WRAP TECHNOLOGIES, INC. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   You should read the following discussion in conjunction with the financial statements and other financial information included elsewhere in this Quarterly Report on Form 10-Q (this “ Report ” ) and with our audited financial statements and other information presented in our Annual Report on Form 10-K for the year ended December 31, 2020. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. Words such as “ expect, ” “ anticipate, ” “ intend, ” “ plan, ” “ believe, ” “ seek, ” “ estimate, ” “ continue, ” “ may, ” “ will, ” “ could, ” “ would, ” or the negative or plural of such words and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the only means of identifying forward-looking statements. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this Report and in our other SEC filings, including particularly matters set forth under Part I, Item 1A (Risk Factors) of our Annual Report on Form 10-K. Furthermore, such forward-looking statements speak only as of the date of this Quarterly Report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. For purposes of Management's Discussion and Analysis within this Report, all monetary amounts are stated in thousands except for par values and per share amounts, unless otherwise stated.   Overview   We are a global public safety technology and services company organized in March 2016 delivering modern policing solutions to law enforcement and security personnel. We began product sales of our first public safety product, the BolaWrap 100 remote restraint device, in late 2018. In October 2021 we released a new generation product, the BolaWrap 150. The BolaWrap 150 is electronically deployed and is more robust, smaller, lighter and simpler to deploy than the BolaWrap 100 that is being phased out.   The immediate addressable domestic market for our solutions consists of approximately 900,000 full-time sworn law enforcement officers at over 15,300 federal, state and local law enforcement agencies and over 12 million police officers in over 100 countries we are targeting globally. We are also exploring other domestic markets, including military and private security. Our international focus is on countries with the largest police forces. The 100 largest international police agencies are estimated to have over 12.1 million law enforcement personnel. According to Statistics MRC, a market research consulting firm, we participate in a segment of the non-lethal products global market expected to grow to $11.85 billion by 2023.   We focus our efforts on the following products, services and solutions:   BolaWrap Remote Restraint Device – is a hand-held remote restraint device that discharges an eight-foot bola style Kevlar tether to entangle an individual at a range of 10-25 feet. BolaWrap assists law enforcement to safely and effectively control encounters early in the use of force continuum without resorting to painful force options.   Wrap Reality – is a law enforcement training system employing immersive computer graphics virtual reality with proprietary software-enabled content. It allows up to two participants to enter a simulated training environment simultaneously, and customized weapons controllers enable trainees to engage in strategic decision making along the force continuum.   In addition to the United States domestic law enforcement market, we have shipped our restraint products to 50 countries. We have established an active distributor network with 14 domestic distributors representing all 50 states and Puerto Rico. We have distribution agreements with 47 international distributors. We focus significant sales, training and business development efforts to support our distribution network.   We focus significant resources on research and development innovations and continue to enhance our products and plan to introduce new products. We believe we have established a strong branding and market presence globally and have established significant competitive advantages in our markets.   -18- Table of Contents     Business Outlook and Challenges   Our products and solutions continue to gain worldwide awareness and recognition through social media, media exposure, trade shows, product demonstrations and word of mouth as a result of positive responses from agencies and early adoption and deployment success. We believe Wrap is gaining traction as a recognized global brand, with innovative technology and an initial product foundation achieved through aggressive marketing and public relations. We believe that we have strong market opportunities for our remote restraint solution throughout the world in the law enforcement and security sectors as a result of increasing demands for less lethal policing and increasing threats posed by non-compliant subjects.   During the first nine months of 2021 the Company received an increased number of field reports of successful BolaWrap usage from law enforcement agencies. Many agencies consider BolaWrap as a very low level, or non-reportable, use of force option and, accordingly, many uses are not reported to us. Others are considered evidence and are also not shared. Some law enforcement agencies have shared bodycam footage of their field uses, some of which we are allowed to use in our marketing activities. We believe increased reports of avoiding escalation will help grow revenues in the future.   We grew our business in the first nine months of 2021 with revenues increasing 109% from the first nine months of 2020. Third quarter revenues increased 79% over the prior year and we continue to expand our business, both domestically and internationally, through direct and distributor sales. We have a robust and growing pipeline of market opportunities for our restraint product offering and training services within the law enforcement, military and homeland security business sectors domestically and internationally. Social trends demanding more compassionate and safe policing practices are expected to continue to drive our global business. We are pursuing large business prospects internationally and also pursuing business with large police agencies in the U.S. It is difficult to anticipate how long it will take to close these opportunities, or if they will ultimately come to fruition especially given the uncertainty of COVID-19 and social unrest, as discussed below.   To support our increased sales and distribution activities we have developed and offer robust training and class materials that certify law enforcement officers and trainers as BolaWrap instructors in the use and limitations of the BolaWrap in conjunction with modern policing tactics for de-escalation of encounters. We believe that law enforcement trainers and officers that have seen demonstrations or have been trained about our products are more supportive of their department’s purchase and deployment of product. As of September 30, 2021 over 940 agencies have received BolaWrap training with over 3,250 training officers at those agencies certified as BolaWrap instructors and qualified to train the rest of their departments. This represents a 113% increase in agencies and a 140% increase in training officers compared to December 31, 2020.   With the acquisition of the NSENA, Inc. (" NSENA ") business in December 2020 and rebranding of the NSENA business as Wrap Reality, we have continued to market our virtual reality system while working to integrate previous scenarios into a robust platform employing BolaWrap and additional de-escalation techniques into new Wrap Reality scenarios. We also seek to enhance the Wrap Reality experience through software and platform innovation. We plan to increase marketing activities for our virtual reality solution as our platform enhancements are introduced to market.   At September 30, 2021 we had backlog of approximately $63 expected to be delivered in the next twelve months. We had deferred revenue of $240 expected to be recognized generally over the next five years. Distributor and customer orders for future deliveries are generally subject to modification, rescheduling or in some instances, cancellation, in the normal course of business.   During the second quarter of 2021, we began to wind down our production line for the BolaWrap 100 product line and in the third quarter completed a shift to a new production process for the next generation BolaWrap 150 product that required new tooling, new production equipment and processes and additional licensing. We recorded $747 of product line exit costs related to this change in production activities in the second quarter.   Since inception in March 2016, we have generated significant losses from operations and anticipate that we will continue to generate significant losses from operations for the foreseeable future. We believe that we have adequate financial resources to sustain our operations for the next year.   We expect that we will need to continue to innovate new applications for our public safety technology, develop new products and technologies to meet diverse customer requirements and identify and develop new markets for our products.   -19- Table of Contents     Impact of COVID-19 and Social Unrest on our Business   We continue to face significant challenges in operating and growing our business related to the global impact of the novel coronavirus (“ COVID-19 ”). COVID-19 impact includes continued travel restrictions, quarantines, “stay-at-home” and “shelter-in-place” orders, shutdowns and slowdowns of certain businesses around the world and impacts on supply chains and logistics. The COVID-19 pandemic has resulted in a substantial curtailment of business activities worldwide and is causing weakened economic conditions, both in the United States and many countries abroad. As part of intensifying efforts to contain the spread of COVID-19, many companies and state, local and foreign governments continue to impose restrictions, including shelter-in-place orders and travel bans. While some of these companies and jurisdictions have started to relax such restrictions, in some cases, the restrictions are put back in place after having been lifted. These factors negatively impacted our operations and results of operations for 2020 and the first nine months of 2021. We expect that the evolving COVID-19 pandemic, associated travel restrictions and social distancing requirements, especially international, may continue to have an adverse impact on our results of operations. While the ultimate economic impact of the COVID-19 pandemic is highly uncertain, we expect that our business and results of operations, including our revenues, earnings and cash flows from operations, will be adversely impacted for at least the balance of 2021, including as a result of:     ● Delays in our ability to travel and train, especially internationally;   ● Greater funding challenges for our customer base, which may adversely affect timing of anticipated contracts and new customer sales;   ● Disruption to our supply chain caused by distribution and other logistical issues, which may further delay our ability to deliver product to customers beyond 2021; and   ● Potential decrease in productivity of our employees or those of our customers or suppliers due to travel bans or restrictions, work-from-home or shelter-in-place policies and orders.   We also may be adversely affected by continued social unrest, protests against racial inequality, protests against police brutality and movements such as “Defund the Police”. These events may directly or indirectly affect police agency budgets and funding available to current and potential customers. Participants in these events may also attempt to create the perception that our solutions are contributing to the perceived problems or ineffective as a solution, which may adversely affect us, our business and results of operations, including our revenues, earnings and cash flows from operations.   It is currently not possible to predict the magnitude or duration of the COVID-19 pandemic’s impact on our business or the future impact of the recent, ongoing and possible future unrest. The extent to which these events impact our business will depend on numerous evolving factors that we may not be able to control or accurately predict, including without limitation:     ● the duration and scope of the challenges created by the COVID-19 pandemic or by ongoing social unrest;   ● governmental, business and individuals’ actions that have been and continue to be taken in response to these events;   ● the impact of the COVID-19 pandemic and social unrest on economic activity and actions taken in response;   ● the effect on our customers and demand for our products and services;   ● our ability to continue to sell and deliver our products and services, including as a result of travel restrictions, logistic and supply chain challenges, people working from home, or restrictions on access to our potential customers;   ● the ability of our customers to pay for our products and services;   ● any closures of our facilities and the facilities of our customers and suppliers; and   ● the degree to which our employees or those of our customers or suppliers become ill with COVID-19.   Critical Accounting Policies and Estimates   The preparation of financial statements in accordance with accounting principles generally accepted in the United States (“ U.S. GAAP ”) requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense, and related disclosure of contingent assets and liabilities. We evaluate our estimates, on an on-going basis, including those estimates related to recognition and measurement of contingencies and accrued expense. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.   -20- Table of Contents     As part of the process of preparing our financial statements, we are required to estimate our provision for income taxes. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, tax contingencies, unrecognized tax benefits, and any required valuation allowance, including taking into consideration the probability of the tax contingencies being incurred. Management assesses this probability based upon information provided by its tax advisers, its legal advisers and similar tax cases. If later our assessment of the probability of these tax contingencies changes, our accrual for such tax uncertainties may increase or decrease. Our effective tax rate for annual and interim reporting periods could be impacted if uncertain tax positions that are not recognized are settled at an amount which differs from our estimates.   Some of our accounting policies require higher degrees of judgment than others in their application. These include share-based compensation and contingencies and areas such as revenue recognition, allowance for doubtful accounts, valuation of inventory and intangible assets, estimates of product line exit costs, warranty liabilities and impairments.   Revenue Recognition . We sell our products to customers including law enforcement agencies, domestic distributors and international distributors and revenue from such transactions is recognized in the periods that products are shipped (free on board (“ FOB ”) shipping point) or received by customers (FOB destination), when the fee is fixed or determinable and when collection of resulting receivables is reasonably assured. We identify customer performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue as we satisfy the performance obligations. Our primary performance obligations are products/accessories and virtual reality software licensing or sale. Our customers do not have the right to return product unless the product is found to be defective.   Share-Based Compensation. We follow the fair value recognition provisions issued by the Financial Accounting Standards Board (“ FASB ”) in Accounting Standards Codification (“ ASC ”) Topic 718, Stock Compensation (“ ASC 718 ”) and we adopted Accounting Standards Update (“ ASU ”) 2018-07 for share-based transactions with non-employees. Share-based compensation expense recognized during 2020 and 2019 includes stock option and restricted stock unit compensation expense. The grant date fair value of stock options is determined using the Black-Scholes option-pricing model. The grant date is the date at which an employer and employee or non-employee reach a mutual understanding of the key terms and conditions of a share-based payment award. The Black-Scholes option-pricing model requires inputs including the market price of the Company’s Common Stock on the date of grant, the term that the stock options are expected to be outstanding, the implied stock volatilities of several publicly-traded peers over the expected term of stock options, risk-free interest rate and expected dividend. Each of these inputs is subjective and generally requires significant judgment to determine. The grant date fair value of restricted stock units is based upon the market price of the Company’s Common Stock on the date of the grant. We determine the amount of share-based compensation expense based on awards that we ultimately expect to vest and account for forfeitures as they occur. The fair value of share-based compensation is amortized to compensation expense over the vesting term.   Allowance for Doubtful Accounts. Our products are sold to customers in many different markets and geographic locations. We estimate our bad debt reserve on a case-by-case basis and the aging of accounts due to a limited number of customers mostly government agencies or well-established distributors. We base these estimates on many factors including customer credit worthiness, past transaction history with the customer, current economic industry trends and changes in customer payment terms. Our judgments and estimates regarding collectability of accounts receivable have an impact on our financial statements.   Valuation of Inventory . Our inventory is comprised of raw materials, assemblies and finished products. We must periodically make judgments and estimates regarding the future utility and carrying value of our inventory. The carrying value of our inventory is periodically reviewed and impairments, if any, are recognized when the expected future benefit from our inventory is less than carrying value.   Valuation of Intangible Assets. Intangible assets consisted of (a) capitalized legal fees and filing expense related to obtaining patents and trademarks, (b) customer agreements, tradenames, software, non-solicitation and non-compete agreements acquired in business combinations and valued at fair value at the acquisition date, and (c) the purchase cost of indefinite-lived website domains. We must make judgments and estimates regarding the future utility and carrying value of intangible assets. The carrying values of such assets are periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from an individual intangible asset is less than carrying value. This generally could occur when certain assets are no longer consistent with our business strategy and whose expected future value has decreased.   -21- Table of Contents     Exit Expense . Our product line exit expense included estimates of end of product life raw material write offs, costs of noncancelable raw material purchase orders and retirement of unamortized production tooling costs. We make these estimates based on current production plans and these judgments and estimates have an impact on our financial statements.   Accrued Expense. We establish a warranty reserve based on anticipated warranty claims at the time product revenue is recognized. This reserve requires us to make estimates regarding the amount and costs of warranty repairs we expect to make over a period of time. Factors affecting warranty reserve levels include the number of units sold, anticipated cost of warranty repairs, and anticipated rates of warranty claims. We have very limited history to make such estimates and warranty estimates have an impact on our financial statements. Warranty expense is recorded in cost of revenues. We evaluate the adequacy of this reserve each reporting period.   We use the recognition criteria of ASC 450-20, “Loss Contingencies” to estimate the amount of bonuses when it becomes probable a bonus liability will be incurred and we recognize expense ratably over the service period. We accrue bonus expense each quarter based on estimated year-end results, and then adjust the actual in the fourth quarter based on our final results compared to targets.   Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. Other than the planned production change requiring a new estimate of exit expense, there were no significant changes or modification of our critical accounting policies and estimates involving management valuation adjustments affecting our results for the period ended September 30, 2021.   Segment and Related Information   The Company operates as a single segment. The Company’s chief operating decision maker is its Chief Executive Officer, who manages operations for purposes of allocating resources. Refer to Note 14, Major Customers and Related Information, in our financial statements for further discussion.   Operating Expenses   Our operating expenses include (i) selling, general and administrative expense, (ii) research and development expense, and in the most recent fiscal quarter, (iii) product line exit expense. Research and development expense is comprised of the costs incurred in performing research and development activities and developing production on our behalf, including compensation and consulting, design and prototype costs, contract services, patent costs and other outside expense. The scope and magnitude of our future research and development expense is difficult to predict at this time and will depend on elections made regarding research projects, staffing levels and outside consulting and contract costs. The future level of selling, general and administrative expense will be dependent on staffing levels, elections regarding expenditures on sales, marketing and customer training, the use of outside resources, public company and regulatory expense, and other factors, some of which are outside of our control. We do not expect any significant further material restructuring and other costs.   We expect our operating costs, excluding restructuring and other costs, will increase as we expand product distribution activities and expand our research and development, production, distribution, training, service and administrative functions in the near term. We may also incur substantial non-cash share-based compensation costs depending on future option and restricted stock unit grants that are impacted by stock prices and other valuation factors. Historical expenditures are not indicative of future expenditures.   -22- Table of Contents     Results of Operations   Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020   The following table sets forth for the periods indicated certain items of our condensed consolidated statement of operations. The financial information and the discussion below should be read in conjunction with the financial statements and notes contained in this Report.       Three Months Ended September 30,     Change       2021     2020        $     %   Revenues:                                 Product sales   $ 1,719     $ 988     $ 731       74 % Other revenue     86       19       67       353 % Total revenues     1,805       1,007       798       79 % Cost of revenues:                                 Products and services     1,094       688       406       59 % Product line exit expense     -       -       -       -   Total cost of revenues     1,094       688       406       59 % Gross profit (loss)     711       319       392       123 %                                   Operating expenses:                                 Selling, general and administrative     4,654       3,255       1,399       43 % Research and development     2,076       927       1,149       124 % Total operating expenses     6,730       4,182       2,548       61 % Loss from operations   $ (6,019 )   $ (3,863 )   $ (2,156 )     56 %   Revenue   We reported revenue of $1,805 for the three months ended September 30, 2021 as compared to $1,007 for the quarter ended September 30, 2020, a 79% increase over the prior year. We believe our sales during the third quarter of 2021 were negatively impacted by the COVID-19 pandemic as we were limited in our ability to make product demonstrations and conduct training primarily internationally. We also believe some customers delayed purchase decisions during the quarter in anticipation of the introduction of our second generation product, the BolaWrap 150.   We incurred product promotional costs of $183 during the three months ended September 30, 2021 related primarily to the cost of demonstration and training products and accessories delivered to law enforcement agencies that were expensed as marketing costs. A total of $261 of such product marketing costs were incurred during the three months ended September 30, 2020. While we continue broad training activities our increased number of successful field uses and brand awareness reduces the need for demonstration product.   We had $240 of deferred revenue at September 30, 2021, of which $152 related to virtual reality training and $88 related to BolaWrap extended warranties and training services.   We believe we can substantially grow sales in future periods; however, the impact of the COVID-19 pandemic has created much uncertainty in the global marketplace by restricting our ability to travel internationally and, to a more limited extent, domestically. We are therefore unable to predict at this time whether our sales will continue to increase materially during the remainder of the fiscal year ending December 31, 2021 due to these uncertainties. Although no assurances can be given, we do believe, however, that the challenges to substantially increasing sales caused by COVID-19 will abate as the rate of vaccinations increase globally, especially given the number of BolaWrap trials currently ongoing and the current environment where non-lethal options are being widely considered by law enforcement domestically and internationally.   At September 30, 2021, we had backlog of $63 expected to be delivered in the next twelve months. Distributor and customer orders for future deliveries are generally subject to modification, rescheduling or in some instance’s cancellation in the normal course of business. Since we generally ship domestic product from inventory shortly after order period backlog generally varies depending on larger foreign orders.   -23- Table of Contents     Gross Profit   Our cost of revenue for the three months ended September 30, 2021 was $1,094 resulting in a gross margin of 39%. The gross margin for the three months ended September 30, 2020 was 32%.   Due to our limited history of revenue historical margins may not be indicative of future margins. During the third quarter ended September 30, 2021, we began production of our new generation BolaWrap 150 product with different material inputs and manufacturing processes such that historical margins may not be indicative of future margins. We expect that the BolaWrap 150, after a startup period, will have higher margins than historical production. Our margins also vary based on the sales channels through which our products are sold and product mix. Currently, our cassettes have lower margins than BolaWrap devices. We implement product updates and revisions, including raw material and component changes that may impact product costs. With such product updates and revisions, we have limited warranty cost experience and estimated future warranty costs can impact our gross margins.   Selling, General and Administrative Expense   Selling, general and administrative (“SG&A”) expense for the three months ended September 30, 2021 increased by $1,399 when compared to the three months ended September 30, 2020.    The largest driver of this increase was related to an increase of $624 in share-based compensation, related to incentives for management and employees.   Other SG&A expense increases included a $607 increase in cash compensation, recruiting and consultancy costs resulting from planned growth in personnel over the prior year and a $136 increase in public company related expense. In addition, our travel costs related to sales, demonstrations and training increased by $88 as a result of increased travel by sales and training personnel. In the third quarter of 2020, we had virtually no travel expense due to the COVID-19 pandemic and the various travel restrictions that were in place. Despite the growth in the third quarter of 2021, we are still well below historical norms for our travel expense but expect travel expense to increase as international travel restrictions ease.   The increase in SG&A expense was partially offset by a $296 decrease in advertising and promotional product expense resulting from reduced demonstration product costs and a planned shift in production efforts to a new generation product.   Research and Development Expense   Research and development expense increased by $1,149 for the three months ended September 30, 2021, compared to the comparable three-month period in fiscal 2020. We incurred a $132 period over period increase in non-cash share-based compensation expense allocated to research and development expense as a result of new award grants to new personnel and vesting timing. The increase in costs during the three months ended September 30, 2021 compared to the prior year included a $301 increase in cash compensation costs resulting from an increase in headcount primarily associated with product development. Outside consulting costs increased by $417 for the three months ended September 30, 2021, primarily due to costs related to the development of our next generation BolaWrap 150 product, initiatives to develop new products and increased development of virtual reality software. Prototype related costs for three months ended September 30, 2021 were $251 comparable to $274 for the prior comparable three-month period. We expect our research and development costs to increase in the future as we add staff and expand our research initiatives in response to market opportunities.    Net Loss   Loss from operations during the three months ended September 30, 2021 increased by $2,156 compared to the three months ended September 30, 2020, resulting, primarily, from increased share-based compensation and increased operating costs due to increased personnel, public company costs, research and development efforts and supporting activities.     -24- Table of Contents     Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020   The following table sets forth for the periods indicated certain items of our condensed consolidated statement of operations. The financial information and the discussion below should be read in conjunction with the financial statements and notes contained in this Report.       Nine Months Ended September 30,     Change       2021     2020       $     %   Revenues:                                 Product sales   $ 4,997     $ 2,486     $ 2,511       101 % Other revenue     283       43       240       558 % Total revenues     5,280       2,529       2,751       109 % Cost of revenues:                                 Products and services     3,276       1,659       1,617       97 % Product line exit expense     747       -       747       -   Total cost of revenues     4,023       1,659       2,364       142 % Gross profit (loss)     1,257       870       387       44 %                                   Operating expenses:                                 Selling, general and administrative     16,210       7,933       8,277       104 % Research and development     4,303       2,038       2,265       111 % Total operating expenses     20,513       9,971       10,542       106 % Loss from operations   $ (19,256 )   $ (9,101 )   $ (10,155 )     112 %   Revenue   We reported revenue of $5,280 for the nine months ended September 30, 2021 as compared to $2,529 for the nine months ended September 30, 2020, a 109% increase over the prior year. We believe our sales during the first nine months of 2021 were negatively impacted by the COVID-19 pandemic as we were limited in our ability to make product demonstrations and conduct training primarily internationally. We also believe some customers delayed purchase decisions during the third quarter in anticipation of the second generation product, the BolaWrap 150.   We incurred product promotional costs of $862 during the nine months ended September 30, 2021 related primarily to the cost of demonstration and training products and accessories delivered to law enforcement agencies that were expensed as marketing costs. A total of $575 of such product marketing costs were incurred during the nine months ended September 30, 2020. We are responding to increased demand for training as a result of expanded product and brand awareness and increased successful field use by agencies.   We had $240 of deferred revenue at September 30, 2021, of which $152 related to virtual reality training and $88 related to BolaWrap extended warranties and training services.   We believe we can substantially grow sales in future periods; however, the impact of the COVID-19 pandemic has created much uncertainty in the global marketplace by restricting our ability to travel internationally and, to a more limited extent, domestically. We are therefore unable to predict at this time whether our sales will continue to increase materially during the remainder of the fiscal year ending December 31, 2021 due to these uncertainties. Although no assurances can be given, we do believe, however, that the challenges to substantially increasing sales caused by COVID-19 will abate as the rate of vaccinations increase globally, especially given the number of BolaWrap trials currently ongoing and the current environment where non-lethal options are being widely considered by law enforcement domestically and internationally.   Gross Profit   Our cost of revenue for the nine months ended September 30, 2021 was $4,023 and included $747 of restructuring inventory charge. Excluding this non-cash $747 charge, the gross margin for the nine months ended September 30, 2021 was 38%. The gross margin for the nine months ended September 30, 2020 was 34%. During the third quarter ended September 30, 2021, we began production of our new generation BolaWrap 150 product with different material inputs and manufacturing processes such that historical margins may not be indicative of future margins. We have limited warranty cost experience and estimated future warranty costs can impact our gross margins.   -25- Table of Contents     Selling, General and Administrative Expense   SG&A expense for the nine months ended September 30, 2021 increased by $8,277 compared to the nine months ended September 30, 2020.    The largest driver of this increase was related to an increase of $2,329 in share-based compensation, of which $1,397 was for director compensation. The remaining $932 was incentive for management and employees.   We continue to invest in our marketing and promotion, which augments the media attention we receive from external sources, such as news broadcasts. During the first nine months of 2021, we incurred increases of $407 related to public relations initiatives and $62 related to advertising and promotional products.   For the first nine months of 2021, our public reporting expense increased by $1,467. This includes shareholder activism costs of $818 in connection with actions by a former executive officer/shareholder seeking changes in the composition of our Board of Directors and candidates to stand for election at the 2021 Annual Shareholders’ Meeting, changes to the Executive Chairman position as well as other related matters. There were no comparable costs in 2020. This matter was settled in March 2021 and we do not expect significant additional costs during the rest of 2021.   Other SG&A expense increases included a $2,920 increase in cash compensation, recruiting and consultancy costs resulting from our planned growth in personnel over the prior year. In addition, our travel costs related to sales, demonstrations and training increased by $339 as a result of increased travel by sales and training personnel. In the second and third quarters of 2020, we had virtually no travel due to the COVID-19 pandemic and the various travel restrictions that were in place. Despite the growth in 2021 to date, we are still well below historical norms for our travel expense but expect travel expense to increase as international travel restrictions ease.   Research and Development Expense   Research and development expense increased by $2,265 for the nine months ended September 30, 2021, compared to the comparable nine-month period in fiscal 2020. We incurred a $419 period over period increase in non-cash share-based compensation expense allocated to research and development expense as a result of new award grants to new personnel and vesting timing. The increase in costs during the nine months ended September 30, 2021 compared to the prior year included a $636 increase in cash compensation costs resulting from an increase in headcount primarily associated with product development. Outside consulting costs increased by $917 for the nine months ended September 30, 2021, primarily due to costs related to a new generation BolaWrap product, initiatives to develop new products and increased development of virtual reality scenarios. The increase in research and development expense is partially offset by the decrease of $66 relating to prototype related costs for nine months ended September 30, 2021, compared to the comparable period in 2020. We expect our research and development costs to increase in the future as we add staff and expand our research initiatives in response to market opportunities.    Net Loss   The $19,256 loss from operations during the nine months ended September 30, 2021 increased by $10,155 compared to the nine months ended September 30, 2020, resulting, primarily, from increased share-based compensation and increased operating costs due to increased personnel, marketing and selling, public company costs and supporting activities. We also incurred a one-time non-cash product line exit expense of $747 during the period that we do not expect to recur.   Liquidity and Capital Resources   Overview   We have experienced net losses and negative cash flows from operations since our inception. As of September 30, 2021, we had cash and cash equivalents of $9,858, short-term investments of $30,004, positive working capital of $42,869 and had sustained cumulative losses attributable to stockholders of $44,530. We believe that our cash on hand and short-term investments will sustain our operations for at least the next twelve months from the date of this Report.   During the nine months ended September 30, 2021 we received $13,726 of proceeds from the exercise of previously issued stock purchase warrants and from the exercise of stock options.   Our primary source of liquidity to date has been funding from our stockholders from the sale of equity securities and the exercise of derivative securities, consisting of options and warrants. We expect our primary source of future liquidity will be from the sale of products, exercise of stock options and warrants and if required from future equity or debt financings.   -26- Table of Contents     Capital Requirements   Due in part to the volatility caused by COVID-19, we do not have a high degree of confidence in our estimates for our future liquidity requirements or future capital needs, which will depend on, among other things, capital required to introduce new products and the operational staffing and support requirements, as well as the timing and amount of future revenue and product costs. We anticipate that demands for operating and working capital may grow depending on decisions on staffing, development, production, marketing, training and other functions and based on other factors outside of our control. We believe we have sufficient capital to sustain our operations for the next twelve months.   Our future capital requirements, cash flows and results of operations could be affected by, and will depend on, many factors, some of which are currently unknown to us, including, among other things:     ● The impact and effects of the global outbreak of the COVID-19 pandemic, and other potential pandemics or contagious diseases or fear of such outbreaks;   ● Decisions regarding staffing, development, production, marketing and other functions;   ● The timing and extent of market acceptance of our products;   ● Costs, timing and outcome of planned production and required customer and regulatory compliance of our products;   ● Costs of preparing, filing and prosecuting our patent applications and defending any future intellectual property-related claims;   ● Costs and timing of additional product development;   ● Costs, timing and outcome of any future warranty claims or litigation against us associated with any of our products;   ● Ability to collect accounts receivable; and   ● Timing and costs associated with any new financing.   Principal factors that could affect our ability to obtain cash from external sources including from exercise of outstanding warrants and options include:     ● Volatility in the capital markets; and   ● Market price and trading volume of our Common Stock.   Off-Balance Sheet Arrangements   We have no off-balance sheet arrangements.   Cash Flow   Operating Activities   During the nine months ended September 30, 2021, net cash used in operating activities was $13,729. The net loss of $19,220 was decreased by non-cash expense of $5,879 consisting primarily of share-based compensation expense of $4,310, restructuring inventory charges of $747, depreciation and amortization expense of $336 and shares issued for services of $239. Other major component changes using operating cash included an increase of $1,414 in accounts receivable and an increase in inventories of $160. An increase of $773 in accounts payable and accrued expense and an increase of $224 in deferred revenue reduced the cash used in operating activities.   During the nine months ended September 30, 2020, net cash used in operating activities was $7,693. The net loss of $9,024 was decreased by non-cash expense of $1,771 consisting primarily of stock-based compensation expense of $1,563. Other major component changes using operating cash included an increase of $985 in accounts receivable, a $216 decrease in customer deposits and a $50 increase in prepaid expense and other current assets. A decrease of $294 in inventories and an increase of $610 in accounts payable and accrued liabilities reduced the cash used in operating activities.   -27- Table of Contents     Investing Activities   During the nine months ended September 30, 2021, we used $30,014 of cash to purchase short-term investments and we had proceeds from maturities of short-term investments of $25,000. We purchased $25,000 of short-term investments during the nine months ended September 30, 2020.   We used $811 and $202 of cash for the purchase of property and equipment during the nine months ended September 30, 2021 and 2020, respectively. We invested $129 and $101 in patents during the nine months ended September 30, 2021 and 2020, respectively.   Financing Activities   During the nine months ended September 30, 2021, we received $12,048 from previously issued stock purchase warrants and $1,678 in proceeds from the exercise of previously issued stock options, and repaid $275 in debt relating to the acquisition of NSENA in December 2020.   During the nine months ended September 30, 2020 we received $11,667 of net proceeds resulting from the consummation of a registered offering of our Common Stock in June 2020, and obtained $24,029 of net proceeds from the exercise of previously issued warrants and stock options. We also obtained $414 in proceeds from a U.S. Small Business Administration Promissory Note pursuant to the Paycheck Protection Program of the Coronavirus Aid, Relief, and Economic Security Act during the period.   Contractual Obligations and Commitments   Pursuant to that certain exclusive Amended and Restated Intellectual Property License Agreement dated September 30, 2016, by and between the Company and Syzygy Licensing, LLC (“ Syzygy ”), we are obligated to pay to Syzygy a 4% royalty fee on future product sales up to an aggregate amount of $1.0 million in royalty payments or until September 30, 2026, whichever occurs earlier.   We are committed to aggregate lease payments on our facility lease of $24 in 2021 and $58 in 2022.   At September 30, 2021 the Company was committed for approximately $713 for future component deliveries and contract services that are generally subject to modification or rescheduling in the normal course of business.   Effects of Inflation   We do not believe that inflation has had a material impact on our business, revenue or operating results during the periods presented.   Recent Accounting Pronouncements   There have been no recent accounting pronouncements or changes in accounting pronouncements during the period ended September 30, 2021, or subsequently thereto, that we believe are of potential significance to our financial statements.   Item 3. Quantitative and Qualitative Disclosures about Market Risk.   Not applicable.