(EDGAR Online via COMTEX) -- Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of financial condition and results of operations in conjunction with the financial statements and related notes appearing elsewhere in this quarterly report and in our annual report on Form 10-K for the year ended December 31, 2020.
As used in this report, unless otherwise indicated, the terms "Company," "Vuzix", "management," "we," "our," and "us" refer to Vuzix Corporation.
Critical Accounting Policies and Significant Developments and Estimates
The discussion and analysis of our financial condition and results of operations is based on our unaudited consolidated financial statements and related notes appearing elsewhere in this quarterly report. The preparation of these statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements, including the statement of operations, balance sheet, cash flow and related notes. We continually evaluate our estimates used in the preparation of our financial statements, including those related to revenue recognition, bad debts, inventories, warranty reserves, product warranty, carrying value of long-lived assets, fair value measurement of financial instruments, valuation of stock compensation awards, and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not apparent from other sources. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. Such differences could be material to the consolidated financial statements.
We believe that our application of accounting policies, and the estimates inherently required therein, are reasonable. We periodically re-evaluate these accounting policies and estimates and make adjustments when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.
Management believes certain factors and trends are important in understanding our financial performance. The critical accounting policies, judgments and estimates that we believe have the most significant effect on our consolidated financial statements are:
? Valuation of inventories;
? Carrying value of long-lived assets;
? Software development costs;
? Revenue recognition;
? Product warranty;
? Stock-based compensation; and
? Income taxes.
Our accounting policies are more fully described in the notes to our consolidated financial statements included in this quarterly report and in our annual report on Form 10-K for the year ended December 31, 2020. There have been no significant changes in our accounting policies for the three months ended March 31, 2021.
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Off Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, an effect on our financial condition, financial statements, revenues or expenses.
We are engaged in the design, manufacture, marketing and sale of wearable computing devices and augmented reality wearable display devices also referred to as head mounted displays (or HMDs), HUDs or near-eye displays, in the form of Smart Glasses and Augmented Reality (AR) glasses. Our wearable display devices are worn like eyeglasses or attach to a head-worn mount. These devices typically include cameras, sensors, and a computer that enable the user to view, record and interact with video and digital content, such as computer data, the Internet, social media or entertainment applications. Our wearable display products integrate display technology with our advanced optics to produce compact high-resolution display engines, less than half an inch diagonally, which when viewed through our Smart Glasses products create virtual images that appear comparable in size to that of a computer monitor or a large-screen television.
With respect to our Smart Glasses and AR products, we are focused on the enterprise, industrial, commercial, security, first responder, medical markets, and, to a lesser degree, defense markets. We also provide custom solutions and engineering services to third parties, including OEMs, of waveguides to enable fully integrated wearable display systems, including head mounted displays to commercial, industrial and defense customers. We do not offer "work for hire" services but rather offer our services for projects that could be expected to result in advancing our technology or lead to a long-term supply or OEM relationship.
All of the mobile display and wearable and mobile electronics markets in which we compete, including mobile and wearable displays and electronics, have been and continue to be subject to consistent and rapid technological change, with ever greater capabilities and performance and, in many cases, including the rapid adoption of tablets and mobile devices with larger screen sizes and improved display resolutions, as well as declining prices on mobile phones and other computing devices. As a result, we must continue to improve our products' performance and lower our costs. We believe our intellectual property portfolio gives us a leadership position in the design and manufacturing of micro-display projection engines, waveguides, mechanical packaging, ergonomics, and optical systems.
Impact of COVID-19
The implications of COVID-19 on our results from operations going forward continue to remain uncertain. The COVID-19 pandemic still has the ongoing potential to cause adverse effects to our customers, suppliers or business partners in locations that have or will experience more pronounced disruptions, which could result in a reduction to future revenue and manufacturing output as well as delays in our new product development activities. Recent increases in demand for certain chips within the technology sectors and other industries has been one of the ripple effects of the Covid crisis that is causing shortages of certain chips and negatively impacting many companies supply chain and their ability to maintain or grow their production to meet market demands. At this time we are operating successfully but are starting to see longer component lead times which is increasing risk in our supply chain.
On the other hand, we have seen positive growth for Vuzix smart glasses products in the medical field with telemedicine and guided remote support and in enterprise use cases with remote support. In addition, the need for enabling remote training and support for equipment in the field is becoming a new challenge for enterprises to address and our smart glasses products are poised to help companies address these challenges. Flying and the resumption of travel in general remain challenged and, in the interest of safety, companies are looking for alternatives. Vuzix smart glasses solutions and those offered by our Value-Added Resellers provide a wide array of solutions that can help immediately address these challenges. In addition, other new use cases for our products are developing, including their use in medical applications from remote support for residents doing their rounds to remote patient care in assisted living facilities or the ICU (intensive care unit).
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Recent Accounting Pronouncements See Note 1 to the consolidated financial statements. Results of Operations Comparison of Three Months Ended March 31, 2021 and March 31, 2020 The following table compares the Company's consolidated statements of operations data for the three months ended March 31, 2021 and 2020: Three Months Ended March 31, Dollar % Increase 2021 2020 Change (Decrease) Sales: Sales of Products $ 3,805,170 $ 1,371,509 $ 2,433,661 177 % Sales of Engineering Services 110,219 160,206 (49,987) (31) % Total Sales 3,915,389 1,531,715 2,383,674 156 % Cost of Sales: Cost of Sales - Products 2,819,971 1,426,038 1,393,933 98 % Cost of Sales - Engineering Services 15,827 25,161 (9,334) (37) % Total Cost of Sales 2,835,798 1,451,199 1,384,599 95 % Gross Profit (exclusive of depreciation shown separately below) 1,079,591 80,516 999,075 1,241 % Gross Profit % 28 % 5 % Operating Expenses: Research and Development 2,079,927 2,023,058 56,869 3 % Selling and Marketing 1,240,734 1,152,808 87,926 8 % General and Administrative 3,703,837 1,537,820 2,166,017 141 % Depreciation and Amortization 517,412 648,541 (131,129) (20) % Impairment of Patents and Trademarks 27,731 57,532 (29,801) (52) % Loss on Fixed Asset Disposal 83,908 - 83,908 NM Loss from Operations (6,573,958) (5,339,243) (1,234,715) 23 % Other Income (Expense): Investment Income 7,838 22,157 (14,319) (65) % Other Taxes (19,725) (17,686) (2,039) 12 % Foreign Exchange Gain Loss (53,518) (26,852) (26,666) 99 % Total Other Expense, Net (65,405) (22,381) (43,024) 192 % Loss Before Provision for Income Taxes (6,639,363) (5,361,624) (1,277,739) 24 % Provision for Income Taxes - - - - % Net Loss $ (6,639,363) $ (5,361,624) $ (1,277,739) 24 %
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Sales. There was an increase in total sales for the three months ended March 31, 2021 over the same period in 2020 of $2,383,674 or 156%. The following table reflects the major components of our sales:
Three Months Ended % of Three Months Ended % of Dollar % Increase March 31, 2021 Total Sales March 31, 2020 Total Sales Change (Decrease) Sales of Smart Glasses $ 3,772,481 96 % 1,354,433 88 % $ 2,418,048 179 % Sales Freight out 32,689 1 % 17,076 1 % 15,613 91 % Sales of Engineering Services 110,219 3 % 160,206 11 % (49,987) (31) % Total Sales $ 3,915,389 100 % $ 1,531,715 100 % $ 2,383,674 156 %
Sales of Smart Glasses products rose by 179% in the three months ended March 31, 2021, primarily as a result of our M400 Smart Glasses, which tripled in sales as compared to the same period in 2020. Sales revenues from our M-Series Smart Glasses were $3,079,609, a 175% increase of $1,961,651 over the prior year's quarter. Revenues of Blade Smart Glasses increased by $127,225 or 54% in the three months ended 2021 versus 2020 primarily driven by a 23% increase in unit sales and higher selling prices on our Blade upgraded model as compared to the previous Blade 1.0.
Sales of Engineering Services for the three months ended March 31, 2021 were $110,219 as compared to $160,206 in the 2020 period. The revenue recognized in the three months ended March 31, 2021 for engineering services was substantially a result of a current waveguide and projector development project for a micro-display organization, which commenced in the third quarter of 2020. This project is expected to be completed in the second quarter of 2021, resulting in an additional $40,000 of engineering services revenue.
Cost of Sales and Gross Profit. Cost of product sales and engineering services are comprised of materials, components, labor, warranty costs, freight costs, manufacturing overhead, software royalties, and the non-cash amortization of software development costs related to the production of our products and rendering of engineering services. The following table reflects the components of our cost of goods sold for products:
Three Months Ended As % Related Three Months Ended As % Related Dollar % Increase March 31, 2021 Product Sales March 31, 2020 Product Sales Change (Decrease) Product Cost of Sales $ 1,998,514 53 % $ 744,575 54 % $ 1,253,939 168 % Freight Costs 190,345 5 % 112,111 8 % 78,234 70 % Manufacturing Overhead 546,673 14 % 506,204 37 % 40,469 8 % Warranty Costs (32,848) (1) % 222 0 % (33,070) (14,896) % Amortization of Software Development Costs 64,999 2 % 25,000 2 % 39,999 160 % Software Royalties 52,288 1 % 37,926 3 % 14,362 38 % Total Cost of Sales - Products $ 2,819,971 74 % $ 1,426,038 104 % $ 1,393,933 98 % Gross Profit (Loss) - Product Sales $ 985,199 26 % $ (54,529) (4) % $ 1,039,728 NM
For the three months ended March 31, 2021, we reported an overall gross profit from product sales of $985,199 as compared to a gross loss of $54,529 in the same period in 2020. On a product cost of sales basis only, product direct costs were 53% of sales in the 2021 period as compared to 54% in 2020. Overall total product margin was also positively impacted by a gain on warranty provision for the three months ended March 31, 2021, as the Company continues to realize lower than expected warranty returns primarily on its M-400 series. Also positively impacting overall product sales margin was the absorption of our relatively fixed overhead costs over a significantly larger sales base.
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Manufacturing overhead costs while increasing in absolute dollars by 8% for the three months ended March 31, 2021 over the 2020 comparable period, primarily due to manufacturing supply chain additions, decreased to 5% from 8% in the same period in 2020 as a percentage of total product sales. There was a gain on warranty provision of $32,848 for the three months ended March 31, 2021 as compared to a warranty expense of $222 in the same period in 2020.
Costs for engineering services for the three months ended March 31, 2021 were $15,827 as compared to $25,161 in 2020. The majority of the 2021 period amounts represented the reclassification of our internal R&D wage costs associated with one current waveguide development project. There was a gross profit of $94,392 from engineering services for the three months ended March 31, 2021 versus $135,045 in the same period in 2020.
Research and Development. Our research and development expenses consist primarily of compensation costs for personnel, related stock compensation expenses, third party services, purchase of research supplies and materials, and consulting fees related to research and development. Software development expenses to determine technical feasibility before final development and ongoing maintenance are not capitalized and are included in research and development costs.
Three Months Ended % of Three Months Ended % of Dollar % Increase March 31, 2021 Total Sales March 31, 2020 Total Sales Change (Decrease) Research and Development $ 2,079,927 53 % $ 2,023,058 132 % $ 56,869 3 %
Research and development costs for the three months ended increased by $56,869 or 3% as compared to the same period in 2020. This increase was largely driven by a $337,186 increase in salary, salary benefits and stock-based compensation; mostly offset by decreases of $253,496 in external consulting fees related to our M400 Smart Glasses development and maintenance, and a decrease of $26,785 in travel related expenses.
Selling and Marketing. Selling and marketing costs consist of trade show costs, advertising, sales samples, travel costs, sales staff compensation costs including stock compensation expense, consulting fees, public relations agency fees, website costs and sales commissions paid to full-time staff and outside consultants.
Three Months Ended % of Three Months Ended % of Dollar % Increase March 31, 2021 Total Sales March 31, 2020 Total Sales Change (Decrease) Selling and Marketing $ 1,240,734 32 % $ 1,152,808 75 % $ 87,926 8 %
Selling and marketing costs for the three months ended March 31, 2021 increased by $87,926 or 8% as compared to the same period in 2020. This increase in costs was due to the following factors: an increase of $179,644 in salary and stock-based compensation related expense; a $119,137 increase in advertising; an increase of $91,201 in website development and maintenance costs; an increase of $87,559 in external consulting fees; an increase of $41,913 in inside sales commissions due to our higher commissionable sales revenue; offset by decreases of $333,516 in trade show expenses and a decrease of $64,481 in travel related expenses.
General and Administrative. General and administrative costs include professional fees, investor relations (IR) costs, salaries and related stock compensation, travel costs, office and rental costs.
Three Months Ended % of Three Months Ended % of Dollar % Increase March 31, 2021 Total Sales March 31, 2020 Total Sales Change (Decrease) General and Administrative $ 3,703,837 95 % $ 1,537,820 100 % $ 2,166,017 141 %
General and administrative costs for the three months ended March 31, 2021 increased by $2,166,017 or 141% as compared to the same period in 2020. This increase in costs was due to the following factors: a net increase in salary, benefits and stock-based compensation expenses of $1,815,215, of which $1,600,688 was non-cash stock-based compensation related to our new Long-term Incentive Plan; an increase of $174,867 in legal fees; an increase in IR and shareholder related expenses of $112,537; an increase of $99,995 in regulatory filing fees with the SEC and FINRA related to our S-3 filing in February; an increase of $70,138 in recruitment and hiring fees; partially offset by a decrease in travel related expenses of $85,080.
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Depreciation and Amortization. Depreciation and amortization expense for the three months ended March 31, 2021 was $517,412 as compared to $648,541 in the same period in 2020, a decrease of $131,129. The decrease in depreciation expense is primarily due our leasehold improvements in our West Henrietta location, which became fully amortized in October 2020.
Other Expense. Total other expense was $65,405 for the three months ended March 31, 2021 as compared to an expense of $22,381 in the same period in 2020, a net increase of $43,024. The overall increase in other expenses was primarily the result of an increase in foreign exchange losses of $26,666 and a decrease of $14,319 in investment interest income, as interest rates continued to decline in the three months ended March 31, 2021 as compared to the same period of 2020.
Provision for Income Taxes. There was not a provision for income taxes in the respective three-month periods ending March 31, 2021 and 2020.
Liquidity and Capital Resources
Capital Resources: As of March 31, 2021, we had cash and cash equivalents of $132,722,096, an increase of $96,652,588 from $36,069,508 as of December 31, 2020.
As of March 31, 2021, we had current assets of $144,089,384 as compared to current liabilities of $3,574,993 which resulted in a positive working capital position of $140,514,391. As of December 31, 2020, we had a working capital position of $41,959,763. Our current liabilities are comprised principally of accounts payable, accrued expenses and operating lease right-of-use liabilities.
May 10, 2021
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