Energy Focus, Inc. — Q3 2017 Form 10-Q
Business context and period. Energy Focus designs, develops, manufactures, and sells LED lighting products for commercial, industrial, and military maritime markets. This unaudited quarterly report covers the three and nine months ended September 30, 2017; comparisons are with the same 2016 periods unless noted. Dollar amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $5.002 | $8.261 | $15.119 | $23.812 |
| Gross profit / margin | $1.137 / 22.7% | $3.082 / 37.3% | $3.199 / 21.2% | $8.749 / 36.7% |
| Operating loss | $(1.788) | $(3.150) | $(9.403) | $(9.041) |
| Net loss | $(1.773) | $(3.177) | $(9.409) | $(9.082) |
| Basic and diluted loss per share | $(0.15) | $(0.27) | $(0.80) | $(0.78) |
- Revenue mix: Commercial product sales were $3.947 million in Q3 and $12.204 million year to date, up 9.5% and 6.0%, respectively. Military maritime sales were $1.055 million and $2.915 million, down 77.3% and 76.3%, respectively.
- Expenses and margins: Q3 SG&A fell to $2.393 million from $5.423 million; year-to-date SG&A fell to $8.802 million from $15.323 million. Product development expense was $0.732 million in Q3 and $2.266 million year to date. Q3 restructuring was a net credit of $0.200 million; year-to-date restructuring charges were $1.534 million.
- Cash flow: Operating cash use was $4.684 million for the first nine months, versus $13.650 million in 2016. Investing cash use was $0.057 million, and financing provided $0.056 million. Cash and cash equivalents, including $0.342 million of restricted cash, were $11.935 million at September 30, down from $16.629 million at December 31, 2016.
- Liquidity and balance sheet: Current assets were $23.153 million and current liabilities were $3.345 million at September 30. The company reported no debt, total liabilities of $3.593 million, and an accumulated deficit of $106.346 million. Inventory was $6.779 million, down from $9.469 million at year-end.
Material changes versus prior periods
- Total sales fell 39.5% in Q3 and 36.5% for the first nine months, chiefly reflecting the sharp decline in military maritime sales. The exclusive distributor agreement with Atlantic Diving Supply ended March 31, 2017; the distributor could meet Navy demand from inventory bought previously.
- Commercial growth and substantial cost reductions helped narrow the Q3 net loss, but the nine-month net loss increased from $9.082 million to $9.409 million. Operating expenses excluding restructuring and asset impairment charges declined approximately $3.1 million in Q3 and $6.7 million year to date versus 2016.
- Gross margin declined materially, which management attributed to lower production volumes and overhead absorption, product mix, and higher-cost inventory purchased to meet demand that did not materialize. The company said it depleted most of this higher-cost inventory during Q3.
- Cash declined by $4.694 million over the first nine months, although operating cash use was substantially lower than in the comparable 2016 period.
Outlook, risks, and unusual items
- Management expects restructuring and related actions to reduce annual operating costs by approximately $8 million to $9 million from 2016 levels; it does not anticipate further major restructuring activity in the near future.
- Management believes the restructuring, available liquidity, executive reorganization, and sales-channel strategy will return the company to profitability in 2018. However, the filing states that substantial doubt about the company’s ability to continue as a going concern continued to exist at September 30, 2017. The company warned that additional funding may be needed if profitability is delayed or not achieved; financing may be unavailable or dilutive.
- Revenue timing remains uncertain: commercial sales cycles can span several months, and sales depend on project timing and order size. Customer concentration is significant: three customers represented approximately 58% of Q3 sales and 41% of year-to-date sales. U.S. Navy products represented about 20% of Q3 sales and 18% of year-to-date sales.
- Restructuring included office closures and headcount reductions of approximately 28%. The company estimated remaining lease obligations of approximately $1.8 million through June 2021, offset by approximately $1.3 million in expected sublease payments, and about $0.1 million of additional costs. The New York sublease was finalized in October 2017.
- The company disclosed normal-course threatened or pending legal matters but did not identify a specific material contingency or quantify a potential loss. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether commercial sales growth can offset continued weakness in military maritime sales following the end of the ADS agreement.
- Whether the company achieves its $8 million to $9 million cost-reduction target and its stated goal of profitability in 2018, given the continuing going-concern doubt.
- Whether gross margins recover as higher-cost inventory is depleted and sales volumes and product mix change.
- Cash consumption, working-capital requirements, customer concentration, and the availability and potential cost or dilution of any required financing.
- Actual sublease receipts and remaining restructuring and lease costs, as well as future warranty claims under the company’s ten-year warranty on specified commercial LED products.