Vuzix Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014; financial statements are unaudited. Vuzix designs, manufactures and sells wearable display devices, including Video Eyewear and smart glasses.
Financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $723,258 | $700,195 | $1,521,676 | $1,439,378 |
| Gross profit / margin | $261,018 / 36% | $293,573 / 42% | $609,187 / 40% | $695,371 / 48% |
| Operating loss | $(925,300) | $(1,107,871) | $(1,918,449) | $(1,813,547) |
| Net income (loss) | $239,110 | $(1,656,736) | $1,751,016 | $(2,593,034) |
| Operating cash flow | Not presented by quarter | $(1,978,999) | $(738,789) |
Q2 revenue rose 3%; first-half revenue rose 6%. Product sales increased while engineering-services revenue declined. Product sales growth was attributed primarily to M100 smart glasses; fewer active Navy waveguide development programs reduced engineering revenue. Gross margin fell as M100 sales represented a larger share of revenue than higher-margin AR Video Eyewear.
Reported net income does not reflect profitable operations: it was driven mainly by non-cash derivative revaluation gains of $1,248,556 in Q2 and $3,823,818 for the first half. First-half net income therefore coexisted with an operating loss and negative operating cash flow. No income tax provision was recorded.
Financial position and funding
- Cash was $1,971,311 at June 30, up from $310,140 at year-end 2013. Current assets were $3,115,010 and current liabilities $3,114,482, leaving working capital of just $528, versus a $1,981,232 deficit at year-end.
- Total liabilities were $13,312,943; stockholders’ deficit was $8,472,256. Accounts payable were $2,092,915.
- In June, Vuzix issued $3 million of 5% senior secured convertible notes, due June 3, 2017, with no scheduled principal payments before maturity. Notes are convertible initially at $2.25 per share, subject to adjustment, and secured by a first-priority interest in company assets. Their reported net carrying value was $1,305,900 after debt discount.
- Cash from financing activities was $4,249,806 for the first half, including $3 million from the notes and $1,586,691 from warrant exercises. Cash used in investing was $609,636, including $482,196 of capitalized software development costs.
- Common shares outstanding were 10,315,141 at June 30; the filing reports 10,563,196 outstanding as of August 14, 2014.
Outlook, risks and unusual items
- Management expected the June note financing to fund its current operating plan and planned new-product development through the remainder of 2014. It also said increased product sales are necessary to reach positive operating cash flow.
- The filing repeats that substantial doubt exists about Vuzix’s ability to continue as a going concern, citing recurring losses, cash needs and past-due payables. Management warned that additional financing may be required; it may not be available on acceptable terms, and equity or convertible financing could dilute shareholders. Failure to secure funding or achieve product success could force cuts or delays to operations, R&D and commercialization.
- Management’s liquidity measures included managing inventory and costs, emphasizing higher-margin products, developing waveguide and HD display products, deferring some R&D or product plans, seeking additional financing and exploring IP licensing. Management gave no assurance these actions would be sufficient or timely.
- Derivative liabilities totaled $8,961,351, measured using valuation models with significant unobservable inputs. Changes in these estimates materially affected reported earnings.
- Disclosure controls were deemed ineffective at June 30 because previously identified material weaknesses had not been remediated. Weaknesses included the financial close and reporting process, segregation of duties, subsidiary monitoring, inventory controls, and documented internal-control and risk-assessment procedures. Management said additional procedures supported the fair presentation of the statements.
- The filing reports no pending litigation and no material change to the risk factors disclosed in the 2013 Form 10-K.
Investor verification points
- Assess cash runway and near-term funding needs given negative operating cash flow and only $528 of working capital.
- Separate recurring operating performance from derivative fair-value gains when evaluating reported net income.
- Review the secured convertible notes’ adjustment and conversion terms, potential dilution, and the substantial derivative liability.
- Track M100 sales, product gross margins, engineering-program revenue and whether new products generate sustained operating cash flow.
- Monitor remediation of material weaknesses and the reliability of inventory valuation and financial reporting controls.