Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Unless specifically noted or the context clearly requires otherwise, all information set forth in this annual report on Form 10-K relates to the Company as it existed as of December 31, 2022 and prior to the Company’s bankruptcy proceedings and does not, and is not intended and should not be read to, reflect the business, financial condition, and results of operations of any other entity, including any entity which may result from the bankruptcy proceedings.
The following discussion and analysis provides information that Rockley’s management believes is relevant to an assessment and understanding of Rockley’s consolidated results of operations and financial condition. The discussion should be read together with the audited annual consolidated financial statements as of and for the years ended December 31, 2022 and 2021 and the related notes thereto, included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements. Unless the context otherwise requires, references in these notes to “Rockley”, the “Company”, “we”, “us”, or “our” and any related terms are intended to mean the Company, Rockley Photonics Holdings Limited, while “Legacy Rockley” and “SC Health” refers to the entities prior to the Business Combination.
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Overview
We have developed a unique sensing platform that we believe can reshape the wellness and healthcare industries through multiple applications in non-invasive, multi-modal biomarker monitoring. We believe products based on our technology platform could have the potential to unlock and accelerate advancements in areas such as early disease detection, nutrition management, and preventative healthcare delivery through continuous health and wellness monitoring.
To date, we have been engaged in developing customer-specific designs of our silicon photonics chipsets for incorporation into our customers’ end products. Accordingly, all of our products are presently in the development stage and we do not currently have any of our own end products in commercial production and have not yet shipped any products commercially. Our unique sensing platform has been built upon our silicon photonics technology, which enables compelling sensor performance, power, resolution, and density. This technology has the potential to allow monitoring devices, currently the size of clinical machines, to be condensed to the size of a wearable device. We believe this in turn has the potential to unlock additional uses in consumer electronics and medical devices. The resulting combination of technologies and manufacturing know-how is the “full-stack Rockley Platform” which is made up of PICs in silicon with integrated III-V devices (devices incorporating certain conductor elements that offer superior electronic properties, such as lasers), ASICs, photonic and electronic co-packaging, together with biosensing algorithms and AI cloud analytics, firmware/software, system architecture, and hardware design.
As testament to the relevance of our product development, we have captured the attention of several consumer electronics companies and, as of the date of this Annual Report on Form 10-K, we have established strategic relationships with six of the world’s top-ten largest manufacturers of smart watches and wristbands (based on volume as reported by IDC) and two of the five largest medtech companies (based on Becker’s ASC Review). We plan to leverage this attention to develop new capabilities in consumer wearables in the near term, and to expand over time into medical devices and other industry applications.
Our vision is to address many pressing healthcare concerns using our technology and we believe that there exists a large market opportunity for our platform. We estimate that the TAM for the consumer wearables, mobile device, and medical device markets is projected to be over $50 billion by 2025, based on data sourced from the Yole Report, the IDtexEx Report, the TrendForce Report, and our internal volume forecasts for smartphone, smart watch, and smart earbuds through 2025 (based on customer data), as the universe of healthcare and consumer wearable devices incorporating additional sensing capabilities emerges. Our target biomarkers for consumer healthcare include lactate, alcohol, glucose (indicator), carbon monoxide, blood pressure, blood oxygen, and core body temperature, among others. Our high-performance lasers have up to 1,000,000 times higher resolution, 1,000 times higher accuracy and 100 times broader range in wavelengths compared with existing LED offerings in wearable solutions (based on product analysis undertaken by Rockley comparing the Rockley silicon photonics-based spectrometer chip to existing solutions). In addition, as opposed to LED-based solutions, our lasers can be turned on more intermittently, and we employ dynamic adaptive power control to optimize laser on-time and overall power consumption for each different biomarker measurement, thus our solution will be more than existing solutions.
We believe our platform will also be able to address existing applications in consumer wearable devices with significantly higher resolution, accuracy, and range. Further, we believe there are multiple additional markets and concrete opportunities for our technology platform in areas such as data center connectivity (optical transceivers), machine vision (robotic and automotive LiDAR), and compute connectivity (co-packaged optics, or CPO).
Following the completion of our product development phase and introduction of our products to the consumer and medtech wearable markets, we expect our revenue to be derived from sales of both high-volume consumer wearable products and wearables targeting medical applications. In addition, we plan to offer advanced module applications with biomarker detection capabilities for advanced health metrics that can detect and classify data that could potentially alert patients and healthcare providers to take preemptive action to prevent disease. We also expect to offer a cloud analytics platform to provide a full range of subscription services, including the deployment of our technology through a subscription and cloud-based software as a service
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To date, we have generated revenue primarily from non-recurring engineering (“NRE”) and development services for customer-specific designs of silicon photonics chipsets for incorporation into their customers’ end products and we have financed our operations primarily through the Business Combination, issuance of convertible loan notes, as well as private placements of ordinary shares. For the year ended December 31, 2022, we incurred a net loss of $224.0 million and utilized $126.2 million in cash to fund our operations.
We expect both our capital and operating expenditures will increase significantly in connection with our ongoing activities, as we:
continue to invest in our technology and our silicon photonics solutions;
continue to develop innovative solutions and applications for our technology;
commercialize our silicon photonics solutions;
continue to invest in our sales and marketing activities and distribution channels;
invest and improve our operational, financial, and management information systems;
retain key talent and increase our headcount;
maintain and expand our intellectual property portfolio
Impact of COVID-19
The COVID-19 pandemic has nearly reached the three-year mark and our priority continues to be the health and safety of our employees. The overall recovery from the COVID-19 pandemic has been uneven and has presented many challenges and risks from general economic uncertainty, changes in consumer demand, disruption of supply chains, challenges with hiring, and labor and supply cost inflation. However, as we implemented our phased return to office plan starting in July 2021, we were able to provide greater levels of work flexibility to employees and maintain health and safety standards for employees meeting all regulatory requirements.
We continually evaluate the nature and extent of changes to the market and economic conditions related to the COVID-19 pandemic and assess the potential impact on our business and financial position. Despite the emergence of vaccines and vaccine boosters, the end of the COVID-19 pandemic is still uncertain. As such, we expect that the pandemic may continue to have an effect on our results, although the magnitude, duration, and full effects of the pandemic on our future results of operations or cash flows remain difficult to predict at this time.
For more information on risks associated with the COVID-19 pandemic and regulatory actions, see “Risk Factors — General Risks.”
Business Combination and Public Company Costs
As described in “ Note 1 – Description of Business and Significant Accounting Policies ” and “Note 2 – Note 2 – Business Combination ” of the notes to the consolidated financial statements, we completed the Business Combination on August 11, 2021, with Legacy Rockley surviving the Business Combination as a wholly owned subsidiary of the Company.
Prior to the Business Combination, Legacy Rockley financed its operations primarily from the issuance of convertible loan notes and private placements of ordinary shares.
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Upon the consummation of the Business Combination, we issued 104.0 million shares of ordinary shares for all the issued and outstanding equity interests of Legacy Rockley inclusive of ordinary shares issued in exchange for the issued and outstanding convertible loan notes (inclusive of interest accrued thereon) and warrants, as if each had converted into the Company’s ordinary shares immediately prior to the Business Combination. In addition, certain accredited investors (including entities affiliated with the SC Health Sponsor) purchased an aggregate of 15.0 million ordinary shares for a purchase price of $10.00 per share, or an aggregate purchase price of $150.0 million. The net cash received from the Business Combination after underwriter and transaction costs was $122.5 million.
The Business Combination was accounted for as a forward recapitalization, with no goodwill or other intangible assets recorded, in accordance with GAAP. Under this method of accounting, SC Health was treated as the acquired company and Rockley was deemed to be the accounting acquirer for financial reporting purposes. This determination was primarily based on the evaluation of the following facts and circumstances:
Legacy Rockley’s existing shareholders hold a majority voting interest in the combined company, and as such, have the power to appoint a majority of the members of the Company’s Board;
Legacy Rockley’s senior management team comprise the majority of the senior management of the combined company;
Legacy Rockley is the larger of the companies based on historical operating activity and employee base; and
Legacy Rockley’s operations comprise the ongoing operations of the combined entity.
Accordingly, for accounting purposes, the financial statements of the Company represent a continuation of the financial statements of Legacy Rockley with the acquisition being treated as the equivalent of Rockley issuing stock for the net assets of SC Health, accompanied by a recapitalization.
As a consequence of the Business Combination, the Company became an SEC-registered and NYSE-listed company, which requires us to hire additional talent and implement procedures and processes to address public company regulatory requirements and customary practices. We expect to incur incremental annual expenses as a public company for, among other things, increased directors’ and officers’ liability insurance; director fees; and additional internal and external accounting, legal, and administrative resources.
Key Factors Affecting Operating Results
We believe that our performance and future success depend on several factors that present significant opportunities for us but also pose risks and challenges, including, without limitation, the following:
Resource Constraints
Our products are currently under development and we do not have any products in commercial production. Our ability to achieve our product roadmaps and development timelines, including our ability to commence commercial production of our products, may be impacted by resource constraints, including the need for additional capital. We have a history of losses and our determination of substantial doubt as a going concern could materially limit our ability to raise additional funds through the issuance of equity securities or otherwise. Further, our products must also meet certain technical standards and customer requirements, which in turn require additional funds and other resources. Additional financing and resources may not be available to us when needed or on commercially reasonable terms.
Ability to Achieve Design Wins or Long-Term Production Contracts
We may engage in discussions with customers and co-develop products but we may not be able to convert the relationship into a design win or a long-term production contract due to resource constraints, delays, or technical challenges. We work closely with our customers and potential customers to understand their product roadmaps and strategies. Our customers also continuously develop new products in existing and new application areas. We believe achieving design wins and the ability to secure long-term
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production contracts will be critical to our future success. The selection process is typically lengthy and may require us to incur significant design and development expenditures in pursuit of a design win with no assurance that our products will be selected. The failure to secure a design win or long-term production contract could adversely affect our business.
Customer Orders and Forecasts
We currently anticipate that sales of our future products will be made pursuant to standard purchase orders, which may be cancelled, reduced, or rescheduled with little or no notice and without penalty. Cancellations of orders could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses. In addition, changes in forecasts or the timing of orders from customers, including if and when we commence commercial production of our products, could expose us to the risks of inventory shortages or excess inventory.
Pricing and Customer Demand
We expect our operating results, including if and when we commence commercial production of our products, will be impacted by the pricing of our products, our average selling prices, and fluctuations in customer purchasing volumes. If and when we begin commercial production of our products, we may not be able to fulfill customer demand in a timely manner or at all. We monitor and work to reduce our product manufacturing costs and improve the potential value our products can provide to our customers’ end products. The cost of raw materials and components critical for the manufacture of our anticipated products is largely out of our control and may fluctuate significantly. Since we rely on third-party wafer foundries and assembly and test contractors to manufacture, assemble, and test our products, we maintain a close relationship with our suppliers to improve quality, increase yields, and lower manufacturing costs.
New Markets and Applications
As we evaluate potential markets and applications for the products we are developing, we analyze forecasts by industry analysts, the adoption curve of technology, and potential competing forces that could hinder such adoption. If we fail to anticipate or respond to technological shifts or market demands, or to timely develop products or technologies in response to the same, it could result in our inability to achieve revenue growth and could harm our business and operations.
Cyclical Nature of the Semiconductor Industry
The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence, price erosion, evolving standards, short product life cycles, and wide fluctuations in product supply and demand. Downturns in the semiconductor industry have been characterized by diminished product demand, production overcapacity, high inventory levels, and accelerated erosion of average selling prices. Any prolonged or significant downturn in the semiconductor industry generally could adversely affect our business and reduce demand for our products and otherwise harm our financial condition and results of operations.
See the “ Risk Factors ” section of this annual report on Form 10-K for additional discussion of the risks and challenges facing our business.
Basis of Presentation
Currently, we conduct business through one operating and reportable segment. All long-lived assets are maintained in, and all losses are attributable to the one segment. See Note 1 in our accompanying audited consolidated financial statements for more information about our operating segment.
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Components of Results of Operations
The following discusses certain line items in our consolidated statements of operations.
Revenue
To date, we have primarily generated revenue from development services, which entail developing customer-specific designs of silicon photonics chipsets. Our contracts with customers include specific achievement of agreed-upon projects and a substantive acceptance criteria for each agreed-upon project. In the event an agreed-upon project is successful and the customer provides acceptance, we allocate the contract consideration related to the performance obligations that are satisfied during the period and recognize the revenue at that point in time.
Following the completion of our product development phase and introduction of our spectra-sense chipsets to the wearable devices market, we expect the majority of our revenue to be derived from sales of high-volume consumer wearable products. In addition, we plan to offer advanced module applications with biomarker detection capabilities for advanced health metrics that can detect, classify, and potentially prevent disease. We also expect to offer a cloud analytics platform to provide a full range of subscription services, including the deployment of our technology through a subscription and cloud-based software as a service.
Cost of Revenue
To date, our cost of revenue has included cost related to our development services, which include cost of materials, cost associated with packaging and assembly, testing and shipping, cost of talent, including stock-based compensation, and equipment associated with manufacturing support, logistics, and quality assurance, overhead, and occupancy costs. Once we commence commercial production of our silicon photonics chipsets, cost of revenues will include direct parts, material, and labor costs, manufacturing overhead, including amortized tooling costs, shipping and logistics costs, and reserves for estimated warranty expenses.
Gross Profit and Gross Margin
Gross profit is calculated based on the difference between our revenue and cost of revenue. Gross margin is the percentage obtained by dividing gross profit by our revenue. As we approach commercial production of spectra-sense chipsets, advanced module applications, and Rockley Photonics Cloud Analytics technology, we expect our gross profit and gross margin to vary.
Selling, General, and Administrative Expense
Selling, general, and administrative expenses consist of human capital related expenses for employees involved in general corporate functions, including executive management and administration, accounting, finance, tax, legal, information technology, marketing, and human resources; depreciation expense and rent relating to facilities; travel costs; professional fees; and other general corporate costs. Human capital expenses primarily include salaries, benefits, bonuses, and stock-based compensation.
Research and Development Expense
Research and development expense consists primarily of talent costs for engineers and third parties engaged in the design and development of products, software, and technologies, including salary, bonus, and stock-based compensation expense, project material costs, services, and depreciation of our research and development facilities and equipment. We expense research and development costs as they are incurred. Research and development expense also includes the research and development tax credits that we are able to claim in accordance with the relevant U.K. tax legislation. These tax credits are payable to us in cash and are carried on the consolidated balance sheets at the amount claimed and expected to be received from the U.K. government within the next 12 months. We expect research and development expense to increase in absolute dollars as we continue to invest in the development of our products and technology.
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Other Income (Expense)
Other income consists of miscellaneous non-operating items, such as forgiveness of debt and related accrued interest.
Interest Income (Expense)
Interest income consists primarily of interest received or earned on our cash, cash equivalents, and investment balances held in interest-bearing deposit accounts. Interest expense consists of interest paid on our convertible loan notes and capital lease obligations.
Equity Method Investment
Equity method investments consist of entities over which we have significant influence but not control or joint control. Under the equity method of accounting, all of our investments are initially recognized at cost and adjusted thereafter to recognize our share of the post-acquisition profits or losses of the investee in our consolidated statements of operations.
Change in Fair Value of Debt Instruments
Gains or losses from the change in fair value of debt instruments are recorded from the remeasurement of the fair value of our convertible loan notes using a discounted cash flow methodology based upon certain valuation assumptions.
Change in Fair Value of Warrant Liabilities
Gains or losses from the change in fair value of warrants are recorded from the remeasurement of the fair value of our private placement warrants, public warrants and warrants issued in connection with certain convertible notes based upon certain valuation assumptions.
Gain (Loss) on Foreign Currency
We have significant international operations that are denominated in foreign currencies, primarily the British Pound and Euro, subjecting us to foreign currency exchange risk that may adversely impact our financial results. We calculate the year-over-year impact of foreign currency movement on our business using foreign currency exchange rates that are applied to transactional currency amounts.
Provision for Income Tax
We are subject to income taxes in the United Kingdom, the United States, Finland, Ireland, and Switzerland. Our income tax provision consists of an estimate of federal, state, and foreign income taxes based on enacted federal, state, and foreign tax rates, as adjusted for allowable credits, deductions, uncertain tax positions, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws. Due to cumulative losses, we maintain a valuation allowance against our U.S. federal and foreign deferred tax assets.
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Results of Operations for the Years Ended December 31, 2022 and 2021
The following table sets forth our historical operating results for the periods indicated (in thousands):
Years Ended December 31,
Revenue
Cost of revenue
Gross profit
Operating expenses:
Selling, general, and administrative expenses
Research and development expenses
Total operating expenses
Loss from operations
Other income (expense):
Forgiveness of PPP loan
Other income
Interest expense, net
Equity method investment loss
Change in fair value of debt instruments
Change in fair value of warrant liabilities
Gain (loss) on foreign currency
Total other income (expense)
Loss before income taxes
Provision for income tax
Net loss
Discussion and Analysis of Results of Operations
Revenue (in thousands, except for percentages)
Years Ended December 31,
Change
Revenue
Revenue decreased by $5.0 million, or 60% to $3.2 million for the year ended December 31, 2022 from $8.2 million for the year ended December 31, 2021. This decrease is primarily driven by timing of project milestones for our significant customers in fiscal 2022 when compared to fiscal 2021.
Cost of Revenue and Gross Profit (in thousands, except for percentages)
Years Ended December 31,
Change
Cost of revenue
Gross Profit
Gross Margin
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NM – Not meaningful
Cost of revenue decreased by $3.0 million, or 26%, to $8.5 million for the year ended December 31, 2022 from $11.4 million for the year ended December 31, 2021. This decrease in cost of revenue was primarily driven by an overall decrease in revenue and decrease in allocation of costs related to revenue generating activities when compared to the prior year.
Gross profit decreased by $2.0 million to $(5.2) million for the year ended December 31, 2022 from $(3.2) million for the year ended December 31, 2021. The decrease in gross profit was primarily driven by a decrease in revenue for the year ended December 31, 2022.
Our gross margin has fluctuated and may fluctuate from period to period based on a number of factors, including the timing of completion of project milestones, with each project requiring differing levels of time and costs. The projects we undertake are determined by our customer commitments and our long-term strategy goals.
To date, our cost of revenue has included cost related to our development services which include cost of materials, cost associated with packaging and assembly, testing and shipping, cost of talent, including stock-based compensation, and equipment associated with manufacturing support, logistics, and quality assurance, overhead, and occupancy costs. Once we commence commercial production of our silicon photonics chipsets, cost of revenues will include direct parts, material, and labor costs, manufacturing overhead, including amortized tooling costs, shipping and logistics costs, and reserves for estimated warranty expenses.
Gross profit is calculated based on the difference between our revenue and cost of revenue. Gross margin is the percentage obtained by dividing gross profit by our revenue. As we approach commercial production of spectra-sense chipsets, advanced module applications, and Rockley Photonics Cloud Analytics technology, we expect our gross profit and gross margin to vary.
Selling, General and Administrative Expenses (in thousands, except for percentages)
Years Ended December 31,
Change
Selling, general and administrative expenses
Selling, general and administrative expenses increased by $21.6 million, or 54%, to $61.5 million for the year ended December 31, 2022 from $40.0 million for the year ended December 31, 2021. The increase was primarily due to an increase in professional fees of $16 million related to our financing activities in fiscal 2022. Further, the increase relates general corporate growth, of which $2.9 million was due to an increase in insurance expense, $1.6 million and $0.6 million were due to increased human capital and stock-based compensation costs, respectively.
Selling, general, and administrative expenses consist of human capital related expenses for employees involved in general corporate functions, including executive management and administration, accounting, finance, tax, legal, information technology, marketing, and human resources; depreciation expense and rent relating to facilities; travel costs; professional fees; and other general corporate costs. Human capital expenses primarily include salaries, benefits, bonuses, and stock-based compensation.
Research and Development Expenses (in thousands, except for percentages)
Years Ended December 31,
Change
Research and development expenses
Research and development expenses increased by $30.5 million, or 42%, to $103.1 million for the year December 31, 2022 from $72.6 million for the year ended December 31, 2021. The increase was primarily attributable to an increase in stock-based compensation expenses of $1.7 million, higher IT infrastructure costs of $1.4 million, higher third party engineering costs of $5.1 million and a decrease in allocation of expenses of $7.9 million to R&D and a decrease in the R&D tax credit of $16.6 million.
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Research and development expense consists primarily of talent costs for engineers and third parties engaged in the design and development of products, software, and technologies, including salary, bonus, and stock-based compensation expense, project material costs, services, and depreciation of our research and development facilities and equipment. We expense research and development costs as they are incurred. Research and development expense also includes the research and development tax credits that we are able to claim in accordance with the relevant U.K. tax legislation. These tax credits are payable to us in cash and are carried on the consolidated balance sheets at the amount claimed and expected to be received from the U.K. government within the next 12 months. We proactively manage research and development expense whilst remaining focused in the development of our products and technology.
Other income, net (in thousands, except for percentages)
Years Ended December 31,
Change
Other income, net
The decrease in other income, net, for the year ending December 31, 2022 compared to the year ending December 31, 2021, is attributable to the absence of the forgiveness of Paycheck Protection Program debt and related accrued interest which only occurred in fiscal 2021.
Interest Expense, net (in thousands, except for percentages)
Years Ended December 31,
Change
Interest expense, net
The change in interest expense, net by $9.9 million, or 207%, for the years ended December 31, 2022 and December 31, 2021, respectively was primarily due to the interest expense recorded in fiscal 2022 due to the imputed interest expense from the 2020 Term Facility Loan and interest on the May and October Notes.
Interest income consists primarily of interest received or earned on our cash, cash equivalents, and investment balances held in interest-bearing deposit accounts. Interest expense consists of interest paid or accrued on our Term Facility Loan and May and October Notes.
Equity Method Investment Loss (in thousands, except for percentages)
Years Ended December 31,
Change
Equity method investment loss
Change in equity method investment captures our share of losses of the investment in HRT according to our percentage of ownership.
Change in Fair Value of Debt Instruments (in thousands, except for percentages)
Years Ended December 31,
Change
Change in fair value of debt instruments
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Change in fair value of debt instruments captures losses from a change in fair value estimates using discounted cash flow and binomial lattice methodologies that are based upon a set of valuation assumptions to value the May and October Notes.
All convertible debt instruments held by the Company prior to the Business Combination in August 2021 were converted to ordinary shares in the Company as part of the close of the Business Combination in August 2021.
Change in Fair Value of Warrant Liabilities (in thousands, except for percentages)
Years Ended December 31,
Change
Change in fair value of warrant liabilities
Change in fair value of warrant liabilities captures activity from a change in fair value estimates based upon a set of Black-Scholes valuation assumptions or binomial lattice methodologies. The warrant liabilities include the Private Placement Warrants assumed from SC Health as part of the Business Combination in August 2021 and the May 144A Warrants issued by the Company in May 2022 and the October 144A Warrants issued by the Company in October 2022.
Gain (Loss) on Foreign Currency (in thousands, except for percentages)
Years Ended December 31,
Change
Gain (loss) on foreign currency
Change in gain (loss) on foreign currency captures losses from the impact of foreign currency exchange rates as a result of the translation of foreign functional currencies into our reporting currency and the re-measurement of foreign currency transactions and balances. For the years ended December 31, 2022 and 2021, most of our balances are held in the reporting currency, which decrease the impact of foreign currency fluctuations on the results of our operations.
Provision for Income Tax (in thousands, except for percentages)
Years Ended December 31,
Change
Provision for income tax
Change in provision for income tax expense for the years ended December 31, 2022 and 2021 is due primarily to changes in U.S. tax laws which required capitalization of certain research and development expenditures for tax purposes. Our effective tax rate differs from the U.K. statutory rate primarily due to a substantially full valuation allowance against our net deferred tax assets where it is more likely than not that some or all of the deferred tax assets will not be realized. The income tax expenses shown above are primarily related to corporate income taxes in the United States, which operates on a cost-plus arrangement and minimum filing fees in the foreign jurisdictions where we have operations.
Liquidity and Capital Resources
Due to Rockley’s history of recurring losses from operations, negative cash flows from operations, and a significant accumulated deficit, and the Chapter 11 bankruptcy petition filed in January 2023, management concluded that there is substantial doubt about Rockley’s ability to continue as a going concern. In addition, our independent registered public accounting firm has included an explanatory paragraph in their opinion for the year ended December 31, 2022 as to the substantial doubt about our ability to continue as a going concern. Since inception, Rockley has financed its operations primarily through the issuance and sale of convertible loan notes, ordinary shares and agreed-upon projects. As of December 31, 2022, the Company had cash, cash equivalents and investments of approximately $23.0 million.
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Short-Term and Long-Term Liquidity Requirements
In October 2021, the Company entered into an equity line of credit arrangement (“ELOC”) with Lincoln Park Capital Fund, LLC, an Illinois limited liability company (“LPCF”). The ELOC is a private placement with registration rights, providing LPCF the ability to purchase up to 7.8 million of the Company’s ordinary shares for up to $50.0 million over 24 months. Proceeds from the sale of shares will go towards the Company to be used for working capital.
On May 27, 2022, the Company issued the May Notes in an aggregate principal amount of $81.5 million pursuant to the May Indenture, dated as of May 27, 2022, among the Company, certain of its subsidiaries, as guarantors, and Wilmington Savings Fund Society, FSB, as trustee and as collateral agent in a private placement financing and in connection therewith agreed to comply with the affirmative and negative covenants contained in the May Indenture, including a covenant that requires the Company to pledge at all time at least $20.0 million of cash and cash equivalents to secure the May Notes. This minimum cash and cash equivalents requirement potentially limits the Company’s liquidity position. See “Risk Factors — We are subject to restrictive debt covenants that limit our ability to finance our future operations and capital needs and to pursue business opportunities and activities.” for a discussion of risks related to restrictive covenants in the May Indenture.
On October 25, 2022, the Company issued the May Notes in an aggregate principal amount of $90.6 million pursuant to the October Indenture, dated as of October 25, 2022, among the Company, certain of its subsidiaries, as guarantors, and Wilmington Savings Fund Society, FSB, as trustee and as collateral agent in a private placement financing and in connection therewith agreed to comply with the affirmative and negative covenants contained in the October Indenture, including a covenant that requires the Company to have a minimum amount of cash and cash equivalents of $5.0 million (including amounts in escrow) through December 29, 2022 and $20.0 million thereafter to secure the October Notes. This minimum cash and cash equivalents requirement potentially limits the Company’s liquidity position. See “Risk Factors — We are subject to restrictive debt covenants that limit our ability to finance our future operations and capital needs and to pursue business opportunities and activities.” for a discussion of risks related to restrictive covenants in the October Indenture.
As of the date of this Annual Report on Form 10-K, we have yet to generate any material revenue from our business operations. In addition, we have substantial debt obligations and limited liquidity. If we are unable to pay our obligations as they become due, our creditors could exercise their remedies under our debt agreements, which could include seizing control of our bank accounts, which in turn could require us to initiate bankruptcy proceedings. These actions could have the effect of substantially reducing or completely eliminating the value of our ordinary shares. You should not invest in our ordinary shares unless you are willing and able to withstand the complete loss of your investment.
On January 23, 2023, the Company filed a voluntary petition for relief under chapter 11 of title 11 (the “Chapter 11 Case”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The Company filed motions with the Bankruptcy Court seeking authorization to continue operating its business as a “debtor in possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court. The Company filed a series of first day motions with the Bankruptcy Court that sought authorization to continue conducting its business without interruption. These motions were designed primarily to minimize the effect of bankruptcy on the Company’s operations and were subsequently approved by the Bankruptcy Court. None of Rockley’s subsidiaries have filed voluntary petitions for relief under the Code. The Company also filed the Prepackaged Chapter 11 Plan of Reorganization of Rockley Photonics Holdings Limited (as amended, supplemented, or modified from time to time, the “Plan”) and a related disclosure statement (the “Disclosure Statement”).. The Company sought expedited approval of the Plan as part of a comprehensive to de-lever the Company’s consolidated balance sheet by eliminating existing debt and introducing a new capital structure that would provide approximately $35 million of cash for ongoing operations. On January 24, 2023, the Company filed a petition with the Grand Court of the Cayman Islands seeking the appointment of joint officers to advise the Company and facilitate the transactions to be effectuated in connection with the Chapter 11 Case.
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The filing of the Chapter 11 Case described above constituted an event of default or otherwise triggered repayment obligations under a number of instruments and agreements relating to direct financial obligations of the Company and certain of its subsidiaries. The May Notes and the October Notes each provide that, as a result of the Chapter 11 Case, the principal, accrued and unpaid interest and certain other amounts due thereunder, including certain prepayment premiums payable, shall be immediately due and payable. Any efforts to enforce such payment obligations under the Debt Instruments as to the Company were automatically stayed as a result of the Chapter 11 Case, and the Company’s creditors’ rights of enforcement in respect of the Debt Instruments are subject to the applicable provisions of the Bankruptcy Code and the Bankruptcy Court’s orders.
On March 10, 2023, the Bankruptcy Court approved the adequacy of the Disclosure Statement and confirmed the Plan. The Plan became effective March 14, 2023 (the “Effective Date”).
Pursuant to the Plan, after the Effective Date, the Company will liquidate pursuant to Cayman Islands law. Holders of existing equity interests in the Company will not receive or retain any distribution or property on account of such equity interests. In connection with the liquidation, the Company expects to file a Form 15 with the Securities and Exchange Commission to terminate the registration of its ordinary shares. Thereafter, the Company’s reporting obligations under the Securities Exchange Act of 1934, as amended shall be terminated.
Historical Cash flows
For the Years Ended December 31, 2022 and 2021
Years Ended December 31,
(in thousands)
Net cash used in operating activities
Net cash used in investing activities
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash Flows from Operating Activities
During the year ended December 31, 2022, net cash used in operating activities was $126.2 million, primarily consisting of net losses of $224.0 million, adjusted by non-cash depreciation and amortization of $6.4 million, bad debt expense and allowance for doubtful accounts of $(0.1) million, stock-based compensation of $14.3 million, equity-method investment loss of $1.2 million, and changes in fair value of debt instruments and warrants of $73.4 million and $(44.1) million, respectively. Changes in assets and liabilities for the year ended December 31, 2022 included the following: decreases in accounts receivable, other receivables, and accrued expenses offset by an increase in trade payables.
During the year ended December 31, 2021, net cash used in operating activities was $126.0 million, primarily consisting of net losses of $168.0 million, adjusted by non-cash depreciation and amortization of $4.6 million, bad debt expense and allowance for doubtful accounts of $0.8 million, stock-based compensation of $12.0 million, equity-method investment loss of $0.3 million, and change in fair value of debt instruments and warrants of $59.9 million and $(10.8) million, respectively. Changes in assets and liabilities for the year ended December 31, 2021 included the following: decreases in accounts receivable, offset by increases in other receivables, trade payables and accrued expenses.
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Cash Flows from Investing Activities
Net cash used in investing activities was $40.6 million for the year ended December 31, 2022, primarily related to the sale of marketable securities of $45.1 million, and also from the purchases of property and equipment to be used in the ordinary course of business. Net cash used in investing activities was $52.8 million for the year ended December 31, 2021, primarily related to the purchase and the sale of marketable securities of $54.7 million and $10.0 million, respectively, and also from the purchases of property and equipment to be used in the ordinary course of business.
Cash Flows from Financing Activities
Net cash provided by financing activities was $71.8 million for the year ended December 31, 2022, primarily related to the proceeds received from the May and October Notes, partially offset by the principal payments we have made on the 2020 Term Facility Loan and payment of transaction costs. Net cash provided by financing activities was $196.4 million for the year ended December 31, 2021, primarily related to the proceeds received from the Business Combination and convertible loan notes.
Contractual Obligations and Commitments
Purchase obligations include commitments to third-party suppliers for various research and development activities. As of December 31, 2022 and December 31, 2021, we had $8.3 million and $13.6 million, respectively in contractual obligations for which we have not yet received services.
Off-Balance Sheet Arrangements
Since the date of our incorporation, we have not engaged in any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.
Recent Accounting Pronouncements
Please refer to Note 1—Description of Business and Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for more information about recent accounting pronouncements, the timing of their adoption, and our assessment, to the extent we have made one, of their potential impact on our financial condition and our results of operations.
Critical Accounting Policies and Estimates
Our financial statements have been prepared in accordance with GAAP as set forth in the Financial Accounting Standards Board’s Accounting Standards Codification, and we consider the various staff accounting bulletins and other applicable guidance issued by the SEC. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates.
See Note 1—Description of Business and Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a summary of our significant accounting policies and the effect on our financial statements.
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Revenue Recognition
We generate revenue principally from development services, which entails developing customer-specific designs of photonics chipsets. Our contracts with customers include specific achievement milestones and a substantive acceptance criteria for each milestone. In the event a milestone is achieved and the customer provides acceptance, the Company allocates the contract consideration related to the performance obligations that are satisfied during the period and recognizes the revenue at that point in time.
Stock-based Compensation
We recognize the cost of stock-based awards granted to our employees and directors based on the estimated grant-date fair value of the awards. Cost is recognized on a straight-line basis over the service period, which is generally the vesting period of the award. We have elected to recognize the effect of forfeitures in the period they occur. We determine the fair value of stock options using the Black-Scholes option pricing model, which is impacted by the following assumptions:
Expected Term—This is the period that the awards that have been granted are expected to remain unexercised. The Company employs the average period the awards are expected to remain outstanding;
Volatility—Our stock was not publicly traded prior to August 11, 2021. The volatility used in stock grants made prior to that date was based on a benchmark of comparable companies within the silicon photonics industries;
Risk-Free Interest Rate—The interest rates used are based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award; and
Dividend Yield—The dividend rate used is zero as we have never paid any cash dividends on our ordinary shares and do not anticipate doing so in the foreseeable future.
Following the Business Combination, the fair value of our ordinary shares is now determined based on the quoted market price. Prior to the Business Combination, our management and board of directors considered various objectives and subjective factors to determine the fair value of Legacy’s Rockley ordinary shares as of each grant date, including the value determined by a third-party valuation firm. These factors included, among other things, financial performance, capital structure, forecasted operating results and market performance analyses of similar companies in our industry.
Convertible Debt
The fair value of the May Notes and October Notes was measured using a binomial lattice model based on assumptions as to when the May and October Notes would be converted or redeemed at each decision point. The lattice model uses the stock price, maturity date, risk-free rate, estimated stock volatility and estimated credit spread as significant assumptions used to estimate fair value. The May Notes and October Notes are re-measured to fair value at each subsequent reporting date. We will continue to adjust the liability for changes in fair value for the May Notes and October until they mature or are converted to Company stock and present the changes in fair value in the consolidated statement of operations at each reporting period.
Warrants
We classify the Private Placement Warrants as a long-term liability on our consolidated balance sheets as of December 31, 2022 and 2021. The Private Placement Warrants were traded on the NYSE prior to their redemption and recorded at fair value using a Black-Scholes option-pricing model. The Private Placement Warrants are re-measured to fair value at each subsequent reporting date. We will continue to adjust the liability for changes in fair value for the Private Placement Warrants until the warrants are exercised, redeemed or cancelled and present the changes in fair value in the consolidated statement of operations at each reporting period.
We classify the Public Warrants as equity and present within Additional Paid-In Capital on our consolidated balance sheets as of December 31, 2022 and 2021. Although an event such as a qualifying cash tender offer could occur outside of the company’s control that would require net cash settlement, equity classification for the Public Warrants is not precluded per ASC 815-40-25. The Public Warrants were initially recorded using the closing stock price as of the measurement date, with no subsequent measurement.
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We classified the May 144A Warrants and October 144A Warrants as long-term liabilities on our consolidated balance sheet as of December 31, 2022. The May 144A and October 144A Warrants were recorded at fair value using the Monte Carlo simulation method. The May 144A Warrants and October 144A Warrants are re-measured to fair value at each subsequent reporting date. We will continue to adjust the liability for changes in fair value for the May 144A Warrants and October 144A Warrants until the warrants are exercised, redeemed or cancelled and present the changes in fair value in the consolidated statement of operations at each reporting period.
Income Taxes
We record income tax expense for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of asset and liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We record valuation allowances to reduce its deferred tax assets to the net amount that it believes is more likely than not to be realized. Its assessment considers the realization of deferred tax assets on a jurisdictional basis. We recognize the income tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by taxing authorities, based on the technical merits of the position. The income tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
