Energy Focus, Inc. — Q2 2019 Form 10-Q
Business and period: Energy Focus designs and sells energy-efficient LED lighting for commercial and military customers. This unaudited report covers the three and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Net sales | $3.082 million | $5.172 million | $6.259 million | $9.831 million |
| Gross profit (loss) | $(0.109) million | $1.296 million | $(0.011) million | $2.112 million |
| Gross margin | (3.5)% | 25.1% | (0.2)% | 21.5% |
| Operating loss | $(2.149) million | $(1.801) million | $(4.952) million | $(4.211) million |
| Net loss | $(2.254) million | $(1.804) million | $(5.119) million | $(4.194) million |
| Loss per share, basic and diluted | $(0.18) | $(0.15) | $(0.42) | $(0.35) |
- Cash flow: First-half operating cash use was $5.120 million, versus $2.300 million in 2018. Investing used $28,000; financing provided $1.015 million, including $1.7 million of convertible-note proceeds and net $568,000 of credit-line repayments. Cash and cash equivalents fell by $4.128 million to $2.207 million, including $342,000 restricted cash.
- Balance sheet at June 30: Total assets were $14.869 million, total liabilities $8.717 million, and stockholders’ equity $6.152 million. Current assets were $12.212 million and current liabilities $7.142 million. Accumulated deficit was $122.620 million.
- Debt and liquidity: Total debt was approximately $3.4 million: $1.652 million drawn on the revolving credit facility and $1.7 million in subordinated convertible notes. The credit-line rate was 7.50%, with approximately $0.3 million available. Notes mature December 31, 2021 and bear 5% interest through June 30, 2019 and 10% thereafter; they may automatically convert into Series A preferred stock subject to stockholder approvals.
- Other balance-sheet items: Net inventory was $7.667 million. Adoption of the new lease standard added approximately $2.9 million of operating lease liabilities; at quarter-end, operating and restructured lease liabilities totaled $2.429 million.
Changes versus prior period
- Q2 sales fell 40.4%; first-half sales fell 36.3%. Military sales decreased 56.8% in Q2 and 53.9% for the first half. Commercial sales decreased 28.3% in Q2 and 20.5% for the first half.
- Management attributed lower military sales largely to timing and fulfillment of U.S. Navy awards. Commercial results reflected project timing and size, and lower sales through an agency network being consolidated and deemphasized.
- Gross margin turned negative. The company cited unfavorable inventory reserves of $0.5 million in Q2 (14.7% of sales) and $0.4 million for the first half (6.8% of sales). Lower operating expenses partly offset lower gross profit: first-half product development and SG&A declined by approximately $0.5 million and $1.3 million, respectively.
- First-half net loss increased by $0.925 million year over year, while operating cash use increased by $2.820 million.
Outlook, risks, and unusual matters
- Going concern and funding: Management stated that substantial doubt about the company’s ability to continue as a going concern remained at June 30. It said that, if its funding, restructuring, inventory, product-development, and sales-channel plans are adequately executed, it believes operations can be financed through 2020. This is conditional, not a guarantee; the company said additional funding may not be available on acceptable terms, on time, or at all. Failure to secure financing could require further cuts, asset sales, or curtailed operations.
- Restructuring and leadership: First-half actions included eliminating 12 positions, closing the San Jose and Taipei offices, reorganizing sales and management, reducing compensation, and outsourcing certain functions. Related severance charges were approximately $0.2 million. CEO and CFO leadership changed effective April 2019; a new CFO assumed the role July 1.
- Customer concentration: In the first half, two customers represented approximately 28% and 17% of sales; U.S. Navy-related sales represented approximately 26%. The company also cited long and unpredictable sales cycles, reliance on government funding, supplier and shipping dependencies, competition, and the need to raise capital.
- Controls and listing: Management concluded disclosure controls were not effective because of a material weakness tied primarily to inadequate segregation of duties and finance staffing. The company was using external consultants and described planned remediation. Nasdaq had notified the company of a minimum-bid-price deficiency in May; the filing says the company was monitoring options to cure it. A separate August notice for late SEC reporting was resolved by filing this report.
- Other items: The company recorded an approximately $0.2 million impairment of its Solon lease right-of-use asset on adoption of the lease standard. It had approximately $0.9 million of inventory purchase commitments at June 30. No material legal proceedings were reported. No specific sales or earnings guidance was provided.
Important facts for investors to verify
- Whether the company obtained sufficient additional financing and whether its stated ability to fund operations through 2020 remained achievable.
- Subsequent sales, gross margins, inventory reserves, and operating cash burn, particularly given the negative Q2 gross margin.
- Progress on customer diversification and the timing of military awards and large commercial projects.
- Terms and status of the convertible notes, potential conversion and dilution, and available credit-line capacity.
- Remediation of the material weakness, Nasdaq bid-price compliance, and the effect of lease obligations and inventory purchase commitments on liquidity.