Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
|
Important Note about Forward-Looking Statements
The following discussion and analysis should be read in conjunction with the Company’s unaudited condensed consolidated financial statements as of March 31, 2020 and notes thereto included in this document and the audited consolidated financial statements in the Company’s 10-K filing for the period ended December 31, 2019 and the notes thereto. In addition to historical information, the following discussion and other parts of this Form 10-Q contain forward-looking information that involves risks and uncertainties. The Company’s actual results could differ materially from those anticipated by such forward-looking information due to factors discussed elsewhere in this Form 10-Q.
The statements that are not historical constitute “forward-looking statements.” Said forward-looking statements involve risks and uncertainties that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements, express or implied by such forward-looking statements. These forward-looking statements are identified by their use of such terms and phrases as "expects,” “intends,” “goals,” “estimates,” “projects,” “plans,” “anticipates,” “should,” “future,” “believes,” and “scheduled.”
The variables which may cause differences include, but are not limited to, the following: general economic and business conditions; changes in regulatory environment; extraordinary external events such as the current pandemic health event resulting from COVID-19; competition; success of operating initiatives; operating costs; advertising and promotional efforts; the existence or absence of adverse publicity; changes in business strategy or development plans; the ability to retain management; availability, terms and deployment of capital; business abilities and judgment of personnel; availability of qualified personnel; labor and employment benefit costs; availability and costs of raw materials and supplies; and changes in, or failure to comply with various government regulations. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate; therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any person that the objectives and expectations of the Company will be achieved.
Overview
Orbital Energy Group (formerly CUI Global, Inc.) is a platform company dedicated to maximizing shareholder value through the acquisition and development of innovative companies, products and technologies. Orbital Energy Group’s subsidiaries, Orbital Gas Systems, Ltd. and Orbital Gas Systems, North America, Inc., are leaders in innovative gas solutions with more than 30 years of experience in design, installation and the commissioning of industrial gas sampling, measurement and delivery systems providing solutions to the energy, power and processing markets. Orbital Gas Systems manufactures and delivers a broad range of technologies including environmental monitoring, gas metering, process control, telemetry, gas sampling and BioMethane. In the three months ended March 31, 2020, the Company launched Orbital Power Services, a full service building, maintenance and support provider to the electrical power distribution, transmission, substation, renewables, and emergency response sectors of North America. Start-up costs at Orbital Power Services contributed to lower margins and increased SG&A in the Energy segment. In addition, the second half of the quarter was negatively affected by generally lower economic activity due to the COVID-19 pandemic that has caused economic slowdowns all over the world.
In 2019, the company divested of its electromechanical components and domestic power businesses and is actively marketing the remaining businesses that comprise the Power and Electromechanical segment, which the Company expects to sell in 2020. Accordingly, the Company has designated the remaining businesses of the Power and Electromechanical segment as discontinued operations and are reflected on the balance sheet as assets and liabilities held for sale. The discussion below will mainly focus on the Company's continuing operations, which consists of the Company's Energy segment.
For the three months ended March 31, 2020, Orbital Energy Group, Inc. had consolidated continuing loss from operations of $7.1 million compared to consolidated continuing loss from operations in the three months ended March 31, 2019 of $4.2 million. During the three months ended March 31, 2020, Orbital Energy Group, Inc. had a consolidated loss from continuing operations of $7.0 million compared to a loss of $3.8 million in the comparable prior year period.
During the three months ended March 31, 2020, Orbital Energy Group, Inc. had consolidated net loss of $7.4 million compared to a consolidated net loss in the three months ended March 31, 2019 of $3.0 million. The higher net loss for the three months ended March 31, 2020, was the result of the reduced sales and earnings associated with the discontinued domestic power and electromechanical components business, following their sale in 2019, higher sales, general and administrative expenses in the Other category and Energy segment due to the addition of Orbital Power Services and additional shared services staff in a new office opened in Dallas, Texas during the first three months of 2020, and higher professional fees due to merger and acquisition activity. The lost income from the sale of the discontinued businesses is expected to be offset by the Reach Construction acquisition acquired in April 2020. In addition, the Company recorded a $0.4 million loss on its equity method investment in the three months ended March 31, 2020 compared with zero in the three months ended March 31, 2019. Revenues from continuing operations increased slightly for the quarter due to the strength of the North American sales growth and the addition of Orbital Power Services, partially offset by lower sales in the U.K. as the U.K.'s top line has been effected by lower translation rates and headwinds from Brexit.
In March 2019, the Company acquired a 21.4% share of Virtual Power Systems (20.58% as of March 31, 2020), which is recorded as an equity method investment.
Continuing Results of Operations
The following tables set forth, for the period indicated, certain financial information regarding revenue and costs by segment.
For the Three Months Ended March 31, 2020:
(dollars in thousands)
|
|
Energy
|
|
|
Percent of Segment Revenues
|
|
|
Other
|
|
|
Percent of Segment Revenues
|
|
|
Total
|
|
|
Percent of Total Revenues
|
|
|
|
|
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Revenues
|
|
$
|
5,688
|
|
|
|
100.0
|
%
|
|
$
|
—
|
|
|
|
—
|
%
|
|
$
|
5,688
|
|
|
|
100.0
|
%
|
Cost of revenue
|
|
|
5,129
|
|
|
|
90.2
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
5,129
|
|
|
|
90.2
|
%
|
Gross profit
|
|
|
559
|
|
|
|
9.8
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
559
|
|
|
|
9.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
4,038
|
|
|
|
71.0
|
%
|
|
|
3,154
|
|
|
|
—
|
%
|
|
|
7,192
|
|
|
|
126.4
|
%
|
Depreciation and amortization
|
|
|
399
|
|
|
|
7.0
|
%
|
|
|
8
|
|
|
|
—
|
%
|
|
|
407
|
|
|
|
7.3
|
%
|
Research and development
|
|
|
17
|
|
|
|
0.3
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
17
|
|
|
|
0.3
|
%
|
Provision for bad debt
|
|
|
6
|
|
|
|
0.1
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
6
|
|
|
|
0.0
|
%
|
Total operating expenses
|
|
|
4,460
|
|
|
|
78.4
|
%
|
|
|
3,162
|
|
|
|
—
|
%
|
|
|
7,622
|
|
|
|
134.0
|
%
|
Continuing loss from operations
|
|
$
|
(3,901
|
)
|
|
|
(68.6
|
)%
|
|
$
|
(3,162
|
)
|
|
|
—
|
%
|
|
$
|
(7,063
|
)
|
|
|
(124.2
|
)%
|
For the Three Months Ended March 31, 2019:
(dollars in thousands)
|
|
Energy
|
|
|
Percent of Segment Revenues
|
|
|
Other
|
|
|
Percent of Segment Revenues
|
|
|
Total
|
|
|
Percent of Total Revenues
|
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
|
$
|
|
|
%
|
|
Total revenues
|
|
$
|
5,458
|
|
|
|
100.0
|
%
|
|
$
|
—
|
|
|
|
—
|
%
|
|
$
|
5,458
|
|
|
|
100.0
|
%
|
Cost of revenue
|
|
|
4,271
|
|
|
|
78.3
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
4,271
|
|
|
|
78.3
|
%
|
Gross profit
|
|
|
1,187
|
|
|
|
21.7
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
1,187
|
|
|
|
21.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
3,254
|
|
|
|
59.6
|
%
|
|
|
1,581
|
|
|
|
—
|
%
|
|
|
4,835
|
|
|
|
88.5
|
%
|
Depreciation and amortization
|
|
|
400
|
|
|
|
7.3
|
%
|
|
|
6
|
|
|
|
—
|
%
|
|
|
406
|
|
|
|
7.4
|
%
|
Research and development
|
|
|
52
|
|
|
|
1.0
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
52
|
|
|
|
1.0
|
%
|
Provision for bad debt
|
|
|
67
|
|
|
|
1.2
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
67
|
|
|
|
1.2
|
%
|
Other operating expenses
|
|
|
(2
|
)
|
|
|
—
|
%
|
|
|
—
|
|
|
|
—
|
%
|
|
|
(2
|
)
|
|
|
—
|
%
|
Total operating expenses
|
|
|
3,771
|
|
|
|
69.1
|
%
|
|
|
1,587
|
|
|
|
—
|
%
|
|
|
5,358
|
|
|
|
98.1
|
%
|
Continuing loss from operations
|
|
$
|
(2,584
|
)
|
|
|
(47.4
|
)%
|
|
$
|
(1,587
|
)
|
|
|
—
|
%
|
|
$
|
(4,171
|
)
|
|
|
(76.4
|
)%
|
Revenue
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Revenues by Segment or Category
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Energy
|
|
$
|
5,688
|
|
|
$
|
5,458
|
|
|
$
|
230
|
|
|
|
4.2
|
%
|
Total revenues
|
|
$
|
5,688
|
|
|
$
|
5,458
|
|
|
$
|
230
|
|
|
|
4.2
|
%
|
The revenues for the three months ended March 31, 2020 were up compared to the 2019 comparable period due to higher integration revenues and Orbital Power revenue in the Company's North America operations partially offset by lower integration revenues in the Company's U.K. operations during the quarter. The U.K. market continues to face headwinds surrounding Brexit, foreign exchange fluctuation and the impact of the political environment on investment within the sector. Revenues will fluctuate generally around the timing of customer project delivery schedules.
The Energy segment held backlogs of customer orders of approximately $9.5 million as of March 31, 2020. This is down slightly from December 31, 2019 backlog of $9.6 million due to lower translation rates in the U.K and timing.
Cost of revenues
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Cost of revenues by Segment or Category
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Energy
|
|
$
|
5,129
|
|
|
$
|
4,271
|
|
|
$
|
858
|
|
|
|
20.1
|
%
|
Total cost of revenues
|
|
$
|
5,129
|
|
|
$
|
4,271
|
|
|
$
|
858
|
|
|
|
20.1
|
%
|
For the three months ended March 31, 2020, the cost of revenues as a percentage of revenue increased to 90% from 78% during the prior-year comparative period. This increase was attributable entirely to start-up costs at the Company's Orbital Power Services group and is expected to improve throughout the remainder of 2020. This percentage will vary based upon the mix of natural gas systems sold, proprietary technology included in projects, contract labor necessary to complete gas related projects, mix of Orbital Power Services projects, the competitive markets in which the Company competes, and foreign exchange rates. In the three months ended March 31, 2020 it was also affected negatively by the COVID-19 pandemic and the resulting world-wide economic slowdown.
The Company expects margins to improve in the second quarter as Orbital Power Services gain efficiencies, Companies learn to cope with the COVID-19 pandemic, and with the April 1, 2020 acquisition of Reach Construction Group.
.
Selling, General and Administrative Expenses
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Selling, general, and administrative expense by Segment or Category
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Energy
|
|
$
|
4,038
|
|
|
$
|
3,254
|
|
|
$
|
784
|
|
|
|
24.1
|
%
|
Other
|
|
|
3,154
|
|
|
|
1,581
|
|
|
|
1,573
|
|
|
|
99.5
|
%
|
Total selling, general and administrative expense
|
|
$
|
7,192
|
|
|
$
|
4,835
|
|
|
$
|
2,357
|
|
|
|
48.7
|
%
|
Selling, General and Administrative (SG&A) expenses include such items as wages, commissions, consulting, general office expenses, business promotion expenses and costs of being a public company, including legal and accounting fees, insurance and investor relations. SG&A expenses are generally associated with the ongoing activities to reach new customers, promote new product lines including GasPT, IRIS, VE, and other new product and service introductions.
During the three months ended March 31, 2020, SG&A increased $2.4 million compared to the prior-year comparative period. The increase in SG&A for the quarter was due to increased corporate costs largely due to strategic initiatives, which included increased professional fees including legal, accounting, tax, investor relations, and costs associated with due diligence activities related to prospective acquisitions. Also contributing to the increase was increased SG&A costs in the Energy segment primarily due to start-up costs at Orbital Power Services group, which included increased payroll and insurance costs.
Depreciation and Amortization
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense by Segment or Category
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Energy
|
|
$
|
478
|
|
|
$
|
400
|
|
|
$
|
78
|
|
|
|
19.5
|
%
|
Other
|
|
|
8
|
|
|
|
345
|
|
|
|
(337
|
)
|
|
|
(97.7
|
)%
|
Total depreciation and amortization
|
|
$
|
486
|
|
|
$
|
745
|
|
|
$
|
(259
|
)
|
|
|
(34.8
|
)%
|
Depreciation and amortization expenses are associated with depreciation on buildings, furniture, equipment, vehicles, and intangible assets over the estimated useful lives of the related assets.
Depreciation and amortization expense in the three months ended March 31, 2020 were down compared to the three months ended March 31, 2019 due to the sale of the Company's domestic power and electronic components businesses in the fourth quarter of 2019. It is also down due to the accounting rule that requires businesses that are held for sale to not record depreciation or amortization after being classified as held for sale, which happened in the third quarter of 2019 for the former Power and Electromechanical segment businesses. The Company's Japan and Canada operations are currently held for sale. The depreciation and amortization associated with the Company's discontinued operations is included in the other category. The overall decrease in depreciation and amortization was partially offset by an increase in the Energy segment's depreciation and amortization due to the start-up of Orbital Power Services.
Research and Development
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Research and development by Segment or Category
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Energy
|
|
$
|
17
|
|
|
$
|
52
|
|
|
$
|
(35
|
)
|
|
|
(67.3
|
)%
|
Total research and development
|
|
$
|
17
|
|
|
$
|
52
|
|
|
$
|
(35
|
)
|
|
|
(67.3
|
)%
|
Research and development costs ("R&D") are associated with the continued research and development of new and existing technologies including GasPT, VE Technology and other energy products.
Provision (Credit) for Bad Debt
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Provision (credit) for bad debt by Segment or Category
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Energy
|
|
$
|
6
|
|
|
$
|
67
|
|
|
$
|
(61
|
)
|
|
|
(91.0
|
)%
|
Total provision for bad debt
|
|
$
|
6
|
|
|
$
|
67
|
|
|
$
|
(61
|
)
|
|
|
(91.0
|
)%
|
The changes in bad debt are due to fluctuations in bad debt reserves, primarily at Orbital Gas Systems Ltd. in the U.K. Collections were generally strong in both the three months ended March 31, 2020 and March 31, 2019.
Equity Method Investment
On March 30, 2019, the Company acquired a 21.4% ownership share of VPS which was subsequently reduced to 20.58% following VPS's issuance of additional equity. The Company records its investment and income or loss based on the equity method of accounting. The Company recorded a loss of $0.4 million and zero for the three months ended March 31, 2020 and March 31, 2019, respectively, related to its share of VPS's loss.
Other Income (Expense), net
(dollars in thousands)
|
|
For the Three Months Ended
|
|
|
|
|
|
|
|
|
|
Other Income (Expense), net
|
|
March 31,
|
|
|
|
|
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
$ Change
|
|
|
% Change
|
|
Foreign exchange gain (loss)
|
|
$
|
(1,200
|
)
|
|
$
|
240
|
|
|
$
|
(1,440
|
)
|
|
|
(600.0
|
)%
|
Interest income
|
|
|
70
|
|
|
|
6
|
|
|
|
64
|
|
|
|
1066.7
|
%
|
Rental income
|
|
|
98
|
|
|
|
3
|
|
|
|
95
|
|
|
|
3166.7
|
%
|
Total Other income (expense)
|
|
$
|
(1,032
|
)
|
|
$
|
249
|
|
|
$
|
(1,281
|
)
|
|
|
(514.5
|
)%
|
Other income (expense) changes were primarily the result of larger foreign currency losses due to the weakening U.K. pound in the three months ended March 31, 2020 compared to a strengthening U.K. pound in the three months ended March 31, 2019.
Interest Expense
For the three months ended March 31, 2020 and 2019, the Company incurred interest expense of $11 thousand and $9 thousand. Interest expense in 2020 is associated with interest on a financing note payable while 2019 interest was on the Company's former U.K. overdraft facility.
Income Tax Expense (Benefit)
The Company is subject to taxation in the U.S., various state and foreign jurisdictions. The Company continues to record a full valuation allowance against the Company's U.S. and United Kingdom net deferred tax assets and partial valuation allowance against the Company’s Canada net deferred tax assets, as it is not more likely than not that the Company will realize a benefit from these assets in a future period.
For the three months ended March 31, 2020, the Company is allocating income tax expense (benefit) in accordance to ASC 740-20-45-7 to more than one financial statement component other than continuing operations. Prior period comparative allocations have also been made.
In the three months ended March 31, 2020, as a result of HM Revenue & Customs review, the Company recorded a $1.6 million tax benefit for estimated prior year taxes related to refunds for the surrender for cash, United Kingdom net operating losses generated related to enhanced research and development deduction claims.
The income tax expense for the three months ended March 31, 2019 included taxes on profitable foreign operations and domestic state minimum taxes.
For additional analysis, see Note 14, "Income Taxes," of the condensed consolidated financial statements in Part I - Item I, "Financial Statements."
Restructuring Charges
During the fourth quarter of 2019, the Company completed the sale of its largest group within the Power and Electromechanical segment. The remaining assets remain held-for-sale. However, in conjunction with that sale, it was concluded that should the remaining power and electromechanical operations not sell, the Company will fulfill its backlog obligations and wind down the remaining operations of CUI-Canada and CUI Japan during 2020. As such, the Company has recorded an accrued liability of 4.0 million Canadian dollars ($2.8 million US dollars at March 31, 2020) for estimated employee termination costs. The termination costs are expected to begin during 2020 based around backlog production and delivery schedule requirements. The lease for the CUI-Canada facility completes during 2020 and the CUI Japan lease includes a four-month notice period to terminate. There were no changes to the restructuring accruals in the three months ended March 31, 2020.
Liquidity and Capital Resources
General
As of March 31, 2020, the Company held Cash and cash equivalents of $6.7 million and Restricted cash of $1.0 million. Operations, investments, and equipment have been funded through cash on hand. Including discontinued operations, the Company's cash used in operations was more in the first three months of 2020 than in the first three months of 2019. Major uses of cash in the first three months of 2020 included inventory purchases, changes in prepayments, and other current assets, contract liabilities and accrued liabilities, partially offset by changes in accounts receivable and accounts payable. The Company continues to work to improve its short-term liquidity through management of its working capital. Long-term liquidity will be benefited from the recent Reach Construction acquisition, which is expected to be cash flow positive during 2020. Overall volume growth in the Company's Energy businesses both organically and through acquisitions and the expected sale of the remaining Power & Electromechanical operations are expected to benefit cash flows as well.
Cash Used in Operations
Cash used in operations of $7.7 million was a $5.1 million increase in cash used compared to the three-month period in 2019. Cash used in operations for the three months ended March 31, 2020 were almost $4.0 million in the other category, $2.6 million in the Energy segment and $1.1 million related to discontinued operations. This compares to cash used of $0.9 million in the Other category, $2.3 million in the Energy segment and $0.5 million provided by the discontinued Power and Electromechanical segment. Increased uses of cash in the first three month of 2020 are primarily for merger and acquisition activity in the Other category in addition to normal administrative costs, and increased cash usage in the Energy segment primarily related to start-up costs on the Company's new Orbital Power Services group. While the Company saw an initial cost increase from Orbital Power Services, management expects this group to become cash flow positive, as the business environment normalizes. The Company believes overall cash used in operations will continue to improve through revenue growth associated with new customers and larger projects, the additional cash expected from operations of Reach Construction Group and in process cost reductions coupled with continued management of working capital allocation. The Company expects the cash usage rate in the other category to decrease due to the closing of the Reach Construction Group acquisition in April.
The change in cash used in operating activities, exclusive of net loss, is primarily the result of increased inventories of $1.8 million associated with inventory purchases in the Canada operation, increased prepaid expenses and other current assets of $0.9 million related to new prepaid insurance policies for the new Orbital Power Services group and $0.9 million change in Deposits and other assets for a Deposit at Orbital U.K. on a future intangible asset. Increased cash used for right of use assets and partially offsetting increased lease liabilities are due to the ramp up of the Orbital Power Services group. The decrease in accrued liabilities was primarily related to payout of employee accrued compensation in 2020 for the 2019 year. Also contract assets increased by $0.5 million that were partially offset by a $0.3 million increase in contract liabilities. These increases in use of cash are partially offset by increased cash provided by the timing of collections on receivables due to the timing and completion of integration projects and increased accounts payable of $0.3 million related to timing and the additional operations of Orbital Power Services in 2020.
During the three months ended March 31, 2020 and 2019, the Company recorded a total of $3 thousand and $51 thousand, respectively, for share-based compensation related to equity given, or to be given to directors, employees and consultants for services provided and as payment for royalties earned. The decrease in expense during the first three months of 2020 compared to the first three months of 2019 is primarily due to a portion of directors' compensation being accrued while the structure of their compensation is being evaluated.
The Company may file an S-3 registration statement in 2020. Following such filing, Orbital Energy Group may from time to time issue various types of securities, including common stock, preferred stock, debt securities and/or warrants, up to an aggregate amount that will be defined in an S-3 registration.
As the Company focuses on growing its energy infrastructure services market presence, it will fund these activities, together with related sales and marketing efforts for its various product offerings with cash on hand, and possible future issuances of equity and debt.
Orbital Energy Group may raise additional capital needed to fund the further development and marketing of its products as well as payment of its debt obligations.
See the section entitled Recent Sales of Unregistered Securities for a complete listing of all unregistered securities transactions.
Capital Expenditures and Investments
During the first three months of 2020 and 2019, Orbital Energy Group invested $1.3 million and $69 thousand, respectively, in property and equipment. In the first three months of 2020, this was primarily for capital assets associated with the Company's new Orbital Power Services group. These investments typically include additions to equipment, tooling for manufacturing, furniture, computer equipment, buildings and leasehold improvements, trucks and other fixed assets as needed for operations. The Company entered into a $3 million note receivable with Reach Construction, Inc. during the three months ended March 31, 2020 prior to the April 1 acquisition. This note will become an intercompany note in the second quarter of 2020. The Company made an additional $0.2 million investment in a convertible note receivable from Virtual Power Systems ("VPS") in the first three months ended March 31, 2020. The Company anticipates further investment in property and equipment during the remainder of 2020 in support of its on-going business and continued development of product lines and technologies for the Energy segment.
During the three months ended March 31, 2020 and 2019, Orbital Energy Group invested $4 thousand and $0.1 million, respectively, in other intangible assets. These investments typically include product certifications, capitalized website development, software for engineering and research and development and software upgrades for office personnel.
During the first three months of 2019, Orbital Energy Group made cash investments of $0.3 million and elected to convert its $0.7 million of convertible notes receivable to VPS stock. In addition to the cash investments, the Company contributed certain property and equipment, other intangible assets, inventories, prepaid assets, open purchases orders, future research and development expenditures and the convertible note receivable for a total investment of $5.3 million for a 21.4% equity investment in VPS. In the second quarter of 2019 the initial investment was marked up to $5.9 million based on the fair value of the non-cash contributions. Through March 31, 2020, the noncash portion of the investment was $3.7 million. The Company's share ownership percentage was subsequently diluted to 20.58% as of March 31, 2020 due to additional share issuances by VPS. Through these investments the Company is continuing its support of the two companies’ continued collaboration and development of industry transforming Software Defined Power technologies (see Note 7).
The Company also paid out $2.8 million in the three months ended March 31, 2020 related to a working capital adjustment on the disposition of the domestic power business to Bel Fuse, Inc in accordance with the sale agreement.
Financing Activities
For the three months ended March 31, 2020 and 2019, the Company recorded net payments of $0 and $0.4 million, respectively, from the overdraft facility in the U.K., and had net proceeds of $0 and of $0.5 million, respectively, from the line of credit. The previous line of credit and overdraft facility were replaced in April 2019 with a new $10.0 million line of credit from Bank of America Merrill Lynch that was reduced to $6.0 million at September 30, 2019 upon the sale of the Company's electronic components business and discontinued following the sale of the domestic power business to Bel Fuse, Inc.
Financing Activities – Related Party Activity
For the three months ended March 31, 2020 and 2019, $0 and $66 thousand of interest payments were made in relation to the promissory note issued to former related party, IED, Inc. This note was assumed by the buyer as part of the sale of the Electromechanical operations.
Recap of Liquidity and Capital Resources
At March 31, 2020, the Company had unrestricted cash and cash equivalents balances of $6.7 million. At March 31, 2020, the Company had $0.9 million of cash and cash equivalents balances at domestic financial institutions that were covered under the FDIC insured deposits programs and $0.2 million and $71 thousand, at foreign financial institutions covered under the United Kingdom Financial Services Compensation (FSC) and Canada Deposit Insurance Corporation (CDIC). At March 31, 2020, the Company had cash and cash equivalents of $0.3 million in Japanese bank accounts, $0.7 million in European bank accounts and $0.3 million in Canadian bank accounts.
The Company had a net loss of $7.4 million and cash used in operating activities of $7.7 million during the three months ended March 31, 2020. As of March 31, 2020, the Company's accumulated deficit is $129.6 million.
The Company expects the revenues from its continuing operations, and cash on hand, to cover operating and other expenses for the next twelve months of operations. However, in the short-term, the Company expects its Orbital Gas Systems operations in Houston and the U.K. to continue to need cash support as the businesses increase their market positions and revenue.
Critical Accounting Policies
The Company has adopted various accounting policies to prepare the consolidated financial statements in accordance with GAAP. Certain of the Company's accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. In the Company's 2019 Annual Report on Form 10-K filed on March 30, 2020, the Company identified the critical accounting policies that affect the Company's more significant estimates and assumptions used in preparing the Company's consolidated financial statements.
Adoption of new accounting standards
See Note 2 Summary of Significant Accounting Policies - Update of the condensed consolidated financial statements in Part I—Item I, “Financial Statements” for a description of recent accounting pronouncement adoptions, including the dates of adoption and effects on financial position, results of operations and cash flows if any.
Recent Accounting Pronouncements
See Note 11 Recent Accounting Pronouncements of the condensed consolidated financial statements in Part I—Item I, “Financial Statements” for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on financial position, results of operations and cash flows.
Off-Balance Sheet Arrangements
As of March 31, 2020, the Company is an indemnitor on a surety bond for an unconsolidated third party related to a $4.6 million Reach Construction Group project that is approximately 90% complete and expected to be completed in 2020. The Company does not expect any liability associated with this off-balance sheet arrangement.
Item 3.
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Quantitative and Qualitative Disclosure about Market Risk.
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The Company is exposed to market risk in the ordinary course of business. Market risk represents the risk of loss that may impact the Company’s financial position due to adverse changes in financial market prices and rates. This market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. The Company neither holds nor issues financial instruments for trading purposes.
The following sections provide quantitative information on the Company’s exposure to foreign currency exchange rate risk. The Company makes use of sensitivity analyses that are inherently limited in estimating actual losses in fair value that can occur from changes in market conditions.
Foreign Currency Exchange Rates
The Company conducts continuing operations in two principal currencies: the U.S. dollar and the British pound sterling. These currencies operate primarily as the functional currency for the Company’s U.S. and U.K. operations, respectively. Cash is managed centrally within each of the two regions.
Because of fluctuations in currency exchange rates, the Company is subject to currency translation exposure on the results of its operations. Foreign currency translation risk is the risk that exchange rate gains or losses arise from translating foreign entities’ statements of earnings and balance sheets from functional currency to the Company’s reporting currency, the U.S. dollar, for consolidation purposes. As currency exchange rates fluctuate, translation of the Company’s statements of operations into U.S. dollars affects the comparability of revenues and operating expenses between years.
Revenues and operating expenses from continuing operations are primarily denominated in the currencies of the countries in which the Company’s operations are located, the U.S. and U.K. The Company’s consolidated results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates.
The Company has discontinued operations in Canada and Japan. Until those entities are sold, in addition to the Company's principal currencies, the Company will have a certain amount of currency risk with the Japanese yen and Canadian dollar.
The tables below detail the percentage of revenues and expenses from continuing operations by the two principal currencies:
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British Pound
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U.S. Dollar
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Sterling
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For the Three Months Ended March 31, 2020
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Revenues
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49
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%
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51
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%
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Operating expenses
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74
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%
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26
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%
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For the Three Months Ended March 31, 2019
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Revenues
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35
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%
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65
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%
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Operating expenses
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52
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%
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48
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%
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To date, the Company has not entered into any hedging arrangements with respect to foreign currency risk and have limited activity with forward foreign currency contracts or other similar derivative instruments. The Company believes that during the three months ended March 31, 2020, the effect of a hypothetical 100 basis point shift in foreign currency exchange rates applicable to the Company’s business would not have had a material impact on the Company’s condensed consolidated financial statements.
Brexit Risk
On January 31, 2020, the United Kingdom (“UK”) formally withdrew from the European Union (“EU”), entering a transitional period which is currently expected to end on December 31, 2020. During this transitional period, EU law will continue to apply in the UK while providing time for the UK and EU to negotiate the details of their future relationship. The impact of the withdrawal may adversely affect business activity, political stability and economic conditions in the U.K., the European Union and elsewhere. The economic conditions and outlook could be further adversely affected by the uncertainty concerning new or modified trading arrangements between the U.K. and other countries. Any of these developments could negatively affect economic growth or business activity in the U.K., the European Union and elsewhere, and could materially and adversely affect our business and results of operations. We continue to closely monitor the negotiations and the impact to foreign currency markets, however we cannot predict the direction of Brexit-related developments or the impact of those developments on our UK operations and the economies of the markets in which we operate.
Investment Risk
The Company has an Investment Policy that, among other things, provides an internal control structure that takes into consideration safety (credit risk and interest rate risk), liquidity and yield. The Company’s investment committee consists of two independent Directors and the CFO, who oversee the investment portfolio and compile a quarterly analysis of the investment portfolio, if any investments exist during the period.
Investments made by the Company are subject to Investment committee Charter and investment policy, which limits the Company’s risk of loss exposure by setting appropriate credit quality requirements for investments held, limiting maturities to be 1 year or less, and also setting appropriate concentration levels to prevent concentrations. This includes a requirement that no more than 3% of the portfolio, or $0.5 million, whichever is greater, may be invested in one particular issue. In 2019, since the equity-method investment in VPS is considered a strategic investment, the board and management reviewed and approved the investment above the board set limit for individual issuers.
Cash and cash equivalents are diversified and maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with financial institutions of reputable credit, therefore, bear minimal credit risk.
The Company has trade receivable and revenues concentrations with large customers. Additionally, the Company has a large concentration of cash, trade receivables and revenues in foreign countries including the United Kingdom, Canada and Japan. Owning assets in a foreign country exposes the Company to foreign currency risk coupled with liquidity risk. Foreign owned assets may be difficult to timely convert to U.S. dollars if necessary.