Workhorse Group Inc. annual report, FY2020

Business context and reporting period

Workhorse Group Inc. (NASDAQ: WKHS) filed this Form 10-K for the fiscal year ended December 31, 2020. The company develops and manufactures electric commercial delivery trucks, including its C-Series, and delivery-drone systems. Its stated priority is scaling C-Series production and fulfilling customer orders. The filing provides annual results; it does not provide clear standalone fourth-quarter financial results.

Financial performance and position

• Revenue increased as initial C-Series production began, but cost of sales substantially exceeded sales; the company remained gross-loss-making.
• Reported net income was driven mainly by $323.1 million of other income, including a $317.5 million increase in the fair value of the Lordstown Motors Corp. (LMC) investment and a $4.8 million royalty advance. This was offset in part by $190.5 million of net interest expense, including large fair-value and conversion-related charges on convertible notes. Net income therefore does not reflect operating profitability.
• Year-end assets were $632.5 million, including a $330.6 million LMC investment. Stockholders’ equity was $395.2 million, versus a $34.9 million deficit at year-end 2019.
• Cash used in investing activities was $5.7 million; cash provided by financing activities was $292.4 million. Financing included convertible-note proceeds and warrant and option exercises.
• Restricted cash was $194.4 million at year-end, primarily proceeds from the October 2020 notes held in escrow and released in January 2021. Unrestricted cash was $46.8 million.
• Convertible notes had a $200 million contractual principal balance and a $197.7 million fair value at year-end. The 2024 notes bear 4% interest, are secured by substantially all company assets and include covenants, including a minimum-sales-backlog covenant beginning in 2022. A $1.4 million PPP note was forgiven in January 2021.

Material changes versus the prior comparable period

• Sales rose from $0.38 million to $1.39 million as C-Series production commenced, but the gross loss widened in dollars.
• Operating cash outflow increased by $33.4 million, which management attributed chiefly to C-Series ramp-up spending, labor costs and inventory build.
• Other income rose sharply due to the publicly traded LMC investment’s fair-value increase. The investment’s year-end value is market-price-sensitive; the filing estimates a hypothetical 30% adverse price move would reduce its value by about $99.2 million.
• Convertible-note fair-value and conversion charges increased substantially. During 2020, the company issued $200 million of senior secured notes and converted or exchanged earlier notes into shares.
• Common shares outstanding increased from 67.1 million at year-end 2019 to 121.9 million at year-end 2020; 123.5 million were outstanding on February 15, 2021.

Outlook, commentary, risks and unusual items

• Management’s strategy is to increase C-Series production and reduce costs, with a goal of achieving gross-margin profitability. The filing gives no quantified revenue or production guidance. Management said resources could support projected needs for several years if it can monetize its LMC investment; elsewhere it said resources were expected to support current and projected needs through 2021. Additional financing may be sought.
• Production was materially disrupted in Q4: approximately 40% of production employees tested positive for COVID-19, while supplier capacity constraints also limited shipments. Planned production volume was significantly reduced.
• The company reports orders from UPS totaling up to 1,405 vehicles, with the latest order dating to 2018, and a Pritchard purchase order received in November 2020. The filing warns that orders do not guarantee delivery, payment, repeat purchases or minimum future volumes.
• On February 23, 2021, after year-end, USPS awarded its Next Generation Delivery Vehicle contract to Oshkosh Defense, not Workhorse. Workhorse had delivered six prototypes.
• Key risks include production scale-up and cost control, supplier and battery availability, limited customer concentration, lack of long-term supply and customer commitments, cash burn, possible future financing and dilution, and competition. The filing also notes a reported global microchip shortage and uncertain effects on the company.
• Warranty expense was $2.1 million in 2020, primarily reflecting a revised estimate of labor needed to support 2016–2017 E-Series trucks; year-end warranty liability was $5.4 million.
• The All Cell patent case was settled for $250,000, paid in July 2020. In a separate fatal-accident lawsuit, the company was dismissed for lack of jurisdiction, but a plaintiff’s jurisdictional-discovery request remained pending as described in the filing.
• Grant Thornton issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective.

Important facts for investors to verify

1. Whether production, deliveries, unit costs and gross margins improve after the COVID-related Q4 disruption; the filing does not provide clear standalone Q4 results.
2. The size, composition and fulfillment status of the order backlog, including customer commitments, cancellation terms and payment protections.
3. Whether the LMC investment can be monetized, any restrictions on sale, and the effect of RIDE share-price changes on earnings, assets and liquidity.
4. Cash availability after escrow release, actual cash burn, financing needs and the ability to meet the secured notes’ interest, covenants and repayment obligations.
5. Share dilution from conversions, warrants, equity compensation or future capital raises, and the status of the Hackney transaction’s remaining payment and escrow arrangements.