Item 1. Business.
GENERAL
We are an innovator and leading provider of light emitting diode (“LED”) lighting technology. We design, develop, manufacture and market advanced illumination products 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 light and color are 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 mission is to lead the convergence of science and light to improve both the environment and human health and wellbeing. We design our lighting technology to consume less electricity for each unit of the 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.
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 distinctive ability to manage the interrelationships between components and subsystems. This system-based approach enables us to provide a broad range of products that deliver a high quality combination of lighting efficacy and reliability.
Our customers include leading retailers and original equipment manufacturers (“OEMs”) such as The Home Depot, Inc. (“The Home Depot”) and Standard Products, Inc. (“Standard Products”), which sell our products on a co-branded or private label basis. Notably, we are The Home Depot’s preferred product partner for LED retrofit lamps, which are currently sold under its EcoSmart® brand. We have also partnered with Google to develop intelligent lighting products controllable through the Android@Home platform. Large retail, hospitality and other corporate customers also purchase products from us directly. In addition, our luminaires are installed in large-scale infrastructure projects throughout the world.
CORPORATE INFORMATION AND HISTORY
We were incorporated in the state of Delaware in 1988. Unless expressly indicated or the context requires otherwise, the terms “Lighting Science Group,” “we,” “us,” “our” or the “Company” in this Form 10-K refer to Lighting Science Group Corporation or, as applicable, its predecessor entities and, where appropriate, its wholly-owned subsidiaries. Our principal executive offices are located at 1227 South Patrick Drive, Building 2A, Satellite Beach, Florida 32937, 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 IV”), LED Holdings, LLC (“LED Holdings”), LSGC Holdings II, LLC (“Holdings II”) and PCA LSG Holdings, LLC (“PCA Holdings”).
INDUSTRY BACKGROUND
A 2013 industry report estimated that in North America, Europe and Asia, the share of the lighting market, on a dollar value basis, represented by LEDs will rise to around 45% in 2016 and around 70% in 2020, including both new fixture installations and light source replacements, and to around 35% in 2016 and between 55-60% in 2020 in Latin America, the Middle East and Africa.
According to the U.S. Department of Energy (“DOE”), LEDs are the most promising technology for reducing energy consumption as lighting is estimated to account for approximately 25% of all U.S. electricity consumption. We believe that the continuing improvements in LED product efficacy and light quality, coupled with reductions in the purchase price, will further reduce the total cost of ownership and accelerate adoption of LEDs for general illumination purposes. Other catalysts expected to play a significant role in adoption are: (i) consumer and governmental focus on energy efficiency and environmental sustainability; (ii) demand for enhanced lighting functionality, (iii) design differentiation enabled by the smaller size, lower heat output, longer lifetime, dimmability, and wireless controllability, (iv) financial incentives for energy efficient technologies from government and utility rebates, and (v) government regulations restricting incandescent bulb sales in the United States and the European Union.
OUR PRODUCTS
We have an extensive product portfolio with three distinct offerings-replacement lamps, luminaires and biological lighting. The products in each of these offerings achieve a unique combination of scientific innovation, lumen distribution and energy efficiency. We expect our lamp and luminaire offerings to be enhanced by our planned introduction of several new products during 2014 that will provide improved performance 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 range of dimmable LED retrofit lamps possess consistent color and delivers 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 name as well as co-branded (for The Home Depot) and private label (for Standard Products) retrofit lamps offered directly to our customers and through distributors across North America.
Luminaires. We offer LED luminaires that combine energy efficiency, long life span and enhanced light distribution, making them ideal for street lighting and in parking garages, outdoor areas, warehouses and manufacturing areas. Our industrial product line includes: (i) PROLIFIC® Series Roadway Luminaires, (ii) Roadmaster™ Roadway Luminaires, (iii) C2D™ LowBay and BayLight luminaires for use in parking garages and (iv) the Forefront® Wall Pack luminaires for use in area, pathway and security lighting.
Biological Lighting. Biological lighting solutions include our circadian, coastal and grow lighting products. In 2013 we launched our Good Night™ and Awake & Alert™ replacement lamps, the MyNature™ Coastal lamps and outdoor luminaires and the MyNature™ Grow lighting lamps and high bay luminaires. Traditional lights have a high level of blue light that causes photo receptors in the eye to suppress the body’s natural production of melatonin. At night, this disrupts the sleep cycle and can negatively affect health. The GoodNight light has a patented spectral filter that greatly reduces blue light and supports the body’s natural melatonin production. The Awake&Alert light has a blue enriched spectrum to naturally enhance the body’s energy and alertness. Our Good Night™ and Awake & Alert™ lighting solutions have been adopted by Miraval® Resort and Six Senses® Resorts and are scheduled to be installed at the International Space Station in 2015. Our Coastal lighting solutions have been installed at Patrick Air Force Base and other locations along Florida’s east coast. There are also numerous commercial and academic greenhouses and growing facilities across the United States and Canada that have implemented our Grow lighting 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. 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 following market segments.
Government-owned and private infrastructure. Public and private infrastructure includes outdoor facilities and spaces that are managed by government and private entities. Primary applications in this market include lighting for streets and highways, parking lots, airports, ports, utilities and other large outdoor areas. Street and highway lighting represents the largest segment within the infrastructure market where the number of street and area lights in the United States alone is estimated at over 100 million fixtures.
Schools and universities. Buildings and outdoor lighting for primary, secondary and higher education represent a significant market opportunity for our energy-efficient solutions. This is due in part to 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.
Retail and hospitality. The market for lighting in the retail and hospitality environment is large and varied and we believe our biological lighting and lighting technology whose light and color are tuned to achieve specific biological effects give us a distinct advantage. We have lighting products suited for 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 retailers have replaced their existing lighting with our LED retrofit lamps and luminaires.
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 leading OEMs that resell them under their own brands both directly to end-users and into retail channels such as home centers. We also have a comprehensive assortment under the Lighting Science brand.
SALES CHANNELS
We employ a multi-faceted channel strategy that addresses distinct market opportunities through branded and co-branded private label programs, our direct sales force, distributors and independent sales agents.
Our strategic account management team focuses on developing new business alliances and managing our existing branded lighting and OEM relationships, such as with The Home Depot whose brand recognition and retail footprint are important for us to access residential and commercial customers. In addition to its business development initiatives, our strategic account management team seeks to expand our revenues 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. 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 all of the components and subsystems that make up our products, but also add capabilities such as controls, adaptability and biological technology. These 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. We dedicate significant financial and personnel resources toward the development of new materials and methods related to our components and subsystems.
Our research and development team is comprised of approximately 30 research scientists and engineers 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 and Oak Ridge National Laboratory, as well as leading technology-oriented companies such as Bayer AG, Google and National Semiconductor Corporation. In addition, we have funded and continue to fund other research including advanced material processing and biological effects of lighting on plants and animals, including a recent study performed at Harvard investigating the effects of lighting on human sleep patterns.
Research and development expenses for the years ended December 31, 2013, 2012 and 2011 were $10.3 million, $10.1 million and $10.7 million, respectively. We expense all of our research and development costs as they are incurred. Research and development expense is 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.
SUPPLIERS AND RAW MATERIALS
The principal materials used in the manufacture and assembly of our products are packaged LEDs and printed circuit boards, metal-oxide-semiconductor field-effect transistors (“MOSFETs”), magnetics and standard electrical components such as capacitors, resistors and diodes used in our power supplies. We source other materials that are manufactured to our precise specifications, such as aluminum heat sinks for our thermal management systems, plastic optics, as well as aluminum and plastic structural elements. 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. We obtain our other components, materials and subsystems from multiple suppliers in North America and Asia.
MANUFACTURING AND ASSEMBLY
We manage the development of our products from concept to sale, while utilizing a combined approach to production that includes in-house resources in the United States and contract manufacturers in the United States and Asia, to produce and assemble our products. In August 2013, we transitioned production of certain products from our contract manufacturer in Mexico to our headquarters in Satellite Beach, Florida and to our contract manufacturers in Asia. We expect to shift a majority of our product manufacturing to our contract manufacturers in Asia during the first half of 2014.
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, provide entry points for new competitors and create 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, as well as on product cost. In addition to the aforementioned factors, which generally contribute to a lower total cost of ownership and enhanced product quality, we offer our customers a broad product portfolio and have access to strong retail channels through our OEM relationships. Our product design approach, proprietary technology and deep understanding of lighting applications aids our ability to compete in all of these arenas.
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, 2013, we had filed 309 U.S. patent applications covering various inventions related to the design and manufacture of LED lighting technology. From these applications, 181 U.S. patents were issued, 106 were pending approval and 22 were no longer active as of December 31, 2013. During 2013 alone, we filed 76 U.S. patent applications and 33 U. S. patents were issued. 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.
The LED 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 providers in serving sophisticated customers. As is customary in the LED 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 resources to defend against the claim and/or develop non-infringing technology, seek a license or relinquish patents or other intellectual property rights.
REGULATIONS, STANDARDS AND CONVENTIONS
Our products are generally required to comply with and satisfy the electrical codes of the jurisdictions in which they are sold. Our products are designed to meet the typically more stringent codes established in the United States and the European Union, which usually allows our products to meet the codes in other geographic regions.
Many of our customers require our products to be certified by Underwriters’ Laboratories, Inc. (“UL”). UL is a United States-based independent, nationally recognized testing laboratory, third-party product safety testing and certification organization. UL develops standards and test procedures for products, materials, components, assemblies, tools and equipment, chiefly 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.
EMPLOYEES
As of December 31, 2013, we had 177 employees in the United States, of which 176 were full-time, and 18 full-time employees outside the United States, primarily in India. We also utilized 237 temporary employees for our Satellite Beach manufacturing operations and 10 contractors as of December 31, 2013, eight of which were in the United States. 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, 2013, 2012 and 2011, we had revenue of $83.2 million, $127.1 million and $109.0 million, respectively, and as of December 31, 2013, we had accumulated a deficit of $734.7 million. In addition, we have negative working capital of $19.7 million as of December 31, 2013. 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.
We believe we will have sufficient capital to fund our operations for at least the next 12 months based on our current business plan and the assumptions set forth therein. Our current business plan includes a focus on increasing revenue by updating and expanding our product offerings and capitalizing on the known product needs of our existing customers, improving gross margins by significantly leveraging contract manufacturers in Asia and reducing operating costs, primarily through the restructuring initiated in 2013. In future periods, if we do not adequately execute upon our business plan or if our assumptions or forecasts do not prove to be accurate, we could exhaust our available capital resources, which could require us to seek additional sources of liquidity, which may not be available in an amount or on terms that are acceptable to us, or we could be required to further reduce our expenditures to preserve our cash.
We have yet to achieve positive cash flow, and our ability to generate positive cash flow is uncertain. If we are unable to obtain sufficient capital when needed, our business and future prospects will be adversely affected and we could be forced to suspend or discontinue operations.
Our operations have not generated positive cash flow for any reporting period since our inception, and we have funded our operations primarily through the issuance of common and preferred stock and short-term and long-term debt. We had significant revenue growth from 2009 through 2012, but we had a decrease in revenue in 2013 compared to 2012 and our limited operating history makes an evaluation of our future prospects difficult. 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, the success of our marketing strategy, market acceptance of our products, the success of our manufacturing and research and development efforts and the transition of our product manufacturing to our contract manufacturers (including any unanticipated delays), our manufacturing and labor costs, 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 flow from operations turns positive will depend on our ability to continue to raise funds through public or private sales of shares of our capital stock or through debt. Through February 19, 2014, we had an asset-based lending facility (the “Wells Fargo ABL”) with Wells Fargo Bank, N.A. (“Wells Fargo”) and a Second Lien Letter of Credit Facility (the “Ares Letter of Credit Facility”) with Ares Capital Corporation (“Ares Capital”). The Wells Fargo ABL provided us with borrowing capacity of up to a maximum of $50.0 million, which capacity is equal to the sum of (i) 85% of our eligible accounts receivable plus $7.5 million of eligible inventory less certain allowances established against such accounts receivable and inventory by Wells Fargo from time to time pursuant to the Wells Fargo Facility, plus (ii) unrestricted cash held in a Wells Fargo deposit account (“Qualified Cash”), plus (iii) the amount of the Ares Letter of Credit Facility. On February 19, 2014, we entered into a $30.5 million five-year term loan (the “Medley Term Loan”) and a two-year delayed draw term loan (the “Medley Delayed Draw Loan”) with Medley Capital Corporation (“Medley”). The Medley Delayed Draw Loan provides us with borrowing capacity of up to a maximum of $22.5 million, which capacity is limited by a borrowing base equal to the sum of (i) 85% of our eligible accounts receivable (ii) 60% of eligible inventory, and (iii) qualified cash less any reserves imposed by Medley. We utilized proceeds from the Medley Term Loan to repay our outstanding obligations under the Wells Fargo ABL and the Ares Letter of Credit Facility. As of December 31, 2013, the balance outstanding on the Wells Fargo ABL was approximately $40.2 million and we had approximately $4.8 million of additional borrowing capacity.
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 Capital for our liquidity needs because other sources of liquidity have been insufficient or unavailable to meet our needs. If we are able to raise funds by selling additional shares of our common stock or securities convertible or exercisable into our common stock, the ownership interest of our existing stockholders will be diluted. If we are unable to obtain sufficient outside capital when needed, our business and future prospects will be adversely affected and we could be forced to suspend or discontinue operations.
If we are unable to manage any future growth effectively, our profitability and liquidity could be adversely affected.
Our revenue growth in prior years placed a significant strain on our limited research and development, selling, distribution and administrative resources and our projected growth may continue to challenge these resources. To manage any future growth, we must continue to improve our operational and financial systems and expand, train and manage our employee base. We also need to continue to improve our supply chain management and quality control operations and hire and train new employees in sales and marketing. If we are unable to manage our growth effectively, our profitability and liquidity could be adversely affected.
We may experience difficulties in the transfer of production capabilities to our contract manufacturers.
We continue to streamline our operations as we transfer our manufacturing processes to our contract manufacturers in Asia. However, we will only benefit from such transition to the extent that our contract manufacturers can produce our products at competitive prices with similar product quality. Uncertainty is inherent within the transfer of our manufacturing process, and unforeseen circumstances could offset the anticipated benefits, disrupt service to customers and impact product quality.
The LED lighting industry is characterized by constant and rapid technological change, product obsolescence, price erosion, evolving standards, short product life cycles and fluctuations in supply and demand. If we fail to anticipate and adapt to these changes and fluctuations, our sales, gross margins and profitability will be adversely affected.
In the LED lighting industry, rapid technological changes and short product life cycles often lead to price erosion and product obsolescence. Companies within the LED lighting industry are continuously developing new products with heightened performance and functionality, putting pricing pressure on existing products. Further, the industry has experienced significant fluctuations, often in connection with, or in anticipation of, product cycles and changes in general economic conditions. These fluctuations have been characterized by lower product demand, production overcapacity, higher inventory levels and increased pricing pressure. Our failure to accurately anticipate the introduction of new technologies or adapt to fluctuations in the industry can, as it has in the past, lead to our having significant amounts of obsolete inventory that can only be sold at substantially lower prices and profit margins than anticipated. Pricing pressure and obsolescence also cause the stated value of our inventory to decline. For the years ended December 31, 2013, 2012 and 2011, we recorded an inventory valuation allowance of $11.4 million, $15.8 million and $20.5 million, respectively, and a provision for expected losses on non-cancellable purchase commitments of $2.3 million, $5.6 million and $8.5 million, respectively. In addition, if we are unable to develop planned new technologies or if the transition of our manufacturing operations are unsuccessful, we may be unable to compete effectively due to our failure to offer products most demanded by the marketplace. If any of these failures occur, our sales, gross margins and profitability will be adversely affected.
If our developed technology or technology under development does not achieve market acceptance, prospects for our growth and profitability would be limited.
Our future success depends on continued market acceptance of our LED technology and the technology currently under development. Although adoption of LED lighting continues to grow, adoption of LED lighting products for general illumination is in its early stages, is still limited and faces significant challenges. Potential
customers may be reluctant to adopt LED lighting products as an alternative to traditional lighting technology because of its higher initial cost or perceived risks relating to its novelty, reliability, usefulness, light quality and cost-effectiveness when compared to other established lighting sources available in the market. Changes in economic and market conditions may also affect the marketability of some traditional lighting technologies such as declining energy prices in certain regions or countries may favor existing lighting technologies that are less energy efficient, reducing the rate of adoption for LED lighting products in those areas. Moreover, if existing sources of light other than LED lighting products achieve or maintain greater market adoption, or if new sources of light are developed, our current products and technologies could become less competitive or obsolete. Even if LED lighting products continue to achieve performance improvements and cost reductions, limited customer awareness of the benefits of LED lighting products, lack of widely accepted standards governing LED lighting products and customer unwillingness to adopt LED lighting products in favor of entrenched solutions could significantly limit the demand for LED lighting products and adversely impact our results of operations.
If we are unable to effectively develop, manage and expand our sales and distribution channels for our products, our operating results may suffer.
We sell a substantial portion of our products to retailers and OEMs who then sell our products on a co-branded or private label basis. Orders from our retail and OEM customers are dependent upon their internal target inventory levels for our products which can vary significantly based upon current and projected market cycles and other factors over which we typically have very little, if any, control. We rely on these retailers and OEMs to develop and expand the customer base for our products and to accurately forecast demand from their customers. If they are not successful in either task, our growth and profitability may be adversely impacted.
We rely on our relationship with The Home Depot, and the loss of this material relationship or any other significant relationship would have a material adverse effect on our results of operations, our future growth prospects and our ability to distribute our products.
We form business relationships and strategic alliances with retailers and other lighting companies to market our products, generally under private or co-branded labels. In certain cases, such relationships are important to our introduction of new products and services, and we may not be able to successfully collaborate or achieve expected synergies with these retailers or lighting companies. We do not control these retailers or lighting companies and they may make decisions regarding their business undertakings with us that may be contrary to our interests, or may terminate their relationships with us altogether. In addition, if these retailers or lighting companies change their business strategies, for example due to business volume fluctuations, mergers and acquisitions and/or performance issues, fail to pay or terminate the relationship altogether, our business could be adversely affected.
For the years ended December 31, 2013, 2012 and 2011, The Home Depot accounted for 55%, 48% and 32% of our net sales, respectively. While we anticipate The Home Depot will remain a significant customer in 2014, our contractual commitment with The Home Depot is also not long term in nature. Specifically, our Strategic Purchasing Agreement with The Home Depot was amended on August 12, 2013 to, among other things, extend the term of the agreement until July 2016, but may be terminated earlier by The Home Depot for any reason upon 180 days written notice to us. At this point, there are no indications that our Strategic Purchasing Agreement with The Home Depot will not be renewed. A loss of The Home Depot as a customer or a significant decline in their purchases or their failure to pay us would have a material adverse effect on our results of operations, our future growth prospects and our ability to distribute our products.
The Home Depot has required, and we expect will continue to require, increased service and order accommodations as well as incremental promotional investments. We may face increased expenses to meet these demands, which would reduce our margins. In addition, we generally have little or no influence on The Home Depot’s promotional or pricing policies, which may impact our sales volume to them. In addition, our Strategic Purchasing Agreement with The Home Depot does not require them to purchase a minimum quantity of products from us. We issued a Warrant to The Home Depot that included incentive-based vesting conditions through 2015 based on annual 20% increases in product purchases made under the Strategic Purchasing Agreement. For both 2011 and 2012, the 20% volume increase was reached and The Home Depot vested in warrants to purchase a total of 2,049,486 shares of common stock at an exercise price of $1.95 per share. However, The Home Depot did not purchase a sufficient quantity of products from us to achieve the incentive-based vesting condition for 2013.
We may be unable to profitably manufacture 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 to cover rising costs of components and raw materials or we may be limited in our ability to increase prices to improve our margins. Even if component and raw material costs were to decline, lower prices offered by competitors may not allow us to hold prices at their current levels, which could negatively impact both net sales and gross margins.
Our products may contain defects that could reduce sales, result in costs associated with the recall of those items and result in claims against us.
The manufacture of our products involves highly complex processes. Despite testing by us 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 year ended December 31, 2013, we incurred a $2.0 million increase in warranty expense as compared to the year ended December 31, 2012 primarily related to an increase in the number of products returned under our standard warranty and the estimate related to failure rates on two of our replacement lamps 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 at our own facility or 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. Our recent decision to transition our manufacturing away from our contract manufacturer in Mexico to our contract manufacturers in Asia, as well as our plans to expand to other contract manufacturers, may subject us to additional risks as we scale these operations. 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;
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our ability to effectively establish adequate management information systems, financial controls and supply chain management and quality control procedures; and
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the occurrence of equipment failures, power outages, environmental risks or variations in the manufacturing process.
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 many 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 many 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 or offsetting internal manufacturing processes could be implemented. Any significant shortages or interruption may cause us to be unable to timely deliver sufficient quantities of our products to satisfy our contractual obligations and particular revenue expectations. Moreover, even if we timely locate substitute products, if their price materially exceeds the original expected cost of such products, our margins and results of operations would be adversely affected.
Furthermore, to qualify new contract manufacturers, familiarize them with our products, quality standards and other requirements and commence volume production may be a costly and time-consuming process. If we are required or choose to change contract manufacturers for any reason, our revenue, gross margins and customer relationships could be adversely affected.
Our issuances of Series H Convertible Preferred Stock, Series I Convertible Preferred Stock and Series J Convertible Preferred Stock may limit our ability to raise additional capital and/or take certain corporate action.
Between May 25 and September 25, 2012, we issued an aggregate of 114,051 shares of our Series H Convertible Preferred Stock, par value $0.001 per share (“Series H Preferred Stock”) and 62,365 shares of our Series I Convertible Preferred Stock, par value $0.001 per share (“Series I Preferred Stock”). Between September 11, 2013 and March 7, 2014, we issued an aggregate of 37,475 shares of our Series J Convertible Preferred Stock, par value $0.001 per share (“Series J Preferred Stock”, and together with the Series H Preferred Stock and Series I Preferred Stock, the “Preferred Shares”). The Certificates of Designation governing the Preferred Shares limit our ability to take certain actions, 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 $50.0 million; or (B) that includes any provision that would limit our ability to redeem any Preferred Shares for a period that exceeds that contained in the Wells Fargo ABL or Ares Letter of Credit Facility;
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issue any equity securities having an aggregate value in excess of $15.0 million;
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enter into any new agreements or transactions with any of our affiliates or any holder of five percent (5%) or more of our common stock or any affiliates of any such stockholder or amend or modify the terms of any such agreements then-existing; 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.
Further, the Certificates of Designation governing the Series H Preferred Stock and Series I Preferred Stock require us to have consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) that is at least $20.0 million for the year ended December 31, 2015 and each year thereafter. A breach of the terms of the Preferred Shares could entitle each holder to redeem their Preferred Shares, which could have a material adverse effect on our liquidity and financial condition.
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 and we depend on our suppliers for 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, MOSFETS, 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 industry is highly competitive and if we are not able to compete effectively, including against larger lighting manufacturers with greater resources, our prospects for future success will be jeopardized.
Our industry is highly competitive. We face competition from both traditional lighting technologies provided by numerous vendors as well as from LED-based lighting products provided by a growing roster of industry participants. The LED lighting industry is characterized by rapid technological change, short product lifecycles and frequent new product introductions and a competitive pricing environment. These characteristics increase the need for continual innovation and provide entry points for new competitors as well as opportunities for rapid share shifts.
Currently, we view our primary competition to be from large, established companies in the traditional general lighting industry. Certain of these companies also provide, or have undertaken initiatives to develop, LED lighting products as well as other energy efficient lighting products. Additionally, we face competition from a fragmented group of smaller niche or low-cost offshore providers of LED lighting products. We also anticipate that larger LED chip manufacturers, including some of those that currently supply us, may seek to compete with us by introducing more complete retrofit lamps or luminaires. We also expect other large technology players with packaged LED chip technology that are currently focused on other end markets for LEDs, such as backlighting for LCD displays, to increasingly focus on the general illumination market as their existing markets saturate and LED use in general illumination grows. In addition, we may compete in the future with vendors of new technological solutions for energy efficient lighting.
Some of our current and future competitors are larger companies with greater resources to devote to research and development, manufacturing and marketing, as well as greater brand name recognition. Some of our more diversified competitors could also compete more aggressively with us by subsidizing losses in their LED lighting businesses with profits from other lines of business. Moreover, if one or more of our competitors or suppliers were to merge with one another, the change in the competitive landscape could adversely affect our customer, channel or supplier relationships or our competitive position. Additionally, any loss of a key channel partner, whether to a competitor or otherwise, could severely and rapidly damage our competitive position. To the extent that competition in our markets intensifies, we may be required to reduce our prices in order to remain competitive. If we do not compete effectively, or if we reduce our prices without making commensurate reductions in our costs, our revenue, gross margins and profitability and our future prospects for success, may be harmed.
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, and any reduction of manufacturing capacity could have long-term implications on our ability to accommodate future demand. As a result of these factors, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance.
Our debt obligations contain restrictions that impact our business and expose us to risks that could adversely affect our liquidity and financial condition.
On February 19, 2014, we entered into the Medley Term Loan and Medley Delayed Draw Loan, which provides us with borrowing capacity of up to a maximum of $22.5 million, which capacity is limited by a borrowing base equal to the sum of (i) 85% of our eligible accounts receivable (ii) 60% of eligible inventory, and (iii) qualified cash less any reserves imposed by Medley. We utilized proceeds from the Medley Term Loan to repay our outstanding obligations under the Wells Fargo ABL and the Ares Letter of Credit Facility. As of December 31, 2013, the balance outstanding on the Wells Fargo ABL was approximately $40.2 million and we had approximately $4.8 million of additional borrowing capacity.
Borrowings under the Medley Term Loan and Medley Delayed Draw Loan are secured by substantially all of our assets and our material wholly-owned subsidiaries (subject to certain permitted liens) and may be used for working capital requirements and other general corporate purposes. We may replace the Delayed Draw Term Loan 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 Medley.
If we are unable to generate sufficient cash flow or otherwise obtain the funds necessary to make required payments under the Medley Term Loan and Medley Delayed Draw Loan, or if we fail to comply with the requirements of our indebtedness, we could default under these facilities. Any default that is not cured or waived could result in the acceleration of the obligations under these facilities, an increase in the applicable interest rate under these facilities and a requirement that our subsidiaries that have guaranteed these facilities pay the obligations in full, and would permit our lenders to exercise remedies with respect to all of the collateral securing these facilities, including substantially all of our and our subsidiary guarantors’ assets. Any such default could have a material adverse effect on our liquidity and financial condition. Additionally, the covenants in such agreements or future debt agreements may restrict the conduct of our business, which could adversely affect our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that may be beneficial to the business.
If we are unable to obtain and protect our intellectual property rights, our ability to commercialize our products could be substantially limited.
As of December 31, 2013, we had filed 309 U.S. patent applications covering various inventions related to the design and manufacture of LED lighting technology. From these applications, 181 U.S. patents had been issued, 106 were pending approval and 22 were no longer active. 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. Our patent applications may not be granted. Because patents involve complex legal, technical and factual questions, the issuance, scope, validity and enforceability of patents cannot be predicted with certainty. 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.
Failure to maintain effective internal controls could have a material adverse effect on our operations and our stock price.
We are subject to Section 404 of the Sarbanes-Oxley Act of 2002, which requires an annual management assessment of the effectiveness of our internal control over financial reporting. Effective internal controls are necessary for us to produce reliable financial reports, and failure to achieve and maintain effective internal controls over financial reporting could cause investors to lose confidence in our operating results, and could have a material adverse effect on our business and on the price of our common stock. Because of our status as a smaller reporting company registrant as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended, or 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.
For the years ended December 31, 2013 and 2012, we concluded that our disclosure controls and procedures were effective in achieving management’s desired controls and procedures objectives in our internal control over financial reporting. However, during the evaluation of disclosure controls and procedures for the year ended December 31, 2011, we concluded that our disclosure controls and procedures were not effective in reaching a reasonable level of assurance of achieving management’s desired controls and procedures objectives in our internal control over financial reporting. We believe that many of the previously observed material weaknesses resulted from our position as a small company with immature processes and inadequate staffing in our financial accounting and reporting functions to support our rapid growth. Over the last few years we have endeavored to enhance our reporting and control standards to accommodate this growth.
We plan to continue to assess our internal controls and procedures and intend to take further action as necessary or appropriate to address any other deficiencies we may identify. The process of designing and implementing effective internal controls and procedures is a continuous effort, however, that requires us to anticipate and react to changes in our business and economic and regulatory environments. Additionally, we or our independent registered public accounting firm may identify additional deficiencies or weaknesses. Complying with the requirements to maintain internal controls may place a strain on our personnel, information technology systems and resources and divert management’s attention from other business concerns.
Certification and compliance are important to the sale and adoption of our lighting products, and failure to obtain such certification or compliance would harm our business.
We are required to comply with certain legal requirements governing the materials used in our products. Although we are not aware of any efforts to amend existing legal requirements or implement new legal requirements in a manner with which we cannot comply, our revenue might be materially harmed if such changes were to occur. Moreover, although not legally required to do so, we strive to obtain certification for substantially all of our products. In the United States, we seek, and to date have obtained, certification for substantially all of our products from UL. We design our products to be UL/cUL and Federal Communications Commission compliant. We have also obtained ENERGY STAR qualification for 102 of the products that we were producing as of December 31, 2013. 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. If we continue to grow, we will need to add additional management and other personnel. Our success will depend on our ability to attract and retain highly skilled personnel including a new Chief Executive Officer and our efforts to obtain or retain such personnel may not be successful.
Our international operations are subject to legal, political and economic risks.
Our financial condition, operating results and future growth could be significantly affected by risks associated with our international activities, including economic and labor conditions, political instability, laws (including U.S. taxes on foreign subsidiaries), changes in the value of the U.S. dollar versus foreign currencies, differing business cultures, foreign regulations that may conflict with domestic regulations, intellectual property protection and trade secret risks, differing contracting process including the ability to enforce agreements, increased dependence on foreign manufacturers, shippers and distributors and import and export restrictions and tariffs.
Compliance with U.S. and foreign laws and regulations that apply to our international operations, including import and export requirements, anti-corruption laws, including the Foreign Corrupt Practices Act, tax laws (including U.S. taxes on foreign subsidiaries), foreign exchange controls, anti-money laundering and cash repatriation restrictions, data privacy requirements, labor laws and anti-competition regulations, increases the costs of doing business in foreign jurisdictions, and any such costs, which may rise in the future as a result of changes in these laws and regulations or in their interpretation. We have not implemented formal policies and procedures designed to ensure compliance with these laws and regulations. Any such violations could individually or in the aggregate materially adversely affect our reputation, financial condition or operating results.
RISKS RELATED TO OWNERSHIP OF OUR COMMON STOCK
Our common stock has been thinly traded and an active trading market may not develop.
The trading volume of our common stock has historically been low, partially because we are not listed on an exchange and our common stock is only traded on the over-the-counter bulletin board (the “OTC Bulletin Board”). In addition, our public float has been further limited due to the fact that the vast majority of our outstanding common stock has historically been beneficially owned by affiliates of Pegasus Capital. Until we
initiate a public offering of our common stock or are approved for listing on a national exchange, a more active trading market for our common stock may not develop, or if developed, may not continue, and a holder of any of our securities may find it difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock.
We are controlled by Pegasus Capital, whose interests in our business may be different from yours.
Affiliates of Pegasus Capital beneficially owned approximately 87.2% of our common stock as of March 25, 2014. As a result of this ownership, Pegasus Capital has a controlling influence on our affairs and its voting power constitutes a quorum of our stockholders voting on any matter requiring the approval of our stockholders. Such matters include the nomination and election of directors, the issuance of additional shares of our capital stock or payment of dividends, the adoption of amendments to our certificate of incorporation and bylaws and approval of mergers or sales of substantially all of our assets. This concentration of ownership may also have the effect of delaying or preventing a change in control of our company or discouraging others from making tender offers for our shares, which could prevent stockholders from receiving a premium for their shares. Pegasus Capital may cause corporate actions to be taken even if the interests of Pegasus Capital conflict with the interests of our other stockholders.
If we applied and our shares were approved for listing on a national stock exchange, we intend to elect to be considered a “controlled company” which would exempt us from certain corporate governance requirements, including the requirement that a majority of our board of directors meet the specified standards of independence and the exemption from the requirement that we have a compensation and governance committee made up entirely of directors who meet such independence standards. Such independence standards are intended to ensure that directors who meet the independence standard are free of any conflicting interest that could influence their actions as directors. It is possible that the interests of Pegasus Capital may in some circumstances conflict with our interests and the interests of our other stockholders, including you.
Because our stock price is volatile, it can be difficult for stockholders to predict the value of our shares at any given time.
The price of our common stock has been and may continue to be highly volatile, which makes it difficult for stockholders to assess or predict the value of their shares. A number of factors may affect the market price of our common stock, including, but not limited to:
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changes in expectations as to our future financial performance;
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announcements of technological innovations or new products by us or our competitors;
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announcements by us or our competitors of significant contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
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changes in laws and government regulations;
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developments concerning our proprietary rights;
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public perception relating to the commercial value or reliability of any of our lighting products;
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future sales of our common stock or issues of other equity securities convertible into or exercisable for the purchase of common stock;
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our involvement in litigation;
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the acquisition or divestiture by Pegasus Capital or its affiliates of part or all of its holdings; and
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general stock market conditions.
Securities analysts may not provide coverage of our common stock or may issue negative reports, which may have a negative impact on the market price of our common stock.
Securities analysts have not historically provided research coverage of our common stock and may elect not to do so in the future. If securities analysts do not cover our common stock, the lack of research coverage may cause the market price of our common stock to decline. The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about our business. If one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline substantially. If one or
more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, rules mandated by the Sarbanes-Oxley Act of 2002 and a global settlement reached in 2003 between the SEC, other regulatory agencies and a number of investment banks have led to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many investment banking firms are required to contract with independent financial analysts for their stock research. It may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.
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 Medley Delayed Draw Loan 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 Capital or its affiliates), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.
Item 2.
Item 2. Properties.
Our principal administrative, sales and marketing and research and development operations, and certain of our assembly and manufacturing activities are located at our Satellite Beach, Florida headquarters. Until November 2013, we also maintained a sales office in Middelburg, The Netherlands and paid monthly rent of $3,037.
As of March 25, 2014, we occupied leased office and industrial space in the following locations:
Item 3.
Item 3. Legal Proceedings.
On June 22, 2012, Geveran Investments Limited (“Geveran”), one of our stockholders, 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 defendants, as well as Pegasus Capital and nine other entities affiliated with Pegasus Capital; Richard Weinberg, our former Director and former interim Chief Executive Officer and a former partner of Pegasus Capital; Gregory Kaiser, our 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 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. In February 2014, Geveran filed a motion to amend their first amended complaint, seeking to assert a claim for punitive damages against the defendants; that motion is currently pending before the court. The case is currently in the discovery stage.
We have retained counsel, deny liability in connection with this matter and intend to vigorously defend against the claims asserted by Geveran. While the case is in its early stages and the outcome of any litigation is inherently difficult to predict, we currently believe that we have strong defenses against Geveran’s claims. Nonetheless, the amount of possible loss, if any, cannot be reasonably estimated at this time. The outcome, if unfavorable, could 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 insurance coverage will be available to cover our legal fees and costs in this matter. However, given the unspecified nature of Geveran’s maximum damage claims, 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. We have also been paying, and expect to continue to pay, the 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 our private placement with Geveran. Such payments are not covered by our insurance coverage. The engagement letter 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.
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.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
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 “LSCG.OB.” Our common stock last traded at $0.39 on March 25, 2014, and there were approximately 272 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 broker “street names” for the benefit of individual investors. As of March 25, 2014, there were 207,850,113 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.
EQUITY COMPENSATION PLAN INFORMATION
Amended and Restated Equity-Based Compensation Plan
We currently have 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. As of December 31, 2013, there were 55.0 million shares authorized for issuance under the plan and 22.1 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 must be 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.
2011 Employee Stock Purchase Plan
On February 10, 2011, our board of directors adopted the Lighting Science Group Corporation 2011 Employee Stock Purchase Program (the “2011 ESPP”).
All employees of the Company and any designated subsidiary are eligible to participate in the 2011 ESPP, subject to certain exceptions. The total number of shares of common stock that may be purchased by eligible employees under the 2011 ESPP is 2,000,000 shares, subject to adjustment. The 2011 ESPP is a qualified employee stock purchase plan under Section 423 of the Code and was approved by our stockholders at the annual meeting on August 10, 2011.
The purpose of the 2011 ESPP is to provide employees of the Company and its 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 our common stock at a discount to the market value through voluntary systematic payroll deductions. The purchase price for each purchase period will be 85% of the fair market value of a share of our common stock 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.
The following table sets forth information as of December 31, 2013, with respect to compensation plans under which shares of our common stock could have been issued.
(1) Represents shares of common stock issued pursuant to the 2011 ESPP.
(2) Represents the average purchase price for shares issued pursuant to the 2011 ESPP.
RECENT SALES OF UNREGISTERED SECURITIES
There were no unregistered securities sold by us during the year ended December 31, 2013 that were not otherwise disclosed by us during the year in our Quarterly Report on Form 10-Q or a Current Report on Form 8-K. On March 6 and March 7, 2014, we issued an aggregate of 45 shares of our Series J Preferred Stock and warrants to purchase an aggregate of 119,250 shares of common stock, with an exercise price of $0.001 per share, for aggregate proceeds of $45,000, pursuant to the exercise of preemptive rights by holders of our Series H Preferred Stock, Series I Preferred Stock and Series J Preferred Stock, in connection with our offering of Series J Preferred Stock warrants to purchase shares of our common stock previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission on January 8, 2014.
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.
CAUTIONARY STATEMENTS REGARDING FORWARD LOOKING STATEMENTS
This section and other parts of this Form 10-K contain forward-looking statements within the meaning of U.S. federal securities laws. In addition, we, or our officers on our behalf, may from time to time make forward-looking statements in reports and other documents our files with the SEC or in connection with oral statements made to the press, current and potential investors, at conferences on our website or otherwise. Forward-looking statements can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts” and similar terms and variations thereof. Forward-looking statements involve risks and uncertainties, are not guarantees of future performance and depend on many factors that are not under our control.
Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Item 1A. “Risk Factors.” Such factors include, among others, (a) projections regarding our liquidity, financial performance and capital expenditures; (b) expectations about our ability to manage uncertainty with respect to product demand, component costs, product costs and end of life-cycle plans; (c) the ability to execute on our strategic plan and realize benefits from initiatives related to streamlining our operations and introducing new products;(d) our ability to successfully identify new customers and business opportunities and retain current material customers (e) our ability to attract and retain key personnel and maintain and enhance the quality, safety and efficacy of our products; (f) general economic and business conditions in our markets and our ability to improve our gross margins and achieve profitable growth; and (g) the risk of an adverse outcome in any pending and future litigation.
Further, additional factors that could materially affect our financial results may emerge from time to time. You should not place undue reliance on any forward-looking statements, which speak only as of the date such forward-looking statements are made, and should recognize that such statements are predictions of future results, which may not occur as anticipated. We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law. The following discussion should be read in conjunction with the consolidated financial statements and related notes thereto included in Item 8.
Item 8. Financial Statements.
The financial statements required by this item are included in Part IV, Item 15 of this Annual Report.
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 Securities Exchange Act of 1934, as amended (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 subsequent to the period covered by this Form 10-K, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, 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, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of December 31, 2013 were effective at a reasonable assurance level.
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, our Chief Executive Officer and Chief Financial Officer, 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 our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on criteria established in “Internal Control-Integrated Framework (1992)” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “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, 2013.
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Below is a list of the names and ages as of March 25, 2014 of our directors and executive officers and a brief account of the experience of each of them.
Executive officers
Richard H. Davis Jr. joined our Board on November 13, 2013 and was appointed interim Chief Executive Officer on February 3, 2014. Mr. Davis joined Pegasus Capital as an Operating Partner in 2005 and became Partner and Chief Operating Officer in 2010. Mr. Davis is a member of the Executive, Investment and Compliance Committees
of Pegasus Capital. In addition, Mr. Davis served on President Ronald Reagan’s political team in three Reagan administration cabinet agencies including as White House Special Assistant to the President for the Domestic Policy Council. In his capacity in the White House, Mr. Davis managed all policy development related to climate, energy and environment. President George H.W. Bush appointed Mr. Davis Deputy Executive Director for the White House Conference on Science and Economic Research Related to Global Climate Change. In 2000 and 2008, Mr. Davis served as Senator John McCain’s national campaign manager leading all aspects of the campaign activity. While serving as Senator McCain’s chief strategist and political advisor, Mr. Davis was integral in the development of some key legislative initiatives including ground breaking climate legislation and campaign finance reform. Mr. Davis currently serves on the Board of The Environmental Defense Action Fund developing initiatives and ties to the corporate community that promotes better stewardship of the environment. Mr. Davis was designated to serve as a director by Pegasus Capital pursuant to certain designation rights held by Pegasus Capital under the Company’s Series I Preferred Stock.
We believe Mr. Davis is qualified to serve on our Board because of his extensive experience in business, relationship management, executive leadership and investing.
Jennifer Sethre was appointed as our President on February 11, 2014. Ms. Sethre founded Lumena SSL, Inc. in 2011, a commercial LED lighting products company, and served as its Chief Marketing Officer. Prior to Lumena, Ms. Sethre held various executive, marketing and product development roles, and has been involved in manufacturing products in China for the past 15 years. From January 2010 to August 2011, Ms. Sethre was founder and Chief Executive Officer of Ilio International, Inc., a producer and seller of holiday products, and from 2008 to 2011, was the founder and Chief Executive Officer of Asia Sales and Marketing, LLC, another holiday retail product seller.
Thomas C. Shields was appointed as our Chief Financial Officer on August 23, 2012. Mr. Shields brings to us over 20 years of experience in finance and operations. From 1999 to 2011, he served in various executive capacities, including chief financial officer and chief operating officer, at Anadigics, Inc., a global manufacturer of radio frequency semiconductor solutions for the wireless broadband markets. Prior to that, from 1997 to 1999, Mr. Shields was vice president of finance and controller at Thermo Fisher Scientific; from 1994 to 1997, served as vice president of finance and controller at Harman International Industries, Inc.; and from 1986 to 1994, Mr. Shields served in various executive management positions with Baker & Taylor, Inc. Mr. Shields holds a Bachelor of Science degree in Accounting and a Masters of Business Administration degree from Fairleigh Dickenson University.
Fredric Maxik has served as our Chief Technology Officer since January 2010 and from June 2004 to October 2007. Mr. Maxik served as our Chief Scientific Officer from October 2007 to January 2010. He also served as a director from August 2004 to October 2007. After graduating from Bard College with a bachelor’s degree in physics and philosophy, Mr. Maxik began his career with Sansui Electric Co., Ltd., in 1983 in Tokyo, Japan where he became vice president of product development. In 1990, he served as vice president of product development for Onkyo Corporation in Osaka, Japan. In 1993, Mr. Maxik formed a product development consulting firm. In 2002, he formed an environmental products company, which developed the intellectual property that eventually became the principal asset of Lighting Science, Inc. that was acquired by us in June 2004. Mr. Maxik has 38 U.S. patents in the field of solid state lighting. Mr. Maxik is an operating advisor for Pegasus Capital.
Directors
Craig Cogut joined our Board on December 5, 2013 and was appointed Chairman of the Board on February 3, 2014. Mr. Cogut has spent a career building successful investment businesses. Mr. Cogut founded Pegasus Capital in 1996 and serves as its Chairman and President. In 1990, Mr. Cogut co-founded and was one of the original partners at Apollo Advisors L.P., a position he held for five years preceding the creation of Pegasus Capital. Mr. Cogut is an active philanthropist in the fields of improving education, building civil society and championing environmental and health issues. Mr. Cogut serves as Chairman of The Polyphony Foundation, an organization that he co-founded to provide equal opportunity music education for Arab and Jewish Israeli youth. In addition, Mr. Cogut serves as a Trustee of Brown University and board member for Arizona State University’s Global Institute of Sustainability, for Human Rights First, for The McCain Institute for International Leadership at Arizona State University and for the R-20 Regions of Climate Action. Mr. Cogut is a member of the Executive Council of the Clinton Health Access Initiative and serves as the Chairman of The Cogut Center for the Humanities at Brown University. Mr. Cogut is an alumnus of Brown University and Harvard Law School. Mr. Cogut was designated to serve as a director by Pegasus Capital pursuant to certain designation rights held by Pegasus Capital under the Company’s Series I Preferred Stock.
We believe Mr. Cogut is qualified to serve on our Board because of his significant experience in global manufacturing and extensive experience in business, finance and investing.
Donald Harkleroad has served as a director since 2003 and served as Vice Chairman of the Board from December 2010 to May 2012. He currently serves as president of The Bristol Company, an Atlanta-based private holding company with interests in the food service, technology services, real estate and merchant banking industries. From 2003 until 2011, Mr. Harkleroad served as a director for Easylink Services International Corp., a global provider of on-demand electronic messaging and transaction services. Until its sale in 2006, he was also a founding director of Summit Bank Corporation, a commercial bank with offices in Georgia, Texas and California.
We believe Mr. Harkleroad is qualified to serve on our Board because he brings significant operating, finance, legal and business knowledge.
Warner Philips joined our Board on February 13, 2014. Mr. Philips is an international cleantech entrepreneur and investor with over 17 years of experience in private equity-owned and venture-backed businesses. Mr. Philips serves as an operating partner to Pegasus Capital. Mr. Philips also advises smart thermostat company Nest Labs, which was recently acquired by Google Inc. Mr. Philips started his career at Netherlands-based venture capital firm NeSBIC as an investment analyst. In 2001, Mr. Philips joined Secon, an Amsterdam-based multi-brand apparel company where he led a strategic reorganization. In 2002, Mr. Philips co-founded the Amsterdam-based cleantech incubator Tendris, which spurned start-ups such as renewable energy retailer Durion (later Oxxio), carbon neutral credit card affinity program Climacount, and LED lighting pioneer Lemnis. Mr. Philips was operationally actively involved in all Tendris companies until 2012 and was CEO of Climacount until 2006. He is an early investor in energy software company C3, in residential solar services company Sungevity, in social impact fashion brand Maiyet, and in community product sharing company Yerdle. Mr. Phillips also serves on several non-profit boards and is the Board Chair of the Cradle to Cradle Products Innovation Institute, a non-profit that promotes the highest standard of sustainable product design.
We believe Mr. Philips is qualified to serve on our Board because of his substantial business, technology and investment experience.
Jonathan Rosenbaum joined our Board on February 3, 2014. Mr. Rosenbaum serves as a managing director for Raycliff Investments and focuses in the areas of consumer, real estate, technology and energy, directing the firm’s investments in those categories. Prior to Raycliff Investments, Mr. Rosenbaum held various executive finance and corporate development roles with a number of companies in the technology and media industries. Most recently, he served in this capacity at PRN, the largest US out of home television media network, until its sale to Thomson SA. Prior to PRN, Mr. Rosenbaum performed in similar capacities for GE/NBC’s online arm, NBC Internet, as well as with other technology startups. Mr. Rosenbaum began his career in business assurance services at Ernst & Young LLP, in the firm’s technology, communication and media practice. Mr. Rosenbaum is a graduate of the University of California at Santa Barbara. Mr. Rosenbaum was designated to serve as a director by Pegasus Capital pursuant to certain designation rights held by Pegasus Capital under the Company’s Series I Preferred Stock.
We believe Mr. Rosenbaum is qualified to serve on our Board because of his extensive experience in business, finance and investing.
Steven Wacaster joined our Board on May 25, 2012. Mr. Wacaster is a partner at Pegasus Capital and has been with the firm since 2005. Previously, Mr. Wacaster worked in the investment banking division at Credit Suisse First Boston in New York. Mr. Wacaster is a graduate of the University of North Carolina at Chapel Hill and the University of Virginia, Darden School of Business. Mr. Wacaster was designated to serve as a director by Pegasus Capital pursuant to certain designation rights held by Pegasus Capital under the Company’s Series I Preferred Stock.
We believe Mr. Wacaster is qualified to serve on our Board because he brings a significant amount of business, finance and operational experience.
Leon Wagner has served as a director since January 2011. Mr. Wagner was a founding partner and chairman of GoldenTree Asset Management (“GoldenTree”), from 2000 to 2010 an alternative asset management firm specializing in leveraged loans, high yield bonds, distressed assets and equities in hedge, long only and structured funds. At the time of his retirement in December 2010, GoldenTree managed in excess of $12 billion in capital. Prior to founding GoldenTree, Mr. Wagner was the co-head of the high yield sales and trading department at CIBC World Markets (“CIBC”), a provider of credit and capital markets products, securities, brokerage and asset
management services, from 1995 to 2000. He joined CIBC in 1995 when it acquired The Argosy Group, LP. Mr. Wagner directed public and private placement marketing and structuring for high yield issuance at both institutions. Mr. Wagner is also a distinguished philanthropist and the 2003 recipient of the Gustave L. Levy Award, presented by the UJA-Federation of New York, in recognition of service to the community. Mr. Wagner received his Masters of Business Administration degree from the University of Chicago Graduate School of Business and a Bachelor of Arts degree from Lafayette College.
We believe Mr. Wagner is qualified to serve on our Board because he brings significant financial experience and knowledge to the Board.
Family relationships
There are no family relationships between any of our executive officers or directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors, executive officers and persons who own more than 10% of a registered class of our equity securities to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. Officers, directors and greater-than-10% stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file.
To our knowledge, based solely on a review of copies of such reports furnished to us and written representations that no other reports were required, each of our directors, officers and ten percent stockholders complied with all Section 16(a) filing requirements applicable to them except: Craig Cogut (2 late filing/3 late transactions); Pegasus Capital IV (1 late filing/2 late transactions); Pegasus Capital IV GP (1 late filing/2 late transactions); Pegasus IV (2 late filing/3 late transactions); Pegasus Capital LLC (1 late filing/1 late transaction); Pegasus Investors (1 late filing/1 late transaction); Pegasus GP (1 late filing/1 late transaction); Holdings II (1 late filing/1 late transaction); Samer Salty (1 late filing/4 late transactions); Cleantech A (2 late filings/4 late transactions); Cleantech B (2 late filings/4 late transactions); Cleantech II General Partner, L.P. (2 late filings/4 late transactions); Cleantech GP (2 late filings/4 late transactions); ZCL (2 late filings/4 late transactions); ZVL (2 late filings/4 late transactions); ZHL (2 late filings/4 late transactions); Jonathan Rosenbaum (1 late filing); Richard Hannah Davis, Jr. (1 late filing); Vincent J. Colistra (1 late filing); and Patrick Louis Meagher (1 late filing).
Code of Business Conduct and Ethics
We have adopted a Code of Business Conduct and Ethics that applies to all of our employees, including employees of our subsidiaries, as well as each of our directors and certain persons performing services for us. The Code of Business Conduct and Ethics addresses, among other things, competition and fair dealing, conflicts of interest, financial matters and external reporting, company funds and assets, confidentiality and corporate opportunity requirements and the process for reporting violations of the Code of Business Conduct and Ethics, employee misconduct, improper conflicts of interest or other violations. Our Code of Business Conduct and Ethics is available on our website at www.lsgc.com in the “Corporate Governance” section found under the “Who We Are” tab.
Audit Committee
Our Board has established an Audit Committee. Our Audit Committee is responsible for, among other matters: (1) appointing, compensating, retaining, evaluating, terminating and overseeing our independent registered public accounting firm; (2) discussing with our independent registered public accounting firm their independence from management; (3) reviewing with our independent registered public accounting firm the scope and results of their audit; (4) approving all audit and permissible non-audit services to be performed by our independent registered public accounting firm; (5) overseeing the financial reporting process and discussing with management and our independent registered public accounting firm the interim and annual financial statements that we file with the SEC; (6) reviewing and monitoring our accounting principles, accounting policies, financial and accounting controls and compliance with legal and regulatory requirements; (7) establishing procedures for the confidential anonymous submission of concerns regarding questionable accounting, internal controls or auditing matters; and (8) reviewing and monitoring the guidelines and policies governing risk assessment and risk management.
Our Audit Committee consists of Messrs. Harkleroad and Rosenbaum, and Mr. Harkleroad is the chairman of our Audit Committee. Our board of directors has determined that Mr. Harkleroad is
independent within the meaning of The NASDAQ Marketplace Rules and Rule 10A-3 under the Exchange Act. Our Board has determined that Mr. Rosenbaum qualifies under the NASDAQ listing standards as an “audit committee financial expert” within the meaning of the rules of the SEC.
Item 11.
Item 11. Executive Compensation.
This Compensation Discussion and Analysis describes the compensation arrangements we have with our named executive officers as set forth under the rules of the SEC. Consistent with the SEC rules, we are providing disclosure for the principal executive officer (our Chief Executive Officer or CEO) and principal financial officer (our Chief Financial Officer or CFO), regardless of compensation level, and the three most highly compensated executive officers in our last completed fiscal year, other than the CEO and CFO. All of these executive officers are referred to in this Compensation Discussion and Analysis as our “NEOs.”
For 2013, our NEOs were:
Name
Title
Vincent J. Colistra (1)
Chief Executive Officer
Thomas C. Shields
Chief Financial Officer
Fredric Maxik
Chief Technology Officer
Jeremy Cage (2)
Former Chief Executive Officer and Director
Brad Knight (3)
Former Chief Executive Officer
(1) Mr. Colistra resigned as Chief Executive Officer on February 3, 2014 and was appointed as Chief Restructuring Officer.
(2) Mr. Cage would have been a NEO for fiscal year 2013 but for the fact that his employment terminated on November 8, 2013.
(3) Mr. Knight would have been a NEO for fiscal year 2013 but for the fact that he resigned as Chief Executive Officer on January 2, 2013.
Recent Events
Mr. Colistra, our former Chief Executive Officer, resigned on February 3, 2014 and Richard H. Davis, Jr. assumed the duties of interim Chief Executive Officer. Mr. Davis agreed to serve in this capacity for no additional compensation.
Overview and responsibility for compensation decisions
The Compensation Committee of our Board has responsibility for evaluating the performance and development of our executive officers in their respective positions, reviewing individual compensation as well as corporate compensation principles and programs, establishing corporate and individual performance objectives as they affect compensation, making determinations as to whether and to what extent such performance objectives have been achieved and ensuring that we have effective and appropriate compensation programs in place. In addition, our Compensation Committee considers whether any of our compensation policies and practices create risks to our risk management practices or provide risk-taking incentives to our executives and other employees. Our Chief Executive Officer supports our Compensation Committee by driving our annual business plan process, providing information related to the ongoing progress under our annual business plan and other business and financial results, undertaking performance assessments of other executives and presenting other personnel-related data for the Compensation Committee’s consideration. In addition, as the manager of our executive team, our Chief Executive Officer assesses each executive’s contribution to corporate goals as well as achievement of his or her individual goals and makes a recommendation to our compensation committee with respect to compensation for executive officers other than himself. Our compensation committee meets, including in executive sessions, to consider these recommendations, conducts a similar evaluation of the Chief Executive Officer’s contributions to corporate goals and achievement of individual goals and makes determinations related to the Chief Executive Officer’s and the other executive officers’ compensation.
Our overall compensation philosophy is to provide a competitive total compensation package that will:
•
fairly compensate our executive officers;
•
attract and retain qualified executive officers who are able to contribute to the long-term success of our company;
•
incentivize future performance toward clearly defined corporate goals without encouraging excessive risk taking; and
•
align our executives’ long-term interests with those of our stockholders.
Our Compensation Committee believes that the quality, skills and dedication of our executive officers are critical factors affecting our long-term value. Our compensation arrangements with executive officers are, to a large degree, based upon our consolidated revenue and earnings achievements along with personal performance objectives agreed upon at the beginning of the fiscal year with the respective executive. We believe in compensating progressively for the achievement of established objectives.
In setting compensation levels for individual officers, our Compensation Committee applies its judgment in determining the amount and mix of compensation elements for each NEO, and to date our compensation process has been a largely discretionary process based upon the collective experience and judgment of the compensation committee members acting as a group. Factors affecting the Compensation Committee’s decisions in setting compensation generally include:
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overall corporate performance;
•
the individual officer’s performance against corporate-level strategic goals established as part of our annual business plan and the officer’s effectiveness in managing toward achievement of those goals;
•
the nature and scope of the officer’s responsibilities; and
•
informal market surveys and the personal experience of members of our Board.
The Compensation Committee has also reviewed our compensation policies and practices for all of the executive officers and other employees and determined that any risks arising from such compensation policies and practices, including any risks to our risk management practices and risk-taking incentives created from such compensation policies and practices, are not reasonably likely to have a material adverse effect on the Company.
While our Compensation Committee is authorized to engage the services of outside consultants and advisors, neither the Compensation Committee nor our management has to date retained a compensation consultant to review or provide advice concerning our policies and procedures with respect to executive compensation. To date, we have not formally benchmarked our executive compensation against peer companies, and we have not identified a group of peer companies against which we would compare our compensation practices. While our Compensation Committee considers the overall mix of compensation components in its review of compensation matters, it has not adopted formal or informal policies or guidelines for allocating compensation between long-term and current compensation or between cash and non-cash compensation. The Compensation Committee intends to continue to manage our executive officer compensation programs on a flexible basis that will allow it to respond to market and business developments as it views appropriate, but will continue to consider whether the use of consultants, formal benchmarking and/or fixed guidelines for allocating between compensation components would aid the Compensation Committee in setting compensation levels or allocating between types of compensation.
We have historically reviewed compensation as part of the annual business plan process undertaken by management and our Board in the early part of each year. During this process, our Compensation Committee reviews overall compensation, evaluates performance, determines corporate-level performance goals for that year’s business plan and, when appropriate, makes changes to one or more components of our executives’ compensation.
During our 2011 annual meeting, we held a stockholder advisory vote on the compensation of our NEOs as described in our 2011 proxy statement, commonly referred to as a say-on-pay vote. Stockholders representing over 99% of the stockholders present and entitled to vote at the meeting voted in favor of the 2011 say-on-pay resolution approving the compensation of our NEOs. As our Compensation Committee evaluated its compensation practices and talent needs throughout 2011, it was mindful of the strong support stockholders expressed for its pay for performance compensation philosophy. Additionally, in determining how often to hold a stockholder advisory vote on executive compensation, our Board took into account the strong preference for a triennial frequency expressed by stockholders at our 2011 annual meeting relating to future advisory stockholder votes on our executive compensation. Accordingly, our Board has determined that we will hold an advisory stockholder vote on our executive compensation on a triennial basis.
Historically, the exercise price of our stock options has been at least equal to the fair market value of our common stock on the date of grant. The fair market value of our common stock has been established by reference to the closing price of our common stock on the OTC Bulletin Board or the Pink Sheets, as applicable, on the date of grant.
Compensation components
Compensation for our executive officers has been highly individualized, at times structured as a result of arm’s length negotiations when an officer is initially hired, and always taking into account our financial condition and available resources. The resulting mix of compensation components has primarily included:
Compensation Component
Description
Relation to Compensation Objectives
Base Salary
Fixed cash compensation for services rendered during the fiscal year
• Fairly compensate executives
• Attract and retain qualified executives
Annual Cash Incentive Bonus
Annual cash payments for achieving predetermined financial and/or performance goals
• Fairly compensate executives
• Attract and retain qualified executives
• Incentivize future performance toward clearly defined corporate goals without encouraging excessive risk taking
Long-Term Incentive Awards
Grants of stock options and/or restricted stock awards designed to focus on long-term growth and increased company value
• Attract and retain qualified executives
• Align executive and stockholder interests
• Incentivize future performance toward clearly defined corporate goals without encouraging excessive risk taking
Severance and Change of Control Benefits
Continued payments of base salary for up to 24 months after involuntary termination
• Fairly compensate executives
• Attract and retain qualified executives
Other Benefits
Health and medical benefits, and the opportunity to participate in an employee stock purchase plan and a 401(k) retirement plan or comparable foreign plan
• Align executive and stockholder interests
• Attract and retain qualified executives
Our Compensation Committee believes this mix is appropriate for our executive team because, among other things, it provides a fixed component (base salary) designed to offer the executive funds from which to manage personal and immediate cash flow needs and variable components (annual incentive bonuses, stock options and restricted stock awards) that incentivize our management team to work toward achievement of corporate goals and our long-term success, as well as offering protection (through termination-related benefits) against abrupt changes in the executive’s circumstances in the event of involuntary employment termination including in the context of a change of control of our company. Our Compensation Committee also believes, based on the collective experience of its members, that this mix is typical of companies in our industry and at our stage of development. It has no current plans to change the mix of components or vary the relative portions of fixed and variable compensation that comprise our overall compensation packages.
As a result of this mix of compensation components, executives earn their compensation over three time frames:
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Current Year Performance: Salary and annual incentives that reflect actions and results over 12 months;
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Long-Term Performance: A long-term incentive plan that reflects results over a period of years, helping to ensure that current results remain sustainable; and
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Full Career Performance: Deferrals and retirement accumulations encourage executives to stay with the company until their working careers end.
Base Salaries. Base salary for our Chief Executive Officer and other executive officers is established based on the scope of their responsibilities, length of service with our company, individual performance during the prior year and competitive market compensation. Base salaries are reviewed annually and adjusted from time-to-time based on competitive conditions, individual performance, our overall financial results, changes in job duties and responsibilities and our company’s overall budget for base salary increases. The budget is designed to allow salary increases to retain and motivate successful performers while maintaining affordability within our company’s business plan.
Annual Cash Incentive Bonus. We also have an annual cash incentive bonus program to motivate our executive officers to attain specific short-term performance objectives that, in turn, further our long-term objectives. This program is managed as part of our annual business plan process and involves a high level of discretion on the part of our Compensation Committee. Typically, the board of directors approves a business plan for the year that incorporates corporate-level objectives. Achievement of those objectives becomes an important factor considered by the Compensation Committee when, after year-end, it makes a final determination of bonus amounts to be paid. Other factors that are considered by the Compensation Committee in determining amounts to pay include:
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our company’s overall performance and business results;
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general market conditions;
•
future business prospects;
•
funds available from which to pay bonuses;
•
individual performance;
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competitive conditions; and
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any other factors it finds relevant.
Each executive officer is measured against their contributions to the consolidated revenue and earnings achievement of our company as a whole along with their performance against individual objectives established at the beginning of the fiscal year with the participation of the respective executive as part of their total compensation plan. This discretionary approach to the variable component of our compensation program allows fluidity in how we manage short-term corporate strategy and executive incentives, while allowing us to achieve more consistency in our focus on longer-term corporate objectives. Our Compensation Committee and our Board believe that this flexibility is important in managing a growing company because it allows executive officers to respond to the often changing demands of the business without undue focus on any one specific short-term performance objective. Our Compensation Committee does not have plans at this time to change the way it manages our annual cash incentive bonus program or to take a more formal or objective approach to the way it sets bonus payment amounts.
Each executive officer has a target bonus amount, established at the time of hire and then reviewed and potentially adjusted annually over the course of the officer’s tenure with our company. For 2013, the target bonuses for executive officers ranged from 35% to 100% of base salary based on our compensation committee’s belief of respective competitive fixed and variable compensation levels for each officer. For 2013, the corporate-level performance objectives specified in our business plan related to consolidated sales growth, earnings and certain strategic objectives. Our Compensation Committee set a consolidated earnings target sufficient to fund the bonus pool during 2013.
For the 2012 fiscal year, we paid Mr. Meagher, our Executive Vice President of Product Development, a signing bonus of $25,000. This bonus payment was not made pursuant to our annual cash incentive bonus program. Because of our limited cash flows and our Company’s historical losses, other than the aforementioned bonus payments, our executive officers have not been awarded cash bonuses during the past three years. Our Compensation Committee elected not to award our NEOs performance based incentive bonuses for the 2012 or 2013 fiscal years due to continued losses.
Long-Term Incentive Compensation. To date, our long-term incentive awards have primarily been in the form of options to purchase our common stock, which options are generally awarded under our Equity Plan. Our stock options have an exercise price at least equal to the fair market value of our common stock on the grant date, generally vest over four years, with 25% of the option shares vesting after the first, second, third and fourth years of service following the grant, and have a ten year term. Additional vesting acceleration benefits apply in certain circumstances discussed below.
Generally, a stock option award is made in the year that an executive officer commences employment. The size of this award is intended to offer the executive a meaningful opportunity for stock ownership relative to his or her position and reflects the Compensation Committee’s assessment of market conditions affecting the position as well as the individual’s potential for future responsibility within our company. Thereafter, additional option grants may be made in the discretion of our Compensation Committee, board of directors or Committee of Independent Directors. To date, we have not granted additional options on an annual basis to executives or other employees, although we do evaluate individual performance annually. Instead, additional options have been granted to executives on a case-by-case basis reflecting the Compensation Committee’s determination that such grants are appropriate or necessary to reward exceptional performance (including upon promotion) or to retain individuals when market conditions change. The size of additional option grants are determined at the discretion of the Compensation Committee or our board of directors, and typically incorporate our Chief Executive Officer’s recommendations (except with respect to his own option grants).
Other than the award of 500,000 restricted shares of common stock granted to Mr. Cage, our Chief Executive Officer from January 2, 2013 through November 8, 2013, the award of 192,308 restricted shares of common stock granted to Mr. Knight, our Interim Chief Executive Officer from October 19, 2012 to January 2, 2013 and our Interim Chief Operating Officer from May 25, 2012 to July 8, 2013, awards of restricted stock granted to our former Chief Executive Officer in 2011 and current Chief Technology Officer in 2008, we have not granted restricted stock awards to our NEOs.
Severance and Change in Control Benefits. We have entered into employment agreements with each of our NEOs, which provide severance benefits in the event the executive officer’s employment is terminated by us without cause or the executive officer is terminated without cause in connection with a change in control, in consideration of a release of potential claims and other customary covenants. These benefits range from 12 months to, following a change-in-control, 24 months of their base salary. In addition, all stock options held by our NEOs provide for full acceleration of unvested stock options upon a change of control of our company. For more information regarding these severance and change in control benefits, see “Executive Compensation - Estimated Benefits and Payments upon Termination of Employment or Change of Control.” Our board of directors and Compensation Committee have determined it appropriate to have these termination-related benefits in place to preserve morale and productivity, and encourage retention in the face of potentially disruptive circumstances that might cause an executive to be concerned that his or her employment is in jeopardy or that might involve an actual or rumored change in control of our company. We believe that our change of control benefits are generally in line with packages offered to executives in our industry.
Other Benefits. Certain NEOs are entitled to monthly car allowances pursuant to their employment agreements and/or were reimbursed for relocation and moving expenses. The values of such benefits are presented below under the “Summary Compensation Table” as “All Other Compensation.”
We also provide our executive officers with benefits that are generally available to our salaried employees. These benefits include health and medical benefits, flexible spending plans, the opportunity to participate in an employee stock purchase plan, and a 401(k) retirement plan or comparable foreign plan.
Tax Matters
Our board of directors and Compensation Committee will consider the deductibility of compensation amounts paid to our executive officers including the potential future effects of Section 162(m) of the Internal Revenue Code on the compensation paid to our executive officers in making its decisions, although such deductibility has not historically been material to our financial position, Section 162(m) disallows a tax deduction for any publicly held corporation for individual compensation exceeding $1.0 million in any taxable year for our Chief Executive Officer and each of the other named executive officers (other than our Chief Financial Officer), unless compensation is “performance-based” as defined under Section 162(m). Our stock option grants are generally designed to qualify as performance-based compensation for purposes of Section 162(m), and we expect compensation amounts related to options to be fully deductible. However, our Compensation Committee may, in its judgment, authorize compensation payments that are not deductible when it believes that such payments are appropriate to attract and retain executive talent.
Summary Compensation Table
The following table summarizes the overall compensation earned by NEOs during each of the past three fiscal years ended December 31, 2013.
(1) Represents the total grant date fair value, as determined under FASB ASC Topic 718, Stock Compensation, of all awards granted to the NEO during 2013, 2012 and 2011, as applicable. Assumptions used to calculate these amounts are included in Note 15, “Equity Based Compensation Plans,” to our consolidated financial statements for the year ended December 31, 2013.
(2) Mr. Colistra began serving as our Interim Chief Executive Officer on November 8, 2013. Mr. Colistra resigned as Interim Chief Executive Officer on February 3, 2014, when Richard H. Davis Jr. began serving as our Interim Chief Executive Officer.
(3) Mr. Colistra is an employee of PMCM, LLC, an affiliate of Phoenix Management Services, LLC, (“Phoenix”) and all payments are made to Phoenix. These expenses include $20,000 per week for consulting services, as well as travel and living expenses for time spent in Satellite Beach, FL.
(4) Mr. Cage began serving as our Chief Executive Officer on January 2, 2012 and was appointed to the Board of Directors on March 5, 2013. Mr. Cage resigned as Chief Executive Officer and from the Board on November 8, 2013.
(5) Includes travel and living expenses as well as separation pay.
(6) Mr. Knight began serving as our Interim Chief Operating Officer from May 25, 2012 and as our Interim Chief Executive Officer on October 19, 2012. Mr. Knight resigned as our Interim Chief Executive Officer on January 2, 2013 when Mr. Cage began serving as our Chief Executive Officer and resigned as our Interim Chief Operating Officer on July 8, 2013. Mr. Knight continued to provide consulting services to us through Riverwood until February 18, 2014.
(6) Mr. Shields began serving as our Chief Financial Officer on August 23, 2012.
(7) Mr. Knight is an employee of Riverwood and all payments are made to Riverwood. These expenses include $7,500 per week for consulting services, as well as travel and living expenses for time spent in Satellite Beach, FL.
(8) Mr. Shields began serving as our Chief Financial Officer on August 23, 2012.
(9) Consists of relocation expenses.
(10) Includes annual car allowance.
(11) Mr. Meagher began serving as our Executive Vice President of Product Development on June 18, 2012. Mr. Meagher resigned as Vice President of Product Development on December 31, 2013.
(12) Includes relocation expenses as well as separation pay.
2013 Grants of Plan-Based Awards
The following table sets forth each Equity Plan-based award granted to our NEOs during the year ended December 31, 2013.
(1) The amount in this column represent the exercise price of the option awards, as determined by our Board with the assistance of management, which is not less than the fair market value of our common stock on the date of grant.
(2) Represents the total grant date fair value, as determined under FASB ASC Topic 718, of the respective award granted to the NEO during fiscal 2013. Assumptions used to calculate these amounts are included in Note 15, “Equity Based Compensation Plans,” to our consolidated financial statements for the year ended December 31, 2013.
Outstanding Equity Awards at 2013 Fiscal Year-End
The following table provides certain information concerning unexercised options, stock that has not vested and Equity Plan awards held by each of our NEOs that were outstanding as of December 31, 2013:
(1) These options were granted on January 2, 2013 and vested on November 8, 2013.
(2) These options were granted on July 5, 2012. 2.08% of these options will vest on the first of each month until fully vested on March 1, 2016.
(3) These options were granted on August 23, 2012, 25% vested on August 23, 2013 and the balance will vest 25% on each of August 23, 2014, 2015 and 2016.
(4) These options were granted on August 7, 2013 and will vest 25% on each of August 7, 2014, 2015, 2016 and 2017.
(5) These options were granted on April 17, 2008 and 25,000 options vested on each of April 17, 2009, April 17, 2010 and April 17, 2011.
(6) These options were granted on August 21, 2009 and vested 25% on August 21, 2010. The vesting was accelerated on December 30, 2010 for the remaining unvested shares due to the achievement of a “capitalization threshold event.”
(7) These options were granted on July 5, 2012, 25% vested on July 5, 2013 and the balance will vest 25% on each of July 5, 2014, 2015 and 2016.
(8) These options were granted on July 5, 2012 and vested on July 5, 2013.
Option Exercises
No options were exercised during the year ended December 31, 2013.
Employment Agreements
We have entered into employment agreements with all of our NEOs during 2013 other than Messrs. Knight and Colistra, each of which is described in more detail below.
Employment Agreement with Jeremy Cage
Effective January 2, 2013, we entered into an employment agreement with Mr. Cage pursuant to which Mr. Cage agreed to serve as our Chief Executive Officer. Pursuant to his employment agreement, Mr. Cage was entitled to a base salary of $400,000 and benefits generally available to other senior executives of the Company. Mr. Cage s was also eligible to receive a target annual bonus of up to 100% of his base salary, subject to satisfactory completion of performance metrics set by the board of directors of the Company and he was eligible for an annual bonus that exceeds 100% of his base salary for exceptional performance by Mr. Cage and the Company during any bonus year. The bonus metrics were to be determined by our Board in its sole discretion.
Mr. Cage was granted 500,000 shares of restricted common stock and options to purchase 4,500,000 shares of common stock at an exercise price of $0.64 per share, each subject to the Company’s Amended and Restated Equity Based Compensation Plan. The restricted stock was to vest (i) in full upon the fourth anniversary following the execution of the employment agreement, provided that Mr. Cage remains employed by the Company through such date; (ii) in full upon the material diminution of duties or responsibilities or the termination of Mr. Cage’s employment after a “change of control” of the Company; or (iii) pro rata upon the termination of Mr. Cage’s employment without “cause,” by Mr. Cage for “good reason” or due to Mr. Cage’s death or “disability” (as each term is defined in the employment agreement”), which pro rata amount will be calculated based upon the number of months Mr. Cage has been employed by the Company at such time of termination divided by 48. The options vest (i) 25% on each anniversary of the execution of the Employment Agreement, provide that Mr. Cage remain employed by the Company as of such time; (ii) in full upon the material diminution of duties or responsibilities or the termination of Mr. Cage’s employment after a “change of control” of the Company, or (iii) pro rata upon the termination of Mr. Cage’s employment without “cause,” by Mr. Cage for “good reason” or due to Mr. Cage’s death or “disability,” which pro rata amount will be calculated based upon the number of months Mr. Cage has been employed by the Company at such time of termination divided by 48. In the event the Company terminates Mr. Cage’s employment for reasons other than “cause” or change of control, or if he resigns for “good reason”, Mr. Cage will be entitled to receive severance in an amount equal to (i) twelve months of his base salary, plus (ii) the annual bonus that he would actually have earned for the year in which termination occurs, prorated through the date of termination.
For purposes of this agreement, “cause” was defined as: (a) a willful material breach of executive’s obligations under the agreement, which the executive fails to cure, if curable, within 30 days after receipt of a written notice of such breach; (b) gross negligence in the performance or intentional non-performance of executive’s material duties to us or any of our affiliates; (c) commission of a felony or a crime of moral turpitude; (d) commission of a material act of deceit, fraud, perjury or embezzlement that involves or directly or indirectly causes harm to us or any of our affiliates; or (e) repeatedly (i.e., on more than one occasion) being under the influence of drugs or alcohol (other than over-the-counter or prescription medicine or other medically-related drugs to the extent they are taken in accordance with their directions or under the supervision of a physician) during the performance of executive’s duties to us or any of our affiliates, or, while under the influence of such drugs or alcohol, engaging in grossly inappropriate conduct during the performance of executive’s duties to us or any of our affiliates.
For purposes of this agreement, “good reason” means the occurrence, without executive’s prior written consent, of any of the following events: (a) any material breach by us of our obligations under the agreement; (b) a reduction in executive’s base salary (other than a reduction made in connection with an across-the-board proportionate reduction in the base salaries of all of our employees with a position of director or above that is no
more than 10% of base salary); (c) a material reduction by us in the kind or level of employee benefits to which executive is entitled immediately prior to such reduction (other than a reduction generally applicable to all our executive level employees that, in combination with any reduction in base salary, does not reduce executive’s total compensation by more than 10%); (d) a material reduction by us of executive’s duties and level of responsibilities; or (e) requiring executive to be based at any office or location that is more than 50 miles from Satellite Beach, Florida; provided, that any such event described in (a) through (e) above will not constitute good reason unless executive delivers written notice of termination for good reason to us within 90 days after executive first learns of the existence of the circumstances giving rise to good reason, and within 30 days following the delivery of such notice, we have failed to cure the circumstances giving rise to good reason.
On November 8, 2013, Mr. Cage resigned as Chief Executive Officer and from such other roles and positions he held with us. In connection with Mr. Cage’s resignation, Mr. Cage was entitled to the following severance: (i) payment of his base salary accrued and unpaid through the termination date; (ii) payment of any earned but unused vacation through the termination date; (iii) reimbursement of any reasonable and qualified expenses properly incurred prior to the termination date and (iv) a $400,000 cash payment, representing one (1) times his annual base salary, payable in bi-weekly installments over a period of 12 months (the “Cage Severance Period”). Mr. Cage also has the right during the Cage Severance Period to continuation of any applicable health, accident and life insurance plans or arrangements for which he was participating as of the termination date. Additionally, upon Mr. Cage’s resignation, 114,583 unvested restricted shares of the common stock and 1,031,250 unvested options to purchase shares of common stock previously granted to Mr. Cage vested in full on the termination date. The remaining unvested restricted shares of common stock or unvested options to purchase shares of common stock held by Mr. Cage were forfeited as of the termination date. Mr. Cage remains subject to certain non-competition, non-solicitation and confidentiality provisions during the Cage Severance Period as described in his employment letter with the Company, dated November 29, 2012.
Employment Agreement with Thomas C. Shields
Effective August 23, 2012, we entered into an employment agreement with Mr. Shields pursuant to which Mr. Shields agreed to serve as our Chief Financial Officer. Pursuant to his employment agreement, Mr. Shields is entitled to a base salary of $320,000 and benefits generally available to other employees. Mr. Shields is also entitled to relocation assistance including temporary lodging for a period of up to nine months, a per diem of $60 per day for 120 days and customary moving expenses and closing costs on both Mr. Shields’ prior and any new home. Mr. Shields is required to repay any lodging expenses paid by the Company if he voluntarily leaves the Company within one year of his date of hire other than for “good reason”. Mr. Shields is also eligible to participate in a bonus plan under which he could receive up to 75% of his base salary, with the bonus payment for 2012, if any, to be pro-rated. The bonus metrics are to be determined by our Board in its sole discretion.
Mr. Shields also received, as of August 23, 2012, options to purchase 2,938,199 shares of common stock at an exercise price of $1.34 per share, which vest in four equal annual installments beginning on the first anniversary of the date of grant. Mr. Shields’ employment is at will and may be terminated at any time. In the event the Company terminates Mr. Shields’ employment for reasons other than “cause” or change of control, or if he resigns for “good reason”, Mr. Shields will be entitled to receive severance in an amount equal to (i) twelve months of his base salary, plus (ii) the annual bonus that he would actually have earned for the year in which termination occurs, prorated through the date of termination.
For purposes of this agreement, termination shall be deemed to be for “cause” if it is, in whole or part, based on: (i) Mr. Shield’s commission of an act of fraud, malfeasance, recklessness or gross negligence against the Company or any of its personnel, or in connection with the performance of his duties of employment hereunder; (ii) his commission of any act which is materially injurious to the Company, its personnel, its interests or its reputation; (iii) his indictment or conviction for, or plea of no contest to, any felony or any other crime involving moral turpitude; or (iv) his willful or intentional failure to fulfill any of his material duties and /or responsibilities thereunder, which failure has not been cured to our reasonable satisfaction within 30 days of the date on which he is given written notice of such failure.
For purposes of this agreement, Mr. Shield’s resignation shall be deemed to be for “good reason” if he resigns following the occurrence of any of the following: (i) a material adverse change of his title, position, responsibilities, authority or duties, in each case, as an executive officer of the Company; (ii) a reduction in his base salary (except with his consent) or bonus opportunity or incentive opportunity; (iii) our requiring him to be based at a materially different geographic location; (iv) our material breach of any provision of his offer letter; or (v) a failure by the Company to obtain the assumption of his original offer letter by any successor to or assignee of substantially all of our business and/or assets. Notwithstanding the foregoing, Mr. Shield’s resignation shall not be considered to be for good reason unless the Company receives, within thirty days following the date on which he knows, or with the exercise of reasonable diligence would know, of the occurrence of any of the events set forth in clauses above, written notice from him specifying the specific basis for his belief that he is entitled to terminate employment for good reason, we fail to cure the event constituting good reason within thirty days after our receipt of such written notice, and he resigns within thirty days following expiration of such cure period.
Employment Agreement with Fredric Maxik
On March 22, 2011, we entered into a new employment agreement with Mr. Maxik pursuant to which Mr. Maxik agreed to serve as our Chief Technology Officer. Under his employment agreement, Mr. Maxik was entitled to an annual base salary of $300,000. However, in October 2011, as part of the annual compensation review, Mr. Maxik’s base salary was increased from $300,000 to $315,000. We could also pay Mr. Maxik bonuses at such times and in such amounts as our board of directors determines, and Mr. Maxik was entitled to participate in the Equity Plan. Mr. Maxik’s employment agreement was extended to October 4, 2014. It may be terminated at any time, without severance, by Mr. Maxik voluntarily or by us with “cause.” In the event that Mr. Maxik’s employment is terminated by us without “cause” or by Mr. Maxik with “good reason,” during the 24-month period following a change of control, Mr. Maxik is entitled to severance pay equal to 24 months’ base salary. Any severance paid reduces the amount that Mr. Maxik otherwise would be entitled to receive for complying with the non-competition restrictions in his employment agreement, except in the case of a qualifying severance following a change of control. “Cause” and “Good Reason” had the same definitions as those terms in Mr. Cage’s employment agreement, except that “Cause” did not explicitly include a misrepresentation of education, work experience or other matter upon which the Company relied in considering and offering employment.
Employment Agreement with Patrick Meagher
On June 12, 2012, we entered into an employment agreement with Mr. Meagher pursuant to which Mr. Meagher agreed to serve as our Executive Vice President, Product Development. Pursuant to the employment agreement, Mr. Meagher was entitled to a base salary of $300,000 and benefits generally available to other employees. Mr. Meagher was also entitled to relocation assistance including (a) temporary lodging for a period of up to nine months and a per diem of $60 per day for 120 days and customary moving expenses and closing costs on both Mr. Meagher’s prior and any new home. Mr. Meagher was required to repay any lodging expenses paid by the Company if he voluntarily left the Company within one year of his date of hire. Mr. Meagher was also eligible to participate in a bonus plan of up to 35% of his base salary based upon a combination of performance and personal achievements. Mr. Meagher was also entitled to a grant of stock options and on July 5, 2012 the Board granted Mr. Meagher an option to purchase 1,836,374 shares of common stock at an exercise price of $1.34 per share, which vest in four equal annual installments beginning on the first anniversary of the date of grant. Mr. Meagher’s employment is at will and may be terminated at any time. If Mr. Meagher was terminated for reasons other than for “cause” or a change of control, Mr. Meagher was entitled to (a) six months of base pay and (b) assistance to relocate to a new location. If he was terminated within twelve months of a change of control, Mr. Meagher is entitled to severance of twelve months of base pay. “Cause” had the same definitions as those terms in Mr. Shield’s employment agreement.
Effective December 31, 2013, Mr. Meagher resigned as Executive Vice President, Product Development.
Estimated Benefits and Payments upon Termination of Employment or Change of Control
The following table describes the potential payments and benefits upon termination of our NEOs’ employment before or after a change in control of our Company as described above, as if each officer’s employment terminated as of December 30, 2013. See “Compensation Discussion and Analysis-Principal Elements of Executive Compensation-Severance and Change in Control Benefits” for a description of the severance and change in control arrangements for our named executive officers.
(1) Assumes a market value of $0.31 per share of common stock, as reported on the OTC Bulletin Board on December 31, 2013.
(2) This severance payment consists of one times the officer’s annual base salary.
(3) Upon termination by us without “cause” or by Mr. Shields for “good reason,” Mr. Shields is entitled to the accelerated vesting of 1,022,050 stock options. Upon termination due to death, disability or a change of control, Mr. Shields is entitled to the accelerated vesting of 2,778,650 stock options. 2,203,650 of these options has an exercise price of $1.34 per share and 575,000 of these options has an exercise price of $0.50 per share. As of December 31, 2013, these options are “out-of-the-money” and have $0 value.
(4) The benefit continuation will be paid by the Company for 12 months as of the separation date.
(5) Upon termination by us without “cause” or by Mr. Maxik for “good reason,” Mr. Maxik is entitled to the accelerated vesting of 377,083 stock options. Upon termination due to a change of control, Mr. Maxik is entitled to the accelerated vesting of 1,275,000 stock options. 700,000 of these options has an exercise price of $1.34 per share and 575,000 of these options has an exercise price of $0.50 per share. As of December 31, 2013, these options are “out-of-the-money” and have $0 value.
(6) This severance payment consists of twice the officer’s annual base salary.
Director Compensation
Director compensation is determined by the board of directors. During 2013, each of our non-employee directors was entitled to the following compensation:
•
200,000 Restricted Stock Awards of our common stock (“RSAs”), to be issued on August 9, 2013, with such RSAs remaining unvested through December 31, 2013, and fully vesting on January 1, 2014;
•
an aggregate of 25,000 additional RSAs for service on one or more committees of the Board. Such RSAs shall be issued as of August 9, 2013, shall remain unvested through December 31, 2013, and shall fully vest on January 1, 2014;
•
an aggregate of 15,000 additional RSAs for service as the Chair of one or more committees of the Board. Such RSAs shall be issued as of August 9, 2013, shall remain unvested through December 31, 2013, and shall fully vest on January 1, 2014; and
•
For any director serving on the Board and/or committees of the Board during a portion of 2013, but for less than the entire year, a pro-rated portion of the aforementioned compensation amounts, equal to the number of days of such director’s service on the Board and/or committees divided by 365 multiplied by such director’s full-year compensation amount. Such shall be issued as of the later of August 9, 2013 or the date of such director’s appointment. The applicable compensation shall fully vest on the later of such director’s date of termination from the Board or January 1, 2014, and shall remain unvested until that date.
•
Beginning in September 2013, the Chairman of the Board will receive $15,000 per month, to be paid in cash.
Director compensation table
Directors who are employees of the company receive no additional compensation for their service on our Board or its committees. The following table shows the overall compensation earned for the 2013 fiscal year with respect to each person who was a non-employee director as of December 31, 2013.
(1) Represents the total grant date fair value, as determined under FASB ASC Topic 718, of all awards granted to the director during fiscal year 2013, as applicable. Assumptions used to calculate these amounts are included in Note 15, “Equity Based Compensation Plans,” to our consolidated financial statements for the year ended December 31, 2013.
(2) Messrs. Brathwaite and Smach served on our Board as designees of Riverwood. Pursuant to the policies of Riverwood, any fees paid to Messrs. Brathwaite and Smach are for the benefit of Riverwood.
(3) Pursuant to the compensation structure adopted by the Board, Messrs. Brathwaite and Smach each received 240,000 RSA’s with a value of $0.42 per share.
(4) Messrs. Cogut, Cooper, Davis and Wacaster have served on our Board as designees of Pegasus Capital. Pursuant to the policies of Pegasus Capital, any fees paid to Messrs. Cogut, Cooper, Davis and Wacaster are for the benefit of Pegasus Capital.
(5) Pursuant to the compensation structure adopted by the Board, Mr. Cogut received pro rata compensation of 14,795 RSA’s with a value of $0.44 per share.
(6) Pursuant to the compensation structure adopted by the Board, Mr. Cooper received pro rata compensation of 77,808 RSA’s with a value of $0.42 per share.
(7) Pursuant to the compensation structure adopted by the Board, Mr. Davis received pro rata compensation of 26,301 RSA’s with a value of $0.48 per share.
(8) For his service as Chairman of the Board, Mr. Handy received cash compensation of $60,000. In addition, pursuant to the compensation structure adopted by the Board, Mr. Handy received pro rata compensation of 140,603 RSA’s with a value of $0.42 per share.
(9) Mr. Salty served on our Board as a designee of Zouk Capital. Pursuant to the policies of Zouk Capital, any fees paid to Mr. Salty are for the benefit of Zouk Capital.
(10) Pursuant to the compensation structure adopted by the Board, Mr. Salty received 200,000 RSA’s with a value of $0.42 per share.
(11) Pursuant to the compensation structure adopted by the Board, Messrs. Smach, Wacaster and Wagner received 225,000 RSA’s with a value of $0.42 per share.
Compensation Committee Interlocks and Insider Participation
During 2013 and through February 6, 2014, the members of our Compensation Committee were Messrs. Brathwaite, Handy, Wacaster and Wagner. On February 3, 2014, Mr. Handy resigned from the Board and on February 6, 2014, Mr. Brathwaite resigned from the Board. Mr. Wacaster is an executive officer and partner of Pegasus Capital. As described in further detail under “Certain Relationships and Related Transactions,” during the year ended December 31, 2013, we did not pay or otherwise accrue any fees and expenses to Pegasus Capital and its affiliates.
Compensation Committee Report
The Compensation Committee reviewed and discussed the Compensation Discussion and Analysis with management. Based on this review and discussion, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Form 10-K.
COMPENSATION COMMITTEE
Steven Wacaster
Leon Wagner
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Stock Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding the beneficial ownership of common stock as of March , 2014 by each person known to us to own beneficially 5% or more of the outstanding common stock, each director, certain named executive officers and the directors and executive officers as a group. The persons named in the table have sole voting and investment power with respect to all shares of common stock owned by them, unless otherwise noted. Percentage of ownership is based on 207,850,113 shares of common stock outstanding on March 25, 2014.
Beneficial ownership is determined in accordance with the rules of the SEC. For the purpose of calculating the number of shares beneficially owned by a stockholder and the percentage ownership of that stockholder, shares of common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of March 25, 2014 by that stockholder are deemed outstanding.
* Less than 1%.
(1) The number and percentage of shares of common stock beneficially owned is determined under the rules of the SEC and is not necessarily indicative of beneficial ownership for any other purpose. Under these rules, beneficial ownership includes any shares for which a person has sole or shared voting power or investment power.
(2) Mr. Davis was appointed as our interim Chief Executive Officer on February 3, 2014.
(3) Represents shares of common stock issuable to upon exercise of stock options issued under the Amended and Restated Equity-Based Compensation Plan (the “Equity Plan”).
(4) Includes 1,808,333 shares of common stock issuable to Mr. Maxik upon the exercise of stock options issued under our Equity Plan.
(5) Mr. Colistra was appointed to serve as our Interim Chief Executive Officer, effective November 8, 2013. Mr. Colistra resigned as our Interim Chief Executive Officer and was appointed as our Chief Restructuring Officer effective as of February 3, 2014.
(6) Mr. Cage was appointed to serve as our Chief Executive Officer, effective January 2, 2013, and as a member of the Board on March 5, 2013. Mr. Cage resigned as our Chief Executive Officer and member of our board of directors effective as of November 8, 2013.
(7) Includes 1,031,250 shares of common stock issuable to Mr. Cage upon the exercise of stock options issued under the Equity Plan.
(8) Mr. Knight was appointed to serve as our Interim Chief Operating Officer, effective May 25, 2012, and as our Interim Chief Executive Officer on October 19, 2012. Mr. Knight resigned as our Interim Chief Executive Officer on January 2, 2013 when Mr. Cage began serving as our Chief Executive Officer and resigned as our Interim Chief Operating Officer on July 8, 2013. Mr. Knight provided consulting services to us through Riverwood until February 18, 2014.
(9) Includes 1,408,131 shares of common stock issuable to Mr. Knight upon the exercise of stock options issued under the Equity Plan.
(10) Mr. Meagher was appointed to serve as our Executive Vice President of Product Development, effective June 18, 2012. Mr. Meagher resigned as our Executive Vice President of Product Development effective as of December 31, 2013.
(11) Mr. Cogut joined our Board effective December 5, 2013 and was named Chairman of our Board effective February 3, 2014. Mr. Cogut serves as Chairman and President of Pegasus Capital, our controlling stockholder.
(12) The principal address and principal office of each of LED Holdings, LLC (“LED Holdings”), LSGC Holdings LLC (“LSGC Holdings”), PP IV (AIV) LED, LLC (“PP IV (AIV)”), PP IV LED, LLC (“PP IV”), LSGC Holdings II LLC (“Holdings II”), Pegasus Partners IV, L.P. (“Pegasus IV”), PCA LSG Holdings, LLC (“PCA Holdings”), and Mr. Cogut is c/o Pegasus Capital Advisors, L.P., 99 River Road, Cos Cob, CT 06807.
(13) Pegasus IV is the managing member of LSGC Holdings and Holdings II. Pegasus Investors IV, LP (“Pegasus Investors”) is the general partner of Pegasus IV and Pegasus Investors IV GP, LLC (“Pegasus GP”) is the general partner of Pegasus Investors. Pegasus GP is wholly owned by Pegasus Capital, LLC (“Pegasus LLC,” and together with Pegasus IV, Pegasus Investors and Pegasus GP, the “Pegasus Entities”). Pegasus LLC may be deemed to be directly or indirectly controlled by Mr. Cogut. By virtue of the foregoing, the Pegasus Entities and Mr. Cogut may be deemed to beneficially own (i) the 20,972,496 shares of Common Stock held by LED Holdings; (ii) the 133,117,333 shares of common stock held directly by LSGC Holdings; (iii) the 2,877,314 shares of common stock, 16,396,843 shares of common stock issuable upon conversion of shares of Series I Convertible Preferred Stock held directly by LSGC Holdings, 20,691,579 shares of common stock issuable upon conversion of shares of Series J Convertible Preferred Stock held directly by LSGC Holdings and 52,091,050 shares of common stock issuable upon exercise of warrants held directly by Holdings II. Additionally, Pegasus Investors, Pegasus GP, Pegasus LLC and Mr. Cogut may be deemed to indirectly beneficially own 2,969,697 shares of common stock held directly by Pegasus IV. Furthermore, Pegasus LLC and Mr. Cogut may be deemed to indirectly beneficially own 1,464,950 shares of common stock, 19,280,000 shares of common stock issuable upon conversion of shares of Series I Convertible Preferred Stock held directly by PCA Holdings, 8,947,368 shares of common stock issuable upon the exercise of shares of Series J Convertible Preferred Stock held directly by PCA Holdings and 22,252,000 shares of common stock issuable upon the exercise of warrants held directly by PCA Holdings Pegasus LLC is the managing member of PCA Holdings. Each of the Pegasus Entities and Mr. Cogut disclaims beneficial ownership of any of the securities held by LED Holdings LLC, LSGC Holdings LLC, LSGC Holdings II LLC and PCA Holdings and this disclosure shall not be deemed an admission that any of Pegasus IV, Pegasus Investors, Pegasus GP, Pegasus LLC or Mr. Cogut is the beneficial owner of such securities for purposes of Section 13(d) or for any other purpose.
Furthermore, Mr. Cogut may be deemed to indirectly own the 5,000,000 shares of common stock issuable upon the exercise of warrants held by Pegasus Capital Partners IV, LP (“PCP IV”) and the 5,000,000 shares of Common Stock issuable upon the exercise of warrants held by Pegasus Capital Partners V, LP (“PCP V”). Pegasus GP is the general partner of PCP IV and Pegasus Investors V (GP), LLC (“Pegasus V GP”) is the general partner of PCP V. Pegasus V GP is wholly owned by Pegasus Capital LLC. Each of Pegasus GP, Pegasus V GP and Mr. Cogut disclaims beneficial ownership of any of the securities held by PCP IV and PCP V and this disclosure shall not be deemed an admission that Pegasus GP, Pegasus V GP or Mr. Cogut is the beneficial owner of such securities for purposes of Section 13(d) or for any other purpose. Additionally, Mr. Cogut may be deemed to indirectly own 602,982 shares of Common Stock that represent payment of director fees paid by us to Pegasus Capital Advisors IV, L.P. (“Pegasus Capital IV”). Pegasus Capital Advisors IV GP, LLC (“Pegasus Capital IV GP”) is the general partner of Pegasus Capital IV and Mr. Cogut is the sole owner and managing member of Pegasus Capital IV GP. Mr. Cogut disclaims beneficial ownership of the securities held by Pegasus Capital IV, and this disclosure shall not be deemed an admission that Mr. Cogut is the beneficial owner of such securities for purposes of Section 13(d) or for any other purpose.
(14) Includes 323,868 shares of common stock issued to The Bristol Company. Additionally, includes 24,000 and 6,250 shares of common stock issuable to Mr. Harkleroad and The Bristol Company, respectively, upon exercise of stock options issued under the Equity Plan. Mr. Harkleroad is the sole shareholder of The Bristol Company and may be deemed the beneficial owner of the shares held by The Bristol Company.
(15) Mr. Philips joined our Board on February 13, 2014.
(16) Mr. Rosenbaum joined our Board on February 3, 2014.
(17) Includes 120,000 shares of common stock held by trusts for which Mr. Wagner may be deemed the beneficial owner and 27,068 shares of common stock issuable to Mr. Wagner upon exercise of stock options issued under the Equity Plan. Also includes 7,001,053 shares of common stock issuable upon conversion of shares of Series I Convertible Preferred Stock held by Mr. Wagner.
(18) LSGC Holdings LLC may be deemed to indirectly beneficially own 20,972,496 shares of common stock held directly by LED Holdings LLC.
(19) PP IV (AIV) and PP IV may be deemed to indirectly beneficially own the 20,972,496 shares of common stock held by LED Holdings and the 133,117,333 shares of common stock held by LSGC Holdings due to their respective membership interests in LSGC Holdings.
(20) The principal address and principal office of RW LSG Holdings LLC (“RW Holdings”), RW LSG Management Holdings LLC (“RW Management”) and Riverwood Capital Management (“Riverwood CM”) is c/o Riverwood Capital Partners L.P., 70 Willow Road, Suite 100, Menlo Park, CA 94304.
(21) Riverwood Capital Partners L.P. (“RCP”) is the sole managing member of RW Holdings. Riverwood Capital L.P. (“RCLP”) is the sole general partner of Riverwood Capital. Riverwood Capital GP Ltd. (“RC Ltd.”) is the sole general partner of RCLP. Riverwood Capital Management L.P. (“RCM LP”) serves as investment advisor to RCP. RCM Ltd. is the sole general partner of RCM LP. As a result of these relationships, each of Riverwood Capital, RCLP, RC Ltd. and RCM Ltd. may be deemed to beneficially own any shares of common stock deemed to be beneficially held by RW Holdings. Additionally, RCM LP is the sole managing member of RW Management. Riverwood Capital Management Ltd. (“RCM Ltd.”) is the sole general partner of RCM LP. As a result of such relationships, each of RCM LP and RCM Ltd. may be deemed to beneficially own any shares of common stock that may be deemed to be beneficially owned by RW Management. By virtue of the foregoing, the Riverwood CM may be deemed to beneficially own the 42,105,263 shares of common stock issuable upon conversion of shares of Series H Convertible Preferred Stock, 5,530,526 shares of common stock issuable upon conversion of shares of Series J Convertible Preferred Stock and 13,923,100 shares of common stock issuable upon exercise of warrants held directly by RW Holdings.
(22) Consists of 554,221 shares of common stock granted to RW Management as compensation for Nicholas Brathwaite and Thomas Smach’s service on the Board during 2012 and 2013.
(23) The principal address and principal office of each of Cleantech Europe II (A) LP (“Cleantech A”), Cleantech Europe II (B) LP (“Cleantech B”), Cleantech GP II Ltd. (“Cleantech GP”), Zouk Capital LLP (“ZCL”) and Zouk Ventures Ltd. (“ZVL”) is 100 Brompton Road, London, SW3 1ER, United Kingdom. The principal address and principal office of Zouk Holdings Ltd. (“ZHL”) is c/o State Street Global Services, 22 Greenville Street, St. Helier, Jersey JE4 8PX, Channel Islands.
(24) Represents 21,960,000 shares of common stock issuable upon conversion of shares of Series H Convertible Preferred Stock, 2,303,158 of common stock issuable upon conversion of shares of Series J Convertible Preferred Stock and 5,798,200 shares of Common Stock issuable upon the exercise of Series J Warrants held directly by Cleantech A.
(25) Represents 21,960,000 and 3,829,474 shares of common stock issuable upon conversion of shares of Series H Convertible Preferred Stock held directly by Cleantech A and Cleantech B, respectively, 2,303,158 and 402.105 shares of common stock issuable upon conversion of shares of Series J Convertible Preferred Stock held directly by Cleantech A and Cleantech B, respectively and 5,798,200 and 1,012,300 shares of common stock issuable upon the exercise of Series J Warrants held directly by Cleantech A and Cleantech B, respectively. Cleantech GP is the general partner of Cleantech A and Cleantech B. ZCL provides certain monitoring, advisory and consulting services to Cleantech A and Cleantech B. ZVL is the majority partner of Cleantech GP and ZCL. As a result of these relationships, each of Cleantech GP, ZCL and ZVL may be deemed to beneficially own any shares of common stock that may be deemed to be beneficially owned by Cleantech A and Cleantech B.
(26) Represents 230,901 shares of common stock issued to ZHL as compensation for Samer Salty’s service on the board of directors during 2012 and 2013. For United Kingdom regulatory reasons, ZHL has been designated as the entity to receive all director fees payable by us in respect of Mr. Salty’s service on our board of directors.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Parent company
LSGC Holdings may be deemed to be our “parent” by virtue of its beneficial ownership of our voting securities. As of March 25, 2014, LSGC Holdings directly owned 154,089,829 shares of our common stock and indirectly owned an additional 20,972,496 shares of our common stock by virtue of its voting and dispositive control over shares held by its affiliate, LED Holdings. LSGC Holdings and LED Holdings are affiliates of Pegasus IV and Pegasus Capital, and they collectively hold approximately 84.2% of our common stock as of March 25, 2014 (calculated in accordance with Rule 13d-3 of the Exchange Act) Act), including 16,396,842 and 19,280,000 shares of common stock issuable upon conversion of shares of Series I Preferred Stock and 20,691,579 and 8,947,368 shares of common stock issuable upon conversion of shares of Series J Preferred Stock held directly by Holdings II and PCA Holdings, respectively.
Related Party Transaction Policy
Our Board has adopted a written policy with respect to the review, approval or ratification of related party transactions. The policy generally defines a related party transaction as a transaction or series of related transactions or any material amendment to any such transaction of $120,000 or more involving the Company and any executive officer of the Company, any director or director nominee of the Company, persons owning 5% or more of our outstanding stock at the time of the transaction, any immediate family member of any of the foregoing persons, or any entity that is owned or controlled by any of the foregoing persons or in which any such person serves as an executive officer or general partner or, together with all of the foregoing persons, owns 10% or more of the equity interests thereof.
The policy requires our Audit Committee to review and approve related party transactions and any material amendments to such related party transactions. In reviewing and approving any related party transaction or any material amendment thereto, the Audit Committee is to (i) satisfy itself that it has been fully informed as to the related party’s relationship and interest and as to the material facts of the proposed related party transaction or the proposed material amendment to such transaction, and (ii) determine that the related party transaction or material amendment thereto is fair to the Company. At each Audit Committee meeting, management is required to recommend any related party transactions and any material amendments thereto, if applicable, to be entered into by us. After review, the Audit Committee must approve or disapprove such transactions and any material amendments to such transactions.
In addition to the above policy, because we have entered into a number of transactions with affiliates of Pegasus Capital, our board of directors established a Committee of Independent Directors, or the Independent Committee, in December 2008 to consider the approval of, and to make recommendations to the board of directors or any committee thereof regarding, any related-party transactions from time to time between us and Pegasus Capital or its affiliates, our executive officers and/or our directors. On June 8, 2012, our Board adopted a charter for the
Committee of Independent Directors in order to expand its authority to negotiate and approve or reject related party transactions between the Company and (i) Pegasus Capital, (ii) our executive officers, (iii) our directors, or (iv) any other person or entity that may be deemed an affiliate or related party.
During 2013 and through February 7, 2014, the committee of independent directors consisted of Messrs. Harkleroad den Daas and Wagner. On February 7, 2014, Mr. den Daas resigned from the Board. Other than our entrance into the Riverwood Subscription Agreement and the Riverwood Support Services Agreement (defined below) and issuance of the Original Riverwood Warrant (defined below), each of the transactions set forth below were reviewed and approved by the Committee of Independent Directors
The Riverwood Offering
On May 25, 2012, we entered into the Subscription Agreement with Riverwood Holdings and certain other purchasers identified on the signature pages thereto (the “Riverwood Subscription Agreement”) pursuant to which we issued an aggregate of 60,705 shares of Series H Preferred Stock and 6,364 shares of Series I Preferred Stock at a price of $1,000 per share (the “Riverwood Offering”). We raised gross proceeds of approximately $67.1 million in the Riverwood Offering. In connection with the Riverwood Offering, we paid approximately $750,000 to Riverwood Holdings as reimbursement of its transaction expenses.
The Certificates of Designation, among other things, currently provide Riverwood and Pegasus Capital and its affiliates, respectively, with the right to designate the number of directors to our Board equal to the greater of (a) two (2) directors and (b) product obtained by multiplying (1) the total number of directors that constitute the whole Board by (2) the applicable primary investor’s pro rata share of our outstanding shares of common stock and securities exercisable, convertible or exchangeable into or for shares of common stock for so long as Riverwood or Pegasus Capital (as applicable) or their respective affiliates continue to beneficially own at least 2,500 shares of Series H Preferred Stock or Series I Preferred Stock, respectively. As of March 25, 2014, Pegasus and Riverwood had the right to appoint five and two directors, respectively. For an additional description of additional terms found in the Certificates of Designation, please see the section entitled “Description of capital stock-Preferred stock” below.
Series J Preferred Offering
On September 11, 2013, we entered into a Preferred Stock Subscription Agreement (the “Series J Subscription Agreement”) with Riverwood Holdings, PCA Holdings and Holdings II pursuant to which we issued an aggregate of 17,394 shares of Series J Preferred Stock and raised gross proceeds of approximately $17.4 million (the “Series J Offering”). We issued 12,500 shares of Series J Preferred Stock to Holdings II, 2,500 shares of Series J Preferred Stock to PCA Holdings and 2,394 shares of Series J Preferred Stock Riverwood Holdings.
Pursuant to the Series J Subscription Agreement, Pegasus agreed to purchase the number of shares of Series J Preferred Stock equal to 20,000 minus the aggregate number of shares of Series J Preferred Stock issued in the Series J Offering and the offering to the then current holders of shares of Series H Preferred Stock and Series I Preferred Stock of the preemptive right to purchase a pro-rata share of the shares of Series J Preferred Stock issued in the Series J Offering (the “Pegasus Series J Commitment”).
The Series J Subscription Agreement also provided Riverwood Holdings, PCA Holdings and Holdings II with the right to exchange all or any part of the Series J Preferred Stock held by such purchaser for securities issued in connection with certain subsequent offerings of the Company’s debt or equity securities (a “Qualified Follow-On”).
Amendments to Certificates of Designation and Preferred Stock Subscription Agreements
On the September 11, 2013, and in connection with the Series J Offering, Riverwood Holdings, Holdings II, PCA Holdings and certain holders of shares of Series H Preferred Stock and Series I Preferred Stock agreed to make certain amendments to the agreements entered into in connection with the purchase of (i) the shares of Series H Preferred Stock and Series I Preferred Stock and (ii) the Company’s previously issued shares of Series F Preferred Stock and Series G Preferred Stock, which were subsequently converted into shares of Series H Preferred Stock and Series I Preferred Stock (collectively, the “Preferred Stock Subscription Agreements”).
The amendments to the Preferred Stock Subscription Agreements include the termination of the right of the holders to seek indemnification from the Company for certain breaches of the representations and warranties contained in the Preferred Stock Subscription Agreements.
Follow-On Offering
On January 3, 2014, we entered into separate Series J Subscription Agreements (the “Follow-On Subscription Agreements”) with each of (i) Holdings II; (ii) PCA Holdings; (iii) Riverwood Holdings; and (iv) Cleantech A and Cleantech B pursuant to which we issued units of our securities (the “Series J Securities”) at a purchase price of $1,000 per Series J Security (the “Follow-On Offering”). Each Series J Security consists of (A) one share of Series J Preferred Stock and (B) a warrant to purchase 2,650 shares of common stock at an exercise price of $0.001 per share (the “Series J Warrants”).
Pursuant to the Follow-on Subscription Agreements, on January 3, 2014 we issued 2,000 Series J Securities to PCA Holdings, 6,000 Series J Securities to Holdings II and 2,860 Series J Securities to Riverwood Holdings. On January 9, 2014, we issued 2,188 Series J Securities to Cleantech A and 382 Series J Securities to Cleantech B. On January 14, 2014, we issued 4,000 Series J Securities to PCA Holdings. We issued an aggregate of 17,430 Series J Securities for aggregate gross proceeds of $17,430,000 in connection with the Follow-On Offering.
The Follow-On Offering was deemed a Qualified Follow-On as such term is used and defined in the Series J Certificate of Designation and the Series J Subscription Agreements. In addition, because Holdings II, PCA Holdings and Riverwood Holdings collectively held at least a majority of the issued and outstanding shares of Series J Preferred Stock as of immediately prior to the sale of Series J Securities pursuant to the Follow-on Subscription Agreement, and because each elected to exchange all of their shares of Series J Preferred Stock for Series J Securities, all of the holders of Series J Preferred Stock were required to exchange all of their shares of Series J Preferred Stock for Series J Securities.
Transactions with affiliates of Riverwood
Riverwood Support Services Agreement
On May 25, 2012, in connection with the Riverwood Offering, we entered into a Support Services Agreement with Riverwood Holdings and Riverwood Management (the “Riverwood Services Agreement”), pursuant to which we agreed to pay Riverwood Holdings $20,000 for the period from May 25, 2012 through June 30, 2012 and thereafter $50,000 for each calendar quarter beginning on July 1, 2012, in exchange for certain support services to be provided by Riverwood Management during such periods. The Riverwood Services Agreement expires upon the earlier of: (i) May 25, 2022, (ii) such date that Riverwood Management and/or its affiliates directly or indirectly beneficially own less than 37.5% of the shares of Series H Preferred Stock purchased pursuant to the Riverwood Offering, on an as-converted basis (together with any shares of common stock issued upon conversion thereof), (iii) such date that we and Riverwood may mutually agree in writing, (iv) a “change of control” or (v) a “QPO” (as such terms are defined in the Riverwood Services Agreement). During 2012, we paid Riverwood Holdings a total of $70,000 pursuant to the Riverwood Services Agreement. On September 25, 2012, Pegasus, Riverwood, Zouk and Portman entered into a Fee Waiver Letter Agreement pursuant to which the parties agreed to suspend payment of the fees payable in connection with their respective support services or other agreements between the Company and such parties until revoked by their unanimous written consent. Since September 25, 2012, we have not made any additional payments to Riverwood pursuant to the Riverwood Services Agreement.
Riverwood Warrant
In connection with the Riverwood Offering, we issued a warrant (the “Original Riverwood Warrant”) to Riverwood Management on May 25, 2012. The Original Riverwood Warrant represented the right to purchase 18,092,511 shares of common stock at an exercise price determined at the date of exercise pursuant to a formula as described therein.
In satisfaction of certain obligations of Riverwood Management, on June 15, 2012, Riverwood Management assigned a portion of the Original Riverwood Warrant to certain third parties. To effect such partial assignment, the Original Riverwood Warrant was cancelled and we issued (i) Riverwood Management a new warrant representing the right to purchase 12,664,760 shares of common stock (the “New Riverwood Warrant”) and (ii) such third parties warrants to purchase, in the aggregate, 5,427,751 shares of common stock (collectively, the “Transfer Warrants”). The terms of the New Riverwood Warrant and the Transfer Warrants are substantially the same as those of the Original Riverwood Warrant, except that the exercise price for such New Riverwood Warrant is determined pursuant to a revised formula as described in more detail therein.
Transactions with affiliates of Pegasus Capital
January 2011 Private Placement
On January 26, 2011, we raised $18.0 million in a private placement pursuant to which we issued 5,454,545 shares of common stock to Pegasus Partners IV, Michael Kempner, Leon Wagner, certain other operating advisors of Pegasus Capital and certain trusts affiliated with, and business associates of, Mr. Wagner. The purchase price of the shares of common stock represents a discount of less than 3% of the closing price of our common stock
on the date our Committee of Independent Directors approved the private placement. Of the shares purchased in this private placement, Pegasus Partners IV and two of its operating advisors purchased an aggregate of 3,167,333 shares of common stock for a purchase price of $10,452,200. Michael Kempner, who is also an operating advisor of Pegasus Capital and a director of the company, and Leon Wagner, a director of the company, also purchased 60,606 and 634,394 shares of common stock, respectively, for a purchase price of $200,000 and $2,093,500, respectively, in the private placement.
Warrant Exchange
On February 4, 2011, we entered into an Exchange Agreement with LSGC Holdings pursuant to which we issued 54,500,000 shares of common stock in exchange for its: (i) Series D Warrant to purchase 60,758,777 shares of common stock and (ii) warrant to purchase 942,857 shares of common stock, which was originally issued to Pegasus IV on July 25, 2008.
Assignment Agreement and Private Placement
On April 22, 2011, we entered into an Assignment Agreement with Holdings II pursuant to which we sold all of our rights, title and interests in the expected proceeds from a key-man life insurance policy on Zachary Gibler, our former Chairman and Chief Executive Officer. We received $6.5 million from Holdings II in conjunction with the sale of these expected proceeds. In connection with the Assignment Agreement, we recognized interest expense of $43,000.
In May 2011, we received $7.0 million in proceeds from Mr. Gibler’s key man life insurance policy, and Holdings II surrendered its rights thereto pursuant to the Assignment Agreement. In exchange for surrendering its rights to these proceeds, we issued Holdings II a demand note on May 6, 2011 pursuant to which we promised to pay $6.5 million to Holdings II plus $1,800 per day in interest from April 22, 2011 until the balance on the demand note (including accrued interest) was paid in full.
On May 16, 2011, we entered into a subscription agreement with LSGC Holdings and Holdings II pursuant to which LSGC Holdings and Holdings II agreed to purchase 3,750,000 and 1,635,800 shares of common stock, respectively, at a price per share of $4.00 for an aggregate purchase price of $21,543,200. The subscription agreement provided Holdings and Holdings II with anti-dilution protections that would require us to issue additional shares of our common stock to LSGC Holdings and Holdings II in the event we sold shares of our common stock for less than $4.00 per share pursuant to our then-proposed underwritten public offering. We issued the shares of our common stock to Holdings II in exchange for, and in full satisfaction of, the May 6, 2011 demand note held by Holdings II. As of May 16, 2011, the outstanding balance on the demand note, including principal and interest, was $6,543,200. In connection with this private placement, we paid Pegasus IV a commission of $600,000 and agreed to pay up to $80,000 of legal fees incurred by Holdings II.
Series F Preferred Offering
On November 17, 2011, we entered into a subscription agreement with PCA Holdings and Pegasus IV pursuant to which we gave PCA Holdings, Pegasus IV and their permitted assigns the option (the “Unit Purchase Option”) to purchase up to 40,000 units of our securities (the “Series F Units”) at a price per Series F Unit of $1,000.00. Each Series F Unit consisted of: (i) one share of Series F Preferred Stock and (ii) 83 shares of our common stock. PCA Holdings purchased 10,000 Series F Units for an aggregate purchase price of $10,000,000 and Mr. Wagner purchased 1,500 Series F Units for an aggregate purchase price of $1,500,000.
The subscription agreement also provided PCA Holdings with the right to exchange, and to require any other purchaser of Series F Units to exchange, its Series F Units for any subsequent security we issued (other than issuances pursuant to our equity-based compensation plans) which PCA Holdings, in its sole discretion, determined were more favorable than the Series F Units. Upon the occurrence of any such exchange, all outstanding rights to purchase Series F Units pursuant to the Unit Purchase Option would also convert into the right to purchase the newly issued securities on substantially the same terms and conditions as those offered to the purchasers of the newly issued securities. On December 1, 2011, PCA Holdings determined that our newly designated Series G Units, each such unit consisting of (i) one share of our Series G Preferred Stock and (ii) 83 shares of our common stock (the “Series G Units”), were more favorable than the Series F Units and exercised its right to exchange its Series F Units, and require Mr. Wagner to exchange his Series F Units, for Series G Units. In connection with the offering of Series F Units we agreed to pay up to $80,000 of legal fees incurred by PCA Holdings and Pegasus IV.
Series G Preferred Offering
On December 1, 2011, we entered into the Series G Unit Subscription Agreement with PCA Holdings, Pegasus IV and certain other investors as identified therein, pursuant to which we issued an aggregate of 6,458 Series G Units to Holdings II for total proceeds of approximately $6.5 million. Additionally, as noted above, the outstanding shares of Series F Preferred Stock held by PCA Holdings and Mr. Wagner were converted in to shares of Series G Preferred Stock. On February 24, 2012, April 12, 2012 and May 2, 2012, respectively, we issued an additional 2,000, 1,000 and 2,000 Series G Units to Mr. Wagner for total proceeds of $5.0 million. On each of March 20, March 28, 2012 and May 18, 2012, we issued 2,000 Series G Units, respectively, to PCA Holdings for total proceeds of $6.0 million. On April 13, 2012, the company issued 2,000 Series G Units to Holdings II for total proceeds of $2.0 million. In connection with the Riverwood Offering, all of the outstanding shares of Series G Preferred Stock were exchanged into shares of Series H Preferred Stock or Series I Preferred Stock, as discussed in more detail below.
The Rollover Offering
The consummation of the Riverwood Offering, and the issuance of the Preferred Shares in connection therewith, constituted a subsequent transaction (as such term is defined in the Certificate of Designation governing the Series G Preferred Stock (the “Series G Certificate of Designation”)). As a result, PCA Holdings, Holdings II, Mr. Wagner and the other holders of Series G Preferred Stock (collectively, the “Series G Investors”) were entitled to elect to convert all or less than all of their shares of Series G Preferred Stock into a number of shares of Series H Preferred Stock or Series I Preferred Stock equal to the aggregate liquidation value (as defined in the Series G Certificate of Designation) of the outstanding shares of Series G Preferred Stock held by such Series G Investor (the “Rollover Offering”).
Pursuant to the Rollover Offering, each of PCA Holdings and Holdings II agreed to cause all 17,650 and 14,958 of their shares of Series G Preferred Stock, respectively, to be converted into 18,314 and 15,575 shares of Series I Preferred Stock, Mr. Wagner elected to convert all 6,500 of his shares of Series G Preferred Stock into 6,649 shares of Series I Preferred Stock. In total, we issued a total of 4,346 shares of Series H Preferred Stock and 50,001 shares of Series I Preferred Stock to the Series G Investors pursuant to the Rollover Offering. In connection with the Rollover Offering, we recognized interest expense of $294,000 during the second quarter of 2012.
2010 Support Services Agreement
Effective June 23, 2010, we entered into a support services agreement with Pegasus Capital (the “2010 Services Agreement”) pursuant to which paid Pegasus Capital $750,000 as reimbursement for prior financial, strategic planning, monitoring and other related services previously provided by Pegasus Capital. In addition, we agreed to pay $187,500 until October 15, 2011, and then $125,000 for each of the calendar quarter in exchange for these support services during such periods. The 2010 Services Agreement expired on June 30, 2012. During the year ended December 31, 2011 and through September 24, 2012, we incurred a total of $875,000 in management fees pursuant to the 2010 Services Agreement.
2012 Support Services Agreement
On May 25, 2012, we entered into a new Support Services Agreement with Pegasus Capital (the “2012 Services Agreement”), pursuant to which we agreed to pay Pegasus Capital $125,000 for each calendar quarter beginning on July 1, 2012, in exchange for certain support services during such periods. The 2012 Services Agreement expires upon the earlier of: (i) June 30, 2017, (ii) a change of control or (iii) a “QPO” (as such terms are defined in the 2012 Services Agreement). During the first 30 days of any calendar quarter, we have the right to terminate the 2012 Services Agreement, effective immediately upon written notice to Pegasus Capital. We have not yet paid any management fees pursuant to the 2012 Services Agreement.
Exchange and Redemption Agreement
On January 17, 2012, we issued 5,000 Series G Units to Continental for total proceeds of $5.0 million. As partial consideration for Continental’s purchase of the Series G Units, LSGC Holdings agreed to certain amendments to the terms of the senior preferred membership interests in LSGC Holdings held by Continental. In addition, LSGC Holdings was obligated to redeem the preferred membership interests if we (i) incur aggregate indebtedness that exceeds (a) the indebtedness permitted under our working capital facility, not to exceed $75.0 million in total credit thereunder and (b) such additional unsecured indebtedness that when aggregated with such working capital facility, if any, exceed 300% of our earnings before interest, taxes, depreciation and amortization for
the last 12 months or (ii) issue outstanding preferred equity securities having an original principal amount of over $80.0 million in the aggregate. On January 17, 2012, in consideration for LSGC Holdings’ agreement to amend the terms of the preferred membership interests held by Continental, we entered into the LSGC Letter Agreement, pursuant to which we agreed to indemnify LSGC Holdings and its affiliates for any and all losses or damages as a result of any breach, or redemption obligation arising in connection with, the preferred membership interests held by Continental arising out of or relating to our incurrence of indebtedness in excess of the applicable cap or our issuance of preferred equity securities in excess of the applicable cap. Additionally, in the event that we would be required to indemnify LSGC Holdings under the LSGC Letter Agreement, LSGC Holdings agreed to surrender 3,750,000 shares of common stock to us less any shares of common stock previously distributed by LSGC Holdings to Continental. Pursuant to the LSGC Letter Agreement, we also agreed to pay Pegasus IV a fee of $250,000 for expenses incurred by Pegasus IV and its affiliates related to certain of our private placements during the fourth quarter of 2011 and first quarter of 2012.
Following consummation of the Riverwood Offering, the amount of preferred equity we had issued exceeded $80.0 million, and, as a result, LSGC Holdings was required to redeem 15,000,000 of its issued and outstanding senior preferred member interests held by Continental (the “Class C Interests”) pursuant to the letter agreement between such parties. On May 25, 2012, we entered into the Exchange Agreement with LSGC Holdings and Continental to, among other things, facilitate the redemption of the Class C Interests and common stock held by Continental and LSGC Holdings, respectively, and the indemnification payments to be made in accordance with the LSGC Letter Agreement. Pursuant to the Exchange Agreement, (a) we made an indemnification payment directly to Continental in the amount of $16.2 million, representing the cost to redeem the Class C Interests, consisting of: (i) a cash payment of $10.2 million, and (ii) in lieu of an additional $6.0 million in cash, 6,000 shares of Series I Preferred Stock, deliverable within 20 days following the date of the Exchange Agreement; (b) Continental surrendered all of the Class C Interests to LSGC Holdings; and (c) LSGC Holdings surrendered a total of 2,505,000 shares of common stock to us.
Commitment Agreement
On May 25, 2012, in conjunction with the Riverwood Offering, we entered into the Commitment Agreement with certain affiliates of Pegasus Capital. Pursuant to the Commitment Agreement, the affiliates of Pegasus Capital and certain permitted assignees may purchase an aggregate of 21,131 shares of the company’s Series H Preferred Stock or Series I Preferred Stock for $1,000.00 per share, and such affiliates have committed to purchase any of such shares that have not been purchased on the four-month anniversary of the Commitment Agreement. This commitment was satisfied by the September 2012 Preferred Offering discussed below.
Pegasus Warrant
As compensation for the advisory services provided by Pegasus, on September 11, 2013, we issued a warrant to Holdings II (the “Pegasus Warrant”) to purchase 10,000,000 shares of our common stock at an exercise price to be determined at the time of exercise pursuant to a formula as described therein. The Pegasus Warrant also provides for certain anti-dilution adjustments and, if unexercised, expires on May 25, 2022.
November Series J
On November 19, 2013, we entered into a Preferred Stock Subscription Agreement with Holdings II pursuant to which we issued 1,157 shares of Series J Preferred Stock at a price of $1,000 per share and total consideration of $1,157,000. The purchase of the shares of Series J Preferred Stock by Holdings II satisfies the Pegasus Series J Commitment.
Transactions with Affiliates of Zouk
September 2012 Preferred Offering
On September 25, 2012, we entered into the September 2012 Subscription Agreements with each of (i) Portman and (ii) Zouk, pursuant to which we issued an aggregate of 49,000 shares of Series H Preferred Stock at a price of $1,000 per Preferred Share and raised gross proceeds of approximately $49.0 million. Zouk purchased an aggregate of 24,500 shares of Series H Preferred Stock pursuant to the 2012 Subscription Agreements for aggregate proceeds of $24.5 million. In conjunction with the September 2012 Preferred Offering, we issued to each of Portman and Zouk warrants (the “September 2012 Warrants”) to purchase 4,000,000 common stock, respectively.
Zouk Support Services Agreement
In connection with the September 2012 Preferred Offering, we entered into a Support Services Agreement (the “Zouk Services Agreement”) with Zouk, pursuant to which the Company agreed to pay Zouk $100,000 each calendar quarter beginning with the quarter ended September 30, 2012, in exchange for certain support services during such periods. The Zouk Support Services Agreement expires upon the earlier of: (i) September 25, 2022; (ii) such date that Zouk and/or its affiliates directly or indirectly beneficially own less than 37.5% of the shares of Series H Preferred Stock purchased pursuant to the September 2012 Preferred Offering, on an as-converted basis; (iii) such date that the Company and Zouk may mutually agree in writing; (iv) a Change of Control and (v) a “QPO” (as such terms are defined in the Zouk Services Agreement).
On September 25, 2012 and in connection with the September 2012 Preferred Offering each of Pegasus Capital, Riverwood, Portman and Zouk entered into a Fee Waiver Letter Agreement, pursuant to which the parties agreed to suspend payment of the fees payable in connection with their respective Support Services or other agreements, including the Zouk Services Agreement, between the Company and such parties until revoked by their unanimous written consent.
Relationship with T&M Protection Resources
During 2013 and through March 25, 2014, we incurred security fees of $15,000 for security services provided by T&M Protection Resources, a security company affiliated with Pegasus Capital, primarily for our facility in Monterrey, Mexico.
Director Independence
Although Lighting Science Group is not currently listed on the NASDAQ Stock Market or any other exchange, we rely on the definition of independence established by NASDAQ rules. Under the NASDAQ Marketplace Rules, a director will only qualify as an “independent director” if, in the opinion of our Board, that person does not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. During 2013, our Board determined that Karel (Kaj) den Daas, who served on our board from May 25, 2012 until his resignation on February 7, 2014 and each of Messrs. Wagner and Harkleroad were “independent directors,” as defined under Rule 5605(a)(2) of the NASDAQ Marketplace Rules.
Because LSGC Holdings holds more than 50% of the voting power for the election of our directors, we would qualify as a “controlled company” under the NASDAQ Marketplace Rules. As a controlled company, exemptions under the NASDAQ Marketplace Rules provide relief from the obligation to comply with certain corporate governance requirements, including the requirements:
•
that a majority of our Board consists of “independent directors,” as defined under the NASDAQ Marketplace Rules; and
•
that our Compensation Committee be composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.
These exemptions do not modify the independence requirements for our Audit Committee, and we would be required to comply with the requirements of Rule 10A-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the NASDAQ Marketplace Rules within the applicable time frame in the event that we become listed on a NASDAQ exchange.
Item 14.
Item 14. Principal Accounting Fees and Services.
Fees to Independent Registered Public Accounting Firm
The following is a summary of the fees billed to us by KPMG LLP for professional services rendered in 2013 and 2012:
Audit Fees. This category includes the audit of the our annual consolidated financial statements, reviews of our financial statements included in our Form 10-Qs and services that are normally provided by our independent registered public accounting firm in connection with its engagements for those years. This category also includes advice on audit and accounting matters that arose during, or as a result of, the audit or the review of our interim financial statements.
Audit-Related Fees. This category consists of assurance and related services by our independent registered public accounting firm that are reasonably related to the performance of the audit or review of our financial statements and are not reported above under “Audit Fees.” The services for the fees disclosed under this category include consents regarding equity issuances.
Tax Fees. This category typically consists of professional services rendered by our independent registered public accounting firm for tax compliance and tax advice.
Pre-Approval Policies and Procedures
Under the Audit Committee’s pre-approval policies and procedures, the Audit Committee is required to pre-approve the audit and non-audit services performed by our independent registered public accounting firm. On an annual basis, the Audit Committee pre-approves a list of services that may be provided by the independent registered public accounting firm without obtaining specific pre-approval from the Audit Committee. In addition, the Audit Committee sets pre-approved fee levels for each of the listed services. Any type of service that is not included on the list of pre-approved services must be specifically approved by the Audit Committee or its designee. Any proposed service that is included on the list of pre-approved services but will cause the pre-approved fee level to be exceeded will also require specific pre-approval by the Audit Committee or its designee.
The Audit Committee has delegated pre-approval authority to the Audit Committee chairman and any pre-approved actions by the Audit Committee chairman as designee are reported to the Audit Committee for approval at its next scheduled meeting.
All of the services rendered by KPMG LLP in 2013 were pre-approved by the Audit Committee.
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, 2013 and 2012, Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2013, 2012 and 2011, Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2013, 2012 and 2011 and Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011.
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.
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.
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, 2013 and 2012, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Orlando, FL
March 31, 2014
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’ EQUITY (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, manufactures 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 both internally and 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 revenues 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 ongoing 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 respective foreign subsidiary. For the operations of Lighting Science Group B.V. (“LSGBV”), the Company’s Netherlands based subsidiary, the functional currency is the Euro, for the operations of Lighting Science Group Mexico SRL, (“LSG Mexico”), the Company’s Mexican subsidiary, the functional currency is the Mexican Peso and for the operations of Lighting Science India Private Limited (“LSIPL”), the Company’s Indian subsidiary, the functional currency is the Indian Rupee. 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) equity 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 December 31, 2013 and 2012, the Company had $0 and $21,000, respectively, in 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, 2013, the Company had $16.0 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 required by the Company’s asset-based revolving credit facility (as amended, the “Wells Fargo ABL”) with Wells Fargo Bank N.A. (“Wells Fargo”) the Company was required to maintain a minimum qualified cash balance of $5.0 million as a compensating balance against the Wells Fargo ABL. Changes in the restricted cash balance were reflected as a financing activity in the consolidated statement of cash flows.
Accounts Receivable
The Company records accounts receivable at the invoiced amount when its products are shipped to customers or upon the completion of specific milestone billing requirements. 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, 2013 and 2012, the Company’s accounts receivable are reflected net of an allowance for doubtful accounts of $475,000 and $1.2 million, respectively.
As of December 31, 2013 and 2012, there were $6.8 million and $11.4 million, respectively of eligible accounts receivable pledged as collateral for the Company’s line of credit with Wells Fargo.
Inventories
Inventories, which consist of raw materials and purchased components and subsystems, work-in-process and finished lighting products, are stated at the lower of cost or market. The Company uses a standard costing methodology to value its inventories. This costing methodology approximates actual cost on a weighted average basis. The Company reviews and sets its standard costs of raw materials, work-in-process and finished goods inventory on a periodic basis to ensure that its inventories approximate current actual costs. Any purchase price variances related to labor and overhead that would indicate a loss on disposition of inventory is recorded to cost of goods sold in the statement of operations at the end of each reporting period. Work in process and finished lighting products include raw materials, labor and allocated overhead. 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 periodic basis to specifically identify obsolete, slow-moving or non-salable inventory. 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 once raw materials are used to produce specific finished goods. The market value of finished goods is determined based upon current sales transactions, less the cost of disposal of the respective finished goods. The write-down of inventory to the lower of cost or market creates a new cost basis that cannot be marked up even if there are subsequent changes in the underlying facts and circumstances.
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:
Estimated
Useful Lives
Leasehold improvements
1-5 years
Office, furniture and equipment
2-5 years
Tooling, production and test equipment
2-4 years
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, such as property, plant and equipment, and purchased intangible assets subject to amortization, 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 of Financial Instruments
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.
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 $3.4 million, $5.1 million and $3.8 million for the years ended December 31, 2013, 2012 and 2011, 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, except for prototypes that have alternative future uses.
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 during the years ended December 31, 2013 and 2012:
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, 2013 and 2012, 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, included in sales and marketing expenses, 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 $1.3 million, $872,000 and $2.0 million for the years ended December 31, 2013, 2012 and 2011, 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.
NOTE 3: LIQUIDITY AND CAPITAL RESOURCES
As shown in the consolidated financial statements, the Company has experienced significant net losses as well as negative cash flows from operations since its inception, resulting in an accumulated deficit of $734.7 million and stockholders’ deficit of $410.8 million as December 31, 2013. In addition, the Company has negative working capital of $19.7 million as of December 31, 2013. The Company’s cash expenditures primarily relate to procurement of inventory, payment of salaries, employee benefits and other operating costs and purchases of production equipment and other capital investments. The Company’s primary sources of liquidity have historically been borrowings from Wells Fargo and sales of common stock and
preferred stock to, and short-term loans from, affiliates of Pegasus Capital Advisors, L.P. (“Pegasus Capital”), including Pegasus Partners IV, L.P. (“Pegasus IV”), LSGC Holdings, LLC (“LSGC Holdings”), LSGC Holdings II, LLC (“Holdings II”) and PCA LSG Holdings, LLC (“PCA Holdings”), which together with its affiliates, is the Company’s controlling stockholder. However, as detailed below, the Series H and I Preferred Offering (defined in Note 10 below) was provided primarily by parties other than Pegasus Capital and its affiliates.
As of December 31, 2013, the Company had cash and cash equivalents of $11.2 million and an additional $5.0 million in cash subject to restriction pursuant to the Wells Fargo ABL. The Wells Fargo ABL provided the Company with a borrowing capacity of up to $50.0 million, which capacity was equal to the sum of (i) 85% of its eligible accounts receivable plus up to $7.5 million of eligible inventory, less certain allowances established against such accounts receivable and inventory by Wells Fargo from time to time pursuant to the Wells Fargo ABL, plus (ii) unrestricted cash held in a Wells Fargo deposit account (“Qualified Cash”), plus (iii) the amount of the Second Lien Letter of Credit Facility with Ares Capital Corporation (“Ares Capital”), pledged in favor of Wells Fargo (the “Ares Letter of Credit Facility”) for the benefit of the Company (collectively, the “Borrowing Base”). The Company was required to maintain (i) a Borrowing Base that exceeds the amount of its outstanding borrowings under the Wells Fargo ABL by at least $5.0 million and (ii) $5.0 million in Qualified Cash. The Company would have been required to comply with certain specified EBITDA requirements in the event that it had less than $2.0 million available for borrowing under the Wells Fargo ABL. As of December 31, 2013, the Company had $40.2 million of outstanding borrowings under the Wells Fargo ABL and additional borrowing capacity of $4.8 million.
On February 19, 2014, the Company entered into a five-year term loan (the “Medley Term Loan”) in the amount of $30.5 million and a two-year delayed draw term loan (the “Medley Delayed Draw Loan”) with Medley Capital Corporation (“Medley”). The Medley Delayed Draw Loan provides the Company with borrowing capacity of up to a maximum of $22.5 million, which capacity is limited by a borrowing base equal to the sum of (i) 85% of the Company’s eligible accounts receivable (ii) 60% of the Company’s eligible inventory, and (iii) qualified cash less any reserves imposed by Medley. The Company utilized proceeds from the Medley Term Loan to repay its outstanding obligations under the Wells Fargo ABL and the Ares Letter of Credit Facility.
From September 11, 2013 through November 18, 2013 , the Company issued an aggregate of 20,000 shares of its Series J Preferred Stock, par value $0.001 per share (the “Series J Preferred Stock”), at a price of $1,000 per share (the “Stated Value”) for aggregate proceeds of $20.0 million (the “Initial Series J Preferred Offering”). The shares of Series J Preferred Stock were issued pursuant to a preferred stock subscription agreement (the “Series J Subscription Agreement”) entered into between the Company, RW LSG Holdings LLC, (“Riverwood Holdings”), an affiliate of Riverwood LSG Management Holdings LLC (“Riverwood Management”) and Riverwood Capital Partners L.P. (“Riverwood Capital,” and together with Riverwood Holdings, Riverwood Management and their affiliates, “Riverwood”), PCA Holdings and Holdings II.
The Company believes it will have sufficient capital to fund its operations for at least the next 12 months based on its current business plan and assumptions of future results. The current business plan includes a focus on increasing revenue by updating and expanding our product offerings and capitalizing on the known product needs of our existing customers, improving gross margins by significantly leveraging contract manufacturers in Asia and reducing operating costs, primarily through the restructuring initiated in 2013. In future periods, if the Company does not adequately execute upon its business plan or its assumptions or forecasts do not prove to be accurate, the Company could exhaust its available capital resources, which could require the Company to seek to raise additional capital and/or further reduce its expenditures of cash. There can be no assurance that sources of liquidity will be available in an amount or on terms that are acceptable to the Company.
Between January 3, 2014 and March 7, 2014, the Company issued an aggregate of 17,475 units of its securities (the “Series J Securities”), at a purchase price of $1,000 per Series J Security for aggregate proceeds of $17.5 million (the “Follow-On Series J Offering”). Each Series J Security consists of (i) one share of the Company’s Series J Preferred Stock and (ii) a warrant to purchase 2,650 shares of the Company’s common stock, at an exercise price of $0.001 per share (the “Series J Warrants”). The Series J Securities were issued pursuant to a preferred stock subscription agreement (the “Series J Securities Subscription Agreement”) entered into between the Company, PCA Holdings, Holdings II, Riverwood Holdings, Cleantech Europe II (A) LP (“ Cleantech A”), Cleantech Europe II (B) LP (“Cleantech B”, and together with Cleantech A, “Zouk”) and certain other accredited investors. In the Initial Series J Preferred Offering and the Following Offering, the Company issued an aggregate of 19,657 Series J Securities to Holdings II, 8,500 Series J Securities to PCA Holdings, 5,254 Series J Securities to Riverwood, 2,570 Series J Securities to Zouk and 1,494 Series J Securities to certain other accredited investors. Upon the consummation of the Follow-On Series J Offering, each of the shares of Series J Preferred Stock issued in the Initial Series J Preferred Offering were converted into Series J Securities pursuant to the terms of the Series J Subscription Agreement. In the Initial Series J Preferred Offering and the Follow-On Series J Offering, the Company issued an aggregate of 19,657 Series J Securities to Holdings II, 8,500 Series J Securities to PCA Holdings, 5,254 Series J Securities to Riverwood, 2,570 Series J Securities to Zouk and 1,494 Series J Securities to certain other accredited investors.
NOTE 4: FAIR VALUE MEASUREMENTS
Cash and cash equivalents, accounts receivable, accounts payable, amounts due under lines of credit and other short term borrowings, accrued expenses and other current liabilities are carried at book value amounts, which approximate fair value due to the short-term maturity of these instruments.
The Company reviewed the amortizable intangible assets acquired in the acquisition of LSGBV for impairment during the year ended December 31, 2012. An impairment charge was recorded primarily due to LSGBV’s ongoing negative cash flows from operations, and as a result these intangible assets were accounted for at fair value on a non-recurring basis, using Level 3 valuation inputs and were written down to their estimated fair values of $0.
The Pegasus Warrant (as defined in Note 9 below) and the Riverwood Warrant, September 2012 Warrants and the Pegasus Commitment (each as defined in Note 10 below) were initially recorded at fair value and are marked to fair value each quarter.
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, 2013, according to the valuation techniques the Company used to determine their fair values:
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, 2013:
The Company had financial assets and liabilities that were accounted for at fair value on a recurring basis during the year ended December 31, 2012 related to Series H and Series I Preferred Stock and Warrants (Note 10) using significant unobservable inputs (Level 3). All of these instruments were issued during the year ended December 31, 2012 and there were no transfers in or out of Level 3 during 2012. The unrealized loss on the Riverwood Warrants was $8.5 million for the year ended December 31, 2012. As of December 31, 2012, the Company had no financial assets or liabilities that were accounted for at fair value on a non-recurring basis.
NOTE 5: INVENTORIES
Inventories are comprised of the following:
Consigned inventory is held at third-party locations, including those of the Company’s contract manufacturers. The Company retains title to the inventory until such inventory is purchased by a third-party. Consigned inventory, consisting of raw materials, was $693,000 and $2.0 million as of December 31, 2013 and 2012, respectively.
On a quarterly basis, the Company performs a review of its inventory for estimated obsolete or slow-moving inventory based upon assumptions about future demand and market conditions. As a result of these reviews, the Company recorded an inventory valuation allowance of $11.4 million, $15.8 million and $20.5 million for the years ended December 31, 2013, 2012 and 2011, respectively, with the expense included in cost of goods sold. As of December 31, 2013 and December 31, 2012, inventories are stated net of inventory valuation allowances (write-downs) of $24.1 million and $25.6 million, respectively. The Company considered a number of factors in estimating the required inventory allowances, 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, 2013, 2012 and 2011, the Company recorded $2.3 million, $5.6 million and $8.5 million, respectively, in provisions for losses on non-cancellable purchase commitments of which $1.6 million and $5.7 million were accrued as of December 31, 2013 and 2012, respectively, which were included in cost of goods sold in the Consolidated Statement of Operations.
The Company has identified certain finished goods that have and continue to generate negative margins. These finished goods are manufactured using common raw materials that are implemented into a number of product SKUs, which are used in the manufacture of other finished goods inventory that also generate positive margins for the Company. On a quarterly basis, the Company considers the need to record a lower of cost or market adjustment for the 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.
NOTE 6: PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
Depreciation related to property and equipment was $8.7 million, $8.2 million and $4.2 million for the years ended December 31, 2013, 2012 and 2011, respectively.
Impairment of Property and Equipment
Property and equipment are depreciated over their estimated economic lives. Long-lived assets, including property and equipment, are evaluated to determine whether, in management’s judgment, events or changes in circumstances have occurred that may warrant a revision of the estimated useful life or whether the remaining balance should be evaluated for possible impairment. Such impairment tests compare estimated undiscounted cash flows over the remaining life of the property and equipment in assessing whether an asset has been impaired. If an impairment is indicated, the asset is written down to its fair value based on an estimate of its discounted cash flows.
In November and December 2013, the Company performed an impairment analysis of property and equipment related to its Satellite Beach, Florida headquarters, its facility in The Netherlands, LSGBV, and its facility in India, LSIPL, in connection with the transition of a majority of the Company’s manufacturing operations to its contract manufacturers in Asia and the winding down of business in the Netherlands and India. This impairment analysis included an assessment of the proposed future use of the property and equipment and their estimated useful lives. As a result of this assessment the Company recorded an impairment charge of $2.6 million for the year ended December 31, 2013, which is included in Restructuring Expense.
In connection with the Company’s September 2012 transition of its manufacturing operations in Mexico to its contract manufacturer in Mexico, Jabil Circuit, Inc. (the “Mexico Closing”), the Company performed an impairment analysis of property and equipment related to its wholly-owned subsidiary, Lighting Science Group Mexico S. de R.L. de C.V. (“LSG Mexico”). This review included an assessment of the proposed future use of the property and equipment and their estimated useful lives. As a result of this assessment the Company recorded an impairment charge of $1.7 million for the year ended December 31, 2012, which is included in restructuring expense.
NOTE 7: INTANGIBLE ASSETS AND GOODWILL
Intangible assets that have finite lives are amortized over their useful lives. The intangible assets, their original fair values, adjusted for impairment charges in the third quarter of 2012, and their net book values are detailed below as of the dates presented:
Total intangible amortization expense was $40,000, $203,000 and $713,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
Impairment of Goodwill and Intangible Assets
Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but instead are tested for impairment annually at the end of the Company’s third quarter, or more frequently if certain indicators arise. This review includes an assessment of industry factors, contract retentions, cash flow projections and other factors the Company believes are relevant. If an impairment is indicated, the asset is written down to its fair market value based on an estimate of its discounted cash flows and income.
The fair value of the business related to the acquisition of LED Effects in 2007 and the associated goodwill was estimated using the income approach, which was based on the future, expected cash flows to be generated by LED Effects, discounted to their present values. During the restructuring of the Company’s California based operations, the Company closed its California location and moved the business to the Company’s Satellite Beach, Florida headquarters in October 2010. The portion of the business related to the acquisition of LED Effects incurred a significant reduction in revenue during 2011, which had an impact on the projected cash flows and estimated fair value of the reporting unit. In connection with the restructuring (see note 16) and the Company’s annual impairment test, that the Company recorded an impairment charge of $1.6 million for the year ended December 31, 2011, which resulted in a write-down of goodwill to $0.
Intangible assets with estimable useful lives are amortized over their respective useful lives to their estimated residual values, and reviewed to determine if their estimable lives have decreased. Long-lived assets, including intangible assets subject to amortization, are reviewed for impairment whenever, in management’s judgment, conditions indicate a possible impairment. Such impairment tests compare estimated undiscounted cash flows to the carrying value of the asset. If an impairment is indicated, the asset is written down to its fair value based on an estimate of its discounted cash flows.
The Company reviewed the amortizable intangible assets acquired in the acquisition of LSGBV for impairment as of September 30, 2012 primarily due to LSGBV’s ongoing negative cash flows from operations, among other factors. This review included an assessment of the current use of these intangible assets and their estimated useful lives. As a result of this review, the Company recorded an impairment charge of $380,000 for the year ended December 31, 2012.
The following table summarizes the total impairment charges recorded by the Company in 2012:
In addition, the Company performed an impairment analysis of amortizable intangible assets related to the acquisition of LED Effects in the third quarter of 2011 due to the reduction in revenue noted above to determine whether the intangible assets were impaired. This review included an assessment of the current use of these intangible assets and their estimated useful lives. The Company also performed an impairment analysis of the intangible assets related to Lamina as of December 31, 2011 due to the continued decline in sales of products related to this acquisition to determine whether the intangible assets were impaired. This review also included an assessment of the current use of these intangible assets and their estimated useful lives. As a result of these assessments, the Company recorded an impairment charge of $4.1 million for the year ended December 31, 2011.
The following table summarizes the total impairment charges recorded by the Company in 2011:
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:
NOTE 8: LINES OF CREDIT
Wells Fargo
The Wells Fargo ABL provided the Company with borrowing capacity of up to $50.0 million, which capacity was equal to the sum of (i) 85% of its eligible accounts receivable plus $7.5 million of eligible inventory less certain allowances established against such accounts receivable and inventory by Wells Fargo from time to time pursuant to the Wells Fargo ABL, plus (ii) Qualified Cash, plus (iii) the amount of the Ares Letter of Credit Facility. As of December 31, 2013 and 2012, the Company had $40.2 million and $1.5 million, respectively, outstanding under the Wells Fargo ABL and additional borrowing capacity of $4.8 million and $48.5 million, respectively.
As of December 31, 2013, eligible collateral included $6.8 million of accounts receivable, $16.2 million of inventory and $11.2 million of Qualified Cash. Borrowings under the Wells Fargo ABL bore interest at one of the following two rates (at the Company’s election): (a) the sum of (1) the greater of: (x) the federal funds rate plus 0.50%, (y) the daily three month LIBOR rate plus 1.0% and (z) Wells Fargo’s prime rate; and (2) 0.75%, 1.25% or 1.75%, as applicable, depending on the amount available for borrowing under the facility and subject to any reserves established by Wells Fargo in accordance with the terms of the Wells Fargo ABL; or (b) the sum of (1) the daily three month LIBOR rate; plus 3.0%, 3.5% or 4.0%, as applicable, depending on the amount available for borrowing under the facility and subject to any reserves established by Wells Fargo in accordance with the terms of the Wells Fargo ABL. The interest rate on the Wells Fargo ABL was 3.3% and 3.1% as of December 31, 2013 and 2012, respectively.
The Company was required to pay certain fees, including an unused line fee ranging from 0.375% to 1.0% of the unused portion of the facility. Outstanding loans could be prepaid without penalty or premium, except that the Company was required to pay a termination fee ranging from $250,000 to $500,000 (depending on the date of termination) if the facility was terminated by Wells Fargo during a default period.
The Wells Fargo ABL contained customary financial covenants that limited the Company’s ability to incur additional indebtedness or guarantee indebtedness of others, create liens on the Company’s assets, enter into mergers or consolidations, dispose of assets, prepay indebtedness, make changes to the Company’s governing documents and certain agreements, pay dividends or make other distributions on the Company’s capital stock, redeem or repurchase capital stock, make investments, including acquisitions; and enter into transactions with affiliates. The Company was also required to maintain (i) a Borrowing Base that exceeded the amount of its outstanding borrowings under the Wells Fargo ABL by at least $5.0 million and (ii) $5.0
million of Qualified Cash. The Company would have been required to comply with certain specified EBITDA requirements in the event that it has less than $2.0 million available for borrowing on the Wells Fargo ABL. The Wells Fargo ABL also contained customary events of default and affirmative covenants, a subjective acceleration clause, a lockbox requirement and cross default provisions.
On February 24, 2012, the Company entered into Amendment No. 5 (“Amendment No. 5”) to the Wells Fargo ABL, which increased the maximum amount of authorized advances or payments to or for the benefit of LSG Mexico in each month from $750,000 to (i) $860,000 for the month ended December 31, 2011, (ii) $1.4 million for the period from January 1, 2012 through March 31, 2012, (iii) $1.5 million for the period from April 1, 2012 through September 30, 2012, and (iv) $1.8 million for October 1, 2012 and for each month thereafter. Amendment No. 5 also provides the Company with borrowing base eligibility for additional accounts receivable. The Company paid Wells Fargo a fee of $5,000 in connection with this amendment.
On March 31, 2013, the Company entered into Amendment No. 6 to the Wells Fargo ABL, which among other things, (i) extended the maturity date of the Wells Fargo ABL to April 2, 2014, and (ii) reduced the maximum credit available under the Wells Fargo ABL by $2.5 million (from $50.0 million to $47.5 million) on November 22, 2013 if (x) the Company’s consolidated earnings (loss) before interest, tax, depreciation and amortization for the nine month period ending on September 30, 2013 is greater than $(20.2 million) and (y) excess availability under the Wells Fargo ABL on November 22, 2013 is less than $10.0 million. As of November 22, 2013, there was no reduction in the maximum credit available under the Wells Fargo ABL.
Pursuant to Amendment No. 6, Wells Fargo also waived certain events of default under the Wells Fargo ABL related to the Company’s creation of LSIPL. The Company also agreed to pledge 65% of the issued and outstanding capital stock of LSIPL as collateral supporting the Wells Fargo ABL. Further, Amendment No. 6 permits the Company to make additional advances to certain affiliates (including LSIPL) in an amount not to exceed $500,000 from the date of Amendment No. 6 through October 1, 2013, and in an amount not to exceed $250,000 thereafter.
On June 4, 2013, the Company entered into Amendment No. 7 to the Wells Fargo ABL, which among other things, increased the limit on the aggregate amount of all letters of credit the Company may issue (the “Letter of Credit Limit”) to $7.0 million from $2.0 million.
On February 19, 2014, the Company entered into the Medley Term Loan and the Medley Delayed Draw Loan and utilized proceeds from the Medley Term Loan to repay its outstanding obligations under the Wells Fargo ABL.
Ares Capital
On September 21, 2011, the Company entered into the Ares Letter of Credit Facility, a $25.0 million standby letter of credit issued by Ares Capital in favor of Wells Fargo for the benefit of the Company. As a condition to Ares Capital’s agreement to provide the Ares Letter of Credit Facility for the benefit of the Company, the Company entered into the Second Lien Letter of Credit, Loan and Security Agreement (the “Ares Loan Agreement”) with Ares Capital. In accordance with the Ares Loan Agreement, the Company agreed to reimburse Ares Capital for any amounts drawn on the Ares Letter of Credit Facility and to permanently reduce the face amount of the Ares Letter of Credit Facility by such amount. Further, the Company agreed that any such reimbursement obligation would automatically convert into a term loan (an “Ares Term Loan”) by Ares Capital to the Company secured by substantially all of the assets of the Company. The Ares Letter of Credit Facility may only be used to collateralize borrowings pursuant to the Wells Fargo ABL.
Interest on any Ares Term Loan accrued at either (at the Company’s election): (a) 9.0% per annum plus the highest of (i) The Wall Street Journal prime rate, (ii) the sum of 0.50% per annum and the federal funds rate and (iii) the sum of 1.0% per annum and the higher of the daily one month LIBOR rate and 1.5% per annum; or (b) 10.0% per annum plus the highest of (i) 1.5% per annum and (ii) the daily one-month LIBOR rate. The Company was required to pay certain fees to Ares Capital under the Ares Loan Agreement including: (a) an annual administrative fee of $50,000, payable quarterly in advance; (b) a quarterly fronting fee equal to the product of the average daily undrawn face amount of the Ares LOC multiplied by 0.75% per annum; and (c) a quarterly letter of credit fee equal to the product of the average daily undrawn face amount of the Ares LOC multiplied by 10.0% per annum.
On April 1, 2013, the Company entered into Amendment No. 1 (“Amendment No. 1”) to the Ares Letter of Credit Facility (the “Ares Amendment”), which extends the maturity date of the Ares Letter of Credit Facility to April 2, 2014. Pursuant to the Ares Amendment, Ares Capital also waived certain events of defaults under the Ares Letter of Credit Facility related to our creation of LSIPL. The Company also agreed to pledge 65% of the issued and outstanding capital stock of LSIPL as collateral supporting the Ares Letter of Credit Facility.
On February 19, 2014, the Company entered into the Medley Term Loan and the Medley Delayed Draw Loan and utilized proceeds from the Medley Term Loan to repay its outstanding obligations under the Ares Letter of Credit Facility.
NOTE 9. SERIES J REDEEMABLE CONVERTIBLE PREFERRED STOCK
Series J Preferred Stock
On September 11, 2013, the Company entered into the Series J Subscription Agreement with Riverwood Holdings, PCA Holdings and Holdings II, pursuant to which the Company issued an aggregate of 17,394 shares of Series J Preferred Stock, at a price of $1,000 per share, for gross proceeds of $17.4 million. The Company issued 12,500, 2,500 and 2,394 shares of Series J Preferred Stock to Holdings II, PCA Holdings and Riverwood Holdings, respectively. As compensation for advisory services provided by Pegasus, on September 11, 2013 the Company issued a warrant to Holdings II, (the “Pegasus Warrant”) representing 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.
In connection with the Series J Preferred Offering, and pursuant to the certificates of designation governing the shares of the Company’s Series H Preferred Stock (the “Series H Certificate of Designation”) and Series I Preferred Stock (the “Series I Certificate of Designation”), the Company agreed to offer to all holders of shares of Series H Preferred Stock (defined in Note 9), and Series I Preferred Stock (defined in Note 9), the right to purchase shares of Series J Preferred Stock based upon such holder’s ownership of the Company’s outstanding shares of common stock on a fully diluted, as converted basis (the “Preemptive Rights Offering”). Pursuant to the Series J Subscription Agreement, Pegasus committed to purchase the number of shares of Series J Preferred Stock equal to 20,000 minus the aggregate number of shares of Series J Preferred Stock issued in the Series J Preferred Offering and the Preemptive Rights Offering at a price per share equal to the Stated Value (the “Pegasus Series J Commitment”). On October 16, 2013, the Company completed the Preemptive Rights Offering and issued an aggregate of 1,449 shares of Series J Preferred Stock at the Stated Value, for aggregate gross proceeds of $1.4 million. On November 21, 2013, Pegasus fulfilled its obligations pursuant to the Pegasus Series J Commitment and purchased 1,157 shares of Series J Preferred Stock for aggregate gross proceeds of $1.2 million.
The Series J Preferred Stock is senior to the Series H Preferred Stock, the Series I Preferred Stock and the common stock and is 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. Each share of Series J Preferred Stock is convertible at any time, at the election of the holder thereof, into the number of shares of common stock (the “Optional Conversion Shares”) equal to the quotient obtained by dividing (a) the Stated Value of such shares of Series J Preferred Stock by (b) the $0.95 conversion price, subject to certain adjustments.
The Company will redeem all outstanding shares of Series J Preferred Stock for an amount in cash equal to the Liquidation Amount (as defined below) upon the Company’s receipt of a notice from the holders of Series H Preferred Stock that would require the Company to redeem the shares of Series H Preferred Stock pursuant to the Series H Certificate of Designation. The redemption of any shares of Series J Preferred Stock would be senior and prior to any redemption of Series H Preferred Stock or Series I Preferred Stock and 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 Series H Preferred Stock, at any time thereafter 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 “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) if the applicable reference date occurs (i) on or prior to May 26, 2014, an amount equal to the product obtained by multiplying (A) the Stated Value by (B) 1.75; and (ii) subsequent to May 26, 2014, an amount equal to the product obtained by multiplying (A) the Stated Value by (B) 2.0.
In accordance with ASC 480, “Distinguishing Liabilities from Equity,” the shares of Series J Preferred Stock are recorded as mezzanine equity because such shares contain terms that allow the holder to redeem the shares for cash, and for which 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 Series J Preferred Stock to equal the redemption value at the end of each reporting period. The Series J Preferred Stock was recorded at redemption value on each date of issuance, which included a deemed dividend due to the redemption feature. As of December 31, 2013, Series J Preferred Stock redemption value included an aggregate deemed dividend of $24.3 million with an offset in additional paid-in capital.
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 $523.9
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 $523.9 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 Monte Carlo valuation method at issuance with changes in fair value measured and recorded at the end of each quarter. There was a change of $935,000 in fair value of the Pegasus Warrant for the period from September 11, 2013 (date of issuance) through December 31, 2013.
NOTE 10: SERIES H AND SERIES I REDEEMABLE CONVERTIBLE PREFERRED STOCK
Series H and I Preferred Stock
On May 25, 2012, the Company entered into the Series H and I Subscription Agreement with Riverwood and certain other accredited investors. Pursuant to the Series H and I Subscription Agreement, the Company issued an aggregate of 60,705 shares of Series H Preferred Stock and 6,364 shares of Series I Preferred Stock at a price of $1,000 (the “Stated Value”) per Preferred Share. The Company raised gross proceeds of $67.1 million in the Series H and I Preferred Offering.
The Preferred Shares 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. Each Preferred Share is convertible at any time, at the election of the holder thereof, into the number of shares of common stock (the “Optional Conversion Shares”) equal to the quotient obtained by dividing (a) the Stated Value of such Preferred Share by (b) the $1.18 conversion price, subject to certain adjustments. The fair market value of the common stock was $1.50 per share on the date of the Series H and I Preferred Offering. Consequently, the Company recorded a beneficial conversion feature of $17.7 million and $16.9 million to the Series H Preferred Stock and Series I Preferred Stock, respectively, and an offset of $34.6 million to additional paid-in capital, each as of May 25, 2012. The beneficial conversion feature was calculated as the product of (a) $0.32 (the difference between the conversion price of $1.18 and the fair market value of the common stock of $1.50) multiplied by (b) the number of shares of common stock issuable upon conversion of such Preferred Shares.
Upon the consummation of a qualified public offering (a “QPO”) where (i) the gross proceeds received by the Company and any selling stockholders in the offering are no less than $100 million and (ii) the market capitalization of the Company immediately after consummation of the offering is no less than $500 million, each outstanding Preferred Share will automatically convert into the number of shares of common stock equal to the greater of (a) the number of Optional Conversion Shares or (b) the quotient obtained by dividing (i) the Returned Value (as defined below) by (ii) the price per share of common stock paid by the public in the QPO.
At any time on or after November 25, 2015, so long as the “Primary Investor” (as defined in the certificate of designation governing the Series H Preferred Stock (the “Series H Certificate of Designation”) and Series I Preferred Stock (the “Series I Certificate of Designation”), respectively) of the respective series of Preferred Shares beneficially owns any shares of such series of Preferred Shares, the respective Primary Investor will have the right to require the Company to redeem all or a portion of such Primary Investor’s Preferred Shares for an amount in cash equal to the Liquidation Amount (as defined below) of such Preferred Shares (the “Optional Redemption Right”). If the Primary Investor of a series of the Preferred Shares elects to exercise its Optional Redemption Right, all other holders of such series of Preferred Shares will have a contingent redemption right to have all or any portion of their Preferred Shares redeemed for an amount in cash equal to the Liquidation Amount of such Preferred Shares.
After the Primary Investor of a series of Preferred Shares no longer beneficially owns any shares of such series of Preferred Shares, each holder of such series will have the right, at any time thereafter, to require the Company to redeem all or a portion of such holder’s Preferred Shares for an amount in cash equal to the Liquidation Amount of such Preferred Shares. Each holder of Preferred Shares may also require the Company to redeem all or a portion of such holder’s Preferred Shares for an amount in cash equal to the Liquidation Amount upon the occurrence of a Redemption Event or a Change of Control (each as defined in the Series H Certificate of Designation and Series I Certificate of Designation). The Company may not redeem, or be required to redeem, any Preferred Shares for so long as such redemption would result in an event of default under the Wells Fargo ABL or the Ares Loan Agreement.
The “Liquidation Amount” of each Preferred Share is equal to the greater of (a) the fair market value of the Optional Conversion Shares and (b) if the applicable reference date occurs (i) on or prior to the one year anniversary of the original date of issuance, an amount equal to the product obtained by multiplying (A) the Stated Value by (B) 1.5; (ii) subsequent to the one year anniversary of the original date of issuance and on or prior to the two year anniversary of the original date of issuance, an amount equal to the product obtained by multiplying (A) the Stated Value by (B) 1.75; and (iii) subsequent to the two year anniversary of the original date of issuance, an amount equal to the product obtained by multiplying (A) the Stated Value by (B) 2.0 (collectively, the “Returned Value”).
On September 11, 2013, in connection with the Series J Preferred Offering, Riverwood and Pegasus, as the “Primary Investors” of the Series H Preferred Stock and Series I Preferred Stock, respectively, approved the Amended and Restated Series H Certificate of Designation and the Amended and Restated Series I Certificate of Designation (collectively, the “ Amended Certificates of Designation”) and certain holders of shares of Series H Preferred Stock and Series I Preferred Stock agreed to make certain amendments to the agreements entered into in connection with the purchase of (i) the shares of Series H Preferred Stock and Series I Preferred Stock and (ii) the Company’s previously issued shares of Series F Preferred Stock and Series G Preferred Stock, which were subsequently converted into shares of Series H Preferred Stock and Series I Preferred Stock (collectively, the “Preferred Stock Subscription Agreements”).
The Amended Certificates of Designation amend the terms of the Series H Certificate of Designation and Series I Certificate of Designation to, among other things, (i) reduce the price used to determine the number of shares of common stock each share of Series H Preferred Stock and Series I Preferred Stock can be converted into at the election of each holder from $1.18 to $0.95 (the “Conversion Price”); (ii) remove the covenant requiring the Company to comply with certain minimum thresholds related to the Company’s consolidated earnings before interest, taxes, depreciation and amortization for 2013 and 2014; (iii) increase, from $10 million to $50 million, the amount of indebtedness the Company can incur without the consent of Riverwood and Pegasus (in each case, in their capacity as “Primary Investor” of the Series H Preferred Stock and Series I Preferred Stock, respectively) and (iv) make certain other clarifying amendments to the Certificates of Designation. The reduction in the Conversion Price for the Series H Preferred Stock and the Series I Preferred Stock resulted in the Company recording a deemed dividend of $14.4 million, which is reflected in earnings per share allocated to controlling shareholders and noncontrolling shareholders.
The Preferred Shares 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. Each Preferred Share is convertible at any time, at the election of the holder thereof, into the Optional Conversion Shares equal to the quotient obtained by dividing (a) the $1,000 by (b) the $0.95 conversion price, subject to certain adjustments.
In accordance with ASC 480, “Distinguishing Liabilities from Equity,” the Preferred Shares are recorded as mezzanine equity because the Preferred Shares contain terms that allow the holder to redeem the shares for cash, and for which 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 Preferred Shares to equal the redemption value at the end of each reporting period. The Preferred Shares were recorded at redemption value as of May 25, 2012, which included a deemed dividend due to the redemption feature and resulted in the Company recording an increase of $66.2 million and $47.7 million to the Series H Preferred Stock and Series I Preferred Stock, respectively, and an offset of $113.9 million to additional paid-in capital. There was no change in the redemption value as of December 31, 2013.
September 2012 Preferred Offering
On September 25, 2012, the Company entered into the September 2012 Subscription Agreements with each of (i) Portman and (ii) Cleantech A and Cleantech B, pursuant to which the Company issued 49,000 shares of Series H Preferred Stock (the “September 2012 Preferred Shares”) for gross proceeds of $49.0 million. In the September 2012 Preferred Offering the Company issued (i) 24,500 shares of Series H Preferred Stock to Portman, and (ii) 20,862 and 3,638 shares of Series H Preferred Stock to Cleantech A and Cleantech B, respectively.
The September 2012 Preferred Shares 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. Each September 2012 Preferred Share is convertible at any time, at the election of the holder thereof, into the Optional Conversion Shares equal to the quotient obtained by dividing (a) the Stated Value of such September 2012 Preferred Share by (b) the $1.18 conversion price, subject to certain adjustments. The fair market value of common stock was $0.86 per share on the date of the September 2012 Preferred Offering. Consequently, since the conversion price was greater than the fair market value of the common stock there was no deemed dividend due to the beneficial conversion feature on the date of issuance.
In accordance with ASC 480, “Distinguishing Liabilities from Equity,” the September 2012 Preferred Shares are recorded as mezzanine equity because the September 2012 Preferred Shares have certain conditions that allow the holder to redeem the shares for cash, and for which 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 September 2012 Preferred Shares to equal the redemption value at the end of each reporting period. The September 2012 Preferred Shares were recorded at redemption value as of September 25, 2012, which included a deemed dividend due to the redemption feature and resulted in the Company recording an increase of $53.6 million to the Series H Preferred Stock and an offset of $53.6 million to additional paid-in capital. There was no change in the redemption value as of December 31, 2013.
The Company initiated the September 2012 Preferred Offering pursuant to the preemptive rights granted to the holders of Preferred Shares (collectively, the “Holders”) in the Series H Certificate of Designation and the Series I Certificate of Designation. On September 25, 2012, the Company offered each Holder the right to purchase its Pro Rata Share (as defined in the Series H Certificate of Designation and the Series I Certificate of Designation) of 51,000 shares of Series H Preferred Stock (the “Offered Shares”) at a purchase price of $1,000 per share. In addition, any Holder, or such Holder’s permitted assignee, that elected to purchase at least 95% of its Pro Rata Share of the Offered Shares would be entitled to receive a Warrant (the “September 2012 Warrants”) to purchase up to 163.2653 shares (rounded to the nearest whole share) of the Company’s common stock with respect to each Offered Share purchased by such Holder or permitted assignee. As further discussed below, an affiliate of Pegasus Capital has agreed to sell shares of common stock equal to the number of shares, if any, issued upon exercise of any September 2012 Warrants, which shares would be sold on the same terms and at the same exercise price as the September 2012 Warrants and having the effect of reducing the dilutive effects of the September 2012 Warrants. Holders owning the right to purchase an aggregate of 49,102 Offered Shares and 8,016,653 September 2012 Warrants assigned their rights to participate in the September 2012 Preferred Offering to Portman and Zouk. In addition, due to the exercise by Portman and Zouk of at least 95% of the Pro Rata Share of Offered Shares assigned to them, each of Portman, Cleantech A and Cleantech B received September 2012 Warrants to purchase 4,000,000, 3,406,041 and 593,959 shares of common stock, respectively.
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 IV, pursuant to which the Company is obligated to buy from Pegasus 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 “Pegasus Commitment”). The purchase price for any Pegasus 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 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 Commitment equal to the reduction in the number of shares underlying the September 2012 Warrants.
Subject to certain limitations, Pegasus 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 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 Commitment subject to the Pegasus Call for an amount equal to the consideration paid by Pegasus IV pursuant to such Pegasus Call.
In addition to the rights provided in the Series H Certificate of Designation, the September 2012 Subscription Agreements provide Portman and Zouk, collectively, with the right, within ten (10) business days following September 25, 2015, to require the Company to redeem all or a portion of the outstanding Offered Shares for an amount in cash equal to the product obtained by multiplying (i) the Stated Value, (ii) the number of Offered Shares to be redeemed and (iii) 1.5. In connection with the September 2012 Preferred Offering, the Company committed to submit to the stockholders of the Company an amendment and restatement to the Series H Certificate of Designation and Series I Certificate of Designation (the “Amended Certificates”) which would, among other things, protect Zouk’s right to elect one director to the Company’s board of directors and amend the date on which the Primary Investors (as defined in the Series H Certificate of Designation and Series I Certificate of Designation, as applicable) could require the Company to redeem the shares of Series H Preferred Stock and Series I Preferred Stock from November 25, 2015 to September 25, 2015.
Rollover Offering
As a result of the consummation of the Series H and I Preferred Offering and the issuance of the Preferred Shares in connection therewith, PCA Holdings, Holdings II, Leon Wagner, Continental and certain other holders of the Company’s Series G Preferred Stock were entitled to elect to convert (the “Conversion Right”) all or less than all of their shares of Series G Preferred Stock into the number of shares of Series H Preferred Stock or Series I Preferred Stock equal to the quotient obtained by dividing (i) the aggregate liquidation value of such holders outstanding shares of Series G Preferred Stock by (ii) the Stated Value (the “Rollover Offering”).
Pursuant to the Conversion Right, (a) each of PCA Holdings and Holdings II converted all 17,650 and 14,958 of their shares of Series G Preferred Stock, respectively, into 18,314 and 15,575 shares of Series I Preferred Stock, respectively; (b) Mr. Wagner converted all 6,500 of his shares of Series G Preferred Stock into 6,649 shares of Series I Preferred Stock, (c) Continental converted all 5,000 of its shares of Series G Preferred Stock into 5,176 shares of Series I Preferred Stock and (d) the remaining holders of Series G Preferred Stock collectively converted all 8,250 of the remaining shares of Series G Preferred Stock into 4,346 shares of Series H Preferred Stock and 4,281 shares of Series I Preferred Stock. In total, the Company issued 4,346 shares of Series H Preferred Stock and 50,001 shares of Series I Preferred Stock pursuant to the Rollover Offering.
Settlement of Repurchase Obligation
Pursuant to that certain letter agreement, dated January 17, 2012 from the Company to LSGC Holdings (the “LSGC Letter Agreement”), the Company agreed to indemnify LSGC Holdings for, among other things, the cost of redeeming the LSGC Holdings Class C Interests (the “Repurchase Obligation”) in the event that the Company issued preferred equity securities in excess of $80.0 million. Additionally, under the terms of the LSGC Letter Agreement, in the event that the Company would be required to indemnify LSGC Holdings under the LSGC Letter Agreement, LSGC Holdings agreed to surrender 3,750,000 shares of common stock to the Company less any shares of common stock previously distributed by LSGC Holdings to Continental. Following the consummation of the Series H and I Preferred Offering, the amount of preferred equity issued by the Company exceeded $80.0 million, and, as a result, LSGC Holdings, a related party, was required to redeem 15,000,000 of its issued and outstanding senior preferred member interests held by Continental (the “LSGC Holdings Class C Interests”). See Note 10 for a discussion of the Repurchase Obligation.
On May 25, 2012, in conjunction with the Series H and I Preferred Offering, the Company, LSGC Holdings and Continental entered into that certain Exchange and Redemption Agreement (the “Exchange Agreement”) to, among other things, facilitate LSGC Holdings’ redemption of the LSGC Holdings Class C Interests held by Continental, the Company’s indemnification payment to LSGC Holdings and LSGC Holdings’ surrender of shares of common stock to the Company in accordance with the LSGC Letter Agreement. Pursuant to the Exchange Agreement, the Company made a $16.2 million indemnification payment directly to Continental, which amount represented the cost to redeem the LSGC Holdings Class C Interests. The payment consisted of: (i) a cash payment of $10.2 million, and (ii) in lieu of an additional $6.0 million in cash, 6,000 shares of Series I Preferred Stock at the Stated Value. Continental also surrendered the LSGC Holdings Class C Interests to LSGC Holdings and LSGC Holdings surrendered a total of 2,505,000 shares of common stock with a fair value of $3.8 million to the Company.
Riverwood Warrant
The Riverwood Warrant was issued to Riverwood Management on May 25, 2012 in consideration for services provided in connection with the Series H and I Preferred Offering. The Riverwood Warrant 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 Warrant. The Riverwood Warrant provides for certain antidilution adjustments and if unexercised, expires on May 25, 2022.
The Riverwood 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 Riverwood Warrant was recorded as a liability at fair value using the Monte Carlo 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 Warrant was $3.0 million and $8.5 million for the years ended December 31, 2013 and 2012, respectively, and was included in the decrease in fair value of liabilities under derivative contracts in the consolidated statement of operations and comprehensive loss.
September 2012 Warrants and September 2012 Commitment Agreement
The September 2012 Warrants are exercisable on or after the tenth business day following the third anniversary of the 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 Series H Certificate of Designation) prior to the three-year anniversary of the Issuance Date; (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 Issuance Date; (iii) consummation of a QPO (as defined in the Series H Certificate of Designation) prior to the three-year anniversary of the Issuance Date or (iv) receipt by the Company of a Redemption Notice (as defined in the 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 Monte Carlo 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 $47,000 and $240,000 for the year ended December 31, 2013 and the period from September 25, 2012 (date of issuance) through December 31, 2012, respectively, and was included in additional paid-in capital.
The Pegasus 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 Commitment was recorded as an asset at fair value using the Monte Carlo 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 Commitment for the year ended December 31, 2013 and the period from September 25, 2012 (date of issuance) through December 31, 2012 was $47,000 and $240,000, respectively, and was included in additional paid-in capital. The change in fair value of the Pegasus Commitment generally offsets the change in fair value of the September 2012 Warrants for the same period.
NOTE 11. SERIES F AND SERIES G PREFERRED UNITS AND REPURCHASE OBLIGATION
Series F Preferred Units and Series G Preferred Units
On November 17, 2011, the Company entered into a Subscription Agreement (the “Series F Subscription Agreement”) with PCA Holdings and Pegasus IV, (together with PCA Holdings and any permitted assignees under the Subscription Agreement, the “Purchasers”) pursuant to which the Company gave the Purchasers the option (the “Series F Option”), on or prior to December 31, 2011, to purchase up to 40,000 units (the “Series F Units”) of its securities at a price per Series F Unit of $1,000. Each Series F Unit consisted of: (i) one share of the Company’s newly designated Series F Preferred Stock (the “Series F Preferred Stock”) and (ii) 83 shares of the Company’s common stock, par value $0.001 per share.
Pursuant to the Series F Subscription Agreement, if, at any time while shares of Series F Preferred Stock remained outstanding, the Company issued securities (other than pursuant to the Company’s equity-based compensation plans) that resulted in gross proceeds to the Company of at least $50.0 million (a “Subsequent Issuance”), the Company was required to notify all holders of Series F Preferred Stock of the terms and conditions of such Subsequent Issuance. Simultaneous with, and subject to the closing of, such Subsequent Issuance, each holder of Series F Preferred Stock had the right to: (i) require the Company to use the proceeds of such Subsequent Issuance to redeem all of such holder’s Series F Preferred Stock or (ii) convert all or a portion of such holder’s Series F Preferred Stock into the securities issued in the Subsequent Issuance on substantially the same terms and conditions governing the Subsequent Issuance. If a holder elected to convert its shares of Series F Preferred Stock, such holder would retain all of the shares of Common Stock issued in conjunction with each converted share of Series F Preferred Stock. All outstanding Series F Preferred Stock were to be redeemed on the later of February 21, 2014 or up to 91 days after a Subsequent Issuance.
In accordance with ASC 480, Distinguishing Liabilities from Equity, the Series F Preferred Stock was recorded initially at fair value as a liability and subsequently recorded at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception. The common stock was recorded to equity at fair value and is not subsequently revalued. The difference between the amount recorded at issuance and the original issuance price is being accreted using the effective interest method over the term of the Series F Preferred Stock.
In connection with the execution of the Series F Subscription Agreement, PCA Holdings purchased 10,000 Series F Units, for an aggregate purchase price of $10.0 million. On November 17, 2011, Leon Wagner, one of the Company’s directors, also purchased 1,500 Series F Units for an aggregate purchase price of $1.5 million.
On December 1, 2011, the Company entered into a Series G Preferred Unit Subscription Agreement (the “Series G Subscription Agreement”) with PCA Holdings, Pegasus IV, Holdings II, Leon Wagner, a member of the Company’s board of directors and certain accredited investors (together with Pegasus IV, PCA Holdings, Holdings II and any additional investors that may become party to the Series G Subscription Agreement, the “Series G Purchasers”). Pursuant to the Series G Subscription Agreement, and subsequent subscription agreements on terms substantially similar to the Series G Subscription Agreement entered into between December 2011 and May 2012, the Company issued an aggregate of 52,358 Series G Preferred Units at a price per Series G Preferred Unit of $1,000 for total consideration of $52.4 million. Each Series G Preferred Unit consists of: (i) one share of the Series G Preferred Stock and (ii) 83 shares of the Company’s common stock. Holdings II purchased an aggregate of 14,958 Series G Preferred Units; PCA Holdings purchased an aggregate of 17,650 Series G Preferred Units; Leon Wagner purchased an aggregate of 6,500 Series G Preferred Units; and the additional accredited investors purchased an aggregate of 13,250 Series G Preferred Units.
In accordance with ASC 480, Distinguishing Liabilities from Equity, the Series G Preferred Stock was recorded initially at fair value as a liability as the Series G Preferred Stock may require settlement in a variable number of shares of common stock. Subsequent to initial recognition, the Series G Preferred Stock was recorded at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception. The common stock was recorded to equity at fair value and is not subsequently revalued. The difference between the amount recorded at issuance and the original issuance price was being accreted using the effective interest method over the term of the Series G Preferred Stock. Accretion of Series G Preferred Stock was $0, $7.5 million and $239,000 for the years ended December 31, 2013, 2012 and 2011, respectively. In conjunction with the Series H and I Preferred Offering, the Company recognized $6.3 million as a loss on the conversion of the Series G Preferred Stock, which is included in the accretion of preferred stock for the year ended December 31, 2012. The Series F Subscription Agreement provided that if the Company issued securities (other than issuances pursuant to the Company’s equity-based compensation plans) which PCA Holdings, in its sole discretion, determined were more favorable than the Series F Units, PCA Holdings would have the right (the “Conversion Right”), at any time prior to November 17, 2013, to require all Series F Unit Purchasers to exchange their Series F Units for such newly issued securities. Upon such occurrence, any outstanding right to purchase Series F Units under the Series F Option would also convert into the right to purchase the newly issued securities on substantially the same terms and conditions as those offered to the purchasers of the newly issued securities.
In connection with the issuance of Series G Preferred Units by the Company, and pursuant to the Conversion Right, PCA Holdings elected to exchange all of its outstanding Series F Units and outstanding Series F Preferred Stock for Series G Preferred Units and Series G Preferred Stock, which required Mr. Wagner to also exchange his Series F Preferred Stock for Series G Preferred Stock. In connection with the exercise of the Conversion Right, (i) the Company exchanged each Series F Preferred Stock for one Series G Preferred Stock and agreed that the Series G Preferred Stock issued to the Series F Preferred Stock purchasers would be deemed to have begun earning and accruing the Dividend (as defined below) as of November 17, 2011 and (ii) the Series F Option was replaced by a right to purchase Series G Preferred Units pursuant to the terms and conditions of the Series G Subscription Agreement (the “Series G Option”). The Company issued 10,000 shares of Series G Preferred Stock to PCA Holdings and 1,500 shares of Series G Preferred Stock to Mr. Wagner pursuant to the Conversion Right. PCA Holdings, Pegasus IV and Holdings II may assign all or any portion of their right to purchase Series G Preferred Units pursuant to the Series G Option to assignees of their choosing. Upon the conversion of the Series F Preferred Stock to Series G Preferred Stock, the Company treated this as an exchange with no remeasurement of the fair value of the Series F Preferred Stock at that time given both the Series F Preferred Shares and Series G Preferred Shares have similar terms. The converted Series F Preferred Stock to Series G Preferred Stock would subsequently be valued consistently with the other outstanding Series G Preferred Stock which is at the present value of the amount to be paid at settlement, accruing interest cost using the rate implicit at inception. All outstanding shares of Series G Preferred Stock are to be redeemed on the later of February 21, 2014 or up to 91 days after a Subsequent Issuance.
As of December 31, 2011, the Company had issued 34,108 Series G Preferred Units and raised an aggregate of $34.1 million pursuant to the Series G Subscription Agreement and the Series F Subscription Agreement. From January 1, 2012 through May 18, 2012, the Company issued an additional 18,250 Series G Preferred Units for total proceeds of $18.3 million.
Pursuant to the Series G Subscription Agreement, if, at any time while shares of Series G Preferred Stock remained outstanding, the Company issued securities (other than pursuant to the Company’s equity-based compensation plans) that resulted in gross proceeds to the Company of at least $50.0 million (a “Series G Subsequent Transaction”), the Company was required to notify all holders of Series G Preferred Stock of the terms and conditions of such Series G Subsequent Transaction. Upon the consummation of the Series H and I Preferred Offering, the Company completed the required notification and, as described above, and pursuant to the Rollover Offering, all holders of Series G Preferred Stock converted their shares of Series G Preferred Stock into a number of shares of Series H Preferred Stock or Series I Preferred Stock (at the holder’s election) equal to the quotient obtained by dividing the aggregate liquidation value of the outstanding shares of Series G Preferred Stock held by each holder by the Stated Value. Each holder retained all of the shares of common stock issued as part of the Series G Preferred Units. Upon this conversion of the Series G Preferred Stock, each share of Series G Preferred Stock was valued at its accrued value, which included the initial fair value plus any dividends accrued through the date of conversion.
The following table sets forth the allocation of the proceeds on the Series F and Series G Preferred Units between the fair market value of the common stock and the redeemable preferred shares:
Series G Preferred Stock Annual Cumulative Dividend
Each share of Series G Preferred Stock was entitled to an annual cumulative dividend of, (i) initially, 10.0%, (ii) commencing on November 17, 2012, 15.0% and (iii) commencing on February 21, 2014, 18.0%, on the accrued value of such share. The dividend accrues daily and compounds on (i) November 17, 2012 and, (ii) from and after November 17, 2012, December 31 and June 30 of each year.
The dividend was scheduled to accrue over the term of the Series G Preferred Stock on a weighted average rate based upon the applicable dividend rate over the term. On each dividend payment date subsequent to November 17, 2012, such dividend was required to be paid to each holder in cash semi-annually in arrears. The Company was only required to pay such dividend in cash to the extent that such payment would not result in an event of default under the Company’s (i) Wells Fargo ABL or (ii) Ares Capital Loan. Any dividend that was scheduled to accrue on or after November 17, 2012, and was required to be paid in cash but was not actually paid in cash, was to continue to accrue and compound and be added to the accrued value of the Series G Preferred Stock.
During the years ended December 31, 2012 and 2011, the Company recorded $1.8 million and $238,000, respectively, of dividends expense on the Series G Preferred Stock.
Repurchase Obligation
In May 2011, the Company entered into an agreement with LSGC Holdings pursuant to which LSGC Holdings agreed to purchase 3,750,000 shares of the Company’s common stock at a purchase price of $4.00 per share (the “Holdings Placement”). This purchase was completed on May 26, 2011 and generated net proceeds, after deducting placement agent commissions of $14.4 million. To facilitate the Holdings Placement, in May 2011, LSGC Holdings issued 15,000,000 LSGC Holdings Class C Interests and distributed 562,500 shares of common stock of the Company to Continental for $15.0 million.
On January 17, 2012, in connection with Continental’s purchase of 5,000 Series G Preferred Units from the Company for $5.0 million, LSGC Holdings agreed to certain amendments to the terms of the LSGC Holdings Class C Interests held by Continental, including to increase the interest rate on the LSGC Holdings Class C Interests and to distribute 682,500 additional shares of common stock of the Company to Continental (the “Class C Amendments”). In addition, pursuant to the terms of the agreement governing the Holdings Placement, LSGC Holdings was obligated to redeem the LSGC Holdings Class C Interests if the Company (i) incurred aggregate indebtedness that exceeded (a) the indebtedness permitted under the Wells Fargo ABL, not to exceed $75.0 million in total credit thereunder and (b) such additional unsecured indebtedness that when aggregated with such working capital facility, if any, exceeded 300% of its earnings before interest, taxes, depreciation and amortization for the preceding 12 months or (ii) issued outstanding preferred equity securities having an original principal amount of more than $80.0 million in the aggregate.
On January 17, 2012, in connection with the Class C Amendments, the Company entered into the LSGC Letter Agreement with LSGC Holdings pursuant to which it agreed to the Repurchase Obligation arising out of or relating to the Company’s incurrence of indebtedness in excess of the applicable cap or issuance of preferred equity securities in excess of the applicable cap in the Class C Amendments. In exchange, LSGC Holdings agreed to return to the Company 3,750,000 shares of common stock less any shares of common stock that had been previously distributed to Continental (or 2,505,000 shares common stock) in the event the Company was required to settle the Repurchase Obligation. Pursuant to the LSGC Letter Agreement, the Company also agreed to pay Pegasus IV a fee of $250,000 for expenses incurred by Pegasus IV and its affiliates related to these transactions. This fee was recognized as interest expense over the life of the Series G Preferred Units. For the year ended December 31, 2012, the Company recognized related party interest expense of $250,000.
The Repurchase Obligation was determined to be a financial instrument that may require the repurchase of common stock based on the contingent events described above. The Repurchase Obligation was recorded initially at fair value as a liability with an offset to additional paid-in capital. Subsequent changes in fair value of the Repurchase Obligation were also measured and recorded at the end of each period in the Company’s consolidated financial statements. The terms of the Repurchase Obligation required the Company to repurchase its common stock held by LSGC Holdings, an entity that is controlled by Pegasus Capital, for an amount that exceeded the fair value of the underlying common stock. The fair value of the Repurchase Obligation was considered a deemed dividend to the Company’s controlling stockholder. The deemed dividend was applicable only to the shares held by Pegasus Capital and its affiliates. The terms of the LSGC Letter Agreement and the related Repurchase Obligation resulted in the establishment of two classes of common stock, for financial reporting purposes only, with common stock attributable to controlling stockholders representing all common stock beneficially owned by Pegasus Capital and its affiliates and common stock attributable to noncontrolling stockholders representing the minority interest stockholders.
As of May 25, 2012, pursuant to the Exchange Agreement, the Company made the required indemnification payments and completed the repurchase of its common stock, fulfilling the Repurchase Obligation. On May 25, 2012, the fair value of the Repurchase Obligation was $12.5 million and was recorded as a deemed dividend with a corresponding offset to additional paid in capital. Prior to fulfillment of the Repurchase Obligation, the fair value of the Repurchase Obligation was based on the probability of required settlement of the contractual terms of the LSGC Holdings Class C Interest of LSGC Holdings less the fair value of the common stock of the Company that it would receive upon settlement. As of May 25, 2012, the fair value of the Repurchase Obligation was based on the actual settlement terms, less the fair value of the common stock received.
NOTE 12: STOCKHOLDERS’ EQUITY AND RECAPITALIZATION AGREEMENT
Common Stock Issuances
On January 2, 2013, Jeremy S. M. Cage was appointed Chief Executive Officer and the Company issued 500,000 shares of restricted stock to Mr. Cage as part of his compensation package. On November 8, 2013, upon the resignation of Mr. Cage, 385,417 unvested shares of restricted stock were cancelled and returned to the Company. On March 22, 2013, the Company issued 192,308 shares of restricted stock to Brad Knight as part of his compensation package. For the year ended December 31, 2013, the Company recorded expense of $173,000 related to the restricted stock awards issued to Messrs. Cage and Knight.
On August 14, 2013, the Company issued 1,813,411 shares of restricted stock in settlement of director fees for the year ended December 31, 2013. On November 11, 2013 and December 4, 2013, the Company issued 26,301 and 14,795 shares, respectively, of restricted stock in settlement of the pro rata portion of director fees for the period served by directors appointed to the board of directors on the respective dates of issuance. The 2013 compensation package consists of: (i) 200,000 shares of restricted stock for each member of the Board of Directors who is not an employee of the Company; (ii) an additional 25,000 shares of restricted stock for each member of the Board of Directors serving on one or more committee of the Board of Directors and (iii) an additional 15,000 shares of restricted stock for chairman of one or more committee of the Board of Directors. The restricted shares vest for directors in office at such time on January 1, 2014. For any director serving less than the full year, a pro-rata portion of the restricted shares were issued on the later of August 14, 2013 or the date of appointment to the Board of Directors, with such pro rata shares vesting on the earlier of the date of resignation or January 14, 2014.
On March 14, 2012, in settlement of director fees of $875,000 for the year ended December 31, 2012, the board of directors issued each of its non-employee directors an option to receive either: (i) stock options to purchase 100,000 shares of the Company’s common stock at an exercise price of $1.19 per share, the closing price of the Company’s common stock on March 13, 2012, or (ii) an amount of restricted shares of the Company’s common stock equal to $100,000 as of March 13, 2012. Additionally, each member of the Company’s Audit Committee and Committee of Independent Directors were issued an option to receive either: (i) stock options to purchase 25,000 shares of the Company’s common stock at an exercise price of $1.19 per share, or (ii) an amount of restricted shares of the Company’s common stock having a value equal to $25,000 as of March 13, 2012. The stock options and restricted shares of common stock vest, for directors in office at such time, on the first day of each calendar quarter, commencing January 1, 2012, at the rate of 25% for each quarter. Any stock options issued to a director would expire, if unexercised, on March 13, 2022. Pursuant to the respective elections made by each director, on March 28, 2012, the Company issued a total of 630,254 shares of restricted common stock and stock options to purchase 125,000 shares of the Company’s common stock to its non-employee directors.
On May 25, 2012, in connection with the Series H and I Preferred Offering, six members of the board of directors resigned and five new directors were appointed. Upon the resignation of the board members, 220,594 unvested restricted shares were cancelled and returned to the Company. In settlement of the director fees of the newly appointed directors, which totaled $347,000 for the period from May 25, 2012 through December 31, 2012, and pursuant to the respective elections made by each new director, the Company issued a total of 218,096 shares of restricted common stock and stock options to purchase 15,068 shares of common stock to these non-employee directors.
On September 25, 2012, in connection with the September 2012 Preferred Offering, one new director was appointed to the Board of Directors. In settlement of the director fees of the newly appointed director, which totaled $27,000 for the period from September 25, 2012 through December 31, 2012, and pursuant to the election made by the new director, the Company issued a total of 30,901 shares of restricted common stock to this non-employee director.
For the years ended December 31, 2013, 2012 and 2011, the Company recorded expenses of $746,000, $846,000 and $945,000, respectively, related to the restricted stock awards and $20,000, $718,000 and $178,000, respectively, related to the stock options issued to the directors.
On April 28, 2011, James Haworth was appointed Chief Executive Officer and the Company issued 1,000,000 shares of restricted stock to Mr. Haworth as part of his compensation package. On May 18, 2012, upon the resignation of Mr. Haworth, 736,111 unvested shares of restricted stock were cancelled and returned to the Company. For the years ended December 31, 2012 and 2011, the Company recorded expense of $332,000 and $592,000, respectively, related to the restricted stock awards issued to Mr. Haworth.
Warrants for the Purchase of Common Stock
On January 13, 2011, the Company issued a warrant (the “THD Warrant”) to The Home Depot, Inc. (“The Home Depot”) pursuant to which The Home Depot may purchase up to 5.0 million shares of the Company’s common stock at an exercise price of $2.00 per share, subject to certain vesting conditions. The THD Warrant was issued in connection with the Company’s Strategic Purchasing Agreement with The Home Depot, which it entered into on July 23, 2010 and pursuant to which it supplies The Home Depot with LED retrofit lamps and fixtures. The THD Warrant provided that 1.0 million shares of common stock would be eligible for vesting following each year ending December 31, 2011 through December 31, 2015, subject to The Home Depot having gross product orders from the Company, in dollar terms, that are at least 20% more than the gross product orders in the immediately preceding year. For the shares underlying the THD Warrant to be eligible for vesting following the years ending December 31, 2014 and 2015, The Home Depot would be required to extend the Strategic Purchasing Agreement for additional one-year periods beyond its initial term of three years. On August 12, 2013, the Company and The Home Depot entered into Amendment No. 1 to the Strategic Purchasing Agreement which, among other things, extended the term of the Agreement for an additional three years. As of May 25, 2012, as a result of the Series H and I Preferred Offering, the exercise
price of the THD Warrants adjusted, pursuant to the terms of such warrants, from $2.00 to $1.95 per share of common stock. The number of shares of common stock into which the THD Warrants were exercisable also adjusted, pursuant to the terms of the warrant, from 5,000,000 to 5,123,715 shares. Each vested portion of the THD Warrant will expire on the third anniversary following the vesting of such portion.
As of May 25, 2012, as a result of the Series H and I Preferred Offering, the exercise price of the warrants to purchase shares of common stock issued pursuant to that certain Securities Purchase Agreement, dated March 9, 2007 (the “2007 Private Placement Warrants”) adjusted pursuant to the terms of such warrants from $1.60 to $1.18 per share of common stock. The number of shares of common stock into which the 2007 Private Placement Warrants were exercisable also adjusted, pursuant to the terms of such warrants, from 1,273,112 to 1,726,249 shares. The remainder of the 2007 Private Placement Warrants expired in November 2012. In addition, as of May 25, 2012, as a result of the Series H and I Preferred Offering, the exercise price of the warrants issued in conjunction with the Company’s Series D Non-Convertible Preferred Stock (the “Series D Warrants”) adjusted pursuant to the terms of such warrants from a range of $5.90 to $5.92 per share of common stock to a range of $5.57 to $5.59 per share of common stock. The number of shares of common stock into which the Series D Warrants were exercisable also adjusted pursuant to the terms of such warrants from 1,171,044 to 1,240,798 shares.
As of December 31, 2013, the Company had the following warrants outstanding for the purchase of common stock:
As of December 31, 2013, all warrants shown in the table above are fully vested and exercisable, except a portion of the THD Warrant, the Riverwood Warrants, the September 2012 Warrants and the Pegasus Warrant. The September 2012 Warrants will become exercisable on October 9, 2015. Per the vesting terms discussed above, no shares issuable pursuant to the THD Warrant vested for the year ended December 31, 2013 and 1,024,743 shares issuable pursuant to the THD Warrant vested during both the years ended December 31, 2012 and 2011, for total warrants vested of 2,049,486, when the product purchases for these periods satisfied the prescribed vesting conditions, and 2,049,486 shares remain subject to vesting in accordance with similar product purchasing terms. Pursuant to the terms of the Riverwood Warrants and the Pegasus Warrant, these were not exercisable as of December 31, 2013 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) was less than $523.9 million (subject to adjustment in accordance with the terms of the Riverwood Warrants and the Pegasus Warrant).
The fair value of the THD Warrant is determined using the Monte Carlo 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, 2013, 2012 and 2011, the Company recorded $0, $458,000 and $2.5 million as a reduction in revenue, respectively.
NOTE 13: EARNINGS (LOSS) PER SHARE
Upon issuance of the LSGC Letter Agreement on January 17, 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, 2013 and 2012, the Company computed net loss per share of noncontrolling stockholders and controlling stockholders common stock using the two-class method. For the year ended December 31, 2011, the Company had a single class of common shares outstanding for financial reporting purposes only. 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. 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 88.1 million, 77.7 million and 9.2 million common stock equivalents for the years ended December 31, 2013, 2012 and 2011, 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 14: RELATED PARTY TRANSACTIONS
Effective June 23, 2010, the Company entered into a support services agreement with Pegasus Capital (the “Original Support Services Agreement”), pursuant to which the Company agreed to pay Pegasus Capital $187,500 for each of the four calendar quarters following the effective date of the Original Support Services Agreement and $125,000 for each of the four calendar quarters thereafter in exchange for certain support services during such periods. The Original Support Services Agreement expired on June 30, 2012. On May 25, 2012, the Company entered into a new Support Services Agreement (“2012 Support Services Agreement”) with Pegasus Capital, pursuant to which the Company agreed to pay Pegasus Capital $125,000 for each calendar quarter beginning on July 1, 2012, in exchange for certain support services during such periods. The 2012 Support Services Agreement expires upon the earlier of: (i) June 30, 2017; (ii) a Change of Control or (iii) a QPO. During the first 30 days of any calendar quarter, the Company has the right to terminate the 2012 Support Services Agreement, effective immediately upon written notice to Pegasus Capital. Pegasus Capital is an affiliate of Pegasus IV and LSGC Holdings, which are the Company’s largest stockholders and beneficially owned approximately 83.1% of the Company’s common stock as of December 31, 2013.
On January 17, 2012, the Company entered into the LSGC Letter Agreement with LSGC Holdings pursuant to which it agreed to the Repurchase Obligation. In accordance with the LSGC Letter Agreement, the Company agreed to pay Pegasus IV a fee of $250,000 for expenses incurred by Pegasus IV and its affiliates related to the these transactions. This fee was recognized as interest expense over the life of the Series G Preferred Units. For the year ended December 31, 2012, the Company recognized interest expense of $250,000 due to the conversion of the Series G Preferred Stock into Series H and I Preferred Stock. For the year ended December 31, 2011, the Company recognized interest expense of $43,000 related to the advance from Holdings II on the key-man life insurance policy for the Company’s former Chief Executive Officer and Chairman of the Board, Zachary Gibler. In addition, during the years ended December 31, 2013, 2012 and 2011, the Company recorded $0, $313,000 and $625,000, respectively, of management fees pursuant to the Original Support Services Agreement and the 2012 Support Services Agreement, included in selling, distribution and administrative expenses.
On May 25, 2012, the Company entered into the Riverwood Support Services Agreement with Riverwood Holdings, pursuant to which the Company agreed to pay Riverwood Holdings $20,000 for the period from May 25, 2012 through June 30, 2012 and thereafter $50,000 for each calendar quarter beginning on July 1, 2012, in exchange for certain support services during such periods. The Riverwood Support Services Agreement expires upon the earlier of: (i) May 25, 2022, (ii) such date that Riverwood Management and/or its affiliates directly or indirectly beneficially own less than 37.5% of the shares of Series H Preferred Stock purchased pursuant to the Preferred Offering, on an as-converted basis (together with any shares of common stock issued upon conversion thereof); (iii) such date that the Company and Riverwood may mutually agree in writing (iv) a Change of Control or (v) a QPO. In addition, the Company has brought in several employees of Riverwood to provide consulting services, including Brad Knight, who served as the Company’s Chief Executive Officer from October 19, 2012 through January 1, 2013 and is currently the Company’s Chief Operations Officer. During the year ended December 31, 2012, the Company
recorded $70,000 of management fees pursuant to the Riverwood Support Services Agreement, included in selling, distribution and administrative expenses. During the years ended December 31, 2013 and 2012, the Company incurred $2.2 million and $1.0 million of consulting fees, respectively, for services provided by Riverwood, which were included in selling, distribution and administrative expenses. In addition, $48,000 was paid to Riverwood for the year ended December 31, 2013, for legal fees and out of pocket expenses related to the Series J Preferred Stock issuance to Riverwood Holdings, which was offset against the funds received for the Series J Preferred Stock.
In connection with the September 2012 Preferred Offering, the Company entered into a Support Services Agreement (the “Zouk Support Services Agreement”) with Zouk, pursuant to which the Company agreed to pay Zouk $100,000 each calendar quarter beginning with the quarter ended September 30, 2012, in exchange for certain support services during such periods. The Zouk Support Services Agreement expires upon the earlier of: (i) September 25, 2022; (ii) such date that Zouk and/or its affiliates directly or indirectly beneficially own less than 37.5% of the shares of Series H Preferred Stock purchased pursuant to the September 2012 Preferred Offering, on an as-converted basis; (iii) such date that the Company and Zouk may mutually agree in writing; (iv) a Change of Control and (v) a QPO.
On September 25, 2012 and in connection with the September 2012 Preferred Offering each of Pegasus Capital, Riverwood Holdings, Portman and Zouk entered into a Fee Waiver Letter Agreement, pursuant to which the parties agreed to suspend payment of the fees payable in connection with their respective Support Services or other agreements between the Company and such parties until revoked by their unanimous written consent.
During the years ended December 31, 2013, 2012 and 2011, the Company incurred consulting fees of $0, $118,000 and $369,000, respectively, for services provided by GYRO LLC, a marketing company affiliated with Pegasus Capital, which were included in selling, distribution and administrative expense.
During the years ended December 31, 2013, 2012 and 2011, the Company incurred consulting fees of $14,000, $40,000 and $122,000, respectively, for services provided by T&M Protection Resources, primarily for the facility in Monterrey, Mexico, which were included in selling, distribution and administrative expense. T&M Protection Resources is a security company affiliated with Pegasus Capital.
During the years ended December 31, 2013, 2012 and 2011, the Company incurred consulting fees of $0, $174,000 and $549,000, respectively, for public relations and corporate communications services provided by MWW Group, a marketing company owned by Michael Kempner, a former director of the Company, which were included in selling, distribution and administrative expenses.
On February 24, 2012, April 12, 2012 and May 2, 2012, respectively, the Company issued 2,000, 1,000 and 2,000 Series G Preferred Units to Leon Wagner, a member of the board of directors, for total proceeds of $5.0 million.
On each of March 20, March 28, 2012 and May 18, 2012 the Company issued 2,000 Series G Preferred Units, respectively, to PCA Holdings for total proceeds of $6.0 million. On April 13, 2012, the Company issued 2,000 Series G Preferred Units to Holdings II for total proceeds of $2.0 million.
NOTE 15: 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. As of December 31, 2013, there were 55.0 million shares authorized for issuance under the plan and 22.1 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, 2013, the Company has reserved an aggregate of 1,000,000 shares of common stock for issuance under the Directors Plan.
Stock Option Awards
The following table summarizes stock option activity for all of the Company’s stock-based plans as of December 31, 2013 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, 2013 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, 2013. This value fluctuates with the changes in the price of the Company’s common stock. As of December 31, 2013, there was $14.5 million of unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted average period of 2.66 years.
The following table summarizes information about stock options outstanding and exercisable as of December 31, 2013:
Other information pertaining to stock options is as follows:
Restricted Stock Awards
A summary of nonvested shares of restricted stock awards (“RSAs”) outstanding under all of the Company’s stock-based plans as of December 31, 2013 and changes during the year then ended is as follows:
As of December 31, 2013, there was $47,000 of unrecognized compensation cost related to restricted stock granted under the Equity Plan and the Directors Plan, which is expected to be recognized over a weighted average period of 0.62 years. For the years ended December 31, 2013, 2012 and 2011, the Company recorded compensation expense related to RSAs of $891,000, $1.2 million and $484,000, respectively.
Stock-Based Compensation Valuation and Expense
The Company accounts for its stock-based compensation plan 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 expense of $6.9 million, $7.3 million and $3.2 million for the years ended December 31, 2013, 2012 and 2011, 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, 2013, 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 2013 offering under the 2011 ESPP, a participant may elect to use up to 30% of his or her compensation to purchase whole shares of common stock of the Company, but may not purchase more than 2,000 shares per year. The purchase price for each purchase period will be 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, 2013, 2012 and 2011, the Company issued 88,284, 89,707 shares and 13,705 shares of its common stock to certain employees under the 2011 ESPP at prices ranging from $0.29 to $2.32 per share.
NOTE 16: 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 includes moving the majority of the Company’s manufacturing to its contract manufacturers in Asia, related workforce reduction in Satellite Beach, Florida of approximately 43 positions, including the termination of several members of the Company’s senior management and a $2.4 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 but one employee at LSGBV and a commitment to close LSIPL. In addition to the charges noted above, the Company expects to incur approximately $100,000 additional expense throughout this cost reduction plan, primarily related to additional headcount reductions. These additional costs are expected to be incurred in the first half of 2014.
(2) On September 24, 2012, the Company’s Board of Directors committed to the closing of our manufacturing facility in Mexico, which was substantially complete as of December 31, 2013. The Mexico Closing resulted in the termination of approximately 520 employees and $1.7 million in a non-cash asset impairment.
(3) 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, following the completion of the Series H and I Preferred Offering in May 2012 and the closing of the Companies offices in the United Kingdom and Australia. As of December 31, 2013, this plan was substantially complete.
As of December 31, 2013 and 2012, the accrued liability associated with the restructuring and other related charges consisted of the following:
The remaining accrual as of December 31, 2013, of $977,000 is expected to be paid during the year ending December 31, 2014.
The restructuring and other related charges are included in the line item restructuring expenses in the consolidated statement of operations.
NOTE 17: 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 provision (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 $168.2 million valuation allowance as of December 31, 2013 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 $31.3 million.
As of December 31, 2013, 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, 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 2016 through 2033. To the extent the Company is able to utilize available loss carryforwards that arose from operations in tax years prior to September 26, 2003, any benefit realized will be credited to income tax expense.
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, 2013 and 2012, 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, 2013, 2012 and 2011.
The Company files income tax returns in its U.S. federal jurisdictions and various state jurisdictions. As of December 31, 2013, the Company’s income tax returns prior to 2010 and 2009 are closed to examination for federal and state purposes, respectively. Additionally, income tax returns filed in the Netherlands for the 2011 and 2012 tax years have received a final assessment from the taxing authorities. The Company does not anticipate any material change in the next 12 months for uncertain tax positions.
NOTE 18: CONCENTRATIONS OF CREDIT RISK
For the year ended December 31, 2013, the Company had one customer whose revenue represented 55% of total revenue. For the years ended December 31, 2012 and 2011, the Company had two customers whose revenue collectively represented 70% and 73% of total revenue, respectively.
As of December 31, 2013, the Company had one customer whose accounts receivable balance represented 55% of accounts receivables, net of allowances. As of December 31, 2012, the Company had two customers whose accounts receivable balance collectively represented 77% of accounts receivables, net of allowances.
NOTE 19: COMMITMENTS AND CONTINGENCIES
Purchase Commitments
As of December 31, 2013, the Company had $19.0 million in purchase commitments, which are generally non-cancellable.
Lease Commitments
As of December 31, 2013, 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, 2013, 2012 and 2011, the Company incurred rent expense of $2.1 million, $2.3 million and $2.6 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 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 our 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 Investments Limited (“Geveran”), a stockholder of the Company, 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 as defendants the Company; Pegasus Capital Advisors, L.P. (“Pegasus”) and nine other entities affiliated with Pegasus; Richard Weinberg, a former Director and former interim CEO of the Company and a former partner of Pegasus; Gregory Kaiser, a former CFO of the Company; 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 attorneys’ fees and court costs, jointly and severally against the Company, Pegasus, Mr. Weinberg, Mr. Kaiser, J.P. Morgan and the two J.P. Morgan employees, for alleged violation 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. In February 2014, Geveran filed a motion to amend their first amended complaint, seeking to assert a claim for punitive damages against the defendants; that motion is currently pending before the court. The case is currently in the discovery stage.
The Company has retained counsel, denies liability in connection with this matter and intends to vigorously defend against the claims asserted by Geveran. While the case is in its early stages and the outcome of any litigation is inherently difficult to predict, the Company currently believes that it has strong defenses against Geveran’s claims. Nonetheless, the amount of possible loss, if any, cannot be reasonably estimated at this time. The outcome, if unfavorable, could have a material adverse effect on the Company.
The Company believes 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 Company’s legal fees and costs in this matter. However, given the unspecified nature of Geveran’s maximum damage claims, 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. The Company has also been paying, and expects to continue to pay, the 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 Company’s private placement with Geveran. Such payments are not covered by the Company’s insurance coverage. The engagement letter 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. While the case is in its early stages and the outcome of any litigation is inherently difficult to predict, the Company currently believes that it has strong defenses against Geveran’s claim for rescission that a grant of the remedy of rescission is unlikely and the amount of possible loss, if any, cannot be reasonably estimated.
During October 2011, the Company was notified of a contract dispute between LSGBV and one of its distributors in which the distributor is seeking monetary damages of approximately $1.2 million. Following arbitration before the International Chamber of Commerce, in The Hague, in January 2013, the parties settled this matter for the sum of  310,000 (or $460,000) in February 2014, which is included in accrued expenses on the Consolidated Balance Sheet.
NOTE 20: 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, 2013, 2012 and 2011, the Company contributed $303,000, $332,000 and $194,000, respectively, to the 401(k) Plan.
NOTE 21: 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, 2013 and 2012:
NOTE 22: VALUATION AND QUALIFYING ACCOUNTS
NOTE 23: SUBSEQUENT EVENTS
2014 Series J Issuance
Between January 3, 2014 and March 7, 2014, the Company issued an aggregate of 17,475 Series J Securities in the Series J Follow-On Offering. The Series J Securities were issued pursuant to separate Series J Securities Subscription Agreements (the “Follow-On Subscription Agreements”) between the Company, PCA Holdings, Holdings II, Riverwood Holdings, Zouk and certain other accredited investors. We issued 6,000, 6,000, 2,860, 2,570 and 45 shares of Series J Preferred Stock to Holdings II, PCA Holdings, Riverwood Holdings, Zouk and other accredited investors, respectively.
The Follow-On Offering was deemed to be a “Qualified Follow-On”, as such term is used and defined in the Series J Certificate of Designation and the Preferred Stock Subscription Agreements (the “Existing Subscription Agreements”) by and between the Company and the existing holders of Series J Preferred Stock (the “Initial Series J Investors”). As a result, and in accordance with the Existing Subscription Agreements, the Initial Series J Investors exchanged their Series J Preferred Stock for Series J Securities (the “Series J Exchange”).
Accordingly, on January 3, 2014, each of LSGC Holdings II, PCA LSG and Riverwood Holdings received Series J Warrants to purchase 36,191,050, 6,625,000 and 6,344,100 shares of Common Stock, respectively. Pursuant to the terms of the Series J Certificate of Designation and the Existing Subscription Agreement, because Holdings II, PCA Holdings and Riverwood Holdings collectively held at least a majority of the issued and outstanding shares of Series J Preferred Stock and elected to participate in the Series J Exchange with respect to all of their previously purchased shares of Series J Preferred Stock, all of the Initial Series J Investors were required to participate in the Series J Exchange. As of March 7, 2014, the Company had issued an aggregate of 37,475 Series J Preferred Stock and Series J Warrants to purchase 99,308,750 shares of Common Stock.
Medley Loan
On February 19, 2014, the Company, entered into the Medley Term Loan and the Delayed Draw Term Loan. The Closing Date Term Loan 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 term loan and (ii) the remaining accrued interest amount is payable in cash monthly in arrears. Additionally, $3.0 million of the Closing Date Term Loan were funded directly into a deposit account in which Medley has exclusive access, to further secure the loan. The outstanding principal balance and all accrued and unpaid interest on the Closing Date Term Loan are due and payable on February 19, 2019.
The Delayed Draw Term Loan may be borrowed and re-borrowed on a revolving basis by the Company, from the closing date through June 2014 (the “Revolving Loan Termination Date”). Following the Revolving Loan Termination Date, the remaining maximum amount of the Delayed Draw Term Loan may be drawn by the Company from time to time, provided that such loan may not be re-borrowed once repaid, subject to certain exceptions. Borrowings under the Delayed Draw Term Loan is limited by a borrowing base equal to the sum of (i) 85% of eligible accounts, (ii) 60% of inventory, and (iii) qualified cash, less any reserves imposed by Medley. Each draw on the Delayed Draw Term Loan made by the Company is subject to a $2.0 million liquidity requirement and the payment of a funding fee based upon the amount of the applicable draw being funded. From February 19, 2014 through the Revolving Loan Termination Date, the Delayed Draw Term Loan bears interest at a floating rate equal to three month LIBOR plus 10.5% per annum, payable in cash monthly in arrears. Following the Revolving Loan Termination Date, the Delayed Draw Term Loan bears interest 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 Closing Date Term Loan and (ii) the remainder is payable in cash monthly in arrears. The outstanding principal balance and all accrued and unpaid interest on the Delayed Draw Term Loan is due and payable on February 19, 2016.
The Company utilized proceeds from the Closing Date Term Loan to repay its outstanding obligations under the Wells Fargo ABL and the Ares Loan Agreement. On February 19, 2014, the Company terminated the Wells Fargo ABL and the Ares Loan Agreement.
Medley Warrants
On February 19, 2014 and in connection with the consummation of the transactions contemplated by the Medley Loan Agreement, the Company issued a warrant to purchase 5,000,000 shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”) to each of Medley and Medley Opportunity Fund II LP (the “Medley Warrants”). The Medley Warrants have an exercise price equal to $0.95 and, if unexercised, expire on February 19, 2024.
The Medley Warrants are not exercisable until the Company amends its Certificate of Incorporation to increase the number of authorized shares of Common Stock to a number sufficient to permit the Company to reserve shares of Common Stock for issuance upon the exercise or conversion in full of all of the Company’s outstanding securities that are convertible into or exercisable or exchangeable for shares of Common Stock (the “Charter Amendment”).
On February 19, 2014, the Company also entered into a Registration Rights Agreement (the “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 Warrants
Pegasus Capital Partners IV, L.P. and Pegasus Capital Partners V, L.P. (collectively, the “Pegasus Guarantors”) have agreed to provide a guaranty of the Company’s obligations under the Medley Loan Agreement in favor of Medley (the “Pegasus Guaranty”). 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 not exercisable until the Company effects the Charter Amendment.
INDEX TO EXHIBITS
* Filed herewith.
+ Management contract or compensatory plan or arrangement.