Energy Focus, Inc. — Q2 2013 Form 10-Q
Business and period: Energy Focus designs, manufactures, markets, and installs energy-efficient lighting. Its two segments are Solutions, focused mainly on turnkey public-sector building projects, and Products, including pool, commercial, industrial, and government lighting. This unaudited report covers the three and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods. Amounts below are in millions unless noted.
Financial results and key metrics
| Metric | Q2 2013 | Q2 2012 | H1 2013 | H1 2012 |
|---|---|---|---|---|
| Net sales | $7.381 | $7.672 | $12.714 | $12.974 |
| Gross profit / margin | $2.022 / 27.4% | $1.704 / 22.2% | $3.223 / 25.4% | $2.489 / 19.2% |
| Operating loss | $(1.258) | $(0.739) | $(2.463) | $(2.425) |
| Net loss | $(0.679) | $(0.900) | $(2.107) | $(2.767) |
| Loss per share | $(0.01) | $(0.02) | $(0.05) | $(0.07) |
- Segment performance: Q2 Solutions sales were $1.983 million, down 6%; Products sales were $5.398 million, down 3%. Products segment income was $0.317 million versus $0.387 million, while Solutions had a $0.593 million segment loss versus a $0.107 million loss. H1 Products segment income was $0.326 million versus $0.106 million; Solutions segment loss was $0.781 million versus $0.493 million.
- Margins and expenses: Management attributed the Products margin improvement primarily to higher government-products sales and supply-chain improvements. Q2 Solutions margin fell to 10.5% from 20.3%, partly because of lower-margin projects and a large project where materials had shipped but installation was incomplete; revenue on those materials was not recognized until installation. Q2 operating expenses included a $0.325 million tradename impairment.
- Cash flow: H1 operating cash use was $3.538 million, versus $6.728 million in H1 2012; investing cash use was $0.151 million versus $0.107 million. Financing provided $4.780 million, principally from convertible debt. Cash and restricted cash ended June at $2.266 million, up from $1.181 million at year-end.
- Balance sheet and debt: At June 30, current assets were $10.378 million and current liabilities $7.881 million. Total liabilities were $12.004 million and shareholders’ equity $1.289 million. Total debt, including the $1.602 million revolving credit balance, was approximately $6.0 million; long-term debt, including current maturities and net of discounts, was $4.370 million. The $4.5 million asset-based credit facility expires December 31, 2014; the company reported covenant compliance.
Material changes and unusual items
- Sales decreased 4% in Q2 and 2% in H1. Pool and commercial products sales declined, partly offset in Products by higher government-products and R&D-services sales. Solutions backlog was $2.5 million at June 30, 2013, compared with $1.0 million a year earlier.
- Gross margin improved year over year, particularly in Products, but Q2 operating loss widened as operating expenses rose and the impairment was recorded. Net loss improved partly because of an $0.892 million gain from settling SRC acquisition obligations; this was not recurring operating revenue.
- Under the June 28 SRC settlement, the company paid $0.200 million and forgave a $0.078 million net receivable, while obligations for a $0.500 million special fee and a $0.500 million convertible note plus $0.092 million interest were cancelled. The company also agreed to stop using the Stones River Companies name by July 1, 2014, prompting the $0.325 million tradename write-off.
- The company received $4.8 million in unsecured convertible notes during H1. These notes bear 5% interest and are convertible at $0.23 per share; $1.0 million was converted into approximately 4.3 million shares during Q2. The notes generated a $1.5 million debt discount. Management expected another $1.0 million of convertible debt in Q3. Outstanding shares were 49,158,886 as of August 9, 2013.
Outlook, risks, and contingencies
- No specific sales or earnings guidance is provided. Management said reaching profitability and growth depends on improving margins, executing sales plans, cost reduction and supply-chain improvements, developing new products, and receiving additional orders on and fulfilling a $23.1 million U.S. Navy supply contract.
- The filing repeats that the auditor’s 2012 report raised substantial doubt about the company’s ability to continue as a going concern. The interim statements assume continued operations. Management said it remained optimistic about securing funding but provided no assurance; it was considering external financing, asset divestitures, or equity/debt issuance. Additional equity could dilute existing holders.
- Risks highlighted include persistent losses and cash use, the need for additional capital, execution and contract-order risks, collections, competition, and intellectual-property costs. The company reported an accumulated deficit of $82.7 million. It also had approximately $70.7 million of tax net operating loss carryforwards at year-end 2012, which may be significantly limited under Section 382.
- Related-party matters include a business-development agreement with an entity associated with Executive Chairman James Tu. The company agreed to pay an additional $425,000 through December 2013, paid $175,000 in H1, and recorded $113,000 of H1 expense. The filing reports no commissions earned under the agreement through June 30, 2013.
Important facts for investors to verify
- Whether the expected additional $1 million of convertible financing was received and whether further financing is available on acceptable terms.
- Actual Navy contract orders, delivery and installation progress, revenue recognition, and the effect on cash and gross margins.
- Whether the $2.5 million Solutions backlog converts to recognized revenue and cash, given project timing and installation requirements.
- Debt conversion terms, potential dilution from convertible notes and outstanding options and warrants, and ongoing credit-facility availability and covenant compliance.
- Progress on profitability and cash conservation, including the effects of the SRC settlement and related-party agreement payments.