Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
SPECIAL NOTE
REGARDING FORWARD-LOOKING STATEMENTS
This
section and other parts of this Quarterly Report on Form 10-Q
(“Form 10-
Q
”) contains forward-looking statements within the meaning of U.S. federal securities laws
.
Forward-looking statements are any statements that look to future events and include, but are not limited to, statements regarding our future liquidity, financial performance and capital expenditures;
the amount of and our ability to obtain the capital required to fund operations;
the sufficiency of our existing cash and cash equivalents to meet our working capital and capital expenditure needs;
the impact of any customer line review;
our ability to successfully identify new customers and business opportunities and retain or expand our relationship with current customers; our ability to manage uncertainty with respect to product demand, product costs and end of life-cycle planning; our ability to execute on our strategic plan and realize benefits from initiatives related to streamlining our operations, cost-cutting measures and the introduction of new products; our ability to attract and retain key personnel; our ability to maintain and enhance the quality, safety and efficacy of our products; general economic and business conditions in our markets
;
our ability to improve our gross
profit
and achieve profitable growth; and the outcome in any pending and future litigation. In addition, forward-looking statements also consist of statements involving trend analyses and statements including such words as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “predicts” and similar terms and variations thereof. These forward-looking statements speak only as of the date of this Form 10-
Q
and are subject to business and economic risks. As such, our actual results may differ significantly from the results discussed in the forward-looking statements.
Factors that might cause such differences include, but are not limited to, those discussed in the “Risk Factors” section of our Annual Report on Form 10-K
for the year ended December 31, 201
5
filed with the U.S. Securities and Exchange Commission (
the
“SEC”) on
April 14, 2016, as amended by the Annual Report on Form 10-K/A filed with the SEC on May 31, 2016 (together, the “Form 10-K”)
and the
c
ondensed
c
onsolidated
f
inancial
s
tatements and notes thereto included elsewhere in this Form 10-Q.
We assume no obligation to revise or update any forward-looking statements for any reason except as required by law.
Company Overview
We are an innovator and global provider of light emitting diode (“LED”) lighting technology. We design, develop and market advanced, environmentally sustainable and differentiated illumination solutions that exclusively use LEDs as their light source. Our product portfolio includes LED-based retrofit lamps (replacement bulbs) used in existing light fixtures as well as purpose-built LED-based luminaires (light fixtures). Our lamps and luminaires are used for many common indoor and outdoor residential, commercial, industrial and public infrastructure lighting applications and include LED lighting technology whose color is tuned to achieve specific biological effects. We believe our proprietary technology, unique designs and key relationships throughout the LED lighting supply chain position us favorably to capitalize on the expanding acceptance of LEDs as a lighting source.
Our strategic plan for the next three fiscal years consists of creating strong
, biologically correct lighting brands in the consumer, residential, commercial and industrial markets. We believe that developing innovative and differentiated brands will deliver strong financial returns and a more loyal user base that is less price sensitive. We intend to continue to implement a nimble and agile “go-to-market” business model and manufacturing and product development system to streamline the processes used to introduce new products. We also intend to continue focusing on developing breakthrough innovation and on becoming a market maker in targeted value-added, high-margin segments within the lighting market. Finally, we plan to reduce our cost structure, preserve cash flow and strengthen liquidity to enhance our financial position.
Over the past few years, we have focused on expanding and optimizing our global supply chain to meet forecasted demand for our products while addressing the inefficiencies that have compressed our gross profit and overall financial performance in prior periods
, such as costs incurred to expedite the production or delivery of component parts. We have adapted our supply chain and logistics processes to improve our ability to provide more efficient service to our customers and focus our efforts on developing innovative products. We anticipate long-term gross profit improvement as we continue to execute on our cost-cutting initiatives. We completed one of our most critical initiatives in 2014 with the transition of the manufacturing of our high volume lamps from Mexico and Satellite Beach to our contract manufacturing partners in Asia, from which we source the majority of our components. In 2015, we opened a new distribution center in Seattle, Washington in order to reduce the transit time for products from Asia and to provide us with an additional port through which we can import goods. We believe that this additional distribution facility will help to better maintain the continuity of our supply chain and improve our supply-to-cash cycle time.
In general, we believe these improvements will position us to capitalize on the innovative, science based and creative engineering talent at our Florida research and development facility, which we believe provides us with a competitive advantage. Further, in addition to developing products targeted at mainstream retail and commercial lighting, we are seeking to expand our product offerings to compete across multiple industry verticals.
LED Lighting Industry Trends
There are a number of industry factors that affect our business and results of operations including, among others:
|
•
|
Rate and extent of adoption of LED lighting products
. Our potential for growth will be driven by the rate and extent of adoption of LED lighting within the general illumination market and our ability to affect this rate of adoption through the offering of competitive lighting solutions. Although LED lighting is relatively new, its adoption has grown in recent years. Innovations and advancements in LED lighting technology that improve product performance and reduce product cost continue to enhance the value proposition of LED lighting for general illumination and expand its potential commercial applications.
|
|
•
|
External legislation and subsidy programs concerning energy efficiency
. The United States and many countries in the European Union and elsewhere have already instituted, or have announced plans to institute, government regulations and programs designed to encourage or mandate increased energy efficiency in lighting. These actions include in certain cases banning the sale after specified dates of certain forms of incandescent lighting, which is advancing the adoption of more energy efficient lighting solutions such as LEDs. In addition, the growing demand for electricity is increasingly driving utilities and governmental agencies to provide financial incentives such as rebates for energy efficient lighting technologies in an effort to mitigate the need for investments in new electrical generation capacity. While this trend is generally positive for us, from time to time there have been political efforts in the United States to change or limit the effectiveness of these regulations.
|
|
•
|
Intellectual property
. LED market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection and licensing of intellectual property is critical. Therefore, LED lighting industry participants often take steps such as additional patent applications, confidentiality and non-disclosure agreements as well as other security measures. To enforce or protect intellectual property rights, market participants frequently threaten or commence litigation.
|
|
•
|
Intense and constantly evolving competitive environment.
Competition in the LED lighting market is intense. Many companies have made significant investments in LED lighting development and production equipment. Traditional lighting companies and new entrants are investing in LED based lighting products as LED adoption has gained momentum and some of these companies have taken steps to limit access to their sales channels. Product pricing pressures are significant and market participants often undertake pricing strategies to gain or protect market share, enhance sales of their previously manufactured products and open new applications to LED based lighting solutions. To remain competitive, market participants must continuously increase product performance and reduce costs.
|
Recent Developments
On July 19, 2016, we (i) filed a Certificate of Increase of Series J Convertible Preferred Stock with the Secretary of State of the State of Delaware increasing the number of authorized shares of our Series J Convertible Preferred Stock (“Series J Preferred Stock”) from 85,100 to 95,100 shares, and (ii) issued and sold 5,000
units of our securities (“Series J Securities”) to LSGC Holdings III LLC (“Holdings III”) for aggregate gross proceeds of $5.0 million, pursuant to the Preferred Stock Subscription and Support Agreement
dated September 11, 2015 among the Company, Pegasus Partners IV, LP (“Pegasus Fund IV”) and Holdings III, as amended. Each Series J Security was issued at a purchase price of $1,000 and consists of (a) one share of Series J Preferred Stock and (b) a warrant (a “Series J Warrant”) to purchase 2,650 shares of our common stock, par value $0.001 per share (“Common Stock”), at an exercise price of $0.001 per share of Common Stock.
Financial
Results
The following table sets forth our revenue, cost of goods sold
, gross profit and operating expenses for the three and nine months ended September 30
, 2016 and 2015:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
14,336,997
|
|
|
$
|
19,587,399
|
|
|
$
|
43,452,518
|
|
|
$
|
62,229,307
|
|
Cost of goods sold
|
|
|
12,003,185
|
|
|
|
14,363,734
|
|
|
|
36,416,274
|
|
|
|
50,658,859
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
2,333,812
|
|
|
$
|
5,223,665
|
|
|
$
|
7,036,244
|
|
|
$
|
11,570,448
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP gross profit percentage
|
|
|
16.3
|
%
|
|
|
26.7
|
%
|
|
|
16.2
|
%
|
|
|
18.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
$
|
3,331,417
|
|
|
$
|
4,976,399
|
|
|
$
|
16,350,117
|
|
|
$
|
20,494,263
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses as a
percentage of revenue
|
|
|
23.2
|
%
|
|
|
25.4
|
%
|
|
|
37.6
|
%
|
|
|
32.9
|
%
|
Our revenue is primarily derived from sales of our LED-based retrofit lamps and luminaires. Our revenue decreased by $5.3 million for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015. This decrease in revenue was due to a $3.4 million decrease in sales to The Home Depot, Inc. (“The Home Depot”) and a $1.9 million decrease in sales to commercial customers. Our revenue decreased by $18.8 million for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015. This decrease in revenue was due to a $17.4 million decrease in sales to The Home Depot and a $1.3 million decrease in sales to commercial customers.
In 2015, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering. Following the line review, we entered into a new supplier buying agreement with The Home Depot, which went into full effect in the second quarter of 2016. Pursuant to this supplier buying agreement, The Home Depot has elected to purchase certain products previously supplied by us directly from overseas suppliers. Such products
represented
a significant percentage of our sales to The Home Depot in 2015, which is the primary reason for
the decline in sales to The Home Depot for the three and nine months ended September 30, 2016 as compared to the same periods in 2015. The $1.9 million and $1.3 million decrease in sales to commercial customers for the three and nine months ended September 30, 2016 as compared to the three and nine months ended September 30, 2015, respectively, was primarily due to the loss of two distribution customers, as well as sales of excess inventory at reduced prices.
We continue to pursue new relationships with retailers and original equipment manufacturers (“OEMs”) to help increase and diversify our sales. In addition, we have increased the roster of distributors and independent sales agents that sell our products and added experienced professionals to our direct sales force to increase the frequency and impact of our activities with key national accounts that are targets for potential adoption of our products
.
Our gross profit is principally driven by the mix and quantity of products we sell. Our financial results are dependent upon the operating costs associated with our supply chain, including materials, labor and freight, and the level of our selling, distribution and administrative, research and development and other operating expenses. We continuously seek to improve our existing products and to bring new products to market. As a result, many of our products have short life-cycles and
, therefore, product life cycle planning is critical. At times we may purchase excess components and other materials used in the manufacture and assembly of our products or we may manufacture finished products in excess of demand. In addition, components, materials and products may become obsolete earlier than expected. These circumstances may require us to record inventory reserves and provisions for expected losses on non-cancellable purchase commitments. When these circumstances are present, we may also incur additional expense as we adjust our supply chain and product life-cycle planning.
For the three months ended September 30, 2016, our gross profit was 16.3% compared to 26.7% for the three months ended September 30, 2015. During the nine months ended September 30, 2016, our gross profit was 16.2% compared to 18.6% for the nine months ended September 30, 2015. These declines in gross profit were primarily due to sales of excess inventory at reduced prices and higher charges of inventory reserves taken in the applicable periods.
Operating expenses declined by $1.6 million for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015. The principal reasons for the decline in the three months ended September 30, 2016, as compared to the three months ended September 30, 2015, were a $1.1 million decrease in stock-based compensation expense resulting from a reversal of expense for the forfeiture of unvested stock options by former employees; a $255,000 decrease in depreciation and amortization resulting from continued use of our existing property and equipment, which we elected not to replace as part of our cost cutting initiatives; a $167,000 decrease in bad debt expense resulting from improved collections; and a $150,000 decrease in travel and entertainment expense resulting from our cost cutting initiatives. Those reductions in expenses were partially offset by a $370,000 increase in distribution expense as a result of consolidating our Dallas warehouse into our Seattle warehouse. For the nine months ended September 30, 2016, operating expenses declined by $4.1 million as compared to the nine months ended September 30, 2015. The primary reasons for the decline in operating expenses in the nine months ended September 30, 2016, as compared to the nine months ended September 30, 2015, were a $1.9 million decrease in stock-based compensation expense, a $1.0 million decrease in employee compensation expense as a result of lower headcount, a $945,000 decrease in professional fees such as legal and consulting expenses, an $836,000 decrease in depreciation and amortization, and an $832,000 decrease in administrative and travel expenses. Those reductions in expenses were partially offset by a $1.4 million increase in distribution expense.
Non-GAAP Financial Measures
Although our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”), we believe the following non-GAAP financial measures provide additional information that is useful to the assessment of our operating performance and trends. As part of our on-going review of financial information related to our business, our management regularly uses non-GAAP measures, particularly non-GAAP adjusted operating expense as a percentage of revenue. These non-GAAP financial measures are not in accordance with, nor are they a substitute for, the comparable GAAP financial measures and are intended to supplement our financial results that are prepared in accordance with GAAP.
We define non-GAAP adjusted operating expenses as total operating expenses less non-cash expenses for stock-based compensation, restructuring expenses and depreciation and amortization. Non-GAAP adjusted operating expenses for the three months ended September 30, 2016 decreased by $268,000 as compared to the three months ended September 30, 2015 and decreased by $1.1 million for the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
14,336,997
|
|
|
$
|
19,587,399
|
|
|
$
|
43,452,518
|
|
|
$
|
62,229,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expense
|
|
$
|
3,331,417
|
|
|
$
|
4,976,399
|
|
|
$
|
16,350,117
|
|
|
$
|
20,494,263
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash stock option and restricted stock compensation (benefit) expense
|
|
|
(2,313,911
|
)
|
|
|
(1,191,488
|
)
|
|
|
(729,323
|
)
|
|
|
1,173,697
|
|
Restructuring expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
297,770
|
|
Depreciation and amortization
|
|
|
219,659
|
|
|
|
474,717
|
|
|
|
632,733
|
|
|
|
1,468,860
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-GAAP adjusted operating expense
|
|
$
|
5,425,669
|
|
|
$
|
5,693,170
|
|
|
$
|
16,446,707
|
|
|
$
|
17,553,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP operating expense as a
percentage of revenue
|
|
|
23.2
|
%
|
|
|
25.4
|
%
|
|
|
37.6
|
%
|
|
|
32.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-GAAP adjusted operating expense as a
percentage of revenue
|
|
|
37.8
|
%
|
|
|
29.1
|
%
|
|
|
37.8
|
%
|
|
|
28.2
|
%
|
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and consolidated results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. Our actual results may differ from these estimates. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates may change as new events occur, additional information is obtained and our operating environment changes.
We believe that our critical accounting policies relate to our more significant estimates and judgments used in the preparation of our condensed consolidated financial statements. Our Annual Report on Form 10-K for the year ended December 31, 2015 contains a discussion of these critical accounting policies. There have been no significant changes in our critical accounting policies since December 31, 2015. See also Note 2 to our unaudited condensed consolidated financial statements for the three months ended September 30, 2016 as set forth herein.
Results of Operations
Three Months Ended
September 30
, 201
6
Compared to the Three Months Ended
September 30
, 201
5
The following table sets forth statement of operations data and such data expressed as a percentage of total revenue for the periods indicated:
|
|
Three Months Ended September 30,
|
|
|
Variance
|
|
|
Percentage of Revenue
|
|
|
|
2016
|
|
|
2015
|
|
|
$
|
|
|
%
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
14,336,997
|
|
|
$
|
19,587,399
|
|
|
|
(5,250,402
|
)
|
|
|
-26.8
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
|
12,003,185
|
|
|
|
14,363,734
|
|
|
|
(2,360,549
|
)
|
|
|
-16.4
|
%
|
|
|
83.7
|
%
|
|
|
73.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, distribution and administrative
|
|
|
2,878,244
|
|
|
|
3,902,694
|
|
|
|
(1,024,450
|
)
|
|
|
-26.2
|
%
|
|
|
20.1
|
%
|
|
|
19.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
233,514
|
|
|
|
598,988
|
|
|
|
(365,474
|
)
|
|
|
-61.0
|
%
|
|
|
1.6
|
%
|
|
|
3.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
*
|
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
219,659
|
|
|
|
474,717
|
|
|
|
(255,058
|
)
|
|
|
-53.7
|
%
|
|
|
1.5
|
%
|
|
|
2.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, including related party
|
|
|
(1,821,545
|
)
|
|
|
(1,721,799
|
)
|
|
|
(99,746
|
)
|
|
|
|
|
|
|
-12.7
|
%
|
|
|
-8.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
|
|
|
|
|
|
|
|
|
Decrease in fair value of liabilities under derivative contracts
|
|
|
1,239,072
|
|
|
|
2,005,783
|
|
|
|
(766,711
|
)
|
|
|
-38.2
|
%
|
|
|
8.6
|
%
|
|
|
10.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
|
418,336
|
|
|
|
(247,463
|
)
|
|
|
665,799
|
|
|
|
-269.0
|
%
|
|
|
2.9
|
%
|
|
|
-1.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
478
|
|
|
|
14,443
|
|
|
|
(13,965
|
)
|
|
|
*
|
|
|
|
0.0
|
%
|
|
|
0.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(1,162,220
|
)
|
|
$
|
269,344
|
|
|
|
(1,431,564
|
)
|
|
|
-531.5
|
%
|
|
|
-8.1
|
%
|
|
|
1.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Variance is not meaningful
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
Revenue decreased $5.3 million, or 26.8%, to $14.3 million for the three months ended September 30, 2016 from $19.6 million for the three months ended September 30, 2015. The decrease in revenue was due to a $3.4 decrease in sales to The Home Depot and a $1.9 million decrease in sales to commercial customers for the three months ended September 30, 2016 as compared to sales for the three months ended September 30, 2015.
Cost of Goods Sold
Cost of goods sold decreased $2.4 million, or 16.4%, to $12.0 million for the three months ended September 30, 2016 from $14.4 million for the three months ended September 30, 2015. The decrease in cost of goods sold was primarily due to the reduction in revenue for the three months ended September 30, 2016 as compared to the three months ended September 30
, 2015.
Cost of goods sold as a percentage of revenue increased for the three months ended September 30, 2016 to 83.7% (or a gross profit percentage of 16.3%) as compared to 73.3% (or a gross profit percentage of 26.7%) for the three months ended September 30, 2015
.
Selling, Distribution and Administrative
Selling, distribution and administrative expense decreased $1.0 million, or 26.2%, to $2.9 million for the three months ended September 30, 2016 from $3.9 million for the three months ended September 30, 2015. The decrease in selling, distribution and administrative expenses was primarily a result of a $1.0 million decrease in stock-based compensation expense, a $167,000 decrease in bad debt expense and a $150,000 decrease in travel and entertainment expense, which were partially offset by a $370,000 increase in distribution expense during the three months ended September 30, 2016 compared to the three months ended September 30, 2015.
Research and Development
Research and development expense decreased $365,000, or 61.0%, to $234,000 for the three months ended September 30, 2016 from $599,000 for the three months ended September 30, 2015. The decrease in research and development expense was primarily a result of a $169,000 decrease in stock-based compensation expense and a $165,000 decrease in employee compensation expense.
Depreciation and Amortization
Depreciation and amortization expense decreased $255,000, or 53.7%, to $220,000 for the three months ended September 30, 2016 from $475,000 for the three months ended September 30, 2015. The decrease in depreciation and amortization expense was primarily a result of our continued use of our existing property and equipment, which we have elected not to replace as part of our cost cutting initiatives.
Decrease (Increase)
in Fair Value of Liabilities under Derivative Contracts
The change in the fair value of liabilities under derivative contracts is driven by several factors, including the change in the fair market value of our Common Stock, issuances of our Series J Preferred Stock and changes in the expected volatility of our Common Stock. The decrease in fair value of liabilities under derivative contracts for the three months ended September 30, 2016 was $1.2 million, compared to a decrease of $2.0 million for the three months ended September 30, 2015, representing a decline of $767,000, or 38.2%. The change was due to the decline in the price of our Common Stock in the three months ended September 30, 2016 compared with the three months ended September 30, 2015, as well as the issuance of Series J Preferred Stock during the three months ended September 30, 2016.
Other Income (Expense), net
Other income (expense), net increased by $666,000, or 269%, to $418,000 for the three months ended September 30, 2016 from other expense of $247,000 for the three months ended September 30, 2015. The increase in other income (expense), net was primarily a result of judgments received during the three months ended September 30, 2016 from successful patent litigation actions against certain individuals and companies that were found to have infringed upon our patents.
Nine
Months Ended
September 30
, 201
6
Compared to the
Nine
Months Ended
September 30
, 201
5
The following table sets forth statement of operations data and such data expressed as a percentage of total revenue for the periods indicated:
|
|
Nine Months Ended September 30,
|
|
|
Variance
|
|
|
Percentage of Revenue
|
|
|
|
2016
|
|
|
2015
|
|
|
$
|
|
|
%
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
43,452,518
|
|
|
$
|
62,229,307
|
|
|
|
(18,776,789
|
)
|
|
|
-30.2
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold
|
|
|
36,416,274
|
|
|
|
50,658,859
|
|
|
|
(14,242,585
|
)
|
|
|
-28.1
|
%
|
|
|
83.8
|
%
|
|
|
81.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, distribution and administrative
|
|
|
13,396,352
|
|
|
|
15,894,335
|
|
|
|
(2,497,983
|
)
|
|
|
-15.7
|
%
|
|
|
30.8
|
%
|
|
|
25.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
2,321,032
|
|
|
|
2,833,298
|
|
|
|
(512,266
|
)
|
|
|
-18.1
|
%
|
|
|
5.3
|
%
|
|
|
4.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring expense
|
|
|
-
|
|
|
|
297,770
|
|
|
|
(297,770
|
)
|
|
|
*
|
|
|
|
0.0
|
%
|
|
|
0.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
632,733
|
|
|
|
1,468,860
|
|
|
|
(836,127
|
)
|
|
|
-56.9
|
%
|
|
|
1.5
|
%
|
|
|
2.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, including related party
|
|
|
(5,334,635
|
)
|
|
|
(5,050,234
|
)
|
|
|
(284,401
|
)
|
|
|
5.6
|
%
|
|
|
-12.3
|
%
|
|
|
-8.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Decrease (Increase) in fair value of liabilities under derivative contracts
|
|
|
514,808
|
|
|
|
(1,499,710
|
)
|
|
|
2,014,518
|
|
|
|
134.3
|
%
|
|
|
1.2
|
%
|
|
|
-2.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
|
248,549
|
|
|
|
(287,857
|
)
|
|
|
536,406
|
|
|
|
-186.3
|
%
|
|
|
0.6
|
%
|
|
|
-0.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
5,450
|
|
|
|
14,443
|
|
|
|
(8,993
|
)
|
|
|
*
|
|
|
|
0.0
|
%
|
|
|
0.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(13,890,601
|
)
|
|
$
|
(15,776,059
|
)
|
|
|
1,885,458
|
|
|
|
-12.0
|
%
|
|
|
-32.0
|
%
|
|
|
-25.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Variance is not meaningful
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
Revenue decreased $18.8 million, or 30.2%, to $43.5 million for the nine months ended September 30, 2016 from $62.2 million for the nine months ended September 30, 2015. This decrease in revenue was due to a $17.4 million decrease in sales to The Home Depot and a $1.3 million decrease in sales to commercial customers for the nine months ended September 30, 2016 as compared to sales for the nine months ended September 30, 2015.
Cost of Goods Sold
Cost of goods sold decreased $14.2 million, or 28.1%, to $36.4 million for the nine months ended September 30, 2016 from $50.7 million for the nine months ended September 30, 2015. The decrease in cost of goods sold was primarily due to the reduction in revenue for the nine months ended September 30, 2016 compared with the nine months ended September 30
, 2015.
Cost of goods sold as a percentage of revenue increased for the nine months ended September 30, 2016 to 83.8% (or a gross profit percentage of 16.2%) as compared to 81.4% (or a gross profit percentage of 18.6%) for the nine months ended September 30, 2015
.
This decline in our gross profit percentage was due to sales of excess inventories at reduced prices and higher charges of inventory reserves.
Selling, Distribution and Administrative
Selling, distribution and administrative expense decreased $2.5 million, or 15.7%, to $13.4 million for the nine months ended September 30, 2016 from $15.9 million for the nine months ended September 30, 2015. The decrease in selling, distribution and administrative expense was primarily a result of a $1.8 million decrease in stock-based compensation expense, a $746,000 decrease in professional fees, a $724,000 decrease in employee compensation expense and a $547,000 decrease in administrative expense for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015. These decreases were partially offset by a $1.4 million increase in distribution costs during the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015.
Research and Development
Research and development expense decreased $512,000, or 18.1%, to $2.3 million for the nine months ended September 30, 2016 from $2.8 million for the nine months ended September 30, 2015. The decrease in research and development expense was primarily a result of a $323,000 decrease in employee compensation expense and a $123,000 decrease in stock-based compensation expense.
Depreciation and Amortization
Depreciation and amortization expense decreased $836,000, or 56.9%, to $633,000 for the nine months ended September 30, 2016 from $1.5 million for the nine months ended September 30, 2015. The decrease in depreciation and amortization expense was primarily a result of our continued use of existing property and equipment, which we have elected not to replace as part of our cost cutting initiatives.
Decrease (Increase) in Fair Value of Liabilities under Derivative Contracts
The change in the fair value of liabilities under derivative contracts is driven by several factors, including the change in the total fair market value of our Common Stock, issuances of our Series J Preferred Stock and changes in the expected volatility of our Common Stock. The decrease in fair value of liabilities under derivative contracts for the nine months ended September 30, 2016 was $515,000, compared to an increase of $1.5 million for the nine months ended September 30, 2015, representing a decrease in value of $2.0 million, or 134%. The change was due to the decline in the price of our Common Stock in the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015, as well as the issuance of Series J Preferred Stock during the nine months ended September 30, 2016.
Other Income (Expense), net
Other income (expense), net increased by $536,000, or 186%, to $249,000 for the nine months ended September 30, 2016 from other expense of $288,000 for the nine months ended September 30, 2015. The increase in other income (expense), net was primarily a result of judgments received during the nine months ended September 30, 2016, from successful patent litigation actions against certain individuals and companies that were found to have infringed upon our patents.
Liquidity and Capital Resources
We have experienced significant historical net losses as well as negative cash flows from operations since our inception, resulting in an accumulated deficit of $841.3 million and stockholders’ deficit of $565.4 million as of September 30, 2016. As of September 30, 2016, we had cash and cash equivalents of $1.5 million. Our cash expenditures primarily relate to procurement of inventory, payment of salaries, employee benefits and other operating costs.
We continue to face challenges in our efforts to achieve profitability and positive cash flows from operations. Our ability to continue to meet our obligations in the ordinary course of business, including continued payment to our trade creditors, is dependent upon establishing profitable operations, supplemented by additional funds that we may raise through public or private financing or increased borrowing capacity.
We believe we will need to raise additional capital to fund our operations, including approximately $5.0 million of additional capital prior to December 31, 2016. In addition, because our existing revolving line of credit facility expires on April 25, 2017, we are seeking to replace it in order to help fund our operations. Sources of additional capital and/or credit may not be available in an amount or on terms that are acceptable to us, if at all. Our complex capital structure, including our obligations to the holders of the outstanding shares of our Convertible Preferred Stock (as defined below) and our Series K Preferred Stock (the “Series K Preferred Stock”), may make it more difficult to raise additional capital from new or existing investors or lenders. If we are not able to raise such additional capital, we may need to restructure or refinance our existing obligations, which restructuring or refinancing would require the consent and cooperation of our creditors and certain stockholders. In such event, we may not be able to complete a restructuring or refinancing on terms that are acceptable to us, if at all. If we are unable to obtain sufficient capital when needed, our business, compliance with our credit facilities and future prospects will be adversely affected.
Our primary sources of liquidity have historically been borrowings from ACF FinCo I LP (“Ares”) under our three-year revolving credit facility with a maximum line amount of $22.5 million (as amended from time to time, the “Ares ABL”), from Medley Capital Corporation (“Medley”) under our five-year $30.5 million term loan (as amended from time to time, the “Medley Term Loan”) and from other previous lenders, as well as sales of Common Stock and Convertible Preferred Stock to, and short-term loans from, affiliates of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), including Pegasus Fund IV, LSGC Holdings, LLC (“LSGC Holdings”), LSGC Holdings II, LLC (“Holdings II”), Holdings III and PCA LSG Holdings, LLC (“PCA Holdings” and collectively with Pegasus Capital, Pegasus Fund IV, LSGC Holdings, Holdings II, Holdings III and their affiliates, “Pegasus”). Pegasus is our controlling stockholder. While Pegasus has led a majority of our capital raises, certain offerings of Convertible Preferred Stock also involved and/or were led by parties other than Pegasus.
We obtained the Medley Term Loan on February 19, 2014. Pursuant to the Medley Term Loan, we are required to achieve a minimum quarterly fixed charge coverage ratio for the preceding 12-month period and to maintain certain minimum quarterly EBITDA levels. We also maintain
$3.0 million in restricted cash subject to a cash collateral dominion agreement pursuant to the Medley Term Loan with Medley.
We also obtained the Ares ABL on April 25, 2014, and it expires on April 25, 2017. As of September 30, 2016, we had $9.2 million in borrowings outstanding under the Ares ABL and additional borrowing capacity of $861,000
. The maximum borrowing capacity under the Ares ABL is based on a formula of eligible accounts receivable and inventory. The Ares
ABL also requires us to maintain certain minimum quarterly EBITDA levels for the preceding 12-month period.
Since January 31, 2015, we have issued an aggregate of 29,525 Series J Securities to Holdings III and 62 Series J Securities to certain existing preferred stockholders upon exercise of their preemptive rights under the certificates of designation governing the Convertible Preferred Stock. In each case, the Series J Securities were issued at a purchase price of $1,000 per Series J Security, and we received aggregate gross proceeds of approximately $29.6 million in connection with these issuances. Each Series J Security consists of (i) one share of Series J Preferred Stock and (ii) one Series J Warrant, which represents the right to purchase 2,650 shares of Common Stock, at an exercise price of $0.001 per share.
In 2015, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering. Following the line review, we entered into a new supplier buying agreement with The Home Depot, which went into full effect in the second quarter of 2016. Pursuant to this 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 and 2014. We were, however, selected to supply certain new products to The Home Depot and will continue to supply certain other products to The Home Depot under our prior agreement. In addition, the terms of the new supplier buying agreement with The Home Depot permit us to pursue opportunities to sell products to specified big box and other retailers, which was prohibited under our prior agreement. Notwithstanding the new supplier buying agreement, as was the case under our prior agreement with The Home Depot, The Home Depot is not required to purchase any minimum amount of products from us. As a result of the line review, and based on our results through the first nine months of 2016, we expect 2016 sales to The Home Depot to be significantly lower than in 2015.
In April 2016, Pegasus committed to provide financial support to us of up to $5.25 million, as needed, to fund our operations and debt service requirements through April 2017. The amount of this commitment has been reduced by the $5.0 million of Series J Securities purchased by Holdings III on July 19, 2016, with a remaining commitment of $250,000. The remaining amount of this commitment will be reduced by the amount of any capital provided by other parties (except for draws under the Ares ABL) that is not repayable by us on or before April 14, 2017. We believe that, based upon current financial assumptions and projections, we will require approximately $5.0 million of additional capital from Pegasus or other financing sources to fund our operations through December 31, 2016.
RW LSG Holdings LLC (“Riverwood Holdings”) and Pegasus each have the right to cause us to redeem their shares of Series H Convertible Preferred Stock (“Series H Preferred Stock”) and Series I Convertible Preferred Stock (“Series I Preferred Stock” and, collectively with the Series H Preferred Stock and the Series J Preferred Stock, the “Convertible Preferred Stock”), respectively, at any time on or after March 27, 2017. If either Riverwood Holdings or Pegasus elects to cause us to redeem our shares of Series H Preferred Stock or Series I Preferred Stock, all other holders of the applicable series will similarly have the right to request the redemption of their shares of Convertible Preferred Stock. In addition, Portman Limited (“Portman”) and affiliates of Zouk Holdings Limited, acting together, have a contractual right to require us to redeem their respective shares of Series H Preferred Stock on or after March 27, 2017, subject to certain conditions and limitations. We are also required to redeem the outstanding shares of our Series J Preferred Stock (a) subject to certain limited exceptions, immediately prior to the redemption of the Series H Preferred Stock, Series I Preferred Stock or any other security that ranks junior to the Series J Preferred Stock and (b) on November 14, 2019, at the election of the holders of Series J Preferred Stock (a “Special Redemption”). Holders of Convertible Preferred Stock would also have the right to require us to redeem such shares upon the uncured material breach of our obligations under our outstanding indebtedness or the uncured material breach of the terms of the certificates of designation governing the Convertible Preferred Stock.
Depending on whether the Appeal Bond (as defined below) has been drawn or fully released, the Series K Certificate of Designation requires us to redeem the outstanding shares of Series K Preferred Stock in the event of a liquidation, dissolution or winding up of the Company or an earlier change of control or “junior security redemption,” which includes events triggering a redemption of the outstanding shares of Convertible Preferred Stock.
As of September 30, 2016, in the event we were required to redeem all of our outstanding shares of Convertible Preferred Stock and Series K Preferred Stock (collectively, the “Preferred Stock”), our maximum payment obligation would have been $540.2 million. We would be required to repay our outstanding obligations under the Medley Term Loan and the Ares ABL prior to the redemption of any shares of Preferred Stock. As of September 30, 2016, we had $39.5 million of aggregate borrowings outstanding under these credit facilities that we would be required to repay prior to any redemption of Preferred Stock.
Any redemption of the Preferred Stock would be limited to funds legally available therefor under Delaware law. The certificates of designation governing the Preferred Stock provide that if there is not a sufficient amount of cash or surplus available to pay for a redemption of Preferred Stock, then the redemption must be paid out of our remaining assets. In addition, the certificates of designation governing the 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 September 30, 2016, based solely on a review of our balance sheet, we did not have legally available funds under Delaware law to satisfy a redemption of our Preferred Stock. In addition, based solely on our projected balance sheet as of March 27, 2017, we do not believe that we will have legally available funds on or before March 27, 2017 to satisfy any such redemption of the Preferred Stock.
The certificate of designation governing the Series H Preferred Stock also provides that upon the occurrence of a “control event,” we must take any and all actions required and permitted to fix the size of our board of directors to a size that would permit Riverwood Holdings (as the primary investor of the Series H Preferred Stock) to appoint a majority of the directors to the board until we satisfy or otherwise cure the obligations giving rise to the control event. A control event occurs if, among other things, Riverwood Holdings exercises its optional redemption right under the certificate of designation governing the Series H Preferred Stock and we are unable to redeem Riverwood Holdings’ shares of Series H Preferred Stock. If Riverwood Holdings were to exercise its optional redemption right and a control event were to occur, Riverwood Holdings could take control of the 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.
In addition, one of our stockholders, Geveran Investments Limited (“Geveran”), filed a lawsuit against us and certain other defendants seeking, among other things, rescissionary damages in connection with its $25.0 million investment in us. On August 28, 2014, the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida, the court presiding over the lawsuit, issued an Order Granting Plaintiff’s Motion for Partial Summary Judgment under its First Cause of Action for Violation of the Florida Securities and Investor Protection Act. On November 30, 2015, the Court entered judgment against the defendants, including us, on a joint and several basis, in the amount of approximately $40.2 million (including pre-trial interest, attorney’s fees, and statutory post-judgment interest). Accordingly, we and certain other related defendants, with the assistance of Pegasus Fund IV, posted an appeal bond in the amount of $20.1 million (the “Appeal Bond”) in support of our appeal of the partial summary judgment order. In consideration of Pegasus Fund IV’s entry into the Appeal Bond and other related agreements (collectively, the “Appeal Bond Agreements”) and as security for the potential payments to be made to the issuer of the Appeal Bond for draws upon the Appeal Bond, we issued 20,106.03 units of our securities (the “Series K Securities”) to Pegasus Fund IV, with each Series K Security consisting of (a) one share of Series K Preferred Stock and (b) a warrant to purchase 735 shares of Common Stock. Although we cannot predict the ultimate outcome of this lawsuit, we believe the court’s partial summary judgment award in favor of Geveran was in error and that we have strong defenses against Geveran’s claims. However, in the event that we are not successful on appeal, we could be liable for the full amount of the $40.2 million judgment, plus post judgment interest. Accordingly, the ultimate outcome of the lawsuit and disposition of the Appeal Bond could have a material adverse effect on our liquidity and our ability to raise capital in the future.
Cash Flows
The following table summarizes our cash flow activities for the nine months ended September 30, 2016 and 2015:
|
|
Nine Months Ended September 30,
|
|
Cash flow activities:
|
|
2016
|
|
|
2015
|
|
Net cash used in operating activities
|
|
$
|
(8,627,159
|
)
|
|
$
|
(21,556,027
|
)
|
Net cash used in investing activities
|
|
|
(825,718
|
)
|
|
|
(340,281
|
)
|
Net cash provided by financing activities
|
|
|
9,905,446
|
|
|
|
20,601,456
|
|
Operating Activities
Cash used in operating activities is net loss adjusted for certain non-cash items and changes in certain working capital assets and liabilities. Net cash used during the nine months ended September 30, 2016, resulted primarily from the net loss for the period. The reduction in net cash used in operating activities in the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015, was due to a reduction in the net loss over the comparable periods, as well as lower levels of current assets used to support the on-going operations. More detailed explanations in the levels of activity and changes in accounts balances follow.
Net cash used in operating activities decreased to $8.6 million for the nine months ended September 30, 2016 from $21.6 million for the nine months ended September 30, 2015. For the nine months ended September 30, 2016, net cash used in operating activities included certain non-cash reconciliation items consisting primarily of $2.3 million in amortization of debt issuance costs, accretion and interest accrual primarily on the Ares ABL and the Medley Term Loan
, $1.3 million of inventory write-downs and $633
,000 in depreciation and amortization. For the nine months ended September 30, 2016, net cash used in operating activities included certain non-cash reconciliation items consisting primarily of $729,000 in stock-based compensation expense and a $515,000 decrease in fair value of derivative contracts. Net cash used in operating activities for the nine months ended September 30, 2015 included certain non-cash reconciliation items comprised primarily of $2.2 million in amortization of debt issuance costs
, accretion and interest accrual primarily on the Ares ABL and the Medley Term Loan, a
$1.5 million net increase in fair value of derivative contracts, $1.5 million in depreciation and amortization
, a $1.2 million of stock-based compensation expense and $853,000 in inventory write-downs.
Changes in working capital also contributed to the decrease in net cash used in operating activities for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015. In the aggregate, working capital changes provided total cash of $2.4 million in the nine months ended September 30, 2016 compared to a net use of cash of $13.2 million in the nine months ended September 30, 2015. For the nine months ended September 30, 2016, the working capital changes consisted primarily of cash generated from reductions in inventory and prepaid expenses of $4.4 million and $461,000, respectively. These sources of cash were partially offset by a $1.1 million increase in accounts receivable, a $1.0 million decrease in accounts payable and a $356,000 decrease in accrued expenses and other liabilities
. For the nine months ended September 30, 2015
, the working capital changes consisted primarily of an increase in inventory of $6.1 million, a decrease in accounts payable of $4.0 million, an increase in accounts receivable of $2.7 million and a decrease in accrued expenses and other liabilities of $1.9 million, which was partially offset by a decrease in prepaid expenses of $2.0 million.
Investing Activities
Cash used in investing activities relates to the purchase of property and equipment and capitalized patents. Net cash used in investing activities was $826,000 and $340,000 for the nine months ended September 30, 2016 and 2015, respectively. The cash used in investing activities for the nine months ended September 30, 2016 was due to purchases of property and equipment of $411,000 and capitalized patents of $415
,000. The cash used in investing activities for the nine months ended September 30, 2015 was primarily due to capitalized patents of $326,000
.
Financing Activities
Cash provided by financing activities has historically been composed of net proceeds from various debt facilities and the issuance of Common Stock and Preferred Stock. We continue to rely on those sources of cash to fund our operations. Net cash provided by financing activities was $9.9 million and $20.6 million for the nine months ended September 30, 2016 and 2015, respectively. The cash provided by financing activities for the nine months ended September 30, 2016
included proceeds from the issuance of Series J Securities for aggregate proceeds of $8.0 million and net draws on our lines of credit and other short term borrowings of $2.3 million, which were partially offset by payment of debt issuance costs of $360,000. The cash provided by financing activities for the nine months ended September 30, 2015
included proceeds from the issuance of Series J Securities in January and September 2015 for aggregate gross proceeds of $21.5 million and net draws on our lines of credit and other short term borrowings of $592,000, partially offset by $1.1 million in fees incurred in connection with the issuance of Series J Securities and $339,000 in debt issuance costs.