Energy Focus, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Financial statement amounts below are in millions of dollars unless otherwise noted. The company designs, manufactures, markets, and installs energy-efficient lighting. It sold its pool-products business in 2013 and began shifting resources away from turnkey lighting solutions toward LED products during Q3 2014.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $7.890 | $4.827 | $19.508 | $14.938 |
| Gross profit / margin | $2.558 / 32.4% | $0.930 / 19.3% | $6.154 / 31.5% | $3.051 / 20.4% |
| Operating loss | $(0.322) | $(1.678) | $(1.957) | $(4.656) |
| Net loss | $(0.403) | $(1.651) | $(5.095) | $(3.758) |
| Loss per share | $(0.05) | $(0.34) | $(0.70) | $(0.80) |
- Q3 sales rose 63.5%; nine-month sales rose 30.6%. Product-segment sales increased 181.5% in Q3 and 76.5% year to date, primarily on high-volume U.S. Navy orders. Solutions sales fell 89.4% in Q3 and 39.9% year to date as the company reduced turnkey activity.
- Q3 gross margin improvement reflected product volume and mix, operational efficiencies, supply-chain improvements, and scale. Solutions recorded an $85,000 gross loss in Q3 after cost estimates increased on two projects.
- Nine-month net loss widened year over year, despite improved operating performance, in part because 2014 included $2.7 million of interest expense tied to converting the unsecured convertible notes. The charge included a $2.3 million noncash discount write-off and $154,000 of additional interest. Excluding these charges, management said the nine-month continuing-operations loss would have decreased by $2.1 million year over year.
- Cash used in operations was $2.749 million for the first nine months, compared with $4.263 million in 2013. Investing activities used $53,000; financing activities provided $6.676 million. Cash and cash equivalents were $6.737 million at September 30, including $130,000 restricted cash and $300,000 held in escrow.
- At September 30, current assets were $15.754 million and current liabilities were $6.839 million. Credit-line borrowings were $736,000; long-term debt, including current maturities, was $249,000. The company reported approximately $1.2 million available under its domestic credit line.
Material changes and unusual items
- The company raised $5.15 million net through an August public offering of 1,351,250 shares, including the underwriters’ overallotment. It also issued the underwriter a warrant for 47,000 shares at $5.40 per share.
- Convertible-note holders converted $6.15 million of principal into 2,671,739 common shares effective March 31, 2014. The company’s 1-for-10 reverse stock split became effective July 16; reported share and per-share amounts are restated for the split.
- The pool-products sale escrow had $300,000 remaining at quarter-end, subject to resolution of buyer claims. No 2014 revenue came from discontinued operations.
- Q3 R&D expense reported in operating expenses increased to $232,000 from $57,000, while gross R&D spending declined year over year as the company focused on LED-related work and reduced research-contract activity.
Outlook, liquidity, and risks
- No quantified earnings or revenue guidance was provided. Management expressed optimism about reducing operating losses and securing funding, but gave no assurance those goals would be achieved.
- The company disclosed that its 2013 auditor’s report raised substantial doubt about its ability to continue as a going concern. It had an accumulated deficit of $88.1 million at September 30 and stated that additional financing may be needed for operations, working capital, and growth.
- The Rosenthal & Rosenthal revolving credit facility, secured by domestic assets, was due to expire December 31, 2014. Management was pursuing a replacement and anticipated a new arrangement in Q1 2015. The company reported covenant compliance at September 30.
- Risks include inability to obtain replacement or other financing, further equity dilution or restrictive debt terms, continued losses, and the possibility of delaying or scaling back the business plan. Execution depends on growing targeted commercial and government sales, converting solutions opportunities to product sales, developing sustainable products, maintaining margins, and improving supply-chain performance.
- Revenue concentration is material: Q3 government product sales were $6.002 million, primarily associated with high-volume U.S. Navy orders. Solutions projects also carry estimation risk, as shown by upward cost revisions on two Q3 jobs.
- The company had $300,000 of sale proceeds in escrow subject to buyer claims; it also maintained a $76,000 product-warranty liability. A full valuation allowance was recorded against U.S. deferred tax assets.
Investor verification points
- Confirm the timing, size, and repeatability of U.S. Navy orders and the company’s customer concentration.
- Track replacement financing for the credit facility, its terms, and liquidity after the facility’s December 2014 expiry.
- Assess whether the improved gross margins and product growth continue as the company shifts away from turnkey solutions.
- Review cash burn, the effect of working-capital needs, and progress toward profitability and going-concern sustainability.
- Monitor resolution of the $300,000 escrow claims and any further dilution from shares, options, or warrants.