Item 1. Business.
Unless expressly indicated or the context requires otherwise, the terms “Lighting Science Group,” “we,” “us,” “our” or the “Company” refer to Lighting Science Group Corporation or, as applicable, its predecessor entities and, where appropriate, its wholly owned subsidiaries.
General
We are an innovator and global provider of light emitting diode (“LED”) lighting technology. We design, develop and market advanced, environmentally sustainable and differentiated illumination solutions that use LEDs as their exclusive light source. Our product portfolio includes LED-based retrofit lamps (replacement bulbs) used in existing light fixtures as well as purpose-built LED-based luminaires (light fixtures). Our lamps and luminaires are used for many common indoor and outdoor residential, commercial, industrial and public infrastructure lighting applications. We have also developed LED lighting technology that emits light at frequencies calibrated along the visible spectrum to achieve specific biological effects.
Our in-house design of power supplies, thermal management solutions and optical systems, along with our detailed specification of the packaged LEDs incorporated into our products, provides us with a unique ability to manage the interrelationships between components and subsystems. This system-based approach enables us to provide a broad range of solutions that deliver a high quality combination of lighting efficacy and reliability. In addition, we believe we can leverage our strong supply chain and sourcing capabilities to support an “all channels” go-to-market strategy and to deliver differentiated lighting solutions at competitive price points.
Our customers include retailers and original equipment manufacturers (“OEMs”) that sell our products on a co-branded or private label basis. Large retail, hospitality and other corporate customers also purchase products from us directly. In addition, our luminaires are utilized in large-scale infrastructure projects throughout the world.
We are seeking to lead the convergence of science and light to improve the environment as well as human health and well-being. Our lighting technology is designed to consume less electricity for each unit of light produced and we continue to improve our product packaging and lifespan to use fewer materials in the production and distribution of our lamps and luminaires.
On March 20, 2017, we formed LSG MLS JV Holdings, Inc. (“LSG JV Holdings”) as a subsidiary and entered into an operating agreement with MLS Co., Ltd. (“MLS”) relating to the formation of Global Value Lighting, LLC (“GVL”). GVL was formed as a joint venture between us and MLS for the purpose of carrying out the manufacturing, marketing, sale and distribution of private label LED lighting products and services to retail and commercial customers in North America and South America. The joint venture is an integral part of our long-term strategy (the “Joint Venture”). We believe the Joint Venture will allow GVL to focus on the private label LED business, which to date has represented a significant portion of our revenues, while allowing us to focus on our technology business featuring product lines such as its proprietary HealthE™, VividGro®, and FreeLED™, which will be operated independently from GVL. The Joint Venture remains subject to certain closing conditions. Upon the closing of the Joint Venture, we (through LSG JV Holdings) will make an initial capital contribution of $5.1 million in cash to GVL, and MLS will make an initial capital contribution of $4.9 million in cash to GVL. Upon the determination of the board of managers of GVL, each of LSG JV Holdings and MLS will be required to make additional capital contributions of up to $7.65 million and $7.35 million in the aggregate, respectively, during the first 12 months following the closing date. LSG JV Holdings will own 51% of the membership interests of GVL and MLS will own 49% of the membership interests of GVL.
Corporate Information and History
We were incorporated in the state of Delaware in 1988. Our principal executive offices are located at 1350 Division Road, Suite 102, West Warwick, Rhode Island 02893, and our telephone number is (321) 779-5520. Our website address is www.lsgc.com. This reference to our website is an inactive textual reference only and is not a hyperlink. The contents of our website are not part of this Form 10-K.
We are controlled by affiliates of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), a U.S.-based private equity fund manager that provides capital and strategic solutions to middle market companies across a variety of industries. Historically, Pegasus Capital has invested in our capital stock through LSGC Holdings, LLC (“LSGC Holdings”), Pegasus Partners IV, L.P. (“Pegasus Fund IV”), LED Holdings, LLC (“LED Holdings”), LSGC Holdings II LLC (“Holdings II”), PCA LSG Holdings, LLC (“PCA Holdings”), LSGC Holdings III LLC (“Holdings III”) and LSGC Holdings IIIa, LLC (“Holdings IIIa” and collectively with Pegasus Capital, Pegasus Fund IV, LSGC Holdings, Holdings II, Holdings III, PCA Holdings and their affiliates, “Pegasus”). Pegasus is the Company’s controlling stockholder.
Our Products
We have an extensive product portfolio with three distinct offerings-replacement lamps, luminaires and biological (or spectrum control) lighting. The products in each of these offerings achieve a unique combination of scientific innovation, lumen distribution and energy efficiency. We enhanced our product line during 2016 with the introduction of several new products, including our Genesis Dynaspectrum™ (the first commercially-available luminaire focusing on users’ health and productivity), the Durabulb (a shatter-resistant lamp), and the L-Bar™ (a high-performance linear lighting solution). Combined with the introduction of new products in 2015, including the Free LED solar roadway system, our Vintage™ Filament Series of LED lamps, our Sleepy Baby™ LED lamp, a new mini-roadway luminaire and our VividGro agricultural grow light product, we anticipate that our new products will provide improved performance relative to our legacy products through the implementation of more effective components and form factors.
Replacement Lamps. We offer a broad range of LED retrofit lamps designed to fit into existing light fixtures as replacements for traditional incandescent, compact fluorescent and halogen lamps. Our dimmable LED retrofit lamps possess consistent color and deliver improved light distribution and brightness in commercial and residential settings as compared to traditional lighting products. Our replacement lamp product line includes lamps that are sold under the Lighting Science® brand as well as co-branded and private label retrofit lamps offered directly to our customers and through distributors across North America. In January 2015, we launched the Vintage Filament Series of LED lamps in many of the traditional, incandescent bulb decorative form factors but with greater energy savings than their traditional counterparts.
Luminaires. We offer LED luminaires that combine energy efficiency, long life span and enhanced light distribution, making them ideal for street lighting and lighting in parking garages, outdoor areas, warehouses and manufacturing areas. In February 2015, we introduced the FreeLED solar roadway system, a sleek, intelligent and powerful street lighting solution that uses solar energy as its power source. We believe the FreeLED will provide a reliable, affordable and sustainable roadway illumination solution for the general public, including those rural or remote communities with limited access to the electric grid.
Biological Lighting. Our biological lighting product line incorporates our patented technology to emit light at frequencies calibrated along the visible spectrum to achieve specific biological effects. Our current line of biological products can be used to induce a sleep, awake or transition state as well as to effectively and efficiently modify and enhance the circadian rhythm of certain agricultural products to optimize growth in terms of both time and energy efficiency. Our biological lighting product line includes the Good Night™ and Good Day™ circadian replacement lamps, the VividGro grow light product, the MyNature™ Coastal lamps and outdoor luminaires and the MyNature Grow lighting lamps and high bay luminaires. In March 2015, building on the proprietary technology underlying our popular Good Night lamp, we released the Sleepy Baby lamp, which delivers a patented, biologically-corrected light source for use during a baby’s nightly bedtime routine, sending natural signals to promote sleep and child wellness. The GoodNight lamp has a patented spectral filter that greatly reduces blue light and supports the body’s natural melatonin production. The GoodDay lamp has a blue enriched spectrum to naturally enhance the body’s energy and alertness. Our coastal lighting solutions have been installed at Patrick Air Force Base and other locations along Florida’s east coast. In addition, numerous commercial and academic greenhouses and growing facilities across the United States and Canada have implemented our MyNature Grow solutions.
Target Markets and Customers
We focus our product development on the applications and markets in which the return on investment, total cost of ownership and other benefits of LED lighting currently offer clear and compelling incentives for customers. In particular, we seek to improve our brand awareness and sales pipeline in major urban areas both in the United States and abroad in the market segments discussed below. Historically we relied on our relationship with The Home Depot, Inc. (“The Home Depot”) for a significant portion of our revenue, although we are working to diversify our customer base and product sales in 2017 and beyond, as we now are aggressively marketing our products to other big box stores and retailers.
Residential and office. We offer a line of retrofit lamps, integrated retrofit kits and luminaires designed to compete with traditional incandescent, florescent and halogen lamps and luminaires for commercial and residential lighting applications. Our retrofit lamps and luminaires targeted for this market are currently sold to distributors and OEMs that resell them both directly to end-users and into retail channels under the Lighting Science brand and, at times, under the distributors’ and OEMs’ own brands. We also have a comprehensive assortment of retrofit lamps and luminaires that we market and sell through our website under the Lighting Science brand.
Retail and hospitality. The market for lighting in the retail and hospitality environment is large and varied. We believe our lighting products are particularly well suited for the retail and hospitality segment, including applications in malls, retail stores, hotels and resorts, cruise ships and restaurants. Our retrofit lamp and luminaire offerings for this market focus on task, down, bay, cove, linear, accent, track and spot lighting as well as retail display lighting. Several major U.S. retailers have replaced their existing lighting with our LED retrofit lamps and luminaires. We believe that our biological lighting technology may provide us with a unique competitive advantage in this market segment.
Government-owned and private infrastructure. Public and private infrastructure includes outdoor facilities and spaces that are managed by government and private entities. Primary applications for our products in this market include lighting for streets and highways, parking lots, airports, ports, utilities and other large outdoor areas, particularly in developing nations. Street and highway lighting represents the largest segment within the infrastructure market.
Schools and universities. Buildings and outdoor lighting for primary, secondary and higher education represent a significant market opportunity for our energy-efficient solutions. This opportunity results in part from the movement across K-12 institutions, as well as colleges and universities, to reduce energy use and environmental impact as well as improve sustainability. We believe that switching to LED lighting is one of the most practical, readily implementable, highest-return, and high profile actions campus administrators can take towards fulfilling this mandate. Principal applications in this market include lighting for parking lots, large outdoor areas, streets and building exteriors, as well as indoor lighting in classrooms and common areas.
Sales Channels
We employ an “all channels” go-to-market strategy that addresses distinct market opportunities through branded and co-branded private label programs, our direct sales force, distributors and independent sales agents, as well as partnerships and joint ventures.
Our strategic account management team focuses on developing new business alliances and managing our existing branded lighting and OEM relationships. In addition to its business development initiatives, our strategic account management team seeks to expand our revenue from our current accounts by providing ongoing energy analysis, market expertise and support to such customers.
Our national account management team focuses on finding new, potentially high-value customers and providing professional support to our current roster of end-users. This team targets and supports retail, hospitality, schools and universities, large real estate management and energy service company customers.
Our project-focused activities involve supporting our network of independent sales agents and distributors that pursue lighting projects in the commercial, industrial and public infrastructure markets on a regional basis, including opportunities for projects in international markets. Our project-focused sales team develops and manages our network of channel partners and works with these partners to submit competitive bids on projects, and oversees the delivery and after-market support related to such projects.
Research and Development
To successfully implement our business strategy, we must continually improve our current products and develop new products for existing and new applications. Our research and development team focuses on advanced technological applications that not only increase the efficiency of the components and subsystems that make up our products, but also add capabilities such as controls, adaptability and biological technology. Components and subsystems include power supplies, thermal management solutions, optical systems and LEDs.
Our research and development team also seeks to enhance the aesthetic appeal and reduce the total cost of ownership of our products. Although we implemented a number of cost cutting measures during the past three years, including reductions in personnel, we intend to continue to dedicate a significant portion of our financial and personnel resources toward the development of new materials and methods related to our products.
Our research and development team is comprised of 12 research scientists and engineers, many with Doctoral or Masters Degrees in disciplines such as power electronics, lighting, thermal and mechanical engineering, materials science and cellular and molecular biology. These professionals combine a thorough understanding of the sciences required to develop LED lighting products with extensive experience in the lighting industry. Our research and development capabilities are further enhanced through collaborations with leaders within and outside the LED lighting industry. We have research and development relationships with professionals and institutions in a wide range of fields, including advanced material science, semiconductor performance, medical and biological research, space exploration and military applications. These institutions include leading research organizations, such as NASA, Harvard, Jefferson Medical College, Florida Institute of Technology, University of Guelph and Oak Ridge National Laboratory, as well as leading technology-oriented companies such as Bayer AG and National Semiconductor Corporation. In addition, we have supported and continue to contribute to research including advanced material processing and biological effects of lighting on plants and animals, including a recent study performed at Harvard and an on-going study at Alertness CRC Limited investigating the effects of lighting on human sleep patterns.
Research and development expenses for the years ended December 31, 2016, 2015 and 2014 were $3.3 million, $4.0 million and $5.6 million, respectively. We have reduced research and development expenses year-over-year since 2014 as part of our overall cost-cutting strategy, which is a key component of our on-going efforts to improve our financial results. We expense all of our research and development costs as they are incurred. Research and development expenses are reported net of any funding received under contracts with governmental agencies or commercial customers that are considered to be cost-sharing arrangements with no contractually committed deliverable.
Manufacturing and Suppliers
During the past three years, we have increasingly focused on our design and engineering competencies in an effort to develop differentiated products. Accordingly, we design and engineer our products and outsource substantially all of the manufacture and assembly of our products to a number of contract manufacturers internationally. These contract manufacturers purchase components based on our specifications and provide the necessary facilities and labor to manufacture our products. We allocate the production of specific products to the contract manufacturer we believe is best suited to manufacture the product. Quality control and lot testing is conducted at our contract manufacturers in Asia. Product qualification and testing is conducted in our facilities in Cocoa Beach, Florida. Our Cocoa Beach facility and each of our contract manufacturers have been ISO9001:2008 certified as conforming to the standards published by the International Organization for Standardization. If the proposed Joint Venture transaction with MLS closes, GVL will engage MLS as its exclusive manufacturer of certain LED lighting products.
We select LEDs based on a combination of availability, price and performance. We believe we have strong relationships with our LED suppliers and receive a high level of cooperation and support from them. In addition, we have entered into strategic relationships with certain of these key LED suppliers that currently give us access to next generation LED technology at an early stage and at competitive prices. Certain of our biological products use a custom LED package that we source from a limited number of suppliers.
Competition
Our products face competition in the general lighting market from both traditional lighting technologies produced by numerous vendors as well as from LED-based lighting products produced by a growing roster of industry participants. LED lighting products compete with traditional lighting technologies on the basis of the numerous benefits of LED lighting relative to such technology including greater energy efficiency, longer lifetime, improved durability, increased environmental sustainability, digital controllability, smaller size, directionality and lower heat output.
The LED lighting industry is characterized by rapid technological change, short product lifecycles and frequent new product introductions and a competitive pricing environment. These characteristics create a market environment that demands continuous innovation, provides entry points for new competitors and creates opportunities for rapid shifts in market share. We primarily compete with other providers of LED lighting on the basis of our product performance, as measured by efficacy, light quality, increased lumen output and reliability relative to industry standards and energy related certifications, such as ENERGY STAR and California Energy Commission specifications, as well as on product cost. In addition to these factors, which generally contribute to a lower total cost of ownership and enhanced product quality as compared to alternative lighting solutions, we offer our customers a broad product portfolio. We believe our product design approach, proprietary technology and deep understanding of lighting applications aids our ability to compete in the market for LED lighting.
Currently, we view our primary competition to be from large, established companies in the traditional general lighting industry. Certain of these companies also provide, or have undertaken initiatives to develop, LED lighting products as well as other energy efficient lighting products. Additionally, we face competition from a fragmented group of smaller niche or low-cost offshore providers of LED lighting products. We also anticipate that larger LED chip manufacturers, including some of those that currently supply us, will continue to seek to compete with us. For example, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering in June 2015. In connection with this line review, The Home Depot elected to purchase certain products previously supplied by us directly from overseas suppliers, including one of our suppliers. We also expect other large technology players with packaged LED chip technology that are currently focused on other end markets for LEDs, such as backlighting for LCD displays, to increasingly focus on the general illumination market as their existing markets saturate and LED use in general illumination grows. In addition, we may compete in the future with vendors of new technological solutions for energy efficient lighting.
Intellectual Property
Our intellectual property portfolio is a key aspect of our product differentiation strategy. We seek to protect our proprietary technologies by obtaining patents and licenses, retaining trade secrets and, when appropriate, defending and enforcing our intellectual property rights. We believe this strategy optimizes our ability to preserve the advantages of our products and technologies and improves the return on our investment in research and development.
As of December 31, 2016, we had obtained 293 patents from the United States Patent Office (the “USPTO”), with another 4 applications allowed and 23 pending, as well as 96 foreign patents, with another three allowed and 29 pending from various jurisdictions outside of the United States. These patents and patent applications cover various inventions related to the design and manufacture of LED lighting technology. During 2016, we filed 23 new U.S. patent applications and 31 U.S. patents were issued to us by the USPTO. When it is appropriate and cost effective, we make corresponding international, regional or national filings to pursue patent protection in other parts of the world. In certain cases, we rely on confidentiality agreements and trade secret protections to defend our proprietary technology. In addition, we license and have cross-licensing arrangements with respect to third-party technologies that are incorporated into elements of our design activities, products and manufacturing processes. Where appropriate, we also license certain of our intellectual property to third parties to further monetize our intellectual property portfolio.
The LED lighting industry is characterized by the existence of a significant number of patents and other intellectual property and by the vigorous pursuit, protection and enforcement of intellectual property rights. We believe that our extensive intellectual property portfolio, along with our license arrangements, provides us with a considerable advantage relative to new entrants to the industry and smaller LED lighting providers in serving sophisticated customers.
We also intend to continue to enforce our intellectual property rights against third parties. In 2016, we settled claims against 11 companies in which we sought damages and injunctive relief in response to such companies’ alleged infringement of our patent rights. We received payments of $1.8 million during 2016 from those companies as a result of those settlements. In 2015, we filed four lawsuits against third parties seeking damages and injunctive relief in response to such third parties’ infringement of our patent rights. Four other companies agreed to take a patent license and pay royalties to us. In addition, in April 2015, we filed a lawsuit against several former employees and the company they formed seeking damages and injunctive relief arising out of the defendants’ misappropriation of our trade secrets and other intellectual property. Pursuant to the terms of a settlement agreement, the defendants agreed not to use or disclose our intellectual property and to reimburse us $200,000 in costs, and the defendants’ company agreed to pay to us a commission equal to the greater of (i) $1.7 million and (ii) 5% of the infringing company’s gross sales of biological and agricultural products during the three-year period ending January 2019.
As is customary in the LED lighting industry, many of our customer agreements require us to indemnify our customers for third-party intellectual property infringement claims. Claims of this sort could harm our relationships with customers and might deter future customers from doing business with us. With respect to any intellectual property rights claims against us or our customers and/or distributors, we may be required to cease manufacture of the infringing product, pay damages and expend significant resources to defend against the claim and/or develop non-infringing technology, seek a license or relinquish patents or other intellectual property rights.
Regulations, Standards and Conventions
Our products are generally required to comply with and satisfy the electrical codes of the jurisdictions in which they are sold. We design our products to meet the typically more stringent codes established in the United States and the European Union, which usually allows our products to meet the codes in other geographic regions.
Many of our customers require our products to be certified by Underwriters’ Laboratories, Inc. (“UL”). UL is a U.S.-based independent, nationally recognized testing laboratory, and third-party product safety testing and certification organization. UL develops standards and test procedures for products, materials, components, assemblies, tools and equipment, primarily dealing with product safety. UL evaluates products, components, materials and systems for compliance to specific requirements, and permits acceptable products to carry a UL certification mark, as long as they remain compliant with the standards. UL offers several categories of certification. Products that are “UL Listed,” are identified by the distinctive UL mark. We have undertaken to have all of our products meet UL standards and be UL listed. There are alternatives to UL certifications but we believe that our customers and end-users prefer UL certification.
In addition to the UL certification, certain of our products must also meet industry standards, such as those set by the Illuminating Engineering Society of North America, and government regulations for their intended application. For example, our roadway luminaires must meet certain structural standards and must also deliver a certain amount of light in specified positions relative to the installed luminaire.
Many customers and end-users also expect our products to meet the applicable ENERGY STAR requirements. ENERGY STAR is a standard for energy efficient consumer products in the United States and Canada. To qualify for ENERGY STAR certification, LED lighting products must pass a variety of tests to prove that the products have certain characteristics. We produced the first LED retrofit lamp to be successfully qualified for ENERGY STAR designation.
We believe our operations comply with all applicable environmental regulations within the jurisdictions in which we operate. The costs of compliance with these regulations are not material.
Employees
As of December 31, 2016, we had 48 employees in the United States all of whom were full-time, and two full-time employees in China. We also utilized approximately 18 temporary employees and contractors in the United States as of December 31, 2016. We believe that our relationship with our employees is good.
Item 1A.
Item 1A. Risk Factors.
Risks Related to Our Business and Industry
We have a history of losses and may be unable to continue operations unless we can generate sufficient operating income from the sale of our products.
We have sustained operating losses since our inception. For the years ended December 31, 2016, 2015 and 2014, we had revenue of $52.7 million, $79.7 million and $91.3 million, respectively, and as of December 31, 2016, we had an accumulated deficit of $847.6 million. As evidenced by these financial results, we have not been able to achieve profitability. Continuing losses may exhaust our capital resources and force us to discontinue our operations.
Our current business plan includes a focus on increasing revenue by capitalizing on the known product needs of our existing customers, improving gross profit by significantly leveraging contract manufacturers in Asia and maintaining the lower cost structure that we have implemented in recent years. Assuming that the pending Joint Venture transaction closes, our business plan also includes shifting the private label LED business to GVL in order to allow us to focus on updating and expanding our product offerings within our technology business, such as our proprietary HealthE-, VividGro-, and FreeLED- product lines, which will be operated independently from GVL. Further, in 2016, our largest customer, The Home Depot, significantly reduced its purchases from us as compared to the prior two years, and the loss of this business adversely impacted our revenues in 2016. If we do not adequately execute upon our current business plan or if we are unable to offset the decline in revenue due to the loss of business from The Home Depot, we could exhaust our available capital resources, which could require us to seek additional sources of liquidity or to further reduce our expenditures to preserve our cash. Additional sources of liquidity may not be available in an amount or on terms that are acceptable to us.
We have yet to achieve positive cash flow, and our ability to generate positive cash flow is uncertain. If we are unable to obtain capital when needed, our business and future prospects will be adversely affected and we could be forced to suspend or discontinue operations.
Our operations have not generated positive cash flow for any reporting period since our inception, and we have funded our operations primarily through the issuance of common and preferred stock and short-term and long-term debt. For each of the years ending December 31, 2016 and 2015, our revenues declined from the previous year, and we have not experienced positive revenue growth since 2014. The actual amount of funds that we will need to meet our operating needs will be determined by a number of factors, many of which are beyond our control. These factors include the timing and volume of sales transactions, our ability to diversify our customer base and product sales and our ability to offset the decrease in sales to The Home Depot. In addition, our liquidity needs will be impacted by the success of our marketing strategy, market acceptance of our products, the costs associated with, and any adverse outcome in, pending or future litigation, our ability to effectively manage our supply chain, the success of our research and development efforts, the costs associated with obtaining and enforcing our intellectual property rights, regulatory changes, competition, technological developments in the market, evolving industry standards and the amount of working capital investments we are required to make.
Our ability to continue to operate until our cash flows from operations turns positive may depend on our ability to continue to raise funds through public or private sales of shares of our capital stock or through debt. Our current indebtedness consists of a five-year term loan (the “Medley Term Loan”) from Medley Capital Corporation (“Medley”) and a three-year asset based revolving credit facility with ACF Finco I LP (“Ares”) (as amended from time to time, the “Ares ABL”), which provides us with a maximum borrowing capacity of $22.5 million, subject to certain limitations. As of December 31, 2016, the outstanding balance on the Ares ABL was approximately $6.1 million and we had approximately $1.9 million of additional borrowing capacity, and our outstanding balance on the Medley Term Loan was $30.7 million. The Ares ABL matures on April 25, 2017. At or prior to the time the Ares ABL matures, we will be required to repay or refinance the facility. Further, as a condition to Medley’s consent to the closing of the Joint Venture transaction, we will be required to repay $5.0 million of the outstanding indebtedness under the Medley Term Loan on or before May 1, 2017 (the “Required Medley Payment”).
Since 2012, we have also raised funds through issuances of our Series H Convertible Preferred Stock (“Series H Preferred Stock”), Series I Convertible Preferred Stock (“Series I Preferred Stock”) and Series J Convertible Preferred Stock (“Series J Preferred Stock” and, collectively with the Series H Preferred Stock and Series I Preferred Stock, the “Convertible Preferred Stock”). We have experienced limited access to the capital and credit markets, and it remains uncertain whether we will be able to obtain outside capital when we need it or on terms that would be acceptable to us. We have historically been dependent on affiliates of Pegasus for our liquidity needs because other sources of liquidity have been insufficient or unavailable. Pegasus has committed to provide financial support to us to fund our operations and debt service requirements of up to $13.2 million as they come due at least until April 12, 2018. The amount of this commitment will be reduced by amounts funded by other parties (except for draws under the Ares ABL) within the next 12 months that are not repayable by us on or before April 12, 2018. Such commitment, which in no way amounts to a guarantee of our obligations, may be provided through a variety of mechanisms, which may or may not be similar to those previously employed. Furthermore, in exchange for such support, Pegasus, as our controlling stockholder, may request that we take certain actions related to operations, capital structure or otherwise, which, if accepted, could have a negative effect on our business and results of operations. In addition, Pegasus may seek other terms and consideration that would require, and may not receive, approval by the independent committee of our board of directors. If we are able to raise funds by selling additional shares of our common stock, par value $0.001 per share (the “Common Stock”) or securities convertible or exercisable into our Common Stock, the ownership interest of our existing stockholders will be further diluted. If we are unable to obtain sufficient outside capital when needed, our business and future prospects will be adversely affected and we could be forced to suspend or discontinue operations.
The pending Joint Venture with MLS may not be completed.
The closing of our pending Joint Venture with MLS is subject to various conditions, including among other things, the execution of offer letters between GVL and certain key employees, the execution of ancillary agreements relating to the transfer of assets and license of certain intellectual property to GVL, the provision of transition services and the manufacture of GVL’s products (collectively, the “Joint Venture Documents”) and other customary closing conditions, such as the parties obtaining and delivering certified copies of all required consents and authorizations relating to the Joint Venture and the Joint Venture Documents. We will also be required to make (through LSG JV Holdings) an initial capital contribution of $5.1 million in cash to GVL, and MLS will be required to make an initial capital contribution of $4.9 million in cash to GVL. If these closing conditions are not satisfied, we and/or MLS may be unable or unwilling to complete the Joint Venture transaction.
We may not achieve the benefits that are anticipated from the Joint Venture, and certain of our obligations with respect to the Joint Venture could have a negative effect on our financial condition.
The benefits that are expected to result from the pending Joint Venture with MLS will depend, in part, on our ability to realize the anticipated synergies in the transaction, GVL’s ability to successfully integrate the assets and operations contributed to the Joint Venture and GVL’s ability to successfully manage the Joint Venture. It is not certain that we will realize these benefits at all, and if we do, it is not certain how long it will take to achieve these benefits. For example, there will be limitations on the ability of GVL to make distributions to its members, including LSG JV Holdings, and any distribution of available cash prior to the first quarter of 2019 will require unanimous approval by the board of managers of GVL. As a result, even if GVL is able to achieve profitability, we may not realize the benefits of such success for several years. Further, upon the determination of the board of managers of GVL, we may be required to make (through LSG JV Holdings) additional capital contributions of up to $7.65 million in the aggregate during the first 12 months following the closing of the Joint Venture transaction. The obligation to make additional capital contributions could have a negative effect on our financial condition.
The restrictions and requirements of our credit facilities may expose us to risks that could adversely affect our liquidity and financial condition or may otherwise impact our business.
As of December 31, 2016, the balance outstanding on the Ares ABL was approximately $6.1 million and we had approximately $1.9 million of additional borrowing capacity, and our outstanding balance on the Medley Term Loan was $30.1 million.
Borrowings under the Medley Term Loan and Ares ABL are secured by substantially all of our assets and our material wholly owned subsidiaries (subject to certain permitted liens) and may be used for working capital requirements and other general corporate purposes.
The inability to generate sufficient cash flow or otherwise obtain the funds necessary to make required payments under the Medley Term Loan and Ares ABL could result in a default under these facilities. We must repay or refinance the Ares ABL prior to its maturity on April 25, 2017 and, as a condition to Medley’s consent to the closing of the Joint Venture transaction, we must make the Required Medley Payment. Based on our cash position as of December 31, 2016 and our projected cash position as of April 25, 2017 and May 1, 2017, we do not believe that we will have sufficient funds available to repay the Ares ABL at maturity or to make the Required Medley Payment. However as discussed above, Pegasus has committed to provide financial support to us to fund our operations and debt service requirements of up to $13.2 million as they come due at least until April 12, 2018.
We may replace the Ares ABL facility with a replacement revolving facility, on a secured first priority basis, without penalty or premium, subject to the negotiation of loan documents and an intercreditor agreement on terms and conditions satisfactory to Ares and Medley. In such case, we would use proceeds from the replacement facility to repay the outstanding indebtedness under the Ares ABL. Nonetheless, we may be unable to obtain replacement financing on acceptable terms, or at all. Even if we are able to obtain replacement financing, such financing may be subject to covenants that restrict the conduct of our business, which could adversely affect our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that may be beneficial to the business.
Finally, we are required under our credit facilities to maintain a certain minimum EBITDA and a minimum fixed charge coverage ratio. Failure to comply with these or any other requirements of our indebtedness could result in a default. Any default that is not cured or waived could result in the acceleration of the obligations under these facilities, an increase in the applicable interest rate under these facilities and a requirement that our subsidiaries that have guaranteed these facilities pay the obligations in full, and would permit our lenders to exercise remedies with respect to all of the collateral securing these facilities, including substantially all of our and our subsidiary guarantors’ assets. Any such default could have a material adverse effect on our liquidity and financial condition.
We may be unable to profitably sell our products in this competitive pricing environment.
Aggressive pricing actions by our competitors may affect our growth prospects and profitability. We may not be able to increase prices if the costs of components and raw materials rise or we may be limited in our ability to increase prices to improve our margins. Even if component and raw material costs were to decline, lower prices offered by competitors may not allow us to hold prices at their current levels, which could negatively impact both net sales and gross profit.
Our industry is highly competitive and if we are not able to compete effectively, including against larger lighting manufacturers with greater resources, our prospects for future success will be jeopardized.
Our industry is highly competitive. We face competition from both traditional lighting technologies provided by numerous vendors as well as from LED-based lighting products provided by a growing roster of industry participants. The LED lighting industry is characterized by rapid technological change, short product lifecycles and frequent new product introductions and a competitive pricing environment. These characteristics increase the need for continual innovation and provide entry points for new competitors as well as opportunities for rapid share shifts.
Currently, we view our primary competition to be from large, established companies in the traditional general lighting industry. Certain of these companies also provide, or have undertaken initiatives to develop, LED lighting products as well as other energy efficient lighting products. Additionally, we face competition from a fragmented group of smaller niche or low-cost offshore providers of LED lighting products. We also anticipate that larger LED chip manufacturers, including some of our current and former suppliers, will continue to seek to compete with us. For example, our largest customer, The Home Depot, performed a periodic product line review relating to its entire private label LED lighting product offering in June 2015. In connection with this line review, The Home Depot elected to purchase certain products previously supplied by us directly from overseas suppliers, including one of our former suppliers. We also expect other large technology players with packaged LED chip technology that are currently focused on other end markets for LEDs, such as backlighting for LCD displays, to increasingly focus on the general illumination market as their existing markets saturate and LED use in general illumination grows. In addition, we may compete in the future with vendors of new technological solutions for energy efficient lighting.
Some of our current and future competitors are larger companies with greater resources to devote to research and development, manufacturing and marketing, as well as greater brand name recognition. Some of our more diversified competitors could also compete more aggressively with us by subsidizing losses in their LED lighting businesses with profits from other lines of business. Moreover, if one or more of our competitors or suppliers were to merge with one another, the change in the competitive landscape could adversely affect our customer, channel or supplier relationships or our competitive position. Additionally, any loss of a key channel partner, whether to a competitor or otherwise, could severely and rapidly damage our competitive position. To the extent that competition in our markets intensifies, we may be required to reduce our prices in order to remain competitive. If we do not compete effectively, or if we reduce our prices without making commensurate reductions in our costs, our revenue, gross profit and profitability and our future prospects for success, may be harmed.
If our preferred stockholders exercise their redemption rights, it would have a material adverse effect on our financial condition and may result in a change of control.
Certain holders of our Convertible Preferred Stock have the right to cause us to redeem such shares at any time on or after March 27, 2017. If any such stockholder elects to cause us to redeem its shares of Convertible Preferred Stock, all other holders of the applicable series will have the right to redeem their shares of Convertible Preferred Stock. We would also be required to redeem the outstanding shares of our Series J Preferred Stock (a) subject to certain limited exceptions, immediately prior to the redemption of the Series H Preferred Stock, Series I Preferred Stock or any other security which ranks junior to, or pari passu with, the Series J Preferred Stock and (b) on November 14, 2019, at the election of the holders of Series J Preferred Stock (the “Special Redemption”). Holders of our Convertible Preferred Stock would also have the right to require us to redeem such shares upon the uncured material breach of our outstanding obligations under our indebtedness or our uncured breach of the terms of the certificates of designation governing the Convertible Preferred Stock. Further, depending on the ultimate disposition of an appeal bond relating to pending litigation, the certificate of designation governing our newly designated Series K Preferred Stock (the “Series K Preferred Stock” and, collectively with the Convertible Preferred Stock, the “Preferred Stock”) requires us to redeem the outstanding shares of Series K Preferred Stock in the event of a liquidation, dissolution or winding up of the Company or an earlier change of control or “junior security redemption,” which includes events triggering a redemption of the outstanding shares of Convertible Preferred Stock. As of December 31, 2016, in the event we were required to redeem all of our outstanding shares of Preferred Stock, our payment obligation would have been $544.0 million. We would also be required to repay our outstanding obligations under the Medley Term Loan and the Ares ABL prior to any redemption of the Preferred Stock. As of December 31, 2016, the aggregate borrowings outstanding under these loan facilities that we would be required to pay was $36.7 million.
Any redemption of shares of Preferred Stock would be limited to funds legally available under Delaware law. The certificates of designation governing our Preferred Stock provide that if there is not a sufficient amount of cash or surplus available to redeem the shares of Preferred Stock, then the redemption must be paid out of the remaining assets of the Company. In addition, the certificates of designation governing our Preferred Stock provide that we are not permitted or required to redeem any shares of Preferred Stock for so long as such redemption would result in an event of default under our credit facilities.
Based solely on a review of our balance sheet, we do not have legally available funds under Delaware law to satisfy a redemption of our Preferred Stock.
The certificate of designation governing the Series J Preferred Stock provides that if we do not have sufficient capital available to redeem the Series J Preferred Stock in connection with a Special Redemption of the Series J Preferred Stock, we will be required to issue a non-interest bearing note or notes (payable 180 days after issuance) in the principal amount of the liquidation amount of any shares of Series J Preferred Stock not redeemed by us in connection with such Special Redemption, subject to certain limitations imposed by Delaware law governing distributions to stockholders.
We have a limited amount of revenue and a history of losses, and we may not have sufficient cash to allow us to comply with our redemption obligations. Our ability to redeem the Preferred Stock depends upon our future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control. If the cash flow from our operating activities is insufficient, we may take certain actions aimed to enable us to redeem the Preferred Stock, such as delaying or reducing capital expenditures, attempting to obtain financing, selling assets or operations or seeking additional equity capital. Any or all of these actions may not be sufficient to allow us to redeem the Preferred Stock. Further, we may be unable to take any of these actions on satisfactory terms, in a timely manner or at all.
Our issuances of shares of Preferred Stock may limit our ability to raise additional capital and/or take certain corporate action.
As of December 31, 2016, we had 282,047 shares of Preferred Stock outstanding, consisting of 111,513.52 shares of Series H Preferred Stock, 57,365 shares of Series I Preferred Stock, 93,062 shares of Series J Preferred Stock and 20,106 shares of Series K Preferred Stock. The certificates of designation governing the Preferred Stock limit our ability to take certain actions without the consent of our primary investors, including, among other things:
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redeem, reacquire, pay dividends or make other distributions on our securities;
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engage in any recapitalization, merger, consolidation, reorganization or similar transaction;
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incur any indebtedness (A) in excess of that contained in the Ares ABL or Medley Term Loan; or (B) that includes any provision that would limit our ability to redeem any shares of Preferred Stock;
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issue any equity securities, subject to limited exceptions;
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enter into any new agreements or transactions with any affiliates or amend or modify the terms of any such agreements; and
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acquire, license, transfer or sell any property, rights or assets or enter into any joint venture where (A) the aggregate consideration to be paid or received, or (B) the fair market value of the relevant property, rights or assets, exceeds $5.0 million.
A breach of the terms of the Preferred Stock could entitle each holder to redeem their shares of Preferred Stock, which could have a material adverse effect on our liquidity and financial condition.
We are currently engaged in litigation and may suffer material adverse results.
On June 22, 2012, Geveran Investments Limited (“Geveran”), one of our stockholders, filed a lawsuit against us and several other defendants seeking rescission of its $25.0 million investment in the Company, recovery of attorneys’ fees and court costs for alleged violations of the Florida securities laws. Geveran alternatively seeks unspecified money damages, as well as recovery of court costs, for alleged common law negligent misrepresentation. On August 28, 2014, the court presiding over the lawsuit granted Geveran’s motion for partial summary judgment with respect to its first cause of action for violation of the Florida securities laws. On November 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.
On December 4, 2015, we, along with the other defendants, filed a Notice of Appeal to the Florida Fifth District Court of Appeal and posted a bond securing the judgment in the amount of approximately $20.1 million. Defendant J.P. Morgan Securities, LLC (“J.P. Morgan”) also posted a separate bond in the amount of approximately $20.1 million, resulting in total bonding of approximately $40.2 million. On March 29, 2016, the trial court judge determined that the posted bonds were sufficient security to stay execution of the judgment pending the appeal.
Although we cannot predict the ultimate outcome of this lawsuit, we believe the court’s summary judgment award in favor of Geveran was in error, that we will prevail on the appeal and the judgment will be overturned, and that the case will be remanded to the trial court for further proceedings. If the case is remanded to the trial court, we believe we have strong defenses against Geveran’s claims. However, in the event that we are not successful on appeal, we could be liable for the full amount of the $40.2 million judgment, plus post judgment interest. Such an outcome would have a material adverse effect on our financial position. Even if we are successful on appeal, we will have to continue with litigation at the trial court level on the merits of the case. In such case, we may be unable to resolve the dispute in our favor and may ultimately be liable to Geveran for damages. Even if we are eventually successful in defending against Geveran’s claims or otherwise settle the litigation, it could result in additional substantial costs to us, could be a distraction to management and could harm our financial position.
We are also a defendant in an action brought by GE Lighting Solutions LLC (“GE Lighting”) in Federal District Court for the Northern District of Ohio in or about January 2013. GE Lighting asserts a claim of patent infringement against us under U.S Patent No. 6,787,999, entitled LED-Based Modular Lamp (“U.S Patent No. 6,787,999”), and U.S. Patent No. 6,799,864, entitled High Power LED Power Pack for Spot Module Illumination (“U.S. Patent No. 6,799,864”), and seeks monetary damages and an injunction. We have denied liability. On August 5, 2015, the court granted our summary judgment motion invalidating the two GE Lighting patents at issue for indefiniteness, and dismissing GE Lighting’s patent infringement claims against us and the other defendants. On September 2, 2015, GE Lighting filed an appeal with the U.S. Court of Appeals for the Federal Circuit. On October 27, 2016, the Federal Circuit issued an opinion that affirmed the lower district court’s ruling that U.S. Patent No. 6,799,864 is invalid, and reversed the district court’s ruling that U.S. Patent No. 6,787,999 is invalid. With respect to U.S. Patent No. 6,787,999, the Federal Circuit remanded the case back to the district court for further proceedings. We continue to believe that we have strong defenses against GE Lighting’s claims with respect to U.S. Patent No. 6,787,999. However, there is no assurance that we will be successful in defending against this action. The outcome, if unfavorable, could have a material adverse effect on our financial position. Even if the outcome is favorable, this litigation could result in substantial additional costs to us, could be a distraction to management and could harm our financial position.
In addition, because we operate in an industry that includes some companies that are much larger and have significantly greater resources than we do, a disagreement with a competitor that is not amicably resolved can result in litigation that, even if a favorable outcome is reached, could result in substantial costs to us, could be a distraction to our management and could harm our financial position.
If we are unable to maintain effective internal control over financial reporting, or if material weaknesses are discovered in the future, the accuracy and timeliness of our financial reporting may be adversely affected.
We are subject to Section 404 of the Sarbanes-Oxley Act of 2002, which requires an annual management assessment of the effectiveness of our internal control over financial reporting. Because of our status as a smaller reporting company registrant as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the independent registered public accounting firm auditing our financial statements has not been required to attest to, and report on, the effectiveness of our internal control over financial reporting.
Although our principal executive officer and principal financial officer concluded that our internal control over financial reporting and our disclosure controls and procedures were effective as of December 31, 2016, in prior years we have identified material weaknesses in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. Although prior material weaknesses have been recently remediated, the process of designing and implementing effective internal controls and procedures is a continuous effort that requires us to anticipate and react to changes in our business and economic and regulatory environments, and we or our independent registered public accounting firm may identify additional weaknesses in the future. Future actions we may take may not be sufficient to ensure that our internal controls are effective. Further, complying with these requirements may place a strain on our personnel, information technology systems and resources and divert management’s attention from other business concerns. Failure to maintain effective internal controls over financial reporting could cause investors to lose confidence in our operating results, and could have a material adverse effect on our business and on the price of our Common Stock.
The LED lighting industry is characterized by constant and rapid technological change, product obsolescence, price erosion, evolving standards, short product life cycles and fluctuations in supply and demand. If we fail to anticipate and adapt to these changes and fluctuations, our sales, gross profit and profitability will be adversely affected.
In the LED lighting industry, rapid technological changes and short product life cycles often lead to price erosion and product obsolescence. Companies within the LED lighting industry are continuously developing new products with heightened performance and functionality, putting pricing pressure on existing products. Further, the industry has experienced significant fluctuations, often in connection with, or in anticipation of, product cycles and changes in general economic conditions. These fluctuations have been characterized by lower product demand, production overcapacity, higher inventory levels and increased pricing pressure. Our failure to accurately anticipate the introduction of new technologies or adapt to fluctuations in the industry can, as it has in the past, lead to our having significant amounts of obsolete inventory that can only be sold at substantially lower prices and profit margins than anticipated. Pricing pressure and obsolescence also cause the stated value of our inventory to decline. For the years ended December 31, 2016, 2015 and 2014, we recorded an inventory write-down of $3.9 million, $3.6 million and $4.7 million, respectively, and a provision for expected losses on non-cancellable purchase commitments of $0, $116,000 and $507,000, respectively. In addition, if we are unable to develop planned new technologies or if our supply chain management is not effective, we may not be able to compete due to our failure to offer products most demanded by the marketplace. If any of these failures occur, our sales, gross profit and profitability will be adversely affected.
If our developed technology or technology under development does not achieve market acceptance, prospects for our growth and profitability would be limited.
Our future success depends on continued market acceptance of our LED technology and the technology currently under development. Potential customers may be reluctant to adopt LED lighting products as an alternative to traditional lighting technology because of its higher initial cost or perceived risks relating to its novelty, reliability, usefulness, light quality and cost-effectiveness when compared to other established lighting sources available in the market. Changes in economic and market conditions may also affect the marketability of some traditional lighting technologies such as declining energy prices in certain regions or countries may favor existing lighting technologies that are less energy efficient, reducing the rate of adoption for LED lighting products in those areas. Moreover, if existing sources of light other than LED lighting products achieve or maintain greater market adoption, or if new sources of light are developed, our current products and technologies could become less competitive or obsolete. Even if LED lighting products continue to achieve performance improvements and cost reductions, limited customer awareness of the benefits of LED lighting products, lack of widely accepted standards governing LED lighting products and customer unwillingness to adopt LED lighting products in favor of entrenched solutions could significantly limit the demand for LED lighting products and adversely impact our results of operations. In addition, we have invested significant resources in the area of biological (or spectrum control) lighting. This technology is in its early stages and therefore may not achieve broad market acceptance. If market acceptance is not achieved, our growth prospects would be limited.
We rely on our relationship with The Home Depot and the loss of this material relationship or any other significant relationship would have a material adverse effect on our results of operations, our future growth prospects and our ability to distribute our products.
We form business relationships and strategic alliances with retailers and other lighting companies to market our products, generally under private or co-branded labels. In certain cases, such relationships are important to our introduction of new products and services, and we may not be able to successfully collaborate or achieve expected synergies with these retailers or lighting companies. We do not control these retailers or lighting companies and they may make decisions regarding their business undertakings with us that may be contrary to our interests, or may terminate their relationships with us altogether. In addition, if these retailers or lighting companies change their business strategies, for example due to business volume fluctuations, mergers and acquisitions and/or performance issues, fail to pay or terminate the relationship altogether, our business could be materially adversely affected.
For the years ended December 31, 2016, 2015 and 2014, The Home Depot accounted for 89%, 91% and 80% of our revenue, respectively. The Home Depot performed a periodic product line review in June 2015 relating to its entire private label LED lighting product offering and, as a result, 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 prior years, and the loss of this business from The Home Depot adversely impacted our revenues in 2016. Following the line review, we entered into a new supplier buying agreement with The Home Depot that took effect in the second quarter of 2016. 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. A loss of The Home Depot as a customer, any additional decrease in their purchases or their failure to pay us would have a material adverse effect on our results of operations, our future growth prospects and our ability to distribute our products.
The Home Depot has required, and we expect will continue to require, increased service and order accommodations as well as incremental promotional investments. We may face increased expenses to meet these demands, which would reduce our margins. In addition, we generally have little or no influence on The Home Depot’s promotional or pricing policies, which may affect our sales volume.
If we do not successfully manage our network of distributors and independent sales representatives, we may not be able to increase sales to meet growth expectations.
Our growth and future financial performance will depend on our ability to maintain and exploit our internal sales and service organization and to substantially increase the scope of our distribution and sales network, both domestically and internationally. We may not be able to negotiate acceptable relationships in the future and cannot predict whether current or future relationships will be successful. We may face intense competition for personnel and we cannot guarantee that we will be able to attract, assimilate or retain additional qualified business development and sales personnel on a timely basis.
Many of these relationships are not subject to a detailed contract and therefore may be subject to termination at any time. The agreements that we do have are generally short-term, not exclusive, and can be cancelled by the counterparty without significant financial consequence. In addition, these parties provide technical sales support to end-users. We cannot control how these sales channels perform and cannot be certain that we or the end-users will be satisfied by their performance. If these distributors and agents significantly change their terms with us, or change their historical pattern of ordering products from us, there could be a significant impact on our revenue and profits.
If we are unable to effectively develop, manage and expand our sales and distribution channels for our products, our operating results may suffer.
We sell a substantial portion of our products to retailers and OEMs who then sell our products on a co-branded or private label basis. Orders from our retail and OEM customers are dependent upon their internal target inventory levels for our products which can vary significantly based upon current and projected market cycles and other factors over which we typically have very little, if any, control. We rely on these retailers and OEMs to develop and expand the customer base for our products and to accurately forecast demand from their customers. If they are not successful in either task, our growth and profitability may be adversely impacted.
Our products may contain defects that could reduce sales, result in costs associated with the recall of or warranty obligations associated with those items and result in claims against us.
The manufacture of our products involves highly complex processes. Despite testing by us, our contract manufacturers and our customers, defects have been and could be found in our existing or future products. These defects may cause us to incur significant warranty, support and repair costs. The costs associated with a recall may divert the attention of our engineering personnel from our product development efforts and harm our relationships with customers and our reputation in the marketplace. We generally provide a five-year warranty on our products, and such warranty may require us to repair, replace or reimburse the purchaser for the purchase price of the product, at our discretion. Moreover, even if our products meet standard specifications, our customers may attempt to use our products in applications they were not designed for or in products that were not designed or manufactured properly, resulting in product failures and creating customer dissatisfaction. These problems could result in, among other things, a delay in the recognition or loss of revenue, loss of market share or failure to achieve market acceptance. For the years ended December 31, 2016, 2015 and 2014, we incurred $735,000, $1.8 million and $4.8 million, respectively, in warranty expense primarily related to products returned under our standard warranty and the estimated expenses related to failure rates on two of our replacement lamp product lines sold in 2011 and 2012. If our products experience failure rates in excess of our estimates, we may continue to incur increased warranty expenses in the future.
Defects, integration issues or other performance problems in our products could also result in personal injury or financial or other damages to our customers for which they might seek legal recourse against us. We may be the target of product liability lawsuits and could suffer losses from a significant product liability judgment against us if the use of our products at issue is determined to have caused injury. A significant product recall or product liability case could also adversely affect our results of operations and result in negative publicity, damage to our reputation and a loss of customer confidence in our products.
If we are unable to increase production capacity for our products with our contract manufacturers in a cost effective and timely manner, we may incur delays in shipment and our revenue and reputation in the marketplace could be harmed.
An important part of our business plan is the expansion of production capacity for our products. In order to fulfill anticipated demand for our products, we invest in capacity in advance of actual customer orders, typically based on preliminary, non-binding indications of future demand. As customer demand for our products changes, we must be able to adjust our production capacity to meet demand while keeping costs down. Uncertainty is inherent within our facility and capacity expansion, and unforeseen circumstances could offset the anticipated benefits, disrupt our ability to provide products to our customers and impact product quality.
Our ability to successfully increase or obtain production capacity in a cost effective and timely manner will depend on a number of factors, including the following:
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our ability to sustain relationships with key contract manufacturers without disruption and the ability of contract manufacturers to allocate more of their existing capacity to us or their ability to add new capacity quickly;
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the ability of any future contract manufacturers to successfully implement our manufacturing processes;
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the availability of critical components and subsystems used in the manufacture of our products; and
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our ability to effectively establish adequate management information systems, financial controls and supply chain management and quality control procedures.
If we are unable to increase production capacity for our products in a cost effective and timely manner while maintaining adequate quality, we may incur delays in shipment or be unable to meet increased demand for our products, which could harm our revenue and operating margins and damage our reputation and our relationships with current and prospective customers.
We utilize contract manufacturers to manufacture most of our products and any disruption in these relationships may cause us to fail to meet our customers’ demands and may damage our customer relationships and adversely affect our business.
We depend on contract manufacturers to manufacture most of our products and provide the necessary facilities and labor to manufacture these products, which are primarily high volume products and components that we intend to distribute to customers in North America. Our reliance on contract manufacturers involve certain risks, including the following:
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lack of direct control over production capacity and delivery schedules;
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risk of equipment failures, natural disasters, civil unrest, industrial accidents, power outages and other business interruptions;
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lack of direct control over quality assurance and manufacturing yield; and
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risk of loss of inventory while in transit.
If our current contract manufacturers or any other contract manufacturers we may engage in the future were to terminate their arrangement with us or fail to provide the required capacity and quality on a timely basis, we would experience delays in the manufacture and shipment of our products until alternative manufacturing services could be contracted. Any significant shortages or interruption may cause us to be unable to timely deliver sufficient quantities of our products to satisfy our contractual obligations and particular revenue expectations. Moreover, even if we timely locate substitute products, if their price materially exceeds the original expected cost of such products, our margins and results of operations would be adversely affected.
Furthermore, to qualify new contract manufacturers, familiarize them with our products, quality standards and other requirements and commence volume production may be a costly and time-consuming process. If we are required or choose to change contract manufacturers for any reason, our revenue, gross profit and customer relationships could be adversely affected.
If we do not properly anticipate the need for our products, we may be unable to meet the demands of our customers and end-users, which could reduce our competitiveness, cause a decline in our market share and have a material adverse effect on our results of operations.
The lighting industry is subject to significant fluctuations in the availability of raw materials, components and subsystems. Our contract manufacturers supply certain standard electronic components as well as custom components critical to the manufacture of our lighting devices. The principal raw materials and components used in the manufacture of our products are packaged LEDs and printed circuit boards, magnetic and standard electrical components such as capacitors, resistors and diodes, wire, plastics for optical systems and aluminum for housings and heat sinks. From time to time, packaged LEDs and electronic components have been in short supply due to demand and production constraints. If we do not accurately forecast demand for our products, we or our contract manufacturers may not be able to find an adequate alternative source of supply at an acceptable cost. Any significant interruption in the supply of these raw materials, components and subsystems or our products could have a material adverse effect on our results of operations.
Our financial results may vary significantly from period-to-period due to unpredictable sales cycles in certain of the markets into which we sell our products, which may lead to volatility in our stock price.
The size and timing of our revenue from sales to our customers is difficult to predict and is market dependent. Our revenue in each period may also vary significantly as a result of purchases, or lack thereof, by The Home Depot or other significant customers. Because most of our operating and capital expenses are incurred based on the estimated number of product purchases and their timing, they are difficult to adjust in the short term. As a result, if our revenue falls below our expectations or is delayed in any period, we may not be able to proportionately reduce our operating expenses or manufacturing costs for that period. As a result of these factors, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance.
If we are unable to obtain and protect our intellectual property rights, our ability to commercialize our products could be substantially limited.
As of December 31, 2016, we held 389 patents and 52 additional patent applications were pending. These patents and patent applications cover various inventions related to the design and manufacture of LED lighting technology. When we believe it is appropriate and cost effective, we make corresponding international, regional or national filings to pursue patent protection in other parts of the world. In addition, as appropriate, we also license certain of our intellectual property to third parties in an effort to monetize our intellectual property portfolio. Because patents involve complex legal, technical and factual questions, the issuance, scope, validity and enforceability of patents cannot be predicted with certainty. Accordingly, some or all of our patent applications may not be granted. Competitors may develop products similar to our products that do not conflict with our patent rights. Others may challenge our patents and, as a result, our patents could be narrowed or invalidated. In some cases, we may rely on confidentiality agreements or trade secret protections to protect our proprietary technology. Such agreements, however, may not be honored and particular elements of our proprietary technology may not qualify as protectable trade secrets under applicable law. In addition, others may independently develop similar or superior technology, and in the absence of applicable prior patents, we would have no recourse against them.
Our business may be impaired by claims that we, or our customers, infringe on the intellectual property rights of others.
Our industry is characterized by vigorous protection and pursuit of intellectual property rights. These traits have resulted in significant and often protracted and expensive litigation. In addition, we may inadvertently infringe on patents or rights owned by others and licenses might not be available to us on reasonable or acceptable terms or at all. Litigation to determine the validity of patents or claims by third parties of infringement of patents or other intellectual property rights could result in significant legal expense and divert the efforts of our technical personnel and management, even if the litigation results in a determination favorable to us. Third parties have and may in the future attempt to assert infringement claims against us, or our customers, with respect to our products. In the event of an adverse result in such litigation, we could be required to pay substantial damages; stop the manufacture, use and sale of products found to be infringing; incur asset impairment charges; discontinue the use of processes found to be infringing; expend significant resources to develop non-infringing products or processes; or obtain a license to use third party technology and whether or not the result is adverse to us, we may have to indemnify our customers if they were brought into the litigation.
Certification and compliance are important to the sale and adoption of our lighting products, and failure to obtain such certification or compliance would harm our business.
We are required to comply with certain legal requirements governing the materials used in our products. Although we are not aware of any efforts to amend existing legal requirements or implement new legal requirements in a manner with which we cannot comply, our revenue might be materially harmed if such changes were to occur. Moreover, although not legally required to do so, we strive to obtain certification for substantially all of our products. In the United States, we seek, and to date have obtained or are in the process of obtaining, certification for substantially all of our products from UL. We design our products to be UL/cUL and Federal Communications Commission compliant. We have also obtained ENERGY STAR qualification for 81 of the products that we were producing as of December 31, 2016, with applications submitted for an additional 42 products. Although we believe that our broad knowledge and experience with electrical codes and safety standards have facilitated certification approvals, we cannot be certain that we will be able to obtain any such certifications for our new products or that, if certification standards are amended, we will be able to maintain any such certifications for our existing products, especially since virtually all existing codes and standards were not created with LED lighting products in mind. The failure to obtain such certifications or compliance could harm our business.
The reduction or elimination of investments in, or incentives to adopt, LED lighting or the elimination of, or changes in, policies, incentives or rebates in certain states or countries that encourage the use of LEDs over some traditional lighting technologies could cause the growth in demand for our products to slow, which could materially and adversely affect our revenue, profits and margins.
We believe the near-term growth of the LED market will be accelerated by government policies in certain countries that either directly promote the use of LEDs or discourage the use of some traditional lighting technologies. Today, the upfront cost of LED lighting exceeds the upfront cost for some traditional lighting technologies that provide similar lumen output in many applications. However, some governments around the world have used policy initiatives to accelerate the development and adoption of LED lighting and other non-traditional lighting technologies that are seen as more environmentally friendly compared to some traditional lighting technologies. Reductions in (including as a result of any budgetary constraints), or the elimination of, government investment and favorable energy policies could result in decreased demand for our products and decrease our revenue, profits and margins. Further, if our products fail to qualify for any financial incentives or rebates provided by governmental agencies or utilities for which our competitors’ products qualify, such programs may diminish or eliminate our ability to compete by offering products at lower prices than our competitors.
Changes in the mix of products we sell during a period could have an impact on our results of operations.
Our profitability from period-to-period may vary significantly due to the mix of products that we sell in different periods. As we expand our product offerings we expect to sell more retrofit lamps and luminaires into additional target markets. These products are likely to have different cost profiles and will be sold into markets governed by different business dynamics. Consequently, sales of individual products may not necessarily be consistent across periods, which could affect product mix and cause gross and operating profits to vary significantly. Given the potentially large size of purchase orders for our products, particularly in the infrastructure market, the loss of or delay in the signing of a customer order could significantly reduce our revenue in any period. In addition, we spend substantial amounts of time and money on our efforts to educate our customers about the use and benefits of our products, including their technical and performance characteristics, and these investments may not produce any sales within expected time frames or at all.
We rely upon key members of our management team and other key personnel and a loss of key personnel could prevent or significantly delay the achievement of our goals.
Our success will depend to a large extent on the abilities and continued services of key members of our management team. The loss of key members of our management team or other key personnel could prevent or significantly delay the implementation of our business plan, research and development and marketing efforts. Our success will depend on our ability to attract and retain highly skilled personnel and our efforts to obtain or retain such personnel may not be successful. Further, if the Joint Venture transaction closes, we expect that certain key members of our management team will also have various roles and responsibilities as members of the management team of GVL and, as such, their attention may at times be diverted from the Company’s day-to-day business.
The operations of many of our third party manufacturers are subject to additional risks that are beyond our control and that could harm our business.
Since mid-2014, substantially all of our products have been manufactured internationally by third-party contract manufacturers. As a result of our international manufacturing, we are subject to risks associated with doing business abroad, including:
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political or labor unrest, terrorism and economic instability resulting in the disruption of trade from foreign countries in which our products are manufactured;
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currency exchange fluctuations;
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the imposition of new laws and regulations, including those relating to labor conditions, quality and safety standards, imports, trade restrictions and restrictions on the transfer of funds, as well as rules and regulations regarding climate change;
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reduced protection for intellectual property rights in some countries;
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disruptions or delays in shipments; and
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changes in local economic conditions in countries where our manufacturers and suppliers are located.
These risks could negatively affect the ability of our manufacturers to produce or deliver our products or procure materials and could increase our cost of doing business generally. In the event that one or more of these factors make it undesirable or impractical for us to conduct business in a particular country, our business could be adversely affected.
In addition, certain of our imported products are subject to duties, tariffs or other import limitations that affect the cost and quantity of various types of goods imported into the United States and other markets. Any country in which our products are produced or sold may eliminate, adjust or impose new import limitations, duties, anti-dumping penalties or other charges or restrictions, any of which could have an adverse effect on our results of operations, cash flows and financial condition.
Our international operations are subject to legal, political and economic risks.
Our financial condition, operating results and future growth could be significantly affected by risks associated with our international activities, including economic and labor conditions, political instability, laws (including U.S. taxes on foreign subsidiaries), changes in the value of the U.S. dollar versus foreign currencies, differing business cultures, foreign regulations that may conflict with domestic regulations, intellectual property protection and trade secret risks, differing contracting process including the ability to enforce agreements, increased dependence on foreign manufacturers, shippers and distributors and import and export restrictions and tariffs.
Compliance with U.S. and foreign laws and regulations that apply to our international operations, including import and export requirements, anti-corruption laws, including the Foreign Corrupt Practices Act, tax laws (including U.S. taxes on foreign subsidiaries), foreign exchange controls, anti-money laundering and cash repatriation restrictions, data privacy requirements, labor laws and anti-competition regulations, increases the costs of doing business in foreign jurisdictions, and any such costs, which may rise in the future as a result of changes in these laws and regulations or in their interpretation. We have not implemented formal policies and procedures designed to ensure compliance with these laws and regulations. Any such violations could individually or in the aggregate materially adversely affect our reputation, financial condition or operating results.
Risks Related to Ownership of Our Common Stock
Our Common Stock has been thinly traded and an active trading market may not develop.
The trading volume of our Common Stock has historically been low, partially because we are not listed on an exchange and our Common Stock is only traded on the over-the-counter bulletin board (the “OTC Bulletin Board”). In addition, our public float has been further limited due to the fact that the vast majority of our outstanding Common Stock has historically been beneficially owned by affiliates of Pegasus. Unless we initiate a public offering of our Common Stock or are approved for listing on a national exchange, a more active trading market for our Common Stock may not develop, or if developed, may not continue, and a holder of any of our securities may find it difficult to dispose of, or to obtain accurate quotations as to the market value of, our Common Stock.
We are controlled by Pegasus, whose interests in our business may be different from yours.
Affiliates of Pegasus beneficially owned approximately 91% of our Common Stock as of December 31, 2016 (on a fully diluted basis). As a result of this ownership, Pegasus has a controlling influence on our affairs and its voting power constitutes a quorum of our stockholders voting on any matter requiring the approval of our stockholders. Such matters include the nomination and election of directors, the issuance of additional shares of our capital stock or payment of dividends, the adoption of amendments to our certificate of incorporation and bylaws and approval of mergers or sales of substantially all of our assets. This concentration of ownership may also have the effect of delaying or preventing a change in control of our company or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares. Pegasus may cause corporate actions to be taken even if the interests of Pegasus conflict with the interests of our other stockholders.
If we applied and our shares were approved for listing on a national stock exchange, we would likely elect to be considered a “controlled company” which would exempt us from certain corporate governance requirements, including the requirement that a majority of our board of directors meet the specified standards of independence and the exemption from the requirement that we have a compensation and governance committee made up entirely of directors who meet such independence standards. Such independence standards are intended to ensure that directors who meet the independence standard are free of any conflicting interest that could influence their actions as directors. It is possible that the interests of Pegasus may in some circumstances conflict with our interests and the interests of our other stockholders, including you.
Because our stock price is volatile, it can be difficult for stockholders to predict the value of our shares at any given time.
The price of our Common Stock has been and may continue to be highly volatile, which makes it difficult for stockholders to assess or predict the value of their shares. A number of factors may affect the market price of our Common Stock, including, but not limited to:
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changes in expectations as to our future financial performance;
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announcements of technological innovations or new products by us or our competitors;
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announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
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changes in laws and government regulations;
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developments concerning our proprietary rights;
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public perception relating to the commercial value or reliability of any of our lighting products;
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future sales of our Common Stock or issues of other equity securities convertible into or exercisable for the purchase of Common Stock;
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our involvement in litigation;
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the acquisition or divestiture by Pegasus or its affiliates of part or all of its holdings; and
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general stock market conditions.
We do not intend to pay cash dividends and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our Common Stock.
We have never declared or paid cash dividends on our Common Stock and we do not anticipate paying any cash dividends in the foreseeable future. We have a history of losses and currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business. In addition, the terms of the Medley Term Loan and the Ares ABL restrict our ability to pay cash dividends and any future credit facilities or loan agreements may further restrict our ability to pay cash dividends. As a result, capital appreciation, if any, of our Common Stock will be your sole source of potential gain for the foreseeable future.
Anti-takeover provisions in our amended and restated certificate of incorporation and amended and restated bylaws, and Delaware law, contain provisions that could discourage a takeover.
Anti-takeover provisions of our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. The provisions of our charter documents include:
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procedures for advance notification of stockholder nominations and proposals;
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the inability of less than a majority of our stockholders to call a special meeting of the stockholders;
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the ability of our board of directors to create new directorships and to fill any vacancies on the board of directors;
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the ability of our board of directors to amend our bylaws without stockholder approval; and
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the ability of our board of directors to issue shares of preferred stock without stockholder approval upon the terms and conditions and with the rights, privileges and preferences as our board of directors may determine.
In addition, as a Delaware corporation, we are subject to Delaware law, including Section 203 of the Delaware General Corporation Law. In general, Section 203 prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder unless certain specific requirements are met as set forth in Section 203. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control.
Future sales or the possibility of future sales of a substantial amount of our Common Stock may depress the price of shares of our Common Stock.
Future sales or the availability for sale of substantial amounts of our Common Stock in the public market could adversely affect the prevailing market price of our Common Stock and could impair our ability to raise capital through future sales of equity securities. We may issue shares of our Common Stock or other securities from time to time to raise capital to fund our operating expenses pursuant to the exercise of outstanding stock options or warrants or as consideration for future acquisitions and investments. If any such issuance, acquisition or investment is significant, the number of shares of our Common Stock, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be substantial. We may also grant registration rights covering those shares of our Common Stock or other securities in connection with any such acquisitions and investments.
We cannot predict the size of future issuances of our Common Stock or the effect, if any, that future issuances and sales of our Common Stock will have on the market price of our Common Stock. Sales of substantial amounts of our Common Stock (including shares of our Common Stock issued in connection with an acquisition or by Pegasus or its affiliates), or the perception that such sales could occur, may adversely affect prevailing market prices for our Common Stock.
Securities analysts may not provide coverage of our Common Stock or may issue negative reports, which may have a negative impact on the market price of our Common Stock.
Securities analysts have not historically provided research coverage of our Common Stock and may elect not to do so in the future. If securities analysts do not cover our Common Stock, the lack of research coverage may cause the market price of our Common Stock to decline. The trading market for our Common Stock may be affected in part by the research and reports that industry or financial analysts publish about our business. If one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline substantially. If one or more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, it may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our Common Stock. This could have a negative effect on the market price of our stock.
Item 2.
Item 2. Properties.
As of March 20, 2017, we occupied leased office and industrial space in West Warwick, Rhode Island, Cocoa Beach, Florida and Cape Canaveral, Florida. Our principal administrative, sales and marketing operations are located at our West Warwick, Rhode Island headquarters. Our research and development operations, which includes product qualification and testing, are located at our Cocoa Beach and Cape Canaveral, Florida locations.
Item 3.
Item 3. Legal Proceedings.
On June 22, 2012, Geveran filed a lawsuit against us and several others in the Circuit Court of the Seventeenth Judicial Circuit in and for Broward County, Florida. On October 30, 2012, the court entered an order transferring the lawsuit to the Ninth Judicial Circuit in and for Orange County, Florida. The action, styled Geveran Investments Limited v. Lighting Science Group Corp., et al., Case No. 12-17738 (07), names us as a defendant, as well as Pegasus Capital and nine other entities affiliated with Pegasus Capital; Richard Weinberg, a former member of our board of directors and former interim Chief Executive Officer and a former partner of Pegasus Capital; Gregory Kaiser, a former Chief Financial Officer; J.P. Morgan; and two employees of J.P. Morgan. Geveran seeks rescission of its $25.0 million investment in the Company, as well as recovery of interest, attorneys’ fees and court costs, jointly and severally against us, Pegasus Capital, Mr. Weinberg, Mr. Kaiser, J.P. Morgan and the two J.P. Morgan employees, for alleged violations of Florida securities laws. Geveran alternatively seeks unspecified money damages, as well as recovery of court costs, for alleged common law negligent misrepresentation against these same defendants.
On August 28, 2014, the court 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).
On December 4, 2015, we, along with certain other related defendants, filed a Notice of Appeal to the Florida Fifth District Court of Appeal and posted a bond securing the judgment in the amount of approximately $20.1 million. Defendant J.P. Morgan also posted a separate bond in the amount of approximately $20.1 million, resulting in total bonding of approximately $40.2 million. On March 29, 2016, the trial court judge determined that the posted bonds were sufficient security to stay execution of the judgment pending the appeal.
Although we cannot predict the ultimate outcome of this lawsuit, we believe the court’s summary judgment award in favor of Geveran was in error, that we will prevail on the appeal and the judgment will be overturned, and that the case will be remanded to the trial court for further proceedings. If the case is remanded to the trial court, we believe we have strong defenses against Geveran’s claims. However, in the event that we are not successful on appeal, we could be liable for the full amount of the $40.2 million judgment, plus post judgment interest. Such an outcome would have a material adverse effect on our financial position.
We believe that, subject to the terms and conditions of the relevant policies (including retention and policy limits), directors’ and officers’ (“D&O”) insurance coverage will be available to cover a substantial majority of our legal fees and costs in this matter. However, insurance coverage may not be available for, or such coverage may not be sufficient to fully pay, a judgment or settlement in favor of Geveran. On July 26, 2016, we, along with certain other related defendants, filed a lawsuit in Delaware state court against our D&O insurance carriers, Liberty Insurance, Starr, and Continental Casualty, seeking a declaratory judgment and damages arising out of the defendant carriers’ breach of their coverage obligations under various applicable D&O policies.
Based upon the terms of an indemnification agreement, we have also paid, and may be required to pay in the future, reasonable legal expenses incurred by J.P. Morgan and its affiliates in this lawsuit in connection with the engagement of J.P. Morgan as placement agent for the private placement with Geveran. Such payments are not covered by our insurance policies. The agreement executed with J.P. Morgan provides that we will indemnify J.P. Morgan and its affiliates from liabilities relating to J.P. Morgan’s activities as placement agent, unless such activities are finally judicially determined to have resulted from J.P. Morgan’s bad faith, gross negligence or willful misconduct.
We are also a defendant in an action brought by GE Lighting in Federal District Court for the Northern District of Ohio in or about January 2013. GE Lighting asserts a claim of patent infringement against us under U.S Patent No. 6,787,999 and U.S. Patent No. 6,799,864 and seeks monetary damages and an injunction. We have denied liability. On August 5, 2015, the court granted our summary judgment motion invalidating the two GE Lighting patents at issue for indefiniteness, and dismissing GE Lighting’s patent infringement claims against us and the other defendants. On September 2, 2015, GE Lighting filed an appeal with the U.S. Court of Appeals for the Federal Circuit. On October 27, 2016, the Federal Circuit issued an opinion that affirmed the lower district court’s ruling that U.S. Patent No. 6,799,864 is invalid, and reversed the district court’s ruling that U.S. Patent No. 6,787,999 is invalid. With respect to U.S. Patent No. 6,787,999, the Federal Circuit remanded the case back to the district court for further proceedings. We continue to believe that we have strong defenses against GE Lighting’s claims with respect to U.S. Patent No. 6,787,999. However, there is no assurance that we will be successful in defending against this action. The outcome, if unfavorable, could have a material adverse effect on our financial position. Even if the outcome is favorable, this litigation could result in substantial additional costs to us, could be a distraction to management and could harm our financial position.
In addition, we may be a party to a variety of legal actions, such as employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims, shareholder suits, including securities fraud, intellectual property related litigation, and a variety of legal actions relating to its business operations. In some cases, substantial punitive damages may be sought. We currently have insurance coverage for certain of these potential liabilities. Other potential liabilities may not be covered by insurance, insurers may dispute coverage or the amount of insurance may not be sufficient to cover the damages awarded. In addition, certain types of damages, such as punitive damages, may not be covered by insurance and insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our Common Stock is currently quoted on the OTC Bulletin Board under the symbol “LSGC.” Our Common Stock last traded at $0.06 per share on March 20, 2017, and there were approximately 305 stockholders of record of our Common Stock on that date. We believe the number of beneficial owners is greater than the number of record holders because beneficial owners of our outstanding Common Stock hold shares of record in “street name” for the benefit of individual investors. As of March 20, 2017, there were 217,787,020 shares of our Common Stock outstanding.
The following table provides the high and low closing bid price information for our Common Stock for each quarterly period within the two most recent years as reported by the OTC Bulletin Board. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.
Common Stock
Dividend Policy
We have not paid any dividends on our Common Stock since our inception and do not intend to pay any cash dividends on our Common Stock in the foreseeable future. We currently anticipate that we will retain all of our available cash, if any, for use as working capital and for other general corporate purposes, including to service our debt and to fund the operation of our business. Payment of future dividends, if any, will be at the discretion of our board of directors and will depend on many factors, including general economic and business conditions, our strategic plans, our financial results and condition, legal requirements and other factors our board of directors deems relevant. Certain of our financing agreements and the terms of our outstanding Preferred Stock also impose restrictions on our ability to pay dividends.
Item 6.
Item 6. Selected Historical Consolidated Financial Data.
The following table presents our selected historical consolidated financial data as of the dates and for the periods indicated. Our historical results are not necessarily indicative of the results to be expected in any future period.
The selected historical consolidated financial data presented below is only a summary. You should read this selected historical consolidated financial data in conjunction with Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the audited and unaudited consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that are subject to risks and uncertainties. See Part I “Special Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks, and assumptions associated with those statements. Actual results could differ materially from those discussed in or implied by forward- looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in the section entitled “Risk Factors.”
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 building our retail business through our Joint Venture (as described in Recent Events below), as well as creating strong biologically correct lighting brands in the consumer, residential, commercial and industrial markets. We believe that developing innovative and differentiated brands will deliver strong financial returns and a more loyal user base that is less price sensitive. We intend to continue to implement a nimble and agile “go-to-market” business model and manufacturing and product development system to streamline the processes used to introduce new products. We also intend to continue focusing on developing breakthrough innovation and on becoming a market maker in targeted value-added, high-margin segments within the lighting market. Finally, we plan to reduce our cost structure, preserve cash flow and strengthen liquidity to enhance our financial position.
Over the past few years, we have focused on expanding and optimizing our global supply chain to meet forecasted demand for our products while addressing the inefficiencies that have compressed our gross profit and overall financial performance in prior periods such as costs incurred to expedite the production or delivery of component parts. We anticipate long-term gross profit improvement as we continue to execute on our initiatives. We completed one of our most critical initiatives in 2014 with the transition of the manufacturing of our high volume lamps from Mexico and Satellite Beach to our contract manufacturing partners in Asia, from which we source the majority of our components. In 2015, we opened a new distribution center in Seattle, Washington in order to reduce the transit time for products from Asia and to provide us with an additional port through which we can import goods. In 2016, we closed our distribution center in Dallas, Texas, consolidating our warehouse operations into our Seattle, Washington warehouse. We believe that consolidating our distribution facilities will help to better maintain the continuity of our supply chain, improve our supply-to-cash cycle time and lower our distribution costs.
Recent Events
On March 20, 2017, we formed LSG MLS JV Holdings, Inc. (“LSG JV Holdings”) as a subsidiary and entered into an operating agreement (the “Operating Agreement”) with MLS Co., Ltd. (“MLS”) relating to the formation of Global Value Lighting, LLC (“GVL”). GVL was formed as a joint venture between us and MLS for the purpose of carrying out the manufacturing, marketing, sale and distribution of private label LED lighting products and services to retail and commercial customers in North America and South America (the “Joint Venture”). The Joint Venture is an integral part of our long-term strategy. We believe the Joint Venture will allow GVL to focus on the retail LED business, including the private label LED business, which to date has represented a significant portion of our revenues, while allowing us to focus on our technology business featuring product lines such as its proprietary HealthE™, VividGro®, and FreeLED™, which will be operated independently from GVL. The Joint Venture remains subject to certain closing conditions. Upon the closing of the Joint Venture, we (through LSG JV Holdings) will make an initial capital contribution of $5.1 million in cash to GVL, and MLS will make an initial capital contribution of $4.9 million in cash to GVL. Upon the determination of the board of managers of GVL, each of LSG JV Holdings and MLS will be required to make additional capital contributions of up to $7.65 million and $7.35 million in the aggregate, respectively, during the first 12 months following the closing date. LSG JV Holdings will own 51% of the membership interests of GVL and MLS will own 49% of the membership interests of GVL.
On January 27, 2017 and February 3, 2017, we issued 3,000 and 7,000 units of our securities (“Series J Securities”), respectively, to LSGC Holdings III LLC (“Holdings III”), an affiliate of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), for aggregate gross proceeds of $10.0 million, with each Series J Security consisting of (a) one share of our Series J Convertible Preferred Stock (“Series J Preferred Stock”) and (b) a warrant to purchase 2,650 shares of our common stock, par value $0.001 per share (the “Common Stock”), at an exercise price of $0.001 per share of Common Stock.
LED Lighting Industry Trends
There are a number of industry factors that affect our business and results of operations including, among others:
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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.
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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.
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Intellectual property. LED market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection and licensing of intellectual property is critical. Therefore, LED lighting industry participants often take steps such as additional patent applications, confidentiality and non-disclosure agreements as well as other security measures. To enforce or protect intellectual property rights, market participants commonly commence or threaten litigation.
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Intense and constantly evolving competitive environment. Competition in the LED lighting market is intense. Many companies have made significant investments in LED lighting development and production equipment. Traditional lighting companies and new entrants are investing in LED based lighting products as LED adoption has gained momentum. Product pricing pressures are significant and market participants often undertake pricing strategies to gain or protect market share, enhance sales of their previously manufactured products and open new applications to LED based lighting solutions. To remain competitive, market participants must continuously increase product performance and reduce costs.
Financial Results
The following table sets forth our revenue, cost of goods sold and gross profit for the years ended December 31, 2016, 2015 and 2014:
Our revenue is primarily derived from sales of our LED-based retrofit lamps and luminaires. Our revenue decreased by $27.1 million during the year ended December 31, 2016 as compared to the year ended December 31, 2015. This decrease in revenue was due to a decrease in sales to The Home Depot, Inc. (“The Home Depot”) of $25.5 million and a decrease in sales to other commercial customers of $1.6 million. The Home Depot performed a periodic product line review in 2015 relating to its entire private label LED lighting product offering and, as a result, The Home Depot 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 for the three years prior to the line review and the loss of this business was the primary reason for the decline in sales to The Home Depot for the year ended December 31, 2016 as compared to the year ended December 31, 2015. The decrease in sales to other commercial customers for the year ended December 31, 2016 as compared to the year ended December 31, 2015 was primarily due to the loss of two distribution customers, the sales of excess inventory at reduced prices and increased competition in the industry generally. Our revenue decreased $11.5 million during the year ended December 31, 2015 as compared to the year ended December 31, 2014. This decrease in revenue was due to a $10.5 million decrease in sales to commercial customers and a $1.0 million decrease in sales to The Home Depot.
We continue to pursue new relationships with retailers and original equipment manufacturers (“OEMs”) to help increase and diversify our sales.
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.
As a result of charges for inventory reserves, our gross profit for the year ended December 31, 2016 declined as compared to the year ended December 31, 2015. For the year ended December 31, 2015 as compared to the year ended December 31, 2014, our gross profit improved due to changes in the mix of products sold (more sales from higher margin inventory) and lower charges for inventory reserves and for warranty expenses, as well as increased use of contract manufacturing in Asia resulting in lower costs of production.
Non-GAAP Financial Measures
Although our 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 year ended December 31, 2016 decreased by $1.9 million (or 8.0%) as compared to the year ended December 31, 2015, while revenue decreased 33.9% compared to the year ended December 31, 2015. Non-GAAP adjusted operating expenses for the year ended December 31, 2015 decreased by $11.5 million (or 32.3%) as compared to the year ended December 31, 2014, while revenue decreased 12.6% compared to the year ended December 31, 2014. Non-GAAP adjusted operating expenses represented 42.1% and 30.2% of revenue for the year ended December 31, 2016 and 2015, respectively. For the year ended December 31, 2016, the decrease in non-GAAP adjusted operating expenses was due to (i) a reduction in stock compensation expense, which resulted from the termination of employees during 2016 that had non-vested stock option grants and the previously recognized stock compensation expense reversed for those non-vested stock option grants, and(ii) and a reduction in depreciation and amortization expense, which was driven by savings resulting from not replacing property and equipment that was fully depreciated. For the year ended December 31, 2015, the decrease in non-GAAP adjusted operating expenses as a percentage of revenue was due primarily to significant cost cutting measures taken in 2014 with the resulting cost savings realized in 2015.
Over the past several years, we adapted our supply chain and logistics processes to improve our ability to more efficiently meet customer needs while continuing to focus on developing innovative products. During this period, we improved our forecasting and finished goods inventory management, transitioned our manufacturing processes to lower cost contract manufacturers in Asia and enhanced our new product innovation process. We believe these changes drove additional improvements in our management and manufacturing infrastructure and expanded our ability to source components and manufacture our products internationally. We believe these improvements will allow us to focus more on innovative, science based and creative engineering talent, which we believe provides us with a competitive advantage. In addition to developing products that target mainstream retail and commercial lighting, we are seeking to expand our product offerings to compete across multiple industry verticals.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and consolidated results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. Our actual results may differ from these estimates. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates may change as new events occur, additional information is obtained and our operating environment changes. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our financial statements.
Inventories
Inventories are stated at the lower of cost or market and consist of finished lighting products. Inventories are valued on a first-in, first out basis.
Significant changes in our strategic plan, including changes in product mix, product demand, slow product adoption, rapid technological changes and new product introductions and enhancements could result in excess or obsolete inventory. We evaluate inventory levels and expected usage on a periodic basis to specifically identify obsolete, slow-moving or non-salable inventory based upon assumptions about future demand and market conditions. The write-down of excess and obsolete inventory based on this evaluation creates a new cost basis and is included in cost of goods sold.
On a quarterly basis, we consider the need to record a lower of cost or market adjustment for our raw materials and finished goods inventory. The market value of finished goods is determined based upon current sales transactions, less the cost of disposal of the respective finished goods.
Revenue Recognition
Product sales are generally recorded when our products are shipped and title passes to customers. Where sales of product are subject to certain customer acceptance terms, revenue from such sales are recognized once these terms have been met.
Income Taxes
We employ the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and net operating loss carryforwards, and are measured using enacted tax rates and laws that are expected to be in effect when the differences are reversed.
We record a valuation allowance to reduce our deferred tax assets to the amount which, we estimate, is more likely than not to be realized. Our ability to realize our deferred tax assets is generally dependent on the generation of taxable income during the future periods in which the temporary differences are deductible and the net operating losses can be offset against taxable income. If we were to determine that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, the resulting adjustment to deferred tax assets would increase net earnings in the period such a determination was made.
Going Concern
We evaluate whether there are conditions or events, considered in the aggregate, that may raise substantial doubt about our ability to continue as a going concern within one year from the date that our financial statements are issued or available to be issued. Conditions or events include expected future results of operations, liquidity needs, financing agreements and capital needs.
Financial Operations Overview
Revenue
Our revenue is derived primarily from the sale of our LED-based retrofit lamps and luminaires for indoor and outdoor general illumination applications in the residential, commercial, industrial and public infrastructure markets. Our revenue is dependent on the continuing adoption of LED lighting in our target markets which, in turn, are subject to improvements in LED lighting performance as well as reductions in LED lighting cost. We expect our selling prices to continue to decline over time and believe that these declines will be offset by increases in sales volume, subject to our ability to access end users of LED lighting products. We depend heavily on the strength of our relationships with certain retail customers, primarily The Home Depot, and OEM customers, which provide us with access to residential and commercial end users of LED lighting products. We may experience significant inflections in growth as we enter into relationships with partners such as these and we will seek to develop similar relationships with new customers. Conversely, any deterioration in our relationships with these customers or in their activities in LED lighting could negatively impact our revenue.
The Home Depot accounted for 89%, 91% and 80% of our revenue for the years ended December 31, 2016, 2015 and 2014, respectively. As discussed above, revenue for the year ended December 31, 2016 was adversely affected by the loss of certain business from The Home Depot, as well as the loss of two distribution customers. Due to these recent challenges, the success of our direct sales efforts, including our ability to effectively grow and manage the roster of distributors and independent sales agents that sell our products is increasingly critical to our business.
Cost of Goods Sold and Gross Profit
Cost of goods sold includes the cost of products purchased from our contract manufacturers as well as the cost of related inbound freight, manufacturing labor, production overhead and warranty costs. We also include provisions for excess and obsolete inventory and non-cancellable purchase commitments in our cost of goods sold. We source our manufactured products based on sales projections and customer orders.
Currently, purchased products from our contract manufacturers represent the largest portion of our cost of goods sold. On a per unit basis, these costs generally decrease as we gain purchasing scale with increases in our sales. In periods of rapidly increasing demand, however, we may incur higher costs to ensure an adequate supply of products and components and to expedite shipping by means of premium inbound freight. These costs are typically higher the more dependent we are on a limited number of suppliers for specific products and the greater the distance is between production sites and such suppliers. We have historically incurred higher costs to the extent our supply chain management and production processes resulted in larger physical inventory variances or lower yields. With our increased reliance on contract manufacturers, we believe we will see continued improvement in our gross profit due to our increased ability to manage our inventory costs. Our contract manufacturers provide improved manufacturing capacity, which we expect will reduce the lead-time requirements for most products and reduce the amount of inventory we will be required to carry in the future. In addition, our increased usage of contract manufacturers has led to a reduction in overhead and labor costs. Assuming that the pending Joint Venture with MLS closes, we believe this relationship will drive additional improvements in cost of goods sold and gross profit.
During 2016, our cost of goods sold continued to be adversely impacted by our ability to accurately forecast product demand and manage the procurement and availability of our materials. Acquisition costs generally decline on a per unit basis with an increase in throughput through better execution and higher volumes of production, as well as technological advances in the manufacturing process. Accordingly, newly introduced products typically have higher per unit costs as we gain supply chain and manufacturing process efficiencies. Our warranty costs depend both on the quality of our manufacturing processes as well as our ability to design products for greater reliability. Additionally, our ability to control excess inventory reserves depends on how accurately we match future purchases of inventory with future sales.
Our gross profit is also affected by a number of other factors, including the average selling price of our products and our ability to offset declining prices with lower production costs. Our mix of products sold and the customers to whom they are sold also impact our gross profit as certain of our products have higher levels of profitability and we may contractually price our products at lower levels for certain customers based on volume expectations, contract duration and our own cost reduction roadmap. To the extent we suffer temporary manufacturing or supply chain inefficiencies, implementation of our cost reduction roadmap may be delayed resulting in unplanned declines in gross profit for certain products until these inefficiencies are addressed.
Operating Expenses
Operating expenses consist of selling, distribution and administrative expenses and research and development expenses. Personnel-related expenses comprise the most significant component of these expenses. In any particular period, the timing of additional hires or layoffs could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.
Selling, Distribution and Administrative Expenses. Selling, distribution and administrative expenses consist primarily of personnel-related expenses, sales commissions, samples and other marketing costs for new products and customer demonstrations, fees for professional services, public company costs, travel and other out-of-pocket expenses, cost of marketing materials and other corporate communications, customer service expenses, and direct and allocated facilities and other related overhead costs. Professional services consist principally of external legal, accounting, tax and other consulting services. Public company costs include director fees, directors’ and officers’ insurance premiums, costs of compliance with securities, corporate governance and other regulations and investor relations expenses. Certain of these expenses, and in particular legal expenses due to patent and other litigation, are inherently hard to predict and may vary materially from period to period. Unbillable freight costs that are incurred to deliver products to our customers but for which they are not separately billed are also included in selling, distribution and administrative expenses. We intend to continue to seek opportunities to lower our cost structure.
Research and Development Expenses. Research and development expenses consist primarily of personnel-related expenses for employees engaged in the development of new products, the enhancement of existing products and research into new platform technologies related to power supplies, optics, thermal management and intelligent controls as well as into emerging uses for LED lighting including in biological applications. Research and development expenses also include costs of lab materials and prototypes related to these activities and allocated facilities and other related overhead costs. We expense research and development costs as they are incurred. Research and development expenses are reported net of any funding received under contracts with governmental agencies and commercial customers that are considered to be cost-sharing arrangements with no contractually committed deliverable.
Restructuring Expenses. We record restructuring expenses associated with management-approved restructuring plans to reorganize one or more of our business functions or to remove duplicative headcount and infrastructure associated with one or more locations. These items primarily include estimates of employee separation costs, non-cash asset impairment charges related to the impairment of equipment and the full amounts payable pursuant to remaining lease obligations (net of anticipated sublease income), which we refer to as accrued rent costs. The timing of associated cash payments is dependent upon the type of restructuring expense and can extend over a multi-year period. Restructuring expenses are recorded based upon planned employee termination dates, site closures and consolidation plans and are not anticipated to be recurring.
Results of operations
The following table sets forth statement of operations data expressed as a percentage of revenue for the periods indicated (some items may not add due to rounding):
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
* Variance is not meaningful
Revenue
Revenue decreased $27.1 million, or 33.9%, to $52.7 million for the year ended December 31, 2016 from $79.7 million for the year ended December 31, 2015. The decrease in revenue was primarily a result of a $25.5 million, or 35.3%, decrease in sales to The Home Depot during the year ended December 31, 2016 as compared to the prior year. Additionally, sales to other commercial customers declined by $1.6 million, or 20.7%, during the year ended December 31, 2016 as compared to the prior year.
Cost of goods sold
Cost of goods sold decreased $22.1 million, or 32.3%, to $46.4 million for the year ended December 31, 2016 from $68.5 million for the year ended December 31, 2015. The decrease in cost of goods sold was due primarily to the 33.9% reduction in revenue for the year ended December 31, 2016 compared to the year ended December 31, 2015. As a result of charges for inventory reserves, cost of goods sold as a percentage of revenue declined for the year ended December 31, 2016 as compared to the year ended December 31, 2015. Cost of goods sold as a percentage of revenue was 88.1% (or gross profit of 11.9%) and 86.0% (or gross profit of 14.0%) for the years ended December 31, 2016 and 2015, respectively.
Selling, distribution and administrative
Selling, distribution and administrative expenses decreased $3.9 million, or 17.2%, to $18.8 million for the year ended December 31, 2016 from $22.7 million for the year ended December 31, 2015, but increased as a percentage of revenue to 35.6% for the year ended December 31, 2016 from 28.4% for the year ended December 31, 2015. The decrease in selling, distribution and administrative expenses was primarily due a $2.4 million decrease in stock compensation expense as a result of headcount reductions and the reversal of previously recognized stock compensation expense recorded for unvested stock options. Additionally, for the year ended December 31, 2016 as compared to the year ended December 31, 2015, there was an $813,000 decrease in professional fees, a $630,000 decrease in personnel-related expense resulting from headcount reductions, a $287,000 decrease in commission expense resulting from a revised commission plan implemented during 2016 as well as reduced sales, a $195,000 decrease in bad debt expense and a $164,000 decrease in travel and entertainment expenses. These reductions were partially offset by an $840,000 increase in distribution expenses as a result of moving our distribution operations from Dallas, Texas to Seattle, Washington.
Research and development
Research and development expenses decreased $747,000, or 18.7%, to $3.3 million for the year ended December 31, 2016 from $4.0 million for the year ended December 31, 2015, but increased as a percentage of revenue to 6.2% for the year ended December 31, 2016 from 5.0% for the year ended December 31, 2015. The decrease in research and development expenses was primarily due to lower personnel-related expenses driven by headcount reductions during 2016 and 2015. The increase in research and development expenses as a percentage of revenue for the year ended December 31, 2016 was due to a reduction in revenue at a higher rate than the percentage reduction in research and development expenses.
Restructuring expenses
Restructuring expenses decreased $1.9 million, or 100.0%, for the year ended December 31, 2016 from $1.9 million for the year ended December 31, 2015. The Company did not undertake any restructuring activities during the year ended December 31, 2016.
Depreciation and amortization
Depreciation and amortization expense decreased $1.2 million, or 60.4%, to $782,000 for the year ended December 31, 2016 from $2.0 million for the year ended December 31, 2015, and decreased as a percentage of revenue to 1.5% for the year ended December 31, 2016 from 2.5% for the year ended December 31, 2015. The decrease in depreciation and amortization expense was primarily a result of our continued use of our existing property and equipment, which we elected not to replace as part of our on-going cost control initiatives.
Interest expense, including related party
Interest expense increased $321,000, or 4.7%, to $7.1 million for the year ended December 31, 2016 from $6.8 million for the year ended December 31, 2015. The increase in interest expense was primarily a result of increases in our borrowing rates on our line of credit and term debt facilities. The borrowing rates on our line of credit and our term debt facilities were 6.12% and 13.00% as of December 31, 2016, respectively, as compared to 5.74% and 12.41% as of December 31, 2015, respectively.
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 year ended December 31, 2016 was $3.0 million, compared to an increase of $599,000 for the year ended December 31, 2015, representing a decline of 592.9%, or $3.5 million.
Other income (expense), net
Other income (expense), net increased by $828,000, or 237.5%, to $480,000 of income for the year ended December 31, 2016 from other expense of $349,000 for the year ended December 31, 2015. The increase in other income (expense), net was primarily a result of settlement payments received during the year ended December 31, 2016 from successful patent litigation actions against certain individuals and companies.
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
* Variance is not meaningful
Revenue
Revenue decreased $11.5 million, or 12.6%, to $79.7 million for the year ended December 31, 2015 from $91.3 million for the year ended December 31, 2014. The decrease in revenue was primarily a result of a $10.5 million decrease in sales to commercial customers during the year ended December 31, 2015 as compared to the prior year. Additionally, sales to The Home Depot declined by $1.0 million, or 1.4%, during the year ended December 31, 2015 as compared to the prior year.
Cost of goods sold
Cost of goods sold decreased $19.2 million, or 21.8%, to $68.5 million for the year ended December 31, 2015 from $87.7 million for the year ended December 31, 2014. The decrease in cost of goods sold was due to several factors, including a $3.0 million decrease in warranty expense and a $1.1 million decrease in inventory reserve charges, as well as a reduction in sales and the impact of our on-going transition to lower cost contract manufacturers in Asia resulting in lower costs of good purchased. Cost of goods sold as a percentage of revenue decreased for the year ended December 31, 2015 to 86.0% (or gross profit of 14.0%) as compared to 96.1% (or gross profit of 3.9%) for the year ended December 31, 2014.
Selling, distribution and administrative
Selling, distribution and administrative expenses decreased $11.4 million, or 33.4%, to $22.7 million for the year ended December 31, 2015 from $34.0 million for the year ended December 31, 2014, and decreased as a percentage of revenue to 28.4% for the year ended December 31, 2015 from 37.3% for the year ended December 31, 2014. The decrease in selling, distribution and administrative expenses was primarily due an $8.6 million decrease in personnel-related expense resulting from the workforce reductions initiated in 2014. Additionally, facilities-related expenses decreased $1.2 million and promotional and sample and other expenses decreased $1.5 million during the year ended December 31, 2015 as compared to the prior year.
Research and development
Research and development expenses decreased $1.6 million, or 29.2%, to $4.0 million for the year ended December 31, 2015 from $5.6 million for the year ended December 31, 2014, and decreased as a percentage of revenue to 5.0% for the year ended December 31, 2015 from 6.2% for the year ended December 31, 2014. The decrease in research and development expenses was primarily due to lower personnel-related expense driven by headcount reductions during 2014.
Restructuring expenses
Restructuring expenses decreased $1.6 million, or 45.7%, to $1.9 million for the year ended December 31, 2015 from $3.5 million for the year ended December 31, 2014. Restructuring expenses during the year ended December 31, 2015 consisted of the loss on the closure of our former Netherlands subsidiary of $1.6 million and severance costs of $297,000 related to additional headcount reductions in the United States.
Depreciation and amortization
Depreciation and amortization expense decreased $1.4 million, or 41.2%, to $2.0 million for the year ended December 31, 2015 from $3.4 million for the year ended December 31, 2014, and decreased as a percentage of revenue to 2.5% for the year ended December 31, 2015 from 3.7% for the year ended December 31, 2014. The decrease in depreciation and amortization expense was primarily a result of the impairment of manufacturing equipment and tools and molds recognized during 2014, in connection with our transition to lower cost contract manufacturers in Asia, which impairment was not repeated in 2015.
(Increase) decrease in fair value of liabilities under derivative contracts
The change in the fair value of liabilities under derivative contracts is driven by changes in the trading price of our Common Stock and changes in risk-free interest rates. The increase in fair value of liabilities under derivative contracts for the year ended December 31, 2015 was $598,000, compared to an increase of $15.7 million for the year ended December 31, 2014, representing a decline of 96.2%, or $15.1 million. The change was due to the relatively small change in the prices of our Common Stock between the year ended December 31, 2015 and the year ended December 31, 2014.
Liquidity and Capital Resources
Overview
We have experienced significant historical net losses as well as negative cash flows from operations since our inception, resulting in an accumulated deficit of $847.6 million and stockholders’ deficit of $570.0 million as of December 31, 2016. As of December 31, 2016, we had cash and cash equivalents of $1.9 million and an additional $3.0 million in restricted cash subject to a cash collateral dominion agreement pursuant to the terms of our five-year term loan (the “Medley Term Loan”) from Medley Capital Corporation (“Medley”). Our cash expenditures primarily relate to procurement of inventory and payment of salaries, employee benefits and other operating costs.
Our primary sources of liquidity have historically been borrowings from various lenders and sales of Common Stock and Convertible Preferred Stock (as defined below) to, and short-term loans from, Pegasus Capital and its affiliates (collectively, “Pegasus”). Pegasus is our controlling stockholder and has led a majority of our capital raises.
We continue to face challenges in our efforts to achieve profitability and positive cash flows from operations. Our ability to continue to meet our obligations in the ordinary course of business is dependent upon establishing profitable operations, which may be supplemented by any additional funds that we may raise through public or private financing or increased borrowing capacity.
Our cash flows in 2016 were adversely affected by the loss of certain business from our largest customer, The Home Depot, following a 2015 product line review. Although we were selected to supply certain new products to The Home Depot under the new supplier buying agreement with The Home Depot that went into full effect in the second quarter of 2016, such new business only partially offset the negative effects of the lost business. 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 under the new supplier agreement.
As a result of our historical losses, we believe we will likely need to raise additional capital to fund our operations. Sources of additional capital may not be available in an amount or on terms that are acceptable to us, if at all. Our capital structure includes four outstanding series of preferred stock: Series H Convertible Preferred Stock (“Series H Preferred Stock”); Series I Convertible Preferred Stock (“Series I Preferred Stock”); Series J Preferred Stock (collectively with the Series H Preferred Stock and the Series I Preferred Stock, the “Convertible Preferred Stock”); and Series K Preferred Stock (collectively with the Convertible Preferred Stock, the “Preferred Stock”). The complexity of our capital structure as well as our obligations to the holders of the outstanding shares of Preferred Stock may make it more difficult to raise additional capital from new or existing investors or lenders. If we are not able to raise such additional capital, we may need to restructure or refinance our existing obligations, which restructuring or refinancing would require the consent and cooperation of our creditors and certain stockholders. In such event, we may not be able to complete a restructuring or refinancing on terms that are acceptable to us, if at all. If we are unable to obtain sufficient capital when needed, our business, compliance with our credit facilities and future prospects may be adversely affected.
Pegasus has committed to provide financial support to us to fund our operations and debt service requirements of up to $13.2 million as they come due at least until April 12, 2018. The amount of this commitment will be reduced by amounts funded by other parties (except for draws under the Ares ABL) within the next 12 months that are not repayable by us on or before April 12, 2018. Such commitment, which in no way amounts to a guarantee of our obligations, may be provided through a variety of mechanisms, which may or may not be similar to those previously employed. Furthermore, in exchange for such support, Pegasus, as our controlling stockholder, may request that we take certain actions related to operations, capital structure or otherwise, which, if accepted, could have a negative effect on our business and results of operations. In addition, Pegasus may seek other terms and consideration that would require, and may not receive, approval by the independent committee of our board of directors.
Debt financing
The Medley Term Loan is subject to the terms of the Term Loan Agreement dated February 19, 2014 (as amended from time to time the “Medley Loan Agreement”). Pursuant to the Medley Loan Agreement, we are required to achieve a minimum quarterly fixed charge coverage ratio for the preceding 12-month period and to maintain certain minimum EBITDA levels.
We also have a three-year revolving credit facility with a maximum line amount of $22.5 million from ACF Finco I LP (“Ares”), which is governed by the terms of the Loan and Security Agreement dated April 25, 2014 (as amended from time to time, the “Ares ABL Agreement”). As of December 31, 2016, we had $6.1 million in borrowings outstanding under the Ares ABL and additional borrowing capacity of $1.9 million. The maximum borrowing capacity under the Ares ABL is based on a formula of eligible accounts receivable and inventory. The Ares ABL Agreement also requires us to maintain certain minimum EBITDA levels.
The Ares ABL matures on April 25, 2017. At or prior to the time the Ares ABL matures, we will be required to repay or refinance the facility. Further, as a condition to Medley’s consent to closing of the pending Joint Venture transaction, we will be required to repay $5.0 million of the outstanding indebtedness under the Medley Term Loan on or before May 1, 2017.
Equity financing and related matters
On February 23, 2016, July 19, 2016 and November 21, 2016, we issued 3,000, 5,000 and 5,000 Series J Securities, respectively, to Holdings III. In each case, the Series J Securities were issued at a purchase price of $1,000 per Series J Security and in accordance with the terms of separate subscription agreements with each of the preemptive rights purchasers and Holdings III. We received aggregate gross proceeds of approximately $13.0 million in connection with the issuances of Series J Securities during 2016. Since December 31, 2016, we have issued an additional 10,000 Series J Securities for aggregate gross proceeds of $10.0 million.
Certain holders of our Convertible Preferred Stock have the right to cause us to redeem such shares at any time on or after March 27, 2017. If any such stockholder elects to cause us to redeem its shares of Convertible 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. We are also required to redeem the outstanding shares of our Series J Preferred Stock (a) subject to certain limited exceptions, immediately prior to the redemption of the Series H Preferred Stock, Series I Preferred Stock or any other security that ranks junior to, or pari passu with, the Series J Preferred Stock and (b) on November 14, 2019, at the election of the holders of Series J Preferred Stock (a “Special Redemption”). Holders of our Convertible Preferred Stock 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. Further, depending on whether the $20.1 million appeal bond posted in connection with the Geveran litigation described below (the “Appeal Bond”) 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 December 31, 2016, in the event we were required to redeem all of our outstanding shares of Convertible Preferred Stock and Series K Preferred Stock (collectively, the “Preferred Stock”), our maximum payment obligation would have been $544.0 million. We would be required to repay our outstanding obligations under the Medley Term Loan and the Ares ABL prior to any redemption of any shares of Preferred Stock. As of December 31, 2016, we had $36.7 million of aggregate borrowings outstanding under these credit facilities that we would be required to repay.
Any redemption of the Preferred Stock would be limited to funds legally available therefor under Delaware law. The certificates of designation governing the Preferred Stock provide that if there is not a sufficient amount of cash or surplus available to pay for a redemption of Preferred Stock, then the redemption must be paid out of the remaining assets of the Company. 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. Based solely on a review of our balance sheet, we do not have legally available funds under Delaware law to satisfy the redemption of all of our outstanding shares of Preferred Stock. 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.
Geveran Litigation
One of our stockholders, Geveran Investments Limited (“Geveran”), filed a lawsuit against us and certain other defendants seeking, among other things, rescissionary damages in connection with its $25.0 million investment in the Company. On November 30, 2015, the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida, the court presiding over the lawsuit, entered an Order Granting Plaintiff’s Motion for Partial Summary Judgment Under its First Cause of Action for Violation of the Florida Securities and Investment Protection Act (the “Summary Judgment Order”). Accordingly, we, with the assistance of Pegasus, posted the Appeal Bond to obtain an automatic stay of enforcement as we appeal the Summary Judgment Order. Although we cannot predict the ultimate outcome of this lawsuit, we believe the court’s Summary Judgment Order was in error and that we have strong defenses against Geveran’s claims. However, in the event that we are not successful on appeal, we could be liable for the full amount of Geveran’s $25.0 million investment, as well as interest, attorneys’ fees and court costs. Accordingly, the Summary Judgment Order and the Appeal Bond could have a material adverse effect on our liquidity and our ability to raise capital in the future. We believe that, subject to the terms and conditions of the relevant policies (including retention and policy limits), directors’ and officers’ insurance coverage will be available to cover the substantial majority of our legal fees and costs in this matter. However, insurance coverage may not be available for, or such coverage may not be sufficient to fully pay, a judgment or settlement in favor of Geveran. Our engagement letter with J.P. Morgan pursuant to which we engaged J.P. Morgan as placement agent in connection with the private placement to Geveran requires us to indemnify J.P. Morgan and its affiliates from liabilities relating to J.P. Morgan’s activities as placement agent, unless such activities are finally judicially determined to have resulted from J.P. Morgan’s bad faith, gross negligence or willful misconduct. Based upon the terms of such engagement letter, we have also paid, and may be required to pay in the future, the reasonable legal expenses incurred by J.P. Morgan and its affiliates in this lawsuit. Such payments are not covered by our insurance.
Joint Venture
As discussed above under “Recent Events,” on March 20, 2017, we and our newly formed subsidiary, LSG JV Holdings, entered into the JV Operating Agreement with MLS. The effectiveness of the JV Operating Agreement and closing of the Joint Venture transaction remain subject to the satisfaction of certain conditions and our performance of certain obligations. On the effective date of the JV Operating Agreement, we (through LSG JV Holdings) must make an initial capital contribution of $5.1 million in cash to GVL and, upon the determination of GVL’s board of managers, will be required to make additional capital contributions of up to $7.65 million in the aggregate during the 12 months thereafter. The Joint Venture is an integral part of our long-term strategy and we anticipate that, as a result of this transaction, gross margins and cash flows will gradually improve over the next 12 months.
Management’s assessment regarding our ability to continue as a going concern
In connection with the preparation of the financial statements for the year ended December 31, 2016, management concluded that due to certain factors discussed above, such as our historical cash flows and operating results, our existing and future debt obligations, the redemption rights of certain preferred stockholders and our obligations to make capital contributions to GVL upon closing of the pending Joint Venture transaction (collectively, the “Liquidity Challenges”), substantial doubt exists regarding our ability to continue as a going concern. Nonetheless, management believes that certain events that have occurred since December 31, 2016 and certain actions expected to be implemented in 2017 will alleviate such substantial doubt. Specifically, management has concluded that it is probable that the following events will alleviate the substantial doubt raised by the Liquidity Challenges and, as a result, that we will be able to satisfy our estimated liquidity needs for 12 months from the issuance of the financial statements included in this Form 10-K:
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We issued Series J Securities in January and February 2017 for $10.0 million in aggregate gross proceeds;
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Proceeds from the recent issuances of Series J Securities were used to repay a portion of the outstanding borrowings under the Ares ABL, bringing the outstanding balance to $2.2 million as of March 31, 2017;
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Headcount reductions in February 2017 are expected to result in significant cost savings;
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We anticipate that gross margins and cash flows will improve following the closing of the Joint Venture;
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Following a series of transactions among certain holders of Preferred Stock, Pegasus solely possesses the optional redemption rights described above under the heading “Equity financing and related matters” and Pegasus has indicted that, subject to certain conditions, it will not exercise such rights through November 14, 2019; and
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As described above, Pegasus has committed to provide financial support to us to fund our operations and debt service requirements of up to $13.2 million as they come due at least until April 12, 2018.
Contractual obligations
As of December 31, 2016, payments to be made pursuant to our principal contractual obligations were as follows:
(1)
Purchase obligations generally relate to the purchase of goods and services in the ordinary course of business such as raw materials, supplies and capital equipment.
(2)
Operating lease obligations include rental amounts due on leases of certain office and manufacturing space, as well as automobiles, office equipment and manufacturing equipment under the terms of non-cancelable operating leases. These leases expire at various times through December 2019. Some of the lease agreements provide for adjustments for increases in base rent (up to specific limits), property taxes and general property maintenance that would be recorded as rent expense, if applicable.
(3)
Line of credit includes principal payments on our line of credit, assuming payment will be made on the agreed upon due date for our Ares ABL.
(4)
Interest obligations represent estimated interest payments on our Ares ABL and the Medley Term Loan, based on the rates as of December 31, 2016, through the date of expected payments.
(5)
Note payable includes principal payments on the Medley Term Loan, assuming payment will be made on the agreed upon due date for our Medley Term Loan.
Cash flows
The following table summarizes our cash flow activities for the years ended December 31, 2016, 2015 and 2014:
Operating activities
Cash used in operating activities is net loss adjusted for certain non-cash items and changes in certain assets and liabilities. Net cash used in operating activities was approximately $9.7 million, $20.6 million and $41.1 million for the years ended December 31, 2016, 2015 and 2014, respectively. The largest driver behind the net cash used in operating activities for the years ended December 31, 2016, 2015 and 2014 was the net loss, which was $20.2 million, $27.1 million and $65.6 million, respectively.
Net cash used in operating activities for the year ended December 31, 2016 included certain non-cash reconciliation items consisting primarily of a $3.9 million inventory write-down, $3.1 million in amortization of debt issuance costs, accretion and interest accrual on the Ares ABL and the Medley Term Loan and $782,000 in depreciation and amortization. These non-cash charges were partially offset by a $3.0 million net decrease in the fair value of warrants and a $187,000 net credit related to stock-based compensation, which resulted from employees departing during 2016 and the reversal of expense associated with their unvested stock options). The $8.0 million decrease in net loss for the year ended December 31, 2016 as compared to the year ended December 31, 2015, in addition to these non-cash reconciliation items, was primarily a result of decreased operating expenses.
Net cash used in operating activities for the year ended December 31, 2015 included certain non-cash reconciliation items consisting primarily of $2.9 million in amortization of debt issuance costs, accretion and interest accrual on the Ares ABL and the Medley Term Loan, $2.5 million of stock-based compensation expense and issuances of restricted stock for directors’ compensation, $2.0 million in depreciation and amortization, a $3.6 million inventory write-down, a $1.6 million charge on the disposal of a subsidiary and a $598,000 net increase in fair value of warrants. The decrease in net loss for the year ended December 31, 2015 as compared to the year ended December 31, 2014, in addition to these non-cash reconciliation items, was primarily a result of decreased operating expenses from our cost cutting initiatives.
Net cash used in operating activities for the year ended December 31, 2014 included certain non-cash reconciliation items comprised primarily of a $15.7 million net increase in fair value of warrants, a $4.7 million inventory write down, $4.1 million of stock-based compensation expense, $3.4 million in depreciation and amortization and $2.8 million in amortization of debt issuance costs, accretion and interest accrual on the Ares ABL, Medley Delayed Draw Loan and the Medley Term Loan.
For the year ended December 31, 2016, changes in operating working capital (current assets and current liabilities, excluding our line of credit) provided $6.0 million in cash. This increase resulted from a decrease in accounts receivable of $3.7 million (a result of lower level of revenue), a decrease in inventories of $1.1 million (due to expected demand for sales to customers), an increase in accounts payable of $995,000 (due to timing of payments to trade creditors) and a decrease in prepaid expenses of $299,000 (due to our ongoing cost control initiatives). That increase was slightly offset by a reduction in accrued expenses of $110,000 (resulting from a reduction in the warranty reserve). For the year ended December 31, 2015, cash was used for the increase in inventories, net of an inventory write down of $3.8 million and reductions in accounts payable and accrued expenses and other liabilities of $6.1 million and $2.6 million, respectively. The use of cash was partially offset by reductions in accounts receivable and prepaid expenses of $2.7 million and $1.8 million, respectively. For the year ended December 31, 2014, cash was used by the increase in inventories, net of the inventory write down, of $10.0 million due to the purchase of finished goods, accounts receivable increased by $2.7 million and prepaid expenses increased by $1.0 million. This use of cash was partially offset by an increase in accounts payable of $3.4 million and an increase in accrued expenses and other liabilities of $2.8 million.
Investing activities
Cash used in investing activities primarily relates to investments made in new patents, and purchases of equipment. Net cash used in investing activities was $1.0 million, $703,000 and $919,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
During the year ended December 31, 2016, we relocated our operations in Melbourne, Florida to Cocoa Beach, Florida and expanded our corporate office in West Warwick, Rhode Island. The buildout of the Cocoa Beach facilities and expansion of our West Warwick office drove a $460,000 increase in property and equipment spending. Additionally, we continued to invest in our intellectual property and invested $576,000 in patents and patents pending during the 2016.
The continued reduction in cash used in investing activities for the year ended December 31, 2015 as compared to the year ended December 31, 2014 reflected reduced spending for tooling, production and test equipment because those activities were performed by contract manufacturers in Asia. We invested $567,000 in new patents during 2015.
The decrease in cash used in investing activities for the year ended December 31, 2014 primarily related to a decrease in the purchase of tooling, production and test equipment as we transitioned to contract manufacturers in Asia and focused on cost saving measures.
Financing activities
Cash provided by financing activities has historically been composed of net proceeds from various debt facilities and the issuance of common and preferred stock. Net cash provided by financing activities was $11.6 million, $20.5 million and $32.1million for the years ended December 31, 2016, 2015 and 2014, respectively.
Cash provided by financing activities for the year ended December 31, 2016 included $13.0 million of proceeds from the issuance of Series J Securities. This increase was partially offset by reductions in borrowings outstanding under our line of credit of $782,000 (due to a reduced need for funding to support operating assets) and payments of $623,000 in fees paid in connection with the issuance of Series J Securities as well as debt issuance and loan amendment costs.
Cash provided by financing activities for the year ended December 31, 2015 included $21.5 million of proceeds from the issuance of Series J Securities and $494,000 of net draws on our line of credit. This increase was partially offset by $1.1 million in fees paid in connection with the issuance of Series J Securities as well as $339,000 in debt issuance costs.
Cash provided by financing activities for the year ended December 31, 2014 included the issuance of Series J Securities for aggregate proceeds of $38.5 million and proceeds of $29.9 million on the Medley Term Loan, partially offset by net payments on our lines of credit and other short term borrowings, including the net repayment of $33.8 million, in the aggregate, on prior credit facilities and the Ares ABL, $3.2 million in debt issuance costs and $1.2 million in fees and commissions paid in connection with the issuance of Series J Securities.
Item 8.
Item 8. Financial Statements.
The financial statements required by this item are included in Part IV, Item 15 of this Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.
We carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and our Executive Vice President and Chief Financial Officer (the “Certifying Officers”), of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-K. Based on that evaluation, the Certifying Officers concluded that our disclosure controls and procedures as of December 31, 2016 were effective.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) is a set of processes designed by, or under the supervision of, the Certifying Officers, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and dispositions of our assets;
•
provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Thus, any system of internal control, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including the Certifying Officers, we conducted an assessment of the effectiveness of our internal control over financial reporting based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (2013) (the “2013 COSO Framework”). As a result of that evaluation, management has concluded that our internal control over financial reporting, involving the preparation and reporting of our consolidated financial statements presented in conformity with GAAP was effective as of December 31, 2016.
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Remediation of Material Weaknesses
During 2016, we made the following changes in our internal controls, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting:
●
We developed a plan to identify critical spreadsheets used in the preparation of our financial statements, and instituted reviews of those spreadsheets by personnel independent of the preparer of such spreadsheets.
●
We have modified and improved the design of our inventory valuation controls for the updating of assumptions and information through the date that financial statements are issued.
●
We developed a methodology to address the accounting and disclosure requirements for non-routine transactions, which includes researching the applicable authoritative literature for such transactions, determining the appropriate accounting and disclosures, and memorializing the result in file memoranda.
These changes were completed during the quarter ended December 31, 2016.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required in response to this Item 10 is incorporated herein by reference to our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A promulgated under the Exchange Act not later than 120 days after the end of the year covered by this Form 10-K.
Item 11.
Item 11. Executive Compensation.
The information required in response to this Item 11 is incorporated herein by reference to our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A promulgated under the Exchange Act not later than 120 days after the end of the year covered by this Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Certain information regarding securities authorized for issuance under our equity compensation plans is included under the caption “Equity Compensation Plan Information” in Part II, Item 5, above, of this Form 10-K and is incorporated by reference herein. Other information required in response to this Item 12 is incorporated herein by reference to our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A promulgated under the Exchange Act not later than 120 days after the end of the year covered by this Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required in response to this Item 13 is incorporated herein by reference to our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A promulgated under the Exchange Act not later than 120 days after the end of the year covered by this Form 10-K.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required in response to this Item 14 is incorporated herein by reference to our definitive proxy statement to be filed with the SEC pursuant to Regulation 14A promulgated under the Exchange Act not later than 120 days after the end of the year covered by this Form 10-K.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
The following documents are filed as part of this Form 10-K:
1. Index to Consolidated Financial Statements, Reports of Independent Registered Public Accounting Firm, Consolidated Balance Sheets as of December 31, 2016 and 2015, Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2016, 2015 and 2014, Consolidated Statements of Stockholders’ Deficit for the years ended December 31, 2016, 2015 and 2014 and Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014.
2. The financial statement schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the Notes to Consolidated Financial Statements.
3. Exhibits: The exhibits required to be filed by this Item 15 are set forth in the Index to Exhibits accompanying this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
LIGHTING SCIENCE GROUP CORPORATION
April 14, 2017
By:
/S/ Edward D. Bednarcik
Edward D. Bednarcik
Chief Executive Officer
(Principal Executive Officer)
April 14, 2017
By:
/S/ Denis M. Murphy
Denis M. Murphy
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates as indicated.
Signature
Capacity in which Signed
Date
/s/ Edward D. Bednarcik
Chief Executive Officer and Director
April 14, 2017
Edward D. Bednarcik
(Principal Executive Officer)
/s/ Denis M. Murphy
Chief Financial Officer
April 14, 2017
Denis M. Murphy
(Principal Financial and Accounting Officer)
Chairman of the Board of Directors
Craig Cogut
/s/ Sanford R. Climan
Director
April 14, 2017
Sanford R. Climan
/s/ David Crane
Director
April 14, 2017
David Crane
/s/ Richard H. Davis, Jr.
Director
April 14, 2017
Richard H. Davis, Jr.
Director
Joel Haney
/s/ Donald R. Harkleroad
Director
April 14, 2017
Donald R. Harkleroad
/s/ Fredric Maxik
Director
April 14, 2017
Fredric Maxik
/s/ DENNIS McGill
Director
April 14, 2017
Dennis McGill
Director
Jonathan Rosenbaum
/s/ Peter Scarpelli
Peter Scarpelli
Director
April 14, 2017
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Lighting Science Group Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Lighting Science Group Corporation and Subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive loss, stockholders’ deficit, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lighting Science Group Corporation and Subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Orlando, FL
April 14, 2017
Certified Public Accountants
LIGHTING SCIENCE GROUP CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
LIGHTING SCIENCE GROUP CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
The accompanying notes are an integral part of the consolidated financial statements.
LIGHTING SCIENCE GROUP CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
The accompanying notes are an integral part of the consolidated financial statements.
LIGHTING SCIENCE GROUP CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
LIGHTING SCIENCE GROUP CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Description of Business and Basis of Presentation
Overview
Lighting Science Group Corporation (the “Company”) was incorporated in Delaware in 1988 and designs, develops and markets general illumination products that exclusively use light emitting diodes (“LEDs”) as their light source. The Company’s product portfolio includes LED-based retrofit lamps (replacement bulbs) that can be used in existing light fixtures and sockets as well as purpose built LED-based luminaires (light fixtures) for many common indoor and outdoor residential, commercial, industrial and public infrastructure lighting applications. The Company assembles and manufactures its products through its contract manufacturers in Asia.
Basis of Financial Statement Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the Securities Exchange Commission (“SEC”). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in the accompanying consolidated financial statements.
Note 2: Summary of Significant Accounting Policies
Use of Estimates
The preparation of the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenue and expenses. Such estimates include the valuation of accounts receivable, inventories, intangible assets and other long-lived assets, legal contingencies, and customer incentives, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an on-going basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. The Company adjusts such estimates and assumptions when facts and circumstances dictate. Illiquid credit markets, volatile equity, foreign currency and energy markets and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
Foreign Currency Translation
The functional currency for the foreign operations of the Company is the local currency of the applicable foreign subsidiary. The translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet dates and for revenue and expense accounts using the average exchange rate for each period during the year. Any gains or losses resulting from the translation are included in accumulated other comprehensive loss in the consolidated statements of stockholders’ deficit and are excluded from net loss.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. As of both December 31, 2016 and 2015, the Company had no cash equivalents. The Company regularly maintains cash balances in excess of federally insured limits. To date, the Company has not experienced any losses on its cash and cash equivalents. As of December 31, 2016, the Company had $4.6 million in cash and cash equivalents and restricted cash held in banks in the United States in excess of the federally insured limits.
Restricted Cash
As of December 31, 2016 and 2015, as required by the Company’s five-year term loan (as amended from time to time, the “Medley Term Loan”) with Medley Capital Corporation (“Medley”), the Company was required to maintain a minimum restricted cash balance of $3.0 million to collateralize the Medley Term Loan. Changes in the restricted cash balance were reflected as a financing activity in the consolidated statements of cash flows.
Accounts Receivable
The Company records accounts receivable at the invoiced amount when its products are shipped to customers. The Company’s receivable balance is recorded net of allowances for amounts not expected to be collected from customers. This allowance for doubtful accounts is the Company’s best estimate of probable credit losses in the Company’s existing accounts receivable. Estimates used in determining the allowance for doubtful accounts are based on historical collection experience, aging of receivables and known collectability issues. The Company writes off accounts receivable when it becomes apparent, based upon age or customer circumstances that such amounts will not be collected. The Company reviews its allowance for doubtful accounts on a quarterly basis. Recovery of bad debt amounts previously written off is recorded as a reduction of bad debt expense in the period the payment is collected. Generally, the Company does not require collateral for its accounts receivable and does not regularly charge interest on past due amounts. As of December 31, 2016 and 2015, the allowance for doubtful accounts was $324,000 and $475,000, respectively.
As of December 31, 2016, $690,000 of eligible accounts receivable were pledged as collateral for the three-year asset-based revolving credit facility (as amended from time to time, the “FCC ABL”) entered into on April 25, 2014 with FCC, LLC d/b/a First Capital (“First Capital”). First Capital sold the FCC ABL to ACF Finco I LP (“Ares”) in May 2015, and the FCC ABL is hereinafter referred to as the “Ares ABL.” As of December 31, 2015, there were $4.2 million of eligible accounts receivable pledged as collateral for the Ares ABL.
Inventories
Inventories are stated at the lower of cost or market and consist of finished lighting products. Inventories are valued on a first-in, first out basis.
Significant changes in the Company’s strategic plan, including changes in product mix, product demand, slow product adoption, rapid technological changes and new product introductions and enhancements could result in excess or obsolete inventory. The Company evaluates inventory levels and expected usage on a quarterly basis to specifically identify obsolete, slow-moving or non-salable inventory based upon assumptions about future demand and market conditions. The write-down of excess and obsolete inventory based on this evaluation creates a new cost basis and is included in cost of goods sold.
On a quarterly basis, the Company considers the need to record a lower of cost or market adjustment for its raw materials and finished goods inventory. The market value of finished goods is determined based upon current sales transactions, less the cost of disposal of the respective finished goods.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Equipment under capital leases is stated at the present value of future minimum lease payments. Depreciation is provided using the straight-line method over the estimated economic lives of the assets, as follows:
Leasehold improvements and equipment under capital leases are amortized on a straight-line basis over the shorter of the minimum lease term or the estimated useful life of the assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs for major renewals and improvements are capitalized and depreciated over their estimated useful lives. All costs incurred for building of production tooling and molds are capitalized and amortized over the estimated useful life of the tooling set or mold.
Intangible Assets
Intangible assets include patents and patents pending. Intangible assets with estimable useful lives are amortized over their respective useful lives on a straight-line basis. Finite-lived intangible assets are reviewed for impairment or obsolescence annually, or more frequently if events or changes in circumstance indicate that the carrying amount of an intangible asset may not be recoverable. If impaired, intangible assets are written down to fair value based on discounted cash flows.
Impairment of Long-lived Assets
Long lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third party independent appraisals, as considered necessary.
Derivative Instruments
The Company recognizes all derivative instruments as either assets or liabilities in the balance sheet at their respective fair values. All derivatives are recorded at fair value on the consolidated balance sheets and changes in the fair value of such derivatives are measured in each period and are reported in other income (expense).
Fair Value Measurements
The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
•
Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities accessible to the reporting entity at the measurement date.
•
Level 2 Inputs: Other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
•
Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.
Fair Value of Financial Instruments
Cash and cash equivalents, accounts receivable, accounts payable, amounts due under lines of credit and other short term borrowings, accrued expenses and note payable are carried at amounts that approximate their fair value due to the short-term maturity of these instruments and/or variable, market driven interest rates.
All outstanding derivative securities are recorded at fair value at the end of each reporting period. The fair value of the THD Warrant is determined using the option pricing model valuation method and will be adjusted at each reporting date until the underlying shares have been earned for each year and these adjustments will be recorded as a reduction in the related revenue (sales incentive) from The Home Depot, Inc. (“The Home Depot”). Once a portion of the THD Warrant vests it is recorded at its fair value at the end of each subsequent reporting period
Revenue Recognition
The Company records revenue when its products are shipped and title passes to customers. When sales of products are subject to certain customer acceptance terms, revenue from such sales is recognized once these terms have been met. The Company also provides its customers with limited rights of return for non-conforming shipments or product warranty claims.
Shipping and Handling Fees and Costs
Shipping and handling fees billed to customers are included in revenue. Shipping and handling costs associated with in-bound freight are included in cost of goods sold. Other shipping and handling costs are included in selling, distribution and administrative expenses and totaled $3.8 million, $3.0 million and $1.8 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Research and Development
The Company expenses all research and development costs, including amounts for design prototypes and modifications made to existing prototypes, as incurred.
Product Warranties
The Company generally provides a five-year limited warranty covering defective materials and workmanship of its products and such warranty may require the Company to repair, replace or reimburse the purchaser for the purchase price of the product. The estimated costs related to warranties are accrued at the time products are sold based on various factors, including the Company’s stated warranty policies and practices, the historical frequency of claims and the cost to repair or replace its products under warranty. The following table summarizes changes in the warranty provision for the years ended December 31, 2016 and 2015 were as follows:
Share Based Compensation
The Company recognizes all employee stock based compensation as a cost in the financial statements based on the fair value of the share based compensation award. Equity classified awards are measured at the grant date fair value of the award. The Company estimates grant date fair value using the Black Scholes Merton option pricing model.
As of December 31, 2016 and 2015, the Company had two share based compensation plans. The fair value of share based compensation awards, which historically have included stock options and restricted stock awards, is recognized as compensation expense in the statement of operations. The fair value of stock options is estimated on the date of grant using the Black-Scholes option pricing model. Option valuation methods require the input of highly subjective assumptions, including the expected stock price volatility. Measured compensation expense related to such option grants is recognized ratably over the vesting period of the related grants. Restricted stock awards are valued on the date of grant.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest related to unrecognized tax benefits in interest expense and penalties in the income tax provision.
Advertising
Advertising costs are included in selling, distribution and administrative expenses and are expensed when the advertising first takes place. The Company primarily promotes its product lines through print media and trade shows, including trade publications and promotional brochures. Advertising expenses were $99,000, $43,000 and $198,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
Segment Reporting
The Company operates as a single segment under Accounting Standard Codification (“ASC”) 280-10-50, “Disclosures about Segments of an Enterprise and Related Information”. The Company’s chief operating decision maker reviews financial information at the enterprise level and makes decisions accordingly.
Recently Adopted Accounting Pronouncements
Debt Issuance Costs
In April 2015, the Financial Accounting Standards Board (the “FASB”) issued ASU 2015-03 that intends to simplify the presentation of debt issuance costs. Debt issuance costs related to a recognized debt liability will be presented on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts. ASU 2015-03 is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The cost of issuing debt will no longer be recorded as a separate asset, except when incurred before receipt of the funding from the associated debt liability. The Company retrospectively adopted ASU 2015-03 as of January 1, 2016. The adoption of this guidance did not have a material impact on the condensed consolidated financial statements or notes to condensed consolidated financial statements.
Deferred Income Taxes
In November 2015, the FASB issued ASU No 2015-17 to simplify the presentation of deferred income taxes by requiring that deferred tax assets and liabilities be classified as non-current in the balance sheet. The new guidance is effective for the annual period ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The Company retrospectively adopted ASU 2015-17 as of January 1, 2016. The adoption of this guidance did not have a material impact on the condensed consolidated financial statements or notes to condensed consolidated financial statements.
Stock Compensation
In March 2016, the FASB issued ASU No. 2016-09: Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU simplifies the current stock compensation guidance for tax consequences. The ASU requires an entity to recognize all excess tax benefits and tax deficiencies as income tax expense or benefit in its income statement. The ASU also eliminates the requirement to defer recognition of an excess tax benefit until the benefit is realized through a reduction to taxes payable. For cash flows statement purposes, excess tax benefits should be classified as an operating activity and cash payments made to taxing authorities on the employee’s behalf for withheld shares should be classified as financing activity. The ASU is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The adoption of this guidance did not have a material impact on the condensed consolidated financial statements or notes to condensed consolidated financial statements.
Going Concern
In August 2014, the FASB issued ASU 2014-15, which requires management to perform interim and annual assessments on whether there are conditions or events that raise substantial doubt about the entity's ability to continue as a going concern within one year of the date the financial statements are issued and to provide related disclosures, if required. The amendments in ASU 2014-15 are effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. The Company adopted ASU 2014-15 in the fourth quarter of 2016.
Recent Accounting Pronouncements Not Yet Adopted
Revenue Recognition
In May 2014, the FASB issued ASU 2014-09, which will replace most existing revenue recognition guidance in United States generally accepted accounting principles (“GAAP”) and is intended to improve and converge the financial reporting requirements for revenue from contracts with customers with International Financial Reporting Standards (“IFRS”). The core principle of ASU 2014-09 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASU 2014-09 also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU 2014-09 allows for both retrospective and prospective methods of adoption and is effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual periods. Early application is permitted but not before annual reporting periods beginning after December 15, 2016.
Management expects to adopt ASU No. 2014-09 for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting year. While Management is still in its assessment process, the Company generally does not expect the impact of the adoption of this ASU to be significant to its consolidated financial statements, it is still evaluating the impact on the disclosures in the notes to consolidated financial statements. Management currently expects to apply ASU 2014-09 retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application recorded as an adjustment to retained earnings, referred to as the "Modified Retrospective Approach."
Inventory
In July 2015, the FASB issued ASU 2015-11, “Inventory (Topic 330).” This update requires an entity to measure inventory within the scope of the update at the lower of cost and net realizable value. This update is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company is currently evaluating the method of adoption and the impact that the adoption of ASU 2015-11 will have on its consolidated financial statements.
Leases
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. ASU 2016-02 introduces a lessee model that brings most leases on the balance sheet. The new standard also aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB's new revenue recognition standard (e.g., those related to evaluating when profit can be recognized). Furthermore, ASU 2016-02 addresses other concerns related to the current leases model. For example, ASU 2016-02 eliminates the requirement in current GAAP for an entity to use bright-line tests in determining lease classification. The standard also requires lessors to increase the transparency of their exposure to changes in value of their residual assets and how they manage that exposure. The Company is required to adopt ASU 2016-02 for periods beginning after December 15, 2018, including interim periods, with early adoption permitted. Management is currently evaluating the method of adoption of this ASU on the Company’s consolidated financial statements, but expects that it will not have a material impact on the consolidated financial statements since the Company’s lease commitments are not material and are not for extended periods of time.
Reclassification
Certain reclassifications have been made to the consolidated balance sheets as of December 31, 2015 as a result of adoption of the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. These reclassifications had no effect on previously reported net loss or stockholders’ deficit.
Note 3: Liquidity and Capital Resources
As shown in the consolidated financial statements, the Company has experienced significant historical net losses as well as negative cash flows from operations since its inception, resulting in an accumulated deficit of $847.6 million and stockholders’ deficit of $570.0 million as of December 31, 2016. As of December 31, 2016, the Company had cash and cash equivalents of $1.9 million and an additional $3.0 million in restricted cash subject to a cash collateral dominion agreement pursuant to the Medley Term Loan. The Company’s cash expenditures primarily relate to procurement of inventory and payment of salaries, employee benefits and other operating costs.
The Company’s primary sources of liquidity have historically been borrowings from various lenders and sales of the Company’s common stock, par value $0.001 per share (the “Common Stock”) and Convertible Preferred Stock (as defined below) to, and short-term loans from, affiliates of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), including Pegasus Partners IV, L.P. (“Pegasus Fund IV”), LSGC Holdings, LLC (“LSGC Holdings”), LSGC Holdings II, LLC (“Holdings II”), LSGC Holdings III, LLC (“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 the Company’s controlling stockholder and has led a majority of the Company’s capital raises.
Cash Flows and Operating Results
The Company continues to face challenges in its efforts to achieve profitability and positive cash flows from operations. The Company’s ability to continue to meet its obligations in the ordinary course of business is dependent upon establishing profitable operations, which may be supplemented by any additional funds that the Company may raise through public or private financing or increased borrowing capacity.
The Company’s cash flows in 2016 were adversely affected by the loss of certain business from its largest customer, The Home Depot, following a 2015 product line review. Although the Company was selected to supply certain new products to The Home Depot under the new supplier buying agreement with The Home Depot that went into full effect in the second quarter of 2016, such new business only partially offset the negative effects of the lost business. As was the case under the Company’s prior agreement with The Home Depot, The Home Depot is not required to purchase any minimum amount of products under the new supplier agreement.
As a result of the Company’s historical losses, the Company believes it will likely need to raise additional capital to fund its operations. Sources of additional capital may not be available in an amount or on terms that are acceptable to the Company, if at all. The Company’s complex capital structure, including its obligations to the holders of the outstanding shares of its Preferred Stock may make it more difficult to raise additional capital from new or existing investors or lenders. If the Company is not able to raise such additional capital, the Company may need to restructure or refinance its existing obligations, which restructuring or refinancing would require the consent and cooperation of the Company’s creditors and certain stockholders. In such event, the Company may not be able to complete a restructuring or refinancing on terms that are acceptable to the Company, if at all. If the Company is unable to obtain sufficient capital when needed, the Company’s business, compliance with its credit facilities and future prospects may be adversely affected.
Outstanding Indebtedness
The Medley Term Loan is subject to the terms of the Term Loan Agreement, dated February 19, 2014 (as amended from time to time the “Medley Loan Agreement”). Pursuant to the Medley Loan Agreement, the Company is required to achieve a minimum quarterly fixed charge coverage ratio for the preceding 12-month period and to maintain certain minimum EBITDA levels. In connection with the Medley Term Loan, the Company issued a warrant to purchase 5,000,000 shares of Common Stock to each of Medley and Medley Opportunity Fund II LP (the “Medley Warrants”).
The Company also has a three-year revolving credit facility with a maximum line amount of $22.5 million from Ares, which is governed by the terms of the Loan and Security Agreement, dated April 25, 2014 (as amended from time to time, the “Ares ABL Agreement”). As of December 31, 2016, the Company had $6.1 million in borrowings outstanding under the Ares ABL Agreement and additional borrowing capacity of $1.9 million. The maximum borrowing capacity under the Ares ABL Agreement is based on a formula of eligible accounts receivable and inventory. The Ares ABL Agreement also requires the Company to maintain certain minimum EBITDA levels.
The Ares ABL matures on April 25, 2017. At or prior to the time the Ares ABL matures, the Company will be required to repay or refinance the facility. Further, as a condition to Medley’s consent to closing of the pending Joint Venture (as defined in Note 22) transaction, the Company will be required to repay $5.0 million of the outstanding indebtedness under the Medley Term Loan on or before May 1, 2017.
Preferred Stock
On February 23, 2016, July 19, 2016 and November 21, 2016, the Company issued 3,000, 5,000 and 5,000 units of its securities (“Series J Securities”), respectively, to Holdings III. In each case, the Series J Securities were issued at a purchase price of $1,000 per Series J Security, and the Company received aggregate gross proceeds of approximately $13.0 million in connection with these issuances. Each Series J Security consists of (i) one share of Series J Convertible Preferred Stock (“Series J Preferred Stock”) and (ii) a warrant to purchase 2,650 shares of Common Stock, at an exercise price of $0.001 per share (the “Series J Warrants”).
Certain holders of the Company’s 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”) have the right to cause the Company to redeem such shares at any time on or after March 27, 2017. If any such stockholder elects to cause the Company to redeem its shares of Convertible 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. The Company is also required to redeem the outstanding shares of its 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 the Company to redeem such shares upon the uncured material breach of the Company’s obligations under its 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 the Company to redeem the outstanding shares of Series K Preferred Stock in the event of a liquidation, dissolution or winding up of the Company or an earlier change of control or “junior security redemption,” which includes events triggering a redemption of the outstanding shares of Convertible Preferred Stock. As of December 31, 2016, in the event the Company was required to redeem all of its outstanding shares of Convertible Preferred Stock and Series K Preferred Stock (collectively, the “Preferred Stock”), the Company’s maximum payment obligation would have been $544.0 million. The Company would be required to repay its outstanding obligations under the Medley Term Loan and the Ares ABL prior to the redemption of any shares of Preferred Stock. As of December 31, 2016, the Company had $36.7 million of aggregate borrowings outstanding under these credit facilities that the Company would be required to repay.
Any redemption of the Preferred Stock would be limited to funds legally available therefor under Delaware law. The certificates of designation governing the Preferred Stock provide that if there is not a sufficient amount of cash or surplus available to pay for a redemption of Preferred Stock, then the redemption must be paid out of the remaining assets of the Company. In addition, the certificates of designation governing the Preferred Stock provide that the Company is 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 the Company’s credit facilities.
As of December 31, 2016, based solely on a review of the Company’s balance sheet, the Company did not have legally available funds under Delaware law to satisfy the redemption of all of its outstanding shares of Preferred Stock. The certificate of designation governing the Series J Preferred Stock provides that if the Company does not have sufficient capital available to redeem the Series J Preferred Stock in connection with a Special Redemption of the Series J Preferred Stock, the Company 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 the Company in connection with such Special Redemption, subject to certain limitations imposed by Delaware law governing distributions to stockholders.
Geveran Litigation
As discussed further in Note 18, one of the Company’s stockholders, Geveran Investments Limited (“Geveran”), filed a lawsuit against the Company and certain other defendants seeking, among other things, rescissionary damages in connection with its $25.0 million investment in the Company. On November 30, 2015, the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida, the court presiding over the lawsuit, entered an Order Granting Plaintiff’s Motion for Partial Summary Judgment Under its First Cause of Action for Violation of the Florida Securities and Investment Protection Act (the “Summary Judgment Order”). Accordingly, the Company, with the assistance of Pegasus Fund IV, posted an appeal bond in the amount of $20.1 million (the “Appeal Bond”) in support of the Company’s appeal of the Summary Judgment Order. As contemplated by the Preferred Stock Subscription and Support Agreement dated September 11, 2015 (the “Subscription and Support Agreement”) among the Company, Holdings III and Pegasus Fund IV, Pegasus Fund IV agreed to assist the Company in securing the Appeal Bond on the terms set forth in a General Indemnity Agreement and related side letter to be entered into by and among the Company, Pegasus Fund IV and the issuer of the Appeal Bond (the “Appeal Bond Agreements”). The Company executed the Appeal Bond Agreements with Pegasus Fund IV and the issuer of the Appeal Bond on December 4, 2015, and on December 7, 2015, in consideration of Pegasus Fund IV’s entry into 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, the Company issued 20,106.03 units of its securities (the “Series K Securities”) to Pegasus Fund IV pursuant to the Subscription and Support Agreement, 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 (a “Series K Warrant”). The number of Series K Securities issued to Pegasus Fund IV was determined based on the quotient obtained by dividing (x) the aggregate amount of the bonds, undertakings, guarantees and/or contractual obligations underlying Pegasus Fund IV’s initial commitment with respect to the Appeal Bond by (y) $1,000. Although the Company cannot predict the ultimate outcome of this lawsuit, it believes the court’s Summary Judgment Order in favor of Geveran is in error and that it has strong defenses against Geveran’s claims. However, in the event that the Company is not successful on appeal, it could be liable for the full amount of Geveran’s $25.0 million investment, as well as interest, attorneys’ fees and court costs. Accordingly, the Summary Judgment Order and the Appeal Bond could have a material adverse effect on the Company’s liquidity and its ability to raise capital in the future.
Joint Venture
See Note 22 for information about the Company’s obligations to contribute capital to Global Value Lighting, LLC (“GVL”) upon closing and in the first 12 months following the pending Joint Venture (as defined in Note 22) transaction.
Management’s Assessment Regarding the Company’s Ability to Continue as a Going Concern
In connection with the preparation of the financial statements for the year ended December 31, 2016, the Company concluded that due to the Company’s historical cash flows and operating results, its existing and future obligations with respect to its outstanding indebtedness, the redemption rights of certain preferred stockholders and the Company’s obligations to make capital contributions to GVL upon closing of the pending Joint Venture transaction (collectively, the “Liquidity Challenges”), substantial doubt exists regarding the Company’s ability to continue as a going concern. However, management believes that (i) certain events that have occurred since December 31, 2016, as discussed in further detail in Note 22, and (ii) certain actions expected to be implemented in 2017 will alleviate such substantial doubt. Specifically, management has concluded that it is probable that the following events will alleviate the substantial doubt raised by the Liquidity Challenges and, as a result, that the Company will be able to satisfy its estimated liquidity needs for 12 months from the issuance of the financial statements included in this report: (a) the January Series J Issuance (as defined in Note 22), which provided $3.0 million in gross proceeds to the Company; (b) the February Series J Issuance (as defined in Note 22), which provided $7.0 million in gross proceeds to the Company; (c) the repayment of a portion of the outstanding borrowings under the Ares ABL bringing the outstanding balance under the Ares ABL to $2.2 million as of March 31, 2017; (d) the expected cost savings resulting from headcount reductions in February 2017; (e) the Company’s expectations regarding the benefits of the Joint Venture, including but not limited to anticipated improvements in gross margins and cash flows within the next 12 months; (f) as discussed in further detail in Note 22, following a series of transactions among certain preferred stockholders, Pegasus solely possesses the optional redemption rights described above under the heading “Preferred Stock” and has indicated that, subject to certain conditions, it will not exercise such rights through November 14, 2019; and (g) Pegasus has committed to provide financial support to fund the Company’s operations and debt service requirements of up to $13.2 million for at least twelve months from April 12, 2017.
Nonetheless, the Company cannot predict, with certainty, the long-term impact of the actions that it has taken to date in order to generate liquidity, or the potential outcome of the actions that the Company intends to take in the near future, including whether such actions will generate the expected liquidity as currently planned. If the Company continues to experience operating losses and is not able to generate additional liquidity through the actions described above or through some combination of other actions, the Company will need to secure additional sources of funds, which may or may not be available on favorable terms, if at all.
Note 4: Fair Value Measurements
The following table sets forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2016, according to the valuation techniques the Company used to determine their fair values:
(1)
On September 25, 2012, the Company entered into a commitment agreement with Pegasus Fund IV (the “Pegasus 2012 Commitment”), pursuant to which the Company is obligated to buy from Pegasus Fund IV or its affiliates shares of Common Stock equal to the number of shares, if any, for which the September 2012 Warrants (as defined below) are exercised, up to an aggregate number of shares of Common Stock equal to the aggregate number of shares of Common Stock underlying all of the September 2012 Warrants. See Note 11 for additional information about the Pegasus 2012 Commitment.
(2)
On May 25, 2012, the Company issued a warrant to purchase 18,092,511 shares of Common Stock to Riverwood LSG Management Holdings LLC (“Riverwood Management”) as consideration for services provided in connection with an offering of Convertible Preferred Stock (the “Riverwood Warrant”). Riverwood Management subsequently partially assigned such warrant to several of its affiliates. The warrants, as amended or assigned from time to time, are referred to herein as the “Riverwood Warrants.” In February 2017, Pegasus purchased the Riverwood Warrants from Riverwood Management and its affiliates.
(3)
In September 2012, in connection with an offering of Convertible Preferred Stock, the Company issued warrants to purchase an aggregate of 8,000,000 shares of Common Stock (the “September 2012 Warrants”) to Portman, Cleantech Europe II (A) L.P. (“Cleantech A” and Cleantech Europe II (B) L.P. (Cleantech B” and together with Cleantech A, “Zouk”). In February 2017, the September 2012 Warrants were cancelled in connection with privately negotiated transactions in which, among other things, Pegasus purchased shares of Series H Preferred Stock from each of Portman, Cleantech A and Cleantech B.
(4)
On September 11, 2013, the Company issued a warrant to purchase 10,000,000 shares of Common Stock to Pegasus (the “Pegasus Warrant”) in consideration for advisory services provided by Pegasus. See Note 11 for additional information about the Pegasus Warrant.
(5)
On February 19, 2014, each of the Pegasus Guarantors (as defined in Note 9) provided a guaranty of the Company’s obligations under the Medley Loan Agreement. As consideration for such guaranties, the Company issued a warrant to purchase 5,000,000 shares of Common Stock to each of the Pegasus Guarantors (the “Pegasus Guaranty Warrants”). See Note 9 for additional information about the Pegasus Guaranty Warrants.
The following table is a reconciliation of the beginning and ending balances for assets and liabilities that were accounted for at fair value on a recurring basis using Level 3 inputs as defined above for the year ended December 31, 2016:
The following table is a reconciliation of the beginning and ending balances for assets and liabilities that were accounted for at fair value on a recurring basis using Level 3 inputs as defined above for the year ended December 31, 2015:
Note 5: Inventories
Inventories consisted primarily of finished goods as of December 31, 2016 and December 31, 2015.
The Company recorded an inventory write-down of $3.9 million, $3.6 million and $4.7 million for the years ended December 31, 2016, 2015 and 2014, respectively, with the expense included in cost of goods sold. As of December 31, 2016 and December 31, 2015, inventories are stated net of inventory reserves of $5.4 million and $6.9 million, respectively. The Company considered a number of factors in estimating the required inventory reserves, including (i) the focus of the business on the next generation of the Company’s products, which utilize lower cost technologies, (ii) the strategic focus on core products to meet the demands of key customers and (iii) the expected demand for the Company’s current generation of products, which are approaching the end of their lifecycle upon the introduction of the next generation of products.
During the years ended December 31, 2016, 2015 and 2014, the Company recorded $0, $116,000 and $507,000, respectively, in provisions for losses on non-cancellable purchase commitments of which $0 was accrued as of December 31, 2016 and 2015, respectively, which were included in cost of goods sold in the consolidated statements of operations.
Note 6: Property and Equipment
Property and equipment consists of the following:
Depreciation related to property and equipment was $677,000, $1.9 million and $3.3 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company recorded an impairment charge of $637,000 for the year ended December 31, 2014, which is included in restructuring expense, in connection with the transition of the Company’s manufacturing operations to contract manufacturers in Asia.
Note 7: Intangible Assets
Intangible assets that have finite lives are amortized over their useful lives. The intangible assets, their original fair values, adjusted for impairment charges, and their net book values are detailed below as of the dates presented:
Total intangible amortization expense was $105,000, $84,000 and $64,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
The table below is the estimated amortization expense, adjusted for any impairment charges, for the Company’s intangible assets for each of the next five years and thereafter:
During the years ended December 31, 2016, 2015 and 2014, there were no impairment charges for intangible assets.
Note 8. Debt Issuance Costs
The Company capitalizes its costs related to the issuance of long-term debt and loan amendment fees and amortizes these costs using the effective interest rate method over the life of the loan. Amortization of debt issuance costs and the accelerated write-off of debt issuance costs in connection with refinancing activities are recorded as a component of interest expense. The Company had net debt issuance costs of $2.1 million and $3.3 million as of December 31, 2016 and 2015, respectively. In connection with the Ares ABL and the Medley Term Loan, an aggregate of $6.2 million of debt issuance costs were capitalized, including $2.8 million related to the fair value of the Pegasus Guaranty (as defined in Note 9 below). The Company amortized $1.7 million, $1.5 million and $1.6 million of debt issuance costs for the years ended December 31, 2016, 2015 and 2014, respectively.
Note 9: Lines of Credit and Note Payable
Ares ABL
The Ares ABL provides the Company with a maximum borrowing capacity of $22.5 million, calculated based on a formula of eligible accounts receivable and inventory. As of December 31, 2016, the Company had additional borrowing capacity of $1.9 million.
At December 31, 2016 and 2015, borrowings outstanding under the Ares ABL were as follows:
During the year ended December 31, 2016, the Ares ABL was amended to, among other things, (a) replace the covenant relating to a minimum fixed charge ratio with minimum EBITDA covenant levels that the Company must meet with respect to each of the twelve-month periods ending June 30, 2016, September 30, 2016, December 31, 2016 and March 31, 2017 (collectively, the “Specified Covenant Periods”) and (b) allow the Company to include the cash proceeds from certain equity issuances in the calculation of EBITDA for purposes of determining compliance with the EBITDA covenant levels for the relevant Specified Covenant Periods. Further, in connection with these amendments, the Company (x) paid Ares a $60,000 amendment fee and (y) agreed to provide Ares with an updated an appraisal of the Company’s intellectual property and a financial forecast covering the 2016 and 2017 fiscal years.
As of December 31, 2016, loan collateral value included $587,000 of accounts receivable and $7.1 million of inventory. Borrowings under the Ares ABL bear interest at a floating rate equal to one-month LIBOR plus 5.5% per annum. As of December 31, 2016, the interest rate on the Ares ABL was 6.12%. The Ares ABL matures on April 25, 2017.
Medley Term Loan
The Medley Term Loan is a $30.5 million term loan facility that bears interest at a floating rate equal to three-month LIBOR plus 12% per annum, as follows: (i) up to 2% (at the Company’s election) of interest may be paid as “payment in kind” by adding such accrued interest to the unpaid principal balance of the Medley Term Loan and (ii) the remaining accrued interest amount is payable in cash monthly in arrears. As of December 31, 2016, the interest rate on the Medley Term Loan was 13.0%. Additionally, $3.0 million of the Medley Term Loan was funded directly into a deposit account to which Medley has exclusive access, to further secure the loan. This $3.0 million is recorded as restricted cash in the accompanying consolidated balance sheets. The outstanding principal balance and all accrued and unpaid interest on the Medley Term Loan are due and payable on February 19, 2019.
At December 31, 2016 and 2015, borrowings outstanding under the Medley Term Loan were as follows:
Activity in the Medley Term Loan for the years ended December 31, 2016 and 2015 is set forth below:
For the years ended December 31, 2016, 2015 and 2014, the Company recognized $779,000, $779,000 and $669,000, respectively, of interest expense for the accretion of the discounts to the balance of the Medley Term Loan related to the commitment fees and the Medley Warrants. In addition, the Company also recognized $648,000, $641,000 and $540,000, respectively, of paid in kind interest accretion for the years ended December 31, 2016, 2015 and 2014.
During the year ended December 31, 2016, the Medley Loan Agreement was amended to, among other things, (a) amend the minimum EBITDA covenant levels with respect to each of the Specified Covenant Periods and each fiscal quarter thereafter during the term of the Medley Loan Agreement, (b) allow the Company to include the cash proceeds from certain equity issuances for purposes of determining compliance with the EBITDA and Fixed Charge Coverage Ratio (as defined in the Medley Loan Agreement) for the relevant Specified Covenant Periods and (c) amend the minimum Fixed Charge Coverage Ratio that the Company was required to maintain for each of the twelve-month periods ending September 30, 2016 and December 31, 2016. Further, in connection with these amendments, the Company agreed to (x) provide Medley with an updated an appraisal of the Company’s intellectual property and a financial forecast covering the 2016 and 2017 fiscal years and (y) reimburse Medley for up to $40,000 of documented out-of-pocket costs, fees and expenses incurred in connection with its financial advisor’s review of the financial forecasts delivered by the Company.
Medley Warrants
On February 19, 2014, in connection with the Medley Loan Agreement, the Company issued the Medley Warrants to Medley and Medley Opportunity Fund II LP, each of which represents the right to purchase 5,000,000 shares of Common Stock. The Medley Warrants have an exercise price equal to $0.95 and, if unexercised, expire on February 19, 2024. The Medley Warrants became exercisable on April 14, 2014.
The Medley Warrants are considered derivative financial instruments in accordance with ASC 815-10-15, “Derivatives and Hedging” due to the down round protection provided to the holders by the instruments. The Medley Warrants were recorded as a liability at fair value using the Black Scholes valuation method at issuance and were valued at $3.2 million as of February 19, 2014, which was recorded as a discount to the Medley Term Loan. The discount is being accreted using the effective interest rate method over the life of the loan as a non-cash charge to interest expense. Changes in the fair value of the Medley Warrants are measured and recorded at the end of each quarter. The decrease in fair value of the Medley Warrants was $348,000, $11,000 and $2.6 million for the years ended December 31, 2016, 2015 and 2014, respectively, and was included in the decrease (increase) in fair value of liabilities under derivative contracts in the consolidated statements of operations and comprehensive loss.
On February 19, 2014, the Company also entered into a registration rights agreement with Medley and Medley Opportunity Fund II LP, pursuant to which the Company granted piggyback registration rights with respect to the shares of Common Stock underlying the Medley Warrants and any other shares of Common Stock that may be acquired by such parties in the future.
Pegasus Guaranty and Pegasus Guaranty Warrants
Pegasus Capital Partners IV, L.P. and Pegasus Capital Partners V, L.P. (collectively, the “Pegasus Guarantors”) agreed to provide a guaranty of the Company’s obligations under the Medley Loan Agreement in favor of Medley (the “Pegasus Guaranty”). The Pegasus Guaranty was recorded as debt issuance costs at fair value on the date of issuance. The fair value was determined to be $2.8 million as of February 19, 2014, using an implied interest rate analysis. The debt issuance costs will be amortized as non-cash interest expense over the life of the Medley Term Loan. As consideration for the Pegasus Guaranty, on February 19, 2014, the Company issued a warrant to purchase 5,000,000 shares of Common Stock to each of the Pegasus Guarantors (the “Pegasus Guaranty Warrants”). The Pegasus Guaranty Warrants have an exercise price equal to $0.50 and, if unexercised, expire on February 19, 2024.
The Pegasus Guaranty Warrants are considered derivative financial instruments in accordance with ASC 815-10-15, “Derivatives and Hedging,” due to the down round protection provided by the instrument. The Pegasus Guaranty Warrants were recorded as a liability at fair value using the Black Scholes valuation method at issuance and were valued at $3.3 million at February 19, 2014. The fair value of the Pegasus Guaranty was $2.8 million at February 19, 2014 and partially offset the fair value of the Pegasus Guaranty Warrants, with the remaining value of $571,000 accounted for as a deemed dividend to the Company’s controlling stockholder. Changes in the fair value of the Pegasus Guaranty Warrants are measured and recorded at the end of each quarter. The decrease in fair value of the Pegasus Guaranty Warrants was $365,000, $29,000 and $2.7 million for the years ended December 31, 2016, 2015 and 2014, respectively, and was included in the (increase) decrease in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss.
Note 10: Redeemable Preferred Stock
As of December 31, 2016, the Company had 282,047 shares of Preferred Stock outstanding, consisting of 111,513.52 shares of Series H Preferred Stock, 57,365 shares of Series I Preferred Stock, 93,062 shares of Series J Preferred Stock and 20,106 shares of Series K Preferred Stock. Each share of Convertible Preferred Stock, consisting of the Series H Preferred Stock, Series I Preferred Stock and Series J Preferred Stock, is convertible at any time, at the election of the holder, into approximately 1,052.63 shares of Common Stock, subject to certain adjustments. The outstanding shares of Convertible Preferred Stock are entitled to dividends of the same type as any dividends or other distribution of any kind payable or to be made on outstanding shares of Common Stock, on an as converted basis. The Series J Preferred Stock is senior to the Series H Preferred Stock, the Series I Preferred Stock and the Common Stock. The Series K Preferred Stock is senior to the Convertible Preferred Stock and the Common Stock.
As described in Note 3, certain holders have the right to cause the Company to redeem their shares of Convertible Preferred Stock at any time on or after March 27, 2017. If any such holder elects to cause the Company to redeem its shares of Convertible 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.
The Company is required to redeem all outstanding shares of the Series J Preferred Stock for an amount in cash equal to the Liquidation Amount (as defined below) (a) subject to certain limited exceptions, immediately prior to the redemption of a Junior Security; (b) on November 14, 2019, as the Special Redemption; and (c) upon the occurrence of an uncured material breach by the Company of any of the certificates of designation governing the Convertible Preferred Stock. The “Liquidation Amount” of each share of Series J Preferred Stock is equal to the greater of (a) the fair market value of the Optional Conversion Shares and (b) an amount equal to the product obtained by multiplying (A) the Stated Value by (B) 2.0.
If the Company does not have sufficient capital available to redeem the Series J Preferred Stock upon the exercise of a Special Redemption, the Company 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 the Company in connection with such Special Redemption, subject to certain limitations imposed by Delaware law governing distributions to stockholders.
The redemption of any shares of Series J Preferred Stock would be senior and prior to any redemption of any Junior Security. Any holder of shares of Series J Preferred Stock may elect to have less than all or none of such holder’s shares of Series J Preferred Stock redeemed. At any time after the Company has redeemed any shares of any Junior Security each holder of shares of Series J Preferred Stock may elect to have all or a portion of such holder’s shares of Series J Preferred Stock redeemed by the Company for an amount in cash equal to the Liquidation Amount of such shares of Series J Preferred Stock.
The Company issued an aggregate of 38,475 Series J Securities in 2014, 21,587 Series J Securities in 2015 and 13,000 Series J Securities in 2016, in each case at a purchase price of $1,000 per Series J Security. The aggregate gross proceeds from issuances of Series J Securities in 2014, 2015 and 2016 were $38.5 million, $21.6 million and $13.0 million, respectively. As of December 31, 2016, the Company had issued Series J Warrants to purchase an aggregate of 246,614,300 shares of Common Stock.
In accordance with ASC 480, “Distinguishing Liabilities from Equity” (“AS 480”), the shares of Convertible Preferred Stock are recorded as mezzanine equity because the holders of such shares are allowed to redeem the shares for cash, and redemption is not solely within the control of the Company. In accordance with ASC 480-10-S99, the Company will recognize changes in the redemption value immediately as they occur and adjust the carrying amount of the shares of Convertible Preferred Stock to equal the redemption value at the end of each reporting period. Shares of Convertible Preferred Stock were recorded at redemption value on each date of issuance, which included a deemed dividend due to the redemption feature. There was no change in the redemption value of the Series H Preferred Stock and Series I Preferred Stock during the years ended December 31, 2016, 2015 and 2014. As of December 31, 2016, Series J Preferred Stock redemption value included an aggregate deemed dividend of $133.2 million, which is reflected as an offset in additional paid-in capital.
In December 2015, the Company issued 20,106.03 Series K Securities to Pegasus Fund IV pursuant to the Subscription and Support Agreement. The number of Series K Securities issued to Pegasus Fund IV was determined based on the quotient obtained by dividing (x) the aggregate amount of the bonds, undertakings, guarantees and/or contractual obligations underlying Pegasus Fund IV’s initial commitment with respect to the Appeal Bond by (y) $1,000. The Series K Preferred Stock is senior to the Common Stock and the Convertible Preferred Stock. Depending on whether the Appeal Bond has been drawn or fully released, the Series K Certificate of Designation requires the Company 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.
In accordance with ASC 480, the shares of Series K Preferred Stock are recorded as mezzanine equity because the holders of such shares are allowed to redeem the shares for cash. The Series K Preferred Stock was initially recorded at fair value (of $1.1 million) with a deemed dividend recorded in additional paid in capital. The deemed dividend was attributed to the shares held by the controlling stockholders. Subsequently, the Series K Preferred Stock was recorded at redemption value which included a deemed dividend as a result of its redemption feature. As a result, the Company recorded a $19.0 million deemed dividend due to the accretion of the Series K Preferred Stock to its redemption value.
Note 11: Stockholders’ Equity
Common Stock Issuances
On August 19, 2016, the Company issued 4,210,528 shares of Common Stock upon conversion of 4,000 shares of Series I Preferred Stock. On October 20, 2016, the Company issued 1,052,632 shares of Common Stock upon conversion of 1,000 shares of Series I Preferred Stock. On October 31, 2016, the Company issued 2,205,264 shares of Common Stock upon conversion of 2,095 shares of Series H Preferred Stock.
On March 24, 2015, the Company issued 2,033,905 shares of restricted stock in settlement of director fees for the year ended December 31, 2015. The shares of restricted stock were scheduled to vest on January 1, 2016, provided that the applicable director was still in office at such time. On November 19, 2015, the Company cancelled 1,459,521 of such shares of restricted stock and, as consideration for the cancelled shares, issued stock options representing the right to purchase an aggregate of 3,132,020 shares of Common Stock to certain directors. The options vested in full on January 1, 2016.
On March 25, 2014, the Company issued 1,484,931 shares of restricted stock in settlement of director fees for the year ended December 31, 2014. In connection with new director appointments and changes in committee composition, the Company issued 150,137, 110,685 and 78,360 shares of restricted stock on April 1, 2014, June 12, 2014 and August 28, 2014, respectively, in settlement of the pro rata portion of director fees for the relevant director’s period of service during 2014. The shares of restricted stock vested on January 1, 2015, provided that the director was still in office at such time.
On June 12, 2014, the Board approved the formation of a Scientific Advisory Board (the “SAB”) and issued restricted stock awards or stock options to the five members of the SAB as part of their compensation package. For the years ended December 31, 2015 and 2014, the Company recorded expense of $37,000 and $64,000, respectively, related to restricted stock awards to the Company’s SAB. The Company did not issue restricted stock awards to the SAB during the year ended December 31, 2016.
For the years ended December 31, 2016, 2015 and 2014, the Company recorded expenses of $0, $79,000 and $670,000, respectively, related to the restricted stock awards and $118,000, $280,000 and $0, respectively, related to the stock options issued to the directors.
Warrants for the Purchase of Common Stock
THD Warrant
The Company issued a warrant to purchase Common Stock to The Home Depot in 2011(the “THD Warrant”). As of December 31, 2016, the THD Warrant represented the right to purchase 4,892,590 shares of Common Stock at an exercise price of $0.82 per share. The fair value of the THD Warrant is determined using the option pricing model valuation method and will be adjusted at each reporting date until they have been earned for each year and these adjustments will be recorded as a reduction in the related revenue (sales incentive) from The Home Depot. For the years ended December 31, 2016, 2015 and 2014, the Company recorded $0, $64,000 and $103,000 as a reduction in revenue, respectively. The change in fair value of the previously vested portion of the THD Warrant was an increase of $61,000 and $83,000 for the years ended December 31, 2016 and 2015, respectively, and was included in the decrease (increase) in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss.
Series D Warrants
The Company issued warrants to purchase Common Stock certain preferred stockholders in 2010 (the “Series D Warrants”). As of December 31, 2016, the Series D Warrants had exercise prices ranging from $2.29 to $2.30 and were exercisable into an aggregate of 1,379,353 shares of Common Stock
Riverwood Warrants
The Company originally issued the Riverwood Warrant to Riverwood Management on May 25, 2012 in consideration for services provided in connection with the initial offering of Series H Preferred Stock and Series I Preferred Stock. The Riverwood Warrant, which Riverwood subsequently assigned, in part, to several of its affiliates, represents the right to purchase 18,092,511 shares of Common Stock at an exercise price to be determined on the date of exercise. The exercise price will be equal to the difference obtained by subtracting (a) the fair market value for each share of Common Stock on the day immediately preceding the date of exercise from (b) the quotient obtained by dividing (i) 5% of the amount by which the total equity value of the Company exceeds $500 million by (ii) the number of shares of Common Stock underlying the Riverwood Warrants. The Riverwood Warrants provide for certain anti-dilution adjustments and if unexercised, expire on May 25, 2022. The Riverwood Warrants are considered derivative financial instruments in accordance with ASC 815-10-15, “Derivatives and Hedging” due to the variable nature of the warrant exercise price. The Riverwood Warrants were recorded as a liability at fair value using the option pricing model valuation method at issuance with changes in fair value measured and recorded at the end of each quarter. The change in fair value of the Riverwood Warrants was $1.4 million, $604,000 and $2.7 million for the years ended December 31, 2016, 2015 and 2014, respectively, and was included in the decrease (increase) in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss. In February 2017, Pegasus purchased the Riverwood Warrants from Riverwood Management and its affiliates.
September 2012 Warrants
The September 2012 Warrants are exercisable on or after the tenth business day following the third anniversary of their issuance date at an exercise price of $0.72 per share of Common Stock. If unexercised, the September 2012 Warrants expire upon the earlier of (i) a change of control of the Company (as defined in the certificate of designation governing the Series H Preferred Stock) prior to the three-year anniversary of the date the September 2012 Warrants were issued; (ii) the occurrence of any event that results in holders of shares of Series H Preferred Stock having a right to require the Company to redeem the shares of Series H Preferred Stock prior to the three-year anniversary of the date the September 2012 Warrants were issued; (iii) consummation of a QPO (as defined in the certificate of designation governing the Series H Preferred Stock) prior to the three-year anniversary the date the September 2012 Warrants were issued or (iv) receipt by the Company of a redemption notice (as defined in the relevant subscription agreements). The September 2012 Warrants also provide for certain anti-dilution adjustments. The September 2012 Warrants are considered derivative financial instruments in accordance with ASC 815-10-15, “Derivatives and Hedging” due to the cash settlement feature in the instrument. The September 2012 Warrants were recorded as liabilities at fair value using the option pricing model valuation method at issuance with changes in fair value measured and recorded at the end of each quarter. The change in fair value of the September 2012 Warrants was $174,000, $506,000 and $687,000 for the years ended December 31, 2016, 2015 and 2014, respectively, and was included in the decrease (increase) in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss. In February 2017, the September 2012 Warrants were cancelled in connection with privately negotiated transactions in which, among other things, Pegasus purchased shares of Series H Preferred Stock from each of Portman, Cleantech A and Cleantech B.
September 2012 Commitment Agreement
In connection with the issuance of the September 2012 Warrants, on September 25, 2012, the Company entered into a Commitment Agreement (the “September 2012 Commitment Agreement”) with Pegasus Fund IV, pursuant to which the Company is obligated to buy from Pegasus Fund IV or its affiliates shares of Common Stock equal to the number of shares, if any, for which the September 2012 Warrants are exercised, up to an aggregate number of shares of Common Stock equal to the aggregate number of shares of Common Stock underlying all of the September 2012 Warrants. The purchase price for any Pegasus 2012 Commitment will be equal to the consideration paid to the Company pursuant to the September 2012 Warrants. With respect to any September 2012 Warrants exercised on a cashless basis, the consideration to Pegasus Fund IV in exchange for the number of shares of Common Stock issued to the exercising holder of September 2012 Warrants would be the reduction in the Pegasus 2012 Commitment equal to the reduction in the number of shares underlying the September 2012 Warrants. Subject to certain limitations, Pegasus Fund IV has the right to cancel its obligations to the Company pursuant to the September 2012 Commitment Agreement with respect to all or a portion of the Pegasus 2012 Commitment then outstanding (a “Pegasus Call”). Upon the exercise of a Pegasus Call, the Company will have the obligation to purchase that number of September 2012 Warrants equal to the Pegasus 2012 Commitment subject to the Pegasus Call for an amount equal to the consideration paid by Pegasus Fund IV pursuant to such Pegasus Call. The Pegasus 2012 Commitment is classified as a financial instrument under ASC 480, “Distinguishing Liabilities from Equity” due to the Company’s obligation to purchase its own shares in the event the September 2012 Warrants are exercised by the holders. The Pegasus 2012 Commitment was recorded as an asset at fair value using the option pricing model valuation method at issuance with changes in fair value measured and recorded at the end of each quarter. The change in fair value of the Pegasus 2012 Commitment for the years ended December 31, 2016, 2015 and 2014 was $174,000, $506,000 and $687,000, respectively, and was included in the decrease (increase) in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss. The change in fair value of the Pegasus 2012 Commitment generally offsets the change in fair value of the September 2012 Warrants for the same period.
Pegasus Warrant
The Pegasus Warrant was issued to Holdings II on September 11, 2013 in consideration for advisory services provided by Pegasus. The Pegasus Warrant represents the right to purchase 10,000,000 shares of Common Stock at a variable exercise price that will be determined on the date of exercise. The exercise price will be equal to the difference obtained by subtracting (a) the fair market value for each share of Common Stock on the day immediately preceding the date of exercise from (b) the quotient obtained by dividing (i) approximately 2.764% of the amount by which the total equity value of the Company exceeds $580.0 million (as may be adjusted for subsequent capital raises) by (ii) the number of shares of Common Stock underlying the Pegasus Warrant; provided that for so long as the total equity value of the Company is less than or equal to $580.0 million (as may be adjusted for subsequent capital raises) the Pegasus Warrant will not be exercisable. The Pegasus Warrant provides for certain anti-dilution adjustments and if unexercised, expires on May 25, 2022. The Pegasus Warrant is considered a derivative financial instrument in accordance with ASC 815-10-15, “Derivatives and Hedging” due to the variable nature of the warrant exercise price. The Pegasus Warrant was recorded as a liability at fair value using the option pricing model valuation method at issuance with changes in fair value measured and recorded at the end of each quarter. There was a change of $775,000, $334,000 and $1.5 million in fair value of the Pegasus Warrant for the years ended December 31, 2016, 2015 and 2014, respectively, and was included in the decrease (increase) in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss.
Series J Warrants
Each Series J Warrant represents the right to purchase 2,650 shares of Common Stock at an exercise price $0.001 and, if unexercised, expires on the fifth anniversary of their issuance date. The Series J Warrants issued in January 2014 were considered derivative financial instruments in accordance with ASC 815, “Derivatives and Hedging” due to the Company not having adequate shares available for issuance on the date that such warrants were issued. Such Series J Warrants were recorded as a liability of $12.5 million based on an allocated portion of the cash proceeds of the relevant offering at issuance. Changes in fair value were measured and recorded at the end of each quarter using the Black Scholes valuation method. The change in fair value of such Series J Warrants was an increase of $25.1 million for the period from the date of issuance to April 14, 2014, which was included in the (increase) decrease in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss. Such Series J Warrants were not exercisable until the Company effected an amendment to its charter on April 14, 2014, at which point such Series J Warrants were reclassified as equity instruments. All Series J Warrants issued after April 14, 2014 were deemed to be equity instruments.
Series K Warrant
Each Series K Warrant represents the right to purchase 735 shares of Common Stock at an exercise price of $0.12 per share. The Series K Warrants were deemed to be equity instruments.
Other Outstanding Warrants
See Note 9 above for a discussion of the Medley Warrants and the Pegasus Guaranty Warrants.
As of December 31, 2016, the Company had outstanding the following warrants for the purchase of Common Stock:
As of December 31, 2016, the Series D Warrants, the warrants held by Aquillian Investments LLC, the September 2012 Warrants, the Series J Warrants, the Medley Warrants, the Pegasus Guaranty Warrants and a portion of the THD Warrants were fully vested and exercisable. In accordance with the vesting terms discussed above, no shares issuable pursuant to the THD Warrant vested for the year ended December 31, 2015 and 2,114,108 shares issuable pursuant to the THD Warrant vested during the years ended December 31, 2014. As of December 31, 2016, the THD Warrant represented a right to purchase 2,446,295 shares of Common Stock. The Series K Warrants are not exercisable until after the Appeal Bond has been fully drawn or all commitments thereunder have been released. Pursuant to the terms of the Riverwood Warrants and the Pegasus Warrant, such warrants were not exercisable as of December 31, 2016 because the aggregate fair market value of the Company’s outstanding shares of Common Stock (as determined in accordance with the terms of the Riverwood Warrants and the Pegasus Warrant, as applicable) was less than $580.0 million (subject to adjustment in accordance with the terms of the Riverwood Warrants or the Pegasus Warrant, as applicable).
Note 12: Loss Per Share
In 2012, the Company determined that two classes of Common Stock had been established for financial reporting purposes only, with Common Stock attributable to controlling stockholders representing shares beneficially owned and controlled by Pegasus Capital and its affiliates and the Common Stock attributable to noncontrolling stockholders representing the minority interest stockholders. For the years ended December 31, 2016, 2015 and 2014, the Company computed net loss per share of noncontrolling stockholders and controlling stockholders Common Stock using the two-class method. Net loss from operations is initially allocated based on the underlying common shares held by controlling and noncontrolling stockholders. The allocation of the net losses attributable to the Common Stock attributable to controlling stockholders is then reduced by the amount of the deemed dividends.
The following table sets forth the computation of basic and diluted net loss per share of Common Stock:
Basic earnings per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the applicable period. The Series J Warrants have an exercise price of $0.001 per share of Common Stock, and are included in the weighted average number of shares of Common Stock outstanding as there are no conditions that must be satisfied before such warrants may be exercised into the shares of Common Stock underlying such warrants. Diluted earnings per share is computed in the same manner as basic earnings per share except the number of shares is increased to assume exercise of potentially dilutive stock options, unvested restricted stock and contingently issuable shares using the treasury stock method and convertible preferred shares using the if-converted method, unless the effect of such increases would be anti-dilutive. The Company had 273.1 million, 265.8 million and 180.5 million common stock equivalents for the years ended December 31, 2016, 2015 and 2014, respectively, which were not included in the diluted net loss per common share as the common stock equivalents were anti-dilutive, as a result of being in a net loss position.
Note 13: Related Party Transactions
On February 19, 2014, the Company entered into the Pegasus Guaranty and, as consideration for the Pegasus Guaranty, the Company issued the Pegasus Guaranty Warrants to the Pegasus Guarantors. The Pegasus Guaranty Warrants were valued at $3.3 million as of February 19, 2014, which was partially offset by the $2.8 million fair value of the Pegasus Guaranty, with the remaining value of $571,000 accounted for as a deemed dividend to the Company’s controlling stockholders. For the years ended December 31, 2016, 2015 and 2014, the Company recorded $553,000, $553,000 and $476,000, respectively, of non-cash related party interest expense related to the amortization of the Pegasus Guaranty.
During the years ended December 31, 2016, 2015 and 2014, the Company incurred consulting fees of $8,000, $3,000 and $12,000, respectively, for services provided by T&M Protection Resources which were included in selling, distribution and administrative expense. T&M Protection Resources is a security company affiliated with Pegasus Capital.
On February 23, 2016, July 19, 2016 and November 21, 2016, the Company issued 3,000, 5,000 and 5,000 Series J Securities, respectively, to Holdings III, in each case at a purchase price of $1,000 per Series J Security for aggregate gross proceeds of $13.0 million. The Series J Securities were issued pursuant to subscription agreements between the Company and Holdings III, an affiliate of Pegasus Capital.
On December 7, 2015, in consideration of Pegasus Fund IV’s entry into 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, the Company issued 20,106 Series K Securities to Pegasus Fund IV pursuant to the Subscription and Support Agreement. The number of Series K Securities issued to Pegasus Fund IV was determined based on the quotient obtained by dividing (x) the aggregate amount of the bonds, undertakings, guarantees and/or contractual obligations underlying Pegasus Fund IV’s initial commitment with respect to the Appeal Bond by (y) $1,000.
On September 11, 2015 and January 30, 2015, the Company issued 10,000 and 11,525 Series J Securities, respectively, to Holdings III, in each case at a purchase price of $1,000 per Series J Security for aggregate gross proceeds of $21.5 million. The Series J Securities were issued pursuant to subscription agreements between the Company and Holdings III, an affiliate of Pegasus Capital.
Note 14: Equity Based Compensation Plans
The Company currently has one equity-based compensation plan, the 2012 Amended and Restated Equity-Based Compensation Plan, (the “Equity Plan”). Awards granted under the Equity Plan may include incentive stock options, which are qualified under Section 422 of the Internal Revenue Code (the “Code”), stock options other than incentive stock options, which are not qualified under Section 422 of the Code, stock appreciation rights, restricted stock, phantom stock, bonus stock and awards in lieu of obligations, dividend equivalents and other stock-based awards. On September 9, 2014, holders of a majority of the Company’s Common Stock executed a written consent in lieu of a special meeting approving an amendment to the Equity Plan that (i) increased the total number of shares of Common Stock available for issuance thereunder from 55.0 million to 155.0 million and (ii) increased the maximum number of stock options or stock appreciation rights that may be granted each fiscal year to any Covered Employee (as defined in the Equity Plan) from 7.0 million to 30.0 million. As of December 31, 2016, there were 90.4 million shares remaining for future grants. Awards may be granted to employees, members of the Board of Directors, and consultants. The Equity Plan is generally administered by the Compensation Committee of the Board of Directors. Vesting periods and terms for awards are determined by the plan administrator. The exercise price of each stock option or stock appreciation right is equal to or greater than the market price of the Company’s stock on the date of grant and no stock option or stock appreciation right granted may have a term in excess of ten years.
The Board of Directors may also issue stock-based awards to the Company’s nonemployee directors who wish their awards to be issued to an entity other than an individual under the Directors Stock Plan (the “Directors Plan”). As of December 31, 2016, the Company has reserved an aggregate of 5 million shares of Common Stock for issuance under the Directors Plan. The total number of shares outstanding under the Directors Plan was 2,695,894 shares as of December 31, 2016.
Stock Option Awards
The following table summarizes stock option activity for all of the Company’s stock-based plans as of December 31, 2016 and changes during the year then ended:
The total intrinsic value in the table above represents the total pretax intrinsic value, which is the total difference between the closing price of the Company’s Common Stock on December 31, 2015 and the exercise price for each in-the-money option that would have been received by the holders if all instruments had been exercised on December 31, 2016. This value fluctuates with the changes in the price of the Company’s Common Stock. As of December 31, 2016, there was $2.1 million of unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average period of 2.72 years.
The following table summarizes information about stock options outstanding and exercisable as of December 31, 2016:
Other information pertaining to stock options is as follows:
Restricted Stock Awards
A summary of unvested shares of restricted stock outstanding under all of the Company’s stock-based plans as of December 31, 2016 and changes during the year then ended is as follows:
As of December 31, 2016 and 2015, there was no unrecognized compensation cost related to restricted stock granted under the Equity Plan or the Directors Plan. For the years ended December 31, 2016, 2015 and 2014, the Company recorded compensation expense related to restricted stock of $0, $121,000 and $730,000, respectively.
Stock-Based Compensation Valuation and Expense
The Company accounts for its stock-based compensation plans using the fair value method. The fair value method requires the Company to estimate the grant date fair value of its stock based awards and amortize this fair value to compensation expense over the requisite service period or vesting term. To estimate the fair value of the Company’s stock-based awards the Company currently uses the Black-Scholes pricing model. The determination of the fair value of stock-based awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, the risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models available today, including future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in the Company’s financial statements. For restricted stock awards, grant date fair value is based upon the market price of the Company’s Common Stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term.
Stock-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.
The Company recorded stock option (credit) expense of ($187,000), $2.1 million and $3.3 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The weighted average assumptions used to value stock option grants were as follows:
The following describes each of these assumptions and the Company’s methodology for determining each assumption:
Risk-Free Interest Rate
The Company estimates the risk-free interest rate using the U.S. Treasury bill rate with a remaining term equal to the expected life of the award.
Expected Life
The expected life represents the period that the stock option awards are expected to be outstanding derived using the “simplified” method as allowed under the provisions of the SEC’s Staff Accounting Bulletin No. 107, as the Company does not believe it has sufficient historical data to support a more detailed assessment of the estimate.
Expected Volatility
The Company estimates expected volatility based on the historical volatility of the Company’s Common Stock and its peers.
Expected Dividend Yield
The Company estimates the expected dividend yield by giving consideration to its current dividend policies as well as those anticipated in the future considering the Company’s current plans and projections.
2011 Employee Stock Purchase Plan
The Company also has an Employee Stock Purchase Plan (the “2011 ESPP”) that provides employees with the opportunity to purchase Common Stock at a discount. All employees of the Company and any designated subsidiary are eligible to participate in the 2011 ESPP, subject to certain exceptions. As of December 31, 2016, there were 2.0 million shares authorized for issuance under the ESPP, with 1.8 million shares remaining for future issuance. The 2011 ESPP is a qualified employee stock purchase plan under Section 423 of the Code and was approved by the Company’s stockholders at its annual meeting on August 10, 2011.
The purpose of the 2011 ESPP is to provide employees of the Company and designated subsidiaries with an opportunity to acquire a proprietary interest in the Company. Accordingly, the 2011 ESPP offers eligible employees the opportunity to purchase shares of Common Stock of the Company at a discount to the market value through voluntary systematic payroll deductions. For the 2016 offering under the 2011 ESPP, a participant could elect to use up to 30% of his or her compensation to purchase whole shares of Common Stock of the Company, but could not purchase more than 2,000 shares during the year. The purchase price for each purchase period is 85% of the fair market value of a share of Common Stock of the Company on the purchase date, rounded up to the nearest whole cent. Unless sooner terminated by the board of directors, the 2011 ESPP will remain in effect until December 31, 2020. During the years ended December 31, 2016, 2015 and 2014, the Company issued 20,150, 9,975 and 23,126 shares to certain employees under the 2011 ESPP at prices ranging from $0.01 to $2.32 per share.
Note 15: Restructuring Expenses
The following table summarizes our restructuring expenses and related charges for the following years ended December 31:
(1)
These charges relate to a significant cost reduction plan initiated during the fourth quarter of 2013 that included moving the majority of the Company’s manufacturing to its contract manufacturers in Asia, related workforce reduction in Satellite Beach, Florida of approximately 69 positions, including the termination of several members of the Company’s senior management and a $3.2 million write-down of property and equipment, cost reductions in our foreign subsidiaries and refocusing the Company’s efforts within North America, which resulted in the elimination of all employees at certain foreign locations.
(2)
In September 2011, the Company began implementing a restructuring plan designed to further increase efficiencies across the organization and lower the overall cost structure. This restructuring plan included a reduction in full time headcount in the United States, which was completed in October 2011. In 2012, the Company extended the restructuring plan to further increase efficiencies across the organization and lower its overall cost structure. The plan included a significant reduction in full time headcount in Mexico resulting from the Company’s continued shift of its manufacturing and production processes to the Company’s contract manufacturer in Mexico, the replacement of ten members of management in the United States and the closing of the Company’s offices in the United Kingdom and Australia. As of December 31, 2014, this plan was complete.
As of December 31, 2016 and 2015, the accrued liability associated with the restructuring and other related charges consisted of the following:
The remaining accrual of $266,000 as of December 31, 2016 is expected to be paid during the years ending December 31, 2017 through 2018.
The restructuring and other related charges are included in the line item restructuring expenses in the consolidated statements of operations.
Note 16: Income Taxes
The Company accounts for income taxes under FASB ASC 740, “Accounting for Income Taxes” (“ASC 740”). Deferred income tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The components of the consolidated income tax benefit from continuing operations are as follows:
The reconciliation of the provision for income taxes from continuing operations at the United States Federal statutory tax rate of 34% is as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred income taxes are as follows:
ASC 740 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all evidence, both positive and negative, management has determined that a $215.0 million valuation allowance as of December 31, 2016 is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. The change in the valuation allowance for the current year is $11.6 million.
As of December 31, 2016, the Company had tax loss carryforwards available to offset future income taxes, subject to expiration as follows:
At the time of the reverse merger transaction and resulting change in control, in June 2007, the Company had accumulated approximately $75.0 million in loss carryforwards. As a result of the change in control, the Company is limited by Section 382 of the Internal Revenue Code in the amount of loss carryforwards that it may apply to its taxable income in any tax year. These loss carryforwards expire from 2018 through 2035.
The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. As of December 31, 2016 and 2015, the Company had no unrecognized tax benefits. The Company’s policy is to recognize interest and penalties related to income taxes in its income tax provision. The Company has not accrued or paid interest or penalties which were material to its results of operations for the years ended December 31, 2016, 2015 and 2014.
The Company files income tax returns in its U.S. federal jurisdictions and various state jurisdictions. As of December 31, 2016, the Company’s income tax returns prior to 2011 and 2010 are closed to examination for federal and state purposes, respectively. The Company’s 2013 federal income tax return is currently being examined by the Internal Revenue Service. The Company does not anticipate any material change in the next 12 months for uncertain tax positions.
Note 17: Concentrations of Business
For the years ended December 31, 2016, 2015 and 2014, the Company had one customer whose revenue represented 89%, 91% and 80% of total revenue, respectively. The loss of this material relationship would have a material adverse effect on our results of operations and cash flows.
As of December 31, 2016 and 2015, the Company had one customer whose accounts receivable balance represented 58% and 70% of accounts receivables, net of allowances, respectively.
Note 18: Commitments and Contingencies
Purchase Commitments
As of December 31, 2016, the Company had $3.2 million in purchase commitments, which are generally non-cancellable.
Lease Commitments
As of December 31, 2016, the Company had the following commitments under operating leases for property and equipment for each of the next five years:
During the years ended December 31, 2016, 2015 and 2014, the Company incurred rent expense of $451,000, $459,000 and $1.7 million, respectively.
Agreements with Contract Manufacturers
The Company currently depends on a small number of contract manufacturers to manufacture its products. If any of these contract manufacturers were to terminate their agreements with the Company or fail to provide the required capacity and quality on a timely basis, the Company may be unable to manufacture and ship products until replacement contract manufacturing services could be obtained.
Other Contingencies
The Company is subject to the possibility of loss contingencies arising in its business and such contingencies are accounted for in accordance with ASC Topic 450, "Contingencies.” In determining loss contingencies, the Company considers the possibility of a loss as well as the ability to reasonably estimate the amount of such loss or liability. An estimated loss is recorded when it is considered probable that a liability has been incurred and when the amount of loss can be reasonably estimated. In the ordinary course of business, the Company is routinely a defendant in or party to various pending and threatened legal claims and proceedings. The Company believes that any probable liability resulting from these various claims will not have a material adverse effect on its results of operations or financial condition; however, it is possible that extraordinary or unexpected legal fees could adversely impact the Company’s financial results during a particular period. During its ordinary course of business, the Company enters into obligations to defend, indemnify and/or hold harmless various customers, officers, directors, employees, and other third parties. These contractual obligations could give rise to additional litigation costs and involvement in court proceedings.
On June 22, 2012, Geveran filed a lawsuit against the Company and several others in the Circuit Court of the Seventeenth Judicial Circuit in and for Broward County, Florida. On October 30, 2012, the court entered an order transferring the lawsuit to the Ninth Judicial Circuit in and for Orange County, Florida. The action, styled Geveran Investments Limited v. Lighting Science Group Corp., et al., Case No. 12-17738 (07), names the Company as a defendant, as well as Pegasus Capital and nine other entities affiliated with Pegasus Capital; Richard Weinberg, the Company’s former Director and former interim Chief Executive Officer and a former partner of Pegasus Capital; Gregory Kaiser, a former Chief Financial Officer; J.P. Morgan Securities, LLC (“J.P. Morgan”); and two employees of J.P. Morgan. Geveran seeks rescission of its $25.0 million investment in the Company, as well as recovery of interest, attorneys’ fees and court costs, jointly and severally against the Company, Pegasus Capital, Mr. Weinberg, Mr. Kaiser, J.P. Morgan and the two J.P. Morgan employees, for alleged violations of Florida securities laws. Geveran alternatively seeks unspecified money damages, as well as recovery of court costs, for alleged common law negligent misrepresentation against these same defendants.
The Summary Judgment Order was issued on August 28, 2014 and entered on November 30, 2015. Accordingly, on December 4, 2015, the Company, along with certain other related defendants, filed a Notice of Appeal to the Florida Fifth District Court of Appeal and posted a bond securing the judgment in the amount of approximately $20.1 million. Defendant J.P. Morgan also posted a separate bond in the amount of approximately $20.1 million, resulting in total bonding of approximately $40.2 million. On March 29, 2016, the trial court judge determined that the posted bonds were sufficient security to stay execution of the judgment pending the appeal.
Although the Company cannot predict the ultimate outcome of this lawsuit, it believes the court’s summary judgment award in favor of Geveran was in error, that the Company will prevail on the appeal and the judgment will be overturned, and that the case will be remanded to the trial court for further proceedings. If the case is remanded to the trial court, the Company believe it has strong defenses against Geveran’s claims. However, in the event that the Company is not successful on appeal, it could be liable for the full amount of the $40.2 million judgment, plus post judgment interest. Such an outcome would have a material adverse effect on its financial position.
The Company believes that, subject to the terms and conditions of the relevant policies (including retention and policy limits), directors’ and officers’ (“D&O”) insurance coverage will be available to cover a substantial majority of its legal fees and costs in this matter. However, insurance coverage may not be available for, or such coverage may not be sufficient to fully pay, a judgment or settlement in favor of Geveran. On July 26, 2016, the Company, along with certain other related defendants, filed a lawsuit in Delaware state court against its D&O carriers, Liberty Insurance, Starr, and Continental Casualty, seeking a declaratory judgment and damages arising out of the defendant carriers’ breach of their coverage obligations under various applicable D&O policies.
Based upon the terms of an indemnification agreement, the Company has also paid, and may be required to pay in the future, reasonable legal expenses incurred by J.P. Morgan and its affiliates in this lawsuit in connection with the engagement of J.P. Morgan as placement agent for the private placement with Geveran. Such payments are not covered by the Company’s insurance coverage. The agreement executed with J.P. Morgan provides that the Company will indemnify J.P. Morgan and its affiliates from liabilities relating to J.P. Morgan’s activities as placement agent, unless such activities are finally judicially determined to have resulted from J.P. Morgan’s bad faith, gross negligence or willful misconduct.
The Company is also a defendant in an action brought by GE Lighting Solutions LLC (“GE Lighting”) in Federal District Court for the Northern District of Ohio in or about January 2013. GE Lighting asserts a claim of patent infringement against the Company under U.S Patent No. 6,787,999, entitled LED-Based Modular Lamp, and U.S. Patent No. 6,799,864, entitled High Power LED Power Pack for Spot Module Illumination, and seeks monetary damages and an injunction. The Company has denied liability. On August 5, 2015, the court granted the Company’s summary judgment motion invalidating the two GE Lighting patents at issue for indefiniteness, and dismissing GE Lighting’s patent infringement claims against the Company and the other defendants. On September 2, 2015, GE Lighting filed an appeal with the U.S. Court of Appeals for the Federal Circuit. On October 27, 2016, the Federal Circuit issued an opinion that affirmed the lower district court’s ruling that U.S. Patent No. 6,799,864 is invalid, and reversed the district court’s ruling that U.S. Patent No. 6,787,999 is invalid. With respect to U.S. Patent No. 6,787,999, the Federal Circuit remanded the case back to the district court for further proceedings. The Company continues to believe that it has strong defenses against GE Lighting’s claims with respect to U.S. Patent No. 6,787,999. However, there is no assurance that the Company will be successful in defending against this action. The outcome, if unfavorable, could have a material adverse effect on our financial position. Even if the outcome is favorable, this litigation could result in substantial additional costs to the Company, could be a distraction to management and could harm its financial position.
In April 2015, the Company filed a lawsuit against several former employees and a company they formed seeking damages and injunctive relief arising out of the defendants’ misappropriation of the Company’s trade secrets and other intellectual property. Pursuant to the terms of a settlement agreement entered into in December 2015, certain of the individual defendants agreed not to use or disclose our intellectual property and to reimburse us for $200,000 in costs, and the defendants’ company agreed to pay us a commission equal to the greater of (i) $1.7 million and (ii) 5% of such company’s gross sales of biological and agricultural products during the three-year period ending January 2019.
In addition, the Company may be a party to a variety of legal actions, such as employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims, shareholder suits, including securities fraud, intellectual property related litigation, and a variety of legal actions relating to its business operations. In some cases, substantial punitive damages may be sought. The Company currently has insurance coverage for certain of these potential liabilities. Other potential liabilities may not be covered by insurance, insurers may dispute coverage or the amount of insurance may not be sufficient to cover the damages awarded. In addition, certain types of damages, such as punitive damages, may not be covered by insurance and insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.
Note 19: Defined Contribution Plan
The Company has a qualified 401(k) plan (the “401(k) Plan”) covering substantially all employees in the United States. The 401(k) Plan was established under Internal Revenue Code Section 401(k). As of January 1, 2011, the Company began matching 50% of the first 6% of employee contributions and for the years ended December 31, 2016, 2015 and 2014, the Company contributed $102,000, $135,000 and $220,000, respectively, to the 401(k) Plan.
Note 20: Quarterly Financial Data (Unaudited)
The following is a summary of the Company’s consolidated quarterly results of operations for each of the years ended December 31, 2016 and 2015:
Note 21: Valuation and Qualifying Accounts
Note 22: Subsequent Events
On January 27, 2017, the Company issued 3,000 Series J Securities to Holdings III pursuant to the Subscription and Support Agreement among the Company, Pegasus Fund IV and Holdings III for aggregate gross proceeds of $3.0 million (the “January Series J Issuance”).
On February 3, 2017, the Company issued 7,000 Series J Securities to Holdings III pursuant to the Subscription and Support Agreement among the Company, Pegasus Fund IV and Holdings III for aggregate gross proceeds of $7.0 million (the “February Series J Issuance”).
On February 3, 2017, Pegasus purchased all of the outstanding membership interests of RW LSG Holdings LLC, an affiliate of Riverwood Management, and renamed the entity LSGC Holdings IIIa, LLC. Such entity owns 45,000 shares of Series H Preferred Stock and is one of the preferred stockholders entitled to the redemption rights described in Note 3 above. Pegasus also purchased an aggregate of 49,000 shares of Series H Preferred Stock from Cleantech A, Cleantech B and Portman. Prior to selling their shares of Series H Preferred Stock, these entities previously could, acting together, also trigger redemption rights with respect to the Convertible Preferred Stock. As a result of the foregoing transactions, Pegasus is currently the only preferred stockholder possessing the right to require the Company to, at any time on or after March 27, 2017, redeem its shares of Convertible Preferred Stock and, consequently, trigger the rights of all other holders of the applicable series to request the redemption of their shares of Convertible Preferred Stock. Pegasus has indicated that, subject to certain conditions, it will not exercise such redemption rights through November 14, 2019. Finally, on February 3, 2017, Pegasus also purchased all of the Riverwood Warrants and, pursuant to the terms of the equity purchase agreements between Pegasus and each of Cleantech A, Cleantech B and Portman, the September 2012 Warrants were cancelled.
On March 20, 2017, the Company and its newly formed subsidiary, LSG MLS JV Holdings, Inc. (“LSG JV Holdings”), entered into an operating agreement (the “JV Operating Agreement”) with MLS Co., Ltd. (“MLS”) relating to the formation of GVL. GVL was formed for the purpose of carrying out the manufacturing, marketing, sale and distribution of private label LED lighting products and services to retail and commercial customers in North America and South America (the “Joint Venture”). LSG JV Holdings will own 51% of the membership interests of GVL and MLS will own 49% of the membership interests of GVL. The Joint Venture is an integral part of the Company’s long-term strategy. On the effective date of the JV Operating Agreement, the Company (through LSG JV Holdings) must make an initial capital contribution of $5.1 million in cash to GVL and MLS must make an initial capital contribution of $4.9 million in cash to GVL. Further, upon the determination of GVL’s board of managers, each of LSG JV Holdings and MLS will be required to make additional capital contributions of up to $7.65 million and $7.35 million in the aggregate, respectively, during the first 12 months following the effective date of the JV Operating Agreement. The effectiveness of the JV Operating Agreement and closing of the Joint Venture transaction remain subject to the satisfaction of certain conditions and the Company’s performance of certain obligations.
INDEX TO EXHIBITS
Exhibit
Number
Description
3.1
Amended and Restated Certificate of Incorporation of Lighting Science Group Corporation (previously filed as Exhibit 3.1 to the Annual Report on Form 10-K filed on March 31, 2015, File No. 0-20354, and incorporated herein by reference).
3.2
Amended and Restated Bylaws of Lighting Science Group Corporation (previously filed as Exhibit 3.1 to the Current Report on Form 8-K filed on December 28, 2010, File No. 0-20354, and incorporated herein by reference).
3.3
Certificate of Amendment to Amended and Restated Certificate of Incorporation (previously filed as Exhibit 3.3 to the Annual Report on Form 10-K filed on March 31, 2015, File No. 0-20354, and incorporated herein by reference).
4.1
Specimen Common Stock Certificate (previously filed as Exhibit 4.14 to Amendment No. 1 to the Registration Statement on Form S-1/A filed on January 12, 2010, File No. 333-162966, and incorporated herein by reference).
4.2
Amended and Restated Certificate of Designation of Series H Convertible Preferred Stock filed with the Secretary of State of Delaware on November 14, 2014 (previously filed as Exhibit 4.1 to the Current Report on Form 8-K filed on November 20, 2014, File No. 0-20354, and incorporated herein by reference).
4.3
Amended and Restated Certificate of Designation of Series I Convertible Preferred Stock filed with the Secretary of State of Delaware on November 14, 2014 (previously filed as Exhibit 4.2 to the Current Report on Form 8-K filed on November 20, 2014, File No. 0-20354, and incorporated herein by reference).
4.4
Amended and Restated Certificate of Designation of Series J Convertible Preferred Stock filed with the Secretary of State of Delaware on November 14, 2014 (previously filed as Exhibit 4.3 to the Current Report on Form 8-K filed on November 20, 2014, File No. 0-20354, and incorporated herein by reference).
4.4.1
Certificate of Increase of Series J Convertible Preferred Stock filed with the Secretary of State of Delaware on September 11, 2015 (previously filed as Exhibit 4.1 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
4.4.2
Certificate of Increase of Series J Convertible Preferred Stock filed with the Secretary of State of Delaware on July 19, 2016 (previously filed as Exhibit 4.1 to the Current Report on Form 8-K filed on July 25, 2016, File No. 0-20354, and incorporated herein by reference).
4.4.3
Certificate of Increase of Series J Convertible Preferred Stock filed with the Secretary of State of Delaware on January 27, 2017 (previously filed as Exhibit 4.1 to the Current Report on Form 8-K filed on February 2, 2017, File No. 0-20354, and incorporated herein by reference).
4.5
Certificate of Designation of Series K Preferred Stock filed with the Secretary of State of Delaware on September 11, 2015 (previously filed as Exhibit 4.2 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
Exhibit
Number
Description
4.18
Warrant, dated as of February 19, 2014, by and between Lighting Science Group Corporation and Pegasus Capital Partners IV, L.P. (previously filed as Exhibit 4.4 to the Current Report on Form 8-K filed on February 25, 2014, File No. 0-20354, and incorporated herein by reference).
4.19
Warrant, dated as of February 19, 2014, by and between Lighting Science Group Corporation and Pegasus Capital Partners V, L.P. (previously filed as Exhibit 4.5 to the Current Report on Form 8-K filed on February 25, 2014, File No. 0-20354, and incorporated herein by reference).
4.20
Warrant to Purchase Common Stock, dated December 7, 2015 and issued to Pegasus Partners IV, L.P. (previously filed as Exhibit 4.23 to the Annual Report on Form 10-K filed on April 14, 2016, File 0-20354, and incorporated herein by reference).
4.21
Amended and Restated Registration Rights Agreement, dated as of January 23, 2009, by and between Lighting Science Group Corporation and Pegasus Partners IV, L.P. (previously filed as Exhibit 4.1 to the Current Report on Form 8-K filed on January 30, 2009, File No. 0-20354, and incorporated herein by reference).
4.21.1
Amendment to Amended and Restated Registration Rights Agreement, dated as of May 25, 2012, by and among Lighting Science Group Corporation, Pegasus Partners IV, L.P. and LSGC Holdings LLC (previously filed as Exhibit 10.5 to the Current Report on Form 8-K filed on June 1, 2012, File No. 0-20354, and incorporated herein by reference).
4.22
Registration Rights Agreement, dated January 14, 2011, between Lighting Science Group Corporation and The Home Depot, Inc. (previously filed as Exhibit 4.2 to the Current Report on Form 8-K filed on January 20, 2011, File No. 0-20354, and incorporated herein by reference).
4.23
Amended and Restated Registration Rights Agreement, dated as of September 25, 2012, by and among Lighting Science Group Corporation, RW LSG Holdings LLC, RW LSG Management Holdings LLC, Portman Limited, Cleantech Europe II (A) LP and Cleantech Europe II (B) LP (previously filed as Exhibit 10.6 to the Current Report on Form 8-K filed on September 27, 2012, File No. 0-20354, and incorporated herein by reference).
4.24
Registration Rights Agreement, dated February 19, 2014 by and between Lighting Science Group Corporation, Medley Capital Corporation and Medley Opportunity Fund II LP (previously filed as Exhibit 4.3 to the Current Report on Form 8-K filed on February 25, 2014, File No. 0-20354, and incorporated herein by reference).
4.25
Registration Rights Agreement, dated November 14, 2014 by and between Lighting Science Group Corporation, Serengeti Lycaon MM L.P. and Serengeti Opportunities MM L.P. (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on November 20, 2014, File No. 0-20354, and incorporated herein by reference).
10.1+
Amended and Restated Equity-Based Compensation Plan (previously filed as Appendix A to the Proxy Statement on Schedule 14A filed on September 18, 2008, File No. 0-20354 and incorporated herein by reference).
10.1.1+
Amendment to the Lighting Science Group Corporation Amended and Restated Equity-Based Compensation Plan, dated August 21, 2009 (previously filed as Exhibit 10.4 to the Current Report on Form 8-K filed on August 27, 2009, File No. 0-20354, and incorporated herein by reference).
Exhibit
Number
Description
10.1.2+
Amendment to the Lighting Science Group Corporation Amended and Restated Equity-Based Compensation Plan, dated February 10, 2011 (previously filed as Exhibit 4.10 to the Registration Statement on Form S-8 filed on February 25, 2011, File No. 333-172461, and incorporated herein by reference).
10.2+
Form of Lighting Science Group Corporation 2005 Equity-Based Compensation Plan Stock Option Agreement (previously filed as Exhibit 4.13 to the Registration Statement on Form S-8 filed on May 5, 2008, File No. 333-150628, and incorporated herein by reference).
10.3+
Form of Lighting Science Group Corporation 2005 Equity-Based Compensation Plan Employee Incentive Stock Option Agreement (previously filed as Exhibit 4.14 to the Registration Statement on Form S-8 filed on May 5, 2008, File No. 333-150628, and incorporated herein by reference).
10.4+
Form of Lighting Science Group Corporation 2005 Equity-Based Compensation Plan Restricted Stock Award Agreement (previously filed as Exhibit 4.15 to the Registration Statement on Form S-8 filed on May 5, 2008, File No. 333-150628, and incorporated herein by reference).
10.5+
Form of Lighting Science Group Corporation Amended and Restated Equity-Based Compensation Plan Nonqualified Stock Option Agreement (previously filed as Exhibit 10.5 to the Current Report on Form 8-K filed on August 27, 2009, File No. 0-20354, and incorporated herein by reference).
10.6+
Form of Lighting Science Group Corporation Amended and Restated Equity-Based Compensation Incentive Stock Option Agreement (previously filed as Exhibit 10.6 to the Current Report on Form 8-K filed on August 27, 2009, File No. 0-20354, and incorporated herein by reference).
10.7+
Lighting Science Group Corporation 2012 Amended and Restated Equity-Based Compensation Plan (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on July 11, 2012, File No. 0-20354, and incorporated herein by reference).
10.7.1+
Amendment to the Lighting Science Group Corporation 2012 Amended and Restated Equity-Based Compensation Plan (previously filed as Appendix A to the Information Statement on Schedule 14C filed on September 11, 2014, File No. 0-020354, and incorporated herein by reference).
10.8+
Form of Lighting Science Group Corporation Amended and Restated Equity-Based Compensation Employee Incentive Stock Option Agreement (previously filed as Appendix C to the Information Statement on Schedule 14C filed on September 11, 2014, File No. 0-020354, and incorporated herein by reference).
10.9+
Form of Lighting Science Group Corporation Amended and Restated Equity-Based Compensation Plan Non-Qualified Stock Option Agreement (previously filed as Appendix D to the Information Statement on Schedule 14C filed on September 11, 2014, File No. 0-020354, and incorporated herein by reference).
10.10+
Form of Lighting Science Group Corporation 2012 Amended and Restated Equity-Based Compensation Plan Restricted Stock Award Agreement (previously filed as Appendix E to the Information Statement on Schedule 14C filed on September 11, 2014, File No. 0-020354, and incorporated herein by reference).
Exhibit
Number
Description
10.11+
Lighting Science Group Corporation 2011 Employee Stock Purchase Plan (previously filed as Exhibit 4.8 to the Registration Statement on Form S-8 filed on February 25, 2011, File No. 333-172466, and incorporated herein by reference).
10.12
Governing Agreement and Complete Releases, dated August 27, 2009, among Lighting Science Group Corporation, LED Holdings, LLC, LED Effects, Inc., Pegasus Capital Advisors, L.P., Pegasus Partners IV, L.P., Philips Electronics North America Corporation, Philips Solid-State Lighting Solutions, Inc. and Koninklijke Philips Electronics N.V. (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on August 28, 2009, File No. 0-20354, and incorporated herein by reference).
10.13
Support Services Agreement, dated as of June 23, 2010, between Lighting Science Group Corporation and Pegasus Capital Advisors, L.P. (previously filed as Exhibit 10.3 to the Current Report on Form 8-K filed on June 29, 2010, File No. 0-20354, and incorporated herein by reference).
10.14
Support Services Agreement, dated as of May 25, 2012, by and between Lighting Science Group Corporation and Pegasus Capital Advisors, L.P. (previously filed as Exhibit 10.7 to the Current Report on Form 8-K filed on June 1, 2012, File No. 0-20354, and incorporated herein by reference).
10.15
Term Loan Agreement, dated February 19, 2014, by and between Lighting Science Group Corporation, the lenders party thereto and Medley Capital Corporation, in its capacity as agent (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on February 25, 2014, File No. 0-20354, and incorporated herein by reference).
10.15.1
First Amendment to Term Loan Agreement, dated April 25, 2014, by and among Lighting Science Group Corporation, the Lenders signatory hereto, and Medley Capital Corporation, as administrative agent for the lenders party thereto (filed as Exhibit 10.2 to the Current Report on Form 8-K filed on May 1, 2014, File No. 0-20354, and incorporated herein by reference).
10.15.2
Limited Consent and Second Amendment to Term Loan Agreement dated January 30, 2015 by and among Lighting Science Group Corporation, Medley Capital Corporation and the lenders party thereto (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on filed on February 5, 2015, File No. 0-20354, and incorporated herein by reference).
10.15.3
Third Amendment to Term Loan Agreement dated September 11, 2015 by and among Lighting Science Group Corporation, Medley Capital Corporation and the lenders party thereto (previously filed as Exhibit 10.6 to the Current Report on Form 8-K filed on filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
10.15.4
Consents regarding issuance of Series J Convertible Preferred Stock and Series K Preferred Stock and amendment to the Amended and Restated Series J Certificate of Designation; Confirmation with respect to Customer 1 and related provisions in Loan Agreement, dated September 11, 2015, by and between Lighting Science Group Corporation and Medley Capital Corporation (previously filed as Exhibit 10.7 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
Exhibit
Number
Description
10.15.5
Fourth Amendment to Term Loan Agreement dated July 19, 2016 by and among Lighting Science Group Corporation, Medley Capital Corporation and the lenders party thereto (previously filed as Exhibit 10.3 to the Current Report on Form 8-K filed on July 25, 2016, File No. 0-20354, and incorporated herein by reference).
10.15.6
Fifth Amendment and Limited Consent to Term Loan Agreement dated November 21, 2016 by and among Lighting Science Group Corporation, Medley Capital Corporation and the lenders from time to time party thereto (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on November 28, 2016, File No. 0-20354, and incorporated herein by reference).
10.16
Loan and Security Agreement, dated April 25, 2014, by and between Lighting Science Group Corporation, Biological Illumination, LLC, FCC, LLC, d/b/a First Capital, in its capacity as agent, and various financial institutions (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on filed on February 5, 2015, File No. 0-20354, and incorporated herein by reference).
10.16.1
Letter Amendment to Loan and Security Agreement, dated September 19, 2014, by and between Lighting Science Group Corporation, Biological Illumination, LLC, FCC, LLC, d/b/a First Capital, in its capacity as agent, and various financial institutions (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on September 24, 2014, File No. 020354 and incorporated herein by reference).
10.16.2
Second Amendment to Loan and Security Agreement dated January 30, 2015 by and among Lighting Science Group Corporation, BioLogical Illumination, LLC, the financial institutions from time to time party thereto as lenders and FCC, LLC, d/b/a First Capital (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on filed on February 5, 2015, File No. 0-20354, and incorporated herein by reference).
10.16.3
Side Letter in Respect of Series J Equity Issuance and Calculation of Fixed Charge Coverage Ratio dated January 30, 2015 by and among Lighting Science Group Corporation, BioLogical Illumination, LLC and FCC, LLC, d/b/a First Capital (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on filed on February 5, 2015, File No. 0-20354, and incorporated herein by reference).
10.16.4
Third Letter Amendment to Loan and Security Agreement dated September 11, 2015 by and among Lighting Science Group Corporation, BioLogical Illumination, LLC, the financial institutions from time to time party thereto as lenders and ACF FinCo I LP, as assignee of FCC, LLC, d/b/a First Capital (previously filed as Exhibit 10.4 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
10.16.5
Consents regarding issuance of Series J Convertible Preferred Stock and Series K Preferred Stock and amendments to the Amended and Restated Series H Certificate of Designation, the Amended and Restated Series I Certificate of Designation, and the Amended and Restated Series J Certificate of Designation; Agreements with respect to Specified Customer provisions in Loan Agreement, dated September 11, 2015, by and between Lighting Science Group Corporation and ACF FinCo I LP (previously filed as Exhibit 10.5 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
Exhibit
Number
Description
10.16.6
Sixth Letter Amendment to Loan and Security Agreement dated July 19, 2016 by and among Lighting Science Group Corporation, BioLogical Illumination, LLC, Environmental Light Technologies Corp., the financial institutions from time to time party thereto as lenders and ACF FinCo I LP, as assignee of FCC, LLC, d/b/a First Capital (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on July 25, 2016, File No. 0-20354, and incorporated herein by reference).
10.16.7
Seventh Amendment to Loan and Security Agreement dated November 21, 2016 by and among Lighting Science Group Corporation, BioLogical Illumination, LLC, Environmental Light Technologies Corp., the financial institutions from time to time party thereto as lenders and ACF FinCo I LP, as assignee of FCC, LLC, d/b/a First Capital (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on November 28, 2016, File No. 0-20354, and incorporated herein by reference).
10.17
Exchange and Redemption Agreement, dated as May 25, 2012, by and among Lighting Science Group Corporation, LSGC Holdings LLC and Continental Casualty Company (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on June 1, 2012, File No. 0-20354, and incorporated herein by reference).
10.18
Subscription Agreement, dated as of May 10, 2011, between Lighting Science Group Corporation and Geveran Investments, Ltd. (previously filed as Exhibit 10.8 to the Quarterly Report on Form 10-Q filed on August 15, 2011, File No. 0-20354, and incorporated herein by reference).
10.19
Subscription Agreement, dated as of May 16, 2011, by and among Lighting Science Group Corporation, LSGC Holdings LLC and LSGC Holdings II LLC (previously filed as Exhibit 10.10 to the Quarterly Report on Form 10-Q filed on August 15, 2011, File No. 0-20354, and incorporated herein by reference).
10.20
Preferred Stock Subscription Agreement, dated as of September 25, 2012, by and among Lighting Science Group Corporation, Cleantech Europe II (A) LP and Cleantech Europe II (B) LP (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on September 27, 2012, File No. 0-20354, and incorporated herein by reference).
10.20.1
Amendment to Preferred Stock Subscription Agreement, dated September 11, 2013, by and among Lighting Science Group Corporation, Cleantech Europe II (A) LP and Cleantech Europe II (B) LP (previously filed as Exhibit 10.3 to the Current Report on Form 8-K filed on September 13, 2013, File No. 0-20354, and incorporated herein by reference).
10.20.2
Amendment No. 2 to Preferred Stock Subscription Agreement, dated September 11, 2015, by and among Lighting Science Group Corporation, Cleantech Europe II (A) LP and Cleantech Europe II (B) LP (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
10.21
Preferred Stock Subscription Agreement, dated September 11, 2013, by and between Lighting Science Group Corporation, RW LSG Holdings LLC, PCA LSG Holdings, LLC and LSGC Holdings II LLC (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on September 13, 2013, File No. 0-20354, and incorporated herein by reference).
Exhibit Number
Description
10.22
Series J Subscription Agreement, dated January 3, 2014, by and between Lighting Science Group Corporation and LSGC Holdings II LLC (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on January 8, 2014, File No. 0-20354, and incorporated herein by reference).
10.23
Series J Subscription Agreement, dated January 3, 2014, by and between Lighting Science Group Corporation and PCA LSG Holdings, LLC (previously filed as Exhibit 10.2 to the Current Report on Form 8-K filed on January 8, 2014, File No. 0-20354, and incorporated herein by reference).
10.24
Series J Subscription Agreement, dated January 3, 2014, by and between Lighting Science Group Corporation and RW LSG Holdings LLC (previously filed as Exhibit 10.3 to the Current Report on Form 8-K filed on January 8, 2014, File No. 0-20354, and incorporated herein by reference).
10.25
Series J Subscription Agreement, dated January 3, 2014, by and between Lighting Science Group Corporation, Cleantech Europe II (A) LP and Cleantech Europe II (B) LP (previously filed as Exhibit 10.4 to the Current Report on Form 8-K filed on January 8, 2014, File No. 0-20354, and incorporated herein by reference).
10.26
Series J Subscription Agreement, dated as of August 14, 2014, by and between Lighting Science Group Corporation and PCA LSG Holdings, LLC (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on August 20, 2014, File No. 0-20354, and incorporated herein by reference).
10.27
Series J Subscription Agreement, dated as of November 14, 2014, by and among Lighting Science Group Corporation, Serengeti Lycaon MM L.P. and Serengeti Opportunities MM L.P. (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on November 20, 2014, File No. 0-20354, and incorporated herein by reference).
10.28
Series J Subscription Agreement, dated January 30, 2015, by and between Lighting Science Group Corporation and LSGC Holdings III LLC (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on February 5, 2015, File No. 0-20354, and incorporated herein by reference).
10.29
Preferred Stock Subscription and Support Agreement, dated September 11, 2015 by and among Lighting Science Group Corporation, Pegasus Partners IV, L.P. and LSGC Holdings III LLC (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
10.29.1
Amendment No. 1 to Preferred Stock Subscription and Support Agreement, dated July 19, 2016 by and among Lighting Science Group Corporation, Pegasus Partners IV, L.P. and LSGC Holdings III LLC (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on July 25, 2016, File No. 0-20354, and incorporated herein by reference).
10.30
Commitment Agreement, dated as of May 25, 2012, by and among Lighting Science Group Corporation, Pegasus Capital Advisors, L.P., Pegasus Partners IV, L.P., PCA LSG Holdings, LLC and LSGC Holdings II LLC (previously filed as Exhibit 10.3 to the Current Report on Form 8-K filed on June 1, 2012, File No. 0-20354, and incorporated herein by reference).
Exhibit
Number
Description
10.31
Commitment Agreement, dated as of September 25, 2012, by and between Lighting Science Group Corporation and Pegasus Partners IV, L.P. (previously filed as Exhibit 10.5 to the Current Report on Form 8-K filed on September 27, 2012, File No. 0-20354, and incorporated herein by reference).
10.32
Form of Indemnification Agreement (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on June 14, 2012, File No. 0-20354, and incorporated herein by reference).
10.33
Mutual General Release Agreement, dated September 11, 2015, by and between Lighting Science Group Corporation and RW LSG Holdings LLC (previously filed as Exhibit 10.3 to the Current Report on Form 8-K filed on September 17, 2015, File No. 0-20354, and incorporated herein by reference).
10.34+
Employment Agreement, dated as of August 28, 2014, between Lighting Science Group Corporation and Edward Bednarcik (previously filed as Exhibit 10.56 to the Annual Report on Form 10-K filed on March 31, 2015, File No. 0-20354, and incorporated herein by reference).
10.35+
Employment Agreement, dated as of September 23, 2014, between Lighting Science Group Corporation and Wayne Nesbit (previously filed as Exhibit 10.57 to the Annual Report on Form 10-K filed on March 31, 2015, File No. 0-20354, and incorporated herein by reference).
10.36+
Employment Agreement, dated as of October 20, 2015, between Lighting Science Group Corporation and Fredric Maxik (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on October 26, 2015, File No. 0-20354, and incorporated herein by reference).
10.37+
Offer Letter, dated March 4, 2016, between Lighting Science Group Corporation and Mark D. Gorton (previously filed as Exhibit 10.1 to the Current Report on Form 8-K filed on April 1, 2016, File No. 0-20354, and incorporated herein by reference).
10.38+
Offer Letter, dated August 31, 2016, between Lighting Science Group Corporation and Denis M. Murphy (previously filed as Exhibit 10.4 to the Quarterly Report on Form 10-Q filed on November 14, 2016, File No. 0-20354, and incorporated herein by reference).
21.1*
Subsidiaries of Lighting Science Group Corporation.
31.1*
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of Principal Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**
Certification of Principal Executive Officer and Principal Financial and Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
* Filed herewith.
**
The certifications attached as Exhibit 32.1 are not deemed “filed” with the SEC and are not to be incorporated by reference into any filing of Lighting Science Group Corporation under the Securities Act or the Exchange Act, whether made before or after the date of this Annual Report on Form 10-K, regardless of any general incorporation language in such filing.
+ Management contract or compensatory plan or arrangement.