NEXGEL, INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis are intended to help prospective investors understand our business, financial condition, results of operations, liquidity and capital resources. You should read this discussion in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this information statement. The statements in this discussion regarding industry outlook, expectations regarding our future performance, liquidity and capital resources and other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Special Note Regarding Forward-Looking Statements.” Actual results may differ materially from those contained in any forward-looking statements. The NexGel Financial Statements, discussed below, reflect the NexGel financial condition, results of operations, and cash flows. The financial information discussed below and included in this information statement, however, may not necessarily reflect what the NexGel financial condition, results of operations, or cash flows would have been had NexGel been operated as a separate, independent entity during the years presented, or what the NexGel financial condition, results of operations, and cash flows may be in the future. Overview We manufacture high water content, electron beam cross-linked, aqueous polymer hydrogels, or gels, used for wound care, medical diagnostics, transdermal drug delivery and cosmetics. We specialize in custom gels by capitalizing on proprietary manufacturing technologies. We have historically served as a contract manufacturer, supplying our gels to third parties who incorporate them into their own products. Beginning in 2020, we created two new lines of business for the company. First, our own line of branded consumer products sold direct to consumers. Second, we expanded into custom and white label opportunities, which focuses on combining our gels with proprietary branded products and white label opportunities. All of our gel products are manufactured using proprietary and non-proprietary mixing, coating and cross-linking technologies. Together, these technologies enable us to produce gels that can satisfy rigid tolerance specifications with respect to a wide range of physical characteristics (e.g., thickness, water content, adherence, absorption, moisture vapor transmission rate [a measure of the passage of water vapor through a substance] and release rate) while maintaining product integrity. Additionally, we have the manufacturing ability to offer broad choices in the selection of liners onto which the gels are coated. Consequently, we and our customers are able to determine tolerances in moisture vapor transmission rate and active ingredient release rates while personalizing color and texture. Joint Venture On March 1, 2023, the Company acquired a 50% interest in its newly formed JV for its converting and packaging business. The JV agreement is effective March 1, 2023. As a result of this transaction, the Company owns 50% of the JV, with the remaining 50% held by CG Labs. 19 Table of Contents Acquisition On December 1, 2023, we purchased substantially all of the assets Olympus Trading Company, LLC (the “Seller”) related to the Seller’s skincare line focused on reducing symptoms associated with psoriasis operating under the tradename “Kenkoderm” (“Kenkoderm acquisition”). Under the terms of the Kenkoderm acquisition, the Company paid the Seller a cash payment of $546,500. Additionally, the Company shall pay the Seller a cash earn-out of the same amount each quarter, payable in the subsequent month flowing quarter end, of $136,625. The cash earn-out can fluctuate higher or lower based on the quarterly results of the Kenkoderm business during 2024 according to the formula contained in the Asset Purchase Agreement relating to the Kenkoderm acquisition. Results of Operations The following sections discuss and analyze the changes in the significant line items in our statements of operations for the comparison years identified. Year Ended December 31, 2023 Compared to the Year Ended December 31, 2022 ($ in thousands) Revenues, net For the year ended December 31, 2023 revenues were $4,089 and increased by $2,041, or 99.7%, when compared to $2,048 for the year ended December 31, 2022. The increase in our overall revenues was primarily due to sales growth in both our contract manufacturing and branded products, including revenue from the JV from March 1, 2023 through December 31, 2023 of $1,987. The Company has four distinct lines of business; Contract Manufacturing, Custom & White Label, Consumer Branded Products, and Medical Devices/Other. Contract Manufacturing Customers order rolls of gel (“rollstock”). The rollstock is shipped to our customers, which they package into finished goods. Historically, this has been the Company’s primary source of revenue. Custom & White Label These products often infuse various ingredients into our base gel to develop unique product offerings to satisfy market demand (e.g. aloe infused into the gel for a beauty mask). The rollstock is converted and packaged into salable units. The finished goods are shipped to the customer, who is ultimately responsible for product distribution. Frequently these products started as development deals, in which the customer paid the company a small fee to develop a specific product. Once completed, the customer places a large order for newly developed product. Consumer Branded Products These products are finished goods marketed and sold directly to the customer by the Company through online and retail channels. The Company is responsible for sales, marketing, and distribution. These products carry the Company’s brand names. Medical Devices/Other Medical Devices are a hybrid business, combining elements of Custom & White Label and Consumer Branded Products. Medical Devices, which are not yet marketed, are expected to be distributed through strategic partnerships. The Company will manufacture and possibly convert/package the device while the strategic partner brings the product to market. Small market Medical Devices could be launched by the Company, but also be offered to a distributor to reach the full scale of the market. Gross profit (loss) Our gross profit was $619 for the year ended December 31, 2023 compared to a gross profit of $256 for the year ended December 31, 2022. The increase in the profit recorded for the year ended December 31, 2023, as compared to December 31, 2022, directly correlates to our higher sales. Gross profit was approximately 15.1% for the year ended December 31, 2023 compared to a gross profit of 12.5% for the year ended December 31, 2022. 20 Table of Contents The components of cost of revenues are as follows for the years ended December 31, 2023 and 2022 ($ in thousands): Year Ended December 31, 2023 2022 Cost of revenues Materials and finished products $ 2,147 $ 541 Compensation and benefits 451 702 Share-based compensation 14 - Depreciation and amortization 103 83 Equipment, production and other expenses 755 466 Total cost of revenues $ 3,470 $ 1,792 Cost of revenues increased by $1,678, or 93.6 %, to $3,470 for the year ended December 31, 2023, as compared to $1,792 for the year ended December 31, 2022. The increase in cost of revenues pertains to an increase in materials and finished products and equipment, production, and other expenses. These increases primarily align with the increased revenues. Selling, general and administrative expenses . The following table highlights selling, general and administrative expenses by type for the years ended December 31, 2023 and 2022 ($ in thousands): Year Ended December 31, 2023 2022 Selling, general and administrative expenses Compensation and benefits $ 740 $ 526 Share-based compensation 203 282 Depreciation and amortization 126 16 Advertising, marketing, and Amazon fees 620 436 Investor and shareholder services 426 567 Franchise taxes and corporate insurance 224 405 Professional and consulting fees 1,339 643 Other expenses and professional fees 315 362 Total selling, general and administrative expenses $ 3,993 $ 3,237 Selling, general and administrative expenses increased by $756, or 23.4%, to $3,993 for the year ended December 31, 2023, as compared to $3,237 for the year ended December 31, 2022. The increase in selling, general and administrative expenses is primarily attributable to an increase of compensation and benefits expense, advertising, marketing, and Amazon fees as well as the costs for professional and consulting fees. Compensation and benefits increased by $214, or 40.7%, to $740 for the year ended December 31, 2023, as compared to $526 for the year ended December 31, 2022. The number of employees increased compared to the prior year with the inclusion of the JV. Share-based compensation decreased by $79, or 28.0%, to $203 for the year ended December 31, 2023, as compared to $282 for the year ended December 31, 2022. The decrease in share-based compensation year over year relates to the issuance of stock, restricted stock, and options to our CEO and options to board members in 2023 in comparison to companywide restricted stock awards issued to employees in 2022. 21 Table of Contents Advertising, marketing, and Amazon fees increased by $184, or 42.20%, to $620 for the year ended December 31, 2023, as compared to $436 for the year ended December 31, 2022. The increase corresponds to increased Amazon sales, partially offset by optimization of Amazon advertising spend in 2023. Investor and shareholder services decreased by $141, or 24.9%, to $426 for the year ended December 31, 2023, as compared to $567 for the year ended December 31, 2022. The decrease is due to the Company’s management of outsourced services. Franchise taxes and corporate insurance decreased by $181, or 44.7%, to $224 for the year ended December 31, 2023, as compared to $405 for the year ended December 31, 2022. The vast majority of this decrease pertains to the Company’s reduction in authorized shares, which lowered its franchise tax expense. Professional and consulting fees increased by $696, or 108.2%, to $1,339 for the year ended December 31, 2023, as compared to $643 for the year ended December 31, 2022. We incurred significant expenses related to our European Medical Device Regulation project in preparation for entering European markets. Other expenses decreased by $47, or 13.0%, to $315 for the year ended December 31, 2023 from $362 for the year ended December 31, 2022. Other selling, general and administrative expenses generally consist of costs associated with our selling efforts and general management, including information technology, travel, training and recruiting. Research and development expenses Research and development expenses decreased by $264 to $103 for the year ended December 31, 2023 from $367 for the year ended December 31, 2022. The decrease is due to the completion of development efforts of two proof of concept studies for drug delivery candidates utilizing our hydrogel technology. Liquidity and Capital Resources Cash Flow (in thousands) Years Ended December 31, 2023 2022 Net cash used in operating activities $ (3,236 ) $ (2,992 ) Net cash provided by (used in) investing activities 4,456 (5,595 ) Net cash provided by (used in) financing activities 379 (3,662 ) Net increase (decrease) in cash and cash equivalents 1,599 (12,249 ) Cash and cash equivalents at beginning of year 1,101 13,350 Cash and cash equivalent at end of year $ 2,700 $ 1,101 As of December 31, 2023, we had $2,700 of cash and cash equivalents compared to $1,101 of cash and cash equivalents and $5,508 of marketable securities at December 31, 2022. Net cash used in operating activities was $3,236 and $2,992 for the years ended December 31, 2023 and 2022, respectively. See Notes 2 and 3 of the accompanying consolidated financial statements for a more detailed discussion of our marketable securities. Net cash provided by investing activities was $4,456 million and net cash used in investing activities was $5,595 for the year ended December 31, 2023 and 2022, respectively, consisting of the sales of marketable securities of $5,699, offset by purchases of capital equipment of $696 and the Kenkoderm acquisition of $547 for the year ended December 31, 2023 and consisting of investments in marketable securities of $6,999, the sale of marketable securities for $1,500, and purchases of capital equipment of $96 for the year ended December 31, 2022. Net cash provided by financing activities for year ended December 31, 2023 was $379 which is attributable to the proceeds of equipment notes payable of $315, proceeds from margin line of credit of $245, offset by principal payments of notes payments of $6 and payments of $175 made on the operating lease liability. Net cash used in financing activities for year ended December 31, 2022 was $3,662 which is attributable to the principal payments of convertible notes of $3,511 and payments of $151 made on the operating lease liability. 22 Table of Contents At December 31, 2023, current assets totaled $5,052 and current liabilities totaled $2,549, as compared to current assets totaling $7,505 and current liabilities totaling $859 at December 31, 2022. As a result, we had working capital of $2,503 at December 31, 2023, compared to a working capital of $6,646 at December 31, 2022. The decrease in the working capital as of December 31, 2023 is primarily attributable to the loss from operations of $3,477. We have never declared or paid any cash dividends on our common stock. For the foreseeable future, we anticipate that all available funds and any earnings generated in our business will be used to finance the growth of our business and will not be paid out as dividends to our shareholders. Any future determination related to our dividend policy will be made at the discretion of our Board of Directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements, contractual restrictions, business prospects and other factors our Board of Directors may deem relevant. Management is exploring new product channel sales in consumer products, such as cosmetics, athletic products, and proprietary medical devices. The Company has increased its focus on sales and developing a sales pipeline for potential customers. This customer base expansion will enable us to provide financial stability for the foreseeable future, expand our current processes, and position us for long-term shareholder value creation. We have sufficient capital to maintain as a going concern due to the recent capital raise on February 14, 2024 (discussed further within Note 20). We believe we have sufficient cash and marketable securities to operate our business plan into 2025. We intend to maintain and attempt to grow our existing contract manufacturing business. We also plan to continue building and developing our catalog of consumer products for sale to branding partners and to use our in-house capabilities to create and test market additional branded products. These products will be target marketed and sold online through social media, television and online marketplaces. Furthermore, the Company plans to develop its own proprietary medical devices and explore drug delivery programs for its technology. Additionally, the Company continues to evaluate strategic initiatives (e.g., acquisitions) and additional capital raises through debt or equity may be necessary to achieve these objectives. We expect to continue incurring losses for the near-term future. Our ability to continue to operate as a going concern in the long term is dependent upon our ability to manage and grow our current products and to ultimately achieve profitable operations. Management may consider various options to raise capital to fund potential acquisitions through equity or debt offerings. There can be no assurances, however, that management will be able to obtain sufficient additional funds, if needed, or that such funds, if available, will be obtained on terms satisfactory to us. The financial statements do not include any adjustments relating to the recoverability and classification of recorded assets and liabilities that might be necessary should we be unable to continue as a going concern. Additionally, it is reasonably possible that estimates made in the financial statements have been, or will be, materially and adversely impacted in the near term as a result of these conditions, including the recoverability of long-lived assets. Additionally, it is reasonably possible that estimates made in the financial statements have been, or will be, materially and adversely impacted in the near term as a result of these conditions, including the recoverability of long-lived assets. Off Balance Sheet Arrangements As of December 31, 2023, we had no off-balance sheet arrangements in the nature of guarantee contracts, retained or contingent interests in assets transferred to entities (or similar arrangements serving as credit, liquidity or market risk support to entities for any such assets), or obligations (including contingent obligations) arising out of variable interests in entities providing financing, liquidity, market risk or credit risk support to us, or that engage in leasing, hedging or research and development services with us. Critical Accounting Policies and Estimates The preparation of our accompanying consolidated financial statements in accordance with generally accepted accounting principles is based on the selection and application of accounting policies that require us to make significant estimates and assumptions about the effects of matters that are inherently uncertain. We consider the accounting policies discussed below to be critical to the understanding of our Financial Statements. Actual results could differ from our estimates and assumptions, and any such differences could be material to our Financial Statements. 23 Table of Contents Share-based compensation – We utilize share-based compensation in the form of incentive stock options. The fair values of incentive stock option award grants are estimated as of the date of grant using a Black-Scholes option valuation model. Compensation expense is recognized in the statements of operations on a straight-line basis over the requisite service period, which is generally the vesting period required to obtain full vesting. The expected term of the awards granted is estimated using the simplified method which computes the expected term as the sum of the award’s vesting term plus the original contractual term divided by two. Warrant Liability – Warrants to purchase common stock were issued in connection with equity financing raises which occurred during 2019 through 2021. The fair values of the warrants are estimated as of the date of issuance and again at each year end using a Black-Scholes option valuation model. At issuance, the fair value of the warrant is recognized as an equity issuance cost within additional paid-in-capital. Fair value adjustments to the warrant liability are recognized in other income (expense) in the statements of operations. The expected term of the awards granted are based on either the three-year or five-year contractual expiration date. Black Scholes Inputs - The fair value of each stock option award and warrant issued was estimated on the date of grant using a Black-Scholes option-valuation model, which requires management to make certain assumptions regarding: (i) fair value of the common stock that underlies the stock option; (ii) the expected volatility in the market price of our common stock; (iii) dividend yield; (iv) risk-free interest rates; and (iv) the period of time employees are expected to hold the award prior to exercise (referred to as the expected term). Under the Black-Scholes option-valuation model, entities typically estimate the expected volatility based on historical volatilities of the entity’s own common stock. Based on the lack of historical data of volatility for the Company’s common stock, the Company based its estimate of expected volatility on a weighted average of the historical volatility of comparable public companies that manufacture similar products and are similar in size, stage of life cycle, and financial leverage. The fair value of the common stock that underlies the stock option is estimated by the Company considering the price of the most recent issuance of the Company’s common stock. The dividend yield is based upon the assumption that the Company will not declare a dividend over the life of the options. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for bonds with maturities consistent with the expected term of the related award. Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not required. 24 Table of Contents