Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
SPECIAL NOTE
REGARDING FORWARD-LOOKING STATEMENTS
This
section and other parts of this Quarterly Report on Form 10-Q
(“Form 10-
Q
”) contains forward-looking statements within the meaning of U.S. federal securities laws
.
Forward-looking statements are any statements that look to future events and include, but are not limited to, statements regarding our future liquidity, financial performance and capital expenditures; the sufficiency of our existing cash and cash equivalents to meet our working capital and capital expenditure needs over the next 12 months; our ability to successfully identify new customers and business opportunities and retain or expand our relationship with current customers; our ability to manage uncertainty with respect to product demand, product costs and end of life-cycle planning; our ability to execute on our strategic plan and realize benefits from initiatives related to streamlining our operations, cost-cutting measures and the introduction of new products; our ability to attract and retain key personnel; our ability to maintain and enhance the quality, safety and efficacy of our products; general economic and business conditions in our markets and our ability to improve our gross
profit
and achieve profitable growth; and the outcome in any pending and future litigation. In addition, forward-looking statements also consist of statements involving trend analyses and statements including such words as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “predicts” and similar terms and variations thereof. These forward-looking statements speak only as of the date of this Form 10-
Q
and are subject to business and economic risks. As such, our actual results may differ significantly from the results discussed in the forward-looking statements.
Factors that might cause such differences include, but are not limited to, those discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 201
5
filed with the U.S. Securities and Exchange Commission (
the
“SEC”) on
April 14, 2016
(the “Form 10-K”) and the
c
ondensed
c
onsolidated
f
inancial
s
tatements and notes thereto included elsewhere in this Form 10-Q.
We assume no obligation to revise or update any forward-looking statements for any reason except as required by law.
Company Overview
We are an innovator and global provider of light emitting diode (“LED”) lighting technology. We design, develop and market advanced, environmentally sustainable and differentiated illumination solutions that exclusively use LEDs as their light source. Our product portfolio includes LED-based retrofit lamps (replacement bulbs) used in existing light fixtures as well as purpose-built LED-based luminaires (light fixtures). Our lamps and luminaires are used for many common indoor and outdoor residential, commercial, industrial and public infrastructure lighting applications and include LED lighting technology whose color is tuned to achieve specific biological effects. We believe our proprietary technology, unique designs and key relationships throughout the LED lighting supply chain position us favorably to capitalize on the expanding acceptance of LEDs as a lighting source.
Our strategic plan for the next three fiscal years consists of creating strong biologically correct lighting brands in the consumer, residential, commercial and industrial markets. We believe that developing innovative and differentiated brands will deliver strong financial returns and a more loyal user base that is less price sensitive. We intend to continue to implement a nimble and agile “go-to-market” business model and manufacturing and product development system to streamline the processes used to introduce new products. We also intend to continue focusing on developing breakthrough innovation and on becoming a market maker in targeted value-added, high-margin segments within the lighting market. Finally, we plan to reduce our cost structure, preserve cash flow and strengthen liquidity to enhance our financial position.
Over the past few years, we have focused on expanding and optimizing our global supply chain to meet forecasted demand for our products while addressing the inefficiencies that have compressed our gross profit and overall financial performance in prior periods such as costs incurred to expedite the production or delivery of component parts. We anticipate long-term gross profit improvement as we continue to execute on our initiatives. We completed one of our most critical initiatives in 2014 with the transition of the manufacturing of our high volume lamps from Mexico and Satellite Beach to our contract manufacturing partners in Asia, from which we source the majority of our components. In 2015, we opened a new distribution center in Seattle, Washington in order to reduce the transit time for products from Asia and to provide us with an additional port through which we can import goods. A labor dispute at the Port of Los Angeles in 2015 caused work slowdowns and, as a result, affected the timing and predictability of our deliveries. We believe that our additional distribution facility will help to better maintain the continuity of our supply chain and improve our supply-to-cash cycle time.
LED Lighting Industry Trends
There are a number of industry factors that affect our business and results of operations including, among others:
|
•
|
Rate and extent of adoption of LED lighting products
. Our potential for growth will be driven by the rate and extent of adoption of LED lighting within the general illumination market and our ability to affect this rate of adoption through the offering of competitive lighting solutions. Although LED lighting is relatively new, its adoption has grown in recent years. Innovations and advancements in LED lighting technology that improve product performance and reduce product cost continue to enhance the value proposition of LED lighting for general illumination and expand its potential commercial applications.
|
|
•
|
External legislation and subsidy programs concerning energy efficiency
. The United States and many countries in the European Union and elsewhere have already instituted, or have announced plans to institute, government regulations and programs designed to encourage or mandate increased energy efficiency in lighting. These actions include in certain cases banning the sale after specified dates of certain forms of incandescent lighting, which is advancing the adoption of more energy efficient lighting solutions such as LEDs. In addition, the growing demand for electricity is increasingly driving utilities and governmental agencies to provide financial incentives such as rebates for energy efficient lighting technologies in an effort to mitigate the need for investments in new electrical generation capacity. While this trend is generally positive for us, from time to time there have been political efforts in the United States to change or limit the effectiveness of these regulations.
|
|
•
|
Intellectual property
. LED market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection and licensing of intellectual property is critical. Therefore, LED lighting industry participants often take steps such as additional patent applications, confidentiality and non-disclosure agreements as well as other security measures. To enforce or protect intellectual property rights, market participants commonly commence or threaten litigation.
|
|
•
|
Intense and constantly evolving competitive environment.
Competition in the LED lighting market is intense. Many companies have made significant investments in LED lighting development and production equipment. Traditional lighting companies and new entrants are investing in LED based lighting products as LED adoption has gained momentum. Product pricing pressures are significant and market participants often undertake pricing strategies to gain or protect market share, enhance sales of their previously manufactured products and open new applications to LED based lighting solutions. To remain competitive, market participants must continuously increase product performance and reduce costs.
|
Financial Results
The following table sets forth our revenue, cost of goods sold and gross profit for the three months ended March 31
, 2016 and 2015:
|
|
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
17,098,013
|
|
|
$
|
19,371,545
|
|
Cost of goods sold
|
|
|
13,619,103
|
|
|
|
16,441,297
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
3,478,910
|
|
|
$
|
2,930,248
|
|
|
|
|
|
|
|
|
|
|
GAAP gross profit percentage
|
|
|
20.3
|
%
|
|
|
15.1
|
%
|
Our revenue is primarily derived from sales of our LED-based retrofit lamps and luminaires. Our revenue decreased by $2.3 million during the three months ended March 31, 2016 as compared to the three months ended March 31, 2015. This decrease in revenue was due to a decrease in sales to commercial customers of $2.0 million and a $365,000 decrease in sales to The Home Depot, Inc. (“The Home Depot”).
We continue to pursue new relationships with retailers and original equipment manufacturers (“OEMs”) to help increase and diversity our sales. In addition, we have increased the roster of distributors and independent sales agents that sell our products and added experienced professionals to our direct sales force to increase the frequency and impact of our activities with key national accounts that are targets for potential adoption of LED lighting.
Our gross profit is principally driven by the mix and quantity of products we sell. Our financial results are dependent upon the operating costs associated with our supply chain, including materials, labor and freight, and the level of our selling, distribution and administrative, research and development and other operating expenses. We continuously seek to improve our existing products and to bring new products to market. As a result, many of our products have short life cycles and
, therefore, product life cycle planning is critical. At times we may purchase excess components and other materials used in the manufacture and assembly of our products or we may manufacture finished products in excess of demand. In addition, components, materials and products may become obsolete earlier than expected. These circumstances may require us to record inventory reserves and provisions for expected losses on non-cancellable purchase commitments. When these circumstances are present, we may also incur additional expense as we adjust our supply chain and product life-cycle planning.
During the three months ended March 31, 2016, our gross profit improved to 20.3% compared to 15.1% for the three months ended March 31, 2015. This improvement was due to changes in the mix of products sold (more sales from higher margin inventory), as well as lower charges for inventory reserves and for warranty expenses.
Non-GAAP Financial Measures
Although our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”), we believe the following non-GAAP financial measures provide additional information that is useful to the assessment of our operating performance and trends. As part of our on-going review of financial information related to our business, we regularly use non-GAAP measures, particularly non-GAAP adjusted gross profit and non-GAAP adjusted operating expense as a percentage of revenue, as we believe they provide meaningful insight into our business and useful information with respect to the results of our operations. These non-GAAP financial measures are not in accordance with, nor are they a substitute for, the comparable GAAP financial measures and are intended to supplement our financial results that are prepared in accordance with GAAP. The adjusted presentation below is used by management to measure our business performance and we believe it provides useful information regarding the trend in gross profit percentage based on revenue from sales of our products to customers.
We define non-GAAP adjusted cost of goods sold as costs of goods sold less provisions for inventory write-offs. Non-GAAP adjusted gross profit was 20.3% of revenue for the three months ended March 31, 2016 compared to 16.5% for the three months ended March 31, 2015.
We define non-GAAP adjusted operating expenses as total operating expenses less non-cash expenses for stock based compensation, restructuring expenses and depreciation and amortization. Non-GAAP adjusted operating expenses for the three months ended March 31, 2016 increased 4.5% while revenue decreased 11.7% compared to the three months ended March 31, 2015. Non-GAAP adjusted operating expenses represented 32.8% of revenue for the three months ended March 31, 2016 compared to 27.7% of revenue for the three months ended March 31, 2015.
|
|
Three Months Ended March 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
17,098,013
|
|
|
$
|
19,371,545
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
|
13,619,103
|
|
|
|
16,441,297
|
|
Deduct:
|
|
|
|
|
|
|
|
|
Provisions for inventory write-offs
|
|
|
-
|
|
|
|
271,452
|
|
|
|
|
|
|
|
|
|
|
Adjusted cost of goods sold
|
|
|
13,619,103
|
|
|
|
16,169,845
|
|
|
|
|
|
|
|
|
|
|
Adjusted gross profit
|
|
$
|
3,478,910
|
|
|
$
|
3,201,700
|
|
|
|
|
|
|
|
|
|
|
Non-GAAP adjusted gross profit percentage
|
|
|
20.3
|
%
|
|
|
16.5
|
%
|
|
|
|
|
|
|
|
|
|
Total operating expense
|
|
$
|
6,378,136
|
|
|
$
|
6,866,670
|
|
Less:
|
|
|
|
|
|
|
|
|
Issuance of restricted stock and stock options for directors
compensation
|
|
|
11,903
|
|
|
|
11,101
|
|
Non-cash stock option and restricted stock
compensation expense
|
|
|
544,706
|
|
|
|
905,396
|
|
Restructuring expense
|
|
|
-
|
|
|
|
83,704
|
|
Depreciation and amortization
|
|
|
221,073
|
|
|
|
506,072
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses, excluding stock based compensation,
restructuring and depreciation and amortization
|
|
$
|
5,600,454
|
|
|
$
|
5,360,397
|
|
|
|
|
|
|
|
|
|
|
GAAP operating expenses as a
percentage of revenue
|
|
|
37.3
|
%
|
|
|
35.4
|
%
|
|
|
|
|
|
|
|
|
|
Non-GAAP adjusted operating expenses as a
percentage of revenue
|
|
|
32.8
|
%
|
|
|
27.7
|
%
|
During 2014 and 2013, we adapted our supply chain and logistics processes to improve our ability to provide more efficient service to our customers and focus our efforts on developing innovative products. We continued to make improvements in our forecasting and finished goods inventory management, continued the transition of our manufacturing processes to lower cost contract manufacturers in Asia and continued to enhance our new product innovation process.
We believe that the changes we initiated improved our management and manufacturing infrastructure, expanded our ability to source components and manufacture our products internationally and positioned us for organic growth. We believe these improvements will position us to capitalize on the innovative, science based and creative engineering talent at our Florida research and development facility, which we believe provides us with a competitive advantage. In addition to developing products targeted at mainstream retail and commercial lighting, we are seeking to expand our product offerings to compete across multiple industry verticals.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and consolidated results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. Our actual results may differ from these estimates. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates may change as new events occur, additional information is obtained and our operating environment changes. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our financial statements.
We believe that our critical accounting policies relate to our more significant estimates and judgments used in the preparation of our condensed consolidated financial statements. Our Annual Report on Form 10-K for the year ended December 31, 2015 contains a discussion of these critical accounting policies. There have been no significant changes in our critical accounting policies since December 31, 2015. See also Note 2 to our unaudited condensed consolidated financial statements for the three months ended March 31, 2016 as set forth herein.
Results of Operations
Three Months Ended
March 31
, 201
6
Compared to the Three Months Ended
March 31
, 201
5
The following table sets forth statement of operations data expressed as a percentage of total revenue for the periods indicated:
|
|
Three Months Ended March 31,
|
|
|
Variance
|
|
|
Percentage of Revenue
|
|
|
|
2016
|
|
|
2015
|
|
|
|
$
|
|
|
%
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
17,098,013
|
|
|
$
|
19,371,545
|
|
|
|
(2,273,532
|
)
|
|
|
-11.7
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of goods sold
|
|
|
13,619,103
|
|
|
|
16,441,297
|
|
|
|
(2,822,194
|
)
|
|
|
-17.2
|
%
|
|
|
79.7
|
%
|
|
|
84.9
|
%
|
Selling, distribution and administrative
|
|
|
5,076,064
|
|
|
|
5,095,581
|
|
|
|
(19,517
|
)
|
|
|
*
|
|
|
|
29.7
|
%
|
|
|
26.3
|
%
|
Research and development
|
|
|
1,080,999
|
|
|
|
1,181,313
|
|
|
|
(100,314
|
)
|
|
|
*
|
|
|
|
6.3
|
%
|
|
|
6.1
|
%
|
Restructuring expense
|
|
|
-
|
|
|
|
83,704
|
|
|
|
(83,704
|
)
|
|
|
*
|
|
|
|
0.0
|
%
|
|
|
0.4
|
%
|
Depreciation and amortization
|
|
|
221,073
|
|
|
|
506,072
|
|
|
|
(284,999
|
)
|
|
|
-56.3
|
%
|
|
|
1.3
|
%
|
|
|
2.6
|
%
|
Interest expense, including related party
|
|
|
(1,750,746
|
)
|
|
|
(1,600,660
|
)
|
|
|
(150,086
|
)
|
|
|
*
|
|
|
|
-10.2
|
%
|
|
|
-8.3
|
%
|
Increase in fair value of liabilities under derivative contracts
|
|
|
(78,734
|
)
|
|
|
(8,100,772
|
)
|
|
|
8,022,038
|
|
|
|
-99.0
|
%
|
|
|
-0.5
|
%
|
|
|
-41.8
|
%
|
Other expense, net
|
|
|
11,018
|
|
|
|
36,764
|
|
|
|
(25,746
|
)
|
|
|
*
|
|
|
|
0.1
|
%
|
|
|
0.2
|
%
|
Income tax expense
|
|
|
2,560
|
|
|
|
-
|
|
|
|
2,560
|
|
|
|
*
|
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
Net income (loss)
|
|
$
|
(4,720,248
|
)
|
|
$
|
(13,601,090
|
)
|
|
|
8,880,842
|
|
|
|
-65.3
|
%
|
|
|
-27.6
|
%
|
|
|
-70.2
|
%
|
* Variance is not meaningful
Revenue
Revenue decreased $2.3 million, or 11.7%, to $17.1 million for the three months ended March 31, 2016 from $19.4 million for the three months ended March 31, 2015. The decrease in revenue was primarily a result of a $365,000 decrease in sales to The Home Depot and a $2.0 million decrease in sales to commercial customers during the three months ended March 31, 2016 as compared to sales during the three months ended March 31, 2015.
Cost of Goods Sold
Cost of goods sold decreased $2.8 million, or 17.2%, to $13.6 million for the three months ended March 31, 2016 from $16.4 million for the three months ended March 31, 2015. The decrease in cost of goods sold was primarily due to the reduction in revenue, as well as lower levels of inventory reserves and warranty provisions taken in the three months ended March 31, 2016 compared with the three months ended March 31, 2015.
Cost of goods sold as a percentage of revenue decreased for the three months ended March 31, 2016 to 79.7% (or a gross profit percentage of 20.3%) as compared to 84.9% (or a gross profit percentage of 15.1%) for the three months ended March 31, 2015.
Depreciation and Amortization
Depreciation and amortization expense decreased $285,000, or 56.3%, to $221,000 for the three months ended March 31, 2016 from $506,000 for the three months ended March 31, 2015. The decrease in depreciation and amortization expense was primarily a result of our continued use of property and equipment, which we have elected not to replace as part of our cost cutting initiative.
Increase in Fair Value of Liabilities under Derivative Contracts
The change in the fair value of liabilities under derivative contracts is driven by changes in the trading price of our common stock, par value $0.001 per share (“Common Stock”) and changes in risk-free interest rates. The increase in fair value of liabilities under derivative contracts for the three months ended March 31, 2016 was $79,000, compared to an increase of $8.1 million for the three months ended March 31, 2015, representing a decline of 99.0%, or $8.0 million. The change was due to the relatively small change in the price of our Common Stock between the three months ended March 31, 2016 compared with the three months ended March 31, 2015.
Liquidity and Capital Resources
We have experienced significant historical net losses as well as negative cash flows from operations, resulting in an accumulated deficit of $832.1 million and stockholders’ deficit of $558.7 million as March 31, 2016. As of March 31, 2016, we had cash and cash equivalents of $1.7 million and an additional $3.0 million in restricted cash subject to a cash collateral dominion agreement pursuant to our five-year term loan (the “Medley Term Loan”) with Medley Capital Corporation (“Medley”). Our cash expenditures primarily relate to procurement of inventory and payment of salaries, benefits and other operating costs. Our primary sources of liquidity have historically been borrowings from various lenders and sales of Common Stock and Convertible Preferred Stock (as defined below) to, and short-term loans from, affiliates of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), including Pegasus IV, L.P. (“Pegasus Fund IV”), LSGC Holdings LLC, LSGC Holdings II, LSGC Holdings III, LLC (“Holdings III”) and PCA LSG Holdings LLC (“PCA Holdings”). While Pegasus Capital and its affiliates (collectively, “Pegasus”) have led the majority of our capital raises, the offerings of our Convertible Preferred Stock also involved and/or were led by parties other than Pegasus.
We obtained the five-year, $30.5 million Medley Term Loan from Medley on February 19, 2014 pursuant to a Term Loan Agreement (as amended, the “Medley Loan Agreement”). Pursuant to the Medley Loan Agreement, we are required to achieve a minimum quarterly fixed charge coverage ratio for the preceding 12-month period and to maintain certain minimum EBITDA levels
.
We also obtained a three-year revolving credit facility with a maximum line amount of $22.5 million from Ares on April 25, 2014 pursuant to a Loan and Security Agreement (as amended, the “Ares ABL Agreement”). As of March 31, 2016, we had $11.0 million in borrowings outstanding under the Ares ABL Agreement and additional borrowing capacity of $2.7 million. The maximum borrowing capacity under the Ares ABL Agreement is based on a formula of eligible accounts receivable and inventory. The Ares ABL Agreement also requires us to achieve a minimum quarterly fixed charge coverage ratio for the preceding 12-month period.
On January 30, 2015, September 11, 2015 and February 23, 2016, we issued 11,525, 10,000 and 3,000 units of our securities (“Series J Securities”), respectively, to Holdings III. On September 30, 2015, we issued 62 Series J Securities to certain existing preferred stockholders upon exercise of their preemptive rights under the certificates of designation
governing the Series H Convertible Preferred Stock (the “Series H Preferred Stock”), Series I Convertible Preferred Stock (the “Series I Preferred Stock”) and Series J Convertible Preferred Stock (the “Series J Preferred Stock” and, collectively with the Series H Preferred Stock and Series I Preferred Stock, the “Convertible Preferred Stock”).
In each case, the Series J Securities were issued at a purchase price of $1,000 per Series J Security and in accordance with the terms of separate subscription agreements with each of the preemptive rights purchasers and Holdings III. We received aggregate gross proceeds of approximately $21.6 million and $3.0 million in connection with the issuances of Series J Securities during 2015 and the three months ended March 31, 2016, respectively.
Each Series J Security consists of (a) one share of Series J Preferred Stock and (b) a warrant to purchase 2,650 shares of our Common Stock (a “Series J Warrant”) at an exercise price of $0.001 per share of Common Stock.
We continue to face challenges in our efforts to achieve profitability and positive cash flows from operations. Our ability to continue to meet our obligations in the ordinary course of business is dependent upon establishing profitable operations, which
may
be supplemented by any additional funds that we may raise through public or private financing or increased borrowing capacity.
In 2015, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering. Following the line review, we entered into a new supplier buying agreement with The Home Depot, which is expected to go into full effect in the second quarter of 2016. Pursuant to this supplier buying agreement, The Home Depot has elected to purchase certain products previously supplied by us directly from overseas suppliers. Such products
represented
a significant percentage of our sales to The Home Depot in 2015 and 2014. We were, however, selected to supply certain new products to The Home Depot and will continue to supply certain other products to The Home Depot under our prior agreement. In addition, the terms of the new supplier buying agreement with The Home Depot permit us to pursue opportunities to sell products to specified “big box” and other retailers, which was prohibited under our prior agreement. Notwithstanding the new supplier buying agreement, as was the case under our prior agreement with The Home Depot, The Home Depot is not required to purchase any minimum amount of products from us. As a result of the line review, we expect 2016 sales to The Home Depot and, as a result, revenue, to be significantly less than they were in 2015. However, because we cannot reasonably estimate the extent to which such reduced revenue may be offset by sales of the new products to The Home Depot or by any potential new sales to other retailers, we cannot determine at this time the overall impact that the results of The Home Depot line review will have on our financial condition and operations in the future.
As a result of our historical losses, we believe we will likely need to raise additional capital to fund our on-going operations. Sources of additional capital may not be available in an amount or on terms that are acceptable to us, if at all. Our complex capital structure, including our obligations to the holders of the outstanding shares of Convertible Preferred Stock and the series of preferred stock designated as Series K (the “Series K Preferred Stock”), may make it more difficult to raise additional capital from new or existing investors or lenders. If we are not able to raise such additional capital, we may need to restructure or refinance our existing obligations, which restructuring or refinancing would require the consent and cooperation of our creditors and certain stockholders. In such event, we may not be able to complete a restructuring or refinancing on terms that are acceptable to us, if at all. If we are unable to obtain sufficient capital when needed, our business, compliance with our credit facilities and future prospects may be adversely affected.
Pegasus has committed to provide financial support to us of up to $5.25 million, as needed, to fund our operations and debt service requirements through April 2017. The amount of this commitment will be reduced by the amount of any capital provided by other parties (except for draws under the Ares ABL) that is not repayable by us on or before April 14, 2017. Such commitment, which in no way amounts to a guarantee of our obligations, may be provided through a variety of mechanisms, which may or may not be similar to those previously employed. Furthermore, in exchange for such support, Pegasus, as our controlling stockholder, may request that we take certain actions related to operations, capital structure or otherwise, which, if accepted, could have a negative effect on our business and results of operations. In addition, Pegasus may seek other terms and consideration that would require, and may not receive, approval by the independent committee of our board of directors. Management believes that, subject to certain conditions, we will have sufficient capital to fund our operations for the next 12 months. Such conditions include, among other things, (1) maintaining our lower cost structure implemented over the last three years, (2) replacing a significant portion of the decline in revenue anticipated as a result of The Home Depot’s line review and (3) if necessary, Pegasus fulfilling its commitment as described above.
RW LSG Holdings LLC (“Riverwood Holdings”) and Pegasus each have the right to cause us to redeem their shares of Series H Preferred Stock and Series I Preferred Stock, respectively, at any time on or after March 27, 2017. If either Riverwood Holdings or Pegasus elects to cause us to redeem its shares of Series H Preferred Stock or Series I Preferred Stock, all other holders of the applicable series will similarly have the right to request the redemption of their shares of Series H Preferred Stock or Series I Preferred Stock. In addition, Portman Limited and affiliates of Zouk Holdings Limited, acting together, have a contractual right to require us to redeem their respective shares of Series H Preferred Stock on or after March 27, 2017, subject to certain conditions and limitations. We are also required to redeem the outstanding shares of our Series J Preferred Stock (a) subject to certain limited exceptions, immediately prior to the redemption of the Series H Preferred Stock, Series I Preferred Stock or any other security that ranks junior to, or pari passu with, the Series J Preferred Stock and (b) on November 14, 2019, at the election of the holders of Series J Preferred Stock (a “Special Redemption”). Holders of our Convertible Preferred Stock would also have the right to require us to redeem such shares upon our uncured material breach of our obligations under our outstanding indebtedness or the uncured material breach of the terms of the certificates of designation governing the Convertible Preferred Stock. Further, depending on whether the Appeal Bond (as defined below) has been drawn or fully released, the Series K Certificate of Designation requires us to redeem the outstanding shares of Series K Preferred Stock in the event of a liquidation, dissolution or winding up of the Company or an earlier change of control or “junior security redemption,” which includes events triggering a redemption of the outstanding shares of Convertible Preferred Stock. As of March 31, 2016, in the event we were required to redeem all of our outstanding shares of Convertible Preferred Stock and Series K Preferred Stock (collectively, the “Preferred Stock”), our maximum payment obligation would have been $538.2 million. We would be required to repay our outstanding obligations under the Medley Term Loan
our three-year asset based revolving credit facility with ACF Finco I LP (as amended from time to time, the “Ares ABL”)
prior to any redemption of any shares of Preferred Stock. As of March 31, 2016, we had $38.1 million of aggregate borrowings outstanding under these credit facilities that we would be required to repay.
Any redemption of the Preferred Stock would be limited to funds legally available therefor under Delaware law. The certificates of designation governing the Preferred Stock provide that if there is not a sufficient amount of cash or surplus available to pay for a redemption of the Preferred Stock, then the redemption must be paid out of the remaining assets of the Company. In addition, the certificates of designation provide that we are not permitted or required to redeem any shares of Preferred Stock for so long as such redemption would result in an event of default under our credit facilities.
As of March 31, 2016, based solely on a review of our balance sheet, we did not have legally available funds under Delaware law to satisfy a redemption of our Preferred Stock. In addition, based solely on our projected balance sheet as of March 27, 2017, we do not believe that we will have legally available funds on or before March 27, 2017 to satisfy any such redemption of our Preferred Stock.
The certificate of designation governing the Series H Preferred Stock also provides that upon the occurrence of a “control event,” we must take any and all actions required and permitted to fix the size of our board of directors to a size that would permit Riverwood Holdings (as the primary investor of the Series H Preferred Stock) to appoint a majority of the directors to the board until we satisfy or otherwise cure the obligations giving rise to the control event. A control event occurs if, among other things, Riverwood Holdings exercises its optional redemption right under the certificate of designation governing the Series H Preferred Stock and we are unable to redeem Riverwood Holdings’s Convertible Preferred Stock. If Riverwood Holdings were to exercise its optional redemption right and a control event were to occur, Riverwood could take control of our board of directors.
The certificate of designation governing the Series J Preferred Stock provides that if we do not have sufficient capital available to redeem the Series J Preferred Stock in connection with a Special Redemption of the Series J Preferred Stock, we will be required to issue a non-interest bearing note or notes (payable 180 days after issuance) in the principal amount of the liquidation amount of any shares of Series J Preferred Stock not redeemed by us in connection with such Special Redemption, subject to certain limitations imposed by Delaware law governing distributions to stockholders.
As discussed more fully in the Form 10-K, one of our stockholders, Geveran Investments Limited (“Geveran”), filed a lawsuit against us and certain other defendants seeking, among other things, rescissionary damages in connection with its $25.0 million investment in the Company. On November 30, 2015, the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida, the court presiding over the lawsuit, entered an Order Granting Plaintiff’s Motion for Partial Summary Judgment Under its First Cause of Action for Violation of the Florida Securities and Investment Protection Act (the “Summary Judgment Order”). Accordingly, we, with the assistance of Pegasus Fund IV, posted an appeal bond in the amount of $20.1 million (the “Appeal Bond”)
to obtain an automatic stay of enforcement as we appeal the Summary Judgment Order in the Geveran case. Although we cannot predict the ultimate outcome of this lawsuit, we believe the court’s Summary Judgment Order was in error and that we have strong defenses against Geveran’s claims. However, in the event that we are not successful on appeal, we could be liable for the full amount of Geveran’s $25 million investment, as well as interest, attorney’s fees and court costs. Accordingly, the Summary Judgment Order and the Appeal Bond could have a material adverse effect on our liquidity and our ability to raise capital in the future.
We believe that, subject to the terms and conditions of the relevant policies (including retention and
policy limits), directors' and officers' insurance coverage will be available to cover the substantial
majority of our legal fees and costs in this matter. However, insurance coverage may not be available
for, or such coverage may not be sufficient to fully pay, a judgment or settlement in favor of Geveran.
Our engagement letter with J.P. Morgan Securities, LLC ("J.P. Morgan") pursuant to which we engaged
J.P. Morgan as placement agent in connection with the private placement to Geveran requires us to
indemnify J.P. Morgan and its affiliates from liabilities relating to J.P. Morgan's activities as placement
agent, unless such activities are finally judicially determined to have resulted from J.P. Morgan's bad
faith, gross negligence or willful misconduct. Based upon the terms of such engagement letter, we have
also paid, and may be required to pay in the future, the reasonable legal expenses incurred by J.P.
Morgan and its affiliates in this lawsuit. Such payments are not covered by our insurance.
Cash Flows
The following table summarizes our cash flow activities for the three months ended March 31, 2016 and 2015:
|
|
Three Months Ended March 31.
|
|
Cash flow activities:
|
|
2016
|
|
|
2015
|
|
Net cash used in operating activities
|
|
$
|
(6,265,868
|
)
|
|
$
|
(17,192,978
|
)
|
Net cash used in investing activities
|
|
|
(154,441
|
)
|
|
|
(94,724
|
)
|
Net cash provided by financing activities
|
|
|
7,651,031
|
|
|
|
16,224,437
|
|
Operating Activities
Cash used in operating activities is net loss adjusted for certain non-cash items and changes in certain assets and liabilities. Net cash used in operating activities decreased to $6.3 million for the three months ended March 31, 2016 from $17.2 million for the three months ended March 31, 2015. For the three months ended March 31, 2016, net cash used in operating activities included certain non-cash reconciliation items consisting primarily of $707,000 in amortization of debt issuance costs, accretion and interest accrual primarily on the Ares ABL and the Medley Term Loan
, $545,000 of stock-based compensation expense and $221,000 in depreciation and amortization. Net cash used in operating activities for the three months ended March 31, 2015 included certain non-cash reconciliation items comprised primarily of
an $8.1 million net increase in fair value of derivative contracts, $916,000 of stock-based compensation expense, $684,000 in amortization of debt issuance costs, accretion and interest accrual primarily on the Ares ABL and the Medley Term Loan, $506,000 in depreciation and amortization and $271,000 in inventory write-downs.
Changes in working capital also contributed to the decrease in net cash used in operating activities for the three months ended March 31, 2016 as compared to the three months ended March 31, 2015. In the aggregate, working capital changes totaled a net use of cash of $3.1 million in the three months ended March 31, 2016 compared to a net use of cash of $14.2 million in the three months ended March 31, 2015. For the three months ended March 31, 2016, the working capital changes consisted primarily of a reduction of accounts payable of $4.3 million and an increase in accounts receivable of $2.8 million, which were partially offset by a $4.2 million decrease in inventory
. For the three months ended March 31, 2015, the working capital changes consisted primarily of a decrease in accounts payable of $9.1 million, an increase in inventories of $5.5 million and a decrease in accrued expense and other liabilities of $920,000, which were partially offset by a $1.1 million decrease in prepaid expenses.
Investing Activities
Cash used in investing activities relates to the purchase of property and equipment and capitalized patents. Net cash used in investing activities was $154,000 and $95,000 for the three months ended March 31, 2016 and 2015, respectively. The cash used in investing activities for the three months ended March 31, 2016 was primarily due to capitalized patents of $145,000. The cash used in investing activities for the three months ended March 31, 2015 was primarily due to capitalized patents of $92,000.
Financing Activities
Cash provided by financing activities has historically been composed of net proceeds from various debt facilities and the issuance of Common Stock and Preferred Stock. Net cash provided by financing activities was $7.7 million and $16.2 million for the three months ended March 31, 2016 and 2015, respectively. The cash provided by financing activities for the three months ended March 31, 2016
included net draws on our lines of credit and other short term borrowings of $4.7 million and proceeds from the issuance of Series J Securities for aggregate proceeds of $3.0 million. The cash provided by financing activities for the three months ended March 31, 2015
included proceeds from the issuance of Series J Securities for aggregate proceeds of $11.5 million and net draws on our lines of credit and other short term borrowings of $5.0 million, partially offset by $135,000 in fees incurred in connection with the issuance of Series J Securities in January 2015.