Spectra7 Microsystems Inc.
Management’s Discussion & Analysis
For the Three Months Ended
March 31, 2022
May 29, 2022
Spectra7 Microsystems Inc.
Management’s Discussion and Analysis
For the Three Months Ended March 31, 2022
This management’s discussion and analysis (“MD&A”) of financial condition and results of operations of Spectra7 Microsystems Inc. (“Spectra7” or the “Company”) was prepared by management as at May 29, 2022. Throughout this MD&A, unless otherwise specified, “Spectra7”, “the Company”, “we”, “us” or “our” refer to Spectra7 Microsystems Inc. and its subsidiaries. This MD&A should be read in conjunction with the audited consolidated financial statements of the Company and notes thereto as at December 31, 2021 (the “Annual Financial Statements”) and the unaudited condensed interim consolidated financial statements for the three months ended March 31, 2022 and 2021 (the “Interim Financial Statements” and, together with the Annual Financial Statements, the “Statements”). In preparing this MD&A, we have taken into account information available to us up to May 29, 2022 unless otherwise stated.
The Financial Statements have been prepared by management in accordance with International Financial Reporting Standards (“IFRS”) issued by the International Accounting Standards Board (“IASB”) and interpretations of the International Financial Reporting Interpretations Committee (“IFRIC”). All amounts are expressed in U.S. dollars unless otherwise noted. Other information contained in this document has also been prepared by management and is consistent with information included in the Financial Statements. You will find the Financial Statements on SEDAR at www.sedar.com.
This MD&A contains commentary from the Company’s management regarding the Company’s strategy, operating results, financial position and outlook. Management is responsible for the accuracy, integrity, and objectivity of the MD&A, and develops, maintains and supports the necessary systems and controls to provide reasonable assurance as to the accuracy of the comments contained herein.
The Audit Committee and the Board of Directors provide an oversight role with respect to all public financial disclosures by the Company. The Board of Directors approves the Financial Statements and MD&A after the completion of its review and recommendation for approval by the Audit Committee, which meets periodically to review all financial reports, prior to filing.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This MD&A contains certain forward-looking information and statements relating, but not limited to, the Company’s future financial position and results of operations, strategies, plans, objectives, goals, targets, and future developments in the markets where the Company participates or is seeking to participate. Forward-looking information typically contains statements with words such as “consider”, “anticipate”, “believe”, “expect”, “plan”, “intend”, “may”, “likely”, or similar words suggesting future outcomes or statements regarding an outlook, or other expectations, beliefs, plans, objectives, assumptions, intentions or statements about future events or performance. Readers should be aware that these statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results, performance or achievements of the Company to differ materially from those suggested by the forward-looking information and statements, some of which may be beyond the control of management.
Although the Company believes that the expectations, estimates, and projections reflected in such forward-looking information and statements are reasonable, such forward-looking information and statements involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward- looking information and statements. On this basis, readers are cautioned not to place undue reliance on such forward looking information and statements.
Factors which could cause actual results to differ materially from current expectations include, but are not limited to:
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the adverse impact of COVID-19 on our staffing, revenue, operations, manufacturing supply chain, project development and customer demand;
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availability of adequate product supplies and third party manufacturing in an environment of semiconductor industry supply shortages;
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our reliance on a limited number of third party manufacturers;
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the degree of competition in the business areas in which we operate;
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our ability to secure orders from a limited number of customers;
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the absence of long-term supply contracts with any of the Company’s third-party vendors and potential disruption in supply of products or materials;
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our ability to make the substantial research and development investments required to remain competitive;
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our ability to charge prices that will result in favorable gross margins;
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our ability to introduce new or enhanced products on a timely basis;
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market demand and penetration of new markets for our products and services;
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our ability to contain and appropriately budget expenses, due to our limited operating history;
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the length of the sales cycle required to establish design wins and bring design wins to production;
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reliance on distributors;
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our ability to deliver our products in the correct product mix required by our customers and ability to control order and shipment uncertainties;
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the substantial quarterly and annual fluctuations in our operating results;
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our dependence on existing members of the senior management team;
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our ability to attract and retain qualified employees and contain payroll costs;
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unforeseen delays, expenses and damage to reputation caused by defects or bugs;
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potential claims of intellectual property infringement;
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our ability to protect our intellectual and intangible properties;
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the use of open source software;
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reliance on third parties to provide services and technology;
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going concern risk;
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impact of negative cash flow from operating activities;
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potential losses to our facilities or distribution system due to catastrophes;
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compliance with various governmental regulations and related costs of compliance;
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cyclicality in the semiconductor industry;
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conformity of the Company’s products to industry standards;
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unanticipated changes in our tax rates;
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fluctuation of share price;
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decline in share price due to the absence of, or negative reports, about the business by securities or industry analysts;
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adverse international economic conditions that adversely affect consumer spending;
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general political and economic conditions in the countries in which we operate;
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strain on our resources as a result of the requirements of being a public company;
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litigation risk;
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market price volatility and potential impact on share price;
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our potential need for additional financings in order to meet future capital requirements for our operations;
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our potential to breach certain covenants, representations and warranties in our loan arrangements;
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our ability to repay the Convertible Debentures (as defined below)
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our ability to declare dividends;
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our ability to meet significant research and development milestones; and
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our ability to enter into agreements with CRX Consortium members or the adoption of interconnects that use the Company’s active copper cable technology.
We caution that this list is not exhaustive of all possible factors. For a detailed description of risk factors associated with the Company, refer to the “Risks Factors” section of the Company’s Annual Information Form filed on May 2, 2022, which is available on SEDAR at www.sedar.com.
The forward-looking information and statements in this MD&A are, unless otherwise indicated, stated as of the date hereof and are presented for the purpose of assisting investors and others in understanding our financial position and results of operations as well as our objectives and strategic priorities, and may not be appropriate for other purposes. The Company does not undertake any obligation to update publicly or to revise any forward-looking information and statements, whether as a result of new information, future events or otherwise, except as required by law.
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OVERVIEW OF THE COMPANY
Background
The Company delivers high performance analog semiconductors at unmatched bandwidth, speed and resolution to enable disruptive industrial design for leading electronics manufacturers in data centers, Virtual Reality (“VR”), Augmented Reality (“AR”), and other connectivity markets.
The Company was incorporated on October 12, 2010 as a capital pool company named “Chrysalis Capital VIII Corporation” (“Chrysalis”) pursuant to the filing of articles of incorporation under the Canada Business Corporations Act. The articles of incorporation of the Company were amended by the filing of articles of amendment dated April 19, 2011 to remove certain provisions. On February 5, 2013, the Company consolidated its common shares (the “common shares”) by a ratio of 3.86364:1 and to change its name to “Spectra7 Microsystems Inc.”. On July 16, 2021, the Company continued its corporate existence from the Canada Business Corporations Act to the Business Corporations Act (Ontario).
On February 5, 2013, the Company, then named Chrysalis Capital VIII Corporation, completed a reverse takeover transaction whereby Chrysalis acquired all of the issued and outstanding shares of Spectra7 Microsystems Corp. (formerly Fresco Microchip Inc.) (“Fresco”), a company incorporated in Ontario, and Spectra7 Microsystems (Ireland) Limited (formerly RedMere Technology Limited), a company incorporated in Ireland. As a result of such transaction, which constituted the Company’s qualifying transaction under the policies of the TSX Venture Exchange (the “TSXV”), the former shareholders of Fresco acquired control of the Company. From February 19, 2013 until July 22, 2015, the common shares of the Company were listed for trading on the TSXV under the symbol “SEV”. From July 23, 2015 to May 21, 2020, the common shares were listed for trading on the Toronto Stock Exchange (the “TSX”) under the symbol “SEV”. As of May 22, 2020, the common shares were again listed for trading on the TSXV under the symbol “SEV”. On June 21, 2021, the Company’s common shares commenced trading on the OTCQB Venture Market under the symbol “SPVNF”.
The registered office of the Company is located at 181 Bay Street, Suite 1800, Toronto, Ontario Canada, M5J 2T9 and its head office is in San Jose, California. The Company also has a design center in Cork, Ireland and a sales office in Dongguan, China. The Company is currently a reporting issuer in each of the provinces of Canada, excluding Québec.
Products
The Company’s family of products features a patented signal processing technology used in the design of active cables and specialty interconnects which enable longer, thinner and lighter interconnects in data centers, for VR, AR, and other connectivity products. The Company holds approximately 55 patents relating to its products.
Data Centers
GaugeChanger™ is an innovative and disruptive silicon technology that allows copper to extend much longer lengths without the cost and power penalty of optics that are used in data centers today. It works equally well at 25 Gbps NRZ, 50 Gbps PAM-4 and 112 Gbps PAM-4 enabling new connector standards of 100, 200, 400 and 800 Gbps.
At present, passive copper cables are struggling to meet the high speed connectivity demands of new data centers. Fiber optics are the primary alternative for data centers seeking high speed, at lengths longer than a few meters. GaugeChanger™, however, extends the use of copper with interconnects that are as fast and as thin as fiber optics, but at dramatically lower cost and power consumption. GaugeChanger™ enabled cables have a reach of up to seven meters to allow for top-of-rack and rack-to-rack applications in data centers.
Virtual Reality (VR)
The Company’s next-generation VR products include the VR7050 which the Company believes to be the industry’s first chip capable of enabling lightweight, ultra-thin active interconnects for gesture recognition and motion control backhaul. When used in conjunction with Spectra7’s VR7100 high speed video chip, the chipset delivers ultra- high bandwidth data, video, audio and power in a unified, ultra-light,super-thin wearable interconnect while
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achieving the low latency for a truly immersive VR experience.
Augmented Reality (AR)
The Company has also developed AR products that provide similar benefit to the VR products on thinner, shorter ‘wearable’ interconnects.
AR-Connect™ is an AR interconnect product line that is powered by the Company’s patented wearable network signal processing technology. The Company believes its patented AR-Connect™ is the industry’s first integrated cable, connector and embedded chipset product line for AR vision systems and wearable computing devices. AR- Connect™ enables AR glasses to connect to a smart phone, proprietary processing device or a desktop GPU/laptop processing unit, with a single unified and ultra-thin link.
DreamWeVR
DreamWeVR is an extensive product line targeted at next generation 4K Ultra-HD and 5K resolution VR and AR platforms for gaming, health care, architecture and business telepresence applications. The product line includes four new chips (VR8181, VR8050, VR8200 and VR8300) featuring SpectraLinear™ technology, new VR-specific connectors and three new head-mounted display (“HMD”) interconnect configurations to support high-bandwidth (up to 50Gbps), near-zero latency VR HMDs and AR glasses with reduced weight and complexity.
USB 3.2 consumer interconnects
The Company’s active VR8050 and VR8051 chips are the industry’s first for ultra-thin implementations of USB
3.2 consumer interconnects, reducing the conductor cross section by up to 90% compared to passive cable implementations. Applications for this interconnect implemented with the new Type-C connector include ultra-thin laptops, tablets, mobile devices, solid state disks and wearable computing devices. The resulting ultra-thin cable enabled by this new Spectra7 technology allows the cable to transfer data at supercomputer speeds (up to 10 times faster) with a plug shell or over-mold and cable strain relief dimension that is thinner than the mobile device itself, a critical dimension when implementing Type-C connectors in tablets and smart phones, and up to 90% lighter than passive cable conductors that would need to be much larger in diameter.
Overall Financial Performance
Net loss for the three months ended March 31, 2022 was $2.8 million compared to a net loss of $1.1 million in the same period in the prior year. Revenue for the three month period ended March 31, 2022 increased by 275% compared to the same period in the prior year. The increased revenue was driven primarily by the ramping product demand on our GaugeChanger™ products from hyperscaler data center operators and our DreamWeVR product.
Gross margin percentage for the three month period ended March 31, 2022 decreased from the same period in 2021 by approximately 14%, due mainly to premiums paid to secure wafers and supply chain availability as well as additional fees to expedite delivery in order to meet customers’ demand for data center and VR products. Expenditures during the three month period ended March 31, 2022 are approximately $3.7 million representing a increase of 158% from the same period in the prior year due to higher personnel costs compared to the prior year in which employees were furloughed, higher consulting fees for IT and investor relations, and costs to support customers’ ramp to production for our DreamWeVR products. This led to increases in research and development, sales and marketing and general and administrative expenditures. In addition, shared-based compensation also increased as more equity awards were issued to existing and new employees.
Impact of COVID-19 outbreak
We rely on third-party suppliers and manufacturers. Currently, the Company’s silicon products are manufactured at foundries by companies in Taiwan and the United States, and are packaged and tested in Taiwan and China. PCBs for active cable products are manufactured by a corporation in Hong Kong, China. The Company also uses third-party contractors for assembly of active cable products including contractors in China and Taiwan. This pandemic has resulted in the extended shutdown of certain businesses in certain jurisdictions, which have resulted in disruptions or delays to our supply chain. These include disruptions from the temporary closure of third-party supplier and manufacturer facilities, interruptions in product supply or restrictions on the export or shipment of our products. As a result of COVID-19, we have been unable to satisfy certain customer orders on a timely basis, with some customers experiencing delays in receiving our products. There is uncertainty around the duration and
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