Energy Focus, Inc. — Q3 2019 Form 10-Q
Business and period. Energy Focus designs and sells energy-efficient LED retrofit lighting for commercial and military markets. This unaudited report covers the three and nine months ended September 30, 2019; comparisons are to the corresponding 2018 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $2.915 | $5.158 | $9.174 | $14.989 |
| Gross profit / margin | $1.028 / 35.3% | $1.281 / 24.8% | $1.017 / 11.1% | $3.393 / 22.6% |
| Operating loss | $(0.833) | $(1.901) | $(5.785) | $(6.112) |
| Net loss | $(0.946) | $(1.920) | $(6.065) | $(6.114) |
| Net loss per share | $(0.08) | $(0.16) | $(0.49) | $(0.51) |
- Revenue fell 43.5% in Q3 and 38.8% year to date. Nine-month commercial sales declined 21.7% to $5.847 million; military sales fell 55.8% to $3.327 million. Management attributed the declines to timing and fulfillment of U.S. Navy awards and variable commercial project timing.
- Q3 gross margin improved year over year, but included a favorable $0.4 million inventory-reserve effect, partly offset by about $0.1 million of unfavorable outbound freight. Nine-month gross margin declined, reflecting warranty costs, freight and manufacturing variances.
- Operating expenses declined: nine-month product development expense was $1.035 million versus $1.940 million, and SG&A was $5.524 million versus $7.611 million. Cost reductions helped reduce the Q3 net loss; the nine-month net loss was broadly unchanged.
- Cash used in operating activities was $6.329 million for nine months, versus $3.846 million in 2018. Investing used $0.057 million; financing provided $0.686 million. Cash and cash equivalents were $0.634 million at September 30, including $0.342 million restricted cash; unrestricted cash was $0.292 million.
- At quarter end, current assets were $10.457 million and current liabilities $6.242 million. Debt totaled about $3.0 million: $1.323 million drawn on the revolving facility and $1.7 million of subordinated convertible notes. The company reported $1.2 million available under the credit facility. Accumulated deficit was $123.566 million.
Material changes and other developments
- During the first half of 2019, the company eliminated 12 positions, closed San Jose and Taipei offices, reorganized sales and management, reduced compensation, streamlined operations and outsourced some functions. It recorded $0.2 million in severance and related charges; no material restructuring charges were recorded in Q3.
- The March 2019 convertible notes carry 10% annual interest after June 30, 2019, mature December 31, 2021, and are convertible into Series A preferred stock at a stated $0.67 conversion rate, subject to stockholder approvals. The company classified the $1.7 million balance as current debt because it expected conversion within 12 months.
- Adoption of lease accounting Topic 842 on January 1, 2019 added approximately $2.9 million of operating lease liabilities. At September 30, operating and restructured lease liabilities totaled $2.175 million; finance lease liabilities were $0.008 million.
- Management and finance leadership changed in 2019. The company hired a new CFO and reported hiring additional finance staff, while using outside consultants for certain reporting matters.
Outlook, risks and contingencies
- Going concern and financing: The filing states that substantial doubt about the company’s ability to continue as a going concern remained at September 30, 2019. Management believed that external financing, restructuring, inventory actions and sales/product initiatives, if successfully executed, could fund operations through 2020; there is no assurance financing will be available on acceptable terms or at all. Failure to secure funding could force further cuts, asset sales or curtailed operations.
- Business risks: The company relies on a small number of customers, including U.S. Navy-related customers; sales are exposed to government funding, award and maintenance timing, long commercial sales cycles, competition, supplier and logistics constraints, and product/warranty risks. Two customers represented approximately 20% and 23% of nine-month sales.
- Nasdaq: The company received notice that its share price was below the $1.00 minimum bid requirement and requested a 180-day extension on October 15, 2019. It had separately received a periodic-filing compliance notice and stated it regained filing compliance after submitting its June 2019 10-Q.
- Controls: Management concluded disclosure controls were not effective at a reasonable assurance level because of a material weakness related primarily to finance staffing and segregation of duties. Remediation was underway, but completion was not reported.
- The company reported no material legal proceedings as of September 30. It had approximately $0.8 million of inventory purchase commitments, of which about $0.7 million was expected to ship in Q4 2019.
- No specific revenue, earnings or margin guidance was provided. Management’s stated outlook was conditional on executing its plans and obtaining additional funding.
Important facts for investors to verify
- Whether Energy Focus obtained sufficient additional financing and maintained adequate liquidity after quarter end.
- Whether the company’s cash burn, sales trends and customer concentration improved, particularly in military and commercial markets.
- Whether the $0.4 million Q3 inventory-reserve benefit is repeatable and whether warranty, freight and manufacturing costs affect future margins.
- Whether the convertible notes converted as expected, including the resulting preferred/common share terms and potential dilution.
- Whether Nasdaq bid-price compliance was regained and the material weakness in internal controls was remediated.