Energy Focus, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The company designs, manufactures, and sells LED lighting products, primarily tubular LED products, to military maritime and commercial and industrial markets. It had exited its turnkey solutions, U.K. subsidiary, and pool-products businesses; results for those operations are reported as discontinued operations.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $7.1 million | $16.2 million | $15.6 million | $28.8 million |
| Gross profit / margin | $2.5 million / 35.4% | $7.4 million / 45.8% | $5.7 million / 36.4% | $12.6 million / 43.7% |
| Operating income (loss) | $(3.9) million | $3.2 million | $(5.9) million | $4.4 million |
| Net income (loss) | $(3.9) million | $2.1 million | $(5.9) million | $3.2 million |
| Net income (loss) per diluted share | $(0.34) | $0.21 | $(0.51) | $0.32 |
Sales mix and margins: Military maritime sales were $3.8 million in Q2 and $7.6 million in the first half, down from $14.1 million and $24.9 million, respectively, in 2015. Commercial sales were $3.3 million and $7.9 million, up 54.0% and 102.1%, respectively, including the revenue adjustment described below. Management attributed lower gross margins to lower sales, product mix, and the generally lower margins of commercial products versus military maritime products.
Expenses: Q2 operating expenses rose to $6.4 million from $4.3 million; first-half expenses rose to $11.6 million from $8.2 million. The company cited investment in sales, administrative infrastructure, product development, marketing, and personnel. Q2 and first-half SG&A were $5.6 million and $9.9 million, respectively. There was no interest expense in 2016; the former revolving credit facility was terminated in December 2015.
Financial position and cash flow
- Cash and cash equivalents were $25.4 million at June 30, 2016, including $342,000 of restricted cash, versus $34.6 million at December 31, 2015.
- Six-month operating cash use was $8.2 million, compared with $701,000 provided in the prior-year period. Investing used $1.0 million; financing provided $77,000. Cash declined by $9.2 million during the half.
- Current assets were $46.9 million and current liabilities $9.9 million. Total liabilities were $10.0 million; the company reported no outstanding debt or credit facility at quarter-end.
- Inventory increased to $14.6 million from $7.7 million, principally as the company built inventory for anticipated commercial demand that was slower than expected. Accounts receivable declined to $5.2 million from $10.1 million.
- Accumulated deficit was $86.0 million. Stockholders’ equity was $40.1 million, down from $45.3 million at year-end.
Material changes, outlook, and risks
- Revenue fell 56.1% in Q2 and 46.0% in the first half year over year, driven mainly by lower U.S. Navy sales and an $814,000 revenue reduction for product returns and related customer credits. The company said certain shipments did not conform to the applicable manufacturing standard for the orders; it stated the issue did not concern product safety or quality. Related adjustments included a $221,000 reduction in cost of sales and a $593,000 increase in net loss. Management said it was implementing process improvements and estimated remaining potential credits would likely not be material.
- Management cited slower Navy ship demand compared with the rapid pace in 2015, while commercial sales grew. It noted commercial order timing can be difficult to predict and sales cycles may span several months. No numerical revenue or earnings guidance was provided.
- The Navy IDIQ contract was scheduled to terminate August 1, 2016. It contributed approximately $1.6 million of first-half 2016 sales and $3.2 million in 2015; management said other ship-level procurement was not affected by its termination. The exclusive distributor agreement with Atlantic Diving Supply was extended through March 31, 2017, with reduced minimum commitments for certain products.
- Customer concentration remains significant: ADS represented 36% of Q2 sales and 64% of quarter-end trade receivables. U.S. Navy-related sales were about 38% of first-half sales. The company also reported a 10-year warranty for certain commercial LED products effective April 1, 2016; management said the extension did not materially affect the reported period.
- Two non-cancellable leases were signed in 2016: a 64-month New York office lease with initial annual base rent of approximately $333,000, and a 74-month Ohio headquarters and manufacturing lease with annual base rent of approximately $618,000.
- Management warned that ongoing losses, cash use, customer concentration, Navy demand, uncertain commercial order timing, and the need to fund growth could pressure liquidity. It said there was no assurance of sufficient future operating cash or acceptable external financing; failure to generate cash could require delaying growth plans, cutting costs, or reducing headcount.
- Legal matters in the ordinary course were disclosed; management did not expect their ultimate resolution to materially adversely affect the company. Disclosure controls and procedures were assessed as effective at June 30, 2016.
Most important facts for investors to verify
- Whether commercial growth can offset lower Navy demand and the scheduled end of the IDIQ contract.
- Actual subsequent-period returns, credits, and any further financial effects from the manufacturing-standard issue.
- Inventory levels and conversion to sales, given the first-half build and slower-than-anticipated commercial demand.
- Cash burn, liquidity runway, and the company’s ability to return to profitability without a credit facility.
- Customer and receivables concentration, especially ADS exposure, and the terms and performance of distributor arrangements.
- Whether the higher operating-cost base and new lease commitments can be supported by future revenue and margins.