Workhorse Group Inc. quarterly report, Q3 FY2019

Workhorse Group Inc. — Q3 2019 Form 10-Q

Reporting period: Three and nine months ended September 30, 2019; balance-sheet comparisons are with December 31, 2018. Workhorse develops and manufactures electric commercial vehicles and related technologies, with a focus on bringing its N-GEN electric cargo van to market and fulfilling its order backlog. The unaudited statements are consolidated.

Financial performance and position

• Margins: Gross loss persisted despite cost of sales exceeding net sales by a wide margin. Revenue was too low for a meaningful positive gross margin.
• Cash flow: Nine-month operating cash use was $24.14 million, versus $17.33 million in 2018. Investing cash use was $4.00 million, mainly for tooling, versus $0.13 million. Financing provided $36.78 million, versus $16.38 million.
• Liquidity: September 30 cash and cash equivalents were $9.26 million, plus $0.90 million restricted cash. Current assets were $18.95 million and current liabilities $39.43 million, implying negative working capital of approximately $20.48 million.
• Debt and other obligations: Net Marathon debt was $14.56 million, including $6.35 million classified as current. The balance sheet also included $18.77 million of mandatorily redeemable Series B preferred stock, a $19.90 million warrant liability, and a $1.34 million Duke financing obligation.
• Equity: Stockholders’ deficit was $38.36 million at September 30, versus $15.42 million at year-end 2018. Common shares outstanding were 66.19 million at September 30 and 66.86 million at October 31.

Changes versus prior comparable period

• Nine-month sales fell about 50%, which management attributed primarily to fewer trucks sold, partly offset by improved pricing. Management cited the strategic shift toward N-GEN development as a reason for lower truck volume.
• Nine-month operating expenses declined, with SG&A down from $8.77 million to $6.64 million and R&D down from $5.68 million to $4.22 million. Q3 R&D, however, increased year over year because of prototype development spending.
• Nine-month net loss roughly doubled. Net interest expense rose to $23.58 million from $0.26 million, mainly due to a $19.1 million warrant fair-value adjustment and higher debt levels. The warrant remeasurement is noncash and materially affected reported earnings.
• Cash increased from $1.51 million at year-end, supported by the $25 million Series B financing, $5.85 million of Marathon borrowing, and common-stock issuance; operating and investing activities consumed cash.

Outlook, risks, contingencies and unusual items

• Funding and going concern: Management said existing capital resources and the Marathon revolver were expected to fund operations through the end of 2019, but stated that substantial doubt exists about the Company’s ability to continue as a going concern absent additional financing, increased revenue, cost reductions, or a strategic relationship. Further funding is needed and is not assured.
• Credit covenants: Marathon financial covenants begin in Q4 2019, including a $4 million minimum liquidity requirement and leverage and debt-service tests. Management expected to meet them through operations or an equity cure; failure could create credit-agreement risk. The facility also requires $0.9 million of restricted cash.
• Capital structure: The $25 million Series B preferred financing carries an 8% annual dividend and mandatory redemption in June 2023, plus warrants. Preferred dividends are recorded as interest expense. Further equity financing could dilute shareholders; debt may impose restrictive covenants.
• Business execution: The Company is ramping production and developing N-GEN vehicles, but revenue remains very small. Management’s cost savings, performance, market-demand and return-on-investment statements are expectations, not reported results.
• Subsequent events: After quarter-end, Workhorse agreed to sell SureFly for $4 million, subject to lender approval; entered a Hackney asset purchase agreement for $7 million, with a $6 million second payment and escrowed cash and shares; and licensed W-15-related intellectual property to Lordstown Motors for equity and potential advance, royalties and commissions. Lordstown payments depend on its capital raise and other conditions, and transfer of approximately 6,000 existing orders requires customer consent.
• Legal and controls: All Cell Technologies and Illinois Institute of Technology sued for patent infringement; Workhorse disputes the claims and intends to defend itself. Management reported disclosure controls were ineffective because of unremediated material weaknesses involving financial-reporting monitoring and reliance on manual entries in the absence of a fully implemented ERP system.

Key facts for investors to verify

• Whether N-GEN production, customer orders and deliveries produce material revenue and improve gross margins.
• Actual cash burn, available revolver capacity and the timing and terms of any additional financing; the filing’s stated runway was only through year-end 2019.
• Compliance with Marathon covenants, including the liquidity minimum and any use of the equity cure.
• The cash and dilution effects of the preferred-stock dividends and redemption, warrants, and Hackney purchase obligations.
• Whether the SureFly sale closes and whether Lordstown raises capital, fulfills transferred orders and generates payments to Workhorse.
• Progress in remediating internal-control weaknesses and developments in the patent litigation.