Odysight.ai Inc. 10-K

item 7. management’s discussion and analysis of financial condition and results of operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical information, the following discussion contains forward-looking statements that involve risks, uncertainties and assumptions. See “Forward-looking Statements” for a discussion of the uncertainties and assumptions associated with these statements. Our actual results may differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this Annual Report on Form 10-K. Overview We were incorporated under the laws of the State of Nevada on March 22, 2013 under the name Intellisense Solutions Inc. We were initially engaged in the business of developing web portals to allow companies and individuals to engage in the purchase and sale of vegetarian food products over the Internet. However, were not able to execute our original business plan, develop significant operations, or achieve commercial sales. On December 30, 2019, we acquired all of the issued and outstanding share capital of ScoutCam Ltd. (the “Closing Date”). Following this transaction, we integrated and fully adopted ScoutCam Ltd.’s business into our Company as our primary business activity. On December 31, 2019, we changed our name to ScoutCam Inc. Through ScoutCam Ltd., we are engaged in the development, production and marketing of innovative visual solutions composed of imaging equipment, cloud and software based image processing (artificial intelligence (AI), Machine Learning (ML), and additional algorithm methodologies). Some of our products that utilize our micro ScoutCam™ technology are used in medical procedures as well as various applications in other industries. Our current business model is a business-to-business (B2B) approach in which we seek to identify target businesses interested in integrating our micro ScoutCam™ technology, or commissioning individual projects using our technology. We derive a substantial portion of our revenue from applications of our micro ScoutCam™ technology within the medical, defense and aerospace fields. We have recently begun examining additional applications for our visual solutions portfolio (composed of image acquisition, data collection and storage and image processing), including Predictive Maintenance (PdM) and Condition Based Monitoring (CBM), as well as additional industries outside of the foregoing listed industries, including sectors such as aviation, automotive, industrial non-destructing-testing industries, energy, maritime (we refer to these applications and sectors as I4.0) We plan to further expand our activity in these non-medical spaces. Impact of COVID-19 Pandemic The COVID-19 pandemic has had a significant impact on global markets and the global economy, including countries in which the Company operates, and we anticipate that it will have a continuing impact on global economies in the near and long-term future. In light of the below mentioned factors, the COVID-19 pandemic had and most likely will continue to have some negative effect on the Company’s operations, and the extent to which the COVID-19 pandemic will impact the Company’s operations will depend on certain developments, including the duration and spread of the outbreak, future prevention and mitigation measures, as well as the potential for some of these measures to be reinstituted in the event of repeat waves of the virus or future variants of the virus. In particular, COVID-19 has had and most likely will continue to have some adverse impact on the Company’s operations and workforce, including its manufacturing activities, product testing and market penetration and sales, as well as its ability to continue to raise capital. Travel restrictions had and most likely will continue to have a negative impact on our penetration, sales and marketing and research and development efforts. Critical Accounting Policies and Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. We evaluate these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions. 31 While our significant accounting policies are more fully described in Note 2 to our financial statements appearing elsewhere in this Form 10-K, we believe that the following accounting policies are the most critical for fully understanding and evaluating our financial condition and results of operations. Development Services Revenue and Contract Liabilities We determine at contract inception whether development services are distinct from the performance obligation to manufacture the product under development. Revenues from development services that we determine as distinct from our performance obligation to manufacture the product under development are recognized over the period of the applicable service contract. Revenues from development services that we determine as not distinct from our performance obligation to manufacture the product under development are deferred until commencement of manufacturing and are recognized over the manufacturing term. As a result, during the years ending 2020 and 2021, we have deferred all service revenues billed by us (representing the contract liabilities balance of $2,420,000, as of December 31, 2021) and the respective service costs (representing the contract fulfillment asset balance of $1,675,000 as of December 31, 2021). Stock-Based Compensation We apply the fair value recognition provisions of ASC 718, Compensation—Stock Compensation , or ASC 718, for stock-based awards granted to employees, directors and other providers for their services. Determining the amount of stock-based compensation to be recorded requires us to develop estimates of the fair value of stock options as of their grant date. We estimate the fair value of each stock option grant using the Black-Scholes option-pricing model. Calculating the fair value of stock-based awards requires that we make subjective assumptions. Pursuant to ASC 718, we measure stock-based awards granted to employees, members of the board of directors and other providers at fair value on the date of grant and recognize the corresponding stock-based compensation expense of those awards on a straight-line basis over the requisite service period. The Black-Scholes option-pricing model requires a number of assumptions, of which the most significant are the stock price volatility and the expected option term. Our expected dividend rate is zero since we not currently pay cash dividends and does not anticipate doing so in the foreseeable future. Each of the above factors requires our to use judgment and make estimates in determining the percentages and time periods used for the calculation. If we were to use different percentages or time periods, the fair value of option awards could be materially different. We recognizes stock-based compensation cost for option awards on a accelerated basis over the employee’s requisite service period, net of estimated forfeitures. Comparison of the Year Ended December 31, 2021 and the Year Ended December 31, 2020 Overview The Company’s primary business activity during 2020 was R&D and preparation for production in connection with a customer-specific project for a Fortune 500 multinational healthcare corporation. The Company’s primary business activities during 2021 were: ● completion of R&D and transition to the serial production in connection with a customer-specific project for a Fortune 500 multinational healthcare corporation; and ● enlarging its focus on R&D activities in the domain of I4.0 (including PdM and CBM in sectors such as the aviation, energy and automotive). The main effect of this activity was an increase in the number of employees to enable the Company to manage the anticipated increased workload and solution development. 32 Other major activities were the following: - Expanding marketing activities, including the recruitment of VP Business Development for Industry 4.0, and launching a multi-platform digital marketing campaign; - Extensive activity in connection with the Company’s IP, including submissions of new patent applications as well as maintenance, defense, and commercialization efforts of existing patents; - Increased operation expenses in order to improve the current Company’s R&D capabilities; - Increase in research and development activities, including the development of new products and the improvement of existing technology, and the examination of additional applications for our visualization solutions, including in the domains of PdM and CBM, as well as additional industries outside of the medical, defense, and aerospace fields, including sectors such as automotive, industrial non-destructing-testing industries, automotive and energy; and - Investment in capital expenses to provide the necessary facilities, IT, and lab tools for our newly recruited employees and to upgrade the Company’s production and quality control capabilities. The following table summarizes our results of operations for the years ended December 31, 2021 and 2020, together with the changes in those items in dollars and as a percentage: 2021 2020 % Change Revenues 387,000 491,000 (21 )% Cost of Revenues 1,108,000 994,000 11 % Gross Loss (721,000 ) (503,000 ) 43 % Research and development expenses 2,002,000 725,000 176 % Sales and marketing expense 908,000 443,000 105 % General and administrative expenses 5,481,000 3,035,000 81 % Operating Loss (9,112,000 ) (4,706,000 ) 94 % Revenues As a result of the nature of our target market and the current stage of our development, a substantial portion of our revenue comes from a limited number of customers. For the year ended December 31, 2021, we generated revenues of $387,000, a decrease of $104,000, or 21%, from 2020 revenues. The decrease in revenues was primarily due to sales of products to A.M. Surgical. Total sales to A.M. Surgical during year ended December 31, 2021 amounted to approximately $199,000, a decrease from approximately $383,000 in 2020. This decrease was partially offset by increase in the sales of our products to other customers. Remaining performance obligations (“RPO”) represents contracted revenue that has not yet been recognized, which includes deferred revenue and amounts that will be invoiced and recognized as revenue in future periods. As of December 31, 2021, the total RPO amounted to $3.2 million, which we expect to recognize over the expected manufacturing term of the product under development. Cost of Revenues Cost of revenue is primarily comprised of cost of personnel includes warehouse personnel costs, inventory write-downs, certain allocated facilities, and expenses associated with logistics and quality control. Cost of revenues for the year ended December 31, 2021 were $1,108,000, an increase of $114,000, or 11%, compared to cost of revenues of $994,000 for the year ended December 31, 2020. The increase was primarily due to an increase in payroll expenses (including stock-based compensation) as a result of hiring additional employees as part of the transition to the production stage with respect to the contract with a Fortune 500 multinational healthcare corporation, partially offset by decrease in materials as a result of a decrease in revenues. 33 Gross Loss Gross loss for the year ended December 31, 2021 was $721,000, an increase of $218,000, or 43%, compared to a gross loss of $503,000 for the year ended December 31, 2020. The increase was primarily due to a decrease in revenues and an increase in cost of revenues as described above. Research and Development Expenses Research and development efforts are focused on new product development and on developing additional functionality for our existing products. These expenses primarily consist of e mployee-related expenses, including salaries, benefits, and stock-based compensation expense for personnel engaged in research and development functions , consulting and professional fees related to research and development activities , prototype materials, facility costs and other allocated expenses, which include expenses for rent and maintenance of our facility, utilities, depreciation, and other supplies . We expense research and development costs as incurred. Research and development expenses for the year ended December 31, 2021 were $2,002,000, an increase of $1,277,000, or 176%, compared to $725,000 for the year ended December 31, 2020. The increase was primarily due to an increase in payroll expenses (including stock-based compensation), materials and subcontractors, and because we have recently begun examining additional applications for our micro ScoutCam™ portfolio outside of the medical, defense and aerospace fields, including in sectors such as automotive, industrial non-destructing-testing industries, automotive, and energy. In addition, there was an increase in R&D payroll expenses in 2021 due to the fact that during 2020 a substantial part of the payroll expenses was capitalized to contract fulfillment asset and was not recognized as expenses in profit and loss. We expect that our research and development expenses will increase as we continue to develop our products and service and recruit additional research and development employees to the I4.0 domain. Sales and Marketing Expenses Sales and marketing expenses primarily consist of personnel costs, consulting services, promotional materials, demonstration equipment and certain allocated facilities infrastructure costs. Sales and marketing expenses for the year ended December 31, 2021 were $908,000, an increase of $465,000, or 105%, compared to $443,000 for the year ended December 31, 2020. The increase was primarily due to expanding marketing activity, including the recruitment of a VP Business Development in Industry 4.0, hiring consultants and launching a multi-platform digital marketing campaign. We expect that our selling and marketing expenses will increase as we continue to increase our selling and marketing efforts. General and Administrative Expenses General and administrative expenses primarily consist of salaries and other related costs, including stock-based compensation, for personnel in executive, finance, and administrative functions. General and administrative expenses also include direct and allocated facility-related costs as well as professional fees for legal, patent, consulting, investor, and public relations, accounting, auditing, tax services, and insurance costs. General and administrative expenses for the year ended December 31, 2021 were $5,481,000, an increase of $2,446,000, or 81%, compared to $3,035,000 for the year ended December 31, 2020. 34 The increase was primarily due to: ● an increase of $675,000 in IP expenses due to maintenance, defense, and commercialization efforts of existing patents; ● the provision of $229,000 due to a VAT audit by the Israeli Tax Authority ; ● an increase of $528,000 in share based compensation due to new option grants; ● expenses of approx. $206,000 related to our efforts to uplist to Nasdaq ; ● an increase in in payroll expenses due to the hiring of additional employees, including a new CEO and controller, and a shift in the position of the CFO from part-time to full-time; and ● an increase in professional services expenses due to the hiring of a financial consultant, HR consultant, the appointment of new directors and additional hires . Operating loss We incurred an operating loss of $9,112,000 for the year ended December 31, 2021, an increase of $4,406,000, or 94%, compared to operating loss of $4,706,000 for the year ended December 31, 2020. The increase in operating loss was primarily due to increases in expenses related to general and administrative, research and development, and sales and marketing, as described above. Liquidity and Capital Resources As of December 31, 2021, we had cash and cash equivalents of $8.6 million and $11 million of short-term deposits compared to cash and cash equivalents $3.4 million and no short-term deposits as of December 31,2020. In addition, as of December 31, 2021 we incurred an accumulated deficit of approximately $15.3 million compared to $6.3 million as of December 31, 2020. Our primary sources of liquidity to date have been from fund raising and warrant exercises. During 2021, we received $22.6 million from the issuance of our shares and warrants in a private placement and from the exercise of outstanding warrants. Additional Cash Requirements We plan to continue to invest for long-term growth, and therefore we expect that our expenses will increase. We currently believe that our existing cash and cash equivalents and short-term deposits will be sufficient to meet our anticipated cash needs for at least the next 12 months and beyond. We expect our expenses will increase in connection with our ongoing activities, particularly as we continue the research and development and the scale up process of our I4.0 solutions. We expect to incur significant commercialization expenses related to product sales, marketing, manufacturing, and distribution. Furthermore, we will continue to incur additional costs associated with operating as a public company. Accordingly, we will need to obtain substantial additional funding in connection with our continuing operations. We may raise these funds through equity financing, debt financing, or other sources, which may result in further dilution in the equity ownership of our common stock. There is no assurance that we will be able to maintain operations at a level sufficient for investors to obtain a return on their investment in our common stock, or that we will be able to raise sufficient capital required to implement our business plan on acceptable terms, if at all. Even if we are successful in raising sufficient capital to implement our business plan, we will, most likely, continue to be unprofitable for the foreseeable future. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce, or eliminate our research and development programs or future commercialization efforts. Cash Flows The following table sets forth the significant sources and uses of cash for the years ended December 31, 2021 and December 31, 2020 (in dollars): 2021 2020 Cash used in Operating Activities (5,886,000 ) (4,187,000 ) Cash used in Investing Activities (11,595,000 ) (276,000 ) Cash provided by Financing Activities 22,559,000 4,506,000 35 Operating Activities Our primary uses of cash from operating activities have been for headcount-related expenditures, research and development costs, manufacturing costs, marketing and promotional expenses, professional services cost and costs related to our facilities. Our cash flows from operating activities will continue to be affected due to the expected increase of spending on our business and our working capital requirements. During the year ended December 31, 2021, cash used in operating activities was $5.9 million, consisting of net loss of $9 million, partially offset by a non-cash benefit of $2 million and an favorable net change in operating assets and liabilities of $1.1 million. Our non-cash benefit consisted primarily of non-cash charges of $2 million for stock-based compensation. The net change in our operating assets and liabilities primarily reflects cash inflows from changes in contract liability of $1.6 million partially offset by cash outflows from changes in contract fulfillment assets of $0.5 million. During the year ended December 31, 2020, cash used in operating activities was $4.2 million, consisting of net loss of $4.7 million, non-cash charges of $1.1 million and a unfavorable net change in operating assets and liabilities of $0.6 million. Our non-cash charges consisted primarily of stock-based compensation expense of $1.1 million. The net change in our operating assets and liabilities primarily reflects cash outflows from the changes in contract fulfillment assets of $1.1 million, accrued expenses and other of $0.4 million and other assets of $0.3 million, partially offset by cash inflows from changes in inventory of $0.7 million and change in contract liability of $0.3 million. Investing Activities During the year ended December 31, 2021, cash used in investing activities was $11.6 million, consisting of investment in short-term deposits of $11 million and purchases of property and equipment of $0.6 million. During the year ended December 31, 200, cash used in investing activities was $0.3 million, consisting of purchases of property and equipment. Financing Activities During the year ended December 31, 2021, cash provided by financing activities was $22.6 million, consisting primarily of $19.1 million from cash proceeds from issuance of shares and warrants in a private placement and $3.5 million proceeds from exercise of outstanding warrants. During the year ended December 31, 2020, cash provided by financing activities was $4.5 million, consisting primarily of $2.9 million from cash proceeds from issuance of shares and warrants and $1.8 million proceeds from exercise of warrants. item 7a. quantitative and qualitative disclosures about market risk As a smaller reporting company, we are not required to provide the information required by this Item. item 8. financial statements and supplementary data The information called for by Item 8 is included following the “Index to Financial Statements” on page F-1 of this Annual Report. item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. 36