FLXT Flexpoint Sensor Systems Inc (PK)

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE OVERVIEW

Flexpoint Sensor Systems, Inc. is a company engaged principally in improving its unique sensor technology, expanding its suite of products, developing new sensor applications, obtaining financing and seeking long-term sustainable manufacturing contracts.  Our operations have not yet commenced to a commercially sustainable level and include designing, engineering, manufacturing and selling sensor technology and products featuring our Bend Sensor^® technology and equipment.

The COVID-19 Pandemic (“the Pandemic”) has had a dramatic effect on our business as well as the business of our customers. The wide-ranging effects on the world-wide business market has led to a general reluctance for businesses to move forward with entering into major commitments until their future markets have been clarified. Because of this, we have experienced a significant slowdown in the size and number of orders received and, while we cannot predict when the influence of the Pandemic will end, we have recently experienced an upturn in orders and we expect that orders will return to their former levels and even increase following a return to normal business operations.

In May 2021, Flexpoint announced that they have formalized a Joint Development and Supply Agreement between Flexpoint Sensor Systems, Inc. and De Amertek Corporation. The companies will work together and collaborate to develop electronics with integrated sensor technologies for an occupant classification system and other automotive products. We are currently collaborating on three separate projects with domestic and foreign automotive manufacturers. De Amertek is a leading designer and manufacturer of microelectronics and one of the most specialized sources of custom-made electronic modules. Headquartered in Chicago, IL, its world-class manufacturing facility and supply chain network exceeds customer expectations in quality, delivery, service and time to market. De Amertek is making way for futuristic developments and setting trends in the technology world.

In July 2021 we announced the addition of key resellers and partners in the Pacific Rim. These are companies Flexpoint has done business with in the past, and these moves strengthen and expand the strategic nature of the relationships. We are realizing new orders from them and anticipate additional immediate and significant volume purchases which will propel us further into existing key markets, as well as expand the reach of the Bend Sensor^® technology into new vertical markets and geographies.

In July 2021 we announced that we are continuing to work closely with a Fortune 50 automotive company on the integration of a system utilizing Flexpoint’s patented Bend Sensor^® technology which was included in a patent issued to the major automotive manufacturer. By utilizing Flexpoint’s technology, this manufacturer, along with Flexpoint, has created an innovative application for automobiles and trucks which allows them to optimize the ride quality of the vehicle. Flexpoint is actively working with the manufacturer on implementation of this new technology in vehicles.

In August 2021 we announced that the Company has entered into an agreement with a leading manufacturer of autonomous vehicles for the design and production of an impact detection system utilizing Flexpoint’s patented Bend Sensor^® technology. This manufacturer is a significant player in autonomous vehicle development and

production. The initial order will be delivered within 45 days with the probability of larger scale production occurring during 2022.

In September 8, 2021, we announced that they have recently entered into a new agreement with a major automotive manufacturer for the design and production of parts to be utilized in the finalization of an innovative application of Flexpoint’s technology for cars and trucks to maximize the ride quality of the vehicle. We believe this application will provide significant cost savings over existing systems and lead to wide spread application of this technology.

Additionally, we have seen significant market interest and the recent adoption of a variety of sensor applications including the Flexpoint seat occupancy sensor and the companies’ more sophisticated, Occupant Classification System (OCS), along with integration of the Impact Detection System. We are currently working with both North American and foreign automotive manufacturers on these systems. These companies include Fortune 50 automotive manufacturers as well as new, well financed companies in the EV and Autonomous Driving vehicle market spaces. We look forward to announcing production agreements with our partners and their anticipated production schedules as the agreements are formalized. We are also working on entering into an arrangement with a large after-market seller for seat products.

We also announced that Flexpoint continues to work with Resellers/Channel partners such as RobotShop, which has been a steady contributor of purchase orders throughout the past three years. We also receive orders from others such as Shopify, PayPal, Amazon and from orders placed on our website. Flexpoint is currently in the process of formalizing reseller agreements with international partners that have committed to develop markets for our sensors in their countries. We are working to increase this market area as it provides effective and significant growth and scale.

In the rapidly growing and emerging wearables space, Flexpoint has recently received additional purchase orders from multiple glove manufacturers across various market sub-segments, including medical, gaming and virtual reality. The “speed to market” commercialization plans of these companies are driving this increased order volume. Flexpoint is aggressively going after this evolving market. The Pandemic has slowed the orders and, while we cannot predict when the influence of the Pandemic will end, we have seen a recent increase in both the size and number of orders and expect this pattern to continue and increase throughout the remainder of 2021 following a return to business. In aggregate, Bend Sensor^® wearables order volumes are expected to number in the tens of thousands in 2021. The wearables market segment is clearly one where our technology is easily adapted and truly illustrates our technological differentiation. Flexpoint’s willingness and ability to customize sensors for these innovative companies and deliver them at a competitive price point allows us to deliver real value to our customers. Again, the Global COVID-19 Pandemic has had a dramatic impact on the orders we have received.

On June 15, 2020, Flexpoint announced its largest order from Manus VR https://manus-vr.com/, consisting of 1,000 pairs of sensors for gloves to be phased into three deliveries. All of the products ordered have been delivered. We have recently received an even larger order for 3,200 sensors from Manus VR. We delivered the first 800 sensors during the second quarter of 2021 and the remaining 2,400 sensors were produced and delivered during the third quarter of 2021. The Company’s Bend Sensor® continues to be a part of the world’s most trending sectors, one being the VR/AR market. The VR/AR industry is predicted to reach more than $25 billion by 2025 and show steady growth, thereafter.

Manus VR has many clients of large industries such as Netflix, Google, and Rolls Royce. Manus VR is widely known for its role in virtual reality gaming and recently announced its newest design, Manus Polygon. Manus Polygon is a tracking system that eliminates the need for any kind of full-body suit, providing a full-body solution for enterprise VR. Manus Polygon is the latest in real-time software to enable fluid full-body motion within any virtual environment.

These groundbreaking glove systems, combined with unique, leading edge software applications, also adapt to a wide range of other applications, including health rehabilitation, unmanned systems control, smartphone interaction and professional training across multiple industries. In addition to producing an array of Bend Sensors^®, the Company is under agreement to supply integrated assemblies comprised of multiple sensor types and associated electronics.

In the VR/VA marketspace, orders of increasing size and frequency were received during 2020 from Manus VR and Neofect as they strive to fulfill production orders. Flexpoint also received orders from other global VR/AR customers during 2021. It is expected those orders will increase as the impact of the Pandemic enables business to resume operations.

Li-ion and Li-polymer batteries are used today in everything from phones to electric cars. Flexpoint’s technology included in the provisional patent provides a method to protect these batteries, their products and those who use them every day, measuring the expansion or swelling of the battery effectively stopping a potentially dangerous state.

Batteries become over heated, over charged, or simply fail due to old age. When this occurs, it is possible for the inner cells of the battery to outgas a flammable electrolyte mixture, causing the battery to swell. The Flexpoint Sensor addresses the swollen battery effect, as batteries are designed to contain as a failsafe the measure of out gassing. The Flexpoint Swell Sensor detects the condition, effectively shutting down the short circuit. Without this type of detection, some batteries can eventually reach temperatures over 1000º F. Designed to detect the dangerous expansion and stop a Lithium ion or Lithium polymer battery from charging or discharging, the Flexpoint battery expansion sensor was created to prevent thermal runaway—how most battery fires occur. The battery expansion sensor can detect a swollen battery and take appropriate action, effectively shutting it down and sending a notice to the user that the battery is no longer safe.

The Company is currently collaborating with three Fortune 100 companies involving the battery expansion sensor. The overall testing phases range from six to nine months. With confidentiality agreements in place, Flexpoint is now in development with these and other companies to integrate the Battery Expansion Sensor (BXS) into their products. Flexpoint Sensor Systems, Inc. has designed a low cost, viable solution.

On October 18, 2018, the Company announced it had signed a five-year manufacturing and supply agreement with Counted LLC. Counted LLC conceived of a medication delivery monitoring system and dispensing monitoring system. Flexpoint designed and produced the monitoring system with Flexpoint features, Flexpoint technology and Flexpoint designed electronics to track and report the dispensing of medications in real time. The information has the potential to be transmitted to physicians, pharmacists and government agencies. Prototypes have been built and successfully tested with additional production and testing continuing. Currently Counted has recently indicated that they have financing and are moving forward on the project.

Finalizing long-term, constant revenue generating production contracts with our existing and other customers remains our greatest challenge because our on-going business is dependent on the types of revenues and cash flows generated by such contracts. Cash flow and cash requirement risks are closely tied to and are dependent upon our ability to attract significant long-term production contracts. This process has been impacted by the recent Pandemic and we are unable to determine what the long-term effect of these impacts will be at this time. We must continue to obtain funding to operate and expand our operations so that we can deliver our unique Bend Sensor^® and Bend Sensor^® related technologies and products to the market.  Management believes that even though we are making positive strides forward with our business plan we will need to raise additional operating capital.

LIQUIDITY AND CAPITAL RESOURCES

The challenges posed by the Pandemic in the United States and global economies increased significantly as the year progressed. Since the onset of the Pandemic, our top priority has been the health and safety of our employees. During this difficult time, we have worked to ensure that our customers continue to receive quality, personalized service.

The Pandemic negatively impacted our revenue during the first nine months of 2021. At this time, it is impossible to accurately predict when this will end. Many of our clients, to protect their employees, have sharply curtailed operations and have most employees working from home. The long-term impact of the Pandemic is difficult to assess at this point, as it will be dependent on how rapidly our clients can resume their business operations and place orders with us for the needed sensors incorporated into their products.

Currently our revenue is primarily from product licensing, development, manufacturing and recurring sales with additional contributions to income from design contract, testing and limited production services for prototypes and samples, and is currently at a level to support our operations.  Depending upon the world returning to some form of normalcy following the end of the Pandemic, we believe, based upon current orders and projected orders over the next twelve months, that we could be producing sensors under long-term contracts in the future that will help support our existing operations and potential future growth. Management recognizes such contracts usually go through a long negotiation process and there can be no guarantee that we will be successful in our negotiations or that such contracts will be sufficient to support our current operations in the near future.

In 2021, we relied on the proceeds of loans and convertible notes from existing shareholders, private placements of our common stock, and fees obtained under licensing agreements. The balances of the convertible notes have a combined total of $1,053,513 as of September 30, 2021. The notes have an annual interest rate of 8% to 10% and default rates of 10% to 15%, have various maturity dates, and are secured by the Company’s business assets.

Management believes that our current cash burn rate is approximately $60,000 per month and expectations are that it will continue at this rate for the foreseeable future. If the Pandemic ends and business returns to pre-Pandemic levels, with proceeds from additional convertible notes and estimated revenues for manufacturing, production, engineering design and prototype products should be sufficient to fund the next twelve months of operations. Our auditors have expressed doubt about our ability to continue as a going concern and that we may not realize significant revenue or become profitable within the next twelve months. We will require additional financing to fund our short-term cash needs. We will have to rely on additional debt financing, loans from existing shareholders and private placements of common stock for additional funding. Based upon our anticipated purchase orders over the next twelve months the revenue generated will not be sufficient to cover our operating expenses, based on our current burn rate. However, we cannot assure that we will be able to obtain short-term financing, or that sources of such financing, if any, will continue to be available, and if available, that they will be on terms favorable to us. Nor is there any guarantee that the projected volume of purchase orders will meet the volumes that we anticipate.

As we enter into new agreements, we must ensure that those agreements provide adequate funding for any pre-production research and development and manufacturing costs. If we are successful in establishing agreements with adequate initial funding, management believes that our operations for the long term will be funded by revenues, licensing fees and/or royalties related to these agreements. However, we have formalized only a few agreements during the past four years and there can be no assurance that the agreements will generate sufficient revenues or be profitable in the future or that a desired technological application will be successful enough to produce the volumes and profits necessary to fund our operations.

FINANCIAL OBLIGATIONS AND CONTINGENT LIABILITIES

Our principal commitments at September 30, 2021 consisted of our operating lease of $6,787.00 per month, and total liabilities of $3,459,104, which includes $1,053,513 of convertible notes payable. Accrued liabilities at September 30, 2021, were $2,090,416 and were related to payroll, payroll tax liabilities, accrued professional expenses, accrued insurance expense, accrued interest expense on notes and accrued paid time off.

In August 2020 the Company received $50,000 from John Kelley, a large shareholder, to meet operating expenses. Mr. Kelly indicated that he would want the $50,000 loan repaid when the Company was in a position to do so. Mr. Kelly subsequently provided an additional $5,000, for a total loan of $55,000. This loan has not formally been documented by a note at the time of this filing, and there is no term or interest on the note. During the nine-month period ended September 30, 2021, $20,000 of the loan was repaid to Mr. Kelly, leaving a remaining balance of $35,000.

The Company has a few major customers who represent a significant portion of revenue and accounts receivable. During the nine months ended September 30, 2021, two customers represented 65% of sales and one customer represented 67% of accounts receivable. The Company has a strong ongoing relationship with these customers with scheduled product deliveries extending through the year and does not believe this concentration poses a significant risk, as their products are based entirely on the Company’s technologies.

OFF-BALANCE SHEET ARRANGEMENTS

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.

SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates of particular significance in our financial statements include goodwill and the annual tests for impairment of goodwill and long-lived assets and valuing stock option compensation.

Goodwill - The Company's goodwill represents the excess of its reorganization value over the fair value of the net assets upon emergence from bankruptcy. Goodwill is not amortized; therefore, we test our goodwill for impairment annually or when a triggering event occur using a fair value approach. A fair value-based test is applied at the overall Company level. The test compares the fair value of the Company to the carrying value of its net assets. The test requires various judgments and estimates. During 2020 and for the nine months ended September 30, 2021, the Company recorded no impairment charge to reduce the carrying value of the goodwill to its estimated fair value. As part of the impairment testing performed at December 31, 2020, the Company considered factors such as the global market volatility, variables in the economy, and the overall uncertainty in the markets that has resulted in a decline in the market price of the Company's stock price and market capitalization for a sustained period, as indicators for potential goodwill impairment.

Valuation of Long-lived Assets - We test long-lived assets for impairment annually or when a triggering event occurs. Impairment is indicated if undiscounted cash flows are less than the carrying value of the assets. The amount of impairment is measured using a discounted-cash-flows model considering future revenues, operating costs and risk-adjusted discount rate and other factors. The analysis compares the present value of projected net cash flows for the remaining current year and next two years against the carrying value of the long-lived assets. If the carrying values of the long-lived assets exceed the present value of the discounted projected revenues an impairment expense would be recognized in the period and the carrying value of the assets would be adjusted accordingly. Impairment tests are conducted on an annual basis and, should they indicate a carrying value in excess of fair value, a charge may be required.

Stock-based Compensation - Financial accounting standards require that recognition of the cost of employee services received in exchange for stock options and awards of equity instruments be based on the grant-date fair value of such options and awards and is recognized as an expense in operations over the period they vest. The fair value of the options we have granted is estimated at the date of grant using the Black-Scholes American option-pricing model. Option pricing models require the input of highly sensitive assumptions, including expected stock volatility. In addition, our stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate.  Management believes the best input assumptions available were used to value the options and that the resulting option values are reasonable. For the nine-month periods ended September 30, 2021 and 2020, we recognized $0 and $0, respectively, of stock-based compensation expense for our stock options and there is no additional unrecognized compensation cost related to employee stock options at the current time.

RESULTS OF OPERATIONS

The Company continues to concentrate its marketing resources on a limited number of customers that have the greatest potential to generate the most short-term revenue while still building relationships with our larger customers. Management believes this approach has the highest potential to bring long-term commercially viable products to market and will provide sustainable cash flow to fund the Company's operations in the future. Currently, overall revenues are not sufficient to sustain our operations. The Pandemic has had a dramatic effect on our business as well as the business of our customers. The wide-ranging effects on the world-wide business market has led to a general reluctance for businesses to move forward with entering into major commitments until their future markets have been clarified. Because of this, we have experienced a significant slowdown in the size and number of orders received and, while we cannot predict when the influence of the Pandemic will end, we expect that orders will return to their former levels and increase throughout the remainder of 2021 following a return to normal business operations. Following a return to normal business operations in the world, management anticipates that revenues will increase as we continue to execute our long-term business plan and cultivate larger customer bases with our existing product offering. However, until the Pandemic ends and a long-term production contract is in place there is no guarantee that our current customer base will order in sufficient volumes to sustain our operations. Therefore, management continues to work with larger companies and industries and is hopeful that in the near future we will sign a long-term licensing or manufacturing contract.

We recognized revenue from repeat orders from our existing customers, design contract, and development engineering. Revenue is recognized using the ASC 606 five step detailed in Note 1 to the financial statements. Revenue from the sale of a product is recorded at the time of shipment to the customer.  Revenue from the license agreements was recognized in the period the agreement was concluded, as it is a right of use license and the Company has no further obligations to perform under the terms of the agreement. Revenue from research and development engineering contracts is recognized as the services are provided and accepted by the customer.

Revenue from contracts to license technology to others is deferred until all conditions under the contract are met and then the sale is recognized as licensing royalty revenue over the remaining term of the contract.

The following discussions are based on the consolidated operations of Flexpoint Sensor Systems, Inc. and should be read in conjunction with our unaudited financial statements for the nine months ended September 30, 2021 and 2020, included in Part I, Item 1, above, and the audited financial statements included in the Company’s annual report on Form 10-K for the years ended December 31, 2020 and 2019.

For the three months ending September 30, 2021, revenue was $55,823, an increase of $30,885 when compared to the same period in 2020. The majority of the revenue variance for this period is attributable to the unfilled demand resulting from the Pandemic.

Of the $229,663 and $225,425 total operating costs and expense for the three months ending September 30, 2021 and 2020, respectively, $51,379 and $80,070 were for direct research and development cost, respectively. For the three months ended September 30, 2021, total operating expenses increased by $4,238 when compared to the same period in 2020, moving expenses of $20,943 comprising the increased expense level.

Other income for the three-month period ended September 30, 2021 was $34,944, a $75,302 improvement compared to the same period in 2020. The majority of the improvement is attributable to the $119,000 gain on forgiveness of debt realized from the forgiveness of the initial PPP loan obtained.

A net loss of $138,896 was realized for the three months ended September 30, 2021. A net loss of $240,845 was realized for the three-month period ended September 30, 2020.

For the nine months ending September 30, 2021, revenue was $155,667, an increase of $49,431 when compared to the same period in 2020. The majority of the revenue variance for this period is attributable to businesses resuming operations after the slowdown created by the Pandemic.

Of the $651,012 and $662,805 total operating costs and expense for the nine months ending September 30, 2021 and 2020, respectively, $201,061 and $227,689 were for direct research and development cost, respectively. For the nine months ended September 30, 2021, total operating expenses decreased by $11,793 when compared to the same

period in 2020. The decrease would have been $34,928 were it not reduced by the $23,135 moving expenses incurred during September 2021.

Other income (expense) for the nine-month period ended September 30, 2021 was $48,664, a $166,546 improvement compared to the expense of ($117,882) for the same period in 2020. The majority of the improvement is attributable to the $119,000 gain on forgiveness of the initial PPP loan obtained and a $45,576 reduction in interest expense.

A net loss of $446,681 was realized for the nine months ended September 30, 2021. A net loss of $674,451 was realized for the nine-month period ended September 30, 2020.

The chart below represents a summary of our condensed consolidated balance sheets at September 30, 2021 and December 31, 2020.