,394)
         
NET CASH USED IN FINANCING ACTIVITIES  (485,782)  (342,130)
         
NET DECREASE IN CASH  (115,201)  (135,805)
         
CASH, beginning of period  189,128   262,519 
         
CASH, end of period $73,927  $126,714 
         
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION        
Cash paid during the period for interest        
Interest $55,554  $82,270 
Income taxes $-  $- 
         
SUPPLEMENTAL DISCLOSURE OF NON-CASH        
INVESTING AND FINANCING ACTIVITIES:        
Reclassification of accrued salary to notes payable - long-term $17,425  $51,239 
Accrued director fees settled with common stock $19,000  $- 

  For the Nine Months Ended 
  September 30, 
  2018  2017 
  (unaudited)  (unaudited) 
CASH FLOWS FROM OPERATING ACTIVITIES        
Net loss $(299,241) $(351,508)
Adjustments to reconcile net loss to net cash provided by operating activities:        
Change in inventory obsolescence reserve  40,678   50,390 
Depreciation and amortization expense  48,404   100,325 
Amortization of deferred lease incentives  -   5,346 
Loss (gain) on sale of property, plant and equipment, net  -   (527)
Loss on disposal of property, plant and equipment  -   122,050 
Stock-based compensation  8,746   140,160 
Change in operating assets and liabilities:        
Accounts receivable  387,076   (96,461)
Accounts receivable - related party  14,226   (3,752)
Inventory  (275,873)  (148,393)
Prepaid expenses and other assets  101,039   (5,481)
Accounts payable  (63,855)  545,714 
Accounts payable - related parties  -   (32,000)
Customer deposits  (149,542)  - 
Accrued expenses  317,797   (112,462)
Deferred revenue  (98,381)  70,180 
         
NET CASH PROVIDED BY OPERATING ACTIVITIES  31,074   283,581 
         
CASH FLOWS FROM INVESTING ACTIVITIES        
Proceeds from sales of property and equipment  -   87,000 
Purchases of property, plant and equipment  (3,917)  - 
         
NET CASH PROVIDED BY INVESTING ACTIVITIES  (3,917)  87,000 
         
CASH FLOWS FROM FINANCING ACTIVITIES        
Proceeds from bank lines of credit  2,198,600   4,964,067 
Repayment of bank lines of credit  (2,230,031)  (5,383,241)
Repayment of bank loans  (54,704)  (56,138)
Repayment of loan to third party  -   (10,470)
Proceeds from advances from related parties  25,000   - 
         
NET CASH USED IN FINANCING ACTIVITIES  (61,135)  (485,782)
         
NET DECREASE IN CASH  (33,978)  (115,201)
         
CASH, beginning of year  233,299   189,128 
         
CASH, end of period $199,321  $73,927 
         
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION        
Cash paid during the period for interest        
Interest $72,092  $55,554 
Income taxes $-  $- 
         
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:        
Reclassification of accrued salary to notes payable - long-term $-  $17,425 
Accrued director fees settled with common stock $19,997  $19,000 

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

Cash $114,321   

73,927

 
Restricted cash  85,000   

-

 
Total cash and restricted cash $199,321  $

73,927

 

 

See accompanying condensed notes to unaudited consolidated financial statements.

 

F-3
 

 

PEN INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 20172018

(UNAUDITED)

 

NOTE 1 –ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

 

PEN Inc. (“we”, “us”, “our”, “PEN” or the “Company”), a Delaware corporation, develops and sells a portfolio of nano-layer coatings, nano-based cleaners, and nano-composite products based on its proprietary technology, and performs nanotechnology product research and development generating revenues through performing contract services.

 

Through our wholly-owned subsidiary, PEN Brands LLC, formerly known as Nanofilm, Ltd., we develop, manufacture and sell consumer and institutional products using nanotechnology to deliver unique performance attributes at the surfaces of a wide variety of substrates. These products are marketed internationally primarily to customers in the optical industry. On May 2, 2017, Nanofilm, Ltd. changed its name to PEN Brands LLC.

 

Through our wholly-owned subsidiary, Applied Nanotech, Inc., we primarily perform design and development services for ourselves and for governmental and private customers.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information. Accordingly, they do not include all the information and disclosures required by US GAAP for annual financial statements. In the opinion of management, such statements include all adjustments (consisting only of normal recurring items) which are considered necessary for a fair presentation of the unaudited consolidated financial statements of the Company as of September 30, 20172018 and for the three and nine months ended September 30, 20172018 and 2016.2017. The results of operations for the three and nine months ended September 30, 20172018 are not necessarily indicative of the operating results for the full year ending December 31, 20172018 or any other period. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related disclosures of the Company as of December 31, 20162017 and for the year then ended, which were filed with the Securities and Exchange Commission on Form 10-K on March 29, 2017.June 15, 2018.

 

Going Concern

 

These consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the consolidated financial statements filed with our Form 10-K on March 29, 2017,June 15, 2018, the Company had a net loss of $556,001$687,068 and $1,869,247$556,001 for the years ended December 31, 20162017 and 2015.2016. Additionally, the Company had a net loss of $124,730$257,921 and $351,508$299,241 for the three and nine months ended September 30, 2017.2018. Furthermore, the Company had an accumulated deficit, a stockholders’ deficit and a working capital deficit of $6,251,675, $770,444$6,886,478, $1,366,504 and $1,033,150,$1,606,365, respectively, at September 30, 2017.2018. These factors raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management cannot provide assurance that the Company will ultimately achieve profitable operations or become cash flow positive, or raise additional debt and/or equity capital. During 20162017 and continuing in the first three quarters of 2017,2018, management has taken measures to reduce operating expenses. Although the Company has historically raised capital from sales of equity, and from the issuance of promissory notes, there is no assurance that it will be able to continue to do so. If the Company is unable to raise additional capital or secure additional lending in the near future, management expects that the Company will need to curtail its operations. These unaudited consolidated financial statements do not include any adjustments related to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

F-4

NOTE 2 –SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

The Company’s consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Applied Nanotech, Inc., PEN Brands LLC and PEN Technology LLC. On December 15, 2016, PEN Technology LLC was merged into PEN Brands LLC. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates for the three and nine months ended September 30, 20172018 and 20162017 include estimates for allowance for doubtful accounts on accounts receivable, the estimates for obsolete inventory, the estimates for cooperative advertising liability, the useful life of property and equipment, assumptions used in assessing impairment of long-term assets, estimates of current and deferred income taxes and deferred tax valuation allowances, the fair value of non-cash equity transactions, and the fair value of equity incentives.

 

Fair Value of Financial Instruments and Fair Value Measurements

 

The Company adopted the guidance of Accounting Standards Codification (“ASC”) 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

 

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

 

Level 2-Inputs are quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.

 

Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

 

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, loans and lines of credit, accounts payable, accrued expenses, and other payables approximate their fair market value based on the short-term maturity of these instruments.

 

The Company analyzes all financial and non-financial instruments with features of both liabilities and equity under the Financial Accounting Standards Board (“FASB”) accounting standard for such instruments. Under this standard, financial and non-financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company accounts for three instruments at fair value using level 3 valuation.

 

  At September 30, 2017  At December 31, 2016  At September 30, 2018  At December 31, 2017 
Description  Level 1  Level 2  Level 3  Level 1  Level 2  Level 3  Level 1 Level 2 Level 3 Level 1  Level 2  Level 3 
Stock Appreciation Rights Plan A  -   -  $54,538   -   -  $53,108   -   -  $-   -   -  $- 
Equity Credits Issued  -   -  $2,278   -   -  $2,278   -   -  $-   -   -  $2,278 

F-5

A rollforward of the level 3 valuation of these three financial instruments is as follows:

 

  Stock Appreciation Rights Plan A  Equity Credits Issued 
Balance at December 31, 2016 $53,108  $2,278 
Change in fair value included in net loss  1,430   - 
Balance at September 30, 2017 $54,538  $2,278 
  Stock
Appreciation
Rights Plan A
  Equity Credits
Issued
 
Balance at December 31, 2017 $-  $2,278 
Change in fair value included in net loss  -   (2,278)
Balance at September 30, 2018 $-  $- 

 

ASC 825-10 “Financial Instruments”, allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.

 

Cash and Cash Equivalents

 

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments with a maturity of three months or less at the purchase date and money market accounts to be cash equivalents. The cash balance included $10,003 which is restricted in its use as it serves as collateral for a credit card.

 

Accounts Receivable

 

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

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out (FIFO) method. At September 30, 20172018 and December 31, 2016,2017, inventory consisted of the following:

 

 September 30, 2017 December 31, 2016  September 30, 2018 December 31, 2017 
Raw materials $660,800  $927,833  $769,820  $595,747 
Work in process  136   -   4,442   - 
Finished goods  753,983   338,643   485,419   388,060 
  1,414,919   1,266,528   1,259,681   983,807 
Less: reserve for obsolescence  (281,417)  (231,027)  (290,507)  (249,828)
Inventory, net $1,133,502  $1,035,499  $969,174  $733,979 

 

Effective January 1, 2017, the Company adopted FASB Accounting Standards Update (“ASU”) No. 2015-11, “Simplifying the Measurement of Inventory,” (“ASU 2015-11”) which requires an entity to measure most inventory at the lower of cost and net realizable value, thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. The adoption of this standard did not have a material impact on the Company’s unaudited consolidated financial statements.

Property and Equipment

 

Property and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives, which range from three to ten years. Leasehold improvements are depreciated over the shorter of the useful life or lease term including scheduled renewal terms. Maintenance and repairs are charged to expense as incurred. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in other income or expense in the year of disposition. The Company examines the possibility of decreases in the value of these assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

 

F-6

Impairment of Long-Lived Assets

 

In accordance with ASC Topic 360, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value. The Company did not record any impairment charge for the three and nine months ended September 30, 20172018 and 2016.2017.

 

Revenue Recognition

 

Pursuant to the guidance of ASC Topic 605, the Company recognizes sales when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the purchase price is fixed or determinable and collectability is reasonably assured.

Types of revenue:

 

Net product sales by our subsidiary PEN Brands LLC.
  
Reimbursements under agreements to perform contract services related to new products and product development for government agencies and others by our subsidiary, Applied Nanotech. We do not perform contracts that are contingent upon successful results. Larger projects are sometimes broken down in phases to allow the customer to determine at the end of each phase if they wish to move to the next phase. The agreements with federal government agencies generally provide that, upon completion of a technology development program, the funding agency is granted a royalty-free license to use any technology developed during the course of the program for its own purposes, but not any preexisting technology that we use in connection with the program. We retain all other rights to use, develop, and commercialize the technology. Agreements with nongovernmental entities generally allow the entity the first opportunity to license the technology from us upon completion of the project.

Product sales and other miscellaneous revenues from our subsidiary, Applied Nanotech such as the sale of conductive inks, graphene foils and thermal management materials.

 

Revenue recognition criteria:

 

Net product sales by our subsidiary PEN Brands LLC, are recognized when the product is shipped to the customer and title is transferred.

Revenue from contract services performed under government contracts is generally recognized when it is earned pursuant to the terms of the contract. These projects are usually billed monthly based on costs, hours, or some other measure of activity during the month and revenue is recognized as services are provided. If there is substantive acceptance terms then revenue will not be recognized until acceptance occurs. The recognition of revenue may not correspond with the billings allowable under the contract. To the extent that billings exceed revenue earned,what we have a portion of the revenue is deferred until it is earned.right to invoice.
Revenue from contract services performed under non-governmental contracts is recognized when it is earned pursuant to the terms of the contract. Each contract is unique and tailored to the needs of the customer and goals of the project. Some contracts may call for a monthly payment for a fixed period of time. Other contracts may be for a fixed dollar amount with an unspecified time period, although there is frequently a targeted completion date. These contracts generally involve some sort of up-front payment. Some contracts may call for the delivery of samples, or may call for the transfer of equipment or other items developed during the project to the customer. These projects are usually billed monthly based on costs, hours, or some other measure of activity during the month and revenue is recognized as services are provided. If there are substantive acceptance terms then revenue will not be recognized until acceptance occurs.

Revenue from other product sales is recognized at the time the product shipped. The Company’s subsidiary Applied Nanotech’s primary business is contract services, not the sale of products. Product sales are generally insignificant in number, and are generally limited to the sale of conductive inks, graphene foils, thermal management materials, samples, proofs of concepts, prototypes, or other items resulting from its contract services.

Other miscellaneous revenue is recognized as deemed appropriate given the facts of the situation and is generally not material.

F-7

 

Sales Incentives and Consideration Paid to Customers

 

The Company accounts for certain promotional costs such as sales incentives and cooperative advertising as a reduction of sales. For the three and nine months ended September 30, 2017 and 20162018 the Company recorded $0 and $0, respectively as a reduction in sales related to sales incentives as compared to $29,526 and $40,471, respectively and $103,031 and $106,262 for the three and nine months ended September 2017 and 2016 respectively, as a reduction of sales related to these costs.30, 2017.

 

The Company has recently become aware ofDuring the year ended December 31, 2017, based on industry trends related to cooperative advertising such that, during the quarter ended September 30, 2017, management now believes it has sufficient data and experience to effect a change in accounting estimate. As a result, the Company recorded a one-time adjustment to reduce its cooperative advertising liability by approximately $346,000$446,000 to $100,000$0 as of September 30,December 31, 2017 with a corresponding $346,000$446,000 increase to product revenue for the three and nine monthsyear ended September 30,December 31, 2017.

 

Cost of Sales

 

Cost of sales includes inventory costs, materials and supplies costs, internal labor and related benefits, subcontractor costs, depreciation, overhead and shipping and handling costs incurred.

 

Shipping and Handling Costs

 

Shipping and handling costs incurred relating to the purchase of inventory are included in inventory which is charged to cost of sales as product are sold. Shipping and handling costs incurred for product shipped to customers are included in cost of sales. For the three months ended September 30, 20172018 and 20162017 shipping and handle costs amounted to $39,102$24,175 and $46,255,$39,102, respectively, and were $136,260$90,615 and $140,059$136,260 for the nine months ended September 30, 20172018 and 2016,2017, respectively.

 

Research and Development

 

Research and development costs incurred in the development of the Company’s products and under other Company sponsored research and development projects are expensed as incurred. Costs such as direct labor, direct costs, and other allocated costs incurred to perform research and development service pursuant to government and private research projects are in included in cost of sales. Research and development costs incurred in the development of the Company’s products for the three months ended September 30, 2018 and 2017 were $1,850 and 2016 were $82,544, and $71,921, respectively, and were $297,697$12,294 and $236,534$297,697 for the nine months ended September 30, 20172018 and 2016,2017, respectively, and are included in operating expenses on the accompanying unaudited consolidated statements of operations.

Advertising Costs

 

The Company participates in various advertising programs. All costs related to advertising of the Company’s products are expensed in the period incurred. Advertising costs charged to operations for the three months ended September 30, 2018 and 2017 and 2016 were $0$279 and $5,193, respectively, and were $14,626$779 and $23,624 for the nine months ended September 30, 20172018 and 2016,2017, respectively, and are included in selling and marketing on the unaudited consolidated accompanying statements of operations. These costs are included in sales and marketing on the consolidated accompanying statements of operations. These advertising expenses do not include cooperative advertising and sales incentives which have been deducted from sales.

 

Federal and State Income Taxes

 

The Company accounts for income tax using the liability method prescribed by ASC 740, “Income Taxes”. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the year in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized as income or loss in the period that includes the enactment date.

 

The Company follows the accounting guidance for uncertainty in income taxes using the provisions of ASC 740“Income Taxes”. Using that guidance, tax positions initially need to be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. As of September 30, 20172018 and December 31, 2016,2017, the Company had no uncertain tax positions that qualify for either recognition or disclosure in the financial statements. Tax years that remain subject to examination are the years ending on and after December 31, 2013. The Company does not expect any significant changes in its unrecognized tax benefits within twelve months of the reporting date. The Company recognizes interest and penalties related to uncertain income tax positions in other expense. However, no such interest and penalties were recorded as of September 30, 20172018 or December 31, 2016.2017.

F-8

On December 22, 2017, H.R. 1, known as the “Tax Cuts and Jobs Act” (the Act), was signed into law. The Act includes a number of changes in existing tax law impacting businesses including, among other things, a permanent change in the corporate income tax rate to a fixed rate of 21%. The new rate took effect on January 1, 2018. As a result, the Company revalued its deferred taxes at December 31, 2017.

 

Stock-Based Compensation

 

Stock-based compensation is accounted for based on the requirements of the Share-Based Payment Topic of ASC 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting period). The ASC also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

 

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the service period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. The Company initially records compensation expense based on the fair value of the award at the reporting date.

Loss Per Share of Common Stock

 

ASC 260 “Earnings Per Share”, requires dual presentation of basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Basic net loss per common share is computed by dividing net loss available to common shareholders by the weighted average number of shares of common shares outstanding during the period. Diluted net loss per common share is computed by dividing net loss by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. As of September 30, 2017,2018, and December 31, 2016,2017, 37,778 contingently issuable common shares that are issuable based on certain market conditions (see Note 8)9) are not included in the potential dilutive shares in calculating the diluted EPS. Additionally, potentially dilutive common shares consist of common stock options and warrants (using the treasury stock method).


These common stock equivalents may be dilutive in the future. Potentially dilutive common shares were excluded from the computation of diluted shares outstanding as they would have an anti-dilutive impact on the Company’s net losses and consisted of the following:

 

 September 30, 2017  December 31, 2016  September 30, 2018  December 31, 2017 
Stock options  20,370   20,483   18,726   19,120 
Stock warrants  712   712   712   712 
Restricted Stock  37,778   37,778   37,778   37,778 
Total  58,860   58,973   57,216   57,610 

 

Additionally, there are an unknown quantity of common stock equivalents that result from a potential conversion of equity credits and stock appreciation rights (See Notes 8 andNote 9).

F-9

 

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

 

Net (loss) income per common shares outstanding: Three Months Ended
September 30, 2017
  Three Months Ended
September 30, 2016
  Nine Months Ended
September 30, 2017
  Nine Months Ended
September 30, 2016
 
Class A common stock $(0.11) $(0.07) $(0.13) $(0.15)
Class B common stock $(0.11) $(0.07) $(0.12) $(0.15)
Class Z common stock $-  $(0.07) $-  $(0.15)
                 
Weighted average shares outstanding:                
Class A common stock  1,645,033   1,358,234   1,502,367   1,346,656 
Class B common stock  1,417,726   1,399,197   1,411,890   1,399,550 
Class Z common stock  -   262,631   137,569   262,631 
Total weighted average shares outstanding  3,062,759   3,020,062   3,051,826   3,006,837 

F-10
Net (loss) income per common shares outstanding: Three Months
Ended
September 30, 2018
  Three Months
Ended
September 30, 2017
  Nine Months
Ended
September 30, 2018
  Nine Months
Ended
September 30, 2017
 
Class A common stock $(0.08) $(0.11) $(0.10) $(0.13)
Class B common stock $(0.08) $(0.11) $(0.10) $(0.12)
                 
Weighted average shares outstanding:                
Class A common stock  1,662,808   1,645,033   1,659,206   1,502,367 
Class B common stock  1,436,052   1,417,726   1,432,251   1,411,890 
Class Z common stock              137,569 
Total weighted average shares outstanding  3,091,457   3,062,759   3,098,860   3,051,826 

 

Segment Reporting

 

The Company uses “the management approach” in determining reportable operating segments. The management approach considers the internal organization and reporting used by the Company’s chief operating decision maker for making operating decisions and assessing performance as the source for determining the Company’s reportable segments. The Company’s chief operating decision maker is the Chairman and chief executive officer (“CEO”) of the Company, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. The Company classified the reportable operating segments into (i) the development, manufacture and sale of consumer and institutional products using nanotechnology to deliver unique performance attributes at the surfaces of a wide variety of substrates (the “Product segment”) and (ii) nanotechnology design and development services for our future products and for government and private entities and sales of products developed for third parties (the “Contract services segment”).

 

Recently Issued Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” (“ASU 2014-09”). ASU 2014-09 supersedes the revenue recognition requirements in ASC 605 - Revenue Recognition (“ASC 605”) and most industry-specific guidance throughout ASC 605. The FASB has issued numerous updates that provide clarification on a number of specific issues as well as requiring additional disclosures. The core principle of ASC 606 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASC 606 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The guidance may be adopted through either retrospective application to all periods presented in the financial statements (full retrospective approach) or through a cumulative effect adjustment to retained earnings at the effective date (modified retrospective approach). The guidance was revised in July 2015 to be effective for public companies for annual and interim periods beginning on or after December 15, 2017.

The Company adopted ASC 606 effective January 1, 2018 using the modified retrospective method. Implementing ASC 606 the Company concluded that no change was required in its accounting for any sources of revenue for the year ended December 3, 2017.

On February 25, 2016, the FASB issued ASU No. 2016-02 (“ASU 2016-02”) to amend the accounting guidance for leases. The accounting applied by a lessor is largely unchanged under ASU 2016-02. However, the standard requires lessees to recognize lease assets and lease liabilities for leases classified as operating leases on the balance sheet. Lessees will recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it will recognize lease expense for such leases generally on a straight-line basis over the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and early adoption is permitted. The Company is currently assessing the impact of the guidance on its consolidated financial statements and notes to its consolidated financial statements.

F-10

In March 2016, the FASB issued ASU No. 2016-09 (“ASU 2016-09”) to amend the accounting guidance for share-based payment accounting. The areas for simplification in ASU 2016-09 involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016. The adoption of this standard did not have a material impact on the Company’s unaudited consolidated financial statements.

 

In May 2017, the FASB issued ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting” (“ASU 2017-09”). ASU 2017-09 provides clarity on the accounting for modifications of stock-based awards. ASU 2017-09 requires adoption on a prospective basis in the annual and interim periods beginning after December 15, 2017 for share-based payment awards modified on or after the adoption date. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its unaudited consolidated financial statements and related disclosures.

 

In July 2017, the FASB issued ASU No. 2017-11, “Earnings Per Share (Topic 260) and Derivatives and Hedging (Topic 815) - Accounting for Certain Financial Instruments with Down Round Features,” (“ASU 2017-11”). Equity-linked instruments, such as warrants and convertible instruments may contain down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under ASU 2017-11, a down round feature will no longer require a freestanding equity-linked instrument (or embedded conversion option) to be classified as a liability that is remeasured at fair value through the income statement (i.e. marked-to-market). However, other features of the equity-linked instrument (or embedded conversion option) must still be evaluated to determine whether liability or equity classification is appropriate. Equity classified instruments are not marked-to-market. For earnings per share (“EPS”) reporting, the ASU requires companies to recognize the effect of the down round feature only when it is triggered by treating it as a dividend and as a reduction of income available to common shareholders in basic EPS. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its unaudited consolidated financial statements.

 

There are no other recently issued accounting standards that apply to us or that are expected to have a material impact on our results of operations, financial condition, or cash flows.

 

Reclassifications

Certain prior period amountsaccounts and financial statement captions in the unaudited consolidated financial statementsprior periods have been reclassified for comparative purposes to conform to the fiscal 2017 presentation. These reclassifications have no impact on the previously reported net loss.current period financial statements.

F-11

 

NOTE 3 –BANK LOANS AND LINES OF REVOLVING CREDIT FACILITY

 

In April 2014, our subsidiary, PEN Brands LLC entered into a $1,500,000 revolving credit line agreement (the “Revolving Note”) with Mackinac Commercial Credit, LLC (the “Lender”) with draws limited to a borrowing base as defined in the Revolving Note. The unpaid principal balance of this Revolving Note is payable on demand, is secured by all of PEN Brands LLC’s assets, and bears interest computed at a rate of interest (the “Effective Rate”) which is equal to 7.0% above the LIBOR Rate, as defined, payable monthly. PEN Brands LLC will pay to Lender a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company may, at any time or from time to time upon three business days’ written notice to Lender, prepay the Note in whole provided that if (i) Borrower prepays the Revolving Note in full and terminates the Revolving Note, or (ii) Lender terminates the Revolving Note after default, then Borrower will pay a termination premium equal to 2.0% of the maximum loan amount. On May 1, 2015, PEN Brands LLC and the Lender entered into an amendment to the Loan and Security Agreement extending the outside maturity date to April 4, 2016 and permitting advances against an expanded borrowing base. The borrowing base was increased by $450,000 through October 31, 2015, with this amount reducing by $7,500 monthly thereafter. In addition, PEN Inc., the parent company, guaranteed PEN Brands LLC’s obligations to the Lender. On April 4, 2016, the maturity date under the Loan & Security Agreement between PEN Brands LLC and the Lender was automatically extended for a one-year renewal term.

F-11

 

Without the Lender’s consent, so long as the obligation remains outstanding, in addition to other covenants as defined in the Revolving Note, PEN Brands LLC shall not a) merge or consolidate with any other company, except for the combination that closed in August 2014Combination and shall not suffer a change of control; b) make any capital expenditures, as defined, materially affecting the business; c) declare or pay cash dividends upon any of its stock, or distribute any of its property, make any loans, make investments, redeem, retire or acquire any of its stock, d) become liable for the indebtedness of anyone else, as defined, and e) incur indebtedness, other than trade payables.

 

On April 3, 2017, PEN Brands LLC and the Lender executed a second amendment to the Revolving Note that extended On April 3, 2017, PEN Brands LLC and the Lender executed a second amendment to the Revolving Note that extended the maturity date to April 4, 2018, with a one-year renewal option. The second amendment also reducedchanged the interest rate to 3.0% above the Prime Rate, as reported in the Wall Street Journal. Under a subsequent amendment, the maturity date was changed to July 3, 2018.

On October 17, 2017, pursuant to the terms of the Revolving Note, the gross proceeds of $85,000 in connection with the Asset Purchase agreement were applied to decrease the borrowing base of the Revolving Note. In connection with the sale of fixed assets, the Company amended the Revolving Note to establish a cash collateral account to be no less than $85,000. Pursuant to this amendment, the Company entered into a loan agreement with two Company directors in the aggregate principal amount of $85,000 in order to fund the cash collateral provision pursuant to the amended loan agreement. The loan bears no interest and is due when cash flow permits, or if earlier, upon the payment or refinancing of the loan from the Lender to PEN Brands.

On March 30, 2018, PEN Brands and the lender entered into the fourth amendment that permits the borrower to request up to three advances of not more than $200,000 each supported by certain qualifying purchase orders. Each purchase order advance to be repaid in not less than 30 days. No subsequent request can be made until any prior purchase order advance has been repaid. Two of the Company’s officers and directors have personally guaranteed repayment of purchase order advances. The fourth amendment also changes the maturity date for the loan to July 3, 2018. That date becomes the date for an automatic one-year renewal unless either the lender or the borrower gives notice of non-renewal. Other terms and conditions of the agreement remain the same.

On August 8, 2018, PEN Brands and the lender entered into the fifth amendment with an effective date of July 3, 2018. The fifth amendment renewed the agreement through July 3, 2019 and provides for an automatic one-year renewal at that time unless it is terminated by either party 60 days in advance. The fifth amendment also limits the amounts that PEN Brands can advance to its parent, and provides that advances based on eligible inventory will reduce monthly by $7,500 per month starting November 1, 2018.

 

At September 30, 20172018 and December 31, 2016,2017, the Company had $689,232$522,893 and $979,688,$563,218, respectively, which includes accrued interest of $10,324$14,097 and $17,494,$14,797, respectively, in amounts outstanding under the Revolving Note with availability of up to $810,768$977,107 as of September 30, 2017,2018, depending on the borrowing base at the time of the request for the advance. The weighted average interest rate during the nine months ended September 30, 20172018 and 20162017 was approximately 6.8%7.8% and 8.1%6.8%, respectively.

 

See Note 12 – Subsequent Events for additional details on the Revolving Note.

 

NOTE 4 –NOTES PAYABLE

On February 10, 2015, Nanofilm entered into a promissory note (the “Equipment Note”) with KeyBank, N.A. (the “Bank”) to borrow up to $373,000. Nanofilm may obtain one or more advances not to exceed $373,000. The unpaid principal balance of this Equipment Note is payable in 60 equal monthly installments payments of principal and interest through June 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. At December 31, 2017, the principal amount due under the Equipment Note amounted to $179,399. As of June 30, 2018, $74,381 and $68,622, represent the current and non-current portion due under this note.

 

In June and November 2015, in connection with a severance package offered to four employees, the Company entered into four promissory note agreements with the four employees which obligate the Company to pay these employees accrued and unpaid deferred salary in an aggregate amount of $51,808. The principal amounts due under these notes shall bear interest at the minimum rate of interest applicable under the internal revenue code (approximately 3.0% at December 31, 2018). All principal and interest payable under three of these notes aggregating $41,178 are due in 2025 and all principal and interest payable under one of these notes amounting to $15,813 are due in 2020. Accordingly, $51,808 is included in non-current notes payable.

On May 31, 2016, in connection with a restatement of our agreement with a former research partner, we delivered a promissory note to repay amounts previously advanced to us and accrued. The initial principal amount was $51,239 bearing interest at 5% per annum. Installment payments include both principal and interest. After an initial payment of $2,000, the note requires payments of $1,000 for eleven months, payments of $2,000 for the following 12 months and monthly payments of $3,000 thereafter until paid in full. The principal balance due on December 31, 2017 was $28,351, all classified as a current liability. At March 31, 2018 the principal balance due was $22,682.05 all classified as a current liability.

January 2017, wethe Company issued a promissory note in the principal amount of $17,425 to a departing employee representing the amount of his accrued and unpaid salary. The note does not bear interest and is due in January 2027.2027, and is included in non-current notes payable.

Future principal payments of notes payable are as follows:

Year 

As of

September 30, 2018

  

As of

December 31, 2017

 
2018 $ 26,712  $96,533 
2019  74,380   74,380 
2020  51,540   51,540 
2021  -   - 
2022  -   - 
Thereafter  54,882   54,883 
Total $207,515  $277,336 

 

NOTE 5 –RELATED PARTY TRANSACTIONS

 

Sales to Related Party

During the three and nine months ended September 30, 2017 and 2016, the Company engaged in certain sales transactions with a company which is a shareholder and related to a director of the Company. Sales to the related party totaled $26,093 and $52,328 for the three months ended September 30, 2017 and 2016, respectively. and totaled $138,004 and $148,624 for the nine months ended September 30, 2017 and 2016. Accounts receivable from the related party totaled $14,227 at September 30, 2017 and $10,474 at December 31, 2016. As of May 23, 2017, that director no longer served on the Company’s Board and the shareholder was no longer an affiliate.

Other

A board member is a principal in DHJH Holdings LLC, the firm that provided the services of the Company’s chief financial officer from May 2016 through February 2017. The Company recognized no fees and expenses during the three months ended September 30, 2017 and 2016 and $0 and $13,195 in fees and expenses during the nine months ended September 30, 2017 and 2016, respectively.

As of September 30, 2017,2018, the Company included the following within accounts payable-related parties: $1,000 ofin accrued director fees and $19,887$159,887 due to certain of the Company’s executives, and $514,947 in accrued payroll to certain of the Companies executives.

F-12

 

NOTE 6 -STOCKHOLDERS’ EQUITY

 

Description of Preferred and Common Stock

 

On December 11, 2015, the Board of Directors of the Company approved a reverse stock split of the issued and outstanding shares of the Company’s common stock at the ratio of 1-for-180 (the “Reverse Stock Split”) and authorized an amendment of the Company’s Amended and Restated Certificate of Incorporation, as amended, to effect the Reverse Stock Split, to reduce the number of authorized shares of common stock, and to set a par value of $0.0001 per share after the Reverse Stock Split. On January 26, 2016, each one hundred eighty (180) shares of the Company’s (i) Class A Common Stock (“Class A common stock”), (iii) Class B Common Stock and (iii) Class Z Common Stock, then issued and outstanding were automatically combined into one (1) validly issued, fully paid and non-assessable share of Class A Common Stock, Class B Common Stock and Class Z Common Stock, respectively, without any further action by the Company or the holder. Additionally, the authorized number of shares of common stock were reduced to 10,000,000 comprised of 7,200,000 shares of Class A Common Stock, 2,500,000 shares of Class B Common Stock (“Class B common stock”), and 300,000 shares of Class Z Common Stock (“Class Z common stock”). The par value of each class of common stock remained the same at $0.0001 per common share. All share and per share data in the accompanying unaudited consolidated financial statements have been retroactively restated to reflect the effect of the Reverse Stock Split and authorized shares. The Company is also authorized to issue 20,000,000 shares of Preferred Stock, par value $0.0001 per share (“preferred stock”).

 

Preferred Stock

 

The preferred stock may be issued in one or more series. The Company’s board of directors are authorized to issue the shares of preferred stock in such series and to fix from time to time before issuance thereof the number of shares to be included in any such series and the designation, powers, preferences and relative, participating, optional or other rights, and the qualifications, limitations or restrictions thereof, of such series.

 

Common Stock – General

 

The rights of each share of Class A common stock, each share of Class B common stock and each share of Class Z common stock are the same with respect to dividends, distributions and rights upon liquidation.

 

Class A Common Stock

 

Holders of the Class A common stock are entitled to one vote per share in the election of directors and other matters submitted to a vote of the stockholders.

 

Class B Common Stock

 

Conversion Rights. Shares of Class B common stock can be converted, one-for-one, into shares of Class A common stock at any time at the option of the holder. Shares of Class B common stock will automatically be converted into shares of Class A common stock if the shares of Class B common stock are not owned by the Company’s chief executive officer, his spouse, or their descendants and their spouses, or by entities or trusts wholly-owned by them.

 

Voting Rights Holders of PEN Class B common stock are entitled to 100 votes per share in the election of directors and other matters submitted to a vote of the stockholders.

Class Z Common Stock

 

Conversion Rights. Shares of Class Z common stock can be converted, one-for-one, into shares of Class A common stock at any time at the option of the holder. Shares of Class Z common stock will automatically be converted into shares of Class A common stock if the shares of Class Z common stock are not owned by Zeiss or an entity wholly owned by the ultimate parent of Zeiss.

 

Voting Rights. Holders of PEN Class Z common stock do not vote in the election of directors or otherwise, but they do have the right to designate a director to the PEN Board, have anti-dilution rights described below and have consent rights with respect to certain amendments to PEN’s certificate of incorporation.

 

Other Rights. The Class Z common stock has anti-dilutive rights that, subject to limited exceptions, permit holders of Class Z common stock to purchase additional shares or equity rights issued by PEN (on the same terms as made available to third parties by PEN) to maintain their economic ownership percentage. The holders of Class Z common stock are also entitled to receive a copy of any notice sent to the holders of Class A common stock or Class B common stock, as and when the notice is sent to such holders.

 

F-13

Issuances of Common Stock

 

Common Stock Issued for Services

 

On February 24, 2017,28, 2018, the Company issued an aggregate of 3,8464,443 shares of Class A common stock and 2,5642,962 shares of Class B common stock to the Company’s directors as paymentcompensation to them for their service on the Company’sits board. These shares were valued on thethat date of grant at $1.56$1.35 per share based on the quoted price of the stock for a total value of $10,000 recognized as stock-based compensation expense.$10,000. On that same day, the Company issued 6,746 shares of Class B common stock in satisfaction of the outstanding equity credits.

 

On April 28, 2017,May 23, 2018, the Company issued an aggregate of 10,0005,043 shares of Class A common stock and 12,3083,362 shares of Class B common stock to the Company’s directors as paymentcompensation to them for their service on the Company’sits board. TheThese shares issued included 4,617 Class A and 3,078 Class B shares as compensation for attendance at the meetingwere valued on that date and the rest were issued in payment of $19,000 in accrued director fees from a prior year. These shares are valued were valued on the date of grant of April 28, 2017 at $1.30$1.19 per share based on the quoted price of the stock for a total value of $29,000 with $10,000 recognized as stock-based compensation expense.$10,000.

 

On July 28, 2017, the Company issued an aggregate of 4,800 shares of Class A common stock and 3,200 shares of Class B common stock to the Company’s directors as payment for their service on the Company’s board. These shares were valued on the date of grant at $1.25 per share based on the quoted closing price of the stock for a total value of $10,000 recognized as stock-based compensation expense.

Stock Options

 

Stock options outstanding are to purchase Class A common stock. Stock option activities for the nine months ended September 30, 20172018 are summarized as follows:

 

  Number of Options  Weighted Average Exercise Price  Weighted Average Remaining Contractual Term (Years)  Aggregate Intrinsic Value 
Outstanding December 31, 2016  20,483  $41.77                       
Exercised  -   -         
Expired  (113)  230.40         
Outstanding September 30, 2017  20,370  $40.72   3.26  $- 
                 
Exercisable September 30, 2017  10,370  $77.28   2.72  $- 
  Number of
Options
  Weighted
Average
Exercise Price
  Weighted
Average
Remaining
Contractual
Term (Years)
  Aggregate
Intrinsic
Value
 
Outstanding December 31, 2017  19,120  $29.38   3.21     
Exercised  -             
Expired  (394)            
Outstanding September 30, 2018  18,726  $29.09   2.53  $- 
                 
Exercisable September 30, 2018  8,726  $59.21   2.19  $- 

 

Contingently Issuable Class A Common Shares

 

On August 27, 2014, the Company entered into a Restricted Stock Agreement with Dr. Zvi Yaniv, the former Chief Operating Officer and President, of Applied Nanotech, and a current employee of the Company granting Dr. Yaniv 37,778 shares of Class A common stock, subject to forfeiture. All these shares become vested and not subject to forfeiture on the earlier of a change of control of the Company, Dr. Yaniv’s death, or if more than 180 days after closing, the average trading price of the shares during a measurement period of ten consecutive trading days reaches certain price thresholds. At an $18.00 price, 5,554 shares vest, with additional tranches of 5,556 shares vesting if the price reaches $27.00, $36.00, $45.00 and $54.00. The last 10,000 shares vest at a $63.00 price threshold.

 

Any shares that have not vested five years after the effective date will be forfeited. The Company also entered into a Piggyback Registration Rights Agreement that will allow Dr. Yaniv, subject to other customary terms and conditions, to register shares that are no longer subject to forfeiture if the Company is registering its shares. Pursuant to ASC 718-10 and related subsections, these shares were valued on the date of grant of August 27, 2014 at $13.12 per share for a total value of $495,720. The Company estimates the fair value of the awards with market conditions using a Binomial simulation, which utilizes several assumptions including the risk-free interest rate, the volatility of the Company’s stock and the exercise behavior of award recipients. The grant-date fair value of $495,720 of the awards will be recognized over the requisite service period of 3 years, which represents the derived service period for the stock grant as determined by the Binomial simulation method. For the three months ended September 30, 20172018 and 2016,2017, in connection with the amortization of the fair value of this stock grant, the Company recorded stock-based compensation of $27,540 and $41,310 respectively, and $110,160 and $123,930, for the nine months ended September 30, 20172018 and 2016,2017, respectively. At September 30, 2017,2018, there is no unamortized stock-based compensation expense to be recognized in future periods.

F-14

 

Conversion of Class Z Common Stock

 

On May 23, 2017, Zeiss converted 262,631 shares of Class Z common stock into 262,631 shares of Class A common stock. Immediately thereafter, Zeiss sold 262,631 shares of Class A common stock to certain buyers which included the Company’s Chief Executive Officer for an aggregate of $100,000. In addition, pursuant to the certificate of incorporation, Zeiss’ Board representation automatically terminated and, as a result, Zeiss ceased to be a related party as of May 23, 2017.

 

F-15

NOTE 7 –CONCENTRATIONS

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable and cash deposits and investments in cash equivalent instruments.

 

Lender Concentration

 

The Company relies primarily on one lender under a $1,500,000 Revolving Note.

 

Customer Concentrations

 

Customer concentrations for the nine months ended September 30, 20172018 and 20162017 are as follows:

 

  Revenues 
  For the Nine Months Ended
September 30,
 
  2017  2016 
Customer A  32%  32%
Customer B  12%  14%
Total  44%  46%

  Revenues 
  

For the Nine Months EndedSeptember 30,

 
  2018  2017 
Customer A  10%  *%
Customer B  *%  32%
Customer C  *%  12%
Total  10%  44%

 

 Accounts Receivable  Accounts Receivable 
 As of
September 30,
 As of
December 31,
  As of As of 
 2017 2016  September 30, 2018 December 31, 2017 
Customer A  43%  14%  22%  *%
Customer B  14%  16%  13%   *%
Customer C  *%  15%  13%  *%
Customer D  10%  *%
Customer E  *%  30%
Customer F  *%  21%
Total  57%  45%  58%  51%

 

*Less than 10%

 

A reduction in sales from or loss of such customers would have a material adverse effect on our consolidated results of operations and financial condition.

 

Geographic Concentrations of Sales

 

For the nine months ended September 30, 20172018 and 2016,2017, total sales in the United States represent approximately 88%94% and 91%88% of total consolidated revenues, respectively. No other geographical area accounting for more than 10% of total sales during the nine months ended September 30, 20172018 and 2016.2017.

F-15

Vendor Concentrations

 

Vendor concentrations for inventory purchases for the nine months ended September 30, 20172018 and 20162017 are:

 

  For the Nine Months Ended
September 30,
 
  2017  2016 
Vendor A  26%  31%
Vendor B  *%  11%
Vendor C  12%  *%
Total  38%  42%

  For the Nine Months Ended September 30, 
  2018  2017 
Vendor A  22%  26%
Vendor B  17%   *%
Vendor C  10%  12%
Vendor D  10%  *%
Total  59%  38%

 

*Less than 10%

 

NOTE 8 –EQUITY CREDITS

 

In 1997, PEN Brands LLC established The Equity Credit Incentive Program. This program enabled select employees the opportunity to purchase equity credits that increase in value based upon an increase in PEN Brands LLC’s revenue over a base year of 1996. Eligible credits can be redeemed after two years at the equity credit value for that year. Under certain circumstances, the equity credits are convertible into PEN Brands LLC equity on a one-for-one basis. During the three months ended September 30, 2017,2018, no equity credits were forfeited and no units were redeemed. As of September 30, 2017 and2018, no equity credits were outstanding. At December 31, 2016,2017, 8,250 equity credits were issued and outstanding with an aggregate redemption value of $2,278. At September 30, 20172018 zero, and at December 31, 2016,2017, $2,278 was accrued, and included in accrued expenses, representing the redemption value associated with the equity credits then outstanding.

 

F-16

Under the terms of the Plan, when the Company completes a registered offering of its common stock, the equity credit participants will have the option to convert the equity credits into Class A common shares of the Company, or in the case of our President, into shares of Class B common stock.

 

NOTE 9 –STOCK APPRECIATION PLAN

 

From June 1, 1988, until December 31, 1997, when the plan was terminated, PEN Brands LLC had in place a Stock Appreciation Rights Plan A (the “Plan”), intended to provide employees, directors, members of a technical advisory board and certain independent contractors selected by the Board with equity-like participation in the growth of PEN Brands LLC. The maximum number of stock appreciation rights that could be granted by the Board was 1,000,000.

 

There were 235,782 fully vested stock appreciation rights (“SARS”) outstanding under the terms of the Plan at September 30, 20172018 and December 31, 2016.2017. The SARS unit value is based on the book value of the Company as of the last fiscal year end multiplied by a SARS multiplier stipulated in the SARS plan. However, in the event of an initial public offering (“IPO”) of PEN Brands, the SARS are redeemable based on a value equal to offering price of the stock in an IPO times the total outstanding shares of the Company just subsequent to the completion of the IPO, multiplied by the SARS multiplier. The SARS multiplier is to be adjusted, as the Board determines, to reflect changes in the capitalization of PEN Brands LLC. Generally, the SARS are redeemable in cash, at their then fair value as computed pursuant to the Plan, in the event of termination of employment or business relationship, death, permanent and total disability, or sale of PEN Brands (as defined). Upon an IPO, SARS are to be redeemed by applying 70% of the redemption value to purchase common shares, with the remaining 30% being distributed in cash to the participant.

 

The business combination completed in August 2014 did not qualify as an IPO under the Plan; however, a future underwritten registered offering may qualify.

 

The accrued redemption value associated with the stock appreciation rights amounted to $54,538 and $53,108, at September 30, 20172018 and December 31, 2016,2017, respectively. If the Company completes an IPO, the value of SARS calculated based on the IPO formula may cause a material increase in the value of the liability.

F-17

 

NOTE 10 –SEGMENT REPORTING

 

The Company’s principal operating segments coincide with the types of products to be sold. The products from which revenues are derived are consistent with the reporting structure of the Company’s internal organization. The Company’s two reportable segments for the three and nine months ended September 30, 20172018 and 20162017 were the Product segment and ii) the Contract services segment (formerly the research and development segment). The Company’s chief operating decision-maker has been identified as the Chairman and CEO, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Segment information is presented based upon the Company’s management organization structure as of September 30, 20172018 and the distinctive nature of each segment. Future changes to this internal financial structure may result in changes to the reportable segments disclosed. There are no inter-segment revenue transactions and, therefore, revenues are only to external customers. As the Company primarily generates its revenues from customers in the United States, no geographical segments are presented.

 

Segment operating profit is determined based upon internal performance measures used by the chief operating decision-maker. The Company derives the segment results from its internal management reporting system. The accounting policies the Company uses to derive reportable segment results are the same as those used for external reporting purposes. Management measures the performance of each reportable segment based upon several metrics, including net revenues, gross profit and operating loss. Management uses these results to evaluate the performance of, and to assign resources to, each of the reportable segments. The Company manages certain operating expenses separately at the corporate level and does not allocate such expenses to the segments. Segment income from operations excludes interest income/expense and other income or expenses and income taxes according to how a particular reportable segment’s management is measured. Management does not consider impairment charges, and unallocated costs in measuring the performance of the reportable segments.

F-17

Segment information available with respect to these reportable business segments for the three and nine months ended September 30, 20172018 and 20162017 was as follows:

  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
  2017  2016  2017  2016 
Revenues:            
Product segment $1,772,960  $1,781,755  $5,523,785  $5,391,305 
Contract services segment  255,301   225,083   723,435   804,522 
Total segment and consolidated revenues $2,028,261  $2,006,838  $6,247,220  $6,195,827 
                 
Gross profit:                
Product segment $651,921  $664,768  $2,286,564  $2,215,676 
Contract services segment  (18,939)  (33,685)  (64,008)  (60,383)
Total segment and consolidated gross profit $632,982  $631,083  $2,222,556  $2,155,293 
                 
Income (loss) from operations:                
Product segment $224,228  $108,634  $535,846  $409,115 
Contract services segment  (73,449)  (91,391)  (219,084)  (248,765)
Total segment income  150,779   17,243   316,762   160,350 
Unallocated costs  (198,910)  (253,015)  (659,049)  (763,257)
Total consolidated loss from operations $(48,131) $(235,772) $(342,287) $(602,907)
                 
Depreciation and amortization:                
Product segment $28,769  $34,516  $89,795  $103,546 
Contract services segment  2,679   7,826   10,530   33,052 
Total segment depreciation and amortization  31,448   42,342   100,325   136,598 
Unallocated depreciation  -   -   -   - 
Total consolidated depreciation and amortization $31,448  $42,342  $100,325  $136,598 
                 
Capital additions:                
Product segment $-  $-  $-  $4,000 
Contract services segment  -   -   -   - 
Total segment capital additions  -   -   -   4,000 
Unallocated capital additions  -   -   -   - 
Total consolidated capital additions $-  $-  $-  $4,000 

 

  September 30, 2017  December 31, 2016 
Segment total assets:        
Product segment $2,330,603  $2,577,034 
Contract services segment  169,937   146,193 
Corporate  72,838   70,504 
Total consolidated total assets $2,573,378  $2,793,731 
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
  2018  2017  2018  2017 
Revenues:                
Product segment $383,000  $1,772,960  $2,445,132  $5,523,785 
Contract services segment $382,957   255,301  $1,131,803   723,435 
Total segment and consolidated revenues $765,957  $2,028,261  $3,576,935  $6,247,220 
Cost of revenues:                
Products $350,969  $1,121,039  $1,806,472  $3,237,221 
Contract services segment $290,810  $274,240  $882,123  $787,443 
Total segment and consolidated cost of revenues $641,779  $1,395,279  $2,688,595  $4,024,664 
                 
Gross profit (loss):                
Product segment $32,031  $651,921  $638,660  $2,286,564 
Contract services segment  92,147   (18,939)  249,680  $(64,008)
Total segment and consolidated gross profit $124,178  $632,982  $888,340  $2,222,556 
Gross margin:                
Product segment  8.4%  36.8%  26.1%  41.4%
Contract services segment  24.1%  -7.4%  22.1%  -8.8%
Total gross margin  16.2%  31.2%  24.8%  35.6%
Segment operating expenses:                
Product segment  258,061   427,693   851,368   1,750,718 
Contract services segment  46,863   54,510   148,901   155,076 
Total segment operating expenses  304,924   482,203   1,000,269   1,905,794 
                 
Income (loss) from operations:                
Product segment $(226,030) $224,228  $(212,708) $535,846 
Contract services segment  45,284   (73,449)  100,779   (219,084)
Total segment income (loss)  (180,746)  150,779   (111,929)  316,762 
Unallocated costs  (102,922)  (198,910)  (415,784)  (659,049)
Total consolidated income (loss) from operations $(283,667) $(48,131) $(527,713) $(342,287)
                 
Depreciation and amortization:                
Product segment $16,143  $28,769  $48,404  $89,795 
Contract services segment  -   2,679   -   10,530 
Total segment depreciation and amortization  16,143   31,448   48,404   100,325 
Unallocated depreciation  -   -   -   - 
Total consolidated depreciation and amortization $16,143  $31,448  $48,404  $100,325 
                 
Capital additions:                
Product segment $-  $-  $-  $- 
Contract services segment  3,917   -   3,917   - 
Total segment capital additions  3,917   -   3,917   - 
Unallocated capital additions  -   -   -   - 
Total consolidated capital additions  3,917  $-   3,917  $- 

  September 30, 2018  31-Dec-17 
Segment total assets:        
Product segment $1,614,141  $1,982,579 
Contract services segment  202,983   168,740 
Corporate  18,539   29,956 
Total consolidated total assets $1,835,663  $2,181,275 

F-18

 

NOTE 11 -11-COMMITMENTS AND CONTINCENGIESCONTINGENCIES

Equity Credits

Equity credits may become convertible into an unknown amount of capital stock of the Company to be determined by the Company’s board of directors (See Note 8).

 

Stock Appreciation Rights

 

If the Company completes an IPO, the value of stock appreciation rights calculated based on the IPO formula may cause a material increase in the value of the liability (See Note 9).

 

Litigation

 

The Company may be, from time to time, subject to various administrative, regulatory, and other legal proceedings arising in the ordinary course of business. We are not currently a defendant in any proceedings. Our policy is to accrue costs for contingent liabilities, including legal proceedings or unasserted claims that may result in legal proceedings, when a liability is probable and the amount can be reasonably estimated.

Lease for Real Property

On September 20, 2017, the Company entered into a three-year lease agreement for 22,172 square feet of office space in Brooklyn Heights, Ohio beginning September 20, 2017 and ending September 20, 2020. Monthly lease payments amount to $8,688 for a total of approximately $312,768 for the total term of the lease.

 

NOTE 12 -SUBSEQUENT EVENTS

 

SaleSales of Fixed AssetsCommon Stock and Derivate Equity Securities

Grant of Registration Rights

 

SubsequentOn October 15, 2018, we sold 590,847 shares of Class A common stock for a purchase price of $0.50 per share in a private placement for aggregate proceeds of $295,423. Purchasers were PEN Comeback, LLC and Scott & Jeanne Rickert. Ronald Berman, one of our directors, and his son, Tom Berman have reported that they each have 50% control of PEN Comeback. Immediately prior to Septemberthis sale, Tom Berman was elected as our President and as President of PEN Brands that operates as our Products segment. Tom Berman was also elected to our board.

On that day we also sold to PEN Comeback options to acquire up to an additional 550,847 shares at an option exercise price of $1.00 per share, exercisable at any time before June 30, 2017,2019; and warrants to purchase up to 550,847 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the Companyearlier of (1) 45 days after the day that our Class A common stock has been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. We also sold additional “warrant options” to purchase warrants. For each share purchased under an option described above, the warrant options entitle PEN Comeback investor can purchase at a price of $0.03 per warrant a warrant to purchase an additional share at an exercise price of $2.00 per share. If purchased, these warrants will expire on the earlier of (1) 45 days after the day that Class A shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the options, warrants and warrant options were $49,576.

On October 15, 2018, we also entered into an asset purchase agreement (the “Asset Purchase Agreement”)that granted to PEN Comeback one demand registration right that is exercisable if certain warrants issued to that investor result in which certain machinery and equipmentproceeds to us of $1 million or more. If the demand is exercised, the investor can register common shares purchased, including common shares purchased directly or upon exercise of the Company has beenoptions or warrants issued to the investor.

F-19

On or about October 15, 2018 as part of the terms for the stock sale, the Rickerts and their family partnership exercised the right to convert Class B shares into Class A shares on a 1:1 basis resulting in the issuance of 1,436,052 shares of Class A common stock. The Rickerts also agreed to forgiveness of accrued salary owed to them and agreed to each receive a salary of $1,000 per month for 2018 and 2019.

On January 31, 2019, we sold an additional 325,581 shares of Class A common stock in a private placement to PEN Comeback at a third partyper share price of $0.40 for aggregate gross proceeds of $85,000.$130,232. At the same time the investor bought warrants to purchase up to 325,581 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that PEN shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the warrants were $9,767.

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

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

 

Amended Loan AgreementStock for Services

On October 15, 2018, we issued an aggregate of 20,000 shares of Class A common stock to the Company’s directors as compensation to them for service on our board. These shares were valued on that date at $0.50 per share based on the price paid in the private placement for a total value of $10,000. On that date 1,774 shares of Class A common stock were issued to fully retire the last outstanding equity credits.

On December 5, 2018, we issued an aggregate of 30,000 shares of Class A common stock to our directors as compensation to them for service on our Board. These shares were valued on that date at $0.40 per share based on the quoted price of the stock for a total value of $12,000.

 

On October 17, 2017, pursuantApril 3, 2019, we issued an aggregate of 18,180 shares of our Class A common stock to five of our directors as compensation to them for service on our Board. The shares were valued at $0.55 per share based on the termsquoted price of the Revolving Note,stock for a total value of $10,000. On that date the gross proceedsBoard also granted to our President an option to purchase up to 550,000 shares of our Class A common stock at a price of $0.55 per share. Under that option, the right to purchase 50,000 shares vested on the date of grant, the right to purchase up to 75,000 shares will vest on December 31, 2019, the right to purchase 100,000 shares will vest on June 30, 2020, and the right to purchase up to 125,000 shares will vest on December 31, 2020 and two tranches entitling him to purchase 100,000 shares will vest if he reaches the cap for cash payments under the bonus program in 2019 or 2020. All rights to purchase have a term of 5 years from date of vesting.

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

Lease for Real Property

On December 10, 2018, we entered into a five-year lease agreement for 3,742 square feet of space for the design facility in Austin, beginning January 2019 and ending February 29, 2024. Monthly lease payments start at $3,472 per month, increasing 3% each year for a total of approximately $238,440 over the term of the lease.

Lender Pay-Off

On January 31, 2019, PEN Brands paid $172,101 to its secured lender, MBank. This payment, and the application of $85,000 in connection with the Asset Purchase agreement were applied to decrease the borrowing base of the Revolving Note. In connection with the sale of fixed assets, the Company amended the Revolving Note to establish a cash collateral account to be no less than $85,000. Pursuant to this amendment,held by MBank paid in full the Company entered into a loan agreement with two Company directors in the aggregateoutstanding principal amount of $85,000 in order to fund the cash collateral provision pursuantbalance, accrued interest and fees due to the amended loan agreement.lender. The loan bears no interestparties also terminated the revolving credit line agreement and is due when cash flow permits, or if earlier, upon the payment or refinancing of the loan from the Lender to PEN Brands.note originally executed in April 2014 that was renewed in August 2018.

 

F-20
 

 

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

 

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 nine months ended September 30, 20172018 were (i) the Product Segment and (ii) the Contract services Segment. For the three and nine months ended September 30, 2016,2017, 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 nine months ended September 30, 20172018 and 2016.2017.

 

Comparison of Results of Operations for the Three and Nine Months ended September 30, 20172018 and 20162017

 

Revenues:

 

For the three and nine months ended September 30, 20172018 and 2016,2017, revenues consisted of the following:

 

 Three Months Ended
September 30,
  Nine Months Ended
September 30,
  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
 2017  2016  2017  2016  2018  2017  2018  2017 
Sales:                         
Product segment $1,772,960  $1,781,755  $5,523,785  $5,391,305  $383,000  $1,772,960  $2,445,132  $5,523,785 
Contract services segment $255,301   225,083   723,435   804,522  $382,957   255,301   1,131,803   723,435 
Total segment and consolidated sales $2,028,261  $2,006,838  $6,247,220  $6,195,827  $765,957  $2,028,261  $3,576,935  $6,247,220 

 

For the three months ended September 30, 2017,2018, sales from the Product segment were essentially flat, decreasingdown by $8,795$1,389,960 or 78% as compared to the three months ended September 30, 2016.2017. For the nine months ended September 30, 20172018 revenue from the Product segment increased slightlywas down by $132,480$3,078,653 or 2%,56% as compared to the nine months ended September 30, 2016.2017. During the three and nine months ended September 30, 2017,2018, we recorded a one-time adjustment to Product revenues as a result of our change in estimate related to our cooperative advertising liability, which resulted in an increase of $346,353 to Product revenues on the statements of operations. The drop in Product segment revenue reflects the loss of two major customers that occurred in May 2018.

For the three months ended September 30, 2017,2018, sales from the Contract services segment increased by $30,218$127,656 or 13%50% as compared to the three months ended September 30, 20162017 because of the final award of several new government contracts. For the nine months ended September 30, 20172018 revenue from the Contract services segment decreasedincreased by $81,087$408,368 or 10%56%, as compared to the nine months ended September 30, 20162017. Results for the Contract services segment in 2017 reflected a decrease in revenue because of researchthe completion of government contracts that were completedwhile the none-month period in prior periods that were not replaced.2018 benefited from new contract awards.

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 ended September 30, 2017,2018, cost of revenues was essentially flat, increasingdown by $19,524$753,500 or 1%54 % as compared to the three months ended September 30, 2016.2017. For the nine months ended September 30, 2017,2018, cost of revenues was essentially flat, decreasing $15,870down by $1,334,216 or 0%60%. These changes consisted of the following:

 

 Three Months Ended
September 30,
  Nine Months Ended
September 30,
  Three Months Ended
September 30,
 Nine Months Ended
September 30,
 
 2017  2016  2017  2016  2018 2017 2018 2017 
Cost of revenues:                         
Product segment $1,121,039  $1,116,987  $3,237,221  $3,175,629  $350,969 $1,121,039 $1,806,472 $3,237,221 
Contract services segment  274,240   258,768   787,443   864,905   290,810  274,240  882,123  787,443 
Total segment and consolidated cost of revenues $1,395,279  $1,375,755  $4,024,664  $4,040,534  $641,779 $1,395,279 $2,688,595 $4,024,664 

 

Gross profit and gross margin

 

For the three months ended September 30, 2017,2018, gross profit amounted to $632,982$124,178 as compared to $631,083$632,982 for the three months ended September 30, 2016, an increase2017, a decrease of $1,899.$508,804 or 80%. For the three months ended September 30, 2017 and 2016,2018, gross margin was essentially unchanged atdecreased to 16.2% from 31.2% and 31.4%, respectively.in the prior period. For the nine months ended September 30, 2017,2018, gross profit amounted to $2,222,556$888,340 as compared to $2,155,293$2,222,556 for the nine months ended September 30, 2016, an increase2017, a decrease of $67,263$1,334,216 or 3%60%. For the nine months ended September 30, 2017 and 2016,2018, gross margins weremargin was 24.8%, down from 35.6% and 34.8%, respectively, essentially unchanged.in the prior period.

 

Gross profit and gross margin by segment isare as follows:

 

 Three Months Ended September 30,  Nine Months Ended September 30,  Three Months Ended September 30,  Nine Months Ended September 30, 
 2017 % 2016 % 2017 % 2016 %  2018 % 2017 % 2018 % 2017 % 
Gross profit:                                                                
Product segment * $651,921   36.8% $664,768   37.3% $2,286,564   41.4% $2,215,676   41.1% $32,031   8.4% $651,921   36.8% $638,660   26.1% $2,286,564   41.4%
Contract services segment *  (18,939)  (7.4)%  (33,685)  (15.0)%  (64,008)  (8.8)%  (60,383)  (7.5)%  92,147   24.1%  (18,939)  (7.4)%  249,680   22.1%  (64,008)  (8.8)%
Total gross profit $632,982   31.2%  631,083   31.4%  2,222,556   35.6%  2,155,293   34.8% $124,178   16.2%  632,982   31.2% $888,340   24.8% $2,222,556   35.6%

 

* Gross margin % based on respective segments revenues.

 

For the three and nine months ended September 30, 2017,2018, as compared to the comparable 20162017 periods, product segment margins were essentially unchanged.down due to lower revenues that were not offset by reductions on cost.

 

The improvement in gross margin from the contract research development segment for the three monthsand nine ended September 30, 20172018 as compared to the three and nine months ended September 30, 20162017 was attributable to increased revenue and fixed costs that were unchanged.

 

5
 

 

Operating expenses

 

For the three months ended September 30, 2017,2018, operating expenses decreased by $185,742$285,228 or 21%42% compared to the three months ended September 30, 2016.2017. Operating expenses decreased by $193,357$1,168,106 or 7%46% for the period ended September 30, 2017,2018, as compared to the nine months ended September 30, 2016.2017. For the three and nine months ended September 30, 20172018 and 2016,2017, operating expenses consisted of the following:

 

  Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
  2017  2016  2017  2016 
Selling and marketing expenses $20,933  $57,942  $257,803  $177,274 
Salaries, wages and related benefits  253,615   375,794   820,051   1,241,033 
Research and development  82,544   71,921   297,697   236,534 
Professional fees  135,261   118,818   536,284   364,450 
General and administrative expenses  188,760   242,380   653,008   738,909 
Total $681,113  $866,855  $2,564,843  $2,758,200 

  

Three Months Ended

September 30,

  

Nine Months Ended

September 30,

 
  2018  2017  2018  2017 
Selling and marketing expenses $5,345  $20,933  $34,121  $257,803 
Salaries, wages and related benefits  133,044   253,615   488,115   820,051 
Research and development  1,850   82,544   12,294   297,697 
Professional fees  141,091   135,261   464,331   536,284 
General and administrative expenses  126,515   188,760   417,192   653,008 
Total $407,845  $681,113  $1,416,053  $2,564,843 

 

For the three months ended September 30, 2017,2018, selling and marketing expenses decreased by $37,009$15,588 or 64%74% as compared to the three months ended September 30, 2016 due to heavy spending earlier in the year.2017. For the nine months ended September 30, 2017,2018, sales and marketing expenses increaseddecreased by $80,529$223,682 or 45%87% as compared to the nine months ended September 30, 2016.2017. The increasedecrease was due to increasedtermination of sales agents and related termination of commission payments as well as reduced spending for commissions, trade shows and social media.
  
For the three months ended September 30, 2017,2018, salaries, wages and related benefits decreased by $122,179,$120,571, or 33%48%, as compared to the three months ended September 30, 2016.2017 due to personnel cuts appropriate to the decline in sales volumes. For the nine months ended September 30, 2017,2018, salaries, wages and related benefits decreased by $420,982,$331,936, or 34%40%, as compared to the nine months ended September 30, 2016.2017. These decreases were attributable to personnel reductions related to our ongoing efforts to reduce costs.

For the three months ended September 30, 2017,2018, research and development costs increaseddecreased by $10,623$80,694 or 15%98%, as compared to the three months ended September 30, 2016.2017. For the nine months ended September 30, 2017,2018, research and development costs increaseddecreased by $61,163$285,403 or 26%96%, as compared to the nine months ended September 30, 2016. For the three and nine months ended September 30, 2017, these increases2017. Decreases were attributable to further work on specialty coatings for new markets and evaluating different parameters and potential enhancements of the surface protector and fortifier product.
For the three and nine months ended September 30, 2017, professional fees increased by $16,443 or 14%, and $171,834 or 47%, as compared to the three and nine months ended September 30, 2016, respectively. This increase is due to contract services related to the inventory build as well as other services related to the move of the product segmenta focus on operations that occurred in September and October.current products rather than potential future products.
  
For the three months ended September 30, 2017,2018, professional fees increased by $5,830 or 4% as compared to the prior period. For the nine months ended September 30, 2018, professional fees were down $71,953 or 13%. The decreases resulted primarily from a reduction in fees paid for assistance from outside accountants.

For the three months ended September 30, 2018, general and administrative expenses decreased by $53,620$62,245 or 22%33% as compared to the three months ended September 30, 2016.2017. For the nine months ended September 30, 2017,2018, general and administrative expenses decreased by approximately $85,901$235,816 or 12%36% as compared to the nine months ended September 30, 2016.2017. The decrease for the nine-month period in 20172018 was attributable to several factors including the end of amortization of intangibles, and personnel reductions in 2018 and extra expenses in 2017 associated with associated general and administrative expenses.the facilities move for the Product segment operations.

 

Loss from operations

 

As a result of the factors described above, for the three months ended September 30, 2017,2018, loss from operations amounted to $(48,131)$(283,667) as compared to loss from operations of $(235,772)$(48,131) for the three months ended September 30, 2016, a decrease2017, an increase of $187,641$235,536 or 80%489%. For the nine months ended September 30, 2017,2018, loss from operations amounted to $(342,287)$(527,713) as compared to a loss from operations of $(602,907)$(342,287) for the nine months ended September 30, 2016,2017, an improvementincreased loss of $260,620$185,426 or 43%54%.

6

Other (income) expense

 

For the three months ended September 30, 2017,2018, other expenseincome was $(76,599)$25,746 as compared to other incomeexpense of $24,870$76,599 for the three months ended September 30, 2016,2017, a decreasedifference of $101,469$102,345 or 408%134%. There was a decreasean increase in interest expense of approximately $5,876 attributable$9,355 for the three-month period as compared to 2017, and a reduced interest rate on our revolving credit loan and an increasedecrease in other income of $14,705 partially offset by athe loss on the disposal of fixed assets of $122,050.$122,050, for asset disposals that were not recurring. Other income for the three-month period ended September 30, 2018 decreased $10,349 or 16% as compared to the same period in 2017. For the nine months ended September 30, 20172018 other expenseincome was $(9,221)$228,472 as compared to other incomeexpense of $146,379$9,221 for the nine months ended 2016,2017, a decreasedifference of $155,600,$237,693 or 106%2578%.

 

Net loss

 

As a result of the foregoing, for the three and nine months ended September 30, 2017,2018, net loss amounted to $(124,730)$(257,921) and $(351,508)$(299,241) as compared to net loss of $(210,902)$(124,730) and $(456,528)$(351,508) for the three and nine months ended September 30, 2016.2017. For the three-month period the loss was decreasedincreased by $86,172$133,191 or 41%107%. For the nine-month period there was in improvement of $105,020$52,267 or 23%15%.

 

For the three months ended September 30, 20172018 and 2016,2017, net (loss) amounted to $(0.04)$(0.08) per common share (basic and diluted), and $(0.07)$(0.04) per common share (basic and diluted), respectively. For the nine months ended September 30, 20172018 and 2016,2017, net (loss) amounted to $(0.12)$(0.10) per common share (basic and diluted), and $(0.15)$(0.12) per common share (basic and diluted), respectively.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity is the ability of an enterprise to generate adequate amounts of cash to meet its needs for cash requirements. We had working capital deficit of $1,033,150$1,606,365 and $73,927$114,321 of cash as of September 30, 20172018 and working capital deficit of $1,072,691and $189,128$1,345,095 and $138,296 of cash as of December 31, 2016.2017.

 

The following table sets forth a summary of changes in our working capital from December 31, 20162017 to September 30, 2017:2018:

 

      December 31, 2016 to
September 30, 2017
       December 31, 2017 to
September 30, 2018
 
 September 30, 2017  December 31, 2016  Change in Working Capital  Percentage
Change
  September 30, 2018  December 31, 2017  Change in Working Capital  Percentage
Change
 
Working capital:                                
Total current assets $2,083,275  $2,033,026  $50,249   2.47% $1,455,668  $1,751,382  $(295,714)  (16.88)%
Total current liabilities  3,116,425   3,105,717   10,708   0.34%  3,062,033   3,096,477   (34,444)  (1.11)%
Working capital deficit: $(1,033,150) $(1,072,691) $60,957   2.81% $(1,606,365) $(1,345,095) $(261,270)  19.4%

 

The increasedecrease in current assets was a combination of increaseddue in substantial part to a reduction in accounts receivable, including those from a related party, and a decrease in pre-paid expenses. The increase in current liabilities was largely due to an increase in accounts payable related to the costs of the inventory build late in the second quarter.

 

Net cash provided by operating activities was $31,074 for the nine months ended September 30, 2018 as compared to $283,581 for the nine months ended September 30, 2017, as compared to $188,459 for the nine months ended September 30, 2016, an improvementa decrease of $95,122$252,507 or 50%89%. Net cash provided by operating activities for the nine months ended September 30, 20172018 primarily reflected a net loss of ($351,508)$(299,241) adjusted for add-backs of $417,744$152,590 and changes in operating assets and liabilities of $217,345.$(74,282).

We expect our cash used in operating activities to increase slightly due to the following:

additional working capital to support increased sales; and
an increase in advertising, commissions and sales promotions for existing and new brands as we expand within existing markets or enter new markets.

 

Net cash flow providedused by investing activities was $87,000$(3,917) for the nine months ended September 30, 20172018 as compared to $17,866$87,000 in cash provided by investing activities for the nine months ended September 30, 2016.2017. For the 20172018 period, the increaseuse of cash by investing activities was due to proceeds from the salepurchases of property, plant and equipment with no offsetting purchases.equipment. The 20162017 period included proceeds from the sale of property and equipment of $21,866, partially offset by the purchase of property and equipment of $4,000.that was not recurring.

 

Net cash used in financing activities of $(485,782) was related to the pay down in obligations on a net basis$(61,135) for the nine months ended September 30, 20172018 as compared to $(342,130)$(485,782) in the same period in 2016.2017. During the nine months ended September 30, 2017,2018, we paid down the bank line of credit with proceedsreborrowing slightly less. We also received advances from related parties of equipment sales, paid down an equipment loan by $56,138 and paid down $10,470 on a third-party note.$25,000.

 

7

Future Liquidity and Capital Needs.

 

Our principal future uses of cash are for working capital requirements, including sales and marketing expenses and reduction of accrued liabilities. Application of funds among these uses will depend on numerous factors including our sales and other revenues and our ability to control costs.

 

Revolving Credit Note

 

In April 2014, our subsidiary, PEN Brands LLC entered into a $1,500,000 revolving credit line agreement (the “Revolving Note”) with Mackinac Commercial Credit, LLC (the “Lender”) with draws limited to a borrowing base as defined in the Revolving Note. The unpaid principal balance of this Revolving Note is payable on demand, is secured by all of PEN Brands LLC’s assets, and bears interest computed at a rate of interest (the “Effective Rate”) which is equal to 7.0% above the LIBOR Rate, as defined, payable monthly. PEN Brands LLC will pay to Lender a late charge of 5.0% of any monthly payment not received by Lender within 10 calendar days after its due date. The Company may, at any time or from time to time upon three business days’ written notice to Lender, prepay the Note in whole provided that if (i) Borrower prepays the Revolving Note in full and terminates the Revolving Note, or (ii) Lender terminates the Revolving Note after default, then Borrower will pay a termination premium equal to 2.0% of the maximum loan amount. On May 1, 2015, PEN Brands LLC and the Lender entered into an amendment to the Loan and Security Agreement extending the outside maturity date to April 4, 2016 and permitting advances against an expanded borrowing base. The borrowing base was increased by $450,000 through October 31, 2015, with this amount reducing by $7,500 monthly thereafter. In addition, the Company guaranteed PEN Brands LLC’s obligations to the Lender. On April 4, 2016, the maturity date under the Loan & Security Agreement between PEN Brands LLC and the Lender was automatically extended for a one-year renewal term.

 

Without the Lender’s consent, so long as the obligation remains outstanding, in addition to other covenants as defined in the Revolving Note, PEN Brands LLC shall not a) merge or consolidate with any other company, except for the combination that closed in August 2014 and shall not suffer a change of control; b) make any capital expenditures, as defined, materially affecting the business; c) declare or pay cash dividends upon any of its stock, or distribute any of its property, make any loans, make investments, redeem, retire or acquire any of its stock, d) become liable for the indebtedness of anyone else, as defined, and e) incur indebtedness, other than trade payables.

 

On April 3, 2017, PEN Brands LLC and the Lender executed a second amendment to the Revolving Note that extended On April 3, 2017, PEN Brands LLC and the Lender executed a second amendment to the Revolving Note that extended the maturity date to April 4, 2018, with a one-year renewal option. The second amendment also reducedchanged the interest rate to 3.0% above the Prime Rate, as reported in the Wall Street Journal.

At September 30, 2017 and December 31, 2016, Under a subsequent amendment, the Company had $689,232 and $979,688, respectively, which includes accrued interest of $10,324 and $17,494, respectively, in amounts outstanding under the Revolving Note with availability of upmaturity date was changed to $810,768 as of September 30, 2017, depending on the borrowing base at the time of the request for the advance. The weighted average interest rate during the nine months ended September 30, 2017 and 2016 was approximately 6.8% and 8.1%, respectively.July 3, 2018.

 

On October 17, 2017,, pursuant to the terms of the Revolving Note, the gross proceeds of $85,000 in connection with the Asset Purchase agreement were applied to decrease the borrowing base of the Revolving Note. In connection with the sale of fixed assets, the Company amended the Revolving Note to establish a cash collateral account to be no less than $85,000. Pursuant to this amendment, the Company entered into a loan agreement with two Company directors in the aggregate principal amount of $85,000 in order to fund the cash collateral provision pursuant to the amended loan agreement. The loan bears no interest and is due when cash flow permits, or if earlier, upon the payment or refinancing of the loan from the Lender to PEN Brands.

On March 30, 2018, PEN Brands and the lender entered into the fourth amendment that permits the borrower to request up to three advances of not more than $200,000 each supported by certain qualifying purchase orders. Each purchase order advance to be repaid in not less than 30 days. No subsequent request can be made until any prior purchase order advance has been repaid. Two of the Company’s officers and directors have personally guaranteed repayment of purchase order advances. The fourth amendment also changes the maturity date for the loan to July 3, 2018. That date becomes the date for an automatic one-year renewal unless either the lender or the borrower gives notice of non-renewal. Other terms and conditions of the agreement remain the same.

On August 8, 2018, PEN Brands and the lender entered into the fifth amendment with an effective date of July 3, 2018. The fifth amendment renewed the agreement through July 3, 2019 and provides for an automatic one-year renewal at that time unless it is terminated by either party 60 days in advance. The fifth amendment also limits the amounts that PEN Brands can advance to its parent, and provides that advances based on eligible inventory will reduce monthly by $7,500 per month starting November 1, 2018.

8

At September 30, 2018 and December 31, 2017, the Company had $522,893 and $563,218, respectively, which includes accrued interest of $14,097 and $14,797, respectively, in amounts outstanding under the Revolving Note with availability of up to $977,107 as of September 30, 2018, depending on the borrowing base at the time of the request for the advance. The weighted average interest rate during the nine months ended September 30, 2018 and 2017 was approximately 7.8% and 6.8%, respectively.

See Note 12 – Subsequent Events for details on the payment in full of the outstanding balance and the termination of the Revolving Note.

 

Equipment Financing

 

On February 10, 2015, PEN Brands entered into a $373,000 promissory note (the “Equipment Note”) with KeyBank, N.A. (the “Bank”). The unpaid principal balance of this Equipment Note is payable in 60 equal monthly installments payments of principal and interest through September 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. At September 30, 2017,2018, the principal amount due under the Equipment Note amounted to $204,546$143,003.

 

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.

 

ITEM 3. Quantitative and Qualitative disclosures about market risk

 

Not applicable to smaller reporting companies.

ITEM 4. Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report (the “Evaluation Date”). Based upon this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the material information required to be included in our Securities and Exchange Commission (“SEC”) reports iswas recorded, processed, summarized,but we lacked the staff or cash to purchase outside resources to process, summarize, and reportedreport within the time periods specified in SEC rules and forms relating to the Company, including, our consolidated subsidiaries, and was made known to them by others within those entities, particularly during the period when this report was being prepared.forms.

 

Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.

 

Changes in Internal Control

 

There were no changes identified in connection with our internal control over financial reporting during the three months ended September 30, 20172018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

9

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None.

 

ITEM 1A. RISK FACTORS

 

Not required of smaller reporting companies.

 

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

 

None.On October 15, 2018, we sold 590,847 shares of Class A common stock for a purchase price of $0.50 per share in a private placement for aggregate proceeds of $295,423. On that same day we issued an aggregate of 20,000 shares of Class A common stock to the Company’s directors as compensation to them for service on our board. These shares were valued on that date at $0.50 per share based on the price paid in the private placement for a total value of $10,000. On that date 1,774 shares of Class A common stock were issued to fully retire the last outstanding equity credits.

In the closing for the private placement on October 15, 2018 we also sold to one investor that purchased 550,847 shares of stock: options to acquire up to an additional 550,847 shares at an option exercise price of $1.00 per share, exercisable at any time before June 30, 2019; and warrants to purchase up to 550,847 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that our Class A common stock has been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. We also sold additional “warrant options” to purchase warrants. For each share purchased under the options described above, the investor can purchase at a price of $0.03 per warrant a warrant to purchase an additional share at an exercise price of $2.00 per share. These warrants will expire on the earlier of (1) 45 days after the day that Class A shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the options, warrants and warrant options were $49,576.

Proceeds were used for working capital and other corporate expenditures.

On January 31, 2019, we sold 325,581 shares of Class A common stock in a private placement at a per share price of $0.40 for aggregate proceeds of $130,232. At the same time the investor bought warrants to purchase up to 325,581 additional shares at a warrant exercise price of $1.50. The right to purchase warrant shares expires on the earlier of (1) 45 days after the day that PEN shares have been trading at or above 120% of the exercise price for a period of 90 days, or (2) four years from date of issue. Aggregate proceeds from the sales of the warrants were $9,767.

Proceeds were used, along with other corporate funds, to pay in full the principal balance, accrued interest and fees due to our lender MBank.

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

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

Proceeds were used for working capital and other corporate expenditures.

On October 15, 2018, we issued an aggregate of 20,000 shares of Class A common stock to the Company’s directors as compensation to them for service on our board. These shares were valued on that date at $0.50 per share based on the price paid in the private placement for a total value of $10,000. On that date 1,774 shares of Class A common stock were issued to fully retire the last outstanding equity credits.

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On December 5, 2018, we issued an aggregate of 30,000 shares of Class A common stock to our directors as compensation to them for service on our Board. These shares were valued on that date at $0.40 per share based on the quoted price of the stock for a total value of $12,000.

On April 3, 2019, we issued an aggregate of 18,180 shares of our Class A common stock to five of our directors as compensation to them for service on our Board. The shares were valued at $0.55 per share based on the quoted price of the stock for a total value of $10,000. On that date the Board also granted to our President an option to purchase up to 550,000 shares of our Class A common stock at a price of $0.55 per share. Under that option, the right to purchase 50,000 shares vested on the date of grant, the right to purchase up to 75,000 shares will vest on December 31, 2019, the right to purchase 100,000 shares will vest on June 30, 2020, and the right to purchase up to 125,000 shares will vest on December 31, 2020 and two tranches entitling him to purchase 100,000 shares will vest if he reaches the cap for cash payments under the bonus program in 2019 or 2020. All rights to purchase have a term of 5 years from date of vesting.

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

The sales and issuances of stock and other securities were exempt from registration under Section 4(2) of the Securities Act.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS

 

Exhibit No. Description
10.1*Third Amendment to Loan and Security Agreement and Loan Documents, dated October 17, 2017, between PEN Brands LLC and Mackinac Commercial Credit ABL Division of MBank.
31.1* Rule 13a-14(a)/15d-14(a) Certificate of ChiefPrincipal Executive Officer
   
31.2* Rule 13a-14(a)/15d-14(a) Certificate of Chief Financial Officer
   
32.1* Section 1350 Certificate of ChiefPrincipal Executive Officer and Chief Financial Officer
   
101.INS XBRL Instance Document
   
101.SCH XBRL Taxonomy Extension Schema
   
101.CAL XBRL Taxonomy Extension Calculation
   
101.DEF XBRL Taxonomy Extension Definition
   
101.LAB XBRL Taxonomy Extension Labels
   
101.PRE XBRL Taxonomy Extension Presentation Linkbase
   
* Filed herewith.

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SIGNATURES

 

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

 

 

PEN Inc.

(Registrant)

  
Date: November 14, 2017May 29, 2019/s/ Scott RickertTom J. Berman
 Scott Rickert.Tom J. Berman
 President and Chief Executive Officer
  
Date: November 14, 2017May 29, 2019/s/ JaquelineJacqueline M. Soptick
 Jacqueline M. Soptick
 Chief Accounting Officer

 

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