Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Readers
are advised to review the following discussion and analysis of our financial condition and results of operations together with
our consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the
consolidated financial statements and related notes thereto in our Annual Report on Form 10-K for the year ended December 31,
2019. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, including
information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and
uncertainties. See “Cautionary Note Regarding Forward-Looking Statements”. You should review the “Risk Factors”
section of our Annual Report for the fiscal year ended December 31, 2019 for a discussion of important factors that could cause
actual results to differ materially from the results described in or implied by the forward-looking statements contained in the
following discussion and analysis.
Overview
ScoutCam
Ltd. (the “Subsidiary”) was formed in Israel on January 3, 2019, as a wholly owned subsidiary of Medigus Ltd., an
Israeli company (“Medigus”), and commenced operations on March 1, 2019. The Subsidiary was incorporated as a part
of the reorganization of Medigus, which was designed to distinguish the Subsidiary’s miniaturized imaging business, the
micro ScoutCam™ portfolio, from Medigus’s other operations and to enable Medigus to form a separate business
unit with dedicated resources focused on the promotion of such technology (the “Reorganization”). In December 2019,
Medigus and the Subsidiary consummated the Amended and Restated Asset Transfer Agreement, which transferred and assigned certain
assets and intellectual property rights related to its miniaturized imaging business.
On
March 1, 2019, 12 employees moved from Medigus to the Subsidiary.
The
following table summarizes our results of operations for the nine months ended September 30, 2020 and 2019, together with the
changes in those items in dollars and as a percentage:
|
|
2020
|
|
|
2019
|
|
|
% Change
|
|
Revenues
|
|
|
86,000
|
|
|
|
272,000
|
|
|
|
(68
|
)%
|
Cost of Revenues
|
|
|
434,000
|
|
|
|
440,000
|
|
|
|
(1
|
)%
|
Gross Loss
|
|
|
(348,000
|
)
|
|
|
(168,000
|
)
|
|
|
107
|
%
|
Research and development expenses
|
|
|
514,000
|
|
|
|
216,000
|
|
|
|
138
|
%
|
Sales and marketing expense
|
|
|
302,000
|
|
|
|
130,000
|
|
|
|
132
|
%
|
General and administrative expenses
|
|
|
2,309,000
|
|
|
|
541,000
|
|
|
|
327
|
%
|
Operating Loss
|
|
|
(3,473,000
|
)
|
|
|
(1,055,000
|
)
|
|
|
229
|
%
|
Revenues
For
the nine months ended September 30, 2020, the Subsidiary generated revenues of $86,000, a decrease of $186,000 from the nine months
ended September 30, 2019 revenues.
The
decrease in revenues was primarily due:
|
a)
|
the
COVID-19 pandemic impact on global markets and the global economy, including countries and industries in which the
Company operates;
|
|
b)
|
most
of the revenues for the nine months ended September 30, 2019 were derived from sales of miniature camera and related equipment
to occasional customers. The Company’s management has decided to reduce sales to occasional customers and focus on large
projects. Our current business model is that of a B2B approach, in which we seek to identify target businesses interested
in integrating our micro ScoutCam™ technology, or commissioning individual projects using our technology.
|
Currently,
we have two major customers that generate most of our current and forecasted revenue in the near term:
(1)
a large international bio-med company that is developing a visualization component for its invasive surgical device.
(2)
a medical device company that specializes in orthopedic surgeries and develops and markets minimally invasive surgical devices.
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 September 30, 2020, the total RPO
amounted to $3.3 million, which the Company expects to recognize during the next 12 months.
Cost
of Revenues
Cost
of revenues for the nine months ended September 30, 2020 were $434,000, a decrease of $6,000 compared to cost of revenues of $440,000
for the nine months ended September 30, 2019. The decrease was primarily due to a decrease in materials as a result of a decrease
in revenues, partially offset by an increase in payroll expenses as a result of hiring additional employees.
Gross
Loss
Gross
loss for the nine months ended September 30, 2020 was $348,000, an increase of $180,000 compared to gross loss of $168,000 for
the nine months ended September 30, 2019.
Research
and Development Expenses
Research
and development expenses for the nine months ended September 30, 2020, were $514,000, an increase of $298,000, or 138%, compared
to $216,000 for the nine months ended September 30, 2019. The increase was primarily due to an increase in payroll expenses and
increase in materials and subcontractors. The increase in payroll expenses was as result of an increase in share - based compensation
expenses (see note 4 to our interim condensed consolidated financial statements as of September 30, 2020) and hiring additional
employees. The increase in materials and subcontractors was primarily due to an increase in research and development activities.
Sales
and Marketing Expenses
Sales
and marketing expenses for the nine months ended September 30, 2020, were $302,000, an increase of $172,000, or 132%, compared
to $130,000 for the nine months ended September 30, 2019. The increase was primarily due to an increase in marketing activities.
General
and Administrative Expenses
General
and Administrative expenses for the nine months ended September 30, 2020, were $2,309,000, an increase of $1,768,000, or 327%,
compared to $541,000 for the nine months ended September 30, 2019. The increase was primarily due to an increase in payroll expenses,
as result of an increase in share - based compensation expenses (see note 4 to our interim condensed consolidated financial statements
as of September 30, 2020) and hiring additional employees and an increase in professional services. The increase in professional
services resulted from the incorporation of the Subsidiary as an independent company and in connection with the execution of that
certain securities exchange agreement involving the Subsidiary.
Operating
loss
We
incurred an operating loss of $3,473,000 for the nine months ended September 30, 2020, an increase of $2,418,000, or 229%, compared
to operating loss of $1,055,000 for the nine months ended September 30, 2019. The increase in operating loss was due to $180,000
increase in gross loss, $298,000 increase in research and development expenses, $172,000 increase in sales and marketing expenses
and $1,768,000 increase in administrative and general expenses.
Liquidity
and Capital Resources
Sources
of Liquidity
The
Company has financed its operations primarily through Medigus, private placement transactions for the issuance of common stock
and warrants, and sales to customers.
Cash
Flows
The
following table sets forth the significant sources and uses of cash for the periods set forth below (in dollars):
|
|
2020
|
|
|
2019
|
|
Cash used in Operating Activity
|
|
|
(2,710,000
|
)
|
|
|
(1,280,000
|
)
|
Cash used in Investing Activity
|
|
|
(249,000
|
)
|
|
|
(46,000
|
)
|
Cash provided by Financing Activity
|
|
|
2,777,000
|
|
|
|
1,402,000
|
|
Profit from exchange differences on cash equivalents
|
|
|
87,000
|
|
|
|
-
|
|
Operating
Activities
For
the nine months ended September 30, 2020, net cash flows used in operating activities was $2,710,000, compared to net cash flows
used in operating activities of $1,280,000 for the nine months ended September 30, 2019, an increase of $1,430,000. The change
was mainly due to an increase in net loss which was partially offset by an increase in stock-based compensation.
Investing
Activities
For the nine months
ended September 30, 2020, net cash flows used in investing activities was $249,000 as compared to $46,000 for the same
period of 2019. The change was due to the purchase of property and equipment during the nine months ended September 30, 2020.
Financing
Activities
For
the nine months ended September 30, 2020, net cash flows provided by financing activities was $2,777,000, compared to net cash
flows provided by financing activities of $1,402,000 for the nine months ended September 30, 2019.
Net
cash provided by financing activities in the nine months ended September 30, 2020 consisted of $2,858,000 in proceeds from the
issuance of shares and warrants, and $81,000 in loan repayments from Medigus. Net cash provided by financing activities in the
nine months ended September 30, 2019 was generated from the transfer of funds from Medigus and from sales of assets to Medigus.
Profit
from exchange differences on cash equivalents
During
the nine months ended September 30, 2020, the Subsidiary generated profit from exchange differences on cash equivalents of $87,000.
This profit represents a change in the Company’s cash and cash equivalents as a result of the change in the dollar exchange
rate against the NIS during the nine months ended September 30, 2020.
The
following table summarizes our results of operations for the three months ended September 30, 2020 and 2019, together with the
changes in those items in dollars and as a percentage:
|
|
2020
|
|
|
2019
|
|
|
% Change
|
|
Revenues
|
|
|
12,000
|
|
|
|
128,000
|
|
|
|
(91
|
)%
|
Cost of Revenues
|
|
|
153,000
|
|
|
|
136,000
|
|
|
|
13
|
%
|
Gross Loss
|
|
|
(141,000
|
)
|
|
|
(8,000
|
)
|
|
|
1,663
|
%
|
Research and development expenses
|
|
|
144,000
|
|
|
|
75,000
|
|
|
|
92
|
%
|
Sales and marketing expense
|
|
|
114,000
|
|
|
|
47,000
|
|
|
|
143
|
%
|
General and administrative expenses
|
|
|
629,000
|
|
|
|
227,000
|
|
|
|
177
|
%
|
Operating Loss
|
|
|
(1,028,000
|
)
|
|
|
(357,000
|
)
|
|
|
188
|
%
|
Revenues
For
the three months ended September 30, 2020, the Subsidiary generated revenues of $12,000, a decrease of $116,000 from the three
months ended September 30, 2019 revenues.
For
reasons for the decrease in revenues see a comparison of nine months.
Cost
of Revenues
Cost of revenues for
the three months ended September 30, 2020 were $153,000, an increase of $17,000 compared to cost of revenues of $136,000
for the three months ended September 30, 2019. The increase was primarily due to a decrease in materials as a result of decrease
in revenues, partially offset by an increase in payroll expenses as a result of hiring additional employees.
Gross
Loss
Gross
loss for the three months ended September 30, 2020 was $141,000, an increase of $133,000 compared to gross loss of $8,000 for
the three months ended September 30, 2019.
Research
and Development Expenses
Research
and development expenses for the three months ended September 30, 2020, were $144,000, an increase of $69,000, or 92%, compared
to $75,000 for the three months ended September 30, 2019. The increase was primarily due to an increase in payroll expenses and
increase in materials and subcontractors. The increase in payroll expenses was as result of an increase in share - based compensation
expenses (see note 4 to our interim condensed consolidated financial statements as of September 30, 2020) and hiring additional
employees. The increase in materials and subcontractors was primarily due to an increase in research and development activities.
Sales
and Marketing Expenses
Sales
and marketing expenses for the three months ended September 30, 2020, were $114,000, an increase of $67,000, or 143%, compared
to $47,000 for the three months ended September 30, 2019. The increase was primarily due to an increase in marketing activities.
General
and Administrative Expenses
General
and Administrative expenses for the three months ended September 30, 2020, were $629,000, an increase of $402,000, or 177%, compared
to $227,000 for the three months ended September 30, 2019. The increase was primarily due to an increase in payroll expenses,
as a result of an increase in share - based compensation expenses (see note 4 to our interim condensed consolidated financial
statements as of September 30, 2020) and hiring additional employees and an increase in professional services. The increase in
professional services resulted from the incorporation of the Subsidiary as an independent company and in connection with the execution
of that certain securities exchange agreement involving the Subsidiary.
Operating
loss
We
incurred an operating loss of $1,028,000 for the three months ended September 30, 2020, an increase of $671,000, or 188%,
compared to operating loss of $357,000 for the three months ended September 30, 2019. The increase in operating loss was due to
$133,000 increase in gross loss, $69,000 increase in research and development expenses, $67,000 increase in sales and marketing
expenses and $402,000 increase in administrative and general expenses.
Liquidity
and Capital Resources
Sources
of Liquidity
The
Company has financed its operations primarily through Medigus, private placement transactions for the issuance of common stock
and warrants, and sales to customers.
Cash
Flows
The
following table sets forth the significant sources and uses of cash for the periods set forth below (in dollars):
|
|
2020
|
|
|
2019
|
|
Cash used in Operating Activity
|
|
|
(433,000
|
)
|
|
|
(381,000
|
)
|
Cash used in Investing Activity
|
|
|
(28,000
|
)
|
|
|
(46,000
|
)
|
Cash provided by Financing Activity
|
|
|
-
|
|
|
|
421,000
|
|
Profit from exchange differences on cash equivalents
|
|
|
3,000
|
|
|
|
-
|
|
Operating
Activities
For
the three months ended September 30, 2020, net cash flows used in operating activities was $433,000, compared to net cash flows
used in operating activities of $381,000 for the three months ended September 30, 2019, an increase of $52,000. The change was
mainly due to an increase in net loss, which was partially offset by an increase in stock-based compensation and increase in contract
liabilities.
Investing
Activities
For
the three months ended September 30, 2020, net cash flows used in investing activities was $28,000 as compared to $46,000
for the same period of 2019.
Financing
Activities
For
the three months ended September 30, 2019, net cash flows provided by financing activities was $421,000.
Net cash provided
by financing activities in the three months ended September 30, 2019 was generated from the transfer of funds from Medigus
and sale of assets to Medigus.
Loss
from exchange differences on cash equivalents
During
the three months ended September 30, 2020, the Subsidiary generated loss from exchange differences on cash equivalents of $3,000.
This loss represents a change in the Company’s cash and cash equivalents as a result of the change in the dollar exchange
rate against the NIS during the three months ended September 30, 2020.
Future
Funding Requirements
The
Company believes that it will require additional financing in order to provide the capital it needs to achieve its growth targets.
Off-Balance
Sheet Arrangements
The
Subsidiary leases its headquarters in Omer, Israel, with a total of approximately 807 gross square meters. In January 2020, ScoutCam
extended the agreement through the end of 2020. The rental payments are linked to the Israeli CPI.
Item
4. Controls and Procedures.
Evaluation
of Disclosure Controls and Procedures
Our
management, with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), evaluated the effectiveness
of our disclosure controls and procedures as of September 30, 2020. The term “disclosure controls and procedures,”
as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are
designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be
disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s
management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding
required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. As a result of the material weakness in our internal control over financial
reporting described below, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were not effective at the reasonable assurance level as of September 30, 2020.
In
connection with the audit of our 2019 annual consolidated financial statements, we identified a material weakness in our internal
control over financial reporting related to the complexities involving the accounting for our reverse recapitalization transaction.
The cause of this material weakness was due to the complex accounting related to the reverse recapitalization transaction, which
required additional qualified accounting personnel with an appropriate level of experience, and additional controls in the period-end
financial reporting process commensurate with the complexity of the matter. A material weakness is defined as a deficiency, or
combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material
misstatement of annual or interim financial statements will not be prevented or detected and corrected on a timely basis. The
material weakness did not result in any identified misstatements to the financial statements, and there were no changes to previously
released financial results. In light of the material weakness, we performed additional analyses and other post-closing procedures
and hired an additional accounting personnel to ensure our consolidated financial statements are prepared in accordance with U.S.
GAAP. Accordingly, our CEO and CFO have certified that, based on their knowledge, the consolidated financial statements, and other
financial information included in this Form 10-Q, fairly present in all material respects our financial condition, results of
operations and cash flows as of, and for, the periods presented in this Form 10-Q.
Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Remediation
Efforts to Address Material Weakness
We
began remediation efforts in the second quarter of 2020 for our accounting of non-routine complex transactions control by hiring
additional personnel for our finance team. We continue to evaluate our internal and external technical accounting resources to
ensure they are appropriate for us and our needs. Additionally, there is a renewed emphasis on our process going forward for initial
identification of potential contracts and transactions that may be non-routine and complex during a reporting period, and then
conducting the necessary procedures with the full internal accounting team and external consultants to review and research the
proper guidance and approach toward the accounting, and documenting as such in a white paper or memo as needed.
We
believe these measures, and others that may be implemented, will remediate the material weakness in internal control over financial
reporting described above.
The
material weakness will not be considered formally remediated until the control has operated effectively for a sufficient period
of time, and after management has concluded, through testing, that the control is operating effectively.
Changes
in Internal Control over Financial Reporting
Other
than the changes intended to remediate the material weakness noted above, there was no change in our internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2020
that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.