Item 1. Business.
Unless expressly indicated or the context requires otherwise, the terms “Lighting Science Group,” “we,” “us,” “our” or the “Company” refer to Lighting Science Group Corporation or, as applicable, its predecessor entities and, where appropriate, its wholly owned subsidiaries.
General
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 use LEDs as their exclusive 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. We have also developed LED lighting technology that emits light at frequencies calibrated along the visible spectrum 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 in-house design of power supplies, thermal management solutions and optical systems, along with our detailed specification of the packaged LEDs incorporated into our products, provides us with a unique ability to manage the interrelationships between components and subsystems. This system-based approach enables us to provide a broad range of solutions that deliver a high quality combination of lighting efficacy and reliability. In addition, we leverage our strong supply chain and sourcing capabilities to support an “all channels” go-to-market strategy and to deliver differentiated lighting solutions at competitive price points.
Our customers include retailers and original equipment manufacturers (“OEMs”) that sell our products on a co-branded or private label basis. Large retail, hospitality and other corporate customers also purchase products from us directly. In addition, our luminaires are utilized in large-scale infrastructure projects throughout the world.
We are seeking to lead the convergence of science and light to improve the environment as well as human health and wellbeing. Our lighting technology is designed to consume less electricity for each unit of light produced and we continue to improve our product packaging and lifespan to use fewer materials in the production and distribution of our lamps and luminaires.
Corporate Information and History
We were incorporated in the state of Delaware in 1988. Our principal executive offices are located at 1350 Division Road, Suite 102, West Warwick, Rhode Island 02893, and our telephone number is (321) 779-5520. Our website address is www.lsgc.com. This reference to our website is an inactive textual reference only and is not a hyperlink. The contents of our website are not part of this Form 10-K.
We are controlled by affiliates of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), a U.S.-based private equity fund manager that provides capital and strategic solutions to middle market companies across a variety of industries. Historically, Pegasus Capital has invested in our capital stock through LSGC Holdings, LLC (“LSGC Holdings”), Pegasus Partners IV, L.P. (“Pegasus Fund IV”), LED Holdings, LLC (“LED Holdings”), LSGC Holdings II LLC (“Holdings II”), PCA LSG Holdings, LLC (“PCA Holdings”) and LSGC Holdings III LLC (“Holdings III” and collectively with Pegasus Capital, Pegasus Fund IV, LSGC Holdings, Holdings II, PCA Holdings and their affiliates, “Pegasus”). Pegasus is the Company’s controlling stockholder.
Industry Background
According to a 2014 report published by the U.S. Department of Energy (the “DOE”), it is estimated that LED sales in the U.S. lighting market will increase to approximately 48% in 2020 and 84% in 2030. Further, LED lighting is predicted to account for a majority of installations by 2022 and 88% of all lumen-hours being produced for general illumination in the United States in 2030. The LED lighting market is also expected to grow outside of the United States.
A 2013 industry report estimated that in North America, Europe and Asia, the share of the lighting market represented by LEDs
, on a dollar value basis, will rise to around 45% in 2016 and around 70% in 2020, including both new fixture installations and light source replacements, and to around 35% in 2016 and between 55% and 60% in 2020 in Latin America, the Middle East and Africa.
LEDs are regarded as the most promising technology for reducing energy consumption, given that, according to a DOE report, lighting accounted for approximately 18% of all U.S. electricity consumption in 2013. We believe that the continuing improvements in LED product efficacy and light quality, coupled with reductions in the purchase price, will further reduce the total cost of ownership and accelerate adoption of LEDs for general illumination purposes. Other catalysts expected to play a significant role in adoption are: (i) consumer and governmental focus on energy efficiency and environmental sustainability; (ii) demand for enhanced lighting functionality; (iii) design differentiation enabled by the smaller size, lower heat output, longer lifetime, dimmability, and wireless controllability; (iv) financial incentives for energy efficient technologies from government and utility rebates; and (v) government regulations restricting incandescent bulb sales in the United States and the European Union.
Our Products
We have an extensive product portfolio with three distinct offerings—replacement lamps
, luminaires and biological (or spectrum control) lighting. The products in each of these offerings achieve a unique combination of scientific innovation, lumen distribution and energy efficiency. We enhanced our product line during 2015 with the introduction of several new products
, including the
Free LED
™ solar roadway system, our
Vintage
™ Filament Series of LED lamps, our
Sleepy Ba
by
™ LED lamp
, a new mini-roadway luminaire and our
VividGro
agricultural grow light product. We anticipate that these new products will provide improved performance relative to our legacy products through the implementation of more effective components and form factors.
Replacement Lamps.
We offer a broad range of LED retrofit lamps designed to fit into existing light fixtures as replacements for traditional incandescent, compact fluorescent and halogen lamps. Our dimmable LED retrofit lamps possess consistent color and deliver improved light distribution and brightness in commercial and residential settings as compared to traditional lighting products. Our replacement lamp product line includes lamps that are sold under the
Lighting Science
®
brand as well as co-branded and private label retrofit lamps offered directly to our customers and through distributors across North America
. In January 2015, we launched the
Vintage
Filament Series of LED lamps in many of the traditional, incandescent bulb decorative form factors but with greater energy savings
.
Luminaires.
We offer LED luminaires that combine energy efficiency, long life span and enhanced light distribution, making them ideal for street lighting and lighting in parking garages, outdoor areas, warehouses and manufacturing areas. In February 2015, we introduced the
FreeLED
solar roadway system, a sleek, intelligent and powerful street lighting solution that uses solar energy as its power source. We believe the
FreeLED
will provide a reliable, affordable and sustainable roadway illumination solution for the general public, including those rural or remote communities with limited access to the electric grid.
Biological Lighting.
Our biological lighting product line incorporates our patented technology to emit light at frequencies calibrated along the visible spectrum to achieve specific biological effects. Our current line of biological products can be used to induce a sleep, awake or transition state as well as to effectively and efficiently modify and enhance the circadian rhythm of certain agricultural products to optimize growth in terms of both time and energy efficiency. Our biological lighting product line includes the
Good Night
™ and
Good Day
™ circadian replacement lamps, the
VividGro
grow light product
, the
MyNature
™ Coastal lamps and outdoor luminaires and the
MyNature Grow
lighting lamps and high bay luminaires. In March 2015, building on the proprietary technology underlying our popular
Good Night
lamp, we released the
Sleepy Baby
lamp, which delivers a patented, biologically-corrected light source for use during a baby’s nightly bedtime routine, sending natural signals to promote sleep and child wellness. The
GoodNight
lamp has a patented spectral filter that greatly reduces blue light and supports the body’s natural melatonin production. The
GoodDay
lamp has a blue enriched spectrum to naturally enhance the body’s energy and alertness. Our coastal lighting solutions have been installed at Patrick Air Force Base and other locations along Florida’s east coast. In addition, numerous commercial and academic greenhouses and growing facilities across the United States and Canada have implemented our
MyNature
Grow solutions.
Target Markets and Customers
We focus our product development on the applications and markets in which the return on investment, total cost of ownership and other benefits of LED lighting currently offer clear and compelling incentives for customers. In particular, we seek to improve our brand awareness and sales pipeline in major urban areas both in the United States and abroad in the market segments discussed below. Historically we relied on our relationship with The Home Depot, Inc. (“The Home Depot”) for a significant portion of our revenue, although we expect to diversify our customer base and product sales in 2016 and beyond, as we now are aggressively marketing our products to other big box stores and national retailers.
Residential and office.
We offer a line of retrofit lamps, integrated retrofit kits and luminaires designed to compete with traditional incandescent, florescent and halogen lamps and luminaires for commercial and residential lighting applications. Our retrofit lamps and luminaires targeted for this market are currently sold to distributors and OEMs that resell them both directly to end-users and into retail channels under the Lighting Science brand and, at times, under the distributors’ and OEMs’ own brands. We also have a comprehensive assortment of retrofit lamps and luminaires that we market and sell through our website under the Lighting Science brand.
Retail and hospitality.
The market for lighting in the retail and hospitality environment is large and varied. We believe our lighting products are particularly well suited for the retail and hospitality segment, including applications in malls, retail stores, hotels and resorts, cruise ships and restaurants. Our retrofit lamp and luminaire offerings for this market focus on task, down, bay, cove, linear, accent, track and spot lighting as well as retail display lighting. Several major U.S. retailers have replaced their existing lighting with our LED retrofit lamps and luminaires. We believe that our biological lighting technology may provide us with a unique competitive advantage in this market segment.
Government-owned and private infrastructure.
Public and private infrastructure includes outdoor facilities and spaces that are managed by government and private entities. Primary applications for our products in this market include lighting for streets and highways, parking lots, airports, ports, utilities and other large outdoor areas, particularly in developing nations. Street and highway lighting represents the largest segment within the infrastructure market. According to a July 2015 DOE report, there were 45 million area and roadway lights installed in the United States in 2014, only 13% of which were LEDs.
Schools and universities.
Buildings and outdoor lighting for primary, secondary and higher education represent a significant market opportunity for our energy-efficient solutions. This opportunity results in part from the movement across K-12 institutions, as well as colleges and universities, to reduce energy use and environmental impact as well as improve sustainability. We believe that switching to LED lighting is one of the most practical, readily implementable, highest-return, and high profile actions campus administrators can take towards fulfilling this mandate. Principal applications in this market include lighting for parking lots, large outdoor areas, streets and building exteriors, as well as indoor lighting in classrooms and common areas.
Sales Channels
We employ an “all channels” go-to-market strategy that addresses distinct market opportunities through branded and co-branded private label programs, our direct sales force, distributors and independent sales agents, as well as partnerships and joint ventures.
Our strategic account management team focuses on developing new business alliances and managing our existing branded lighting and OEM relationships. In addition to its business development initiatives, our strategic account management team seeks to expand our revenue from our current accounts by providing on-going energy analysis, market expertise and support to such customers.
Our national account management team focuses on finding new, potentially high-value customers and providing professional support to our current roster of end-users. This team targets and supports retail, hospitality, schools and universities, large real estate management and energy service company customers.
Our project-focused activities involve supporting our network of independent sales agents and distributors that pursue lighting projects in the commercial, industrial and public infrastructure markets on a regional basis, including opportunities for projects in international markets. Our project-focused sales team develops and manages our network of channel partners and works with these partners to submit competitive bids on projects, and oversees the delivery and after-market support related to such projects.
Research and Development
To successfully implement our business strategy, we must continually improve our current products and develop new products for existing and new applications. Our research and development team focuses on advanced technological applications that not only increase the efficiency of the components and subsystems that make up our products, but also add capabilities such as controls, adaptability and biological technology. Components and subsystems include power supplies, thermal management solutions, optical systems and LEDs.
Our research and development team also seeks to enhance the aesthetic appeal and reduce the total cost of ownership of our products. Although we implemented a number of cost cutting measures during the past three years, including reductions in personnel, we intend to continue to dedicate a significant portion of our financial and personnel resources toward the development of new materials and methods related to our products
.
Our research and development team is comprised of 16 research scientists and engineers, many with Doctoral or Masters Degrees in disciplines such as power electronics, lighting, thermal and mechanical engineering, materials science and cellular and molecular biology. These professionals combine a thorough understanding of the sciences required to develop LED lighting products with extensive experience in the lighting industry. Our research and development capabilities are further enhanced through collaborations with leaders within and outside the LED lighting industry. We have research and development relationships with professionals and institutions in a wide range of fields, including advanced material science, semiconductor performance, medical and biological research, space exploration and military applications. These institutions include leading research organizations, such as NASA, Harvard, Jefferson Medical College, Florida Institute of Technology, University of Guelph and Oak Ridge National Laboratory, as well as leading technology-oriented companies such as Bayer AG and National Semiconductor Corporation
. In addition, we have supported and continue to contribute to research including advanced material processing and biological effects of lighting on plants and animals, including a recent study performed at Harvard and an on-going study at Alertness CRC Limited investigating the effects of lighting on human sleep patterns.
Research and development expenses for the years ended December 31, 2015, 2014 and 2013 were $4.0 million
, $5.6 million and $10.3 million, respectively. We reduced research and development expenses as part of our overall cost-cutting strategy, which we believe is a key component of our on-going efforts to improve our financial results. We expense all of our research and development costs as they are incurred. Research and development expenses are reported net of any funding received under contracts with governmental agencies or commercial customers that are considered to be cost sharing arrangements with no contractually committed deliverable.
Manufacturing and Suppliers
During the past three years, we have increasingly focused on our design and engineering competencies in an effort to develop differentiated products. Accordingly, we design and engineer our products and outsource substantially all of the manufacture and assembly of our products to a number of contract manufacturers internationally. These contract manufacturers purchase components based on our specifications and provide the necessary facilities and labor to manufacture our products. We allocate the manufacture of specific products to the contract manufacturer we believe is best suited for the task. Quality control and lot testing is conducted at our contract manufacturers in Asia. Product qualification and testing is conducted in our facilities in Melbourne, Florida. Our Melbourne facility and each of our contract manufacturers have been ISO9001:2008 certified as conforming to the standards published by the International Organization for Standardization.
We select LEDs based on a combination of availability, price and performance. We believe we have strong relationships with our LED suppliers and receive a high level of cooperation and support from them. In addition, we have entered into strategic relationships with certain of these key LED suppliers that currently give us access to next generation LED technology at an early stage and at competitive prices. Certain of our biological products use a custom LED package that we source from a limited number of suppliers.
Competition
Our products face competition in the general lighting market from both traditional lighting technologies produced by numerous vendors as well as from LED-based lighting products produced by a growing roster of industry participants. LED lighting products compete with traditional lighting technologies on the basis of the numerous benefits of LED lighting relative to such technology including greater energy efficiency, longer lifetime, improved durability, increased environmental sustainability, digital controllability, smaller size, directionality and lower heat output.
The LED lighting industry is characterized by rapid technological change, short product lifecycles and frequent new product introductions and a competitive pricing environment. These characteristics create a market environment that demands continuous innovation, provides entry points for new competitors and creates opportunities for rapid shifts in market share. We primarily compete with other providers of LED lighting on the basis of our product performance, as measured by efficacy, light quality, increased lumen output and reliability relative to industry standards and energy related certifications, such as ENERGY STAR and California Energy Commission specifications, as well as on product cost. In addition to these factors, which generally contribute to a lower total cost of ownership and enhanced product quality as compared to alternative lighting solutions, we offer our customers a broad product portfolio. We believe our product design approach, proprietary technology and deep understanding of lighting applications aids our ability to compete in the market for LED lighting.
Currently, we view our primary competition to be from large, established companies in the traditional general lighting industry. Certain of these companies also provide, or have undertaken initiatives to develop, LED lighting products as well as other energy efficient lighting products. Additionally, we face competition from a fragmented group of smaller niche or low-cost offshore providers of LED lighting products. We also anticipate that larger LED chip manufacturers, including some of those that currently supply us, will continue to seek to compete with us. For example, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering in June 2015. In connection with this line review, The Home Depot elected to purchase certain products previously supplied by us directly from overseas suppliers, including one of our suppliers. We also expect other large technology players with packaged LED chip technology that are currently focused on other end markets for LEDs, such as backlighting for LCD displays, to increasingly focus on the general illumination market as their existing markets saturate and LED use in general illumination grows. In addition, we may compete in the future with vendors of new technological solutions for energy efficient lighting.
Intellectual Property
Our intellectual property portfolio is a key aspect of our product differentiation strategy. We seek to protect our proprietary technologies by obtaining patents and licenses, retaining trade secrets and, when appropriate, defending and enforcing our intellectual property rights. We believe this strategy optimizes our ability to preserve the advantages of our products and technologies and improves the return on our investment in research and development.
As of December 31, 2015, we had obtained 366 patents from the United States Patent Office (the “USPTO”), with another 77 applications pending. These patents and patent applications cover various inventions related to the design and manufacture of LED lighting technology. During 2015, we filed 27 new U.S. patent applications and 35 U.S. patents were issued to us by the USPTO. When it is appropriate and cost effective, we make corresponding international, regional or national filings to pursue patent protection in other parts of the world. In certain cases, we rely on confidentiality agreements and trade secret protections to defend our proprietary technology. In addition, we license and have cross-licensing arrangements with respect to third-party technologies that are incorporated into elements of our design activities, products and manufacturing processes. Where appropriate, we also license certain of our intellectual property to third parties to further monetize our intellectual property portfolio.
The LED lighting industry is characterized by the existence of a significant number of patents and other intellectual property and by the vigorous pursuit, protection and enforcement of intellectual property rights. We believe that our extensive intellectual property portfolio, along with our license arrangements, provides us with a considerable advantage relative to new entrants to the industry and smaller LED lighting providers in serving sophisticated customers.
We also aggressively enforce our intellectual property rights against third parties. In 2015, we filed four lawsuits against third parties seeking damages and injunctive relief in response to such third parties’ infringement of our patent rights. Four other companies agreed to take a patent license and pay royalties to us. In addition, in April 2015, we filed a lawsuit against several former employees and the company they formed seeking damages and injunctive relief arising out of the defendants’ misappropriation of our trade secrets and other intellectual property. Pursuant to the terms of a settlement agreement, the defendants agreed not to use or disclose our intellectual property and to reimburse us $200,000 in costs, and the defendants’ company agreed to pay to us a commission equal to the greater of (i) $1.7 million and (ii) 5% of defendants’ company’s gross sales of biological and agricultural products during the three-year period ending January 2019
.
As is customary in the LED lighting industry, many of our customer agreements require us to indemnify our customers for third-party intellectual property infringement claims. Claims of this sort could harm our relationships with customers and might deter future customers from doing business with us. With respect to any intellectual property rights claims against us or our customers and/or distributors, we may be required to cease manufacture of the infringing product, pay damages and expend significant company resources to defend against the claim and/or develop non-infringing technology, seek a license or relinquish patents or other intellectual property rights.
Regulations, Standards and Conventions
Our products are generally required to comply with and satisfy the electrical codes of the jurisdictions in which they are sold. Our products are designed to meet the typically more stringent codes established in the United States and the European Union, which usually allows our products to meet the codes in other geographic regions.
Many of our customers require our products to be certified by Underwriters’ Laboratories, Inc. (“UL”). UL is a U.S.-based independent, nationally recognized testing laboratory, and third-party product safety testing and certification organization. UL develops standards and test procedures for products, materials, components, assemblies, tools and equipment, primarily dealing with product safety. UL evaluates products, components, materials and systems for compliance to specific requirements, and permits acceptable products to carry a UL certification mark, as long as they remain compliant with the standards. UL offers several categories of certification. Products that are “UL Listed,” are identified by the distinctive UL mark. We have undertaken to have all of our products meet UL standards and be UL listed. There are alternatives to UL certifications but we believe that our customers and end-users prefer UL certification.
In addition to the UL certification, certain of our products must also meet industry standards, such as those set by the Illuminating Engineering Society of North America, and government regulations for their intended application. For example, our roadway luminaires must meet certain structural standards and must also deliver a certain amount of light in specified positions relative to the installed luminaire.
Many customers and end-users also expect our products to meet the applicable ENERGY STAR requirements. ENERGY STAR is a standard for energy efficient consumer products in the United States and Canada. To qualify for ENERGY STAR certification, LED lighting products must pass a variety of tests to prove that the products have certain characteristics. We produced the first LED retrofit lamp to be successfully qualified for ENERGY STAR designation.
We believe our operations are in compliance with all applicable environmental regulations within the jurisdictions in which we operate. The costs of compliance with these regulations are not material.
Employees
As of December 31, 2015, we had 52 employees in the United States all of which were full-time, and seven full-time employees outside the United States, primarily in Hong Kong and China. We also utilized seven temporary employees and 12 contractors as of December 31, 2015, nine of whom were in the United States. We believe that our relationship with our employees is good.
Item 1A. Risk Factors.
Risks Related to Our Business and Industry
We have a history of losses and may be unable to continue operations unless we can generate sufficient operating income from the sale of our products.
We have sustained operating losses since our inception. For the years ended December 31, 2015, 2014 and 2013, we had revenue of $79.7 million, $91.3 million and $83.2 million, respectively, and as of December 31, 2015, we had accumulated a deficit of $827.4 million. As evidenced by these financial results, we have not been able to achieve profitability. Continuing losses may exhaust our capital resources and force us to discontinue our operations.
Management believes that, based on our current business plan and subject to certain conditions, we will have sufficient capital to fund our operations for the next 12 months. Our current business plan includes a focus on increasing revenue by updating and expanding our commercial and retail product offerings and capitalizing on the known product needs of our existing customers, improving gross margins by significantly leveraging contract manufacturers in Asia and maintaining our lower cost structure implemented over the last three years
. We also believe we will need to replace a significant portion of the decline in revenue anticipated as a result of The Home Depot’s 2015 line review. We could also be forced to rely upon Pegasus’ commitment to help fund our operations and debt service requirements, as described further in the immediately succeeding risk factor. If we do not adequately execute upon our current business plan or if our assumptions or forecasts do not prove to be accurate, we could exhaust our available capital resources, which could require us to seek additional sources of liquidity or to further reduce our expenditures to preserve our cash. Additional sources of liquidity may not be available in an amount or on terms that are acceptable to us.
We have yet to achieve positive cash flow, and our ability to generate positive cash flow is uncertain. If we are unable to obtain capital when needed, our business and future prospects will be adversely affected and we could be forced to suspend or discontinue operations.
Our operations have not generated positive cash flow for any reporting period since our inception, and we have funded our operations primarily through the issuance of common and preferred stock and short-term and long-term debt. We had significant revenue growth from 2009 through 2012 and again in 2014, but we had a decrease in revenue in 2013 as compared to 2012 and in 2015 as compared to 2014. The actual amount of funds that we will need to meet our operating needs will be determined by a number of factors, many of which are beyond our control. These factors include the timing and volume of sales transactions, our ability to diversify our customer base and product sales and to offset the expected decrease in revenue resulting from The Home Depot’s line review in 2015. In addition, our liquidity needs will be impacted by the success of our marketing strategy, market acceptance of our products, the costs associated with, and any adverse outcome in, pending or future litigation, the success of our research and development efforts, the impact of the transition of our product manufacturing to our contract manufacturers, the costs associated with obtaining and enforcing our intellectual property rights, regulatory changes, competition, technological developments in the market, evolving industry standards and the amount of working capital investments we are required to make.
Our ability to continue to operate until our cash flows from operations turns positive may depend on our ability to continue to raise funds through public or private sales of shares of our capital stock or through debt. Through February 19, 2014, we had an asset-based lending facility (the “Wells Fargo ABL”) with Wells Fargo Bank, N.A. (“Wells Fargo”) that provided us with borrowing capacity calculated based on our accounts receivable and inventory, unrestricted cash held in a Wells Fargo deposit account, and the amount of a Second Lien Letter of Credit Facility (the “Ares Letter of Credit Facility”) with Ares Capital Corporation (“Ares Capital”). On February 19, 2014, we entered into a $30.5 million five-year term loan (the “Medley Term Loan”) and a two-year delayed draw term loan (as amended from time to time, the “Medley Delayed Draw Loan”) with Medley Capital Corporation (“Medley”) that provided us with borrowing capacity of up to a maximum of $22.5 million. We utilized proceeds from the Medley Term Loan to repay our outstanding obligations under the Wells Fargo ABL and the Ares Letter of Credit Facility. On April 25, 2014, we entered into a three-year asset based revolving credit facility (as amended from time to time, the “FCC ABL”) with FCC, LLC d/b/a First Capital (“First Capital”), which provides us with a maximum borrowing capacity of $22.5 million, subject to certain limitations. First Capital sold the FCC ABL to ACF Finco I LP (“Ares”) in May 2015, and the FCC ABL is hereinafter referred to as the “Ares ABL.” We utilized proceeds from the Ares ABL to repay outstanding obligations under the Medley Delayed Draw Loan. As of December 31, 2015, the outstanding balance on the Ares ABL was approximately $6.9 million and we had approximately $6.3 million of additional borrowing capacity, and our outstanding balance on the Medley Term Loan was $29.2 million (net of loan costs and loan discount)
.
In recent years, we have also raised funds through issuances of our Series H Convertible Preferred Stock (“Series H Preferred Stock”), Series I Convertible Preferred Stock (“Series I Preferred Stock”) and Series J Convertible Preferred Stock (“Series J Preferred Stock” and, collectively with the Series H Preferred Stock and Series I Preferred Stock, the “Convertible Preferred Stock”). We have experienced limited access to the capital and credit markets, and it remains uncertain whether we will be able to obtain outside capital when we need it or on terms that would be acceptable to us.
We have historically been dependent on Pegasus for our liquidity needs because other sources of liquidity have been insufficient or unavailable to meet our needs. 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 for at least the next 12 months. The amount of this commitment will be reduced by amounts funded by other parties (except for draws under the Ares ABL) within the next 12 months that are 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. If we are able to raise funds by selling additional shares of our Common Stock or securities convertible or exercisable into our Common Stock, the ownership interest of our existing stockholders will be diluted. If we are unable to obtain sufficient outside capital when needed, our business and future prospects will be adversely affected and we could be forced to suspend or discontinue operations
.
We may be unable to profitably sell our products in this competitive pricing environment.
Aggressive pricing actions by our competitors may affect our growth prospects and profitability. We may not be able to increase prices if the costs of components and raw materials rise or we may be limited in our ability to increase prices to improve our margins. Even if component and raw material costs were to decline, lower prices offered by competitors may not allow us to hold prices at their current levels, which could negatively impact both net sales and gross margins.
Our industry is highly competitive and if we are not able to compete effectively, including against larger lighting manufacturers with greater resources, our prospects for future success will be jeopardized.
Our industry is highly competitive. We face competition from both traditional lighting technologies provided by numerous vendors as well as from LED-based lighting products provided by a growing roster of industry participants. The LED lighting industry is characterized by rapid technological change, short product lifecycles and frequent new product introductions and a competitive pricing environment. These characteristics increase the need for continual innovation and provide entry points for new competitors as well as opportunities for rapid share shifts.
Currently, we view our primary competition to be from large, established companies in the traditional general lighting industry. Certain of these companies also provide, or have undertaken initiatives to develop, LED lighting products as well as other energy efficient lighting products. Additionally, we face competition from a fragmented group of smaller niche or low-cost offshore providers of LED lighting products. We also anticipate that larger LED chip manufacturers, including some of those that currently supply us, will continue to seek to compete with us. For example, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering in June 2015. In connection with this line review, The Home Depot elected to purchase certain products previously supplied by us directly from overseas suppliers, including one of our suppliers. We also expect other large technology players with packaged LED chip technology that are currently focused on other end markets for LEDs, such as backlighting for LCD displays, to increasingly focus on the general illumination market as their existing markets saturate and LED use in general illumination grows. In addition, we may compete in the future with vendors of new technological solutions for energy efficient lighting.
Some of our current and future competitors are larger companies with greater resources to devote to research and development, manufacturing and marketing, as well as greater brand name recognition. Some of our more diversified competitors could also compete more aggressively with us by subsidizing losses in their LED lighting businesses with profits from other lines of business. Moreover, if one or more of our competitors or suppliers were to merge with one another, the change in the competitive landscape could adversely affect our customer, channel or supplier relationships or our competitive position. Additionally, any loss of a key channel partner, whether to a competitor or otherwise, could severely and rapidly damage our competitive position. To the extent that competition in our markets intensifies, we may be required to reduce our prices in order to remain competitive. If we do not compete effectively, or if we reduce our prices without making commensurate reductions in our costs, our revenue, gross margins and profitability and our future prospects for success, may be harmed.
If our preferred stockholders exercise their redemption rights, it would have a material adverse effect on our financial condition and may result in a change of control.
RW LSG Holdings LLC, (“Riverwood Holdings”), an affiliate of Riverwood LSG Management Holdings LLC (“Riverwood Management”) and Riverwood Capital Partners L.P. (“Riverwood Capital,” and collectively with Riverwood Holdings, Riverwood Management and their affiliates, “Riverwood”) and Pegasus each have the right to cause us to redeem its shares of Series H Preferred Stock and Series I Preferred Stock, respectively, at any time on or after March 27, 2017. If either Riverwood 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 have the right to redeem their shares of Series H Preferred Stock or Series I Preferred Stock. In addition, Portman Limited (“Portman”) and affiliates of Zouk Holdings Limited (“Zouk”), 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 would also be 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 which 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 (the “Special Redemption”). Holders of our Convertible Preferred Stock would also have the right to require us to redeem such shares upon the uncured material breach of our outstanding obligations under our indebtedness or our uncured breach of the terms of the certificates of designation governing the Convertible Preferred Stock. Further, depending on the ultimate disposition of an appeal bond relating to pending litigation, the certificate of designation governing our newly designated Series K Preferred Stock (the “Series K Preferred Stock” and, collectively with the Convertible Preferred Stock, the “Preferred Stock”) 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 December 31, 2015, in the event we were required to redeem all of our outstanding shares of Preferred Stock, our payment obligation would have been $532.2 million. We would also be required to repay our outstanding obligations under the Medley Term Loan and the Ares ABL prior to any redemption of the Preferred Stock. As of December 31, 2015, the aggregate borrowings outstanding under these loan facilities that we would be required to pay was $36.1 million.
Any redemption of shares of Preferred Stock would be limited to funds legally available under Delaware law. The certificates of designation governing our Preferred Stock provide that if there is not a sufficient amount of cash or surplus available to redeem the shares of Preferred Stock, then the redemption must be paid out of the remaining assets of the Company. In addition, the certificates of designation governing our Preferred Stock 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 December 31, 2015, 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
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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 (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 exercises its optional redemption right under the certificate of designation governing the Series H Preferred Stock and we are unable to redeem the shares of Series H Preferred Stock held by Riverwood. If Riverwood 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.
We have a limited amount of revenue and a history of losses, and we may not have sufficient cash to allow us to comply with our redemption obligations. Our ability to redeem the Preferred Stock depends upon our future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control. If the cash flow from our operating activities is insufficient, we may take certain actions aimed to enable us to redeem the Preferred Stock, such as delaying or reducing capital expenditures, attempting to obtain financing, selling assets or operations or seeking additional equity capital. Any or all of these actions may not be sufficient to allow us to redeem the Preferred Stock. Further, we may be unable to take any of these actions on satisfactory terms, in a timely manner or at all.
Our issuances of shares of Preferred Stock may limit our ability to raise additional capital and/or take certain corporate action.
As of December 31, 2015, we had 276,141.55 shares of Preferred Stock issued and outstanding, consisting of 113,608.52 shares of Series H Preferred Stock, 62,365 shares of Series I Preferred Stock, 80,062 shares of Series J Preferred Stock and 20,106.03 shares of Series K Preferred Stock. The certificates of designation governing the Preferred Stock limit our ability to take certain actions without the consent of Pegasus and Riverwood, including, among other things:
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redeem, reacquire, pay dividends or make other distributions on our securities;
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engage in any recapitalization, merger, consolidation, reorganization or similar transaction;
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incur any indebtedness (A) in excess of that contained in the Ares ABL or Medley Term Loan; or (B) that includes any provision that would limit our ability to redeem any shares of Preferred Stock;
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issue any equity securities, subject to limited exceptions;
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enter into any new agreements or transactions with any affiliates or amend or modify the terms of any such agreements; and
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acquire, license, transfer or sell any property, rights or assets or enter into any joint venture where (A) the aggregate consideration to be paid or received, or (B) the fair market value of the relevant property, rights or assets, exceeds $5.0 million.
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A breach of the terms of the Preferred Stock could entitle each holder to redeem their shares of Preferred Stock, which could have a material adverse effect on our liquidity and financial condition.
We are currently engaged in litigation and may suffer material adverse results.
On June 22, 2012, Geveran Investments Limited (“Geveran”), one of our stockholders, filed a lawsuit against us and several other defendants seeking rescission of its $25.0 million investment in the Company, recovery of attorneys’ fees and court costs for alleged violations of the Florida securities laws. Geveran alternatively seeks unspecified money damages, as well as recovery of court costs, for alleged common law negligent misrepresentation. On August 28, 2014, the court presiding over the lawsuit granted Geveran’s motion for partial summary judgment with respect to its first cause of action for violation of the Florida securities laws. On November 25, 2015, the court entered judgment against the defendants, including us, on a joint and several basis, in the amount of approximately $40.2 million.
On December 4, 2015, we, along with the other defendants, filed a Notice of Appeal to the Florida Fifth District Court of Appeal and posted a bond securing the judgment in the amount of approximately $20.1 million. Defendant J.P. Morgan Securities, LLC (“J.P. Morgan”) also posted a separate bond in the amount of approximately $20.1 million, resulting in total bonding of approximately $40.2 million. On March 29, 2016, the trial court judge determined that the posted bonds were sufficient security to stay execution of the judgment pending the appeal.
Although we cannot predict the ultimate outcome of this lawsuit, we believe the court’s summary judgment award in favor of Geveran was in error, that we will prevail on the appeal and the judgment will be overturned, and that the case will be remanded to the trial court for further proceedings. If we win the appeal, we believe 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 the $40.2 million judgment, plus post judgment interest. Such an outcome would have a material adverse effect on our financial position. Even if we are successful on appeal, we will have to continue with litigation at the trial court level on the merits of the case. In such case, we may be unable to resolve the dispute in our favor and may ultimately be liable to Geveran for damages. Even if we are eventually successful in defending against Geveran’s claims or otherwise settle the litigation, it could result in additional substantial costs to us, could be a distraction to management and could harm our financial position.
We are also a defendant in an action brought by GE Lighting Solutions LLC (“GE Lighting”) in Federal District Court for the Northern District of Ohio in or about January 2013. GE Lighting asserts a claim of patent infringement against us under U.S. Patent No. 6,787,999, entitled
LED-Based Modular Lamp
, and U.S. Patent No. 6,799,864, entitled
High Power LED Power Pack for Spot Module Illumination
, and seeks monetary damages and an injunction. We have denied liability. On August 5, 2015, the court granted our summary judgment motion invalidating the two GE Lighting patents at issue for indefiniteness, and dismissing GE Lighting’s patent infringement claims against us and the other defendants. On September 2, 2015, GE Lighting filed an appeal with the U.S. Court of Appeals for the Federal Circuit. A ruling from the appellate court is not expected until late 2016 or early 2017
. If GE Lighting were to prevail on its appeal, the case would likely be remanded to the trial court for further proceedings. If the case is remanded to the trial court, we believe that we have strong defenses against GE Lighting’s claims. However, if GE Lighting’s appeal is successful, we cannot be certain that we will be successful in defending against this action. The outcome, if unfavorable, could have a material adverse effect on our financial position. Even if the outcome is favorable, this litigation could result in substantial additional costs to us, could be a distraction to management and could harm our financial position.
We also are a plaintiff in four pending patent infringement litigation matters in which we allege that the various defendants infringe certain of our U.S. patents. Although we believe we have strong claims in these matters, we may not be able to obtain a favorable outcome, and such litigating will require us to expend significant financial resources.
In addition, because we operate in an industry that includes some companies that are much larger and have significantly greater resources than we do, a disagreement with a competitor that is not amicably resolved can result in litigation that, even if a favorable outcome is reached, could result in substantial costs to us, could be a distraction to our management and could harm our financial position.
We have identified material weaknesses in our internal control over financial reporting and we may be unable to develop, implement and maintain appropriate controls in future periods. If the material weaknesses are not remediated, such weaknesses could have a material adverse effect on our operations and/or there could be material misstatements in our financial statements.
We are subject to Section 404 of the Sarbanes-Oxley Act of 2002, which requires an annual management assessment of the effectiveness of our internal control over financial reporting. Effective internal controls are necessary for us to produce reliable financial reports, and failure to achieve and maintain effective internal controls over financial reporting could cause investors to lose confidence in our operating results, and could have a material adverse effect on our business and on the price of our Common Stock. Because of our status as a smaller reporting company registrant as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the independent registered public accounting firm auditing our financial statements has not been required to attest to, and report on, the effectiveness of our internal control over financial reporting.
We have identified material weaknesses in our internal control over financial reporting. As a result of the material weaknesses listed below, our management, with the participation of our principal executive officer and principal financial officer, concluded that our disclosure controls and procedures and internal control over financial reporting were not effective as of December 31, 2015.
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We identified several weaknesses involving the inconsistent application of our spreadsheet formula controls. Specifically, we discovered errors (incorrect formulas and internal spreadsheet references) in spreadsheets used to compute our inventory valuation, our inventory reserve and stock price volatility.
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We identified a weakness specific to our inventory valuation methodology that led to a year-end adjustment to our financial statements. We evaluated the inventory reserve requirements as of December 31, 2015 and, due to updated assumptions and conclusions resulting from changing market conditions, we determined that an incremental inventory reserve was required.
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We identified a weakness regarding the application of U.S. GAAP as it relates to the issuance of the Series K Preferred Stock issued during the year ended December 31, 2015. As a result, several adjustments to this transaction were recorded prior to the issuance of the consolidated financial statements as of and for the year ended December 31, 2015.
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These material weaknesses resulted in the misstatement of inventory
, an understatement of cost of goods sold and misstatements of additional paid in capital and Series K Preferred Stock, all of which were corrected by management with year-end adjustments that were recorded after December 31, 2015, but prior to the issuance of our consolidated financial statements as of and for the year ended December 31, 2015. Accordingly, the year-end adjustments are properly reflected in the consolidated financial statements included as part of this Form 10-K. We plan to take the necessary actions to remediate the weaknesses identified in our internal controls and to continue to assess our internal controls and procedures. The process of designing and implementing effective internal controls and procedures is a continuous effort, however, that requires us to anticipate and react to changes in our business and economic and regulatory environments. Additionally, we or our independent registered public accounting firm may identify additional weaknesses. The steps we have taken, or may subsequently take, may not be sufficient to fully remediate the material weakness identified or ensure that our internal controls are effective. Complying with these requirements may place a strain on our personnel, information technology systems and resources and divert management’s attention from other business concerns. We may need to hire, at a material expense to us, additional accounting and financial staff with appropriate public company experience and technical accounting knowledge as part of the remediation of our material weakness or otherwise.
The LED lighting industry is characterized by constant and rapid technological change, product obsolescence, price erosion, evolving standards, short product life cycles and fluctuations in supply and demand. If we fail to anticipate and adapt to these changes and fluctuations, our sales, gross margins and profitability will be adversely affected.
In the LED lighting industry, rapid technological changes and short product life cycles often lead to price erosion and product obsolescence. Companies within the LED lighting industry are continuously developing new products with heightened performance and functionality, putting pricing pressure on existing products. Further, the industry has experienced significant fluctuations, often in connection with, or in anticipation of, product cycles and changes in general economic conditions. These fluctuations have been characterized by lower product demand, production overcapacity, higher inventory levels and increased pricing pressure. Our failure to accurately anticipate the introduction of new technologies or adapt to fluctuations in the industry can, as it has in the past, lead to our having significant amounts of obsolete inventory that can only be sold at substantially lower prices and profit margins than anticipated. Pricing pressure and obsolescence also cause the stated value of our inventory to decline. For the years ended December 31, 2015, 2014 and 2013, we recorded an inventory write-down of $3.8 million, $4.7 million and $11.4 million, respectively, and a provision for expected losses on non-cancellable purchase commitments of $116,000, $507,000 and $2.3 million, respectively. In addition, if we are unable to develop planned new technologies or if our transition to contract manufacturing is unsuccessful, we may not be able to compete effectively due to our failure to offer products most demanded by the marketplace. If any of these failures occur, our sales, gross margins and profitability will be adversely affected.
If our developed technology or technology under development does not achieve market acceptance, prospects for our growth and profitability would be limited.
Our future success depends on continued market acceptance of our LED technology and the technology currently under development. Although adoption of LED lighting has grown in recent years, adoption of LED lighting products for general illumination is in its early stages, is still limited and faces significant challenges. Potential customers may be reluctant to adopt LED lighting products as an alternative to traditional lighting technology because of its higher initial cost or perceived risks relating to its novelty, reliability, usefulness, light quality and cost-effectiveness when compared to other established lighting sources available in the market. Changes in economic and market conditions may also affect the marketability of some traditional lighting technologies such as declining energy prices in certain regions or countries may favor existing lighting technologies that are less energy efficient, reducing the rate of adoption for LED lighting products in those areas
. Moreover, if existing sources of light other than LED lighting products achieve or maintain greater market adoption, or if new sources of light are developed, our current products and technologies could become less competitive or obsolete. Even if LED lighting products continue to achieve performance improvements and cost reductions, limited customer awareness of the benefits of LED lighting products, lack of widely accepted standards governing LED lighting products and customer unwillingness to adopt LED lighting products in favor of entrenched solutions could significantly limit the demand for LED lighting products and adversely impact our results of operations. In addition, we have invested significant resources in the area of biological (or spectrum control) lighting. This technology is in its early stages and therefore may not achieve broad market acceptance. If market acceptance is not achieved, our growth prospects would be limited.
If we are unable to effectively develop, manage and expand our sales and distribution channels for our products, our operating results may suffer.
We sell a substantial portion of our products to retailers and OEMs who then sell our products on a co-branded or private label basis. Orders from our retail and OEM customers are dependent upon their internal target inventory levels for our products which can vary significantly based upon current and projected market cycles and other factors over which we typically have very little, if any, control. We rely on these retailers and OEMs to develop and expand the customer base for our products and to accurately forecast demand from their customers. If they are not successful in either task, our growth and profitability may be adversely impacted.
We rely on our relationship with The Home Depot and the loss of this material relationship or any other significant relationship would have a material adverse effect on our results of operations, our future growth prospects and our ability to distribute our products.
We form business relationships and strategic alliances with retailers and other lighting companies to market our products, generally under private or co-branded labels. In certain cases, such relationships are important to our introduction of new products and services, and we may not be able to successfully collaborate or achieve expected synergies with these retailers or lighting companies. We do not control these retailers or lighting companies and they may make decisions regarding their business undertakings with us that may be contrary to our interests, or may terminate their relationships with us altogether. In addition, if these retailers or lighting companies change their business strategies, for example due to business volume fluctuations, mergers and acquisitions and/or performance issues, fail to pay or terminate the relationship altogether, our business could be materially adversely affected.
For the years ended December 31, 2015, 2014 and 2013, The Home Depot accounted for 91%
, 80% and 55% of our revenue, respectively. The Home Depot performed a periodic product line review in June 2015 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 the new 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, 2014 and 2013. We were, however, selected to supply certain new products to The Home Depot and we 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, total revenue, to be significantly less than it was 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. A loss of The Home Depot as a customer or a significant and continuing decline in their purchases or their failure to pay us would have a material adverse effect on our results of operations, our future growth prospects and our ability to distribute our products.
The Home Depot has required, and we expect will continue to require, increased service and order accommodations as well as incremental promotional investments. We may face increased expenses to meet these demands, which would reduce our margins. In addition, we generally have little or no influence on The Home Depot’s promotional or pricing policies, which may affect our sales volume.
If we do not successfully manage our network of distributors and independent sales representatives, we may not be able to increase sales to meet growth expectations.
Our growth and future financial performance will depend on our ability to maintain and exploit our internal sales and service organization and to substantially increase the scope of our distribution and sales network, both domestically and internationally. We may not be able to negotiate acceptable relationships in the future and cannot predict whether current or future relationships will be successful. We may face intense competition for personnel and we cannot guarantee that we will be able to attract, assimilate or retain additional qualified business development and sales personnel on a timely basis.
Certain of these relationships are not subject to a detailed contract and therefore may be subject to termination at any time. The agreements that we do have are generally short-term, not exclusive, and can be cancelled by the counterparty without significant financial consequence. In addition, these parties provide technical sales support to end-users. We cannot control how these sales channels perform and cannot be certain that we or the end-users will be satisfied by their performance. If these distributors and agents significantly change their terms with us, or change their historical pattern of ordering products from us, there could be a significant impact on our revenue and profits.
Our products may contain defects that could reduce sales, result in costs associated with the recall of or warranty obligations associated with those items and result in claims against us.
The manufacture of our products involves highly complex processes. Despite testing by us, our contract manufacturers and our customers, defects have been and could be found in our existing or future products. These defects may cause us to incur significant warranty, support and repair costs. The costs associated with a recall may divert the attention of our engineering personnel from our product development efforts and harm our relationships with customers and our reputation in the marketplace. We generally provide a five-year warranty on our products, and such warranty may require us to repair, replace or reimburse the purchaser for the purchase price of the product, at our discretion. Moreover, even if our products meet standard specifications, our customers may attempt to use our products in applications they were not designed for or in products that were not designed or manufactured properly, resulting in product failures and creating customer dissatisfaction. These problems could result in, among other things, a delay in the recognition or loss of revenue, loss of market share or failure to achieve market acceptance. For the years ended December 31, 2015 and 2014, we incurred $1.8 million and $4.8 million, respectively, in warranty expense primarily related to products returned under our standard warranty and the estimated expenses related to failure rates on two of our replacement lamp product lines sold in 2011 and 2012
. If our products experience failure rates in excess of our estimates, we may continue to incur increased warranty expenses in the future.
Defects, integration issues or other performance problems in our products could also result in personal injury or financial or other damages to our customers for which they might seek legal recourse against us. We may be the target of product liability lawsuits and could suffer losses from a significant product liability judgment against us if the use of our products at issue is determined to have caused injury. A significant product recall or product liability case could also adversely affect our results of operations and result in negative publicity, damage to our reputation and a loss of customer confidence in our products.
If we are unable to increase production capacity for our products with our contract manufacturers in a cost effective and timely manner, we may incur delays in shipment and our revenue and reputation in the marketplace could be harmed.
An important part of our business plan is the expansion of production capacity for our products. In order to fulfill anticipated demand for our products, we invest in capacity in advance of actual customer orders, typically based on preliminary, non-binding indications of future demand. As customer demand for our products changes, we must be able to adjust our production capacity to meet demand while keeping costs down. Uncertainty is inherent within our facility and capacity expansion, and unforeseen circumstances could offset the anticipated benefits, disrupt our ability to provide products to our customers and impact product quality.
Our ability to successfully increase or obtain production capacity in a cost effective and timely manner will depend on a number of factors, including the following:
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our ability to sustain relationships with key contract manufacturers without disruption and the ability of contract manufacturers to allocate more of their existing capacity to us or their ability to add new capacity quickly;
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the ability of any future contract manufacturers to successfully implement our manufacturing processes;
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the availability of critical components and subsystems used in the manufacture of our products; and
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our ability to effectively establish adequate management information systems, financial controls and supply chain management and quality control procedures.
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If we are unable to increase production capacity for our products in a cost effective and timely manner while maintaining adequate quality, we may incur delays in shipment or be unable to meet increased demand for our products, which could harm our revenue and operating margins and damage our reputation and our relationships with current and prospective customers.
We utilize contract manufacturer
s
to manufacture
most
of
our products and any disruption in th
ese
relationship
s
may cause us to fail to meet our customers’ demands and may damage our customer relationships and adversely affect our business.
We depend on contract manufacturers to manufacture most of our products and provide the necessary facilities and labor to manufacture these products, which are primarily high volume products and components that we intend to distribute to customers in North America. Our reliance on contract manufacturers involve certain risks, including the following:
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lack of direct control over production capacity and delivery schedules;
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risk of equipment failures, natural disasters, civil unrest, industrial accidents, power outages and other business interruptions;
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lack of direct control over quality assurance and manufacturing yield; and
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risk of loss of inventory while in transit.
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If our current contract manufacturers or any other contract manufacturers we may engage in the future were to terminate their arrangement with us or fail to provide the required capacity and quality on a timely basis, we would experience delays in the manufacture and shipment of our products until alternative manufacturing services could be contracted. Any significant shortages or interruption may cause us to be unable to timely deliver sufficient quantities of our products to satisfy our contractual obligations and particular revenue expectations. Moreover, even if we timely locate substitute products, if their price materially exceeds the original expected cost of such products, our margins and results of operations would be adversely affected.
Furthermore, to qualify new contract manufacturers, familiarize them with our products, quality standards and other requirements and commence volume production may be a costly and time-consuming process. If we are required or choose to change contract manufacturers for any reason, our revenue, gross margins and customer relationships could be adversely affected.
If we do not properly anticipate the need for our products, we may be unable to meet the demands of our customers and end-users, which could reduce our competitiveness, cause a decline in our market share and have a material adverse effect on our results of operations.
The lighting industry is subject to significant fluctuations in the availability of raw materials, components and subsystems. Our contract manufacturers supply certain standard electronic components as well as custom components critical to the manufacture of our lighting devices. The principal raw materials and components used in the manufacture of our products are packaged LEDs and printed circuit boards, magnetic and standard electrical components such as capacitors, resistors and diodes, wire, plastics for optical systems and aluminum for housings and heat sinks. From time to time, packaged LEDs and electronic components have been in short supply due to demand and production constraints. If we do not accurately forecast demand for our products, we or our contract manufacturers may not be able to find an adequate alternative source of supply at an acceptable cost. Any significant interruption in the supply of these raw materials, components and subsystems or our products could have a material adverse effect on our results of operations.
Our financial results may vary significantly from period-to-period due to unpredictable sales cycles in certain of the markets into which we sell our products, which may lead to volatility in our stock price.
The size and timing of our revenue from sales to our customers is difficult to predict and is market dependent. Our revenue in each period may also vary significantly as a result of purchases, or lack thereof, by The Home Depot or other significant customers. Because most of our operating and capital expenses are incurred based on the estimated number of product purchases and their timing, they are difficult to adjust in the short term. As a result, if our revenue falls below our expectations or is delayed in any period, we may not be able to proportionately reduce our operating expenses or manufacturing costs for that period. As a result of these factors, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance.
Our debt obligations contain restrictions that impact our business and expose us to risks that could adversely affect our liquidity and financial condition
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On February 19, 2014, we entered into the Medley Term Loan and Medley Delayed Draw Loan, and we utilized proceeds from the Medley Term Loan to repay our outstanding obligations under the Wells Fargo ABL and the Ares Letter of Credit Facility. On April 25, 2014, we entered into the Ares ABL
which provides us with a maximum borrowing capacity of $22.5 million, which capacity is limited by a borrowing base equal to (i) the sum of (A) 85% of the Company’s eligible accounts receivable and (B) the lesser of (a) $10 million and (b) the sum of (x) the lesser of (1) 65% of the dollar value of certain eligible inventory and (2) 85% of the net orderly liquidation value of such eligible inventory, (y) 65% of certain other inventory and (z) the lesser of (1) $4.5 million and (2) the lesser of 65% of the dollar value or 85% of the net orderly liquidation value of eligible inventory that is in-transit, minus (ii) the sum of reserves established by First Capital and the amount of our outstanding letter of credit obligations. We utilized proceeds from the Ares ABL to repay outstanding obligations under the Medley Delayed Draw Loan. As of December 31, 2015, the balance outstanding on the Ares ABL was approximately $6.9 million and we had approximately $6.3 million of additional borrowing capacity.
Borrowings under the Medley Term Loan and Ares ABL are secured by substantially all of our assets and our material wholly owned subsidiaries (subject to certain permitted liens) and may be used for working capital requirements and other general corporate purposes. We may replace the Ares ABL facility with a replacement revolving facility, on a secured first priority basis, without penalty or premium
, subject to the negotiation of loan documents and an intercreditor agreement on terms and conditions satisfactory to Ares and Medley
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The inability to generate sufficient cash flow or otherwise obtain the funds necessary to make required payments under the Medley Term Loan and Ares ABL could result in a default under these facilities. Further, we are required under our credit facilities to maintain a certain minimum EBITDA and a minimum fixed charge coverage ratio of 1.00 to 1.00. Failure to comply with these or any other requirements of our indebtedness could result in a default. Any default that is not cured or waived could result in the acceleration of the obligations under these facilities, an increase in the applicable interest rate under these facilities and a requirement that our subsidiaries that have guaranteed these facilities pay the obligations in full, and would permit our lenders to exercise remedies with respect to all of the collateral securing these facilities, including substantially all of our and our subsidiary guarantors’ assets. Any such default could have a material adverse effect on our liquidity and financial condition. Additionally, the covenants in such agreements or future debt agreements may restrict the conduct of our business, which could adversely affect our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that may be beneficial to the business.
If we are unable to obtain and protect our intellectual property rights, our ability to commercialize our products could be substantially limited.
As of December 31, 2015, we held 366 U.S. patents and 77 additional patent applications were pending. These patents and patent applications cover various inventions related to the design and manufacture of LED lighting technology. When we believe it is appropriate and cost effective, we make corresponding international, regional or national filings to pursue patent protection in other parts of the world. In addition, as appropriate, we also license certain of our intellectual property to third parties in an effort to monetize our intellectual property portfolio. Because patents involve complex legal, technical and factual questions, the issuance, scope, validity and enforceability of patents cannot be predicted with certainty. Accordingly, some or all of our patent applications may not be granted. Competitors may develop products similar to our products that do not conflict with our patent rights. Others may challenge our patents and, as a result, our patents could be narrowed or invalidated. In some cases, we may rely on confidentiality agreements or trade secret protections to protect our proprietary technology. Such agreements, however, may not be honored and particular elements of our proprietary technology may not qualify as protectable trade secrets under applicable law. In addition, others may independently develop similar or superior technology, and in the absence of applicable prior patents, we would have no recourse against them.
Our business may be impaired by claims that we, or our customers, infringe on the intellectual property rights of others.
Our industry is characterized by vigorous protection and pursuit of intellectual property rights. These traits have resulted in significant and often protracted and expensive litigation. In addition, we may inadvertently infringe on patents or rights owned by others and licenses might not be available to us on reasonable or acceptable terms or at all. Litigation to determine the validity of patents or claims by third parties of infringement of patents or other intellectual property rights could result in significant legal expense and divert the efforts of our technical personnel and management, even if the litigation results in a determination favorable to us. Third parties have and may in the future attempt to assert infringement claims against us, or our customers, with respect to our products. In the event of an adverse result in such litigation, we could be required to pay substantial damages; stop the manufacture, use and sale of products found to be infringing; incur asset impairment charges; discontinue the use of processes found to be infringing; expend significant resources to develop non-infringing products or processes; or obtain a license to use third party technology and whether or not the result is adverse to us, we may have to indemnify our customers if they were brought into the litigation.
Certification and compliance are important to the sale and adoption of our lighting products, and failure to obtain such certification or compliance would harm our business.
We are required to comply with certain legal requirements governing the materials used in our products. Although we are not aware of any efforts to amend existing legal requirements or implement new legal requirements in a manner with which we cannot comply, our revenue might be materially harmed if such changes were to occur. Moreover, although not legally required to do so, we strive to obtain certification for substantially all of our products. In the United States, we seek, and to date have obtained, certification for substantially all of our products from UL. We design our products to be UL/cUL and Federal Communications Commission compliant. We have also obtained ENERGY STAR qualification for 142 of the products that we were producing as of December 31, 2015. Although we believe that our broad knowledge and experience with electrical codes and safety standards have facilitated certification approvals, we cannot be certain that we will be able to obtain any such certifications for our new products or that, if certification standards are amended, we will be able to maintain any such certifications for our existing products, especially since virtually all existing codes and standards were not created with LED lighting products in mind. The failure to obtain such certifications or compliance could harm our business.
The reduction or elimination of investments in, or incentives to adopt, LED lighting or the elimination of, or changes in, policies, incentives or rebates in certain states or countries that encourage the use of LEDs over some traditional lighting technologies could cause the growth in demand for our products to slow, which could materially and adversely affect our revenue, profits and margins.
We believe the near-term growth of the LED market will be accelerated by government policies in certain countries that either directly promote the use of LEDs or discourage the use of some traditional lighting technologies. Today, the upfront cost of LED lighting exceeds the upfront cost for some traditional lighting technologies that provide similar lumen output in many applications. However, some governments around the world have used policy initiatives to accelerate the development and adoption of LED lighting and other non-traditional lighting technologies that are seen as more environmentally friendly compared to some traditional lighting technologies. Reductions in (including as a result of any budgetary constraints), or the elimination of, government investment and favorable energy policies could result in decreased demand for our products and decrease our revenue, profits and margins. Further, if our products fail to qualify for any financial incentives or rebates provided by governmental agencies or utilities for which our competitors’ products qualify, such programs may diminish or eliminate our ability to compete by offering products at lower prices than our competitors.
Changes in the mix of products we sell during a period could have an impact on our results of operations.
Our profitability from period-to-period may vary significantly due to the mix of products that we sell in different periods. As we expand our product offerings we expect to sell more retrofit lamps and luminaires into additional target markets. These products are likely to have different cost profiles and will be sold into markets governed by different business dynamics. Consequently, sales of individual products may not necessarily be consistent across periods, which could affect product mix and cause gross and operating profits to vary significantly. Given the potentially large size of purchase orders for our products, particularly in the infrastructure market, the loss of or delay in the signing of a customer order could significantly reduce our revenue in any period. In addition, we spend substantial amounts of time and money on our efforts to educate our customers about the use and benefits of our products, including their technical and performance characteristics, and these investments may not produce any sales within expected time frames or at all.
We rely upon key members of our management team and other key personnel and a loss of key personnel could prevent or significantly delay the achievement of our goals.
Our success will depend to a large extent on the abilities and continued services of key members of our management team. The loss of key members of our management team or other key personnel could prevent or significantly delay the implementation of our business plan, research and development and marketing efforts. Our success will depend on our ability to attract and retain highly skilled personnel and our efforts to obtain or retain such personnel may not be successful.
The operations of many of our third party manufacturers are subject to additional risks that are beyond our control and that could harm our business.
Most of our products are manufactured by third-party contract
manufacturers in foreign
countries. Approximately 99%, 85% and
60% of our products were manufactured internationally during 2015, 2014 and 2013, respectively. As a result of our international manufacturing, we are subject to risks associated with doing business abroad, including:
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political or labor unrest, terrorism and economic instability resulting in the disruption of trade from foreign countries in which our products are manufactured;
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currency exchange fluctuations;
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the imposition of new laws and regulations, including those relating to labor conditions, quality and safety standards, imports, trade restrictions and restrictions on the transfer of funds, as well as rules and regulations regarding climate change;
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reduced protection for intellectual property rights in some countries;
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disruptions or delays in shipments; and
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changes in local economic conditions in countries where our manufacturers and suppliers are located.
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These risks could negatively affect the ability of our manufacturers to produce or deliver our products or procure materials and could increase our cost of doing business generally. In the event that one or more of these factors make it undesirable or impractical for us to conduct business in a particular country, our business could be adversely affected.
In addition, certain of our imported products are subject to duties, tariffs or other import limitations that affect the cost and quantity of various types of goods imported into the United States and other markets. Any country in which our products are produced or sold may eliminate, adjust or impose new import limitations, duties, anti-dumping penalties or other charges or restrictions, any of which could have an adverse effect on our results of operations, cash flows and financial condition.
Our international operations are subject to legal, political and economic risks.
Our financial condition, operating results and future growth could be significantly affected by risks associated with our international activities, including economic and labor conditions, political instability, laws (including U.S. taxes on foreign subsidiaries), changes in the value of the U.S. dollar versus foreign currencies, differing business cultures, foreign regulations that may conflict with domestic regulations, intellectual property protection and trade secret risks, differing contracting process including the ability to enforce agreements, increased dependence on foreign manufacturers, shippers and distributors and import and export restrictions and tariffs.
Compliance with U.S. and foreign laws and regulations that apply to our international operations, including import and export requirements, anti-corruption laws, including the Foreign Corrupt Practices Act, tax laws (including U.S. taxes on foreign subsidiaries), foreign exchange controls, anti-money laundering and cash repatriation restrictions, data privacy requirements, labor laws and anti-competition regulations, increases the costs of doing business in foreign jurisdictions, and any such costs, which may rise in the future as a result of changes in these laws and regulations or in their interpretation. We have not implemented formal policies and procedures designed to ensure compliance with these laws and regulations. Any such violations could individually or in the aggregate materially adversely affect our reputation, financial condition or operating results.
Risks Related to Ownership of Our Common Stock
Our Common Stock has been thinly traded and an active trading market may not develop.
The trading volume of our Common Stock has historically been low, partially because we are not listed on an exchange and our Common Stock is only traded on the over-the-counter bulletin board (the “OTC Bulletin Board”). In addition, our public float has been further limited due to the fact that the vast majority of our outstanding Common Stock has historically been beneficially owned by affiliates of Pegasus Capital. Until we initiate a public offering of our Common Stock or are approved for listing on a national exchange, a more active trading market for our Common Stock may not develop, or if developed, may not continue, and a holder of any of our securities may find it difficult to dispose of, or to obtain accurate quotations as to the market value of, our Common Stock.
We are controlled by Pegasus Capital, whose interests in our business may be different from yours.
Affiliates of Pegasus Capital beneficially owned approximately 90% of our Common Stock as of December 31, 2015. As a result of this ownership, Pegasus Capital has a controlling influence on our affairs and its voting power constitutes a quorum of our stockholders voting on any matter requiring the approval of our stockholders. Such matters include the nomination and election of directors, the issuance of additional shares of our capital stock or payment of dividends, the adoption of amendments to our certificate of incorporation and bylaws and approval of mergers or sales of substantially all of our assets. This concentration of ownership may also have the effect of delaying or preventing a change in control of our company or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares. Pegasus Capital may cause corporate actions to be taken even if the interests of Pegasus Capital conflict with the interests of our other stockholders.
If we applied and our shares were approved for listing on a national stock exchange, we would likely elect to be considered a “controlled company” which would exempt us from certain corporate governance requirements, including the requirement that a majority of our board of directors meet the specified standards of independence and the exemption from the requirement that we have a compensation and governance committee made up entirely of directors who meet such independence standards. Such independence standards are intended to ensure that directors who meet the independence standard are free of any conflicting interest that could influence their actions as directors. It is possible that the interests of Pegasus Capital may in some circumstances conflict with our interests and the interests of our other stockholders, including you.
Because our stock price is volatile, it can be difficult for stockholders to predict the value of our shares at any given time.
The price of our Common Stock has been and may continue to be highly volatile, which makes it difficult for stockholders to assess or predict the value of their shares. A number of factors may affect the market price of our Common Stock, including, but not limited to:
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changes in expectations as to our future financial performance;
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announcements of technological innovations or new products by us or our competitors;
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announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
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changes in laws and government regulations;
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developments concerning our proprietary rights;
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public perception relating to the commercial value or reliability of any of our lighting products;
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future sales of our Common Stock or issues of other equity securities convertible into or exercisable for the purchase of Common Stock;
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our involvement in litigation;
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the acquisition or divestiture by Pegasus Capital or its affiliates of part or all of its holdings; and
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general stock market conditions.
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We do not intend to pay cash dividends and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our Common Stock.
We have never declared or paid cash dividends on our Common Stock and we do not anticipate paying any cash dividends in the foreseeable future. We have a history of losses and currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business. In addition, the terms of the Medley Term Loan and the Ares ABL restrict our ability to pay cash dividends and any future credit facilities or loan agreements may further restrict our ability to pay cash dividends. As a result, capital appreciation, if any, of our Common Stock will be your sole source of potential gain for the foreseeable future.
Anti-takeover provisions in our amended and restated certificate of incorporation and amended and restated bylaws, and Delaware law, contain provisions that could discourage a takeover.
Anti-takeover provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. The provisions of our charter documents include:
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procedures for advance notification of stockholder nominations and proposals;
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the inability of less than a majority of our stockholders to call a special meeting of the stockholders;
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the ability of our board of directors to create new directorships and to fill any vacancies on the board of directors;
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the ability of our board of directors to amend our bylaws without stockholder approval; and
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the ability of our board of directors to issue shares of preferred stock without stockholder approval upon the terms and conditions and with the rights, privileges and preferences as our board of directors may determine.
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In addition, as a Delaware corporation, we are subject to Delaware law, including Section 203 of the Delaware General Corporation Law. In general, Section 203 prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder unless certain specific requirements are met as set forth in Section 203. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control.
Future sales or the possibility of future sales of a substantial amount of our Common Stock may depress the price of shares of our Common Stock.
Future sales or the availability for sale of substantial amounts of our Common Stock in the public market could adversely affect the prevailing market price of our Common Stock and could impair our ability to raise capital through future sales of equity securities. We may issue shares of our Common Stock or other securities from time to time to raise capital to fund our operating expenses pursuant to the exercise of outstanding stock options or warrants or as consideration for future acquisitions and investments. If any such issuance, acquisition or investment is significant, the number of shares of our Common Stock, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial. We may also grant registration rights covering those shares of our Common Stock or other securities in connection with any such acquisitions and investments.
We cannot predict the size of future issuances of our Common Stock or the effect, if any, that future issuances and sales of our Common Stock will have on the market price of our Common Stock. Sales of substantial amounts of our Common Stock (including shares of our Common Stock issued in connection with an acquisition or by Pegasus Capital or its affiliates), or the perception that such sales could occur, may adversely affect prevailing market prices for our Common Stock.
Securities analysts may not provide coverage of our Common Stock or may issue negative reports, which may have a negative impact on the market price of our Common Stock.
Securities analysts have not historically provided research coverage of our Common Stock and may elect not to do so in the future. If securities analysts do not cover our Common Stock, the lack of research coverage may cause the market price of our Common Stock to decline. The trading market for our Common Stock may be affected in part by the research and reports that industry or financial analysts publish about our business. If one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline substantially. If one or more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, rules mandated by the Sarbanes-Oxley Act of 2002 and a global settlement reached in 2003 between the SEC, other regulatory agencies and a number of investment banks have led to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many investment banking firms are required to contract with independent financial analysts for their stock research. It may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our Common Stock. This could have a negative effect on the market price of our stock.