Energy Focus, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; balance-sheet comparisons are to December 31, 2015. Energy Focus designs, develops, manufactures, and sells LED lighting, with a focus on tubular LED products for military maritime and commercial markets. Figures below are in millions of dollars except per-share data and percentages.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $8.26 | $18.34 | $23.81 | $47.15 |
| Gross profit / margin | $3.08 / 37.3% | $9.13 / 49.8% | $8.75 / 36.7% | $21.72 / 46.1% |
| Operating income (loss) | ($3.15) | $3.74 | ($9.04) | $8.17 |
| Net income (loss) | ($3.18) | $4.26 | ($9.08) | $7.50 |
| Diluted EPS | ($0.27) | $0.40 | ($0.78) | $0.72 |
- Q3 sales fell 54.9% year over year; nine-month sales fell 49.5%. Military maritime product sales were $4.66 million in Q3 and $12.30 million for nine months, versus $14.90 million and $39.78 million, respectively, in 2015.
- Commercial product sales increased 8.0% to $3.61 million in Q3 and 58.7% to $11.51 million for nine months. The nine-month comparison includes an $814,000 revenue reduction for product returns and customer credits.
- Management attributed lower gross margins primarily to sales and product mix: commercial products generally carry lower margins than military maritime products. Nine-month gross margin was also affected by the product-return and inventory adjustments.
- At September 30, cash and cash equivalents were $19.59 million, including $342,000 restricted cash, down from $34.64 million at year-end. Current assets were $39.74 million and current liabilities $5.60 million. Total liabilities were $5.70 million; the company reported no outstanding debt or credit facility.
- Cash used in operating activities was $13.65 million for nine months, versus $2.77 million provided in the prior-year period. Investing activities used $1.47 million; financing activities provided $77,000. Cash declined by $15.05 million during the period.
- Accumulated deficit was $89.13 million. Inventory rose to $14.02 million from $7.73 million, principally reflecting purchases to meet forecast demand, particularly for commercial products.
Material changes and unusual items
- Military maritime sales slowed from the rapid pace of 2015. The U.S. Navy IDIQ supply contract expired August 1, 2016; it generated about $2.1 million of sales in the first nine months of 2016. Other Navy sales through ship-level procurement were not affected by that expiration.
- In the second quarter, the company reduced revenue by $814,000 for returned products and related discounts on earlier shipments that did not conform to the specified manufacturing standard. The issue was not related to product safety or quality. Related inventory adjustments reduced cost of sales by $221,000; together the adjustments increased the nine-month net loss by $593,000. The company said it had credited affected customers and was improving sales, supply-chain, and manufacturing processes.
- Operating expenses increased as the company invested in commercial sales, marketing, product development, and supporting infrastructure. Nine-month selling, general, and administrative expense rose to $15.32 million from $11.62 million; product development expense rose to $2.47 million from $1.94 million.
- Commercial LED tube, globe, and troffer warranties were extended to ten years effective April 1, 2016. A limited number of Intellitube product failures associated with certain installation methods or ballasts were identified; management said they raised no health or safety concerns and were addressed under the standard warranty. The September 30 warranty reserve was $295,000.
Outlook, commentary, and risks
- No specific revenue, earnings, or cash-flow guidance is provided. Management said commercial sales continued to grow year over year, but large-order timing made sequential growth difficult to sustain. Sales cycles may span several months, and the company continues to invest in products, sales capacity, and marketing.
- Management identified customer and Navy concentration, reduced Navy demand, uncertain commercial-market growth, operating losses, and the need to generate cash or obtain financing as significant concerns. If cash generation is insufficient, the company may need to delay or scale back plans, cut costs, or reduce headcount.
- ADS, a Navy distributor, represented approximately 40% of Q3 sales and 32% of nine-month sales, and 65% of trade receivables at September 30. Navy products represented approximately 46% of Q3 and 40% of nine-month sales. The ADS distribution agreement was extended through March 31, 2017, with reduced minimum commitments for certain products through year-end 2016.
- The company had entered into non-cancellable leases for a New York sales office and its Solon, Ohio headquarters and manufacturing facility, with stated base rents of approximately $333,000 and $618,000 annually, respectively. The New York lease required $342,000 of restricted cash for a letter of credit.
- Management reported disclosure controls and procedures were effective as of September 30, 2016, and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether commercial growth can offset lower Navy demand, particularly following expiration of the IDIQ contract.
- Cash burn, inventory growth, and the company’s ability to fund operations without new financing.
- Customer concentration and ADS receivable exposure, including the terms and performance of the extended distributor agreement.
- The effect of the product-return adjustments and process improvements on future revenue, margins, and customer relationships.
- Warranty claims and reserve adequacy given the ten-year warranty and reported Intellitube failures.
- The cost and commitments associated with expanded operating infrastructure and multi-year leases.