NANOPHASE TECHNOLOGIES Corp

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(1)Basis of Presentation

The accompanying unaudited consolidated condensed interim financial statements of Nanophase Technologies Corporation (“Nanophase”, “Company”, “we”, “our”, or “us”) reflect all adjustments (consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair statement of our financial position and operating results for the interim periods presented. All statements include the results from both Nanophase and our wholly-owned subsidiary, Solésence, LLC (“Solésence,” or our “Solésence® subsidiary”). Operating results for the three months ended March 31, 2024 are not necessarily indicative of the results that may be expected for the year ending December 31, 2024.

These financial statements should be read in conjunction with our audited financial statements and notes thereto for the year ended December 31, 2023, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 as filed with the Securities and Exchange Commission.

(2)Description of Business

Nanophase Technologies Corporation (“Nanophase,” “Company,” “we,” “our,” or “us”) is a science-driven company which, along with its wholly owned subsidiary, Solésence, LLC (our “Solésence beauty science subsidiary”), is focused in various beauty- and life-science markets. Using consumer health as our end-goal and science and innovation to guide the path, skin health and medical diagnostics combined currently make up the majority of our business and drive our forward growth strategy. We offer engineered materials, formulation development and commercial manufacturing through an integrated family of technologies. Our expertise in materials engineering allows us to effectively coat and disperse particles on a nano and “non-nano” scale for use in a variety of skin health markets, including for use in sunscreens as active ingredients and as fully developed prestige skin care and cosmetics products, marketed and sold through our Solésence beauty science subsidiary. In terms of our life sciences focus, we have seen demand decrease for our medical diagnostics ingredients. Additionally, we continue to sell products in legacy markets, including architectural coatings, industrial coating applications, abrasion-resistant additives, plastics additives, and surface finishing technologies (polishing) applications, all of which, along with medical diagnostics, fall into the advanced materials product category.

We target markets, primarily related to skin health products and ingredients, as well as diagnostic life sciences ingredients where we believe our materials and products offer practical and competitive minerals-based solutions. We traditionally work closely with current customers in these target markets to identify their material and performance requirements. We market our materials to various end-use applications manufacturers, and our Solésence® products to cosmetics and skin care brands.

Recently developed technologies have made certain new products possible and opened potential new markets. During 2015 we were granted a patent on a new type of particle surface treatment (coating) — now called Active Stress Defense ™ Technology — which became the cornerstone of our new product development in personal care, with first revenue recognized during 2016. Active Stress Defense™ now refers to a suite of three proprietary technologies — Original Active Stress Defense™, Kleair™, and Bloom™ — all three of which either utilize a unique and proprietary, mineral-based technology or work synergistically with one of our unique and proprietary, mineral-based technologies to improve performance and/or aesthetics. Our ongoing innovation efforts include new IP in areas that advance environmental protection, align with market needs, and complement our existing technologies Through the creation of our Solésence beauty science subsidiary, we utilize our technology suite to manufacture and sell fully developed solutions to targeted customers in the skin care industry, typically in prestige skin care and cosmetics markets, in addition to the ingredients we have traditionally sold in the personal care area.

Although our primary strategic focus has been the North American market, we currently sell materials to customers overseas and have been working to expand our reach within foreign markets. Our common stock trades on the OTCQB marketplace under the symbol NANX.

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

Under SEC Release 33-10513; 34-83550, Amendments to Smaller Reporting Company Definition, the Company qualifies as a smaller reporting company and accordingly, it has scaled some of its disclosures of financial and non-financial information in this quarterly report. The Company will continue to determine whether to provide additional scaled disclosures of financial or non-financial information in future quarterly reports, annual reports and/or proxy statements if it remains a smaller reporting company under SEC rules.

(3)Revenues and Other Income

Revenues are recognized when control of the promised goods is transferred to customers, in an amount that reflects the consideration we expect to receive in exchange for those goods. When our ingredients and finished products are shipped, with control being transferred at the shipping point almost universally, is the point in time at which we recognize the related revenue.

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within selling, general and administrative expenses. Customers’ deposits, deferred revenue and other receipts are deferred and recognized when the revenue is realized and earned. Cash payments to customers are classified as reductions of revenue in our statements of operations.

Contract balances at March 31, 2024, December 31, 2023, and December 31, 2022 are as follows:

Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period was $679 and $1,297 for the three months ended March 31, 2024 and 2023, respectively.

Other revenue may include revenue from technology license fees and paid development projects. Technology license fees and paid development projects are recognized over time when the obligations under the agreed upon contractual arrangements are performed on our part. Other revenue recognized over time was $96 and $121 for the three months ended March 31, 2024 and 2023, respectively.

Nanophase Technologies also had $55 in Other Receivables which consisted of pending sublease rental payments.

Nanophase Technologies subleases portions of its leased facilities that are used to support operations for the lessees. Total lease payment received for the period of March 31, 2024 and 2023 was $204 and $196, respectively. The arrangement is not with a related party.

Payments received by the Company for these subleases are comprised of two components, which include base rent and Common Area Maintenance (CAM) charges. While the base rent is fixed, the CAM charges are indexed directly to the Master Lease and are expected to be adjusted periodically as actual costs are incurred. However, the executed sublease agreements specifically itemize these costs with a provision that informs the sublessee that the CAM charges will be adjusted (up or down) based on actual amounts once this information becomes known. As such, the nature of the charges is more closely representative of a fixed payment (an “in-substance fixed” charge) with the adjustments occurring simply to “true up” the listed CAM charges once actual charges from the head lessor become known. As sublessor, Nanophase Technologies has elected the practical expedient to not separate lease and nonlease components in disclosing future undiscounted cashflows and treats the combined components as a single lease component.

The one sublease arrangement that is not now month to month automatically renews following expiration of the initial term on May 31, 2025, with a one-year notice required to terminate the lease. As of the issuance of these financial statements the sublessee has not yet provided notice of their intent to renew or terminate said arrangement. The Company believes the sublease will not be renewed.

The future undiscounted lease payments associated with this arrangement are provided below, and only include the period for which enforceable rights and obligations exist as of the date of financial statement issuance. The below is taken from the December 31, 2023 Form 10-K and is still relevant at March 31, 2024.

(4)Earnings Per Share

Included in the computation of diluted earnings per share for the three months ended March 31, 2024 was a total of 5,359,890 in potential common stock. This total was comprised of: 1) options to purchase approximately 250,000 shares of common stock outstanding, and 2) preferred stock convertible into a total of 5,109,890 shares of common stock outstanding as of March 31, 2024. Options to purchase approximately 1,164,000 shares of common stock that were outstanding as of March 31, 2023 were not included in the computation of earnings per share for the three months ended March 31, 2023, as inclusion of these shares would have resulted in an anti-dilutive effect and were thus omitted from disclosure.

Earnings applicable to common stock and common stock shares used in the calculation of basic and diluted earnings per share are as follows:

ASC 260-10-45-40 requires that convertible preferred stock be assumed to have been converted at the beginning of the period (or at time of issuance, if later), and the resulting common shares shall be included in the denominator. As such, the 15,000,000 potential common shares from the instruments were included in the weighted-average common shares outstanding computation for diluted earnings per share and was applied using the “if converted” method per ASC 260-10-45-40(a).

(5)Financial Instruments

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

Our financial instruments include cash, cash equivalents, accounts receivable, accounts payable and accrued expenses, along with any short-term and long-term borrowings as described in Note 6. The carrying values of cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses are reasonable estimates of their fair value due to the short-term nature. The fair value of short-term and long-term debt approximates carrying value based on comparison of terms to similar debt offering in the marketplace.

There were no financial instruments adjusted to fair value on March 31, 2024 and December 31, 2023.

(6)Related Party Notes and Lines of Credit

Notes and lines of credit consist of the following:

The Company classifies the line of credit – accounts receivable as current because we are required to pay back the borrowings as cash is received from our customers. The company’s remaining debt is presented within the consolidated balance sheet as of March 31, 2024, and December 31, 2023 in accordance with the maturity dates in the financing agreements.

Beachcorp, LLC and Strandler, LLC are affiliates of Mr. Bradford T. Whitmore, who beneficially owns a majority of the Company’s common stock and is the brother of Ms. R. Janet Whitmore, a director of the Company and the chair of the Company’s board of directors. The A/R Revolver Facility, the Inventory Facility and the New Term Loan are all secured by all the unencumbered assets of the Company and subordinated to the Company’s credit facility with Libertyville Bank & Trust.

Related party interest expense consists of the following:

Accrued interest consists of the following:

Outstanding balances associated with related parties are as follows:

(7)Inventories

Inventories consist of the following:

(8)Capital Stock

On March 1, 2024, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”), between the Company and Strandler, LLC (“Strandler”).

Pursuant to the Purchase Agreement, the Company issued to Strandler 15,000 shares of the Company’s Series X Preferred Stock (the “Series X Preferred Stock”) at a purchase price per share of$400, for total consideration of$6,000,000, in a transaction exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) thereof. The terms of the Preferred Stock are set forth in the Company’s Certificate of Designations to its Certificate of Incorporation, filed with the Secretary of State of the State of Delaware on March 4, 2024 (the “Certificate of Designations”).

Under the Purchase Agreement, the Company granted Strandler customary registration rights with respect to shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), it may receive in connection with any conversion of Series X Preferred Stock into Common Stock, as described below. For so long as any amount of Preferred Stock is outstanding, the Purchase Agreement also (i) prevents the Company from paying any dividend on any shares of the Company’s capital stock (other than dividends consisting solely of Common Stock or rights to purchase Common Stock), (ii) prevents the Company from repurchasing any Common Stock, and (iii) subject to certain permitted exceptions, restricts the Company’s ability to permit any lien or other encumbrance on Company assets.

At any time and from time to time, in whole or in part, following the Company properly filing an amendment (the “Certificate Amendment”) to its Certificate of Incorporation to increase the number of authorized shares of its Common Stock from 60,000,000 to 95,000,000, each share of Series X Preferred Stock is convertible, at the option of the holder, into 1,000 shares of Common Stock at no additional cost. If the Company has not properly filed, upon shareholder approval, the Certificate Amendment on or before August 1, 2024, then each share of Series X Preferred Stock will be redeemable at the holder’s option, in whole or in part, without penalty or premium, at a redemption price equal to $420 per share (each, a “Redemption”). If the Company fails to fully pay any Redemption within five days of receiving notice, all unpaid amounts will bear interest at a rate of 10% per annum. In addition, in the event of a Change in Control (as defined in the Certificate of Designations) of the Company, each share of the Series X Preferred Stock is redeemable at the option of the holder, without penalty or premium, at a redemption price equal to $420 per share. Upon any conversion of Preferred Stock into Common Stock by Strandler, Strandler is required to hold the Common Stock received in the conversion for a period of 12 months.

Holders of Series X Preferred Stock (i) are not entitled to receive dividends, subject to customary anti-dilution protections, (ii) have no voting rights, and (iii)receive a liquidation preference of $400 per share. The Series X Preferred Stock ranks senior in right of payment to all securities designated as junior securities, including Common Stock.

ASC 815-15-25-17D provides guidance for assessing host contracts in the form of preferred shares, in which 25-17D(b) states that an investor’s ability to “convert a preferred share into a fixed number of common shares generally is viewed as an equity-like characteristic”. Because conversion of the Series X shares is at the discretion of the Holder, conversion is in a fixed number of shares, dividends are not typically paid and cash settlement would only occur in the unlikely event of change in control, the host contract has the characteristics of, and is classified as, an equity instrument, and the embedded derivatives and host contract are considered clearly and closely related. As such, the embedded derivatives does not require bifurcation and the Series X preferred shares shall be reported as mezzanine equity on the balance sheet.

Issuance costs associated with issuance of the Series X Preferred Stock were immaterial.

**(9)Significant Customers and Contingencies **

The portion of total revenue from our significant customers are as follows for the periods ending March 31, 2024, and 2023:

Accounts receivable balances for these four customers were approximately:

We currently have exclusive supply agreements with BASF Corporation (“BASF”), that have contingencies outlined which could potentially result in the sale of production equipment from the Company to the customer intended to provide capacity sufficient to meet the customer’s production needs. This outcome may occur if we fail to meet certain performance requirements. In the event of an equipment sale, upon incurring a triggering event, the equipment would be sold to the customer at either 115% of the equipment’s net book value or the greater of 30% of the original book value of such equipment, and any associated upgrades to it, or 115% of the equipment’s net book value, depending on the equipment and related products.

If a triggering event were to occur and BASF elected to proceed with the equipment sale mentioned above, we would lose significant revenue. Replacement of necessary equipment that could be purchased and removed by the customer pursuant to this triggering event could take in excess of twelve months. Any additional capital outlays required to rebuild capacity would probably be greater than the proceeds from the purchase of the assets as dictated by our agreement with the customer. Similar consequences would occur if we were determined to have materially breached certain other provisions of the supply agreement with BASF.

**(10)Business Segmentation and Geographical Distribution **

Revenue from international sources approximated$288 and$1,435 for the three months ended March 31, 2024 and 2023, respectively.

Our operations comprise a single business segment and all of our long-lived assets are located within the United States. We categorize our revenue stream into three main product categories, Personal Care Ingredients, Advanced Materials and Solésence. The revenues, by category, for the three months ended March 31, 2024 and 2023 are as follows:

(11)Subsequent Event

On April 10, 2024 the Company and BASF entered into a Settlement Agreement and General Release (the “Settlement Agreement”), providing for settlement of the New Jersey Complaint and resolution of the parties’ disputes. Under the Settlement Agreement, the Company and BASF agreed to enter into the Amendment (defined below) in exchange for (i) a mutual release of all claims related to the New Jersey Complaint and any claims based on similar facts or legal theories (collectively, the “Claims”), (ii) the filing of a Stipulation of Dismissal with the SCNJ voluntarily dismissing the New Jersey Complaint with prejudice, (iii) mutual covenants by the Company and BASF not to sue the other party for the Claims, (iv) the Company and BASF entering into the Modified Product MOU (defined below), (v) mutual indemnification as to certain claims arising out of the making, use, purchase, sale, or development of products in connection with the Modified Product MOU, and (vi) provisions regarding confidentiality of settlement terms and other customary settlement terms. The Stipulation of Dismissal was filed with the SCNJ on April 11, 2024, thereby concluding the New Jersey Complaint.

In connection with the Settlement Agreement, the Company and BASF entered into an Amendment No. 5 (the “Amendment”) to the Agreement, and a Binding Memorandum of Understanding regarding the Company using its commercially reasonable efforts to develop a modified zinc oxide product for BASF’s exclusive purchase under the Agreement (the “Modified Product MOU”). The Amendment includes provisions (a) amending the exclusivity section of the Agreement to provide that (i) BASF has the exclusive right to use zinc oxide materials that the Company develops, makes, or sells to BASF as an ingredient for uses in the Field, and (ii) the Company or its affiliates, including Solésence, can supply and sell both certain finished products containing zinc oxide for use in the Field to customers anywhere in the world and certain zinc oxide dispersions that the Company developed or develops for a particular customer, and (b) amending the provisions of the Agreement concerning order forecasting and procedures, operational planning, inventory and capacity requirements, and periodic facility shutdown arrangements, to more effective serve each party’s business needs with respect to all product that BASF purchases from the Company under the Agreement.