ITEM 1A. Risk Factors
Before deciding to purchase,
hold or sell our common stock, you should carefully consider the risks described below in addition to the other information contained
in this Quarterly Report on Form 10-Q and in our other filings with the SEC, including subsequent reports on Forms 10-Q and 8-K.
The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known
to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties
actually occurs with material adverse effects on Polar Power, our business, financial condition, results of operations and/or liquidity
could be seriously harmed. In that event, the market price for our common stock will likely decline, and you may lose all or part
of your investment.
Risks Related to Our Business and Industry
We are dependent on a limited number of customers.
Currently, the majority
of our revenues are derived from two customers. Revenues from these customers, comprised 64% and 27%, respectively, of our total
revenues for the three months ended March 31, 2018. These two customers comprised 0% and 92% of total revenues for the same period
in 2017, respectively. We expect this trend to continue until we receive orders from one additional Tier-1 wireless telecommunications
carrier that granted us approved supplier status during the first quarter of 2017. An unfavorable change in our business relationship
with any of these customers, our inability to obtain purchase orders from our new Tier-1 wireless telecommunications carrier customers
or delays in customer implementation and deployment of our products, could have a material adverse effect on results of operation
and financial condition.
To date, we have derived substantially all of our
revenue from sales of our DC base power systems to two customers within the telecommunications market. Our efforts to expand our
customer base, our product portfolio or markets within which we operate may not succeed, and may reduce our revenue growth rate.
To date, we have derived
substantially all our revenues from sales of our DC base power systems to two customers within the telecommunications market. Any
factor adversely affecting sales of these power systems to these two customers or to other customers within this market, including
market acceptance, product competition, performance and reliability, reputation, price competition and economic and market conditions,
could adversely affect our business and results of operations. Our plan to invest in the development of higher capacity DC hybrid
solar systems to address data centers and other applications within the telecommunications market may not result in an anticipated
growth in sales and may reduce our revenue growth rate.
Many of our DC power systems involve long design and sales
cycles, which could have an adverse impact on our results of operations and financial performance.
The design and sales cycle for our DC power
systems, from initial contact with our potential customer to the shipments of our product, may be lengthy. Customers generally
consider a wide range of factors before making a purchase decision. Prior to purchasing our products, our customers often require
a significant technical review, tests and evaluations over long periods of time, assessments of competitive products and approval
at a number of management levels within their organization. During the time our customers are evaluating our products, we may incur
substantial sales and service, engineering and research and development expenses to customize our products to meet customer’s
application needs. We may also expend significant management efforts, increase manufacturing capacity, order long-lead-time components
or purchase significant amounts of components and other inventory prior to receiving an order. Even after this evaluation process,
a potential customer may not purchase our products.
The product development time before our
customer agrees to purchase our DC power systems can be considerable. Our process for developing an integrated solution may require
use of significant engineering resources, including design, prototyping, modeling, testing and application engineering. The length
of this cycle is influenced by many factors, including the difficulty of the technical specification and complexity of the design
and the customer’s procurement processes. A significant period may elapse between our investment of time and resources in
designing and developing a product for our customer and revenue from sales of that product. The length of this process combined
with unanticipated delays in the development cycle could materially affect results of operations and financial conditions.
We do not have long-term commitments for significant revenues
with most of our customers and may be unable to retain existing customers, attract new customers or replace departing customers
with new customers that can provide comparable revenues and profits.
Because we generally do not obtain firm,
long-term volume purchase commitments from our customers, most of our sales are derived from individual purchase orders. We remain
dependent upon securing new purchase orders in the future in order to sustain and grow our revenues. Accordingly, there is no assurance
that our revenues and business will grow in the future. Our failure to maintain and expand our customer relationships could materially
and adversely affect our business and results of operations.
The high concentration of our sales within the telecommunications
market could result in a significant reduction in sales and negatively affect our profitability if demand for our DC power systems
declines within this market.
We expect to be predominately focused on
the manufacturing, marketing and sales of DC power systems to telecommunications companies for the foreseeable future. We may be
unable to shift our business focus away from these activities. Accordingly, the emergence of new competing DC power products or
lower-cost alternative technologies may reduce the demand for our products. A downturn in the demand for our DC power systems within
the telecommunications market would likely materially and adversely affect our sales and profitability.
Any failure by management to properly manage our expected
growth could have a material adverse effect on our business, operating results and financial condition.
We anticipate that we will continue to grow
in the near future. The growth of our business will require significant investments of capital and management’s close attention.
Our strategy envisions a period of growth that may impose a significant burden on our administrative, financial, and operational
resources. If we experience difficulties in any of these areas, we may not be able to expand our business successfully or effectively
manage our growth. Our ability to effectively manage our growth will require us to substantially expand the capabilities of our
administrative and operational resources and to attract, train, manage and retain qualified management, engineers, and other personnel.
We may be unable to do so. Further, our failure to properly manage our expected growth could have a material adverse effect on
our ability to retain key personnel. In addition, our failure to successfully manage our growth could result in our sales not increasing
commensurately with our capital investments. Any failure by management to manage growth and to respond to changes in our business
could have a material adverse effect on our business, financial condition and results of operations.
The markets within which we compete are highly competitive.
Many of our competitors have greater financial and other resources than we do and one or more of these competitors could use their
greater financial and other resources to gain market share at our expense.
If our business continues to develop as
expected, we anticipate that we will continue to grow in the near future. If, due to capital constraints or otherwise, we are unable
to fulfill our existing backlog in a timely manner and/or procure and timely fulfill our anticipated future backlog, our customers
and potential customers may decide to use competing DC power systems or continue the use of alternating current, or AC, power systems.
If we are unable to fulfill the growing demand for products and services in a timely manner, our customers and potential customers
may choose to purchase products from our competitors. Some of our larger competitors may be willing to reduce prices and accept
lower margins in order to compete with us. In addition, we could face new competition from large international or domestic companies
with established industrial brands and distribution networks that enter our end markets. Demand for our products may also be affected
by our ability to respond to changes in design and functionality, to respond to downward pricing pressure, and to provide shorter
lead times for our products than our competitors. If we are unable to respond successfully to these competitive pressures, we could
lose market share, which could have an adverse impact on our results. We cannot assure that we will be able to compete successfully
in our markets, or compete effectively against current and new competitors as our industry continues to evolve.
Rapid technological changes may prevent us from
remaining current with our technological resources and maintaining competitive product and service offerings.
The markets in which we
and our customers operate are characterized by rapid technological change, especially within the telecommunications market. Significant
technological changes could render our existing and potential new products, services and technology obsolete. Our future success
will depend, in large part, upon our ability to:
|
●
|
effectively identify and develop leading energy efficient technologies;
|
|
●
|
continue to develop our technical expertise;
|
|
●
|
enhance our current products and services with new, improved and competitive technology; and
|
|
●
|
respond to technological changes in a cost-effective and timely manner.
|
If we are unable to successfully
respond to technological change or if we do not respond to it in a cost-effective and timely manner, then our business will be
materially and adversely affected. We cannot assure you that we will be successful in responding to changing technology. In addition,
technologies developed by others may render our products, services and technology uncompetitive or obsolete. Even if we do successfully
respond to technological advances, the integration of new technology may require substantial time and expense, and we cannot assure
you that we will succeed in adapting our products, services and technology in a timely and cost-effective manner.
If we are unable to continue to develop new and
enhanced products and services that achieve market acceptance in a timely manner, our competitive position and operating results
could be harmed.
Our future success will
depend on our ability to continue to develop new and enhanced DC power systems and related products and services that achieve market
acceptance in a timely and cost-effective manner. The markets in which we and our customers operate are characterized by frequent
introductions of new and enhanced products and services, evolving industry standards and regulatory requirements, government incentives
and changes in customer needs. The successful development and market acceptance of our products and services depends on a number
of factors, including:
|
●
|
the changing requirements and preferences of the potential customers in our markets;
|
|
●
|
the accurate prediction of market requirements, including regulatory issues;
|
|
●
|
the timely completion and introduction of new products and services to avoid obsolescence;
|
|
●
|
the quality, price and performance of new products and services;
|
|
●
|
the availability, quality, price and performance of competing products and services;
|
|
●
|
our customer service and support capabilities and responsiveness;
|
|
●
|
the successful development of our relationships with existing and potential customers; and
|
|
●
|
changes in industry standards.
|
We may experience financial or technical
difficulties or limitations that could prevent us from introducing new or enhanced products or services. Furthermore, any of these
new or enhanced products and services could contain problems that are discovered after they are introduced. We may need to significantly
modify the design of these products and services to correct problems. Rapidly changing industry standards and customer preferences
and requirements may impede market acceptance of our products and services.
Development and enhancement of our products
and services will require significant additional investment and could strain our management, financial and operational resources.
The lack of market acceptance of our products or services or our inability to generate sufficient revenues from this development
or enhancement to offset their development costs could have a material adverse effect on our business. In addition, we may experience
delays or other problems in releasing new products and services and enhancements, and any such delays or problems may cause customers
to forego purchases of our products and services and to purchase those of our competitors.
We cannot provide assurance that products
and services that we have recently developed or that we develop in the future will achieve market acceptance. If our new products
and services fail to achieve market acceptance, or if we fail to develop new or enhanced products and services s that achieve market
acceptance, our growth prospects, operating results and competitive position could be adversely affected.
We are dependent on relationships with our key material
suppliers, and the partial or complete loss of one of these key suppliers, or the failure to find replacement suppliers or manufacturers
in a timely manner, could adversely affect our business.
We have established relationships
with a third party engine supplier and other key suppliers from which we source components for our power systems. We purchase standard
configurations of engines for our DC power systems and are substantially dependent on timely supply from our key engine supplier,
Yanmar Engines Company. Purchases from Yanmar represented approximately 91% of our total cost of sales for the three months ended
March 31, 2018 and represented approximately 13% of our total cost of sales for the same period in 2017. We do not have any long-term
contracts or commitments with Yanmar Engines Company. If this engine supplier were to fail to provide emissions certified engines
in a timely manner or fail to supply engines that meet our quality, quantity or cost requirements, or were to discontinue manufacturing
any engines we source from them or discontinue providing any of these engines to us, and we were unable to obtain substitute sources
in a timely manner or on terms acceptable to us, our ability to manufacture our products could be materially adversely affected.
Price increases in some of the key components in
our DC power systems could materially and adversely affect our operating results and cash flows.
The prices of some
of the key components of our DC power systems are subject to fluctuation due to market forces beyond our control, including
changes in the costs of raw materials incorporated into these components. Such price increases occur from time to time due to
spot shortages of commodities, increases in labor costs or longer-term shortages due to market forces. In particular, the
prices of engines can fluctuate frequently and often significantly. We do not have any long-term contracts or commitments
with our key engine supplier. Substantial increases in the prices of raw materials used in components which we source from
our suppliers may result in increased prices charged by our suppliers. If we incur price increases from our suppliers for key
components in our DC power systems, our production costs will increase. Given competitive market conditions, we may not be
able to pass all or any of those cost increases on to our OEM customers in the form of higher sales prices. To the extent our
competitors do not suffer comparable component cost increases, we may have even greater difficulty passing along price
increases and our competitive position may be harmed. As a result, increases in costs of key components may adversely affect
our margins and otherwise adversely affect our operating results and cash flows.
A portion of our key components are sourced in foreign
countries, exposing us to additional risks that may not exist in the U.S.
A portion of our key components,
such as engines, magnets and cooling systems, are purchased from suppliers located overseas, primarily in Asia. Our international
sourcing subjects us to a number of potential risks in addition to the risks associated with third-party sourcing generally. These
risks include:
|
●
|
inflation or changes in political and economic conditions;
|
|
●
|
unstable regulatory environments;
|
|
●
|
changes in import and export duties;
|
|
●
|
currency rate fluctuations;
|
|
●
|
logistical and communications challenges; and
|
|
●
|
other restraints and burdensome taxes.
|
These factors may have
an adverse effect on our ability to source our purchased components overseas. In particular, if the U.S. dollar were to depreciate
significantly against the currencies in which we purchase raw materials from foreign suppliers, our cost of goods sold could increase
materially, which would adversely affect our results of operations.
The unavailability or shortage, or increase in the
cost, of raw materials and components could have an adverse effect on our sales and profitability.
Our operations require
raw materials, such as aluminum, copper and permanent magnets. Commodities such as aluminum and copper are known to have significant
price volatility based on global economic conditions. An increase in global economic outlook may result in significant price increases
in the cost of our raw materials. In addition, we use Neodymium permanent magnets in our alternators, for which there are a limited
number of global suppliers that can meet our standards. Increase in manufacturing of electric vehicles worldwide can have an adverse
effect on the cost or supply of these magnets. At our current production volumes, we are unable to secure large quantities of these
commodities at fixed prices; however, we do have multiple sources of supply for our raw materials to meet our near term forecasted
needs.
Various factors could
reduce the availability of raw materials and components and shortages may occur from time to time in the future. An increase in
lead times for the supply of raw materials due to a global increase in demand for commodities outlined may significantly increase
material costs of our products. If production was interrupted due to unavailability or shortage of raw materials and we were not
able to find alternate third-party suppliers or re-engineer our products to accommodate different components or materials, we could
experience disruptions in manufacturing and operations including product shortages, higher freight costs and re-engineering costs.
If our supply of raw materials or components is disrupted or our lead times extended, our business, results of operations or financial
condition could be materially adversely affected.
We manufacture and assemble a majority of our products
at one facility. Any prolonged disruption in the operations of this facility would result in a decline in our sales and profitability.
We manufacture and assemble
our DC power systems at our facility located in Gardena, California. Any prolonged disruption in the operations of our manufacturing
and assembly facility, whether due to equipment or information technology infrastructure failure, labor difficulties, destruction
of or damage to this facility as a result of an earthquake, fire, flood, other catastrophes, and other operational problems would
result in a decline in our sales and profitability. In the event of a business interruption at our facility, we may be unable to
shift manufacturing and assembly capabilities to alternate locations, accept materials from suppliers or meet customer shipment
needs, among other severe consequences. Such an event could have a material and adverse impact on our financial condition and results
of our operations.
Our business operations are subject to substantial
government regulation.
Our business operations
are subject to certain federal, state, local and foreign laws and regulations. For example, our products, services and technologies
are subject to regulations relating to building codes, public safety, electrical connections, security protocols, and local and
state licensing requirements. The regulations to which we are subject may change, additional regulations may be imposed, or existing
regulations may be applied in a manner that creates special requirements for the implementation and operation of our products or
services that may significantly impact or even eliminate some of our revenues or markets. In addition, we may incur material costs
or liabilities in complying with any such regulations. Furthermore, some of our customers must comply with numerous laws and regulations,
which may affect their willingness and ability to purchase our products, services and technologies.
The modification of existing
laws and regulations or interpretations thereof or the adoption of future laws and regulations could adversely affect our business,
cause us to modify or alter our methods of operations and increase our costs and the price of our products, services and technology.
In addition, we cannot provide any assurance that we will be able, for financial or other reasons, to comply with all applicable
laws and regulations. If we fail to comply with these laws and regulations, we could become subject to substantial penalties or
restrictions that could materially and adversely affect our business.
Certain of our products are used in critical communications
networks which may subject us to significant liability claims.
Because certain of our
products for customers in the telecommunications industry are used in critical communications networks, we may be subject to significant
liability claims if our products do not work properly. We warrant to our current customers that our products will operate in accordance
with our product specifications. If our products fail to conform to these specifications, our customers could require us to remedy
the failure or could assert claims for damages. The provisions in our agreements with customers that are intended to limit our
exposure to liability claims may not preclude all potential claims. In addition, any insurance policies we have may not adequately
limit our exposure with respect to such claims. Liability claims could require us to spend significant time and money in litigation
or to pay significant damages. Any such claims, whether or not successful, would be costly and time-consuming to defend, and could
divert management’s attention and seriously damage our reputation and our business.
We could be adversely affected by our failure to
comply with the laws applicable to our foreign activities, including the U.S. Foreign Corrupt Practices Act and other similar worldwide
anti-bribery laws.
The U.S. Foreign Corrupt
Practices Act, or the FCPA, and similar anti-bribery laws in other jurisdictions prohibit U.S.-based companies and their intermediaries
from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. We may pursue opportunities
in certain parts of the world that experience government corruption, and in certain circumstances, compliance with anti-bribery
laws may conflict with local customs and practices. Our policies mandate compliance with all applicable anti-bribery laws. Further,
we require our partners, subcontractors, agents and others who work for us or on our behalf to comply with the FCPA and other anti-bribery
laws. Although we have policies and procedures, and have conducted training, designed to ensure that we, our employees, our agents
and others who work with us in foreign countries comply with the FCPA and other anti-bribery laws, there is no assurance that such
policies, procedures or training will protect us against liability under the FCPA or other laws for actions taken by our agents,
employees and intermediaries. If we are found to be liable for FCPA violations (either due to our own acts or inadvertence, or
due to the acts or inadvertence of others), we could suffer from severe criminal or civil penalties or other sanctions, which could
have a material adverse effect on our reputation, business, results of operations or cash flows. In addition, detecting, investigating
and resolving actual or alleged FCPA violations is expensive and could consume significant time and attention of our senior management.
We are exposed to risks
related to our international sales, and the failure to manage these risks could harm our business. If we fail to expand our business
into international markets, our revenues and results of operations may be adversely affected.
In addition to our sales
to customers within the U.S., we may become increasingly dependent on sales to customers outside the U.S. as we pursue expanding
our business with current and potential customers worldwide. In 2017, we established full-time sales executives and support staff
in: Australia, Dubai, Singapore, Romania, Poland, Africa and the Dominican Republic. During the first quarter of 2018, our sales
to international customers accounted for 1% of total revenue. We expect that international sales will increase over time and that
a significant portion of our future international sales will be from less developed or developing countries. As a result, the occurrence
of any international, political, economic, or geographic event could result in a significant decline in revenue. There are significant
risks associated with conducting operations internationally, requiring significant financial commitments to support such operations.
These operations present a number of challenges including oversight of daily operating practices in each location, handling employee
benefits and employee behavior. In addition, compliance with complex foreign and U.S. laws and regulations that apply to our international
operations increases our cost of doing business in international jurisdictions. These numerous and sometimes conflicting laws and
regulations include internal control and disclosure rules, data privacy and filtering requirements, anti-corruption laws, such
as the FCPA, and other local laws prohibiting corrupt payments to governmental officials, and anti-competition regulations, among
others. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers,
or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more
countries, and could also materially affect our brand, our international expansion efforts, our ability to attract and retain employees,
our business, and our operating results. Although we have implemented policies and procedures designed to ensure compliance with
these laws and regulations, there can be no assurance that our employees, contractors, or agents will not violate our policies.
Some of the risks and
challenges of doing business internationally include:
|
●
|
requirements or preferences for domestic products or solutions, which could reduce demand for our products;
|
|
●
|
unexpected changes in regulatory requirements;
|
|
●
|
imposition of tariffs and other barriers and restrictions;
|
|
●
|
restrictions on the import or export of critical technology;
|
|
●
|
management communication and integration problems resulting from cultural and geographic dispersion;
|
|
●
|
the burden of complying with a variety of laws and regulations in various countries;
|
|
●
|
difficulties in enforcing contracts;
|
|
●
|
the uncertainty of protection for intellectual property rights in some countries;
|
|
●
|
application of the income tax laws and regulations of multiple jurisdictions, including relatively
low-rate and relatively high-rate jurisdictions, to our sales and other transactions, which results in additional complexity and
uncertainty;
|
|
●
|
tariffs and trade barriers, export regulations and other regulatory and contractual limitations on our ability to sell products;
|
|
●
|
greater risk of a failure of foreign employees to comply with both U.S. and foreign laws, including
export and antitrust regulations, the FCPA and any trade regulations ensuring fair trade practices;
|
|
●
|
heightened risk of unfair or corrupt business practices in certain geographies and of improper
or fraudulent sales arrangements that may impact financial results and result in restatements of, or irregularities in, financial
statements;
|
|
●
|
potentially adverse tax consequences, including multiple and possibly overlapping tax structures;
|
|
●
|
general economic and geopolitical conditions, including war and acts of terrorism;
|
|
●
|
lack of the availability of qualified third-party financing; and
|
|
●
|
currency exchange controls.
|
While these factors and
the impacts of these factors are difficult to predict, any one or more of them could adversely affect our business, financial condition
and results of operations in the future.
Failures or security breaches of our networks or
information technology systems could have an adverse effect on our business.
We rely heavily on information
technology, or IT, both in our products and services for customers and in our IT systems. Further, we collect and store sensitive
information in our data centers and on our networks. Government agencies and security experts have warned about growing risks of
hackers, cyber-criminals, malicious insiders and other actors targeting confidential information and all types of IT systems. These
actors may engage in fraudulent activities, theft of confidential or proprietary information and sabotage.
Our IT systems and our
confidential information may be vulnerable to damage or intrusion from a variety of attacks including computer viruses, worms or
other malicious software programs. These attacks pose a risk to the security of the products, systems and networks of our customers,
suppliers and third-party service providers, as well to the confidentiality of our information and the integrity and availability
of our data. While we attempt to mitigate these risks through controls, due diligence, training, surveillance and other measures,
we remain vulnerable to information security threats.
Despite the precautions
we take, an intrusion or infection of our systems could result in the disruption of our business, loss of proprietary or confidential
information, or injuries to people or property. Similarly, an attack on our IT systems could result in theft or disclosure of trade
secrets or other intellectual property or a breach of confidential customer or employee information. Any such events could have
an adverse impact on sales, harm our reputation and cause us to incur legal liability and increased costs to address such events
and related security concerns. As the threats evolve and become more potent, we may incur additional costs to secure the products
that we sell, as well as our data and infrastructure of networks and devices.
Risks Related to Our Intellectual Property
If we fail to adequately protect our intellectual
property rights, we could lose important proprietary technology, which could materially and adversely affect our business.
Our success and ability
to compete depends, in substantial part, upon our ability to develop and protect our proprietary technology and intellectual property
rights to distinguish our products, services and technology from those of our competitors. The unauthorized use of our intellectual
property rights and proprietary technology by others could materially harm our business.
Historically, we have
relied primarily on a combination of trademark, copyright and trade secret laws, along with non-competition and confidentiality
agreements, contractual provisions, licensing arrangements and proprietary software and manufacturing processes, to establish and
protect our intellectual property rights. Although we hold several unregistered copyrights in our business, we believe that the
success of our business depends more upon our proprietary technology, information, processes and know-how than on patents or trademark
registrations. In addition, much of our proprietary information and technology may not be patentable; if we decided to apply for
patents and/or trademarks in the future, we might not be successful in obtaining any such future patents or in registering any
marks.
Despite our efforts to
protect our intellectual property rights, existing laws afford only limited protection, and our actions may be inadequate to protect
our rights or to prevent others from claiming violations of their proprietary rights. Unauthorized third parties may attempt to
copy, reverse engineer or otherwise obtain, use or exploit aspects of our products and services, develop similar technology independently,
or otherwise obtain and use information that we regard as proprietary. We cannot assure you that our competitors will not independently
develop technology similar or superior to our technology or design around our intellectual property. In addition, the laws of some
foreign countries may not protect our proprietary rights as fully or in the same manner as the laws of the U.S.
We may need to resort
to litigation to enforce our intellectual property rights, to protect our trade secrets, and to determine the validity and scope
of other companies’ proprietary rights in the future. However, litigation could result in significant costs and in the diversion
of management and financial resources. We cannot assure you that any such litigation will be successful or that we will prevail
over counterclaims against us. Our failure to protect any of our important intellectual property rights or any litigation that
we resort to in order to enforce those rights could materially and adversely affect our business.
If we face claims of intellectual property infringement
by third parties, we could encounter expensive litigation, be liable for significant damages or incur restrictions on our ability
to sell our products and services.
Although we are not aware
of any present infringement of our products, services or technology on the intellectual property rights of others, we cannot be
certain that our products, services and technologies do not or in the future will not infringe on the valid intellectual property
rights held by third parties. In addition, we cannot assure you that third parties will not claim that we have infringed their
intellectual property rights.
In recent years, there
has been a significant amount of litigation in the U.S. involving patents and other intellectual property rights. In the future,
we may be a party to litigation as a result of an alleged infringement of others’ intellectual property. Successful infringement
claims against us could result in substantial monetary liability, require us to enter into royalty or licensing arrangements, or
otherwise materially disrupt the conduct of our business. In addition, even if we prevail on these claims, this litigation could
be time-consuming and expensive to defend or settle, and could result in the diversion of our time and attention and of operational
resources, which could materially and adversely affect our business. Any potential intellectual property litigation also could
force us to do one or more of the following:
|
●
|
stop selling, incorporating or using our products and services that use the infringed intellectual property;
|
|
●
|
obtain from the owner of the infringed intellectual property right a license to sell or use
the relevant technology, which license may not be available on commercially reasonable terms, or at all; or
|
|
●
|
redesign the products and services that use the technology.
|
If we are forced to take
any of these actions, our business may be seriously harmed. Although we carry general liability insurance, our insurance may not
cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed.
Risks Related to Our Common Stock
Our operating results can fluctuate significantly
from period to period, which makes our operating results difficult to predict and can cause our operating results in any particular
period to be less than comparable periods and expectations from time to time.
Our operating
results have fluctuated significantly from quarter-to-quarter, period-to-period and year-to-year during our operating history
and are likely to continue to fluctuate in the future due to a variety of factors, many of which are outside of our control.
Certain factors that may affect our operating results include, without limitation, those set forth under
“Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical
Accounting Policies” in this Quarterly Report on Form 10-Q.
Because we have little
or no control over many of these factors, our operating results are difficult to predict. Any adverse change in any of these factors
could negatively affect our business and results of operations.
Our revenues, net income
and other operating results are heavily dependent upon the size and timing of customer orders and projects, and the timing of the
completion of those projects. The timing of our receipt of large individual orders, and of project completion, is difficult for
us to predict. Because our operating expenses are based on anticipated revenues over the mid- and long-term and because a high
percentage of our operating expenses are relatively fixed, a shortfall or delay in recognizing revenues can cause our operating
results to vary significantly from quarter-to-quarter and can result in significant operating losses or declines in profit margins
in any particular quarter. If our revenues fall below our expectations in any particular quarter, we may not be able, or it may
not be prudent for us, to reduce our expenses rapidly in response to the revenue shortfall, which can result in us suffering significant
operating losses or declines in profit margins in that quarter.
Due to these factors and
the other risks discussed in this Quarterly Report on Form 10-Q, you should not rely on quarter-to-quarter, period-to-period or
year-to-year comparisons of our results of operations as an indication of our future performance. Quarterly, period and annual
comparisons of our operating results are not necessarily meaningful or indicative of future performance. As a result, it is likely
that, from time to time, our results of operations or our revenue backlog could fall below historical levels or the expectations
of public market analysts and investors, which could cause the trading price of our common stock to decline significantly.
Our Chairman, President and Chief Executive Officer
owns a majority of our common stock and will exercise significant influence over matters requiring stockholder approval, regardless
of the wishes of other stockholders.
Our Chairman, President,
Chief Executive Officer and Secretary, Arthur D. Sams, beneficially owns approximately 55% of our outstanding shares of common
stock. Mr. Sams therefore has significant influence over management and significant control over matters requiring stockholder
approval, including the annual election of directors and significant corporate transactions, such as a merger or other sale of
our company or our assets, for the foreseeable future. This concentrated control will limit stockholders’ ability to influence
corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial. As a result, the market
price of our common stock could be adversely affected.
We are a “controlled company” within
the meaning of the NASDAQ Listing Rules. Although we do not currently intend to rely on the exemptions from certain corporate governance
requirements afforded to a “controlled company” under NASDAQ Listing Rules, we could potentially seek to rely on such
exemptions in the future.
Our Chairman, President,
Chief Executive Officer and Secretary, Arthur D. Sams, controls a majority of our common stock. As a result, we are a “controlled
company” within the meaning of the NASDAQ Listing Rules. Under these rules, a company of which more than 50% of the voting
power for the election of directors is held by an individual, a group or another company is a “controlled company”
and may elect not to comply with certain NASDAQ corporate governance requirements, including, without limitation (i) the requirement
that a majority of the board of directors consist of independent directors, (ii) the requirement that the compensation of our officers
be determined or recommended to our board of directors by a compensation committee that is comprised solely of independent directors,
and (iii) the requirement that director nominees be selected or recommended to the board of directors by a majority of independent
directors or a nominating committee comprised solely of independent directors. We do not currently intend to rely on those exemptions
afforded to a “controlled company.” Nonetheless, in the future, we could potentially seek to rely on certain of those
exemptions afforded to a “controlled company,” and in such case, you would not have the same protections afforded to
stockholders of companies that are subject to all of the NASDAQ corporate governance requirements.
The price of our shares of common stock is volatile,
and you could lose all or part of your investment.
The trading price of our
shares of common stock is volatile and could be subject to wide fluctuations in response to various factors, some of which are
beyond our control, including limited trading volume. In addition to the factors discussed in the “Risk Factors” section
and elsewhere in this Quarterly Report on Form 10-Q, these factors include, without limitation:
|
●
|
competition from existing technologies and products or new technologies and products that may emerge;
|
|
●
|
a significant reduction in sales from our largest customers, including our legacy customer;
|
|
●
|
actual or anticipated variations in our quarterly operating results;
|
|
●
|
failure to meet the estimates and projections of the investment community or that we may otherwise provide to the public;
|
|
●
|
announcement or expectation of additional financing efforts;
|
|
●
|
issuances of debt or equity securities;
|
|
●
|
our inability to successfully enter new markets or develop additional products;
|
|
●
|
actual or anticipated fluctuations in our competitors’ operating results or changes in their respective growth rates;
|
|
●
|
sales of our shares of common stock by us, or our stockholders in the future;
|
|
●
|
trading volume of our shares of common stock on The NASDAQ Capital Market;
|
|
●
|
market conditions in our industry;
|
|
●
|
overall performance of the equity markets and general political and economic conditions;
|
|
●
|
introduction of new products or services by us or our competitors;
|
|
●
|
additions or departures of key management, engineering or other personnel;
|
|
●
|
publication of research reports about us or our industry or positive or negative recommendations
or withdrawal of research coverage by securities or industry analysts;
|
|
●
|
changes in the market valuation of similar companies;
|
|
●
|
disputes or other developments related to intellectual property and other proprietary rights;
|
|
●
|
changes in accounting practices;
|
|
●
|
significant lawsuits, including stockholder litigation; and
|
|
●
|
other events or factors, many of which are beyond our control.
|
Furthermore, the public
equity markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices
of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance
of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions
such as recessions, interest rate changes or international currency fluctuations, may negatively impact the market price of our
shares of common stock.
We do not anticipate paying cash dividends, and
accordingly, stockholders must rely on stock appreciation for any return on their investment.
We have never declared
or paid cash dividends on our capital stock. We intend to retain a significant portion of our future earnings, if any, to finance
the operations, development and growth of our business. Any future determination to declare dividends will be made at the discretion
of our board of directors, subject to applicable laws, and will depend on number of factors, including our financial condition,
results of operations, capital requirements, contractual restrictions, general business conditions and other factors that our board
of directors may deem relevant. As a result, only appreciation of the price of our common stock, which may never occur, will provide
a return to stockholders.
If securities or industry analysts do not publish
research or reports, or publish inaccurate or unfavorable research or reports about our business, our share price and trading volume
could decline.
The trading market for
our shares of common stock depends, in part, on the research and reports that securities or industry analysts publish about us
or our business. We do not have any control over these analysts. If no securities or industry analysts undertake coverage of our
company, the trading price for our shares of common stock may be negatively impacted. If we obtain securities or industry analyst
coverage and if one or more of the analysts who covers us downgrades our shares of common stock, changes their opinion of our shares
or publishes inaccurate or unfavorable research about our business, our share price would likely decline. If one or more of these
analysts ceases coverage of us or fails to publish reports on us regularly, demand for our shares of common stock could decrease
and we could lose visibility in the financial markets, which could cause our share price and trading volume to decline.
We are not subject to the provisions of Section
203 of the Delaware General Corporation Law, which could negatively affect your investment.
We elected in our certificate
of incorporation to not be subject to the provisions of Section 203 of the Delaware General Corporation Law, or Section 203. In
general, Section 203 prohibits a publicly held Delaware corporation from engaging in a “business combination” with
an “interested stockholder” for a period of three years after the date of the transaction in which the person became
an interested stockholder, unless the business combination is approved in a prescribed manner. A “business combination”
includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder. An “interested
stockholder” is a person who, together with affiliates and associates, owns (or, in certain cases, within three years prior,
did own) 15% or more of the corporation’s voting stock. Our decision not to be subject to Section 203 will allow, for example,
Arthur D. Sams, our Chairman, President, Chief Executive Officer and Secretary (who beneficially owns approximately 55% of our
common stock) to transfer shares in excess of 15% of our voting stock to a third-party free of the restrictions imposed by Section
203. This may make us more vulnerable to takeovers that are completed without the approval of our board of directors and/or without
giving us the ability to prohibit or delay such takeovers as effectively.
Some provisions of our charter documents and Delaware
law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial
to our stockholders, and may prevent attempts by our stockholders to replace or remove our current management.
Provisions in our certificate
of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us
or increase the cost of acquiring us, even if doing so would benefit our stockholders. These provisions include:
|
●
|
a requirement that special meetings of stockholders be called only by the board of directors,
the president or the chief executive officer;
|
|
●
|
advance notice requirements for stockholder proposals and nominations for election to our board of directors; and
|
|
●
|
the authority of the board of directors to issue preferred stock on terms determined by the board
of directors without stockholder approval and which preferred stock may include rights superior to the rights of the holders of
common stock.
|
These anti-takeover provisions
and other provisions in our certificate of incorporation and bylaws could make it more difficult for stockholders or potential
acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors
and could also delay or impede a merger, tender offer or proxy contest involving our Company. These provisions could also discourage
proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing or cause us to take
other corporate actions you desire. Any delay or prevention of a change of control transaction or changes in our board of directors
could cause the market price of our common stock to decline.
Our certificate of incorporation designates the
Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may
be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes
with us or our directors, officers or other employees.
Our certificate of incorporation
provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware
shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting
a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii)
any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, our certificate of incorporation
or our bylaws, or (iv) any action asserting a claim against us governed by the internal affairs doctrine. Any person or entity
purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and consented to
the provisions of certificate of incorporation described above. This choice of forum provision may limit a stockholder’s
ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees,
which may discourage such lawsuits against us and our directors, officers and other employees. Alternatively, if a court were to
find these provisions of our certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified
types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which
could adversely affect our business, financial condition or results of operations.
We are an “emerging growth company,”
and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our shares of
common stock less attractive to investors.
We are an “emerging
growth company,” as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage
of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies,
including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002,
or the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in this report, our periodic reports
and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder
approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years,
although circumstances could cause us to lose that status earlier, including if the market value of our shares of common stock
held by non-affiliates exceeds $700 million as of any March 30 before that time or if we have total annual gross revenue of $1.0
billion or more during any fiscal year before that time, in which cases we would no longer be an emerging growth company as of
the following December 31, or if we issue more than $1.0 billion in non-convertible debt during any three-year period before that
time, in which case we would no longer be an emerging growth company immediately. We cannot predict if investors will find our
shares of common stock less attractive because we may rely on these exemptions. If some investors find our shares of common stock
less attractive as a result, there may be a less active trading market for our shares of common stock and our share price may be
more volatile.
Under the JOBS Act, emerging
growth companies also can delay adopting new or revised accounting standards until such time as those standards apply to private
companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore,
will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
If we fail to maintain an effective system of internal
control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result,
stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price
of our common stock.
Effective internal controls
over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls
and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered
in their implementation could cause us to fail to meet our reporting obligations. In addition, any testing by us conducted in connection
with Section 404 of the Sarbanes-Oxley Act, or any subsequent testing by our independent registered public accounting firm, may
reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses or that may require
prospective or retroactive changes to our financial statements or identify other areas for further attention or improvement. Inferior
internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative
effect on the trading price of our common stock.
We are required to disclose
changes made in our internal controls and procedures on a quarterly basis and our management is required to assess the effectiveness
of these controls annually. However, for as long as we are an “emerging growth company” under the JOBS Act, our independent
registered public accounting firm will not be required to attest to the effectiveness of our internal controls over financial reporting
pursuant to Section 404. We could be an “emerging growth company” for up to five years. An independent assessment of
the effectiveness of our internal controls could detect problems that our management’s assessment might not. Undetected material
weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.
We incur significant costs as a result of operating
as a public company and our management expects to devote substantial time to public company compliance programs.
As a public company, we
incur significant legal, accounting and other expenses due to our compliance with regulations and disclosure obligations applicable
to us, including compliance with the Sarbanes-Oxley Act as well as rules implemented by the SEC and NASDAQ. The SEC and other regulators
have continued to adopt new rules and regulations and make additional changes to existing regulations that require our compliance.
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted. There are significant
corporate governance and executive compensation related provisions in the Dodd-Frank Act that have required the SEC to adopt additional
rules and regulations in these areas. Stockholder activism, the current political environment, and the current high level of government
intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional
compliance costs and impact, in ways we cannot currently anticipate, the manner in which we operate our business. Our management
and other personnel devote a substantial amount of time to these compliance programs and monitoring of public company reporting
obligations and, as a result of the new corporate governance and executive compensation related rules, regulations, and guidelines
prompted by the Dodd-Frank Act and further regulations and disclosure obligations expected in the future, we will likely need to
devote additional time and costs to comply with such compliance programs and rules. These rules and regulations cause us to incur
significant legal and financial compliance costs and make some activities more time-consuming and costly.
To comply with the requirements
of being a public company, we may need to undertake various activities, including implementing new internal controls and procedures
and hiring new accounting or internal audit staff. The Sarbanes-Oxley Act requires that we maintain effective disclosure controls
and procedures and internal control over financial reporting. We are continuing to develop and refine our disclosure controls and
other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file with the
SEC is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that information
required to be disclosed in reports under the Exchange Act, is accumulated and communicated to our principal executive and financial
officers. Our current controls and any new controls that we develop may become inadequate and weaknesses in our internal control
over financial reporting may be discovered in the future.
Any failure to develop
or maintain effective controls could adversely affect the results of periodic management evaluations and annual independent registered
public accounting firm attestation reports regarding the effectiveness of our internal control over financial reporting which we
may be required to include in our periodic reports we will file with the SEC under Section 404 of the Sarbanes-Oxley Act, harm
our operating results, cause us to fail to meet our reporting obligations, or result in a restatement of our prior period financial
statements. In the event that we are not able to demonstrate compliance with the Sarbanes-Oxley Act, that our internal control
over financial reporting is perceived as inadequate or that we are unable to produce timely or accurate financial statements, investors
may lose confidence in our operating results and the price of our common stock could decline. In addition, if we are unable to
continue to meet these requirements, we may not be able to remain listed on The NASDAQ Capital Market.
We are not currently required
to comply with the SEC rules that implement Section 404 of the Sarbanes-Oxley Act, and are therefore not yet required to make a
formal assessment of the effectiveness of our internal control over financial reporting for that purpose. However, we are required
to comply with certain of these rules, which require management to certify financial and other information in our quarterly and
annual reports and provide an annual management report on the effectiveness of our internal control over financial reporting commencing
with our next annual report. This assessment will need to include the disclosure of any material weaknesses in our internal control
over financial reporting identified by our management or our independent registered public accounting firm. We are just beginning
the costly and challenging process of compiling the system and processing documentation needed to comply with such requirements.
We may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation
and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be
unable to assert that our internal control over financial reporting is effective.
Raising additional capital, including through future
sales and issuances of our common stock, the exercise of warrants or the exercise of rights to purchase common stock pursuant to
our equity incentive plan could result in additional dilution of the percentage ownership of our stockholders, could cause our
share price to fall and could restrict our operations.
We expect that significant
additional capital will be needed in the future to continue our planned operations, including any potential acquisitions, purchasing
of capital equipment, hiring new personnel, and continuing activities as an operating public company. To the extent we seek additional
capital through a combination of public and private equity offerings and debt financings, our stockholders may experience substantial
dilution. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership
interest of our existing stockholders may be diluted, and the terms may include liquidation or other preferences that adversely
affect the rights of our stockholders. Debt and receivables financings may be coupled with an equity component, such as warrants
to purchase shares of our common stock, which could also result in dilution of our existing stockholders’ ownership. The
incurrence of indebtedness would result in increased fixed payment obligations and could also result in certain restrictive covenants,
such as limitations on our ability to incur additional debt and other operating restrictions that could adversely impact our ability
to conduct our business. A failure to obtain adequate funds may cause us to curtail certain operational activities, including sales
and marketing, in order to reduce costs and sustain the business, and would have a material adverse effect on our business and
financial condition.
Under our 2016 Plan, we
may grant equity awards covering up to 1,754,385 shares of our common stock. As of the date of this Quarterly Report on Form 10-Q,
we had granted options to purchase an aggregate of 360,000 shares of our common stock under the 2016 Plan. We have registered 1,754,385
shares of common stock available for issuance under our 2016 Plan. Sales of shares issued upon exercise of options or granted under
our 2016 Plan may result in dilution to our existing stockholders, which could cause our share price to fall.
Our issuance of shares of preferred stock could
adversely affect the market value of our common stock, dilute the voting power of common stockholders and delay or prevent a change
of control.
Our board of directors
has the authority to cause us to issue, without any further vote or action by the stockholders, up to 5,000,000 shares of preferred
stock in one or more series, to designate the number of shares constituting any series, and to fix the rights, preferences, privileges
and restrictions thereof, including dividend rights, voting rights, rights and terms of redemption, redemption price or prices
and liquidation preferences of such series.
The issuance of shares
of preferred stock with dividend or conversion rights, liquidation preferences or other economic terms favorable to the holders
of preferred stock could adversely affect the market price for our common stock by making an investment in the common stock less
attractive. For example, investors in the common stock may not wish to purchase common stock at a price above the conversion price
of a series of convertible preferred stock because the holders of the preferred stock would effectively be entitled to purchase
common stock at the lower conversion price causing economic dilution to the holders of common stock.
Further, the issuance
of shares of preferred stock with voting rights may adversely affect the voting power of the holders of our other classes of voting
stock either by diluting the voting power of our other classes of voting stock if they vote together as a single class, or by giving
the holders of any such preferred stock the right to block an action on which they have a separate class vote even if the action
were approved by the holders of our other classes of voting stock. The issuance of shares of preferred stock may also have the
effect of delaying, deferring or preventing a change in control of our company without further action by the stockholders, even
where stockholders are offered a premium for their shares.
Claims for indemnification by our directors and
officers may reduce our available funds to satisfy successful third-party claims against us and may reduce the amount of money
available to us.
Our certificate of incorporation
and bylaws provide that we will indemnify our directors and officers, in each case to the fullest extent permitted by Delaware
law. In addition, as permitted by Section 145 of the Delaware General Corporation Law, our bylaws and the indemnification agreements
that we have entered into with our directors and officers provide that:
|
●
|
We will indemnify our directors and officers for serving us in those capacities or for serving
other business enterprises at our request, to the fullest extent permitted by Delaware law. Delaware law provides that a corporation
may indemnify such person if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed
to the best interests of the registrant and, with respect to any criminal proceeding, had no reasonable cause to believe such person’s
conduct was unlawful.
|
|
●
|
We may, in our discretion, indemnify employees and agents in those circumstances where indemnification
is permitted by applicable law.
|
|
●
|
We are required to advance expenses, as incurred, to our directors and officers in connection
with defending a proceeding, except that such directors or officers shall undertake to repay such advances if it is ultimately
determined that such person is not entitled to indemnification.
|
|
●
|
We will not be obligated pursuant to our bylaws to indemnify a person with respect to proceedings
initiated by that person against us or our other indemnitees, except with respect to proceedings authorized by our board of directors
or brought to enforce a right to indemnification.
|
|
●
|
The rights conferred in our bylaws are not exclusive, and we are authorized to enter into indemnification
agreements with our directors, officers, employees and agents and to obtain insurance to indemnify such persons.
|
|
●
|
We may not retroactively amend our bylaw provisions to reduce our indemnification obligations
to directors, officers, employees and agents.
|
To the extent that a claim
for indemnification is brought by any of our directors or officers, it would reduce the amount of funds available for use in our
business.