Energy Focus, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Energy Focus designs, manufactures, markets, and installs energy-efficient lighting. It completed its remaining turnkey “solutions” projects in Q1 2015 and shifted its focus to developing and selling LED products in commercial and government markets.
Financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $16.6 million | $6.7 million | $29.8 million | $11.6 million |
| Gross profit / margin | $7.6 million / 45.9% | $2.2 million / 32.5% | $13.0 million / 43.8% | $3.6 million / 31.0% |
| Operating income (loss) | $3.1 million | $(0.6) million | $4.3 million | $(1.6) million |
| Net income (loss) | $2.1 million | $(0.6) million | $3.2 million | $(4.7) million |
| Diluted EPS | $0.21 | $(0.08) | $0.32 | $(0.72) |
Sales growth was driven primarily by high-volume government product sales to a U.S. Navy distributor; Q2 also included the first shipment for the Royal Australian Navy. Government product sales were $14.1 million in Q2 and $24.9 million for the first half. Commercial sales were $2.5 million and $4.8 million, respectively. Improved product mix, lower supplier costs, value engineering, and operating efficiencies lifted gross margins. SG&A and product-development spending rose as the company expanded its sales infrastructure and developed its Intellitube product line.
First-half results in 2014 included approximately $2.7 million of one-time noncash charges related to conversion of convertible notes. Q2 2015 included a $36,000 loss on sale of discontinued operations; the first-half discontinued-operations loss was $72,000. The first-half 2015 tax provision was $913,000, and Q2’s was $923,000.
Cash, liquidity, and debt
- Cash and cash equivalents were $10.2 million at June 30, 2015, versus $7.5 million at year-end. The reported balance included $136,000 of restricted cash and $300,000 held in escrow.
- For the first half, operating cash flow was positive $424,000, investing cash flow was negative $360,000, and financing cash flow was positive $2.6 million. Financing included $2.5 million from warrant exercises. Increased inventory and accrued taxes partly offset earnings in operating cash flow.
- Inventory rose to $9.8 million from $7.3 million. Accounts payable fell to $4.9 million from $7.6 million.
- Credit-line borrowings were $455,000; approximately $1.7 million was available under the asset-based facility. The company also reported $70,000 of long-term debt. It was in compliance with facility covenants at quarter-end. The lender may terminate the facility with 60 days’ notice.
- Accumulated deficit was $85.6 million. Management cautioned that continued profitability and growth depend on executing sales plans, developing products, improving operations, and potentially obtaining external financing.
Material changes, outlook, and risks
- Net sales increased 148.1% year over year in Q2 and 156.2% for the first half. Government product sales drove the increase; turnkey solutions sales were zero in Q2 as the company completed its exit from that business.
- Customer concentration is substantial: one customer represented approximately 77% of Q2 sales and 79% of first-half sales, and 64% of receivables at June 30. The filing identifies a U.S. Navy distributor as the source of high-volume government sales.
- The company provided no quantified financial guidance. Management noted that failure to generate cash or secure financing could require delaying or scaling back its plans, reducing costs, or cutting headcount.
- The $4.5 million revolving facility is secured by domestic assets and has borrowing rates of 8.5% on receivables and 10% on inventory. The U.K. subsidiary’s invoice-discounting arrangement ended in January 2015; no replacement was in place at quarter-end.
- A former-employee lawsuit was settled in May; the company paid the settlement and recorded $330,000 of first-half SG&A expense. Separately, $300,000 from the 2013 pool-products sale remained in escrow amid buyer claims; the company could not estimate a reasonably possible loss range.
- After quarter-end, on August 4, 2015, the company sold its U.K. subsidiary, Crescent Lighting Limited, for nominal consideration and forgave intercompany balances. It did not expect a material loss; the subsidiary had first-half sales of $923,000.
- The company had a full valuation allowance against deferred tax assets. Tax-loss carryforwards are subject to Section 382 annual limitations that restrict their use.
- Management concluded disclosure controls were effective as of June 30, 2015; no significant changes to the previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether high sales to the concentrated government customer and Navy-related demand are sustained, and how customer concentration evolves.
- Whether gross margins, commercial-market growth, and operating cash generation continue as inventory and sales scale.
- Availability and renewal terms of the revolving credit facility, and whether additional financing is needed.
- Resolution and potential financial impact of the pool-sale escrow claims, and the accounting and operational effects of the U.K. subsidiary sale.
- Actual tax payments and the extent to which Section 382 limits use of tax-loss carryforwards.