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 and nine months ended September 30, 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.

Long-term debt, related parties of $1,000 and long-term line of credit – inventory, related party of $5,000 at December 31, 2023 were reclassified to current in the current consolidated balance sheet for comparability purposes.

(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 (which we do almost universally) we recognize the related revenue at the time of shipping. In the rare instances when we use FOB destination, we would not recognize revenue until the customer receives the product.

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 September 30, 2024, December 31, 2023, and December 31, 2022 are as follows:

Contract assets consist of trade accounts receivable.

Revenue recognized in the reporting period that was included in the contract liability balance at the beginning of the period was$1,279 and$414, for the three months ended September 30, 2024 and 2023, respectively, and$2,882 and$2,438 for the nine months ended September 30, 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$81 and$212, for the three months ended September 30, 2024 and 2023, respectively, and$301 and$361 for the nine months ended September 30, 2024 and 2023, respectively.

(4)Earnings Per Share

Included in the computation of diluted earnings per share for the three and nine months ended September 30, 2024 was a total of 2,062,000 and 1,947,000 in potential common stock, respectively. Options to purchase approximately 853,000 and 728,000 shares of common stock that were outstanding as of September 30, 2023 were not included in the computation of diluted earnings per share for the three and nine-months ended September 30, 2023, respectively. The inclusion of these shares for the three and nine months ended September 30, 2023 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:

(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, any 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 of these accounts. 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 September 30, 2024 and December 31, 2023.

(6)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 September 30, 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. The Company’s loan agreements with Strandler, LLC and Beachcorp, LLC currently are set to expire on October 1, 2025, which could become an operating risk if we are not able to refinance or extend the maturity dates. Related party interest summary:

Related party interest expense consists of the following:

Outstanding notes and lines of credit balances associated with related parties are as follows:

7)Leases

On September 1, 2024 the Company extended the term of its Romeoville lease for an additional 37 months beginning on January 1, 2025. The total monthly payments for 2025 will be $34, escalating to $36 and $37 for the year 2026 and 2027, respectively, with one payment of $39 for the final month of the extension on January 1, 2028. All other terms remain unchanged.

Nanophase Technologies subleases portions of its leased facilities that are used to support operations for the lessees. Total lease payment received for the three and nine months ended September 30, 2024 was$125 and$399, respectively. Total lease payment received for the three and nine months ended September 30, 2023 was$196 and$599, 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.

Both subleases are now month to month. There are no future undiscounted lease payments that are guaranteed.

(8)Inventories

Inventories consist of the following:

The Company had reserves for excess and obsolete inventory of$2,302 and$677 as of September 30, 2024 and December 31, 2023, respectively.

(9) 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 Series X 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 was outstanding, the Purchase Agreement also (i) prevented 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) prevented the Company from repurchasing any Common Stock, and (iii) subject to certain permitted exceptions, restricted 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 was convertible, at the option of the holder, into 1,000 shares of Common Stock at no additional cost. If the Company had not properly filed, upon shareholder approval, the Certificate Amendment on or before August 1, 2024, then each share of Series X Preferred Stock would have been 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 failed to fully pay any Redemption within five days of receiving notice, all unpaid amounts would 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 would have been 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 Preferred 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 derivative 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.

On June 18, 2024, the Company held a special meeting of stockholders where the Certificate Amendment was approved. The Certificate Amendment was filed with the State of Delaware on June 19, 2024. On June 20, 2024, Strandler converted its 15,000 shares of Series X Preferred Stock to 15,000,000 shares of Common Stock.

**(10)Significant Customers and Contingencies **

The portion of total revenue from our significant customers are as follows for the periods ending September 30, 2024, and 2023:

Accounts receivable balances for these 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.

We recently amended our Zinc Oxide Supply Agreement with BASF regarding using our commercially reasonable efforts to develop a modified zinc oxide product for BASF’s exclusive purchase. The amendment also 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 we develop, make, or sell to BASF as an ingredient for uses in the field of use designated in the Agreement, and (ii) we can supply and sell both certain finished products containing zinc oxide for use in the field of use to customers anywhere in the world and certain zinc oxide dispersions that we developed or develop 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 effectively serve each party’s business needs with respect to all product that BASF purchases from us under the Agreement.

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

Revenue from international sources approximated $735 and $1,490 for the three and nine months ended September 30, 2024, respectively, compared to $731 and $2,918 for the three and nine months ended September 30, 2023, respectively. All of this revenue was product revenue.

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 and nine months ended September 30, 2024 and 2023 are as follows: