Item 7. Management’s Discussion and Analysis
ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
Sigma
is a leading provider of in-process quality assurance (IPQA®) software to the additive manufacturing industry. Sigma specializes
in the development and commercialization of real-time monitoring solutions known as PrintRite3D® for 3D metal advanced manufacturing
technologies. PrintRite3D detects and classifies defects and anomalies real-time during the manufacturing process, enabling significant
cost-savings and production efficiencies. We are dedicated to setting the quality standard for Additive Manufacturing and accelerating
the worldwide adoption of 3D metal printing. We work closely with international standards organizations, renowned universities, research
organizations, advanced manufacturers, and leading design and simulation software companies. PrintRite3D is printer agnostic and works
with most of the leading 3D metal printers.
Long-Term Strategic Direction
In January 2022, we
announced the foundational elements of a three-year plan that we believe will increase the Company’s ability to achieve its
mission of setting the quality standard for additive manufacturing. The combined strategies are geared at making our technology more
consumable in terms of ease of use and cost by end users, both for initial purchases and expansion opportunities, making it
easier for original equipment manufacturers (“OEMs”) to embed our technology and generate attractive revenue streams for
the OEM, and finally increasing the Company’s gross margins by moving towards a software-only solution.
To lower the barrier for
initial users and for expansion opportunities within end users with a large number of printers, the Company announced that it will
be offering its current PrintRite3D integrated hardware and software solution on a subscription basis. The impact of the change will
reduce the initial upfront cost to a new user from over $100,000 to approximately $3,000-$4,000 per month. In addition, the
subscription model will smooth out the Company’s revenue and cash receipts while making them more predictable.
In order to expand the number of OEMs distributing
our technology, we recently launched a three-tiered OEM program directed to: (1) new OEMs without their own quality assurance
or monitoring solution; (2) established OEMs with a quality monitoring offering, but who have customers with multiple printers from multiple
OEMs and want a single 3rd party quality and analytics solution with consistent quality metrics across printers, processes and materials;
and (3) OEMs building open APIs to integrate components of Sigma’s proprietary technology with their current offerings.
In 2019, Sigma entered
the market with a productized integrated hardware/software solution to address the retrofit market, i.e., end users that had
purchased a printer, and wanted a 3rd party quality and analytics solution. Subsequently, the Company was successful in creating
initial partnerships with OEMs such as Additive Industries and DMG Mori to offer PrintRite3D as an integrated hardware/software edge
computing solution. We are now working with OEMs on their next generation printers to offer a software-only solution that will
utilize the printer’s computing infrastructure and dramatically reduce the overall cost of its technology, enabling the
opportunity to move towards a software only embedded solution on every printer sold by partner OEMs.
The combination of
subscription pricing and the software-only embedded OEM offerings are intended to make our technology more affordable to acquire and
easier for OEM’s to bundle, distribute and support in an effort to become the industry standard.
Covid-19
Business Update
The worldwide
COVID-19 pandemic caused a reduction, and in some cases a freeze, in capital spending within the Company’s targeted industries
and had what the Company believes to be a short-term negative impact on the Company’s expected timing of generating meaningful
revenue. Further, the future impact of the outbreak, including variations of the virus, is highly uncertain so
that no assurance can be given that the outbreak will not have a material adverse impact on the future results of the Company. It is
also uncertain as to any further disruption of the financial markets, which may reduce our ability to access capital, either at
all, or on favorable terms.
Critical
Accounting Policies and Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management
to make estimates and assumptions that affect the reported assets, liabilities, sales and expenses in the accompanying financial statements.
Critical accounting policies are those that require the most subjective and complex judgments, often employing the use of estimates about
the effect of matters that are inherently uncertain. By their nature, changes in these assumptions and estimates could significantly
affect our financial position or results of operations. Significant accounting estimates that may materially change in the near future
are revenue recognition, impairment of long-lived assets, values of stock compensation awards and stock equivalents granted as offering
costs, and allowance for bad debts and inventory obsolescence. Such critical accounting policies, including the assumptions and judgments
underlying them, are disclosed in Note 1 to the Financial Statements included in this Annual Report. However, we do not believe that
there are any alternative methods of accounting for our operations that would have a material effect on our financial statements.
19
The
critical accounting policies and estimates addressed below reflect our most significant judgements and estimates used in the preparation
of our financial statements
Revenue
Recognition - The Company’s revenue is derived primarily from sales of our software and related hardware suite and from providing
engineering services under contracts. Generally, revenue is recognized upon 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.
Significant estimates and judgements for determining revenue recognition include: (1) identifying the contract, or contracts, with our
customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction
price to performance obligations in the contract; and (5) recognizing revenue when, or as, we satisfy performance obligations by transferring
the promised goods or services.
Accounts
Receivable and Allowance for Doubtful Accounts - Trade accounts receivable are carried at original invoice amount less an estimate
made for doubtful accounts. We determine the allowance for doubtful accounts by identifying potential troubled accounts and by using
historical experience and future expectations applied to an aging of accounts. Trade accounts receivable are written off when deemed
uncollectible. Recoveries of trade accounts receivable previously written off are recorded as income when received.
Inventory
Valuation - Inventories consist of raw materials used in the production of customized parts, work-in-process and finished goods components
which will be sold to customers. Inventories are valued at the lower of cost or net realizable value, using the first-in, first-out (FIFO)
method. Charges for obsolete inventory are based on specific identification of inventory items resulting from regular, on ongoing reviews
of our build of materials.
Long-Lived
and Intangible Assets – Long-lived assets and certain identifiable definite life intangibles to be held and used by the Company
are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
The Company continuously evaluates the recoverability of its long-lived assets based on estimated future cash flows and the estimated
liquidation value of such long-lived assets and provides for impairment if such undiscounted cash flows are insufficient to recover the
carrying amount of the long-lived assets. If impairment exists, an adjustment is made to write the asset down to its fair value, and
a loss is recorded as the difference between the carrying value and fair value. Fair values are determined based on quoted market values,
discounted cash flows or internal and external appraisals, as applicable. Assets to be disposed of are carried at the lower of carrying
value or estimated net realizable value. Utility patents are amortized over a 17-year period. Patents which are pending are not amortized.
Stock
Based Compensation – We measure the compensation costs of share-based compensation arrangements based on the grant-date fair
value and recognize the costs in the financial statements over the period during which employees are required to provide services. Share
based compensation arrangements may include stock options, grants of shares of common stock with and without restrictions, performance-based
awards, share appreciation rights and employee share purchase plans. Compensation cost is measured on the date of grant at its fair value.
Equity
instruments issued to non-employees are recorded on the basis of the grant date fair value of the instruments. In general, the measurement
date is either (a) when a performance commitment, as defined, is reached or (b) the earlier of the date that (i) the non-employee performance
requirement is complete or (ii) the instruments are vested. The measured value related to the instruments is recognized over a period
based on the facts and circumstances of each particular grant.
The
grant date fair value of stock based and other equity instruments is calculated using the Black Scholes valuation model, and requires
estimates of several inputs to the model, including risk-free interest rates, dividends, and expected volatility of our stock price.
Results
of Operations
Year
Ended December 31, 2021 Compared to the Year Ended December 31, 2020.
We
generate revenues through hardware and software licensing of our PrintRite3D® technology to customers that seek to improve their
manufacturing production processes, and through ongoing annual software upgrades and maintenance fees. Additionally, we generate revenues
from our contract manufacturing activities in metal AM. Our ability to generate revenues in the future will depend on our ability to
further commercialize and increase market presence of our PrintRite3D® technologies, and it will depend on whether key prospective
customers continue to move from AM metal prototyping to production.
20
During
fiscal 2021, we made a significant investment in both our employees and our infrastructure, adding resources to be in a position to grow
our business.
Employees
and Headcount
We
added 13 full-time employees in 2021. We increased our sales team from two at the beginning of the year to seven in an
effort to expand our business. Specifically, we hired a senior director of sales in the US Western region, an area sales
manager for the European, Middle East and Africa (EMEA ) region, and three technical sales engineers, one of whom is in Europe, to support
our business development and sales efforts. We also added a total of seven engineers including three software engineers and four applications
engineers, who will be furthering our machine learning and artificial intelligence (“AI”) initiatives, as well as increasing
our manufacturing capacity and ability to perform customer installations and field support. Finally, in September 2021, we hired a Senior
VP of Product Management and Strategic Relationships.
The
labor market is extremely competitive, and our highly trained, skilled, and talented employees are heavily recruited by others. To that
end, we have made additional investments in our employees designed to ensure we remain competitive in the marketplace. This also aligns
well with, and reinforces, our “employee first” culture. In addition to salaries, we improved our benefits by offering a
premium health care plan option and increasing the Company’s contribution to premiums. We have also added a Company paid short-term
disability insurance plan and optional long-term disability insurance plan. And finally, we have increased equity related compensation
to everyone in our Company, from non-employee directors to executive management to employees and consultants. We believe that this is
an important component of aligning shareholder, company, and employee interests and vests everyone in the growth and success of Sigma.
Gross
Margin
In
fiscal year 2021, we increased our gross margin to 66% from 27% in 2020. The primary reasons for the 39% improvement are: (1) sourcing
components from multiple vendors has enabled us to secure alternative supply sources as well as lower material costs; (2) engineering
enhancements, particularly around optics redesigns and computing power and storage, have lowered costs while improving unit performance;
(3) we have become more efficient in our customer installations, through the use of virtual technology; (4) changes to our Rapid Test
and Evaluation (“RTE”) program making them shorter in duration, with clearly defined objectives and more certain outcomes
in terms of ultimately leading to unit sales; and (5) adopting lean manufacturing principles which has improved controls, lowered costs,
and improved efficiency.
Infrastructure
In
addition to the investments made to improve our manufacturing processes and engineering designs, in fiscal 2021 we added new software
applications to assist us in achieving the leverage we need in our operations, both now and for the future. In particular, we added software
subscriptions for a customer relationship management system (CRM”), a product lifecycle management system (“PLM”),
and a project tracking and management system, all of which we believe will help us improve controls, efficiency and communication throughout
the Company.
Revenue
and Cost of Revenue
During
the fiscal year ended December 31, 2021 (“fiscal 2021”), we generated an aggregate of $1,651,765 in revenues, as compared
to an aggregate of $807,488 in revenues generated by us in the fiscal year ended December 31, 2020 (“fiscal 2020”). The contributors
to the $844,277 increase were: (1) increased new PrintRite3D® system sales of $888,954; (2) increased on-site engineering and installation
revenues of $26,200; and (3) increased annual maintenance revenues of $12,402, partially offset by (1) a decrease in revenues from our
Rapid Test and Evaluation (“RTE”) program of $82,064; and (2) decreased revenue from contract AM jobs of $1,215. Our cost
of revenue for fiscal 2021 was $559,965 compared to $591,957 during the same period in 2020, a decrease of $31,992. The decrease is primarily
due to a decrease in RTE program expenses and a decrease in the cost of manufacturing PrintRite 3D units through the aforementioned combination
of lower component costs, engineering redesign and increased manufacturing efficiency, partially offset by increase in the cost of revenues
due to increased sales volume in 2021. The Company sold 11 PrintRite3D units in 2021 as compared to 6 units in 2020.
21
Operating
Expenses
Sigma’s operating expenses for fiscal 2021 were $9,571,185 as compared to $5,914,299 for fiscal 2020, a $3,656,886 increase.
In
fiscal 2021, salaries and benefits costs were $4,286,368 as compared to $2,622,162 for the same period in fiscal 2020. The $1,664,206
increase is comprised of: (a) $657,298 related to the hire of 13 additional employees; (b) $486,168 related to salary increases for existing
employees; (c) increased incentive bonuses of $179,250; (d) increased commissions of $57,580 as a result of increased sales in 2021;
(e) increased taxes and benefits of $244,977; and (f) increased severance of $50,793. Partially offsetting these increases was a decrease
in stock appreciation rights expense of $12,355 due to the year-end revaluation of the compensation liability.
Stock-based
compensation for fiscal 2021 was $1,066,455 compared to $596,842 for the same period in fiscal 2020. This $469,613 increase resulted
primarily from options granted to our new Senior Vice President of Product Management and Strategic Relationships of $264,352, initial
options granted to 13 new employees totaling $56,123, and annual option grants to existing employees totaling $149,138.
During
fiscal 2021 and 2020, Sigma incurred operations and research and development expenditures of $890,553 and $351,404 respectively. Of the
total expense in 2021, $417,744 related to research and development and $472,809 related to operations expenses. Of the total expense
in 2020, $126,292 related to research and development and $225,112 related to operations expenses. The increase of $291,452 in research
and development costs in 2021 is primarily related to: (a) costs incurred in connection with PrintRite3D version 7.0 of $89,798 and $20,977
for PrintRite3D 8.0; (b) an increase in CT scans conducted for new development work and a simulation project totaling $87,988; (c) increased
consulting expense related to our optics redesign of $67,189; and (d) $25,500 of expenses related to upgrading the date acquisition component
of the PrintRite3D unit (“DAQ”). Operations expenses in fiscal year 2021 increased $247,698 from 2020, primarily due to:
(a) increased purchases of lab supplies and equipment of $129,617; (b) write offs of three returned RTE systems with unusable parts of
$34,273; and (c) write-off of metal powder and obsolete inventory of $111,158. These increases were partially offset by a decrease in
consulting costs of $27,350 due to the full time hire of a consultant in 2021
Sigma’s
investor and public relation fees incurred in fiscal 2021 were $503,823, compared to $408,717 in fiscal 2020. The $95,106 increase in
the comparative expenditures results primarily from an increase in IR consulting costs of $48,847, and increased tradeshow and conference
expenses of $90,548 based on increased attendance due to reduced COVID restrictions, partially offset by decreased advertising expenses
of $44,316 due to discontinuation of our public relations firm and Network Newswire services.
Organizational
costs for fiscal 2021 were $726,147, compared to
$451,982 for the same period in fiscal 2020. The increase of $274,165 is primarily attributable to increased directors compensation,
consisting of stock options expense of $298,706 partially offset by lower cash compensation of $22,717.
Legal
and professional service fees in fiscal 2021 were $915,530 compared to $676,142 in fiscal 2020. The increase of $239,388 is primarily
attributable to an increase in recruiting fees of $169,978 related to 9 of our 13 new hires, an increase in IT services fees of $10,814,
and an increase in consulting fees of $64,494 due to the engagement of external HR, accounting, and manufacturing consultants as well
as increased compensation for a consultant to our CEO of $72,000. These amounts were partially offset by reduced legal fees of $83,669
due to non-recurring expenses incurred in 2020, including expenses related to Nasdaq compliance, our reverse stock split, and an abandoned
financing.
During
fiscal 2021, Sigma’s office expenses were $734,386 compared to $416,580 in the same period of fiscal 2020. The $317,806
increase in these expenditures resulted primarily from: (a) increased payroll service fees of $18,314 due to 4 months of free service
in 2020; (b) increased postage of $45,644 due to RTE returns, shipping PrintRite3D units to trade shows, and expedited shipping of parts
and materials due to increased lead times; (c) an increase in computer hardware and office supplies of $40,171 due to the purchase of
computers for new hires, promotional items, and cleaning, sanitary and safety supplies related to COVID pandemic; (d) an increase in
dues and subscriptions expense of $50,330 for new customer relationship management, product lifecycle management, and project management
software; (e) increased travel expenses of $148,507 due to virtually no travel in 2020 as a result of COVID 19 restrictions; and (f)
an increase in training and education expense of $15,059 for cable manufacturing certification and employee team building exercises.
22
Other
operating expenses for fiscal 2021 totaled $353,818, compared to $285,295 for fiscal 2020. The increase of $68,523 is primarily due to
an increase in insurance premiums, in particular our director’s & officer’s policy premium.
In
fiscal 2021, our net other income & expense was net income of $1,094,780, compared to net income of $498,629 in fiscal 2020.
The increase of $596,151 was primarily due to a gain on the derivative liability of $1,092,441, as compared to the 2020 State
of New Mexico’s high wage tax credit incentive program of $151,656, as well as the Payroll Protection Plan loan forgiveness of
$361,700.
Sigma’s
net loss before preferred dividends for fiscal 2021 increased by $2,184,466 and totaled $7,384,605, as compared to a net
loss before preferred dividends of $5,200,139 for fiscal 2020. Net loss applicable to common stockholders for fiscal 2021 was $7,488,172,
as compared to $7,009,414 for fiscal 2020. The 2021 net operating loss component of the overall loss being $2,768,405 higher than in
2020 and the other income component being a $596,151 higher. Preferred stock dividends were $103,567 in fiscal 2021 and $1,809,275
in fiscal 2020.
Liquidity
and Capital Resources
As
of December 31, 2021, we had $11,447,047 in cash and working capital of $11,702,358, as compared to $3,700,814 in cash and working capital
of $4,332,053 as of December 31, 2020.
We
believe that our existing cash on hand will be sufficient to fund our anticipated operating costs and capital expenditure requirements
through 2022. We have based this estimate on assumptions that may prove to be wrong, and we could exhaust our capital resources sooner
than we expect.
Because
of the numerous risks and uncertainties associated with the research, development, and commercialization of our products, we are unable
to estimate the exact amount of our working capital requirements. Our future capital requirements will depend on many factors, including:
●
The
cost of expending, maintaining, and enforcing our intellectual property portfolio, including filing, prosecuting, defending and enforcing
our patent claims and other intellectual property rights;
●
The
effect of competing technological and market developments;
●
The
revenue from the sales of our existing and future products;
●
The
cost of operating as a public company; and
●
The
other factors listed under Item 1A “Risk Factors.”
Our
major sources of funding have been proceeds from public and private offerings of our equity securities (both common stock and preferred
stock), and from warrant exercises. In January 2021, the Company closed a public offering of 1,711,783
shares of common stock at $3.00 per share, resulting in net proceeds of approximately $4,532,444 after deducting underwriting discounts
and commissions and other offering expenses payable by the Company. In March 2021, the Company closed a public offering of 2,190,000 shares of common stock at $4.445 per share, resulting in net proceeds to the Company of approximately $8,736,488
after deducting placement agent commissions and other offering costs payable by the Company. Concurrent with the public offering, the
Company issued warrants to investors to purchase an aggregate of 2,190,000 shares of common stock to holders in a private placement.
The warrants entitle the holders to purchase one share of our common stock at an exercise price equal to $4.32 per share commencing on
May 24, 2021 and will expire two years from such date.
During
the first quarter of 2021, the Company issued 454,404 shares of common stock pursuant to the exercise of warrants, resulting in net proceeds
to the Company of $1,136,010.
We
will need to raise additional amounts to fund our operations, maintain compliance with the NASDAQ listing requirements and implement
our business plan. There is no assurance as to the amount and availability of any required future financing or the terms thereof. Such
financing, if in the form of equity, may be highly dilutive to our existing stockholders and may otherwise include onerous terms. If
in the form of debt, such financing may include covenants and repayment obligations which may be difficult to meet and that could adversely
affect our business operations. There is also significant uncertainty from the affect that the novel coronavirus may have on the availability
and type of financing. To the extent that funds are not available to us, we may be required to delay, limit, or terminate our business
operations and lose our NASDAQ listing.
23
During
2022, we expect to sustain our operations and our commercialization and marketing efforts with our cash reserves and revenues generated
from sales of our PrintRite 3D® technology. We expect that continued enhancements of our IPQA®-enabled PrintRite3D® technology
will enable us to further commercialize this technology into the AM metal market in 2022. To support the commercialization of our PrintRite3D®
technology, we plan to continue funding our development activities and operating expenses by licensing our PrintRite3D® systems and
supporting field services, as applicable, and providing PrintRite3D®-enabled engineering consulting services concerning our areas
of expertise (materials and manufacturing quality assurance and process control technologies) and through the use of proceeds from sales
of our securities and potential exercises of our outstanding warrants.
Net
Cash Used in Operating Activities
Net cash used in operating activities
in fiscal 2021 increased to $6,298,959 from $4,809,868 in fiscal 2020. This increase was primarily attributable
to: (1) an increase in our net loss before preferred dividends of $2,184,466; (2) the gain on the derivative liability of $1,092,441;
(3) a decrease in depreciation expense of $11,070; (4) a decrease in current and long-term prepaid assets of 132,534; and (5) a decrease
in deferred payroll taxes under the CARES Act of $37,728 due to repayment of 50% of the total deferral in December 2021. Partially offsetting
these increases were: (1) higher equity-based compensation expenses of $828,623 due to: (a) increased options and common share grants
awarded to employees of $469,613; (b) increased stock options granted to consultants in lieu of cash of $60,308, and (c) increased equity
based compensation for directors of $298,702; (2) a decrease in accounts receivable of $195,392 due to increased cash collections from
higher sales volume; (3) a decrease in inventory in 2021 from 2020 of $10,503; (4) an increase in accounts payable and other accrued
expenses of $802,242 primarily due to (a) $196,071 of increased year end compensation accruals; (b) an increase in SAR’s liability
of $93,926; (c) increased trade accounts payable of $77,245; (d) additional professional services fee accruals of $35,000; (e) approximately
$400,000 of payments made in fiscal 2020 related to fiscal 2019 payables following closing of our January and April 2020
financings; and (5) an increase in deferred revenue of $132,388
Net
Cash Used by Investing Activities
Net
cash used by investing activities during fiscal 2021 was $359,750, which compares to cash used by investing activities during 2020 totaling
$298,359. The increase was primarily due to increased purchases of fixed assets of $94,448, the most significant of which
was the purchase of a new laser for our 3D metal printer of $63,000, partially offset by lower costs incurred for patents of $33,557.
Net
Cash Provided by Financing Activities
Cash
provided by financing activities during fiscal 2021 increased to $14,404,942 from $8,722,122 during the same period in 2020, an increase
of $5,682,820 primarily as a result of higher net proceeds from our 2021 financings as compared to 2020 of $10,489,160, partially offset
by lower proceeds from exercise of warrants in 2021 of $4,856,340.
24
We
have no off-balance sheet arrangements as defined in Item 303(a) of Regulation S-K.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not
applicable to a “smaller reporting company.”
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial
statements included in Item 15 are incorporated herein by reference.
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.