Introduction and Certain Cautionary Statements
As used in this Quarterly Report, unless the context requires otherwise, references to the "Company," "we," "us," and "our" refer to SG Blocks, Inc. and its subsidiaries. The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes and schedules included elsewhere in this Quarterly Report on Form 10-Q and with our audited condensed consolidated financial statements and notes for the year ended December 31, 2019, which were included in our Annual Report for the year then ended December 31, 2019, as filed with the Securities and Exchange Commission (the "SEC") on March 30, 2020 and Amendment No. 1 thereto filed with the SEC on April 15, 2020 (the "2019 Form 10-K"). This discussion, particularly information with respect to our future operations, includes forward-looking statements that involve risks and uncertainties as described under the heading "Special note regarding forward-looking statements" in this Quarterly Report on Form10-Q. You should review the disclosure under the heading "Risk Factors" in this Quarterly Report on Form 10-Q for a discussion for important factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements.
Special note regarding forward-looking statements
This Quarterly Report on Form-10Q contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed in the forward-looking statements. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Statements contained in this Quarterly Report on Form 10-Q may use forward-looking terminology, such as "anticipates," "believes," "could," "would," "estimates," "may," "might," "plan," "expect," "intend," "should," "will," or other variations on these terms or their negatives. All statements other than statements of historical facts are statements that could potentially be forward-looking. The Company cautions that forward-looking statements involve risks and uncertainties and actual results could differ materially from those expressed or implied in these forward-looking statements or could affect the extent to which a particular objective, projection, estimate or prediction is realized. Factors that could cause or contribute to such differences include, but are not limited to: general economic, political and financial conditions, both in the United States and internationally; our ability to obtain additional financing on acceptable terms, if at all, or to obtain additional capital in other ways; our ability to increase sales, generate income, effectively manage our growth and realize our backlog; competition in the markets in which we operate, including the consolidation of our industry, our ability to expand into and compete in new geographic markets and our ability to compete by protecting our proprietary manufacturing process; a disruption or cybersecurity breach in our or third-party suppliers' information technology systems; our ability to adapt our products and services to industry standards and consumer preferences and obtain general market acceptance of our products; product shortages and the availability of raw materials, and potential loss of relationships with key vendors, suppliers or subcontractors; the seasonality of the construction industry in general, and the commercial and residential construction markets in particular; a disruption or limited availability with our third party transportation vendors; the loss or potential loss of any significant customers; exposure to product liability, including the possibility that our liability for estimated warranties may be inadequate, and various other claims and litigation; our ability to attract and retain key employees; our ability to attract private investment for sales of product; the credit risk from our customers and our customers' ability to obtaining third-party financing if and as needed; an impairment of goodwill; the impact of federal, state and local regulations, including changes to international trade and tariff policies, and the impact of any failure of any person acting on our behalf to comply with applicable regulations and guidelines; costs incurred relating to current and future legal proceedings or investigations; the cost of compliance with environmental, health and safety laws and other local building regulations; our ability to utilize our net operating loss carryforwards and the impact of changes in the United States' tax rules and regulations; dangers inherent in our operations, such as natural or man-made disruptions to our facilities and project sites, the impact of COVID-19, and related government “shelter-in-place” mandates and other restrictions on business and commercial activity and the adequacy of our insurance coverage; our ability to comply with the requirements of being a public company; fluctuations in the price of our common stock, including decreases in price due to sales of significant amounts of stock; potential dilution of the ownership of our current stockholders due to, among other things, public offerings or private placements by the Company or issuances upon the exercise of outstanding options or warrants and the vesting of restricted stock units; the ability of our principal stockholders, management and directors to potentially exert control due to their ownership interest; any ability to pay dividends in the future; potential negative reports by securities or industry analysts regarding our business or the construction industry in general; Delaware law provisions discouraging, delaying or preventing a merger or acquisition at a premium price; our ability to remain listed on the Nasdaq Capital Market and the possibility that our stock will be subject to penny stock rules; our classification as a smaller reporting company resulting in, among other things, a potential reduction in active trading of our common stock or increased volatility in our stock price; and any factors discussed in "Part II - Item 1A. Risk Factors" to this Quarterly Report on Form 10-Q as well as our 2019 Form 10-K and other filings with the Securities Exchange Commission. In addition, certain information presented below is based on unaudited financial information. There can be no assurance that there will be no changes to this information once audited financial information is available. As a result, readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date of this report. The Company will not undertake to update any forward-looking statement herein or that may be made from time to time on behalf of the Company.
Overview
Using our proprietary technology and design and engineering expertise, we modify code-engineered cargo shipping containers and purpose-built modules for use for safe and sustainable commercial, industrial and residential building construction. Rather than consuming new steel and lumber, our proprietary technology and design and engineering expertise allows for the redesign, repurpose and conversion of heavy-gauge steel cargo shipping containers into SGBlocks™, which are safe green building blocks for commercial, industrial, and residential building construction. Our technology and expertise is also used to purpose-build modules, or prefabricated steel modular units customized for use in modular construction (“SGPBMs” and, together with SGBlocks™, “Modules”), primarily to augment or complement an SGBlocks™ structure. Our core customer base is comprised of architects, landowners, builders and developers who use our Modules in commercial and residential structures. Our operating model combines product design and outsourcing of the modifications and finish out of Modules using proprietary algorithms developed by the Company to produce and deliver Modules across the country. We believe this combination enables us to generate economies of scale while maintaining high customer service levels in the environmentally-friendly construction space.
Prior to October 2019, our business model was solely a project-based construction model pursuant to which we were responsible for the design and construction of finished products that incorporated our technology primarily to customers in the multi-family housing, restaurant, military and education industries throughout the United States. In October 2019, we changed our business model for our residential building construction to a royalty fee model when we entered into a five year exclusive license with CPF GP 2019-1 LLC ("CPF") pursuant to which CPF licensed on an exclusive bases our proprietary technology, intellectual property, any improvements thereto, and any related permits, with the right to develop and commercialize products in the United States and its territories within the field of design and project management platforms for residential use, including, without limitation, single-family residences and multi-family residences, but specifically excluding military housing. CPF, at the time the License Agreement was entered into, was already a significant customer for our Modules and had completed a $5.0 million equity financing to develop a 302-unit multifamily project in Sullivan County, New York. Now, in the United States with respect to residential construction (other than residential construction for the military) we are no longer responsible for constructing the Modules that are based on our technology or the related costs and instead that service is performed by CPF and its subcontractors and our revenue for such residential construction is no longer generated from sales of products direct to the end customer but instead is generated from royalties received from CPF based on the gross revenue that CPF receives from sales of products that are based upon our technology.
In April 2020, we expanded our product offerings and began focusing on the medical projects when we entered into the COVID-19 diagnostic market through a collaboration for our distribution of COVID-19 diagnostic tests manufactured by Osang Healthcare Co., Ltd., ("Osang"). We have subsequently entered into additional collaborations for the distribution of Osang’s diagnostic tests as well as collaborations for the use of our modular technology for the building of medical test centers that will include COVID-19 testing.
Recent Business Developments
On July 6, 2020, we entered into a Joint Development Agreement with Grimshaw Design, LLC ("Grimshaw"). Our joint agreement is to develop a prototype and "proof of concept" for a scalable, customizable and rapidly deployable educational facility with classrooms, spaces for teaching, workshops, dining, recreation, sports and/or other education-related purposes, based upon Grimshaw's designs and utilizing our container-cased or other modular structures, or pre-fabricated modular structures jointly developed by us and Grimshaw.
On August 27, 2020, we entered into a joint venture agreement with Clarity Lab Solutions, LLC (“Clarity Labs”) (the “JV”). Clarity Labs is a licensed clinical laboratory that uses specialized molecular testing equipment and that focuses on the diagnosis and treatment of critical diseases, including COVID-19. Clarity Labs is also engaged in the business of manufacturing, importing and distributions various medical tests. Under the JV, we, along with Clarity Labs will jointly market, sell, and distributed certain products and services (“Clarity Mobile Venture”). As of September 30, 2020, the only activity of Clarity Mobile Venture was a cash transfer from the Company and is included in the condensed consolidated financial statements. On November 16, 2020, we announced that the State of Hawaii had selected Clarity Labs and Clarity Mobile Venture to provide COVID-19 testing and clinical laboratory at Los Angeles International Airport (“LAX”) for testing of passengers travelling between Los Angeles and Hawaii.
On September 17, 2020, we, through our wholly owned subsidiary SG Echo LLC (“SG Echo”), entered into an Asset Purchase Agreement (“Asset Purchase Agreement”) with Echo DCL, LLC, a Texas limited liability company (“Echo”) a container/modular manufacturer that had been a supplier of ours, to acquire substantially all the assets of Echo, except for Echo’s real estate holdings, for which SG Echo has obtained a right of first refusal to acquire same. On September 23, 2020, we, SG Echo and Echo completed the transactions as contemplated by the Asset Purchase Agreement (the “Closing”).
Pursuant to the terms of the Asset Purchase Agreement, at the Closing we paid to Echo an aggregate of $1,059,600 in cash, subject to the escrow of certain of the purchase price funds, and SG Echo agreed to pay certain of Echo’s indebtedness, including the obligation to (i) satisfy a Guidance Line of Credit loan (“GLOC Loan”) in the principal amount of approximately $616,000 ($316,432 of which payoff proceeds was delivered by Echo to SG Echo at the closing), (ii) pay the debt service on certain of Echo’s indebtedness in the approximate principal amount of $1.7 million for 12 months following the closing, (iii) payoff at maturity a certain line of credit of Echo with BTH Bank in the principal amount of $500,000, and (iv) pay earn out payments equal to the net income received from the acquired business during the 3-month period beginning on the first day of the first full month that is 3 months after the closing date, the 3-month period following the first earn out period and the 3-month period following the second earn out period, payable in 50% in cash and 50% in shares of our common stock to be valued a $2.50 per share; provided, that up to approximately $300,000 of any amounts paid in respect of the GLOC Loan, and any amounts paid in respect of the debt service on Echo’s indebtedness and line of credit with BTH Bank, as described in subparagraphs (i), (ii) or (iii) above, shall be offset against and reduce the earnout payments due to Echo. In no event may the number of shares of common stock to be issued to Echo exceed 19.99% of our outstanding shares on the date of the execution of the Asset Purchase Agreement.
On October 12, 2020, we and Osang, the manufacturer and supplier of the GeneFinderTM COVID-19 Plus RealAmp KitTM that we distribute, entered into a Managed Supply Agreement (the “Supply Agreement”) which memorialized of our obligations and Osang's obligations as it relates to the consignment (the “Consignment”) to us of two (2) million units of Osang's flagship Genefinder Plus RealAmp Covid-19 PCR Test (the “Product”) from Osang for the cold-chain storage and distribution of Product in the United States of America and Canada by us on behalf of ourself, as well as for Osang to other distributors in Territory as well as for direct sales by Osang worldwide where permissible for a period of 180 days thereafter. The Supply Agreement included confirmation by Osang that we have no payment obligation for the Consignment until we sell the Product and any unsold product remains the responsibility of Osang except that we are responsible for the sold-storage fees and Osang’s agreement to use best efforts that all sales of Products will be drawn from the Consignment with priority.
On November 12, 2020, our joint venture partnership in Clarity Mobile Venture entered into a contract with the City of Los Angeles for the operations of a COVID-19 PCR Test Laboratory at Los Angeles International Airport to provide a full-service modular COVID-19 laboratory and testing facility onsite at Los Angeles International Airport. The facility will be located across from Terminal 6 and is expected to open in December 2020. The facility will administer PCR tests with results available within 3 hours for passengers and airline crew, and no later than 24 hours for LAWA airport employees. Additionally, other rapid coronavirus tests including antigen tests will be provided. Clarity Mobile Venture will be the primary operator of the facility and will deploy the GeneFinder™ test for COVID-19, produced by OSANG Healthcare Co., Ltd.
On November 19, 2020, we and Memorial Hospital, of Michigan (“Memorial), entered into a Professional Services and Capital Support Contract (“PSCSC”) with Wayne County, Michigan to appoint Memorial the primary contractor for the construction of portable on-site laboratory facilities for COVID-19 testing. The PSCCS engages the Company as a sub-contractor to render services and support to Memorial in connection with the fulfillment of statements of work submitted from Wayne County to Memorial. The program deploys the D-Tec Product Series, including D-Tec 1 and D-Tec 5 facilities, designed by Grimshaw Architects and developed by SG Blocks, to deliver highly accurate PCR testing and on-site CLIA lab services directly into high risk and underserved areas. The D-Tec 1 units are expected to be deployed throughout Wayne County and will provide sample extraction and lab services. The D-Tec 5 will serve as the main CLIA lab and have the capacity to process 7,000 tests per day in a single eight-hour shift. The facilities will be used to test residents for COVID-19 using the OSANG GeneFinder™ test, which is able to deliver medical grade results in approximately 3 hours. Clarity Mobile Venture will be the primary operator of the facility.
Results of Operations
As a result of our new licensing model that commenced in October 2019, our operations for the nine months ended September 30, 2020 and 2019 may not be indicative of our future operations.
Nine Months Ended September 30, 2020 and 2019:
| | For the Nine Months Ended September 30, 2020 | | | For the Nine Months Ended September 30, 2019 | |
Total Revenue | | $ | 1,404,265 | | | $ | 2,647,558 | |
Total Cost of revenue | | | (789,445 | ) | | | (2,018,392 | ) |
Total Operating expenses | | | (3,730,383 | ) | | | (3,365,040 | ) |
Total Operating loss | | | (3,115,563 | ) | | | (2,735,874 | ) |
Total Other income (expense) | | | 51,890 | | | | (52,039 | ) |
Net loss | | $ | (3,063,673 | ) | | $ | (2,787,913 | ) |
Revenue
Total revenue for the nine months ended September 30, 2020 was $1,404,265 compared to $2,647,558 for the nine months ended September 30, 2019. This decrease of $1,243,293 or approximately 47% was mainly driven by a decline in revenue of approximately $968,000 in retail projects, a decline in revenue of approximately $1,038,000 in office projects, a decline in revenue of approximately $37,000 in multi-family/single-family projects, offset by an increase of approximately $300,000 in other projects, an increase of approximately $58,500 in medical projects, an increase of approximately $65,000 in special use projects and an increase of approximately $340,000 in hospitality projects for the nine months ended September 30, 2020, as compared to September 30, 2019
Cost of Revenue and Gross Profit
Cost of revenue was $789,445 for the nine months ended September 30, 2020, compared to $2,018,392 for the nine months ended September 30, 2019. The decrease of $1,228,947 or a decrease of approximately 61%, is primarily related to lower revenues and the lower procurement and manufacturing costs of modifying containers as well as $300,000 of construction revenue earned during the nine months ending September 30, 2020 with no costs of revenue.
Gross profit was $614,820 and $629,166 for the nine months ended September 30, 2020 and 2019, respectively.
Gross profit percentage increased to approximately 44% for the nine months ended September 30, 2020 compared to approximately 24% for the nine months ended September 30, 2019 primarily due to a single contract in the amount of $300,000 with no estimated costs.
Payroll and Related Expenses
Payroll and related expenses for the nine months ended September 30, 2020 were $1,344,009 compared to $1,832,333 for the nine months ended September 30, 2019. This decrease was primarily caused by a decrease of approximately $57,000 in stock-based compensation expense, as well as a decrease in salaries and additional head count of approximately $417,000 recognized during the year ended September 30, 2020 compared to the nine months ended September 30, 2019. We recognized $414,563 in stock-based compensation expense related to payroll and related expenses for the nine months ended September 30, 2020, compared to $472,013 for September 30, 2019.
Other Operating Expenses (General and administrative expenses, Marketing and business development expense, and Pre-project expenses)
Other operating expenses (general and administrative expenses, marketing and business development expenses, pre-project expenses) for the nine months ended September 30, 2020 were $2,386,374 compared to $1,532,707 for the nine months ended September 30, 2019. The increase resulted primarily from an increase in legal fees of approximately $455,000, an increase in insurance expenses by approximately $37,500, an increase in advisory service fees by approximately $434,000, an increase in marketing expense by approximately $46,000, an increase in amortization expense by approximately $30,590, and an increase in accounting fees by approximately $53,000, offset by a decrease in travel expenses by approximately $120,000, and a decrease contract labor expenses of approximately $120,000. We recognized $57,120 in stock-based compensation expense related to legal expenses for the nine months ended September 30, 2020. We recognized $10,125 in stock-based compensation expense related to marketing expenses for the nine months ended September 30, 2019.
Results of Operations (continued)
Other Income (Expense)
Interest income for the nine months ended September 30, 2020 was $38,497 and related to the outstanding note receivable. There was no interest income for the nine months ended September 30, 2019. Interest expense for the nine months ended September 30, 2020 of $8,877 was mainly related to the Securities Purchase Agreement entered into on February 4, 2020 with an accredited investor. There was no interest expense for the nine months ended September 30, 2019. Other income for the nine months ended September 30, 2020 was $23,282 and there was no other income for the nine months ended September 30, 2019. Loss on asset disposal for the nine months ended September 30, 2020 and 2019 was $1,012 and $52,039, respectively.
Three Months Ended September 30, 2020 and 2019:
|
|
| For the Three Months Ended September 30, 2020 |
|
| For the Three Months Ended September 30, 2019 |
|
| Total Revenue |
| $ | 576,560 |
| $ | 184,526 |
|
| Total Cost of revenue |
|
| (381,954 | ) |
| (366,783 | ) |
| Total Operating expenses |
|
| (1,719,936 | ) |
| (1,091,173 | ) |
| Total Operating loss |
|
| (1,525,330 | ) |
| (1,273,430 | ) |
| Total Other income (expense) |
|
| 47,057 |
|
| (52,039 | ) |
| Net loss |
| $ | (1,478,273 | ) | $ | (1,325,469 | ) |
Revenue
Total revenue for the three months ended September 30, 2020 was $576,560 compared to $184,526 for the three months ended September 30, 2019. This increase of $392,034 or approximately 211% was mainly driven by an increase of approximately $296,000 in hospitality projects, an increase of approximately $119,000 in office projects, an increase of approximately $72,000 in special use projects offset by a decline of approximately $154,000 in retail projects for the three months ended September 30, 2020, as compared to September 30, 2019.
Cost of Revenue and Gross Profit
Cost of revenue was $381,954 for the three months ended September 30, 2020, compared to $366,783 for the three months ended September 30, 2019. The increase of $15,171 or a increase of approximately 4%, is primarily related to higher revenues earned during the three months ending September 30, 2020, as compared to September 30, 2019.
Gross profit was $194,606 for the three months ended September 30, 2020 and gross loss was $182,257 for the three months ended September 30, 2019.
Gross profit percentage increased to approximately 34% for the three months ended September 30, 2020 compared to gross loss percentage increased to approximately 99% for the three months ended September 30, 2019 primarily due to higher site installation in the three months ended September 30, 2019 from a retail project.
Payroll and Related Expenses
Payroll and related expenses for the three months ended September 30, 2020 were $679,863 compared to $548,156 for the three months ended September 30, 2019. This increase was primarily caused by an increase of approximately $164,000 in stock-based compensation expense offset by a decrease in salaries and additional head count of approximately $23,000 recognized during the year ended September 30, 2020 compared to the three months ended September 30, 2019. We recognized $303,169 in stock-based compensation expense related to payroll and related expenses for the three months ended September 30, 2020, compared to $139,402 for September 30, 2019.
Results of Operations (continued)
Other Operating Expenses (General and administrative expenses, Marketing and business development expense, and Pre-project expenses)
Other operating expenses (general and administrative expenses, marketing and business development expenses, pre-project expenses) for the three months ended September 30, 2020 were $1,040,073 compared to $543,017 for the three months ended September 30, 2019. The increase resulted primarily from an increase in special meeting fees of approximately $19,800, an increase in rent expense of approximately $17,600, an increase in legal fees of approximately $142,700, an increase in advisory service fees of approximately $319,100, an increase in promotions and marketing expense of approximately $14,300, offset by a decrease in employee travel by approximately $28,200 and a decrease in contract labor of approximately $48,400. We recognized no stock-based compensation expense related to legal expenses for the three months ended September 30, 2020. We recognized $3,375 in stock-based compensation expense related to marketing expenses for the three months ended September 30, 2019.
Other Income (Expense)
Interest income for the three months ended September 30, 2020 was $27,401 and related to the outstanding note receivable. There was no interest income for the three months ended September 30, 2019. Interest expense for the three months ended September 30, 2020 was $2,614. There was no interest expense for the three months ended September 30, 2019. Other income for the three months ended September 30, 2020 was $23,282 and there was no other income for the three months ended September 30, 2019. Loss on asset disposal for the three months ended September 30, 2020 and 2019 was $1,012, and $52,039, respectively.
Income Tax Provision
A 100% valuation allowance was provided against the deferred tax asset consisting of available net operating loss carry forwards and, accordingly, no income tax benefit was provided.
Impact of Inflation
The impact of inflation upon the Company’s revenue and income (loss) from continuing operations during each of the past two fiscal years has not been material to its financial position or results of operations for those years because the Company does not maintain any inventories whose costs are affected by inflation.
Impact of Coronavirus (COVID-19)
With the global spread of the ongoing novel coronavirus ("COVID-19") pandemic during the first nine months of 2020, the Company has implemented business continuity plans designed to address and mitigate the impact of the COVID-19 pandemic on its employees and business. The worldwide spread of the COVID-19 virus is expected to result in a global slowdown of economic activity which is likely to decrease demand for a broad variety of goods and services, including from our customers, while also resulting in delays in projects due to labor shortages and supplier disruptions for an unknown period of time until the disease is contained. To date, we have experienced some delays in projects due to COVID-19 which we expect to have an impact on our revenue and our results of operations, the size and duration of which we are currently unable to predict. Any quarantines, the timing and length of containment and eradication solutions, travel restrictions, absenteeism by infected workers, labor shortages or other disruptions to the Company's suppliers and contract manufacturers or customers would likely adversely impact the Company's sales and operating results and result in further project delays. In addition, the pandemic could result in an economic downturn that could affect the ability of the Company's customers and licensees to obtain financing and therefore impact demand for the Company's products. Order lead times could be extended or delayed and pricing could increase. Some products or services may become unavailable if the regional or global spread were significant enough to prevent alternative sourcing. Accordingly, the Company is considering alternative product sourcing in the event that product supply becomes problematic. The Company expects this global pandemic to have an impact on the Company's revenue and results of operations, the size and duration of which the Company is currently unable to predict. In addition, to the extent the ongoing COVID-19 pandemic adversely affects the Company's business and results of operations, it may also have the effect of heightening many of the other risks and uncertainties which the Company faces. While the Company expects to derive revenue from its newly entered into distributorship agreement discussed below, the Company cannot at this time estimate the impact that sales under the agreement will have on its revenue.
Liquidity and Capital Resources
As of September 30, 2020 and December 31, 2019, we had an aggregate of $13,047,565 and $1,625,671, respectively, of cash and cash equivalents and short-term investments.
Historically, our operations have primarily been funded through proceeds from equity and debt financings, as well as revenue from operations.
In June 2017, we completed a public offering, resulting in net proceeds of approximately $6,800,000 after deducting underwriting discounts and commissions and other expenses. In July 2017, in connection with a public offering, the underwriters exercised their option to purchase 11,250 additional shares of common stock from us in full at a price to the public of $100.00 per share. As a result of the exercise and closing of the option to purchase additional shares, total net proceeds from the public offering were approximately $7,900,000 after deducting underwriting discounts and commissions and related expenses. We incurred a total of $1,565,386 in issuance costs in connection with the Public Offering.
In April 2019, we issued 42,388 shares of our common stock at a price of $22.00 per share through a Securities Purchase Agreement (the “Purchase Agreement”) with certain institutional investors and accredited investors. Concurrently with the sale of the common stock, pursuant to the Purchase Agreement, we also sold common stock purchase warrants to such investors to purchase up to an aggregate of 42,388 shares of common stock. We incurred $379,816 in issuance costs from the offering and issued 4,239 warrants to the underwriters.
In August 2019, we issued 45,000 shares of our common stock at a price of $17.00 per share pursuant to the terms of an Underwriting Agreement to the public. We incurred $181,695 in issuance costs from the offering and issued warrants to purchase 2,250 shares of common stock to the underwriter.
In December 2019, we completed the public offering where we issued 857,500 shares of common stock at a public offering price of $3.00 per share resulting in net proceeds of approximately $2,117,948 after deducting underwriting discounts and commissions and other expenses. We incurred a total of $454,552 in issuance costs in connection with the public offering. In our November 2019 debt financing, we received a cash payment in the aggregate amount of $375,000 pursuant to a Securities Purchase Agreement that we entered into with RedDiamond Partners LLC (the “Lender”), and we issued to the Lender a Debenture (the "Debenture") in the aggregate principal amount of $480,770 (representing an original issue discount of 22%), which Debenture was secured by a security interest in all of our existing and future assets, subject to existing security interests and exceptions. We received net proceeds of approximately $326,250 after deducting certain fees due to the placement agent and certain transaction expenses. The Debenture was repaid in full out of the proceeds of our December 2019 public offering.
On February 4, 2020, we entered into a Securities Purchase Agreement with an accredited investor, pursuant to which we issued to the investor a secured note in the aggregate principal amount of $200,000 (the “Note”). The Note bears interest at a rate of nine percent (9%) per annum, is due on July 31, 2023, and is secured under a Pledge Agreement, dated February 4, 2020, entered into with the investor (the “Pledge Agreement”) by a security interest in the royalty payable to us under that certain Exclusive License Agreement, dated October 3, 2019, with CPF GP 2019-1 LLC. We have the right to prepay the Note, in whole or in part, at any time and from time to time, without premium or penalty. During the three months ending September 30, 2020, the Note to investor of $200,000 and unpaid accrued interest of $86,263 was converted into 73,665 shares of common stock.
In April 2020, we completed a public offering where we pursuant to which we 440,000 shares of common stock at a public offering price of $4.25 per share which resulted in net proceeds of approximately $1,522,339 after deducting underwriting discounts and commissions and other expenses related to the offering. We incurred a total of approximately $347,661 in issuance costs in connection with the offering and issued no warrants to purchase shares of common stock to the underwriter.
In May 2020, we sold 6,000,000 shares of our common stock at a public offering price of $2.50 per share and on May 15, 2020, pursuant to the terms of the Underwriting Agreement dated May 6, 2020 by and among us and ThinkEquity, a division of Fordham Financial Management, Inc., as representatives of several underwriters named therein ("ThinkEquity"), ThinkEquity was granted an over-allotment option to purchase up to an additional 900,000 shares of our common stock, in connection with the previously announced public offering. On May 15, 2020, ThinkEquity exercised in full such option with respect to all 900,000 shares of our common stock. After giving effect to the full exercise of the over-allotment option, the total number of shares of common stock sold by us in the public offering was 6,900,000 shares of common stock and total net proceeds to us, after deducting underwriting discounts and commissions and other offering expenses payable by us, were approximately $15,596,141. We incurred a total of approximately $1,653,859 in issuance costs in connection with the offering and issued warrants to purchase 300,000 shares of common stock to the underwriter.
Liquidity and Capital Resources (continued)
We anticipate that we will continue to generate losses from operations for the foreseeable future. At September 30, 2020 and December 31, 2019 we had a cash balance and short-term investment of $13,047,565 and $1,625,671, respectively. As of September 30, 2020, our stockholders’ equity was $19,092,780, compared to $4,360,149 as of December 31, 2019. Our net loss for the nine months ended September 30, 2020 was $3,063,673 and net cash used in operating activities was $4,453,862. We anticipate our cash balance is sufficient to last at least twelve months from November 19, 2020.
We may need to generate additional revenues or secure additional financing sources, such as debt or equity capital, to fund future growth, which financing may not be available on favorable terms or at all. We do not have any additional sources secured for future funding, and if we are unable to raise the necessary capital at the times we require such funding, we may need to materially change our business plan, including delaying implementation of aspects of such business plan or curtailing or abandoning such business plan altogether.
Cash Flow Summary
| Nine Months Ended
September 30, |
|
|
|
| 2020 | | 2019 |
Net cash provided by (used in): | | | | | | | |
Operating activities | | $ | (4,453,862 | ) | $ | (2,500,387 | ) |
Investing activities | | | (1,442,602 | ) | | (2,070 | ) |
Financing activities | | | 17,318,358 | | | 1,136,015 | |
Net increase (decrease) in cash and cash equivalents | | $ | 11,421,894 | | $ | (1,366,442 | ) |
Operating activities used net cash of $4,453,862 during the nine months ended September 30, 2020, and $2,500,387 during the nine months ended September 30, 2019. Generally, our net operating cash flows fluctuate primarily based on changes in our profitability and working capital. Cash used in operating activities increased by approximately $1,953,475 primarily due to an decrease in working capital of approximately $1,671,797, an increase of approximately $23,185 in interest income, a decrease of approximately $10,457 in stock-based compensation, an increase of approximately $30,588 in amortization expense, an increase in the overall net loss of approximately $275,760, a decrease in loss on asset disposals of approximately $51,027 and a decrease of approximately $54,000 in bad debt benefits in the nine months ended September 30, 2020 compared to nine months ended September 30, 2019.
Investing activities used net cash of $1,442,602 during the nine months ended September 30, 2020, and $2,070 net cash the nine months ended September 30, 2019. Cash used in investing activities increase from the corresponding period of the prior year primarily due to an advance in note receivable of approximately $650,000, purchase of Echo DCL, LLC assets of approximately $743,168, and the purchase of property, plant and equipment of approximately, $49,434.
Financing activities provided net cash of $17,318,358 during the nine months ended September 30, 2020, and $1,136,015 net cash during the nine months ended September 30, 2019. Cash provided by financing activities increased by $16,182,343 primarily due to an increase in proceeds from public stock offerings, and to a lesser extent, an increase in proceeds from long-term note payable.
We provide services to our customers in three separate phases: the design phase, the architectural and engineering phase and the construction phase. Each phase is independent of the other, but builds through a progression of concept through delivery of a completed structure. These phases may be embodied in a single contract or in separate contracts, which is typical of a design build process model. As of September 30, 2020, we had 17 projects totaling $24,865,499 under contract, which, if they all proceed to construction, will result in our constructing approximately 210,550 square feet of container and modular space. Of these contracts, all seventeen projects combine all three phases or parts thereof and including construction. We expect that all of this revenue will be realized by September 30, 2022.
Backlog may fluctuate significantly due to the timing of orders or awards for large projects and is not necessarily indicative of future backlog levels or the rate at which backlog will be recognized as revenue. The increase in backlog of approximately $8,660,000 from December 31, 2019 is primarily attributable to two new contracts we entered into during the third quarter of 2020 for approximately $4,000,000 and $2,950,000 and offset by work in progress or completed contracts during the first nine months of 2020 for approximately $1,400,000.
There can be no assurance that our customers will decide to and/or be able to proceed with these construction projects, or that we will ultimately recognize revenue from these projects in a timely manner or at all.
Off-Balance Sheet Arrangements
As of September 30, 2020 and December 31, 2019, we had no material off-balance sheet arrangements to which we are a party.
In the ordinary course of business, we enter into agreements with third parties that include indemnification provisions which, in our judgment, are normal and customary for companies in our industry sector. These agreements are typically with consultants and certain vendors. Pursuant to these agreements, we generally agree to indemnify, hold harmless, and reimburse indemnified parties for losses suffered or incurred by the indemnified parties with respect to actions taken or omitted by us. The maximum potential amount of future payments we could be required to make under these indemnification provisions is unlimited. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, the estimated fair value of liabilities relating to these provisions is minimal. Accordingly, we have no liabilities recorded for these provisions as of September 30, 2020.
Critical Accounting Policies and New Accounting Pronouncements
Critical Accounting Policies
Our condensed consolidated financial statements have been prepared using generally accepted accounting principles in the United States of America (“GAAP”). In connection with the preparation of the financial statements, we are required to make assumptions and estimates and apply judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and the related disclosures. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors that we believe to be relevant at the time the consolidated financial statements are prepared. On a regular basis, we review the accounting policies, assumptions, estimates, and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our significant accounting policies are discussed in “Note 3— Summary of Significant Accounting Policies” of the notes to our condensed consolidated financial statements included elsewhere in this report. We believe that the following accounting policies are the most critical in fully understanding and evaluating our reported financial results.
Share-based payments. We measure the cost of services received in exchange for an award of equity instruments based on the fair value of the award. For employees and directors, including non-employee directors, the fair value of the award is measured on the grant date. For non-employees, the fair value of the award is generally re-measured on interim financial reporting dates and vesting dates until the service period is complete. The fair value amount is then recognized over the period services are required to be provided in exchange for the award, usually the vesting period. We recognize stock-based compensation expense on a graded-vesting basis over the requisite service period for each separately vesting tranche of each award. Stock-based compensation expense to employees and all directors is reported within payroll and related expenses in the consolidated statements of operations. Stock-based compensation expense to non-employees is reported within marketing and business development expense in the consolidated statements of operations.
Other derivative financial instruments. SGB classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) provide a choice of net-cash settlement or settlement in SGB’s own shares (physical settlement or net-share settlement), provided that such contracts are indexed to SGB’s own stock. SGB classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net-cash settle the contract if any event occurs and if that event is outside SGB’s control) or (ii) give the counterparty a choice of net-cash settlement or settlement shares (physical settlement or net-cash settlement). SGB assesses classification of common stock purchase warrants and other free-standing derivatives at each reporting date to determine whether a change in classification between assets and liabilities or equity is required.
Critical Accounting Policies (continued)
Convertible instruments. SGB bifurcates conversion options from their host instruments and accounts for them as free-standing derivative financial instruments according to certain criteria. The criteria include circumstances in which (i) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract; (ii) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable GAAP measures with changes in fair value reported in earnings as they occur; and (iii) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument.
SGB determined that the embedded conversion options that were included in the previously outstanding convertible debentures should be bifurcated from their host and a portion of the proceeds received upon the issuance of the hybrid contract has been allocated to the fair value of the derivative. The derivative was subsequently marked to market at each reporting date based on current fair value, with the changes in fair value reported in results of operations.
Revenue recognition. We apply recognition of revenue over time, which is similar to the method we applied under previous guidance (i.e., percentage of completion). We determine, at contract inception, whether we will transfer control of a promised good or service over time or at a point in time—regardless of the length of contract or other factors. The recognition of revenue aligns with the timing of when promised goods or services are transferred to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. To achieve this core principle, we apply the following five steps in accordance with our revenue policy:
(1) Identify the contract with a customer
(2) Identify the performance obligations in the contract
(3) Determine the transaction price
(4) Allocate the transaction price to performance obligations in the contract
(5) Recognize revenue as performance obligations are satisfied
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost input method, changes in total estimated costs, and related progress toward complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs for a performance obligation indicate a loss, a provision for the entire estimated loss on the unsatisfied performance obligation is made in the period in which the loss becomes evident.
On October 3, 2019, we entered into an Exclusive License Agreement (“ELA” ) pursuant to which we granted an exclusive license for our technology as outlined in the ELA. See Note 3 to the accompanying consolidated financial statements for a discussion on the ELA. Under the ELA, we will receive royalty payments based upon gross revenues earned by the licensee for commercialize products within the field of design and project management platforms for residential use, including single-family residences and multi-family residences, but excluding military housing. We determined that the ELA grants the licensee a right to access our intellectual property throughout the license period (or its remaining economic life, if shorter), and thus recognizes revenue over time as the licensee recognizes revenue and we have the right to payment of royalties.
Critical Accounting Policies (continued)
Goodwill – Goodwill represents the excess of reorganization value over the fair value of identified net assets upon emergence from bankruptcy. In accordance with the accounting guidance on goodwill, we perform our impairment test of goodwill at the reporting unit level each fiscal year, or more frequently if events or circumstances change that would more likely than not reduce the fair value of its reporting unit below its carrying value. Our evaluation of goodwill completed during the year ended December 31, 2019, resulted in an impairment loss of $2,938,653. There was no impairment during the nine months ended September 30, 2020.
Intangible assets – Intangible assets consist of $2,766,000 of proprietary knowledge and technology which is being amortized over 20 years, $18,848 of customer contracts which is being amortized over 1 year, $105,762 of trademarks which is being amortized over 5 years, $7,928 of non-compete agreement which is being amortized over 5 years and $5,300 of website fees which is being amortized over 5 years. Our evaluation of intangible assets for impairment during the year ended December 31, 2019, and determined that there were no impairment losses. There was no impairment during the nine months ended September 30, 2020.
New Accounting Pronouncements
See Note 3 to the accompanying consolidated financial statements for all recently adopted and new accounting pronouncements.
Non-GAAP Financial Information
In addition to our results under GAAP, we also present EBITDA and Adjusted EBITDA for historical periods. EBITDA and Adjusted EBITDA are non-GAAP financial measures and have been presented as supplemental measures of financial performance that are not required by, or presented in accordance with, GAAP. We calculate EBITDA as net income (loss) before interest expense, income tax benefit (expense), depreciation and amortization. We calculate Adjusted EBITDA as EBITDA before certain non-recurring adjustments such as loss on conversion of convertible debentures, change in fair value of financial instruments and stock compensation expense.
EBITDA and Adjusted EBITDA are presented because they are important metrics used by management as one of the means by which it assesses our financial performance. EBITDA and Adjusted EBITDA are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. These measures, when used in conjunction with related GAAP financial measures, provide investors with an additional financial analytical framework that may be useful in assessing us and our results of operations.
EBITDA and Adjusted EBITDA have certain limitations. EBITDA and Adjusted EBITDA should not be considered as alternatives to net income (loss), or any other measures of financial performance derived in accordance with GAAP. These measures also should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items for which these non-GAAP measures make adjustments. Additionally, EBITDA and Adjusted EBITDA are not intended to be liquidity measures because of certain limitations, including, but not limited to:
| ● | They do not reflect our cash outlays for capital expenditures; |
| ● | They do not reflect changes in, or cash requirements for, working capital; and |
| ● | Although depreciation and amortization are non-cash charges, the assets are being depreciated and amortized and may have to be replaced in the future, and these non-GAAP measures do not reflect cash requirements for such replacements. |
Other companies, including other companies in our industry, may not use such measures or may calculate one or more of the measures differently than as presented in this Quarterly Report on Form 10-Q, limiting their usefulness as a comparative measure.
Non-GAAP Financial Information (continued)
In evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we will incur expenses that are the same or similar to some of the adjustments made in our calculations, and our presentation of EBITDA and Adjusted EBITDA should not be construed to mean that our future results will be unaffected by such adjustment. Management compensates for these limitations by using EBITDA and Adjusted EBITDA as supplemental financial metrics and in conjunction with our results prepared in accordance with GAAP. The non-GAAP information should be read in conjunction with our consolidated financial statements and related notes.
The following is a reconciliation of EBITDA and Adjusted EBITDA to the nearest GAAP measure, net loss:
|
| Three Months Ended September 30, 2020 |
|
| Three Months Ended September 30, 2019 |
| | Nine Months Ended September 30, 2020 | | | Nine Months Ended September 30, 2019 | |
Net loss |
| $ | (1,478,273 | ) |
| $ | (1,325,469 | ) | | $ | (3,063,673 | ) | | $ | (2,787,913 | ) |
| Addback interest expense |
|
| 2,614 |
|
|
| — |
|
|
| 8,877 |
|
|
| — |
|
| Addback interest income |
|
| (27,401 | ) |
|
| — |
|
|
| (38,497 | ) |
|
| — |
|
| Addback depreciation and amortization |
|
| 47,488 |
|
|
| 38,677 |
|
|
| 142,290 |
|
|
| 117,540 |
|
EBITDA (non-GAAP) |
|
| (1,455,572 | ) |
|
| (1,286,792 | ) | | | (2,951,003 | ) | | | (2,670,373 | ) |
| Addback loss on asset disposal |
|
| 1,012 |
|
|
| 52,039 |
|
|
| 1,012 |
|
|
| 52,039 |
|
| Addback litigation expense |
|
| 127,205 |
|
|
| — |
|
|
| 395,045 |
|
|
| — |
|
| Addback stock compensation expense |
|
| 303,169 |
|
|
| 142,777 |
|
|
| 471,683 |
|
|
| 482,139 |
|
Adjusted EBITDA (non-GAAP) |
| $ | (1,024,186 | ) |
| $ | (1,091,976 | ) | | $ | (2,083,263 | ) | | $ | (2,136,195 | ) |
Not applicable.
Evaluation of Disclosure Controls and Procedures
Management of SG Blocks, Inc., with the participation of our Principal Executive Officer and Principal Financial Officer, carried out an evaluation of the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and (ii) is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
The Principal Executive Officer and the Principal Financial Officer believe that the condensed consolidated financial statements and other information contained in this Quarterly Report on Form 10-Q present fairly, in all material respects, our business, financial condition and results of operations.
Changes in Internal Control over Financial Reporting
We have a limited number of employees with accounting and reporting responsibilities and we experienced changes in other accounting personnel with roles in our accounting and financial reporting processes that included allocation of work to outside vendors. Other than such personnel changes, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) of the Exchange Act) occurred during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The information included in "Note 17 - Commitments and Contingencies" of the Company's condensed consolidated financial statements included elsewhere in this Form 10-Q is incorporated by reference into this Item.
Investing in our common stock involves a high degree of risk. You should consider carefully the following risks, together with all other information in this Quarterly Report on Form 10-Q, including our unaudited condensed consolidated financial statements and notes thereto. If any of the following risks actually materializes, our operating results, financial condition and liquidity could be materially adversely affected. As a result, the trading price of our common stock could decline and you could lose part or all of your investment. The following information updates, and should be read in conjunction with, the information disclosed in Part I, Item 1A, "Risk Factors," contained in the Annual Report on Form 10-K for the year ended December 31, 2019 as amended by the Amendment No. 1 thereto (the “2019 Form 10-K”). There have been no material changes from the risk factors disclosed in “Part I—Item 1A. Risk Factors” in our 2019 Form 10-K, except as follows:
If we are not successful in our efforts to increase sales or raise capital, we could experience a shortfall in cash over the next twelve months, and our ability to obtain additional financing on acceptable terms, if at all, may be limited.
As of September 30, 2020 and December 31, 2019, we had cash and cash equivalents and a short-term investment, collectively, of $13,047,565 and $1,625,671, respectively. However, during the nine months ended September 30, 2020 and year ended December 31, 2019, we reported a net loss of $3,063,673 and $6,920,540 respectively, and used $4,453,862 and $2,815,621 of cash for operations, respectively. Despite raising capital in the April 2020 Offering resulting in aggregate net proceeds of approximately $1,522,339 and May 2020 Offering resulting in the aggregate net proceeds of approximately $15,596,141, after deducting underwriting discounts and commissions and other expenses related to the offering, if we are not successful with our efforts to increase revenue, we could experience a shortfall in cash over the next twelve months. If there is a shortfall, we may be forced to reduce operating expenses, among other steps, all of which would have a material adverse effect on our operations going forward.
We may also seek to obtain debt or additional equity financing to meet any cash shortfalls. The type, timing and terms of any financing we may select will depend on, among other things, our cash needs, the availability of other financing sources and prevailing conditions in the financial markets. However, there can be no assurance that we will be able to secure additional funds if needed and that, if such funds are available, the terms or conditions would be acceptable to us. If we are unable to secure additional financing, further reduction in operating expenses might need to be substantial in order for us to ensure enough liquidity to sustain our operations. Any equity financing would be dilutive to our stockholders. If we incur debt, we will likely be subject to restrictive covenants that significantly limit our operating flexibility and require us to encumber our assets. If we fail to raise sufficient funds and continue to incur losses, our ability to fund our operations, take advantage of strategic opportunities, or otherwise respond to competitive pressures will be significantly limited. Any of the above limitations could force us to significantly curtail or cease our operations, and you could lose all of your investment in our common stock. These circumstances and continued cash losses may risk our status as a going concern. Our consolidated financial statements do not include any adjustments that might be necessary should we be unable to continue as a going concern.
There can be no assurance that our collaboration with Transcend will be successful and generate revenue.
On March 30, 2020, we entered into a non-binding Memorandum of Understanding with Transcend to provide joint products and services. Products that are expected to be implemented include modular primary care medical units, COVID-19 diagnostic testing units, quarantine living units, as well as drive through testing units at employer onsite clinics and community hospitals. The Memorandum of Understanding does not specify a quantity of units to be built or provide for any guarantee of services by either party. There can be no assurance that the collaboration will yield the anticipated benefits or generate significant revenue.
There can be no assurance that our Distributorship Agreement with Osang will generate revenue or that we will derive substantial revenue from our collaboration with Clarity Labs or our selection as a COVID-19 test provider at LAX.
On April 30, 2020, we entered into the Distributorship Agreement with Osang that provides us with the non-exclusive right to distribute Osang’s GeneFinder COVID-19 Plus RealAmp Kit in the United States for a stated term of one (1) year. The Distribution Agreement does not guarantee us a specific quantity of kits to sell or a customer list, requires us to pay for 100% of the purchase order prior to delivery (though we do not expect to make any cash outlays for product and expect instead to require our customers to make such cash outlays) and may be terminated by either party at any time on thirty (30) days’ notice. To date, we have never sold any medical devices or kits and there can be no guarantee that we will be able to establish a sales force, establish distribution channels or solicit customers for the kits. There can be no assurance that the Distributorship Agreement will continue, that it will yield the anticipated benefits or generate significant revenue, if any.
On November 16, 2020, we announced that the State of Hawaii had selected Clarity Labs and Clarity Mobile Venture to provide COVID-19 testing and clinical laboratory at Los Angeles International Airport (“LAX”) for testing of passengers travelling between Los Angeles and Hawaii. In order to provide such testing, we will be required to build certain facilities, which will require time and capital. There can be no assurance that the collaboration with Clarity Labs or the selection as a COVID-19 test provider at LAX will provide substantial revenue.
Product liability and other claims with respect to Osang’s GeneFinder COVID-19 Plus RealAmp Kit may have material adverse effects on our business.
Companies that distribute medical tests, are generally subject to risks related to product liability litigation and other claims or litigation. Product liability risks are inherent in marketing and sale of pharmaceutical products. Even though we are not currently subject to any product liability claims such claims could arise at a later date. Though Osang has agreed to indemnify us for certain product liability claims, claims arising under the Distributorship Agreement must be arbitrated in Singapore and enforcement of such indemnification provisions would be time-consuming for our management and lead to significant costs and losses, which would adversely affect our business, results of operations, cash flows, financial condition, and/or prospects.
We have obtained product liability insurance and Osang has agreed to indemnify us for certain claims arising out of the manufacture of the kits, there can be no assurance that such insurance coverage will continue to be available on reasonable commercial terms or that such insurance or indemnification will prove adequate. If sufficient insurance coverage is not obtained covering product liability, or if such future litigation or investigation exceeds our insurance coverage, we could be subject to significant liabilities, which could have material adverse effect on our business, results of operations, cash flows, financial condition, and/or prospects.
In December 2019, a novel strain of coronavirus, COVID-19, was reported to have surfaced in Wuhan, China. Since then, the COVID-19 coronavirus has spread to multiple countries, including the United States. The impact of the COVID-19 coronavirus outbreak, or similar global health concerns, has and could continue to negatively impact our ability to source certain products, impact product pricing, impact our customers’ ability or that of our licensee to obtain financing or have a negative impact on our business.
In March 2020, the World Health Organization declared COVID-19 a global pandemic. As of November 12, 2020, the United States had the world’s most reported COVID-19 cases, and all 50 states and the District of Columbia have reported cases of infected individuals. Several states and countries, including New York, where we are headquartered, have declared states of emergency. This contagious disease outbreak, which has continued to spread, and the related adverse public health developments, have adversely affected work forces, economies and financial markets globally. Our use of third-party suppliers for production and shipping of certain products could be negatively impacted by the regional or global outbreak of illnesses, including the COVID-19 coronavirus outbreak. To date, we have experienced some delays in projects due to COVID-19. Any quarantines, the timing and length of containment and eradication solutions, travel restrictions, absenteeism by infected workers, labor shortages or other disruptions to our suppliers and their contract manufacturers or our customers or our licensee, CPF, would likely adversely impact our sales and operating results and result in further project delays. In addition, the pandemic could result in an economic downturn that could affect the ability of our customers and licensees to obtain financing and therefore impact demand for our products. Order lead times could be extended or delayed and pricing could increase. Some products or services may become unavailable if the regional or global spread were significant enough to prevent alternative sourcing. Accordingly, we are considering alternative product sourcing in the event that product supply becomes problematic. We expect this global pandemic to have an impact on our revenue and our results of operations, the size and duration of which we are currently unable to predict.
In addition, the outbreak of the COVID-19 coronavirus could disrupt our operations due to absenteeism by infected or ill members of management or other employees, or absenteeism by members of management and other employees who elect not to come to work due to the illness affecting others in our office or other workplace, or due to quarantines. COVID-19 illness could also impact members of our Board of Directors resulting in absenteeism from meetings of the directors or committees of directors, and making it more difficult to convene the quorums of the full Board of Directors or its committees needed to conduct meetings for the management of our affairs.
The global outbreak of the COVID-19 coronavirus continues to rapidly evolve. The extent to which the COVID-19 coronavirus may impact our business and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the duration of the outbreak, travel restrictions and social distancing in the United States and other countries, business closures or business disruptions and the effectiveness of actions taken in the United States and other countries to contain and treat the disease.
The issuance of shares of our common stock upon the exercise of outstanding options, warrants and restricted stock units may dilute the percentage ownership of the then-existing stockholders and may make it more difficult to raise additional equity capital.
As of November 14, 2020, there are outstanding options and warrants to purchase 52,337 and 353,190 shares of common stock, respectively, in addition to 512,343 vested and unvested restricted stock units. The exercise of such options and warrants and the vesting of restricted stock units would dilute the then-existing stockholders’ percentage ownership of our stock, and any sales in the public market of common stock underlying such securities could adversely affect prevailing market prices for the common stock. Moreover, the terms upon which we would be able to obtain additional equity capital could be adversely affected because the holders of our options and warrants can be expected to exercise them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than those provided by such securities.
The loss of one or a few customers could have a material adverse effect on us.
A few customers have in the past, and may in the future, account for a significant portion of our revenues in any one year or over a period of several consecutive years. For example, for the nine months ended September 30, 2020, approximately 53% of our revenue was generated from three customers and for the year ended December 31, 2019, approximately 78% of our revenue was generated from two customers. Although we have contractual relationships with many of our significant customers, our customers may unilaterally reduce or discontinue their contracts with us at any time. The loss of business from a significant customer could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We rely on certain vendors to supply us with materials and products that, if we were unable to obtain, could adversely affect our business.
We have relationships with key materials vendors, and we rely on suppliers for our purchases of products from them. Any inability to obtain materials or services in the volumes required and at competitive prices from our major trading partners, the loss of any major trading partner or the discontinuation of vendor financing (if any) may seriously harm our business because we may not be able to meet the demands of our customers on a timely basis in sufficient quantities or at all. Other factors, including reduced access to credit by our vendors resulting from economic conditions, may impair our vendors’ ability to provide products in a timely manner or at competitive prices. We also rely on other vendors for critical services such as transportation, supply chain and professional services. Any negative impacts to our business or liquidity could adversely impact our ability to establish or maintain these relationships. For the nine months ended September 30, 2020 and year ended December 31, 2019, 67% and 74%, respectively of our cost of revenue related to four and three vendors.
Our clients may adjust, cancel or suspend the contracts in our backlog; as such, our backlog is not necessarily indicative of our future revenues or earnings. In addition, even if fully performed, our backlog is not a good indicator of our future gross margins.
Backlog represents the total dollar amount of revenues we expect to record in the future as a result of performing work under contracts we have been awarded. We include in backlog only those contracts for which we have reasonable assurance that the customer can obtain the permits for construction and can fund the construction. As of September 30, 2020, our backlog totaled approximately $24.86 million and as of December 31, 2019, our backlog totaled approximately $17.6 million. The increase in backlog at September 30, 2020 from December 31, 2019 is primarily attributable to two new contracts executed during the third quarter of 2020 for approximately $4.0 million and $2.95 million offset by work in progress or completed contracts during the first nine months of 2020 for approximately $1.4 million. We cannot provide assurance that our backlog will be realized as revenues in the amounts reported or, if realized, will result in profits. In accordance with industry practice, substantially all of our contracts are subject to cancellation, termination or suspension at our customer’s discretion. In the event of a project cancellation, we generally would not have a contractual right to the total revenue reflected in our backlog. Projects can remain in backlog for extended periods of time because of the nature of the project and the timing of the particular services required by the project. In addition, the risk of contracts in backlog being cancelled or suspended generally increases during periods of widespread economic slowdowns or in response to changes in commodity prices.
The contracts in our backlog are subject to changes in the scope of services to be provided and adjustments to the costs relating to the contracts. The revenue for certain contracts included in backlog is based on estimates. Additionally, our performance of our individual contracts can affect greatly our gross margins and, therefore, our future profitability. We can provide no assurance that the contracts in backlog, assuming they produce revenues in the amounts currently estimated, will generate gross margins at the rates we have realized in the past.
None that have not been previously disclosed in our filings with the SEC.
None.
Not applicable.
On October 12, 2020, we and Osang, the manufacturer and supplier of the GeneFinderTM COVID-19 Plus RealAmp KitTM that we distribute, entered into a Managed Supply Agreement (the “Supply Agreement”) which memorialized of our obligations and Osang's obligations as it relates to the consignment (the “Consignment”) to us of two (2) million units of Osang's flagship Genefinder Plus RealAmp Covid-19 PCR Test (the “Product”) from Osang for the cold-chain storage and distribution of Product in the United States of America and Canada by us on behalf of ourself, as well as for Osang to other distributors in Territory as well as for direct sales by Osang worldwide where permissible for a period of 180 days thereafter. The Supply Agreement included confirmation by Osang that we have no payment obligation for the Consignment until we sell the Product and any unsold product remains the responsibility of Osang except that we are responsible for the sold-storage fees and Osang’s agreement to use best efforts that all sales of Products will be drawn from the Consignment with priority.
On November 12, 2020, our joint venture partnership in Clarity Mobile Venture entered into a contract with the City of Los Angeles for the operations of a COVID-19 PCR Test Laboratory at Los Angeles International Airport to provide a full-service modular COVID-19 laboratory and testing facility onsite at Los Angeles International Airport. The facility will be located across from Terminal 6 and is expected to open in December 2020. The facility will administer PCR tests with results available within 3 hours for passengers and airline crew, and no later than 24 hours for LAWA airport employees. Additionally, other rapid coronavirus tests including antigen tests will be provided. Clarity Mobile Venture will be the primary operator of the facility and will deploy the GeneFinder™ test for COVID-19, produced by OSANG Healthcare Co., Ltd.
On November 19, 2020, we and Memorial Hospital, of Michigan (“Memorial), entered into a Professional Services and Capital Support Contract (“PSCSC”) with Wayne County, Michigan to appoint Memorial the primary contractor for the construction of portable on-site laboratory facilities for COVID-19 testing. The PSCCS engages the Company as a sub-contractor to render services and support to Memorial in connection with the fulfillment of statements of work submitted from Wayne County to Memorial. The program deploys the D-Tec Product Series, including D-Tec 1 and D-Tec 5 facilities, designed by Grimshaw Architects and developed by SG Blocks, to deliver highly accurate PCR testing and on-site CLIA lab services directly into high risk and underserved areas. The D-Tec 1 units are expected to be deployed throughout Wayne County and will provide sample extraction and lab services. The D-Tec 5 will serve as the main CLIA lab and have the capacity to process 7,000 tests per day in a single eight-hour shift. The facilities will be used to test residents for COVID-19 using the OSANG GeneFinder™ test, which is able to deliver medical grade results in approximately 3 hours. Clarity Mobile Venture will be the primary operator of the facility.
