10-K 1 f10k2018_workhorsegroup.htm ANNUAL REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

☒  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2018

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

 

Commission file number: 000-53704

 

WORKHORSE GROUP INC.

(Name of registrant as specified in its charter)

 

Nevada   26-1394771
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

100 Commerce Drive    
Loveland, Ohio 45140   513-360-4704
(Address of principal executive offices)   (Registrant’s telephone number)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT:

 

Title of each Class:   Name of Each Exchange
Common Stock, $0.001 par value per share   The NASDAQ Stock Market LLC

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:

None.

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐     No  ☒

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐     No  ☒

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒     No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒     No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer
Non-accelerated filer

Smaller reporting company

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐     No  ☒

 

As of June 30, 2018, the last business day of the Registrant’s most recently completed second fiscal quarter, the market value of our common stock held by non-affiliates was $64,864,154.

 

The number of shares of the Registrant’s common stock, $0.001 par value per share, outstanding as of March 18, 2019, was 61,496,990.

 

 

 

 

 

TABLE OF CONTENTS

 

PART I    
     
Item 1. Business 1
     
Item 1A. Risk Factors 10
     
Item 1B. Unresolved Staff Comments 22
     
Item 2. Properties 22
     
Item 3. Legal Proceedings 22
     
Item 4. Mine Safety Disclosures 22
     
PART II    
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 23
     
Item 6. Selected Financial Data 26
     
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
     
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 33
     
Item 8. Financial Statements and Supplementary Data F-1
     
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 34
     
Item 9A. Controls and Procedures 34
     
Item 9B. Other Information 35
     
PART III    
     
Item 10. Directors, Executive Officers and Corporate Governance 36
     
Item 11. Executive Compensation 43
     
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 50
     
Item 13. Certain Relationships and Related Transactions, and Director Independence 52
     
Item 14. Principal Accounting Fees and Services 52
     
PART IV    
     
Item 15. Exhibits 53
     

Item 16.

Form 10-K Summary

55
   
Signatures 56

 

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Forward-Looking Statements

 

The discussions in this Annual Report contain forward-looking statements reflecting our current expectations that involve risks and uncertainties. When used in this Report, the words “anticipate”, expect”, “plan”, “believe”, “seek”, “estimate” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements about the features, benefits and performance of our products, our ability to introduce new product offerings and increase revenue from existing products, expected expenses including those related to selling and marketing, product development and general and administrative, our beliefs regarding the health and growth of the market for our products, anticipated increase in our customer base, expansion of our products functionalities, expected revenue levels and sources of revenue, expected impact, if any, of legal proceedings, the adequacy of liquidity and capital resource, and expected growth in business. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, market acceptance for our products, our ability to attract and retain customers for existing and new products, our ability to control our expenses, our ability to recruit and retain employees, legislation and government regulation, shifts in technology, global and local business conditions, our ability to effectively maintain and update our product and service portfolio, the strength of competitive offerings, the prices being charged by those competitors and the risks discussed elsewhere herein and our ability to raise capital under acceptable terms. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

All references in this Form 10-K that refer to the “Company”, “Workhorse Group”, “Workhorse”, “we,” “us” or “our” are to Workhorse Group Inc. and unless otherwise differentiated, its wholly-owned subsidiaries, Workhorse Technologies Inc., Workhorse Motor Works Inc. Workhorse Properties Inc. and Surefly Inc.

 

ii

 

 

PART I

 

ITEM 1. BUSINESS

 

Overview


 

We are a technology company focused on providing sustainable and cost-effective solutions to the commercial transportation sector. As an American manufacturer, we design and build high performance battery-electric vehicles and aircraft that make movement of people and goods more efficient and less harmful to the environment. As part of our solution, we also develop cloud-based, real-time telematics performance monitoring systems that enable fleet operators to optimize energy and route efficiency. Although we operate as a single unit through our subsidiaries, we approach our development through two divisions, Automotive and Aviation. We are currently focused on our core competency of bringing the N-GEN electric cargo van to market and fulfilling our existing backlog of orders. We are also exploring other opportunities in monetizing our intellectual property which could include a sale, license or other arrangement of assets that are outside of our core focus. We cannot guarantee that we will be successful in such efforts to monetize our non-core assets.

 

Automotive

 

We are an Original Equipment Manufacturer (“OEM”) of Class 3-6 commercial-grade, medium-duty truck chassis, to be marketed under the Workhorse® brand. All Workhorse last mile delivery vans are assembled in the Union City assembly facility. We will be expanding our product portfolio with the N-GEN electric cargo van in 2019, as well as the W-15 range-extended electric pickup truck sequential to that.

 

We believe our battery-electric and range-extended battery electric commercial vehicles offer fleet operators significant benefits, which include:

 

  Low Total Cost-of-Ownership vs. conventional gas/diesel vehicles

 

  Competitive advantage to increase brand loyalty and last mile delivery market share

 

  Improved profitability through:

 

  Lower maintenance costs

 

  Reduced fuel expenses

 

  Increased package deliveries per day through use of more efficient delivery methods

 

  Decreased vehicle emissions and reduction in carbon footprint

 

  Improved vehicle safety and driver experience

 

The Company currently sells and leases its vehicles to fleet customers directly and through its primary distributor Ryder System, Inc. Ryder also is the exclusive maintenance provider for Workhorse, which provides fleet operators with access to Ryder’s network of 800 maintenance facilities and nearly 6,000 trained service technicians across North America.

 

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Cargo Vans for Last Mile Delivery and Commercial Work Use

 

Workhorse delivery vans are produced at our Union City, Indiana plant and are in use by our customers on daily routes across the United States. To date, we have built and delivered over 360 electric and range extended medium-duty delivery trucks to our customers. To our knowledge, we are the only American commercial electric vehicle OEM to achieve such a milestone. Our delivery customers include companies such as UPS, FedEx Express, Alpha Baking, W.B. Mason and Ryder System.

 

In addition to improved fuel economy, we anticipate that the performance of our vehicles on-route will reduce long-term vehicle maintenance expense by approximately 50% as compared to fossil-fueled trucks. Over a 20-year vehicle life, we estimate that our E-GEN Range-Extended Electric delivery vans will save over $150,000 in fuel and maintenance savings. Due to this positive return-on-investment, we charge a premium price for our vehicles when selling to major fleet operators. We expect that fleet operators will be able to achieve a four-year or better total cost of ownership breakeven (without government incentives), which we believe justifies the higher acquisition cost of our vehicles.

 

Our goal is to continue to increase sales and production of our existing vehicle portfolio, while executing on a cost-down strategy in order to achieve sustained gross margin profitability of the last mile-delivery van platform. It is our intention that this strategy, in combination with the development and launch of the N-GEN cargo van and W-15 pickup truck platforms, which targets high-volume market segments, will drive further cost-down volume synergies across our supply chain.

 

U.S. Post Office Replenishment Program / Next Generation Delivery Vehicle Project

 

Workhorse, with our partner VT Hackney, is one of five awardees that the United States Postal Service (“USPS”) selected to build prototype vehicles for the USPS Next Generation Delivery Vehicle (“NGDV”) project. Presently, there are only four awardees still pursuing the NGDV project. The USPS has stated that the number of vehicles to be replaced in the project is approximately 180,000. In September 2017, Workhorse delivered six vehicles for prototype testing under the NGDV Acquisition Program in compliance with the terms set forth in their USPS prototype contract. The vehicles have completed the required testing protocol as specified by the USPS.

 

N-GEN Electric Cargo Van

 

In 2017, Workhorse announced the development of its N-GEN electric cargo van, which leverages the existing ultra-low floor, long-life commercial delivery vehicle platform that was developed for the USPS, as well as our extensive customer experience gained from working with our E-GEN and E-100 customers. The N-GEN incorporates lightweight materials, all-wheel drive, best in class turning radius, 360o cameras, collision avoidance systems and an optional roof mounted HorseFly™ delivery drone. 

 

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The Workhorse N-GEN electric cargo van platform will be available in 450, 700 and 1,000 cubic feet configurations. We intend to initially launch the 450 cubic foot and 1,000 cubic foot configurations with the goal of competing with conventional market leaders, including the Mercedes Sprinter, Ford Transit and Dodge ProMaster gasoline/diesel vans for both last-mile delivery and other service-oriented applications such as telecommunications. We expect these vehicles to achieve a fuel economy of approximately 60 miles per gallon equivalent (“MPGe”) and offer fleet operators the most favorable total cost-of-ownership of any comparable conventional van utilizing an internal combustion engine that is available today.

 

W-15 Range-Extended Electric Pickup Truck

 

In May 2017, we unveiled a working prototype of our W-15 range-extended electric pickup truck to address the specific needs of commercial fleet work truck operators, including utilities, municipalities, construction, airports and service businesses. We believe that the W-15 has the potential to transform the pickup truck market for fleet operators in the United States, estimated at 250,000 new vehicle purchases per year. The performance specifications of the Workhorse W-15 pickup include a true all-wheel drivetrain and two electric motors that generate up to 460 horsepower and provide a top acceleration time from 0 to 60 MPH of 5.6 seconds. The W-15 also has a fuel-economy rating of 75 MPGe and a range of 80 miles in all-electric operation. A gasoline-powered range extender also comes as on option on the truck to extend the driving range to 300 miles on a single tank of gas by continuously charging the batteries during operation.

 

We have secured letters-of-intent for more than 5,500 trucks, amounting to nearly $300 million from corporate fleets representing the utility, municipality and automotive logistics sectors. We have established a Leadership Council comprised of seasoned fleet experts from our LOI partners.

 

We intend to produce the W-15 at our existing 250,000 square foot facility in Union City, Indiana. This plant has the capability to produce more than 60,000 vehicles per year. The battery packs for all Workhorse vehicles will be built in our Loveland, Ohio battery pack plant using Panasonic cells produced in Japan.

 

Aviation

 

Delivery Drones

 

Our HorseFly delivery drone is a custom-designed, purpose-built drone that is fully integrated with our electric trucks. Workhorse was granted a patent on this architecture with the description “Package Delivery By Means Of An Automated Multi-Copter UAS/UAV Dispatched From A Conventional Delivery Vehicle.” We believe we are the only company in the world with a working drone/truck system. The HorseFly delivery drone and truck system is designed to work within the FAA Rule 107 that permits the use of commercial drones in U.S. airspace under certain conditions.

 

To date, we have conducted two demonstration deliveries with large multi-national corporations, including UPS. UPS conducted a successful real-world test with us in February 2017 and it received worldwide news coverage. The knowledge we have gained in building electric delivery trucks for last-mile delivery has led us to believe that a drone/truck delivery system can have significant cost savings in the growing last mile delivery market.

 

UPS has estimated in a press release dated February 21, 2017 that a reduction of just one mile per driver per day over one year can save UPS up to $50 million. Rural delivery routes are the most expensive to serve due to the time and vehicle expenses required to complete each delivery. In this test, the drone made one delivery while the driver continued down the road to make another. We believe that this truck/drone architecture represents significant cost savings for delivery fleets and that we are first to market with such a system. We continue to work closely with the FAA as we strive to bring the system to the point of daily drone deliveries across rural America.

 

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SureFly™ Multicopter

 

SureFly is our entry into the emerging vertical take-off and landing (“VTOL”) market. It is designed to be a two-person, 400-pound payload aircraft with a hybrid internal combustion/electric power generation system. Our approach in the design is to build the safest and simplest to fly rotary wing aircraft in the world. We believe it is a practical answer to personal flight, and has additional applications in the commercial transportation segments, including air taxi services, agriculture and others.

 

The FAA to date has granted 14 separate Experimental Airworthiness Certifications, registered as N834LW, for the aircraft. These certifications come after an extensive design review and inspection of the aircraft with each renewed certificate.

 

Our SureFly team continues to further develop the SureFly platform and routinely performs test cards, including testing the aircraft’s power systems, executing high-power ground tests and manned flights.

 

Technology

 

Batteries Are Key

 

The battery pack is key to the design, development, and manufacture of advanced electric-vehicle powertrains. Where some other electric vehicle (“EV”) manufacturers purchase their batteries in a plug-and-play pack, we build our own battery packs. This keeps the intellectual property related to the design and production of the pack in-house and avoids the issues that occur when a battery supplier fails. It also enables us to pay less for our battery packs than our competitors, thus our all-electric truck is less expensive than competitive vehicles. We use Panasonic 18650 cells and design the pack around these commodity cells.

 

In-House Software Development is Essential

 

Our powertrains encompass the complete motor assemblies, computers, and software required for vehicle electrification. We use off-the-shelf proven components and combine them with our proprietary software.

 

Innovation is the Future

 

Additionally, we have developed a cloud-based, remote management system to manage and track the performance of all of the vehicles that we deploy in order to provide a 21st Century solution for fleet managers.

 

The telematics system and associated hardware installed in the Workhorse vehicles is designed to monitor the controller area network traffic for specific signals. These signals are uploaded along with GPS data to a Workhorse server facility where the data signals are tracked at ten second intervals while driving and during the electricity generating process and at sixty seconds during a plug-in charge. The real-time data is stored in a database as it arrives and delivers updates to clients connected through the web interface.

 

As a parameter-based system, we can set route-specific parameters to better manage the battery-provided power with the additional power generated through the regenerative braking process (not applicable to E-100). In an upcoming release, we will add the ability to integrate Metron Telematics with the client’s internal telematics system and automatically update the parameters each day with information about the route. This enhancement will result in a “SMART-GEN” vehicle that will maximize efficiency by automating the process to determine the ideal times and locations to use the E-GEN to add electricity to the batteries.

 

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Locations and Facilities

 

Our company headquarters and R & D facility is located at 100 Commerce Drive, Loveland, Ohio, a Cincinnati suburb. We occupy a 45,000 sq. ft. facility that allows for the manufacture of 5,000 electric powertrain kits per year. Powertrains are delivered to the Workhorse facility in Indiana.

 

Our truck assembly facility is located in Union City, Indiana. This facility consists of three buildings with 250,000 square feet of manufacturing and office space on 47 acres.

 

In March of 2013, we purchased the former Workhorse Custom Chassis assembly plant in Union City, Indiana. With this acquisition, we became an OEM of Class 3-6 commercial-grade, medium-duty truck chassis marketed under the Workhorse® brand.

 

Ownership and operation of this plant enables us to build new chassis with gross vehicle weight capacity of between 10,000 and 26,000 pounds.

 

Our approach is to provide battery-electric powertrains utilizing proven, automotive-grade, mass-produced parts coupled with in-house control software that it has developed over the last five years.

 

The Workhorse Custom Chassis acquisition included other important assets including the Workhorse brand and logo, intellectual property, and schematics.

 

Marketing

 

Our sales team is focused on the goal of securing purchase orders from commercial transportation companies. These purchases will give us additional data toward chassis demand related to electric and extended range electric vehicles.

 

Our priority is to establish the commercial delivery van as our core business. We intend to be the best choice for a vehicle in this segment regardless of the fuel type that the customer chooses. Our sales plan is to meet with the top potential customers and obtain purchase orders for new electric and extended range electric vehicles for their production vehicle requirements.

 

As the last mile delivery service space expands and non-traditional customers enter, Workhorse is reaching to those potential new customers as part of their supply chain enhancement. This market is comprised of a higher quantity of smaller delivery vehicles, such as the Workhorse N-GEN platform.

 

Finally, since our competitive advantage in the marketplace is our ability to provide purpose-built solutions to customers that have unique requirements at relatively low-volume, we have submitted proposals to companies for purpose-built vehicle applications.

 

Strategic Relationships

 

Panasonic: Workhorse Group has signed an agreement with the rechargeable battery division of Panasonic Industrial Devices Sales Co. of America for the supply of 18650 cylindrical Panasonic lithium-ion batteries for Workhorse’s battery-electric, medium-duty trucks.

 

Ryder: On April 27, 2017, the Company entered into an agreement with Ryder to serve as the primary distributor, except with respect to certain exclusive accounts, in the United States, Mexico and Canada. Ryder will also serve as the sole and exclusive provider of certain repair services and the sole and exclusive distributor of certain vehicle parts in the United States, Canada and Mexico.

 

5

 

 

BMW: Workhorse has partnered with BMW where BMW provides the internal combustion engine used in the range extended vehicle applications as a source for on board battery recharging. BMW provides the engine, service support and technical advice necessary for vehicle certification. The engine currently used in production is the same engine used in the i3 passenger car.

 

Prefix: Michigan-based Prefix Corporation began in 1979 developing innovative design and engineering solutions for the automotive industry. Workhorse relies on Prefix’s complementary capabilities in the areas of complete prototype design, build and finishing to more rapidly advance product development.

 

Duke Energy Corp.: Workhorse continues working in partnership with Duke Energy (NYSE:DUK). On November 28, 2018, as the first step in the relationship, a subsidiary of Duke Energy purchased 615,000 Panasonic battery cells for approximately $1.3 million from Workhorse. The transaction is intended as an initial step toward an arrangement between Duke Energy and Workhorse in creating an innovative battery leasing program designed to provide customers a cost competitive electric vehicle product alternative. Through this relationship, Duke Energy intends to explore further development of eFleet solutions to Workhorse customers which may include single-point management and financing of all the Behind the Meter infrastructure necessary to support depot wide electrification, vehicle/battery leasing and distributed energy resources. Duke Energy and Workhorse believe a seamless/integrated solution will help reduce the overall costs of converting fleets to electric power enabling faster adoption of electric vehicles into commercial fleets.

 

Research and Development

 

The majority of our research and development is conducted in-house at our facilities near Cincinnati, Ohio. Additionally, we contract with engineering firms to assist with validation and certification requirements as well as specific vehicle integration tasks.

 

Competitive Companies

 

The commercial vehicle market, specifically in the last mile delivery segment, is highly competitive and we expect it to become even more so in the future as additional companies launch competing vehicle offerings. However, the commercial alternative fueled vehicle market is less developed and less competitive. There are two primary competitors in the medium-duty vehicle segment in the US market: Ford and Freightliner. Neither has disclosed any plans to offer 100% EVs or electric range extended vehicles in this segment. Ford is a vertically integrated company building a complete vehicle or chassis. They provide a chassis as a strip-chassis (which is similar to the Workhorse product) or they provide it with a cab. Freightliner provides a chassis as a strip-chassis, which is similar to the Workhorse Truck chassis.

 

Chanje is a California-based, privately held electric vehicle and energy solutions company that specializes in the last mile industry. Chanje introduced its first vehicle in the last quarter of 2017.

 

Motiv Power Systems is a manufacturer of all-electric powertrain control systems for commercial vehicles, based in Foster City, California. They also produce software for the systems and install them in vehicles that have already been manufactured.

 

We believe the most dramatic difference between Workhorse and the other competitors in the medium-duty truck market is our ability to offer customers purpose-built solutions that meet the needs of their unique requirements at a competitive price. While there are many electric car companies from abroad, there are only a few foreign companies that have vehicles in the category of medium-duty trucks.

 

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We believe that the primary competitive factors within the medium-duty commercial vehicle market are:

 

  the difference in the initial purchase prices of electric vehicles and comparable vehicles powered by internal combustion engines, both including and excluding the impact of government and other subsidies and incentives designed to promote the purchase of electric vehicles;

 

  the total cost of vehicle ownership over the vehicle’s expected life, which includes the initial purchase price and ongoing operational and maintenance costs;

 

  vehicle quality, performance and safety;

 

  government regulations and economic incentives promoting fuel efficiency and alternate forms of energy; and

 

  the quality and availability of service for the vehicle, including the availability of replacement parts.

 

GOVERNMENT REGULATION

 

Our electric vehicles are designed to comply with a significant number of governmental regulations and industry standards, some of which are evolving as new technologies are deployed. Government regulations regarding the manufacture, sale and implementation of products and systems similar to our electric vehicles are subject to future change. We cannot predict what impact, if any, such changes may have upon our business.

 

Emission and fuel economy standards

 

Government regulation related to climate change is in effect at the U.S. federal and state levels. The U.S. Environmental Protection Agency (“EPA”) and the National Highway Traffic Safety Administration (“NHTSA”) issued a final rule for greenhouse gas emissions and fuel economy requirements for trucks and heavy-duty engines on August 9, 2011, which is applicable in model years 2018 through 2020. NHTSA and EPA also issued a final rule on August 16, 2016 increasing the stringency of these standards for model years 2021 through 2027.

 

The rules provide emission standards for CO2 and fuel consumption standards for three main categories of vehicles: (i) combination tractors, (ii) heavy-duty pickup trucks and vans and (iii) vocational vehicles. We believe that the Workhorse vehicles would be considered “vocational vehicles” and “heavy-duty pickup trucks and vans” under the rules. According to the EPA and NHTSA, vocational vehicles consist of a wide variety of truck and bus types, including delivery, refuse, utility, dump, cement, transit bus, shuttle bus, school bus, emergency vehicles, motor homes and tow trucks, and are characterized by a complex build process, with an incomplete chassis often built with an engine and transmission purchased from other manufacturers, then sold to a body manufacturer.

 

The EPA and NHTSA rule also establishes multiple flexibility and incentive programs for manufacturers of alternatively fueled vehicles, such as the Workhorse vehicles, including an engine Averaging, Banking and Trading (“ABT”) program, a vehicle ABT program and additional credit programs for early adoption of standards or deployment of advanced or innovative technologies. The ABT programs will allow for emission and/or fuel consumption credits to be averaged, banked or traded within defined groupings of the regulatory subcategories. The additional credit programs will allow manufacturers of engines and vehicles to be eligible to generate credits if they demonstrate improvements in excess of the standards established in the rule prior to the model year the standards become effective or if they introduce advanced or innovative technology engines or vehicles.

 

The Clean Air Act requires that we obtain a Certificate of Conformity issued by the EPA and a California Executive Order issued by the California Air Resource Board (“CARB”) with respect to emissions for our vehicles. The Certificate of Conformity is required for vehicles sold in states covered by the Clean Air Act’s standards and the Executive Order is required for vehicles sold in states that have sought and received a waiver from the EPA to utilize California standards. The California standards for emissions control for certain regulated pollutants for new vehicles and engines sold in California are set by CARB. States that have adopted the California standards as approved by EPA also recognize the Executive Order for sales of vehicles.

 

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Manufacturers who sell vehicles in states covered by federal requirements under the Clean Air Act without a Certificate of Conformity may be subject to penalties of up to $44,539 per violation and be required to recall and remedy any vehicles sold with emissions in excess of Clean Air Act standards. In 2013, we received approval from CARB to sell the E-100 in California based on our own emissions tests.

 

Vehicle safety and testing

 

The National Traffic and Motor Vehicle Safety Act of 1966 (the “Safety Act”) regulates motor vehicles and motor vehicle equipment in the United States in two primary ways. First, the Safety Act prohibits the sale in the United States of any new vehicle or equipment that does not conform to applicable motor vehicle safety standards established by NHTSA. Meeting or exceeding many safety standards is costly, in part because the standards tend to conflict with the need to reduce vehicle weight in order to meet emissions and fuel economy standards. Second, the Safety Act requires that defects related to motor vehicle safety be remedied through safety recall campaigns. A manufacturer is obligated to recall vehicles if it determines that the vehicles do not comply with a safety standard. Should we or NHTSA determine that either a safety defect or noncompliance exists with respect to any of our vehicles, the cost of such recall campaigns could be substantial.

 

Battery safety and testing

 

Our battery pack configurations are designed to conform to mandatory regulations that govern transport of “dangerous goods,” which includes lithium-ion batteries, which may present a risk in transportation. The governing regulations, which are issued by the Pipeline and Hazardous Safety Administration and are based on the UN Recommendations on the Safe Transport of Dangerous Goods Model Regulations, and related UN Manual of Tests and Criteria. The requirements for shipments of these goods vary by mode of transportation, such as ocean vessel, rail, truck and air.

 

Our battery suppliers have completed the applicable transportation test for our prototype and production battery packs demonstrating our compliance with the UN Manual of Tests and Criteria, including:

 

  altitude simulation, which involves simulating air transport; 

 

  thermal cycling, which involves assessing cell and battery seal integrity;

 

  vibration, which involves simulating vibration during transport;

 

  shock, which involves simulating possible impacts during transport;

 

  external short circuit, which involves simulating an external short circuit; and

 

  overcharge, which involves evaluating the ability of a rechargeable battery to withstand overcharging.

 

Vehicle dealer and distribution regulation

 

Certain states’ laws require motor vehicle manufacturers and dealers to be licensed in such states in order to conduct manufacturing and sales activities. To date, we are registered as a motor vehicle manufacturer in Indiana and Ohio and as a dealer in California, New York and Chicago. We have not yet sought formal clarification of our ability to manufacture or sell our vehicles in any other states.

 

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Intellectual Property

 

We have four pending trademark applications and 12 issued trademark registrations (US and foreign). We also intend to pursue additional trademark registrations. We have five pending (three non-provisional and two provisional) U.S. and foreign patent applications, and eight existing patents, two of which are design patents. We also plan to pursue appropriate foreign patent protection on those inventions, if available. The following is a summary of our patents:

 

Country   Status   Serial Number   Application Date   Patent Number     Issue/Grant Date   Expiration Date     Title
United States   G   13/283,663   10/28/2011     8,541,915     9/24/2013     12/16/2031     Drive module and manifold for electric motor drive assembly
Canada   G   2523653   10/17/2005     2523653     12/22/2009     10/17/2025     Vehicle chassis assembly
United States   G   11/252,220   10/17/2005     7,717,464     5/18/2010     9/6/2026     Vehicle chassis assembly
United States   G   11/252,219   10/17/2005     7,559,578     7/14/2009     9/6/2026     Vehicle chassis assembly
United States   G   29/243,074   11/18/2005     D561,078     2/5/2008     2/5/2022     Vehicle header
United States   G   29/243,129   11/18/2005     D561,079     2/5/2008     2/5/2022     Vehicle header
United States   G   14/606,497   1/27/2015     9,481,256     11/1/2016     5/3/2035     Onboard generator drive system for electric vehicles
United States   F   14/989,870   1/7/2016     9,915,956     3/13/2018     6/24/2036     Package delivery by means of an automated multicopter UAS/UAV dispatched from a conventional delivery vehicle
United States   F   15/994,185   5/31/2018                       Auxiliary power system for rotorcraft with folding propeller arms and crumple zone landing gear
United States   F   15/915,144   3/8/2018                       Package delivery by means of an automated multicopter UAS/UAV dispatched from a conventional delivery vehicle
PCT-International   F   US2018/035353   5/31/2018                       Auxiliary power system for rotorcraft with folding propeller arms and crumple zone landing gear
United States   F   62/777,296   12/10/2018                       Automated vehicle with robotic arm
United States   F   62/733,870   9/20/2018                       Autonomous tractor system

 

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Employees

 

We currently have 74 full-time and seven part-time employees located in Loveland, Ohio and 24 full-time employees located in Union City, Indiana. We also contract for hire with approximately three outside consultants and contractors.

 

ITEM 1A. RISK FACTORS

 

Our results of operations have not resulted in profitability and we may not be able to achieve profitability going forward.

 

We have incurred net losses amounting to $141.6 million for the period from inception (February 20, 2007) through December 31, 2018.  We have had net losses in each quarter since our inception. We expect that we will continue to incur net losses in the first part of 2019. We may incur significant losses in the future for a number of reasons, including the other risks described in this report, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown events. Accordingly, we may not be able to achieve or maintain profitability. Our management is developing plans to alleviate the negative trends and conditions described above and there is no guarantee that such plans will be successfully implemented. Our business plan is focused on providing sustainable and cost-effective solutions to the commercial transportation sector but is still unproven. There is no assurance that even if we successfully implement our business plan, that we will be able to curtail our losses. If we incur additional significant operating losses, our stock price may decline, perhaps significantly.

 

We have yet to achieve positive cash flow and, given our projected funding needs, our ability to generate positive cash flow is uncertain.

 

We have had negative cash flow from operating activities of $21.8 million and $38.7 million for the years ended December 31, 2018 and 2017, respectively. We anticipate that we will continue to have negative cash flow from operating and investing activities for in the first part of 2019 as we expect to incur research and development, sales and marketing, and general and administrative expenses and make modest capital expenditures in our efforts to increase sales and ramp up operations at our Union City facility. Our business also will at times require significant amounts of working capital to support our growth of additional platforms. An inability to generate positive cash flow for the near term may adversely affect our ability to raise needed capital for our business on reasonable terms, diminish supplier or customer willingness to enter into transactions with us, and have other adverse effects that may decrease our long-term viability.

 

10

 

 

We need access to additional financing in 2019 and beyond, which may not be available to us on acceptable terms or at all. If we cannot access additional financing when we need it and on acceptable terms, our business may fail.

 

Our business plan to design, produce, sell and service commercial electric vehicles through our Union City facility will require continued capital investment in 2019. Our research and development activities will also require continued investment. For the year ended December 31, 2018, our independent registered public accounting firm issued a report on our 2018 financial statements that contained an explanatory paragraph stating that the lack of sales, negative working capital and stockholders’ deficit, raise substantial doubt about our ability to continue as a going concern. For example, our existing capital resources will be insufficient to fund our operations through the first half of 2019. Although we have entered into a Credit Agreement with Marathon Asset Management, LP (“Marathon”), which provides us with a $25 million credit line to be used for vehicle production and are subject to the receipt of confirmed purchase orders, we expect that we will need funding to be used in our research and development activities and operational expenses. The additional funding will allow us to continue to deliver vehicles associated with existing and expected orders, further expand our N-GEN platform resulting in “production ready vehicles”. Unless and until we are able to generate a sufficient amount of revenue, reduce our costs and/or enter a strategic relationship, we expect to finance future cash needs through public and/or private offerings of equity securities and/or debt financings. As discussed above, we have committed debt funding through our Credit Agreement with Marathon to support inventory purchases for confirmed customer purchase orders, but do not currently have any committed future funding for other operating costs. If we are not able to obtain additional financing and/or substantially increase revenue from sales, we will be unable to continue as a going concern. As a result, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our consolidated financial statements, and investors will likely lose a substantial part or all of their investment. We cannot be certain that additional financing will be available to us on favorable terms when required, or at all, particularly given that we do not now have a committed credit facility with any government or financial institution. Further, if there remains doubt about our ability to continue as a going concern, investors or other financing sources may be unwilling to provide additional funding on acceptable terms or at all. If we cannot obtain additional financing when we need it and on terms acceptable to us, we will not be able to continue as a going concern.

 

The development of our business in the near future is contingent upon the implementation of orders from UPS and other key customers for the purchase of Workhorse vehicles and if we are unable to perform under these orders, our business may fail.

 

On June 4, 2014, the Company entered into a Vehicle Purchase Agreement with United Parcel Service Inc. (“UPS”) which outlined the relationship by which the Company would sell vehicles to UPS. To date, we have received six separate orders totaling up to 1,405 vehicles from UPS. The sixth and most recent order is from Q1 2018. We have entered into various purchase orders with UPS relating to the delivery of the vehicles ordered. There is no guarantee that the Company will be able to perform under these orders and if it does perform, that UPS will purchase additional vehicles from the Company. Also, there is no assurance that UPS will not terminate its agreement with the Company pursuant to the termination provisions therein. Further, if the Company is not able to raise the required capital to purchase required parts and pay certain vendors, the Company may not be able to comply with UPS’s deadlines. Accordingly, despite the receipt of the orders from UPS, there is no assurance, due to the Company’s financial constraints and status as a development stage company, that the Company will be able to deliver such vehicles or that it will receive additional orders whether from UPS or other potential customers.

 

If we are unable to perform under our orders with UPS, the Company business will be significantly negatively impacted.

 

11

 

 

Our limited operating history makes it difficult for us to evaluate our future business prospects and make decisions based on those estimates of our future performance.

 

As we begin to fully implement our manufacturing capabilities, it is difficult, if not impossible, to forecast our future results based upon our historical data. Because of the uncertainties related to our lack of historical operations, we may be hindered in our ability to anticipate and adapt to increases or decreases in revenues or expenses.  If we make poor budgetary decisions as a result of unreliable historical data, we could be less profitable or incur losses, which may result in a decline in our stock price.

 

We offer no financing on our vehicles. As such, our business is dependent on cash sales, which may adversely affect our growth prospects.

 

While most of our current customers are well-established companies with significant purchasing power, many of our potential smaller and medium-sized customers may need to rely on credit or leasing arrangements to gain access to our vehicles. Unlike some of our competitors who provide credit or leasing services for the purchase of their vehicles, we do not provide, and currently do not have commercial arrangements with a third party that provides, such financial services. We believe the current limited availability of credit or leasing solutions for our vehicles could adversely affect our revenues and market share in the commercial electric vehicle market.

 

Our business, prospects, financial condition and operating results will be adversely affected if we cannot reduce and adequately control the costs and expenses associated with operating our business, including our material and production costs.

 

We incur significant costs and expenses related to procuring the materials, components and services required to develop and produce our electric vehicles. We have secured supply agreements for our critical components including our batteries. However, these are dependent on volume to ensure that they are available at a competitive price. We continually work on cost-down initiatives to reduce our cost structure so that we may effectively compete. If we do not reduce our costs and expenses, our net losses will continue which will negatively impact our business and stock price.

 

Increases in costs, disruption of supply or shortage of lithium-ion cells could harm our business.

 

We may experience increases in the cost or a sustained interruption in the supply or shortage of lithium-ion cells. Any such increase, supply interruption or shortage could materially and negatively impact our business, prospects, financial condition and operating results. The prices for these lithium-ion cells can fluctuate depending on market conditions and global demand for these materials and could adversely affect our business and operating results. We are exposed to multiple risks relating to lithium-ion cells including:

 

  the inability or unwillingness of current battery manufacturers to build or operate battery cell manufacturing plants to supply the numbers of lithium-ion cells we may require going forward;
     
  disruption in the supply of cells due to quality issues or recalls by battery cell manufacturers;
     
  an increase in the cost of raw materials used in the cells; and
     
  fluctuations in the value of the Japanese yen against the U.S. dollar in the event our purchasers of lithium-ion cells are denominated in Japanese yen.

 

12

 

 

Our business is dependent on the continued supply of battery cells for the battery packs used in our vehicles. While we believe several sources of the battery cells are available for such battery cells, we have fully qualified only Panasonic for the supply of the cells used in such battery packs and have very limited flexibility in changing cell suppliers. Any disruption in the supply of battery cells could disrupt production of our vehicles until such time as a different supplier is fully qualified. Furthermore, fluctuations or shortages in petroleum, tariff or trade issues and other economic or tax conditions may cause us to experience significant increases in freight charges. Substantial increases in the prices for the battery cells or prices charged to us, would increase our operating costs, and could reduce our margins if we cannot recoup the increased costs through increased vehicle prices. Any attempts to increase vehicle prices in response to increased costs in our battery cells could result in cancellations of vehicle orders and therefore materially and adversely affect our brand, image, business, prospects and operating results.

 

The demand for commercial electric vehicles depends, in part, on the continuation of current trends resulting from dependence on fossil fuels. Extended periods of low diesel or other petroleum-based fuel prices could adversely affect demand for our vehicles, which would adversely affect our business, prospects, financial condition and operating results.

 

We believe that much of the present and projected demand for commercial electric vehicles results from concerns about volatility in the cost of petroleum-based fuel, the dependency of the United States on oil from unstable or hostile countries, government regulations and economic incentives promoting fuel efficiency and alternative forms of energy, as well as the belief that climate change results in part from the burning of fossil fuels. If the cost of petroleum-based fuel decreased significantly, the outlook for the long-term supply of oil to the United States improved, the government eliminated or modified its regulations or economic incentives related to fuel efficiency and alternative forms of energy, or if there is a change in the perception that the burning of fossil fuels negatively impacts the environment, the demand for commercial electric vehicles could be reduced, and our business and revenue may be harmed.

 

Diesel and other petroleum-based fuel prices have been extremely volatile, and we believe this continuing volatility will persist. Lower diesel or other petroleum-based fuel prices over extended periods of time may lower the perception in government and the private sector that cheaper, more readily available energy alternatives should be developed and produced. If diesel or other petroleum-based fuel prices remain at deflated levels for extended periods of time, the demand for commercial electric vehicles may decrease, which would have an adverse effect on our business, prospects, financial condition and operating results.

 

Our future growth is dependent upon the willingness of operators of commercial vehicle fleets to adopt electric vehicles and on our ability to produce, sell and service vehicles that meet their needs. This often depends upon the cost for an operator adopting electric vehicle technology as compared to the cost of traditional internal combustion technology.

 

Our growth is dependent upon the adoption of electric vehicles by operators of commercial vehicle fleets and on our ability to produce, sell and service vehicles that meet their needs. The entry of commercial electric vehicles into the medium-duty commercial vehicle market is a relatively new development, particularly in the United States, and is characterized by rapidly changing technologies and evolving government regulation, industry standards and customer views of the merits of using electric vehicles in their businesses. This process has been slow as without including the impact of government or other subsidies and incentives, the purchase prices for our commercial electric vehicles currently is higher than the purchase prices for diesel-fueled vehicles. Our growth has also been negatively impacted by the relatively low price of oil over the last few years.

 

13

 

 

If the market for commercial electric vehicles does not develop as we expect or develops more slowly than we expect, our business, prospects, financial condition and operating results will be adversely affected.

 

As part of our sales efforts, we must educate fleet managers as to the economical savings we believe they will benefit from during the life of the vehicle. As such, we believe that operators of commercial vehicle fleets should consider a number of factors when deciding whether to purchase our commercial electric vehicles (or commercial electric vehicles generally) or vehicles powered by internal combustion engines, particularly diesel-fueled or natural gas-fueled vehicles. We believe these factors include:

 

  the difference in the initial purchase prices of commercial electric vehicles and vehicles with comparable gross vehicle weight powered by internal combustion engines, both including and excluding the impact of government and other subsidies and incentives designed to promote the purchase of electric vehicles;
     
  the total cost of ownership of the vehicle over its expected life, which includes the initial purchase price and ongoing operating and maintenance costs;
     
  the availability and terms of financing options for purchases of vehicles and, for commercial electric vehicles, financing options for battery systems;
     
  the availability of tax and other governmental incentives to purchase and operate electric vehicles and future regulations requiring increased use of nonpolluting vehicles;
     
  government regulations and economic incentives promoting fuel efficiency and alternate forms of energy;
     
  fuel prices, including volatility in the cost of diesel;
     
  the cost and availability of other alternatives to diesel fueled vehicles, such as vehicles powered by natural gas;
     
  corporate sustainability initiatives;
     
  commercial electric vehicle quality, performance and safety (particularly with respect to lithium-ion battery packs);
     
  the quality and availability of service for the vehicle, including the availability of replacement parts;
     
  the limited range over which commercial electric vehicles may be driven on a single battery charge;
     
  access to charging stations and related infrastructure costs, and standardization of electric vehicle charging systems;
     
  electric grid capacity and reliability; and
     
  macroeconomic factors.

 

If, in weighing these factors, operators of commercial vehicle fleets determine that there is not a compelling business justification for purchasing commercial electric vehicles, particularly those that we produce and sell, then the market for commercial electric vehicles may not develop as we expect or may develop more slowly than we expect, which would adversely affect our business, prospects, financial condition and operating results.

 

If our customers are unable to efficiently and effectively integrate our electric vehicles into their existing commercial fleets our sales may suffer and our business, prospects, financial condition and operating results may be adversely affected.

 

Our sales strategy involves a comprehensive plan for the pilot and roll-out of our electric vehicles, as well as the ongoing replacement of existing commercial vehicles with our electric vehicles, that is tailored to the individual needs of our customers. If we are unable to develop and execute fleet integration strategies or fleet management support services that meet our customers’ unique circumstances with minimal disruption to their businesses, our customers may not realize the economic benefits they expect from our electric vehicles. If this were to occur, our customers may not order additional vehicles from us, which could adversely affect our business, prospects, financial condition and operating results.

 

14

 

 

We currently do not have long-term supply contracts with guaranteed pricing which exposes us to fluctuations in component, materials and equipment prices. Substantial increases in these prices would increase our operating costs and could adversely affect our business, prospects, financial condition and operating results.

 

Because we currently do not have long-term supply contracts with guaranteed pricing, we are subject to fluctuations in the prices of the raw materials, parts and components and equipment we use in the production of our vehicles. Substantial increases in the prices for such raw materials, components and equipment would increase our operating costs and could reduce our margins if we cannot recoup the increased costs through increased vehicle prices. Any attempts to increase the announced or expected prices of our vehicles in response to increased costs could be viewed negatively by our customers and could adversely affect our business, prospects, financial condition and operating results.

 

If we are unable to scale our operations at our Union City facility in an expedited manner from our limited low volume production to high volume production, our business, prospects, financial condition and operating results will be adversely affected.

 

We are currently assembling our orders at our Union City facility which has been acceptable for our historical orders. To satisfy increased demand, we will need to quickly scale operations in our Union City facility as well as scale our supply chain including access to batteries. Such a substantial and rapid increase in operations may strain our management capabilities. Our business, prospects, financial condition and operating results could be adversely affected if we experience disruptions in our supply chain, if we cannot obtain materials of sufficient quality at reasonable prices or if we are unable to scale our Union City facility.

 

We depend upon key personnel and need additional personnel. The loss of key personnel or the inability to attract additional personnel may adversely affect our business and results of operations.

 

Our success depends on the continuing services of our CEO, Duane Hughes and top management. On February 4, 2019, Mr. Hughes and the Company entered into an Executive Retention Agreement whereby Mr. Hughes was retained as Chief Executive Officer in consideration of an annual salary of $350,000. Further, on various separate dates, the Company entered Executive Retention Agreements with Rob Willison as President and Chief Operating Officer, Paul Gaitan as Chief Financial Officer and Julio Rodriguez as Chief Information Officer. The loss of any of these individuals could have a material and adverse effect on our business operations. Additionally, the success of our operations will largely depend upon our ability to successfully attract and maintain competent and qualified key management personnel. As with any company with limited resources, there can be no guarantee that we will be able to attract such individuals or that the presence of such individuals will necessarily translate into profitability for our company. Our inability to attract and retain key personnel may materially and adversely affect our business operations. Any failure by our management to effectively anticipate, implement, and manage the changes required to sustain our growth would have a material adverse effect on our business, financial condition, and results of operations.

 

15

 

 

We face intense competition. Some of our competitors have substantially greater financial or other resources, longer operating histories and greater name recognition than we do and could use their greater resources and/or name recognition to gain market share at our expense or could make it very difficult for us to establish market share.

 

Companies currently competing in the fleet logistics market offering alternative fuel medium-duty trucks include Ford Motor Company and Freightliner. Ford and Freightliner are currently selling alternative fuel fleet vehicles including hybrids. Ford and Freightliner have substantially more financial resources, established market positions, long-standing relationships with customers and dealers, and who have more significant name recognition, technical, marketing, sales, financial and other resources than we do. Although we believe that HorseFly, our unmanned aerial system (“UAS”), is unique in the marketplace in that it currently does not have any competitors when it comes to a UAS that works in combination with a truck, there are better financed competitors in this emerging industry, including Google and Amazon. While we are seeking to partner with existing delivery companies to improve their efficiencies in the last mile of delivery, our competitors are seeking to redefine the delivery model using drones from a central location requiring extended flight patterns. Our competitors’ new aerial delivery model would essentially eliminate traditional package delivery companies. Our model is focused on coupling our delivery drone with delivery trucks supplementing the existing model and providing shorter term flight patterns. Google and Amazon have more significant financial resources, established market positions, long-standing relationships with customers, more significant name recognition and a larger scope of resources including technical, marketing and sales than we do.

 

The market for personal VTOL aircraft is new, rapidly evolving, characterized by rapidly changing technologies, price competition, additional competitors, evolving government regulation and industry standards, frequent new vehicle announcements and changing consumer demands and behaviors. The market is highly competitive, and the SureFly design is competing with experimental aircraft from large original equipment manufacturers, or OEMs, small OEMs, other aviation related companies, technology companies and entrepreneurs. Currently, there are several VTOL aircraft being developed that have some similarity to SureFly, including eHang and Volocopter.

 

The resources available to our competitors to develop new products and introduce them into the marketplace exceed the resources currently available to us. As a result, our competitors may be able to compete more aggressively and sustain that competition over a longer period than we can. This intense competitive environment may require us to make changes in our products, pricing, licensing, services, distribution, or marketing to develop a market position. Each of these competitors has the potential to capture significant market share in our target markets which could have an adverse effect on our position in our industry and on our business and operating results.

 

If we are unable to keep up with advances in electric vehicle technology, we may suffer a decline in our competitive position.

 

There are companies in the electric vehicle industry that have developed or are developing vehicles and technologies that compete or will compete with our vehicles. We cannot assure that our competitors will not be able to duplicate our technology or provide products and services similar to ours more efficiently. If for any reason we are unable to keep pace with changes in electric vehicle technology, particularly battery technology, our competitive position may be adversely affected. We plan to upgrade or adapt our vehicles and introduce new models to continue to provide electric vehicles that incorporate the latest technology. However, there is no assurance that our research and development efforts will keep pace with those of our competitors.

 

Our electric vehicles compete for market share with vehicles powered by other vehicle technologies that may prove to be more attractive than ours.

 

Our target market currently is serviced by manufacturers with existing customers and suppliers using proven and widely accepted fossil fuel technologies. Additionally, our competitors are working on developing technologies that may be introduced in our target market. If any of these alternative technology vehicles can provide lower fuel costs, greater efficiencies, greater reliability or otherwise benefit from other factors resulting in an overall lower total cost of ownership, this may negatively affect the commercial success of our vehicles or make our vehicles uncompetitive or obsolete.

 

16

 

 

We currently have a limited number of customers, with whom we do not have long-term agreements, and expect that a significant portion of our future sales will be from a limited number of customers. The loss of any of these customers could materially harm our business.

 

A significant portion of our projected future revenue is expected to be generated from a limited number of fleet customers. Additionally, much of our business model is focused on building relationships with a few large fleet customers. Currently, we have no contracts with customers that include long-term commitments or minimum volumes that ensure future sales of vehicles. As such, a customer may take actions that negatively affect us for reasons that we cannot anticipate or control, such as reasons related to the customer’s financial condition, changes in the customer’s business strategy or operations or as the result of the perceived performance or cost-effectiveness of our vehicles. The loss of or a reduction in sales or anticipated sales to our most significant customers would have a material adverse effect on our business, prospects, financial condition and operating results.

 

Changes in the market for electric vehicles could cause our products to become obsolete or lose popularity.

 

The modern electric vehicle industry is in its infancy and has experienced substantial change in the last few years. To date, demand for electric vehicles has been slower than forecasted by industry experts. As a result, growth in the electric vehicle industry depends on many factors outside our control, including, but not limited to:

 

  continued development of product technology, especially batteries;
     
  the environmental consciousness of customers;
     
  the ability of electric vehicles to successfully compete with vehicles powered by internal combustion; engines
     
  limitation of widespread electricity shortages; and
     
  whether future regulation and legislation requiring increased use of non-polluting vehicles is enacted.

 

We cannot assume that growth in the electric vehicle industry will continue. Our business will suffer if the electric vehicle industry does not grow or grows more slowly than it has in recent years or if we are unable to maintain the pace of industry demands.

 

President Trump’s administration may create regulatory uncertainty for the alternative energy sector and may materially harm our business, financial condition and operating results.

 

President Trump’s administration may create regulatory uncertainty in the alternative energy sector. During the election campaign, President Trump made comments suggesting that he was not supportive of various clean energy programs and initiatives designed to curtail global warming. Since taking office, President Trump has released his America First Energy Plan which relies on fossil fuels, cancelled U.S. participation in the Paris Climate Agreement and signed several executive orders relating to oil pipelines. It remains unclear what specifically President Trump would or would not do with respect to these programs and initiatives, and what support he would have for any potential changes to such legislative programs and initiatives in the Unites States Congress. If President Trump and/or the United States Congress take action or publicly speak out about the need to eliminate or further reduce legislation, regulations and incentives supporting alternative energy or take action to further support the use of fossil fuels, such actions may result in a decrease in demand for alternative energy in the United States and may materially harm our business, financial condition and operating results.

 

The unavailability, reduction, elimination or adverse application of government subsidies, incentives and regulations could have an adverse effect on our business, prospects, financial condition and operating results.

 

We believe that, currently, the availability of government subsidies and incentives including those available in California and other areas is an important factor considered by our customers when purchasing our vehicles, and that our growth depends in part on the availability and amounts of these subsidies and incentives. Any reduction, elimination or discriminatory application of government subsidies and incentives because of budgetary challenges, policy changes, the reduced need for such subsidies and incentives due to the perceived success of electric vehicles or other reasons may result in the diminished price competitiveness of the alternative fuel vehicle industry.

 

17

 

 

We may be unable to keep up with changes in electric vehicle technology and, as a result, may suffer a decline in our competitive position.

 

Our current products are designed for use with, and are dependent upon, existing electric vehicle technology. As technologies change, we plan to upgrade or adapt our products to continue to provide products with the latest technology. However, our products may become obsolete or our research and development efforts may not be sufficient to adapt to changes in or to create the necessary technology. Thus, our potential inability to adapt and develop the necessary technology may harm our competitive position.

 

The failure of certain key suppliers to provide us with components could have a severe and negative impact upon our business.

 

We have secured supply agreements for our critical components, including our batteries. However, the agreements are dependent on volume to ensure that they are available at a competitive price. Further, we rely on a small group of suppliers to provide us with components for our products. If these suppliers become unwilling or unable to provide components or if we are unable to meet certain volume requirements in our existing supply agreements, there are a limited number of alternative suppliers who could provide them and the price for them could be substantially higher. Changes in business conditions, wars, governmental changes, and other factors beyond our control or which we do not presently anticipate could negatively affect our ability to receive components from our suppliers. Further, it could be difficult to find replacement components if our current suppliers fail to provide the parts needed for these products. A failure by our major suppliers to provide these components could severely restrict our ability to manufacture our products and prevent us from fulfilling customer orders in a timely fashion.

 

Product liability or other claims could have a material adverse effect on our business.

 

The risk of product liability claims, product recalls, and associated adverse publicity is inherent in the manufacturing, marketing, and sale of electrical vehicles. Although we have product liability insurance for our consumer and commercial products, that insurance may be inadequate to cover all potential product claims. We also carry liability insurance on our products. Any product recall or lawsuit seeking significant monetary damages either in excess of our coverage, or outside of our coverage, may have a material adverse effect on our business and financial condition. We may not be able to secure additional product liability insurance coverage on acceptable terms or at reasonable costs when needed. A successful product liability claim against us could require us to pay a substantial monetary award. Moreover, a product recall could generate substantial negative publicity about our products and business and inhibit or prevent commercialization of other future product candidates. We cannot provide assurance that such claims and/or recalls will not be made in the future.

 

We may have to devote substantial resources to implementing a retail product distribution network.

 

Dealers are often hesitant to provide their own financing to contribute to our product distribution network. Thus, we anticipate that we may have to provide financing or other consignment sale arrangements for dealers. A capital investment such as this presents many risks, foremost among them being that we may not realize a significant return on our investment if the network is not profitable. Our inability to collect receivables from dealers could cause us to suffer losses. Additionally, the amount of time that our management will need to devote to this project may divert them from performing other functions necessary to assure the success of our business. We have established a non-exclusive distribution agreement with Ryder to lower this risk.

 

18

 

 

Regulatory requirements may have a negative impact upon our business.

 

While our vehicles are subject to substantial regulation under federal, state, and local laws, we believe that our vehicles are or will be materially in compliance with all applicable laws. However, to the extent the laws change, or if we introduce new vehicles in the future, some or all of our vehicles may not comply with applicable federal, state, or local laws. Further, certain federal, state, and local laws and industrial standards currently regulate electrical and electronics equipment. Although standards for electric vehicles are not yet generally available or accepted as industry standards, our products may become subject to federal, state, and local regulation in the future. Compliance with these regulations could be burdensome, time consuming, and expensive.

 

Our products are subject to environmental and safety compliance with various federal and state regulations, including regulations promulgated by the EPA, NHTSA, FAA and various state boards, and compliance certification is required for each new model year. The cost of these compliance activities and the delays and risks associated with obtaining approval can be substantial. The risks, delays, and expenses incurred in connection with such compliance could be substantial.

 

Our success may be dependent on protecting our intellectual property rights.

 

We rely on trade secret protections to protect our proprietary technology as well as several registered patents and five patent applications. Our patents relate to the vehicle chassis assembly, vehicle header and drive module and manifold for electric motor drive assembly. Our existing patent applications relates to the onboard generator drive system for electric vehicles, the delivery drone, and the manned multicopter. Our success will, in part, depend on our ability to obtain additional trademarks and patents. We are working on obtaining patents and trademarks registered with the United States Patent and Trademark Office but have not finalized any as of this date. Although we have entered into confidentiality agreements with our employees and consultants, we cannot be certain that others will not gain access to these trade secrets. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets.

 

Our business may be adversely affected by union activities.

 

Although none of our employees are currently represented by a labor union, it is common throughout the automotive industry for many employees at automotive companies to belong to a union, which can result in higher employee costs and increased risk of work stoppages. Our employees may join or seek recognition to form a labor union, or we may be required to become a union signatory. Our production facility in Union City, Indiana was purchased from Navistar. Prior employees of Navistar were union members and our future work force at this facility may be inclined to vote in favor of forming a labor union. Furthermore, we are directly or indirectly dependent upon companies with unionized work forces, such as parts suppliers and trucking and freight companies, and work stoppages or strikes organized by such unions could have a material adverse impact on our business, financial condition or operating results. If a work stoppage occurs, it could delay the manufacture and sale of our trucks and have a material adverse effect on our business, prospects, operating results or financial condition. The mere fact that our labor force could be unionized may harm our reputation in the eyes of some investors and thereby negatively affect our stock price. Consequently, the unionization of our labor force could negatively impact our company’s health.

 

We may be exposed to liability for infringing upon the intellectual property rights of other companies.

 

Our success will, in part, depend on our ability to operate without infringing on the proprietary rights of others. Although we have conducted searches and are not aware of any patents and trademarks which our products or their use might infringe, we cannot be certain that infringement has not or will not occur. We could incur substantial costs, in addition to the great amount of time lost, in defending any patent or trademark infringement suits or in asserting any patent or trademark rights, in a suit with another party.

 

19

 

 

Our electric vehicles make use of lithium-ion battery cells, which, if not appropriately managed and controlled, have occasionally been observed to catch fire or vent smoke and flames. If such events occur in our electric vehicles, we could face liability associated with our warranty, for damage or injury, adverse publicity and a potential safety recall, any of which would adversely affect our business, prospects, financial condition and operating results.

 

The battery packs in our electric vehicles use lithium-ion cells, which have been used for years in laptop computers and cell phones. On occasion, if not appropriately managed and controlled, lithium-ion cells can rapidly release the energy they contain by venting smoke and flames in a manner that can ignite nearby materials. Highly publicized incidents of laptop computers and cell phones bursting into flames have focused consumer attention on the safety of these cells. These events also have raised questions about the suitability of these lithium-ion cells for automotive applications. There can be no assurance that a field failure of our battery packs will not occur, which would damage the vehicle or lead to personal injury or death and may subject us to lawsuits. Furthermore, there is some risk of electrocution if individuals who attempt to repair battery packs on our vehicles do not follow applicable maintenance and repair protocols. Any such damage or injury would likely lead to adverse publicity and potentially a safety recall. Any such adverse publicity could adversely affect our business, prospects, financial condition and operating results. Warranty expense for the years ended December 31, 2018 and 2017 were $8.0 million and $0.1 million, respectively. The increase during the current year relates to issues with certain battery packs in our 2016 and 2017 E-GEN and E-100 vehicles. During the fourth quarter of 2018, the battery pack monitoring software indicated that some of the battery packs were not performing at expected levels. Some vehicles have undergone replacement of battery pack components. The Company is continuing to investigate the issue and explore potential quality issues with certain vendors. As a result of the above information, the Company increased its warranty reserve by $6.9 million in the fourth quarter.

  

We are subject to significant corporate regulation as a public company and failure to comply with all applicable regulations could subject us to liability or negatively affect our stock price.

 

As a publicly traded company, we are subject to a significant body of regulation, including the Sarbanes-Oxley Act of 2002. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices in corporate governance and continue to update this program in response to newly implemented or changing regulatory requirements, we cannot provide assurance that we are or will be in compliance with all potentially applicable corporate regulations. In connection with management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, we identified material weaknesses pertaining to the lack of established adequate financial reporting activities and the lack of established proper accounting and financing reporting oversight. We cannot provide assurance that, in the future, our management will not find additional material weakness in connection with its annual review of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot provide assurance that we will be able to remediate existing weaknesses and any such additional weakness identified; our failure to do so would prevent our management from concluding that our internal control over financial reporting as of the end of our fiscal year is effective. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines or other sanctions or litigation. If we must disclose any material weakness in our internal control over financial reporting, our stock price could decline.

 

Cyber attacks could adversely affect the company

 

The Company faces a heightened risk of cyber-attack. Cyber-attacks may include hacking, viruses, malware, denial of service attacks, ransomware or other data security breaches. The Company’s business requires the continued operation of information systems and network infrastructure. In the event of a cyber-attack that the Company was unable to defend against or mitigate, the Company could have its operations and the operations of its customers and others disrupted. The Company could also have their financial and other information systems and network infrastructure impaired, property damaged and customer and employee information stolen; experience substantial loss of revenues, response costs and other financial loss; and be subject to increased regulation, litigation, penalties and damage to their reputation. The Company has experienced cyber-attacks, although none of the attacks had a material impact.

 

Risks Related to Owning Our Common Stock

 

If we fail to continue to meet the listing standards of NASDAQ, our common stock may be delisted, which could have a material adverse effect on the liquidity of our common stock.

 

Our common stock is currently listed on the Nasdaq Capital Market. The NASDAQ Stock Market LLC has requirements that a company must meet in order to remain listed on NASDAQ. In particular, NASDAQ rules require us to maintain a minimum bid price of $1.00 per share of our common stock. The Company was notified on December 4, 2018 that pursuant to NASDAQ Listing Rule 5810(c)(3)(A), it will be afforded 180 calendar days, or until June 3, 2019, to regain compliance with the minimum bid price requirement. There can be no assurance that we will meet the regain compliance with the minimum bid price requirement, or any other requirement in the future. If we fail to regain compliance with the minimum bid price requirement, The NASDAQ Stock Market LLC may initiate the delisting process with a notification letter. If we were to receive such a notification, we would be afforded a grace period of 180 calendar days to regain compliance with the minimum bid price requirement. In order to regain compliance, shares of our common stock would need to maintain a minimum closing bid price of at least $1.00 per share for a minimum of 10 consecutive trading days. In addition, we may be unable to meet other applicable NASDAQ listing requirements, including maintaining minimum levels of stockholders’ equity or market values of our common stock in which case, our common stock could be delisted. If our common stock were to be delisted, the liquidity of our common stock would be adversely affected and the market price of our common stock could decrease.

 

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The trading of our shares of common has been relatively thin and there is no assurance that a liquid market for our shares of common stock will develop.

 

Our common stock has traded on the Nasdaq Capital Market, under the symbol “WKHS”, since January 2016. Since that date, our common stock has been relatively thinly traded. There can be no assurance that we will be able to successfully develop a liquid market for our common shares. The stock market in general, and early stage public companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of such companies. If we are unable to develop a market for our common shares, you may not be able to sell your common shares at prices you consider to be fair or at times that are convenient for you, or at all.

 

Our stock price and trading volume may be volatile, which could result in substantial losses for our stockholders.

 

The equity trading markets may experience periods of volatility, which could result in highly variable and unpredictable pricing of equity securities. The market price of our common stock could change in ways that may or may not be related to our business, our industry or our operating performance and financial condition. In addition, the trading volume in our common stock has been low and may fluctuate and cause significant price variations to occur. We have experienced significant volatility in the price of our stock. In addition, the stock markets in general can experience considerable price and volume fluctuations.

 

We have not paid cash dividends in the past and have no immediate plans to pay cash dividends.

 

We plan to reinvest all of our earnings, to the extent we have earnings, in order to develop our products, deliver on our orders and cover operating costs and to otherwise become and remain competitive. We do not plan to pay any cash dividends with respect to our securities in the foreseeable future. We cannot assure you that we would, at any time, generate sufficient surplus cash that would be available for distribution to the holders of our common stock as a dividend. Therefore, you should not expect to receive cash dividends on our common stock.

 

Shares eligible for future sale may adversely affect the market for our common stock.

 

Of the 61,496,990 shares of our common stock outstanding as of March 18, 2019, approximately 51.3 million shares are held by “non-affiliates” and may be freely tradable without restriction assuming compliance with Rule 144. In addition, we have Registration Statements on Form S-3 for purposes of registering the resale of 3,033,717 shares of common stock and 8,085,519 shares of common stock issuable upon exercise of stock purchase warrants that have been declared effective.  We are also obligated to register an additional 8,948,211 shares of common stock issuable upon exercise of stock purchase warrants. Any substantial sale of our common stock pursuant to Rule 144 or pursuant to any resale prospectus may have a material adverse effect on the market price of our common stock.

 

Shareholders may experience future dilution as a result of future equity offerings.

 

In order to raise additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeable for our common stock at prices that may not be the same as the price per share in our prior offerings. We may sell shares or other securities in any future offering at a price per share that is lower than the price per share paid by historical investors, which would result in those newly issued shares being dilutive. In addition, investors purchasing shares or other securities in the future could have rights superior to existing stockholders, which could impair the value of existing shareholders. The price per share at which we sell additional shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower than the price per share paid by our historical investors.

 

Our charter documents and Nevada law may inhibit a takeover that stockholders consider favorable.

 

Provisions of our certificate of incorporation and bylaws and applicable provisions of Nevada law may delay or discourage transactions involving an actual or potential change in control or change in our management, including transactions in which stockholders might otherwise receive a premium for their shares, or transactions that our stockholders might otherwise deem to be in their best interests. The provisions in our certificate of incorporation and bylaws:

 

  limit who may call stockholder meetings;
     
  do not provide for cumulative voting rights; and
     
  provide that all vacancies may be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum.

 

There are limitations on director/officer liability.

 

As permitted by Nevada law, our certificate of incorporation limits the liability of our directors for monetary damages for breach of a director’s fiduciary duty except for liability in certain instances. As a result of our charter provision and Nevada law, shareholders may have limited rights to recover against directors for breach of fiduciary duty. In addition, our certificate of incorporation provides that we shall indemnify our directors and officers to the fullest extent permitted by law.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

Our principal offices are located at 100 Commerce Drive, Loveland, Ohio 45140, which include 7,500 square feet in office space and 37,500 square feet in manufacturing/development space. In August 2018, Workhorse paid off the mortgage for the property.

 

We are currently leasing office space at 119 Northeast Drive, Loveland, Ohio 45140. The leased office space is 5,810 square feet of office space in a 255,392 square foot building. We pay $4,500 per month and are on month-to-month terms from an agreement which commenced July 10, 2017.

 

The following table sets forth the location, approximate size and primary use of our principal owned, leased and licensed facilities:

 

Location  Approximate Size (Building) in Square Feet   Primary Use  Owned, Lease or Licensed  Lease/License Expiration Date (if applicable)
Loveland, Ohio   45,000   Administration, Research and Development, Manufacturing  Owned  N/A
               
Union City, Indiana   250,000   Manufacturing  Owned  N/A
               
Loveland, Ohio   5,810   Administration  Lease  Monthly
               
Cincinnati, Ohio   3,000   Hanger  Lease  Monthly

 

We believe our facilities are in good operating condition and that our facilities are adequate for all present and near term uses.

 

ITEM 3. LEGAL PROCEEDINGS

 

In May 2018, Precision Manufacturing Company, Inc. (“PMC”) filed a complaint against the Company in the Common Pleas Court of Montgomery, Ohio, which complaint was amended July 26, 2018.  PMC, a former vendor, is claiming Breach of Contract, Unjust Enrichment, Action on Account and Fraud and is seeking $132,189 in damages plus attorney fees and costs. The Company has filed its Answer to the Amended Complaint.

 

In August 2018, Workhorse Motor Works Inc. was served with a Declaration of Forced Intervention and Application in Warranty in connection with an action in the Superior Court (Civil Division) located in the Province of Quebec, District of Montreal between Aviva Insurance Company of Canada v. Thor Motor Coach and Navistar Canada, Inc. pertaining to the motor home destroyed by fire. Navistar Canada, Inc. provided the chassis sourced from Workhorse Motor Works Inc. which at the time was owned by Navistar. Workhorse Group Inc. did not acquire the assets of Workhorse Motor Works Inc. until 2013. The Company intends to vigorously defend this action.

 

On January 10, 2019, the Company was served with a Default Request, Affidavit, Entry and Judgment in the Circuit Court for the County of Oakland by a former service provider (“Vendor”) relating to a Verified Complaint by Pilot for Breach of Contract claim that the Company was not properly served. On February 14, 2019, the Company and Pilot entered into a Stipulated Order to Set Aside and Dismiss Lawsuit providing that the parties have entered into a Settlement Agreement whereby Workhorse agreed to make cash payments in the amount of $600,000 in several tranches in return of certain property including two development chassis, the development vehicle and all intellectual property developed as well as a full release of all parties.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

None.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

On January 4, 2016 the Company was approved by Nasdaq Capital Market and our common stock is now quoted on Nasdaq under the symbol “WKHS”. Our common stock was previously quoted on the OTCQB under the symbol “TTSO” from July 14, 2009 through May 24, 2010 and then under the symbol “AMPD” from May 24, 2010 to April 16, 2015 when the Company was renamed Workhorse Group Inc. The following table sets forth the range of high and low prices per share of our common stock for each period indicated.

 

Quarter Ended   2018   2017   2016 
March 31    High   $3.35   $7.29   $10.73 
     Low   $2.56   $1.90   $4.43 
June 30    High   $3.04   $4.89   $11.41 
     Low   $1.54   $1.90   $6.40 
September 30    High   $1.81   $3.82   $9.34 
     Low   $0.94   $2.60   $5.79 
December 31    High   $1.15   $3.24   $8.52 
     Low   $0.43   $2.43   $6.37 

 

On December 9, 2015, the Company filed a Certificate of Change with the State of Nevada to effect a reverse stock split of its outstanding and authorized shares of common stock at a ratio of 1 for 10 (the “Reverse Stock Split”). Fractional shares that resulted from the Reverse Stock Split were rounded up to the next highest number. The Reverse Stock Split was approved by the Board of Directors of the Company. The effective date of the Reverse Stock Split was December 11, 2015. At the effective time, every ten shares of common stock issued and outstanding were automatically combined into one share of issued and outstanding common stock, without any change in the par value. In addition, the authorized shares of common stock were reduced from 500,000,000 to 50,000,000. The above market prices reflect such Reverse Stock Split. On August 7, 2017, the shareholders of the Company voted to increase the authorized shares of common stock to 100,000,000 and the Certificate of Amendment amending the Articles of Incorporation was filed with the State of Nevada on August 8, 2017.

 

Holders of our Common Stock

 

As of March 18, 2019, there were approximately 195 stockholders of record of our common stock. This number does not include shares held by brokerage clearing houses, depositories or others in unregistered form. The stock transfer agent for our securities is Empire Stock Transfer, Inc., 1859 Whitney Mesa Drive, Henderson, Nevada 89014.

 

Dividends

 

The Company has never declared or paid any cash dividends on its common stock. The Company currently intends to retain future earnings, if any, to finance the expansion of its business. As a result, the Company does not anticipate paying any cash dividends in the foreseeable future.

 

Stock Performance Graph

 

This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act), or incorporated by reference into any filing of Workhorse under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

 

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The following graph shows a comparison from January 1, 2013 through December 31, 2018, of the cumulative total return for our common stock, the NASDAQ Composite Index, and a group of peer group companies similarly situated. Such returns are based on historical results and are not intended to suggest future performance. Data for The NASDAQ Composite Index and the peer group assumes an investment of $100 on January 1, 2013 and reinvestment of dividends. We have never declared or paid cash dividends on our capital stock nor do we anticipate paying any such cash dividends in the foreseeable future.

 

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table sets forth the aggregate information of our equity compensation plans in effect as of December 31, 2018:

 

Plan  Number of Securities to be Issued upon Exercise of Outstanding Options and Rights   Weighted Average Exercise Price of Outstanding Options and Rights   Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in first column 
             
Equity Compensation Plans approved by security holders - 2010
Stock Incentive Plan
   30,000   $7.20    - 
                
Equity Compensation Plans approved by security holders - 2011
Stock Incentive Plan
   65,000   $6.64    - 
                
Equity Compensation Plans approved by security holders - 2014
Stock Incentive Plan
   891,621   $1.07    - 
                
Equity Compensation Plans approved by security holders - 2016
Stock Incentive Plan
   636,000   $6.47    - 
                
Equity Compensation Plans approved by security holders - 2017
Stock Incentive Plan
   2,245,000   $4.43    2,755,000 
    3,867,621         2,755,000 

 

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Unregistered Sales of Equity Securities

 

On January 10, 2017, the Company entered into a Securities Purchase Agreement with Joseph T. Lukens (“Lukens”) providing for the sale by the Company to Lukens of a 6% Convertible Debenture in the aggregate amount of $2,000,000 (the “Lukens Debenture”) in consideration of $2,000,000. The financing closed on January 10, 2017. On January 27, 2017, the Company and Lukens entered into a Conversion Agreement pursuant to which Lukens agreed to convert his outstanding 6% Convertible Debenture in the principal amount of $2,000,000 plus interest into shares of common stock of the Company at the offering price of the Company’s public offering.

 

During the year ended December 31, 2017, employees and members of the Board of Directors exercised options into 964,525 shares of common stock of the Company. During the year ended December 31, 2017, the Company granted options to acquire 1,900,000 shares of common stock to employees, executives and members of the Board of Directors.

 

In November 2017, Prefix Corporation converted an existing Accounts Payable Liability of $1,034,539 into 272,247 shares of Common Stock at a price per share of $3.80. In addition, the Company issued Prefix Corporation 130,000 shares of common stock valued at $3.80 per share for modeling and mule services as well as consulting services associated with USPS support, component sourcing and integration services needed for the chassis sub-assembly contractor. 

 

During the year ended December 31, 2018, the Company granted options to acquire 340,000 shares of common stock to employees, executives and members of the Board of Directors.

 

On April 24, 2018, the Company entered into an Agreement with Prefix Corporation, an integral vendor, pursuant to which the Company issued 113,874 shares of common stock to settle an invoice in the amount of $298,350.

 

On April 26, 2018, the Company entered into and closed Subscription Agreements with accredited investors (the “April 2018 Accredited Investors”) pursuant to which the April 2018 Accredited Investors purchased 531,066 shares of the Company’s common stock (“April 2018 Shares”) for a purchase price of $1,444,500 or $2.72 per share. Stephen Burns, Benjamin Samuels, Gerald Budde and Julio Rodriguez, executive officers and/or directors of the Company, participated in this offering.

 

On July 6, 2018, we, as borrower, entered into a Loan Agreement with a fund managed by Arosa Capital Management LP (“Arosa”), as lender, providing for a term loan (the “Arosa Loan”) in the principal amount of $6.1 million (the “Loan Agreement”), which was subsequently increased to $7.8 million. We paid off the Arosa Loan on December 31, 2018. In accordance with the Loan Agreement, we issued Arosa a warrant to purchase 5,000,358 shares of common stock of the Company at an exercise price of $2.00 per share, which was subsequently reduced to $1.25, exercisable in cash only for a period of five years. Since July 6, 2018, we issued Arosa an additional warrant to acquire 108,768 shares of common stock at an exercise price of $1.596, which was subsequently reduced to $1.25, on October 1, 2018. As a result of our August 2018 public offering including the over-allotment, we issued to Arosa an additional warrant to purchase 1,143,200 shares of common stock at an exercise price of $1.21. The Company issued Arosa a Warrant to purchase 894,821 shares of common stock exercisable at $1.25 per share upon the closing of the Marathon financing. Pursuant to the warrant, Arosa may not exercise such warrant if such exercise would result in Arosa beneficially owning in excess of 9.99% of our then issued and outstanding common stock. On November 28, 2018, in consideration for consenting to the Company selling certain battery cells to Duke Energy, which served as collateral for Arosa Opportunistic Fund LP (“Arosa”) under a Loan Agreement, dated as of July 8, 2018, as amended, for $7.8 million, the Company entered into a Limited Consent, Waiver and Release with Arosa pursuant to which the Company issued Arosa 2,000,000 shares of common stock and restruck the exercise price of  warrants previously issued to Arosa to $1.25 per share.

 

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On December 31, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”), among the Company, as borrower, Marathon Asset Management, LP, on behalf of certain entities it manages, as lenders (collectively, with their permitted successors and assignees, the “Lenders”), and Wilmington Trust, National Association, as the agent (“Wilmington”).  The Credit Agreement provided the Company with a $10 million tranche of term loans and a $25 million tranche of term loans which may be re-borrowed following repayment. In accordance with the Credit Agreement, the Company issued each Lender a Common Stock Purchase Warrant to purchase, in the aggregate, 8,053,390 shares of common stock of the Company at an exercise price of $1.25 per share exercisable in cash only for a period of three years and then for cash or cashless thereafter (collectively, the “Initial Warrants”). Until the later of the repayment of all obligations owed to the Lenders or two years from the closing date, the Company will be required to issue additional Common Stock Purchase Warrants (the “Additional Warrants”) to the Lenders equal to 10%, in the aggregate, of any additional issuance, subject to certain exceptions, on substantially the same terms and conditions of the Initial Warrants, except that (i) the applicable expiration date thereof shall be five years from the issuance date of the applicable warrant, (ii) the initial exercise price shall be a price equal to the price per share of common stock used in the relevant issuance multiplied by 110% and (iii) the holder shall be entitled to exercise the warrant on a cashless exercise at any time the warrant is exercisable.

 

Commencing February 11, 2019, the Company entered into and closed Subscription Agreements with accredited investors (the “February 2019 Accredited Investors”) pursuant to which the February 2019 Accredited Investors purchased 1,499,684 shares of the Company’s common stock for a purchase price of $1,365,000. If, prior to the six month anniversary, the Company issues shares of its common stock for a purchase price per share less than the purchase price paid by the February 2019 Accredited Investors subject to standard carve-outs (a “Down Round”), the Company will issue additional shares of common stock (for no additional consideration) to the February 2019 Accredited Investors such that the effective purchase price per share is equal to the purchase price per share paid in the Down Round. Benjamin Samuels and Gerald Budde, directors of the Company, acquired 841,928 and 26,310 shares of common stock, respectively, as part of this offering, provided, however, their per share purchase was $0.9501, which was above the closing price the date prior to close and they did not receive the Down Round protection.

 

The offers, sales, and issuances of the securities described above were deemed to be exempt from registration under the Securities Act in reliance on Section 4(a)(2) of the Securities Act or Regulation D promulgated thereunder as transactions by an issuer not involving a public offering. The recipients of securities in each of these transactions acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the securities issued in these transactions. Each of the recipients of securities in these transactions was an accredited or sophisticated person and had adequate access, through employment, business or other relationships, to information about us.

 

ITEM 6. SELECTED FINANCIAL DATA 

 

YEARS ENDED DECEMBER 31,  2018   2017   2016 
OPERATING SUMMARY            
Sales  $763,173   $10,038,460   $6,414,800 
Net loss  $(36,502,316)  $(41,216,788)  $(19,555,868)
Net loss attributable to common stockholders per share – basic and diluted  $(0.74)  $(1.06)  $(0.78)
Shares used in per share calculation   50,377,909    38,755,796    25,201,261 
                
FINANCIAL POSITION SUMMARY               
Total assets  $11,804,773   $16,504,293   $10,239,793 
Cash and cash equivalents  $1,512,750   $4,069,477   $469,570 
Total current assets  $6,369,232   $10,696,276   $3,916,668 
Total current liabilities  $18,915,137   $11,282,848   $4,334,390 
Net working capital  $(12,545,905)  $(586,572)  $(417,722)
Stockholders’ equity (deficit)  $(15,422,443)  $3,511,564   $3,816,974)
Common stock outstanding   58,270,934    41,529,181    27,578,864 
                
CASH FLOW SUMMARY               
Net cash used by operations  $(21,754,133)  $(38,662,541)  $(19,034,163)
Net cash used by investing activities  $(18,422)  $(143,355)  $(528,095)
Net cash provided by financing activities  $19,215,828   $42,405,803   $12,354,665 
Net increase (decrease) in cash and equivalents  $(2,566,727)  $3,599,907   $(7,207,593 

 

Note: Share and per share data adjusted for reverse stock split

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes that appear elsewhere in this Annual Report on Form 10-K

 

Overview and 2018 Highlights

 

We are a technology company focused on providing sustainable and cost-effective solutions to the commercial transportation sector. As an American manufacturer, we design and build high performance battery-electric vehicles and aircraft that make movement of people and goods more efficient and less harmful to the environment. As part of our solution, we also develop cloud-based, real-time telematics performance monitoring systems that enable fleet operators to optimize energy and route efficiency. Although we operate as a single unit through our subsidiaries, we approach our development through two divisions, Automotive and Aviation. We are currently focused on our core competency of bringing the N-GEN electric cargo van to market and fulfilling our existing backlog of orders. We are also exploring other opportunities in monetizing our intellectual property which could include a sale, license or other arrangement of assets that are outside of our core focus.

 

Workhorse electric delivery vans are currently in production and are in use by our customers on U.S. roads. Our delivery customers include companies such as UPS, FedEx Express, Alpha Baking and W.B. Mason. Data from our in-house developed telematics system demonstrates our vehicles on the road are averaging approximately a 500% increase in fuel economy as compared to conventional gasoline-based trucks of the same size and duty cycle.

 

In addition to improved fuel economy, we anticipate that the performance of our vehicles on-route will reduce long-term vehicle maintenance expense by approximately 50% as compared to fossil-fueled trucks.

 

We are an OEM capable of manufacturing Class 3-6 commercial-grade, medium-duty truck chassis at our Union City, Indiana facility, marketed under the Workhorse® brand. All Workhorse last mile delivery vans are assembled in the Union City assembly facility.

 

From our development modeling and the existing performance of our electric vehicles on American roads, we estimate that our E-GEN Range-Extended Electric delivery vans will save over $150,000 in fuel and maintenance savings over the 20-year life of the vehicle. Due to the positive return-on-investment, we place a premium price for our vehicles when selling to major fleet buyers. We expect that fleet buyers will be able to achieve a four-year or better return-on-investment (without government incentives), which we believe justifies the higher acquisition cost of our vehicles.

 

Our goal is to continue to increase sales and production, while executing on our cost-down strategy to a point that will enable us to achieve gross margin profitability of the last mile-delivery van platform. As a key strategy, we have developed the Workhorse N-GEN platform, which has been accelerated from our development efforts on the USPS NGDV program.

 

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The Workhorse N-GEN electric cargo van platform will be available in multiple size configurations, 450, 700 and 1,000 cubic feet. We intend to initiate the launch with the 450 cubic foot configuration where it is designed to compete with the Sprinter, Transit and RAM gasoline/diesel trucks in the commercial sector with an emphasis on last-mile delivery and other service-oriented businesses, such as telecom. This ultra-low floor platform incorporates state-of-the-art safety features, economy and performance: we expect these vehicles to achieve a fuel economy of approximately 60 MPGe and offer fleet operators the most favorable total cost-of-ownership of any comparable vehicle available today. We believe we are the first American OEM to market a U.S. built electric cargo van, and early indications of fleet interest are significant. We expect the N-GEN trucks will be supported by our Ryder Systems partnership. Using N-GEN light duty prototypes, we delivered over 100,000 packages in San Francisco and Ohio during our testing. During the period we achieved 50 MPGe and successfully demonstrated the role the vehicle can have in last mile delivery.

 

As a direct result of the USPS award and development efforts, Workhorse has begun development on the Workhorse W-15, a medium- and light-duty pickup truck platform aimed at commercial fleets. The W-15 pickup truck powertrain is a smaller version of its sister vehicle, the medium-duty battery electric powertrain, and will have two purpose-built variants, a W-15 work truck (pickup) and an N-GEN cargo van. Either of these two variants will appeal to delivery fleets, utility companies, telecom companies, municipalities and more.

 

Our HorseFly delivery drone is a custom designed, purpose-built drone that is fully integrated in our electric trucks. HorseFly is an octocopter designed with a maximum gross weight of 30 lbs., a 10 lb. payload and a maximum air speed of 50 mph. It is designed and built to be rugged and consisting of redundant systems to further meet the FAA’s required rules and regulations.

 

SureFly is our entry into the emerging VTOL market. It is designed to be a two-person, 400-pound payload aircraft with a hybrid internal combustion/electric power generation system. Our approach in the design is to build the safest and simplest way to fly rotary wing aircraft in the world. We believe it is a practical answer to personal flight, as well as, commercial transportation segments, including air taxi series, agriculture and beyond.

 

The FAA to-date has granted 14 separate Experimental Airworthiness Certifications, registered as N834LW, for the aircraft. These certifications come after an extensive design review and inspection of the aircraft with each renewed certificate.

 

In November 2018, Workhorse signed cooperative research and development agreement with a branch of the U.S. Military to test SureFly with a specific focus on military applications. This further expands the potential market for the aircraft.

 

We are continuing with our efforts to consummate a sale of the SureFly business although we cannot guarantee that we will be successful in such efforts.

 

Executive Team Changes

 

On January 30, 2019, Stephen S. Burns, Chief Executive Officer and a member of the Board of Directors (the “Board”) of the Company, resigned as Chief Executive Officer and as a member of the Board, effective immediately. Mr. Burns will serve the Company as a consultant pursuant to a Services Agreement between Mr. Burns and the Company dated as of February 4, 2019 (the “Services Agreement”).

 

On February 4, 2019, the Company announced the appointment of Duane Hughes as Chief Executive Officer and a member of the Board effective February 4, 2019. Mr. Hughes previously served as the Company’s President and Chief Operating Officer. Prior to joining the Company, Mr. Hughes served as Chief Operating Officer of Cumulus Interactive Technologies Group (“Cumulus ITG”). Prior to joining Cumulus ITG, Mr. Hughes served in senior management positions with Gannett Co., Inc., including as Vice President of Sales and Operations for Gannett Media Technologies International.

 

There is no understanding or arrangement between Mr. Hughes and any other person pursuant to which Mr. Hughes was selected as a director of the Company. Mr. Hughes does not have any family relationship with any director, executive officer or person nominated or chosen by us to become a director or an executive officer.  Since January 1, 2018, Mr. Hughes has not had a direct or indirect material interest in any transaction or proposed transaction, in which the Company was or is a proposed participant exceeding $120,000.

 

In connection with his appointment as Chief Executive Officer, the Company entered into an amended and restated retention agreement (the “Retention Agreement”) with Mr. Hughes effective February 4, 2019. Pursuant to the Retention Agreement, Mr. Hughes will receive a base salary of $350,000 per year and will be eligible to receive a target performance bonus equal to 50% of his base salary with the potential to increase to 100% or 150% of his base salary assuming pre-determined milestones are met as determined by the Board. Mr. Hughes will also receive a $25,000 signing bonus as well as a $25,000 bonus upon the Company raising $10 million in financing. The Company also granted an option to purchase 1,000,000 shares of the Company’s common stock that will vest over a three-year period. The stock option award was granted under the Company’s 2017 Incentive Stock Plan with an exercise price equal to $0.97. The shares subject to such options will vest over three years in equal quarterly installments commencing March 31, 2019.

 

28

 

 

In the event Mr. Hughes is terminated without cause or resigns for good reason (as such terms are defined in the Retention Agreement), he will be entitled to severance payments in an amount equal to his base salary plus a prorated portion of his target performance bonus. In addition, any outstanding equity awards will immediately accelerate and vest. The Company will also continue to pay the employer portion of the COBRA premium cost for up to twelve months. In the event Mr. Hughes is terminated without cause or resigns for good reason within twelve months following a change in control of the Company (as such term is defined in the Retention Agreement) he shall be entitled to severance benefits described above.

 

In connection with his appointment as Chief Executive Officer, on February 4, 2019, the Company entered into a letter agreement (the “Director Agreement”) with Mr. Hughes setting forth certain terms of his appointment as director of the Company. The Director Agreement provides that Mr. Hughes will receive an annual fee of $40,000 as consideration for his service as a director.  Additionally, the Company granted Mr. Hughes options to purchase 50,000 shares of the Company’s common stock at $0.97 per share. The options will expire ten years from the vesting period with 10,000 options vesting immediately and 4,000 every June 30 and December 31 thereafter.

 

Under the Services Agreement, Mr. Burns will provide consulting services to the Company for a term of one year and will receive a consulting fee of $27,083 per month. The Company also granted Mr. Burns an option to purchase 1,000,000 shares of the Company’s common stock which vested immediately. The stock option award was granted under the Company’s 2017 Incentive Stock Plan with an exercise price equal to $0.97.

 

On February 19, 2019, the Company announced the appointment of Robert Willison as Chief Operating Officer effective February 18, 2019. Mr. Willison previously served as Director of Fleet Technology for Sysco Corporation. Prior to joining Sysco, Mr. Willison served as the Company’s Director of Research and Development from 2016 until 2018. Prior to joining the Company, Mr. Willison served as a Partner and Chief Technology Officer for Räv Technology LLC from 2014 until 2016. Prior to joining Räv Technology, Mr. Willison served as Director of International Operations and New Business Development for PDi Communication Systems.

 

Mr. Willison does not have any family relationship with any director, executive officer or person nominated or chosen by us to become a director or an executive officer.  Since January 1, 2018, Mr. Willison has not had a direct or indirect material interest in any transaction or proposed transaction, in which the Company was or is a proposed participant exceeding $120,000.

 

In connection with his appointment as Chief Operating Officer, the Company entered into a retention agreement (the “Retention Agreement”) with Mr. Willison effective February 18, 2019. Pursuant to the Retention Agreement, Mr. Willison will receive a base salary of $250,000 per year and will be eligible to receive a target performance bonus equal to 50% of his base salary with the potential to increase to 100% or 150% of his base salary assuming pre-determined milestones are met as determined by the Board. Subject to the approval by the Company’s shareholders of the Company’s 2019 Stock Incentive Plan, the Company will grant an option to purchase 400,000 shares of the Company’s common stock that will vest over a four-year period in equal quarterly installments commencing in the quarter in which the 2019 Stock Incentive Plan is approved. The stock option award will be granted under the Company’s 2019 Incentive Stock Plan with an exercise price equal to the closing price of the Company’s common stock on the date of shareholder approval of the 2019 Incentive Stock Plan.

 

In the event Mr. Willison is terminated without cause or resigns for good reason (as such terms are defined in the Retention Agreement), he will be entitled to severance payments in an amount equal to his base salary plus a prorated portion of his target performance bonus. In addition, any outstanding equity awards will immediately accelerate and vest. The Company will also continue to pay the employer portion of the COBRA premium cost for up to twelve months. In the event Mr. Willison is terminated without cause or resigns for good reason within twelve months following a change in control of the Company (as such term is defined in the Retention Agreement) he shall be entitled to severance benefits described above.

 

The foregoing summary description of the Retention Agreement does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the agreement, a copy of which is filed as Exhibit 10.1 hereto and incorporated by reference herein.

 

On February 19, 2019 the Company issued a press release regarding Mr. Willison’s appointment. The press release is filed with this report on Form 8-K as Exhibit 99.1 and is incorporated herein by reference.

 

29

 

 

Results of Operations

 

Our condensed consolidated statement of operations data for the period presented follows:

 

   Years Ended
December 31,
 
   2018   2017 
         
Net sales  $763,173    10,038,460 
           
Cost of sales   7,981,413    24,399,363 
Warranty expense   7,972,152    117,500 
Gross loss   (15,190,392)   (14,478,403)
           
Operating expenses          
Selling, general and administrative   11,485,482    8,820,211 
Research and development   7,391,693    17,737,737 
Total operating expenses   18,877,175    26,557,948 
           
Interest expense, net   2,434,749    180,437 
           
Net loss  $(36,502,316)  $(41,216,788)
           
Net loss attributable to common stockholders per share - basic and diluted  $(0.74)  $(1.06)
           
Weighted average number of common shares outstanding   50,377,909    38,755,796 

 

Revenue

 

Sales for the years ended December 31, 2018 and 2017 were $0.8 million and $10.0 million, respectively. The net sales decrease was primarily due to a decrease in volume of trucks sold due to strategic shift to development of the N-GEN platform.

 

Cost of Sales

 

Cost of sales for the years ended December 31, 2018 and 2017 were $8.0 million and $24.4 million, respectively. The cost of sales decrease was primarily due to a decrease in volume of trucks sold due to strategic shift to development of the N-GEN platform.

 

Warranty Expense

 

Warranty expenses for the years ended December 31, 2018 and 2017 were $8.0 million and $0.1 million, respectively. The increase during the current year relates to issues with certain battery packs in our 2016 and 2017 E-Series trucks. During the fourth quarter of 2018, the battery pack monitoring software indicated that some of the battery packs were not performing at expected levels. Some vehicles have undergone replacement of battery pack components. The Company is continuing to investigate the issue and has found specific quality issues with components from certain vendors. $6.9 million of the expense was recorded in the fourth quarter to increase the warranty accrual at year-end. The accrual includes coverage for labor and transportation and excludes any contribution from related vendors.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses during year ended December 31, 2018 were $11.5 million, an increase from $8.8 million for the year ended December 31, 2017. The SG&A expense increase primarily related to higher marketing and advertising costs of approximately $1.6 million, investment banking related fees of approximately $0.7 million and legal settlement costs of $0.4 million. This was partially offset by lower consulting fees of approximately $0.4 million.

 

Research and Development Expenses

 

Research and development (“R&D”) expenses during the year ended December 31, 2018 were $7.4 million, a decrease from $17.7 million for the year ended December 31, 2017. The decrease in R&D expenses is due to the decrease in prototype and consulting expenses for the USPS, NGDV and SureFly.

 

30

 

 

Interest Expenses

 

Interest expenses during the year ended December 31, 2018 and December 31, 2017 were $2.4 million and $0.2 million, respectively. The increase during 2018 was primarily due to cash interest and the amortization of debt issuance costs and discounts associated with the Arosa Loan as well as the amortization of the discount associated with the Senior Secured Notes.

 

Liquidity and Capital Resources

 

Cash Requirements

 

From inception, we have financed our operations primarily through sales of equity securities. We have utilized this capital in our research and development of five truck-based platforms (i.e., E-GEN, E-100, W-15 Pickup Truck, USPS Prototype and N-GEN) and two aviation platforms (HorseFly and SureFly) and to fund designing, building and delivering our vehicles to our customer base and for working capital purposes.

 

As of December 31, 2018, we had approximately $1.5 million in cash, cash equivalents and short-term investments, compared to approximately $4.1 million as of December 31, 2017, a decrease of $2.6 million. The decrease in cash and cash equivalents was primarily attributable to the operating loss for the period partially offset by the issuance of common stock during the period.

 

On December 31, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”), among the Company, as borrower, Marathon Asset Management, LP, on behalf of certain entities it manages, as lenders (collectively, with their permitted successors and assignees, the “Lenders”), and Wilmington Trust, National Association, as the agent (“Wilmington”).  The Credit Agreement provided the Company with a $10 million tranche of term loans (the “Tranche One Loans”) which may not be re-borrowed following repayment and (ii) a $25 million tranche of term loans which may be re-borrowed following repayment (the “Tranche Two Loans” together with the Tranche One Loans, the “Loans”). The Company used the proceeds for the Tranche One Loans (x) to pay off a loan provided by Arosa Opportunistic Fund LP (“Arosa”) in the principal amount of $7.8 million plus interest and (y) for working capital purposes. Draws from the Tranche Two Loans will be used in connection with vehicle production and are subject to the Company’s receipt of purchase orders. The Company’s ability to borrow amounts under the Credit Agreement is conditioned upon its compliance with specified covenants, including certain reporting covenants and financial covenants that, in addition to other items, require the Company to maintain (i) minimum liquidity of at least $4 million at all times on or after March 31, 2019, (ii) a maximum total leverage ratio (ratio of total debt borrowed by the Company to EBITDA for the four consecutive fiscal quarters most recently ended, subject to certain adjustments set forth in the Credit Agreement) not to exceed 4.50:1.00 on the last day of the quarter ended September 30, 2019, which total leverage ratio is adjusted for subsequent quarters as set forth in the Credit Agreement and (iii) a maximum debt service coverage ratio (ratio of EBITDA (for the four consecutive fiscal quarters most recently ended, subject to certain adjustments set forth in the Credit Agreement) to interest expense and payments for operating leases) not to exceed 1.25:1.00 on the last day of the quarter ended September 30, 2019, which debt service coverage ratio is adjusted for subsequent quarters as set forth in the Credit Agreement. In the event the Company breaches the total leverage ratio or the debt service coverage ratio covenants, the Company may cure such breach by raising capital through the sale of equity, which capital will be added on a dollar-for-dollar basis to the calculation of EBITDA for purposes of such test period to determine compliance with the financial covenant. In each consecutive four fiscal quarter period, equity cures can only be made for two fiscal quarters, and only four equity cures are allowed during the term of the Credit Agreement. The capital raised in connection with such equity cure must be used to repay the Loans. In addition, the Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants. The Tranche One Loans, and both the drawn and undrawn portions of the Tranche Two Loan, will bear interest at a rate per annum (based on a year of 360 days) equal to LIBOR (as defined in the Credit Agreement) plus 7.625%, which interest is payable quarterly commencing April 5, 2019, as amended. The Credit Agreement contains customary events of default, including for non-payment, misrepresentation, breach of covenants, defaults under other material indebtedness, material adverse change, bankruptcy, change of control and material judgments. The Loans mature on the third anniversary of the closing date. The Company is required to repay a portion of the Tranche One Loans with $500,000 installment payments on each of June 30, 2020, December 31, 2020 and June 30, 2021. Upon the occurrence and during the continuance of an event of default, the Lenders may declare all outstanding amounts thereunder immediately due and payable and may terminate commitments to make any additional advances under the Tranche Two Loans. The Tranche Two Loans are required to be prepaid in an amount equal to the payments received from the subject purchase orders. The Company is also obligated to repay the Loans with a specified percentage of the net cash proceeds the Company receives in connection with certain dispositions of assets, casualty events, incurrences of debt and any issuances of capital stock (other than issuances of capital stock during the first 9 months after closing). The Company is required to prepay the Loans utilizing 100% of the net proceeds from any casualty event or the issuance or incurrence of debt and 50% of the net proceeds from any disposition. If the Company receives net cash proceeds from the issuance of capital stock after the nine-month anniversary of the closing date, the Company is required to prepay the Loans utilizing 35% of the net cash proceeds from such issuance. With limited exceptions, if the Company prepays any portion of the Tranche One Loans or the Tranche Two Loans (with the concomitant termination of the portion of the commitments under the Tranche Two Loans that is repaid) during the 12 months following the closing date, it is required to pay 100% of the interest that would have been due on such prepaid Loans if the prepaid amounts had been outstanding for a period of 12 months after the date of prepayment. If such prepayment occurs during the period beginning after the 12 month anniversary of the closing date and continuing through the 18 month anniversary of the closing date, the Company is required to pay 50% of the interest that would have been due on such prepaid Loans for the 12 month period following the date of such prepayment on a prorated basis. The Company, the Company’s subsidiaries and Wilmington, as agent for the Lenders, entered into a Security Agreement, a Pledge Agreement and a Guarantee, among other loan documents, providing that the Company’s obligations to the Lenders are secured by a first priority security interest in substantially all of the Company’s and its subsidiaries’ tangible and intangible assets including the Company’s real property located in Loveland, Ohio and Union City, Indiana. On March 13, 2019, the Company and the Lenders entered into the First Amendment, Waiver and Consent to Credit Agreement, which, among other items, adjusted the interest payment date to the fifth day of January, April, July and October.

 

We believe our existing capital resources, including our new Marathon Credit Facility, will be sufficient to support our current and projected funding requirements into the second quarter of 2019. Additional funding will be required.

 

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Our operations will require significant additional funding for the foreseeable future. Unless we are able to generate a sufficient amount of revenue and reduce our costs, we expect to finance future cash needs through public and/or private offerings of equity securities and/or debt financings. With the exception of contingent and royalty payments that we may receive under our existing collaborations, we do not currently have any committed future funding. To the extent we raise additional capital by issuing equity securities, our stockholders could at that time experience substantial dilution. Any debt financing that we are able to obtain may involve operating covenants that restrict our business.

 

Our future funding requirements will depend upon many factors, including, but not limited to:

 

  our ability to acquire or license other technologies or compounds that we may seek to pursue;
     
  our ability to manage our growth;
     
  competing technological and market developments;
     
  the costs and timing of obtaining, enforcing and defending our patent and other intellectual property rights; and
     
  expenses associated with any unforeseen litigation.

 

Insufficient funds have required a reduction in business activity. Additional delay in funding will continue to defer, scale back or eliminate some or all of our research or development programs, limit our sales activities, limit or cease production or negatively impact our operations.

 

For the years ended December 31, 2018 and 2017, we maintained an investment in a bank money market fund. Cash in excess of immediate requirements is invested with regard to liquidity and capital preservation. Wherever possible, we seek to minimize the potential effects of concentration and degrees of risk. We will continue to monitor the impact of the changes in the conditions of the credit and financial markets to our investment portfolio and assess if future changes in our investment strategy are necessary.

 

Summary of Cash Flows

 

   2018   2017 
         
Net cash used in operating activities  $(21,754,133)  $(38,662,441)
Net cash used in investing activities  $(18,422)  $(143,355)
Net cash provided by financing activities  $19,215,828   $42,405,803 

 

Cash Flows from Operating Activities

 

Our cash flows from operating activities are affected by our cash investments to support the business in research and development, manufacturing, selling, general and administration. Our operating cash flows are also affected by our working capital needs to support fluctuations in inventory, personnel expenses, accounts payable and other current assets and liabilities.

 

During the year ended December 31, 2018 and 2017, cash used in operating activities was $21.8 million and $38.7 million, respectively. The decrease in net cash used in operations in 2018 as compared to 2017 was mainly due to a lower net loss for the period as well as increases in inventory and warranty reserves and accrued liabilities.

 

Cash Flows from Financing Activities

 

During the years ended December 31, 2018 and 2017, net cash provided by financing activities was $19.2 million and $42.4 million, respectively. Cash flows from financing activities during the year ended December 31, 2018 consisted primarily of shares issued related to the Company’s August 2018 Offering with National Securities, the Cowen Agreement, the April 2018 closed Subscription Agreements and the Marathon Credit Facility. Cash flows from financing activities for the period ended December 31, 2017 consisted primarily of a net $37.0 million from a public stock offering. 

 

The Company may seek to raise additional capital through public or private debt or equity financings in order to fund its operations.

 

Off-Balance Sheet Arrangements

 

The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

 

Federal Tax Credit Qualification by the IRS

 

The Company has been qualified by the IRS for a vehicle federal tax credit of up to $7,500 on vehicles whose gross vehicle rate weighting is less than 14,000 lbs. The Company joins a list of plug-in electric drive motor vehicle manufacturers, including Ford Motor Company, General Motors Corporation, Tesla, Toyota, and 13 EV manufacturers in all, qualifying purchasers for up to a $7,500 tax credit when purchasing an electric vehicle.

 

Additionally, many states offer additional sales tax exemptions and zero emission tax credits of up to $5,000 that can also be applied to the purchase.

 

32

 

 

California Air Resources Board Approval

 

On February 20, 2013, CARB approved the Company’s E-100 all-electric commercial truck for sale in the state of California. Most other states use this approval for sale of vehicles in their state.

 

Critical Accounting Policies and Estimates

 

The following accounting principles and practices of the Company are set forth to facilitate the understanding of data presented in the consolidated financial statements:

 

Nature of operations

 

We are a technology company focused on providing sustainable and cost-effective solutions to the commercial transportation sector. As an American manufacturer we design and build high performance battery-electric electric vehicles and aircraft that make movement of people and goods more efficient and less harmful to the environment. As part of our solution, we also develop cloud-based, real-time telematics performance monitoring systems that enable fleet operators to optimize energy and route efficiency. Although we operate as a single unit through our subsidiaries, we approach our development through two divisions, Automotive and Aviation. Our core products, under development and/or in manufacture, are the medium duty step van, the light duty pickup, the delivery drone and the manned multicopter.

 

Use of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates.

 

Property and depreciation

 

Property and equipment is recorded at cost. Depreciation is provided on the straight-line over the estimated useful lives of the respective assets.

 

Income taxes

 

As no taxable income has occurred from the date of this merger to December 31, 2018, cumulative deferred tax assets of approximately $29.6 million are fully reserved, and no provision or liability for federal or state income taxes has been included in the financial statements. Carryover amounts are:

 

Approximate net operating loss 
($ millions)
  Carryover to be used against taxable income
generated through year
     
4.0   2030
6.7   2031
3.9   2032
4.6   2033
6.0   2034
8.9   2035
17.9   2036
38.5   2037
23.5   indefinite

 

Research and development costs

 

Research and development costs are expensed as they are incurred. Research and development expense incurred was approximately $7.4 million and $17.7 million for the years ended December 31, 2018 and 2017, respectively, consisting of consulting, payroll and payroll taxes, engineering, purchased supplies, legal fees, parts and small tools.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities in which we invest may have market risk. This means that a change in prevailing interest rates may cause the fair value amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the market value amount of our investment will decline. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including money market funds and government and non-government debt securities and the maturities of each of these instruments is less than one year. In 2018, we maintained an investment portfolio primarily in money market funds. Due to the primarily short-term nature and low interest rate yields of these investments, we believe we do not have a material exposure to interest rate risk and market risk arising from our investments. Therefore, no quantitative tabular disclosure is provided.

 

We have operated primarily in the United States. Accordingly, we have not had any significant exposure to foreign currency rate fluctuations.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

TABLE OF CONTENTS

 

Report of Independent Registered Public Accounting Firm   F-2
Financial Statements:    
Consolidated Balance Sheets   F-5
Consolidated Statements of Operations   F-6
Consolidated Statements of Stockholders’ Equity   F-7
Consolidated Statements of Cash Flows   F-8
Notes to Consolidated Financial Statements   F-9

 

F-1

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders

Workhorse Group Inc.

 

Opinion on internal control over financial reporting

We have audited the internal control over financial reporting of Workhorse Group Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, because of the effect of the material weaknesses described in the following paragraph on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by COSO.

 

A material weakness is a control deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management’s assessment:

 

·The Company has not established adequate financial reporting monitoring activities to mitigate the risk of accounting errors.

 

·The lack of a fully implemented automated financial reporting system caused over reliance on manual entries.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2018, and our report dated March 18, 2019 expressed an unqualified opinion on those financial statements.

 

Basis for opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report On Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

  

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definition and limitations of internal control over financial reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, 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.

 

Other information 

We do not express an opinion or any other form of assurance on the Company’s remediation plan disclosed as part of Management’s Report on Internal Control.

 

/s/ GRANT THORNTON LLP

 

Cincinnati, Ohio

March 18, 2019 

 

 F-2

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Shareholders

Workhorse Group Inc.

 

Opinion on the financial statements

We have audited the accompanying consolidated balance sheet of Workhorse Group Inc. (a Nevada corporation) and subsidiaries (the “Company”) as of December 31, 2018, the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the year ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the year ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated March 18, 2019 expressed an adverse opinion.

 

Going concern

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company incurred a net loss of $36,502,316 during the year ended December 31, 2018, and as of that date, the Company’s current liabilities exceeded its current assets by $12,545,905 and its total liabilities exceeded its total assets by $15,422,443. These conditions, along with other matters as set forth in Note 1, raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

Basis for opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

/s/ GRANT THORNTON LLP

 

We have served as the Company’s auditor since 2018.

 

Cincinnati, Ohio

March 18, 2019

 

 F-3

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and
Stockholders of Workhorse Group, Inc.

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Workhorse Group, Inc. (the Company) as of December 31, 2017 as restated, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows, as restated for the year ended December 31, 2017, and the related notes (collectively referred to as the financial statements) as restated. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for each of the year ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As described in Note 1 to the consolidated financial statements, the Company has not had positive cash flows from operations and has incurred significant net losses which have caused a significant accumulated deficit. These conditions raise substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to that matter.

 

 

We had served as the Company’s auditor since 2007.

 

Cincinnati, Ohio

March 14, 2018 (May 8, 2018 as to the effect of the restatement)

  

RESULTS THROUGH REMARKABLE RELATIONSHIPS

 

 F-4

 

 

Workhorse Group, Inc.

Consolidated Balance Sheets

December 31, 2018 and 2017

 

 

   2018   2017 
Assets        
         
Current assets:        
Cash and cash equivalents  $1,512,750   $4,069,477 
Accounts receivable, less allowance for doubtful accounts of $0 at December 31, 2018 and 2017   -    1,013,423 
Lease receivable current   48,271    45,300 
Inventory   2,533,616    4,621,942 
Prepaid expenses and deposits   2,274,595    946,134 
    6,369,232    10,696,276 
           
Property, plant and equipment, net   5,237,451    5,596,013 
Lease receivable long-term   198,090    212,004 
           
   $11,804,773   $16,504,293 
           
Liabilities and Stockholders’ Equity (Deficit)          
           
Current liabilities:          
Accounts payable  $4,340,463   $5,657,771 
Accrued liabilities   3,946,386    284,115 
Warranty liability   7,058,769    142,560 
Warrant liability   1,822,819    - 
Customer deposits   406,000    54,405 
Duke financing obligation   1,340,700    - 
Current portion of long-term debt   -    381,497 
    18,915,137    6,520,348 
           
Principal amount of notes payable   -    5,750,000 
Less unamortized discount and debt issuance costs   -    987,500 
Notes payable less unamortized discount and debt issuance costs   -    4,762,500 
           
Long-term debt   8,312,079    1,709,881 
Stockholders’ equity (deficit):          
Series A preferred stock, par value of $.001 per share 75,000,000 shares authorized, 0 shares issued and outstanding at December 31, 2018 and December 31, 2017   -    - 
Common stock, par value of $.001 per share 100,000,000 shares authorized, 58,270,934 shares issued and outstanding at December 31, 2018 and 41,529,181 shares issued and outstanding at December 31, 2017   58,271    41,529 
Additional paid-in capital   126,076,782    107,760,036 
Accumulated deficit   (141,557,496)   (104,290,001)
    (15,422,443)   3,511,564 
           
   $11,804,773   $16,504,293 

 

See accompanying notes to the consolidated financial statements.

 

 F-5

 

 

Workhorse Group, Inc.
Consolidated Statements of Operations
For the Years Ended December 31, 2018 and 2017

 

   2018   2017 
         
Net sales  $763,173    10,038,460 
           
Cost of sales   7,981,413    24,399,363 
Warranty expense   7,972,152    117,500 
Gross loss   (15,190,392)   (14,478,403)
           
Operating expenses          
Selling, general and administrative   11,485,482    8,820,211 
Research and development   7,391,693    17,737,737 
Total operating expenses   18,877,175    26,557,948 
           
Interest expense, net   2,434,749    180,437 
           
Net loss  $(36,502,316)  $(41,216,788)
           
Deemed dividend – September 2017 Warrants   765,179    - 
           
Net loss attributable to common stockholders   (37,267,495)   (41,216,788)
Net loss attributable to common stockholders per share - basic and diluted  $(0.74)  $(1.06)
           
Weighted average number of common shares outstanding   50,377,909    38,755,796 

 

See accompanying notes to the consolidated financial statements.

 

 F-6

 

 

 

Workhorse Group, Inc.
Consolidated Statement of Stockholders’ Equity (Deficit)
December 31, 2018 and 2017

 

   Common Stock   Series A
Preferred Stock
   Additional       Total
Stockholders’
 
   Number
of Shares
   Amount   Number
of Shares
   Amount   Paid-in
Capital
   Accumulated
Deficit
   Equity
(Deficit)
 
Balance as of December 31, 2016   27,578,864   $27,579   $-   $-   $66,862,608   $(63,073,213)  $3,816,974
Issuance of common stock   12,966,712    12,967    -    -    37,029,501    -    37,042,468 
Stock options and warrants exercised   581,358    581    -    -    906,598    -    907,179 
Issuance of Common Stock in exchange for future services   130,000    130    -    -    493,870    -    494,000 
Conversion of accounts payable   272,247    272    -    -    1,034,267    -    1,034,539 
Share based compensation for the year ended December 31, 2017   -    -    -    -    1,433,192    -    1,433,192 
Net loss from operations, the year ended December 31, 2017   -    -    -    -    -    (41,216,788)   (41,216,788)
Balance as of December 31, 2017   41,529,181   $41,529   $-   $-   $107,760,036   $(104,290,001)  $3,511,564 
Issuance of common stock   14,614,500    14,614    -    -    16,105,698    -    16,120,312 
Stock options and warrants exercised   44,643    45    -    -    90,020    -    90,065 
Exchange offer – 2017 Warrants – deemed dividend                       765,179    (765,179)   - 
Exchange offer – 2017 Warrants   1,968,736    1,969    -    -    (1,969)   -    - 
Conversion of accounts payable   113,874    114    -    -    298,236    -    298,350 
Share based compensation for the year ended December 31, 2018   -    -    -    -    1,059,582    -    1,059,582 
Net loss from operations, the year ended December 31, 2018   -    -    -    -    -    (36,502,316)   (36,502,316)
Balance as of December 31, 2018   58,270,934   $58,271   $-   $-   $126,076,782   $(141,557,496)  $(15,422,443)

 

See accompanying notes to the consolidated financial statements.

 

 F-7

 

 

Workhorse Group, Inc.

Consolidated Statements of Cash Flows

For Years Ended December, 2018 and 2017

 

 

   2018   2017 
         
Cash flows from operating activities:        
Net loss  $(36,502,316)  $(41,216,788)
Adjustments to reconcile net loss from operations to cash used by operations:          
Depreciation   348,339    549,973 
Amortized discount and debt issuance costs on Senior Secured Notes   987,500    - 
Amortization of Arosa Loan issuance cost   3,610,589    - 
Change in fair value of common stock warrant liability   (2,683,470)   - 
Stock based compensation   1,059,582    1,433,192 
Write down of inventory   2,488,100    - 
Loss on sale of asset   28,645    - 
Effects of changes in operating assets and liabilities:          
Accounts receivable   1,024,366    (223,133)
Inventory   (399,774)   (2,157,107)
Prepaid expenses and deposits   (1,328,461)   (196,971)
Accounts payable and accrued liabilities   2,399,877    3,140,313 
Warranty   6,916,209    - 
Accounts payable, related parties   (54,914)   (46,425)
Customer deposits   351,595    54,405 
           
Net cash used by operations   (21,754,133)   (38,662,541)
           
Cash flows from investing activities:          
Capital expenditures   (23,222)   (143,355)
Proceeds from sale of fixed assets   4,800    - 
           
Net cash used by investing activities   (18,422)   (143,355)
           
Cash flows from financing activities:          
Proceeds from notes payable   -    4,762,500 
Payments on notes payable   (5,750,000)   - 
Proceeds from Duke financing arrangement   1,340,700    - 
Proceeds from advances   -    26,732 
Proceeds from long-term debt   17,800,000    - 
Payments on long-term debt   (9,891,378)   (76,572)
Loan issue costs   (792,221)   - 
Shareholder advances, net of repayments   -    - 
Issuance of common stock   16,418,662    37,042,468 
Exercise of warrants and options   90,065    650,675 
           
Net cash provided by financing activities   19,215,828    42,405,803 
           
Change in cash and cash equivalents   (2,556,727)   3,599,907 
           
Cash at the beginning of the period   4,069,477    469,570 
Cash at the end of the period  $1,512,750   $4,069,477 

 

Cash paid for interest was $1,128,470 and $104,621 for the years ended December 31, 2018 and 2017, respectively.

 

Supplemental disclosure of non-cash activities:

 

During the year ended December 31, 2018, the Company issued warrants to purchase common stock to Marathon in association with the Marathon Loan, which were valued at $965,747. The company recorded a provision for the warrant liability in accrued liabilities with the offset recorded as a debt discount against the Marathon Loan.

 

During the year ended December 31, 2018, the Company issued warrants to purchase common stock to Arosa in association with the Arosa Loan, which were valued at $3,540,542. The company recorded a provision for the warrant liability in accrued liabilities with the offset recorded as a debt discount against the Arosa Loan.

 

During the year ended December 31, 2018, the Company converted accounts payable of $298,350 to common stock of $114 and additional paid-in-capital of $298,236.

 

During the year ended December 31, 2017, a vendor converted an existing accounts payable liability of $1,034,539 into common stock. In addition, the company issued $494,000 in common stock in exchange for future services with modeling and mule services as well as future consulting services.

 

During the year ended December 31, 2017, converted $256,504 of shareholder advances into common stock.

 

See accompanying notes to the consolidated financial statements.

 F-8

 

 

Workhorse Group, Inc.

Notes to Consolidated Financial Statements

 

1. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING PRINCIPLES

 

The following accounting principles and practices are set forth to facilitate the understanding of data presented in the condensed consolidated financial statements:

 

Nature of operations and principles of consolidation

 

Workhorse Group Inc. and its predecessor companies (“Workhorse”, the “Company”, “we”, “us” or “our”) is a technology company focused on providing sustainable and cost-effective solutions to the commercial transportation sector. As an American manufacturer, we design and build high performance battery-electric vehicles and aircraft that make movement of people and goods more efficient and less harmful to the environment. As part of our solution, we also develop cloud-based, real-time telematics performance monitoring systems that enable fleet operators to optimize energy and route efficiency. Although we operate as a single unit through our subsidiaries, we approach our development through two divisions, Automotive and Aviation. We are currently focused on our core competency of bringing the N-GEN electric cargo van to market and fulfilling our existing backlog of orders. We are also exploring other opportunities in monetizing our intellectual property which could include a sale, license or other arrangement of assets that are outside of our core focus.

 

The Company’s wholly owned subsidiaries include Workhorse Technologies Inc., Workhorse Motor Works Inc. and Workhorse Properties Inc.

 

Basis of presentation

 

The financial statements have been prepared on a going concern basis, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. However, the Company has limited revenues and a history of negative working capital and stockholders’ deficits. Our existing capital resources will be insufficient to fund our operations through the first half of 2019. Unless and until we are able to generate a sufficient amount of revenue, reduce our costs and/or enter a strategic relationship, we expect to finance future cash needs through public and/or private offerings of equity securities and /or debt financings. If we are not able to obtain additional financing and/or substantially increase revenue from sales, we will be unable to continue as a going concern. These conditions raise substantial doubt about the ability of the Company to continue as a going concern.

 

In view of these matters, continuation as a going concern is dependent upon the continued operations of the Company, which, in turn, is dependent upon the Company’s ability to meet its financial requirements, raise additional capital, and successfully carry out its future operations. The financial statements do not include any adjustments to the amount and classification of assets and liabilities that may be necessary, should the Company not continue as a going concern.

 

 F-9

 

  

The Company has continued to raise capital.  Management believes the proceeds from these offerings, future offerings, and the Company’s anticipated revenue, provides an opportunity to continue as a going concern.  If additional funding is required, the Company plans to obtain working capital from either debt or equity financing from the sale of common, preferred stock, and/or convertible debentures. Obtaining such working capital is not assured. The Company is currently in a production ramp up mode and placing greater emphasis on manufacturing capability.

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from these estimates.

 

Certain reclassifications were made to the prior year financial statements to conform to the current year presentation. These reclassifications had no effect on previously reported results of operation or stockholders’ equity.

 

Financial instruments

 

The carrying amounts of financial instruments including cash, inventory, accounts payable and short-term debt approximate fair value because of the relatively short maturity of these instruments.

 

Accounts receivable

 

Accounts receivable consist of collectible amounts for products and services rendered. The Company carries its accounts receivable at invoice amount less an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts based on a history of past write-offs and collections and current credit conditions. The Company generally does not require collateral for accounts receivable. Sales to our top two customers totaled 0% and 33% for the year ended December 31, 2018 and 98% and 0% for the year ended December 31, 2017.

 

Lease Receivable

 

The Company’s leasing activities consist of the leasing of trucks which are classified as direct financing leases.  Revenue is recognized at the inception of the lease.  The leases have a term of eight years.  Future payments to be received on the leases are as follows:

 

2019  $48,271 
2020   41,375 
2021   41,375 
2022   41,375 
2023   41,375 
Thereafter   32,590 
   $246,361 

 

Inventory

 

Inventory is stated at the lower of cost or net realizable value. Manufactured inventories are valued at standard cost, and consist of raw materials, work in process and finished goods.

 

Property, plant and equipment, net

 

Property, plant and equipment, net is stated at cost less accumulated depreciation.  Major renewals and improvements are capitalized while replacements, maintenance and repairs, which do not improve or extend the lives of the respective assets, are expensed. When property, plant and equipment is retired or otherwise disposed of, a gain or loss is realized for the difference between the net book value of the asset and the proceeds realized thereon. Depreciation is calculated using the straight-line method, based upon the following estimated useful lives:

 

Buildings:   15 - 39 years 
Leasehold improvements:   7 years 
Software:   3 - 6 years 
Equipment:   5 years 
Vehicles and prototypes:   3 - 5 years 

 

 F-10

 

 

Common stock

 

On April 22, 2010, the directors of the Company approved a forward stock split of the common stock of the Company on a 14:1 basis.  On May 12, 2010, the stockholders of the Company voted to approve the amendment of the certificate of incorporation resulting in a decrease of the number of shares of common stock.   Management filed the certificate of amendment decreasing the authorized shares of common stock with the State of Nevada on September 8, 2010. On February 11, 2015, the Company filed a certificate of amendment to its articles of incorporation to increase the authorized shares of common stock to 50,000,000.

 

On December 9, 2015, the Company filed a Certificate of Amendment to its Certificate of Incorporation to implement a one-for-ten reverse split of the Corporation’s issued and outstanding common stock (the “Reverse Stock Split”), as authorized by the stockholders of the Company. The Reverse Stock Split became effective at the open of trading on December 11, 2015 (the “Effective Date”). As of the Effective Date, every ten shares of issued and outstanding common stock were combined into one newly issued share of common stock. No fractional shares were issued in connection with the Reverse Stock Split. Total cash payments made by the Company to stockholders in lieu of fractional shares was not material.

 

On August 7, 2017, the shareholders of the Company voted to increase the authorized shares of common stock to 100,000,000 and the Certificate of Amendment amending the Articles of Incorporation was filed with the State of Nevada on August 8, 2018.

 

All references in the financial statements and MD&A to number of common shares, price per share and weighted average shares of common stock have been adjusted to reflect the Reverse Stock Split on a retroactive basis for all prior periods presented, unless otherwise noted, including reclassifying an amount equal to the reduction in par value of common stock to additional paid in capital.

 

The capital stock of the Company is as follows:

 

Preferred Stock - The Company has authorized 75,000,000 shares of preferred stock with a par value of $.001 per share. These shares may be issued in series with such rights and preferences as may be determined by the Board of Directors. There are no shares of preferred stock outstanding.

 

Common Stock - The Company has authorized 100,000,000 shares of common stock with a par value of $0.001 per share as of December 31, 2018.

 

Income taxes

 

As no taxable income has occurred from the date of this merger to December 31, 2018 cumulative deferred tax assets of approximately $29.6 million are fully reserved, and no provision or liability for federal or state income taxes has been included in the financial statements. Carryover amounts are:

 

Approximate net operating loss
($ millions)
  Carryover to be used against taxable
income generated through year
     
4.0   2030
6.7   2031
3.9   2032
4.6   2033
6.0   2034
8.9   2035
17.9   2036
38.5   2037
23.5   Indefinite

 

 F-11

 

 

Research and development costs

 

The Company expenses research and development costs as they are incurred. Research and Development costs were approximately $7.4 million and $17.7 million for the years ended December 31, 2018 and 2017, respectively, consisting primarily of personnel costs for our teams in engineering and research, prototyping expense, and contract and professional services.

 

Basic and diluted loss per share

 

Basic loss per share is computed by dividing net loss available to common shareholders (numerator) by the weighted average number of shares outstanding (denominator) during the period.  For all periods, all of the Company’s common stock equivalents were excluded from the calculation of diluted loss per common share because they were anti-dilutive, due to the Company’s net losses.

 

Stock based compensation

 

The Company accounts for its stock-based compensation in accordance with “Share-Based Payments” (codified in FASB ASC Topic 718 and 505). The Company recognizes in its consolidated statement of operations the grant-date fair value of stock options and warrants issued to employees and non-employees over the option or warrant’s vesting period.  The fair value is estimated on the date of grant using a Black-Scholes valuation model that uses assumptions concerning expected volatility, expected term, and the expected risk-free rate of return.  For the awards granted, the expected volatility was estimated by management as 50% based on results from other public companies in our industry.  The expected term of the awards granted was assumed to be the contract life of the option or warrant (one, two, three, five or ten years as determined in the specific arrangement).  The risk-free rate of return was based on market yields in effect on the date of each grant for United States Treasury debt securities with a maturity equal to the expected term of the award.

 

Subsequent events

 

The company has evaluated subsequent events for potential recognition and disclosures through the date the consolidated financial statements were filed.

 

2. INVENTORY

 

As of December 31, 2018, and 2017, inventory consisted of the following:

 

   2018   2017 
Raw materials  $4,319,637   $3,205,618 
Work in process   702,079    1,416,324 
Finished goods   -    - 
    5,021,716    - 
Less: Inventory reserve   2,488,100    - 
   $2,533,616   $4,621,942 

 

During the year ended December 31, 2018, the Company recorded an inventory reserve of approximately $2.5 million. The increase in reserve related to the Company’s strategic switch from the legacy E-GEN/E-100 platform to our N-GEN platform, which occurred in the fourth quarter of 2018. Certain raw materials and work in process were unique to the E-GEN/E-100 vehicles and cannot currently be repurposed. As such, the company recorded a reserve related to these items.

 

 F-12

 

 

3.REVENUE

 

Change in Accounting Principle

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The guidance in this ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). This guidance requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services.

 

Beginning in January 2018, the Company adopted the provisions of ASU 2014-09 Topic 606 under the modified retrospective method, which requires a cumulative effect adjustment to the opening balance of retained earnings on the date of adoption. This approach was applied to contracts not completed as of December 31, 2017. No significant change to revenue recognition, as previously recognized, was identified. At date of adoption, there was no adjustment to retained earnings related to the adoption of ASU 2014-09. At date of adoption, there was no significant change to our past revenue recognition practices and therefore no adjustment to the opening balance of retained earnings was required.

 

Revenue Recognition

 

Net sales include products and shipping and handling charges, net of estimates for customer allowances. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products. All revenue is recognized when we satisfy our performance obligations under the contract. We recognize revenue by transferring the promised products to the customer, with the majority of revenue recognized at the point in time the customer obtains control of the products. We recognize revenue for shipping and handling charges at the time the products are delivered to or picked up by the customer. The majority of our contracts have a single performance obligation and are short term in nature.

 

Revenues related to repair and maintenance services are recognized over time as services are provided. Payment for used vehicles, services, and merchandise are typically received at the point when control transfers to the customer or in accordance with payment terms customary to the business.

 

Accounts Receivable

 

Credit is extended based upon an evaluation of the customer’s financial condition. Accounts receivable are stated at their estimated net realizable value. The allowance for doubtful accounts is based on an analysis of customer accounts and our historical experience with accounts receivable write-offs.

 

The Company has elected the following practical expedients allowed under ASU 2014-09:

 

  Performance obligations are satisfied within one year from a given reporting date, consequently we omit disclosure of the transaction price apportioned to remaining performance obligations on open orders

 

Disaggregation of Revenue

 

Our revenues related to the following types of business were as follows for the periods ended December 31:

 

   Year Ended
December 31,
 
   2018   2017 
         
Automotive  $498,000   $10,038,460 
Aviation   -    - 
Other   265,173    - 
Total revenues  $763,173   $10,038,460 

 

Automotive Revenue – consists of sales of any of our E-GEN or E-100 platforms. We recognize revenue when control transfers upon shipment to customers in accordance with the new revenue standard as a sale.

 

Aviation – consists of sales of our SureFly multicopter. No sales have been recorded to date. We would recognize revenue when control transfers upon shipment to customers in accordance with the new revenue standard as a sale.

 

Other – consists of our former Delivery Service Protocol program, grant-related research work and non-warranty after-sales vehicle services. There were no significant changes to the timing or amount of revenue recognition as a result of our adoption of the new revenue standard.

  

 F-13

 

 

4. PROPERTY, PLANT AND EQUIPMENT, NET

 

Property, Plant and Equipment as of December 31, 2018 and 2017 consists of the following:

 

   2018   2017 
Land  $700,000   $700,000 
Buildings   5,900,000    5,900,000 
Leasehold Improvements   19,236    19,225 
Software   102,367    86,050 
Equipment   836,646    829,742 
Vehicles and prototypes   86,679    156,567 
    7,644,928    7,691,584 
Less accumulated depreciation   (2,407,477)   (2,095,571)
   $5,237,451   $5,596,013 

 

5. LONG-TERM DEBT

 

Long-term debt as of December 31, 2018 and 2017 consists of the following:

 

   December 31,
2018
   December 31,
2017
 
Marathon Tranche I Loan, due December 31, 2021, interest only quarterly payments, variable interest rate of 10.4% as of December 31, 2018 (discount is based on warrant valuation of approximately 9.7%)  $10,000,000   $- 
Marathon Credit Agreement unamortized discount and issuance costs   (1,687,921)   - 
Net Marathon Credit Agreement   8,312,079      
Senior Secured Notes, due July 6, 2018 (discount is based on imputed interest rate of 26%)   -    5,750,000 
Less: unamortized discount and debt issuance costs on Senior Secured Notes   -    (987,500)
Net Senior Secured Notes   -    4,762,500 
Secured mortgage payable, due November 2026, to Bank for 100 Commerce Drive building, interest rate 6.5%, due in monthly installments of $11,951, inclusive of principal and interest   -    1,741,378 
Note payable, former building owner interest payment only due in monthly installments of $1,604 interest at 5.5%. A balloon payment of $350,000 plus unpaid interest due August 2018.   -    350,000 
    8,312,079    6,853,878 
Less current portion   -    5,143,997 
Long-term debt  $8,312,079   $1,709,881 

 

Aggregate maturities of long-term debt are as follows:

 

2019   - 
2020   1,000,000 
2021   9,000,000 
2022   - 
2023   - 
Thereafter   - 
    10,000,000 

 

 F-14

 

 

On December 26, 2017, as part of its initial efforts to spin-off Surefly Inc., the Company entered into a Securities Purchase Agreement with several existing institutional investors (the “Spin-Off Investors”) pursuant to which the Company issued original issue discount Senior Secured Notes in the aggregate principal amount of $5,750,000 in consideration of gross proceeds of $5,000,000 paid by the Spin-Off Investors. The loan was convertible into Surefly Inc. equity upon achieving the spin-off. On June 28, 2018, the Company entered into an amendment agreement with the Spin-Off Investors. The amendment agreement provided that the Senior Secured Notes were amended to provide a maturity date of July 6, 2018. Upon the closing of the Loan Agreement with Arosa Capital Management LP (“Arosa”), the Company paid off the Senior Secured Notes.

 

Amortization expense recorded as interest related to the debt issuance costs and unamortized discounts for the Senior Secured Notes was $987,500 for the year ended December 31, 2018.

 

On June 7, 2018, the Company received a short-term loan in the aggregate principal amount of $550,000 from Stephen S. Burns, H. Benjamin Samuels, Gerald Budde and Ray Chess, each an executive officer and/or director of the Company (collectively, the “Related Parties”). The Company used the net proceeds from the transaction for general business and working capital purposes. To evidence the loans, the Company issued the Related Parties promissory notes (the “Related Parties Notes”) in the aggregate principal amount of $550,000. The Related Parties Notes were unsecured obligations of the Company and were not convertible into equity securities of the Company. Principal and interest under the Related Parties Notes was due and payable December 6, 2018, however, in the event that the Company raised in excess of $10,000,000 in equity financing, then the Company would use part of its proceeds to pay off the Related Parties Notes. Under no circumstance were the Related Parties Notes be paid off on or prior to the 91st day following the maturity date of the Senior Secured Notes issued by the Company on December 27, 2017. Interest accrued on the Related Parties Notes at the rate of 12.0% per annum. The Related Parties Notes contained terms and events of default customary for similar transactions.

 

On July 6, 2018, the Company received a short-term loan in the aggregate principal amount of $500,000 from accredited investors (collectively, the “Loan Parties”), which included Mr. Samuels, a director of the Company. To evidence the loans, we issued the Loan Parties promissory notes (the “Loan Parties Notes”) in the aggregate principal amount of $500,000. The Loan Parties Notes were unsecured obligations of the Company and were not convertible into equity securities of our company. Principal and interest under the Loan Parties Notes was due and payable January 5, 2019, however, in the event that the Company raised in excess of $10,000,000 in equity or debt financing, the Company would use a portion of the proceeds to pay off the Loan Parties Notes. Interest accrues on the Loan Parties Notes at the rate of 12.0% per annum. The Loan Parties Notes contained terms and events of default customary for similar transactions.

 

The Related Parties Notes and Loan Parties Notes were paid off following the closing of the August 2018 public offering.

 

 F-15

 

 

On July 6, 2018, the Company, as borrower, entered into a Loan Agreement with a fund managed by Arosa, as lender, providing for a term loan (the “Arosa Loan”) in the principal amount of $6,100,000 (the “Loan Agreement”). The maturity date of the Arosa Loan was July 6, 2019 (the “Maturity Date”). The interest rate for the Arosa Loan was 8% per annum payable in quarterly installments and commenced on October 6, 2018. The Company could prepay the Arosa Loan at any time upon three days written notice.

 

The Company used the proceeds from the Arosa Loan to satisfy the Senior Secured Loans and a loan in the amount of $350,000 payable to the former owner of the Company’s facility based in Loveland, Ohio.

 

The Loan Agreement required the Company to pay Arosa’s expenses including attorney fees. The Loan Agreement also required the Company to make certain representations and warranties and other agreements that are customary in loan agreements of this type and also included covenants to raise $10,000,000 in equity prior to September 30, 2018 and to consummate a sale of Surefly, Inc., the Company’s indirect wholly-owned subsidiary resulting in cash proceeds of no less than $20,000,000. The Loan Agreement also contained customary events of default, including non-payment of principal or interest, violations of covenants, bankruptcy and material judgments. The Company’s subsidiaries and Arosa also entered into a Guarantee and Collateral Agreement and Intellectual Property Security Agreement providing that the Company’s obligations to Arosa were secured by substantially all of the Company’s assets. In addition, the Company was required to appoint to the Board of Directors a person designated in writing by Arosa for a period of no less than 12 months.

 

In accordance with the Loan Agreement, the Company issued Arosa a warrant to purchase 5,000,358 shares of common stock of the Company at an exercise price of $2.00 per share exercisable in cash only for a period of five years. While the Arosa Loan remained outstanding, the Company was be required to issue additional warrants to purchase common stock to Arosa equal to 10% of any additional issuance excluding issuances under an approved stock plan. The additional warrants to purchase common stock have an exercise price equal to the lesser of $2.00 or a 5% premium to the price utilized in such financing. Pursuant to the warrant, Arosa may not exercise such warrant if such exercise would result in Arosa beneficially owning in excess of 9.99% of the Company’s then issued and outstanding common stock. On August 2, 2018, after conducting additional due diligence on the Company’s available collateral base, Arosa agreed to enter into the First Amendment to the Loan Agreement with the Company pursuant to which an additional $1,700,000 was loaned to the Company for working capital purposes and general corporate purposes. In addition, various covenants were added or amended including, but not limited to, requiring the Company to satisfy its Mortgage on its Loveland, Ohio facility no later than October 1, 2018, which we paid off in August 2018 with a payment of $1.85 million.

 

The Company determined that the Arosa Loan and related warrants were freestanding instruments issued together and therefore should be accounted for separately. The Company determined the warrants did not qualify for equity classification and therefore has applied liability treatment to the instruments. The value of the warrants on the date of the Arosa Loan was determined to be $3,540,542, which was determined using the Black-Scholes method and was recorded as a liability with the offset being recorded as a debt discount, which will be amortized into interest expense over the life of the loan. The liability for the warrants, as well as any future warrant issuances, will be marked to marked quarterly in accordance with liability accounting.

 

On August 14, 2018, in accordance with the Loan Agreement, we issued a warrant to acquire 1,143,200 shares of common stock at an exercise price of $1.21 warrants to Arosa following the closing of our public offering on August 13, 2018 and the related over-allotment on August 14, 2018. On October 1, 2018, we issued a warrant to acquire 108,768 shares of common stock at an exercise price of $1.60 warrants to Arosa due to our At The Market (“ATM”) offerings that occurred during the third quarter of 2018.

 

 F-16

 

 

On December 31, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”), among the Company, as borrower, Marathon Asset Management, LP, on behalf of certain entities it manages, as lenders (collectively, with their permitted successors and assignees, the “Lenders”), and Wilmington Trust, National Association, as the agent (“Wilmington”).  The Credit Agreement provided the Company with a $10 million tranche of term loans (the “Tranche One Loans”) which may not be re-borrowed following repayment and (ii) a $25 million tranche of term loans which may be re-borrowed following repayment (the “Tranche Two Loans” together with the Tranche One Loans, the “Loans”). The Company used the proceeds for the Tranche One Loans (x) to pay off a loan provided by Arosa in the principal amount of $7.8 million plus interest and (y) for working capital purposes. Draws from the Tranche Two Loans will be used in connection with vehicle production and are subject to the Company’s receipt of purchase orders.

 

In connection with the extinguishment of the Arosa loan, a loss on extinguishment of approximately $2.2 million was recognized and is recorded within interest expense in the accompanying statement of operations for the year ended December 31, 2018.

 

The Company’s ability to borrow amounts under the Credit Agreement is conditioned upon its compliance with specified covenants, including certain reporting covenants and financial covenants that, in addition to other items, require the Company to maintain (i) minimum liquidity of at least $4 million at all times on or after March 31, 2019, (ii) a maximum total leverage ratio (ratio of total debt borrowed by the Company to EBITDA for the four consecutive fiscal quarters most recently ended, subject to certain adjustments set forth in the Credit Agreement) not to exceed 4.50:1.00 on the last day of the quarter ended September 30, 2019, which total leverage ratio is adjusted for subsequent quarters as set forth in the Credit Agreement and (iii) a maximum debt service coverage ratio (ratio of EBITDA (for the four consecutive fiscal quarters most recently ended, subject to certain adjustments set forth in the Credit Agreement) to interest expense and payments for operating leases) not to exceed 1.25:1.00 on the last day of the quarter ended September 30, 2019, which debt service coverage ratio is adjusted for subsequent quarters as set forth in the Credit Agreement. In the event the Company breaches the total leverage ratio or the debt service coverage ratio covenants, the Company may cure such breach by raising capital through the sale of equity, which capital will be added on a dollar-for-dollar basis to the calculation of EBITDA for purposes of such test period to determine compliance with the financial covenant. In each consecutive four fiscal quarter period, equity cures can only be made for two fiscal quarters, and only four equity cures are allowed during the term of the Credit Agreement. The capital raised in connection with such equity cure must be used to repay the Loans.

 

In addition, the Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants, including, among others, restrictions on the Company’s ability to dispose of property, enter into mergers, acquisitions or other business combination transactions, incur additional indebtedness, grant liens, pay dividends and make certain other restricted payments.

 

 F-17

 

 

The Tranche One Loans, and both the drawn and undrawn portions of the Tranche Two Loan, will bear interest at a rate per annum (based on a year of 360 days) equal to LIBOR (as defined in the Credit Agreement) plus 7.625%, which interest is payable quarterly commencing March 5, 2019.

 

The Credit Agreement contains customary events of default, including for non-payment, misrepresentation, breach of covenants, defaults under other material indebtedness, material adverse change, bankruptcy, change of control and material judgments.

 

The Loans mature on the third anniversary of the closing date. The Company is required to repay a portion of the Tranche One Loans with $500,000 installment payments on each of June 30, 2020, December 31, 2020 and June 30, 2021. Upon the occurrence and during the continuance of an event of default, the Lenders may declare all outstanding amounts thereunder immediately due and payable and may terminate commitments to make any additional advances under the Tranche Two Loans. The Tranche Two Loans are required to be prepaid in an amount equal to the payments received from the subject purchase orders. The Company is also obligated to repay the Loans with a specified percentage of the net cash proceeds the Company receives in connection with certain dispositions of assets, casualty events, incurrences of debt and any issuances of capital stock (other than issuances of capital stock during the first 9 months after closing). The Company is required to prepay the Loans utilizing 100% of the net proceeds from any casualty event or the issuance or incurrence of debt and 50% of the net proceeds from any disposition. If the Company receives net cash proceeds from the issuance of capital stock after the nine-month anniversary of the closing date, the Company is required to prepay the Loans utilizing 35% of the net cash proceeds from such issuance. With limited exceptions, if the Company prepays any portion of the Tranche One Loans or the Tranche Two Loans (with the concomitant termination of the portion of the commitments under the Tranche Two Loans that is repaid) during the 12 months following the closing date, it is required to pay 100% of the interest that would have been due on such prepaid Loans if the prepaid amounts had been outstanding for a period of 12 months after the date of prepayment. If such prepayment occurs during the period beginning after the 12-month anniversary of the closing date and continuing through the 18-month anniversary of the closing date, the Company is required to pay 50% of the interest that would have been due on such prepaid Loans for the 12-month period following the date of such prepayment on a prorated basis.

 

The Company, the Company’s subsidiaries and Wilmington, as agent for the Lenders, entered into a Security Agreement, a Pledge Agreement and a Guarantee, among other loan documents, providing that the Company’s obligations to the Lenders are secured by a first priority security interest in substantially all of the Company’s and its subsidiaries’ tangible and intangible assets including the Company’s real property located in Loveland, Ohio and Union City, Indiana.

 

For so long as the Credit Agreement is in effect, the Lenders holding a majority of the Loans and unused commitments for the Tranche Two Loan will be entitled to have one representative acceptable to the Company attend all meetings of the Company’s board of directors (and any committees thereof), in a non-voting observer capacity, and such representative will receive copies of all notices, minutes, consents and other materials the Company provides to its directors in connection with such meeting. The Company may exclude such representative from access to any of such materials or meetings or portions thereof if it believes that any such material or portion thereof is a trade secret or similar confidential information or such exclusion is necessary to preserve the attorney-client privilege.

 

In accordance with the Credit Agreement, the Company issued each Lender a Common Stock Purchase Warrant to purchase, in the aggregate, 8,053,390 shares of common stock of the Company at an exercise price of $1.25 per share exercisable in cash only for a period of three years and then for cash or cashless thereafter (collectively, the “Initial Warrants”). Until the later of the repayment of all obligations owed to the Lenders or two years from the closing date, the Company will be required to issue additional Common Stock Purchase Warrants (the “Additional Warrants”) to the Lenders equal to 10%, in the aggregate, of any additional issuance, subject to certain exceptions, on substantially the same terms and conditions of the Initial Warrants, except that (i) the applicable expiration date thereof shall be five years from the issuance date of the applicable warrant, (ii) the initial exercise price shall be a price equal to the price per share of common stock used in the relevant issuance multiplied by 110% and (iii) the holder shall be entitled to exercise the warrant on a cashless exercise at any time the warrant is exercisable.

 

The Company determined that the Marathon Credit Agreement and related warrants were freestanding instruments issued together and therefore should be accounted for separately. We determined the warrants did not qualify for equity classification and therefore have applied liability treatment to the instruments. The value of the warrants on the date of the Marathon Credit Agreement was determined to be $965,747, which was determined using the Black-Scholes method and was recorded as a liability with the offset being recorded as a debt discount, which will be amortized into interest expense over the life of the loan. The liability for the warrants, as well as any future warrant issuances, will be marked to marked quarterly in accordance with liability accounting.

 

 F-18

 

 

As a condition to the closing of the Credit Agreement, the Company entered into a Registration Rights Agreement with the Lenders (the “Registration Rights Agreement”). Pursuant to the Registration Rights Agreement, the Company is required, not later than 90 days following the execution of the Credit Agreement, to file a shelf registration statement on Form S-3 with the SEC with respect to the resale of the shares of common stock issuable upon exercise of the Initial Warrants or any Additional Warrant, if any (the “Warrant Shares”). The Company is required to use its reasonable best efforts to have such registration statement declared effective as soon as reasonably practicable but in no event no later than 180 days after the closing date of the Credit Agreement. The Company is required to keep such shares registered for as long as they are deemed Registrable Securities (as defined in the Registration Rights Agreement). In addition, any holder of Registrable Securities (as defined in the Registration Rights Agreement) will have the right, subject to certain limitations, to request an underwritten takedown of any Warrant Shares. Any holder of Registrable Securities (as defined in the Registration Rights Agreement) will have the right, on up to four occasions, to demand that the Company file a registration statement with the SEC with respect to the resale of the Warrant Shares, subject to certain limitations. In addition, any holder of Registrable Securities (as defined in the Registration Rights Agreement) is entitled to unlimited piggyback registration rights with respect to the registration of any equity securities of the Company, subject to certain limitations. These registration rights are subject to customary conditions and limitations regarding cutbacks and indemnification, among others. Subject to certain exceptions, the Company is generally required to bear all expenses of such registration, other than underwriting discounts and commissions and certain travel expenses.

 

The Company, at closing, paid a fee equal to 1.0% of the Tranche One Loans and the commitment for the Tranche Two Loans. Upon the first drawing of any Tranche Two Loans, the Company is required to pay another fee equal to 1.0% of the Tranche One Loans and the commitment for the Tranche Two Loans.

 

In connection with entry into the Credit Agreement, the Company agreed to pay Cowen & Company, LLC a cash fee equal to 2% of the gross proceeds received from the Lenders on the earlier of the next capital raise or March 31, 2019.

 

The closing costs associated with the Marathon Credit Agreement were allocated based on proportional value to Tranche 1, Tranche 2 and the Marathon Warrants. Costs of $722,174 allocated to Tranche 1 were recorded as a debt discount; costs of $1,830,435 allocated to Tranche 2 were recorded as a prepaid asset and will be amortized over the expected life of the loan; and costs of $69,744 allocated to the Marathon Warrants were expensed in the year ended December 31, 2018.

 

On December 31, 2018, concurrently with the closing of the Credit Agreement and the initial borrowing of the Tranche One Loans, the Company utilized a portion of the proceeds from the Tranche One Loans to repay in full all outstanding amounts under the Company’s existing Loan Agreement, dated July 6, 2018, as amended to date, by and among the Company, and Arosa, as lender (the “Existing Loan Agreement”) and terminated all commitments by Arosa to extend further credit thereunder and all guarantees and security interests granted by the Company to Arosa in connection therewith.  Pursuant to the Existing Loan Agreement, the Company issued Arosa a Warrant to purchase 894,821 shares of common stock exercisable at $1.25 per share. As the full amount of all outstanding amounts under the Company’s Existing Loan Agreement have been repaid in full, the Company is no longer required to issue additional warrants to Arosa going forward.

 

Principal amounts:  At December 31,
2018
 
Principal  $10,000,000 
Unamortized debt discount and issuance costs (1)   (1,687,921)
Net debt carrying amount  $8,312,079 
Carrying amount of warrant the liability component (2)  $965,747 

 

  (1) Includes the unamortized portion of the initial warrant liability of $965,747 and issuance costs of $722,174.

 

  (2) Includes marked to market liability of initial Marathon warrant liability.

 

 F-19

 

 

6. DUKE FINANCING OBLIGATION

 

On November 28, 2018, the Company entered into a Sales Agreement with Duke Energy One, Inc., a wholly-owned subsidiary of Duke Energy Corporation (NYSE: DUK) (“Duke”), pursuant to which the Company sold Duke 615,000 battery cells (the “615,000 Cells”) in consideration of $1,340,700.  Workhorse will continue to use the cells in the near term for the delivery of trucks to UPS and DHL.  Until May 1, 2019, the Company has the right and option to require Duke to sell the 615,000 Cells back to the Company and Duke has the right and option to require the Company to purchase the 615,000 Cells at price equal to the price the 615,000 Cells were sold.

 

On November 28, 2018, in consideration for consenting to the Company selling the Cells to Duke, which served as collateral for Arosa the Loan Agreement, the Company entered into a Limited Consent, Waiver and Release with Arosa pursuant to which the Company issued Arosa 2,000,000 shares of common stock and restruck the exercise price of warrants previously issued to Arosa to $1.25 per share.  In addition, while the Arosa Loan remains outstanding, the exercise price of the Arosa Warrants will be restruck to equal the price of any equity issued by the Company, including the issuance of any common stock purchase warrants or other derivative convertible securities, if the issuing price of such securities is less than $1.25.

 

The Duke transactions was accounted for as a financing obligation and as such, the company has recorded a $1,340,700 liability related to the transaction.

 

7.INCOME TAXES

 

For the years ended December 31, 2018 and 2017, the Company has taxable losses primarily due to operations and thus has no current tax expense recorded. The Company has recorded a full valuation allowance on its deferred tax assets and thus, for the years ended December 31, 2018 and 2017 there is no deferred tax expense recorded.

 

The U.S. components of loss before income taxes and a reconciliation of the statutory federal income tax with the provision for income taxes follow:

 

    2018    2017 
           
Current Federal   -    - 
Current State & Local   -    - 
    Total Current   -    - 
           
Deferred Federal   -    - 
Deferred State & Local   -    - 
    Total Deferred   -    - 
           
Total   -    - 

 

 F-20

 

 

   12/31/2018  12/31/2017
       
Federal tax benefit at statutory rates  21.0%  35.0%
State and local tax at statutory rate  0.8%  0.6%
Mark-to-Market Adjustment on Stock Warrants  1.5%  0.0%
Other permanent differences and credits  0.0%  (0.1)%
Change in valuation allowance  (23.3)%  (35.5)%
       
Total tax expense  0.0%  0.0%

 

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. When realization of the deferred tax asset is more likely than not to occur, the benefit related to the deductible temporary differences attributable to operations is recognized as a reduction of income tax expense. Valuation allowances are provided against deferred tax assets when, based on all available evidence, it is considered more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. The Company cannot be certain that future taxable income will be sufficient to realize its deferred tax assets, and accordingly a full valuation allowance has been provided on its deferred tax assets. The Company continues to maintain the underlying tax benefits to offset future taxable income and to monitor the need for a valuation allowance based on the profitability of its future operations. The valuation allowance increased by approximately $8.5 million and $8.6 million, during the years ended December 31, 2018 and 2017, respectively. Significant components of the Company’s deferred tax assets and liabilities are as follows:

 

   2018   2017 
Deferred Tax Assets:        
Accrued Expenses & Reserves  $850,857   $308,116 
Warranty Allowance   1,539,765    31,097 
Non-Qualified Stock Options   1,034,261    796,999 
Fixed Assets   183,917    170,072 
Disallowed Interest Expense   1,118,212    - 
Net Operating Losses   24,818,785    19,729,451 
Total Deferred Tax Assets   29,545,797    21,035,735 
Valuation Allowance   (29,545,797)   (21,035,735)
Total Deferred Tax Assets, net of valuation allowance  $-   $- 

 

 F-21

 

 

At December 31, 2018 and 2017, the Company has approximately $90.6 million, of federal net operating loss (“NOL”) carry-forwards which expire through 2037. Additionally, at December 31, 2018 the Company has approximately $23.5 million of federal NOLs that carry-forward indefinitely. Additionally, at December 31, 2018 and 2017, the Company has approximately $0.9 million and $0.7 million, respectively, of state and local NOLs carry-forwards which expire through 2038. The NOL carry-forwards may be limited in certain circumstances, including ownership changes.

 

Under the provisions of the Internal Revenue Code, the net operating loss and tax credit carry-forwards are subject to review and possible adjustment by the Internal Revenue Service and state tax authorities. Net operating loss and tax credit carryforwards may become subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50%, as defined under Sections 382 and 383 of the Internal Revenue Code, respectively, as well as similar state provisions. This could limit the amount of tax attributes that can be utilized annually to offset future taxable income or tax liabilities. The amount of the annual limitation is determined based on the value of the Company immediately prior to the ownership change. Subsequent ownership changes may further affect the limitation in future years. The Company has not yet analyzed whether it has experienced an ownership change for this purpose to determine if any of the net operating losses to date have a limitation on future deductibility.

 

Tabular Reconciliation of unrecognized tax benefits

 

    2018     2017  
             
Unrecognized tax benefits - January 1   1,163,282     $ 1,163,182  
Gross increases - tax positions in prior period     -       -  
Gross decreases - tax positions in prior period     -       -  
Gross increases - tax positions in current period     -       100  
Settlement     -       -  
Lapse of statute of limitations     -       -  
Unrecognized tax benefits - December 31   $ 1,163,282     $ 1,163,282  

 

The Company will recognize interest and penalties related to uncertain tax positions in income tax expense. As of December 31, 2018, and 2017, due to the Company’s continued losses, no amounts of interest and penalties have been recognized in the Company’s consolidated statements of operations. If the unrecognized tax benefits were reversed, a deferred tax asset and corresponding valuation allowance would be recorded, and thus the reversal would have no impact on the effective rate.

 

The Company files income tax returns in the U.S. federal jurisdiction, various state jurisdictions and local jurisdictions. Generally, the Company’s 2015 through 2017 tax years remain open and subject to examination by federal, state and local taxing authorities. However, federal, state, and local net operating losses from 2009 through 2017 are subject to review by taxing authorities in the year utilized.

 

 F-22

 

 

On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act. This legislation makes significant change in U.S. tax law including a reduction in the corporate tax rates to 21% starting in 2018. The legislation reduced the U.S. corporate tax rate from the current rate of 35% to 21% for tax years beginning after December 31, 2017. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities existing as of December 31, 2017 from the 35% federal rate in effect through the end of 2017, to the new 21% rate. As a result of the change in law, the company recorded a $13.5 million reduction in the deferred tax asset and corresponding valuation allowance.

 

8. STOCK BASED COMPENSATION

 

Options to directors, officers, consultants and employees

 

The Company maintains, as adopted by the board of directors, the 2017 Stock Incentive Plan, the 2016 Stock Incentive Plan, the 2014 Stock Incentive Plan, the 2014 Stock Compensation Plan, 2013 Incentive Stock Plan, the 2012 Incentive Stock Plan, the 2011 Incentive Stock Plan and the 2010 Stock Incentive Plan (the “Plans”) providing for the issuance of options to employees, officers, directors or consultants of the Company. Non-qualified stock options granted under the plans may only be granted with an exercise price equal to the fair market value of the Company’s common stock on the date of grant.  Awards under the plans may be either vested or unvested options. The 2017 Stock Incentive Plan authorized 5,000,000 shares with vesting in sixteen equal quarterly tranches.

 

In addition to the Plans, the Company has granted, on various dates, stock options to directors, officers, consultants and employees to purchase common stock of the Company. The terms, exercise prices and vesting of these awards vary. 

 

The following table summarizes option activity for directors, officers, consultants and employees:

 

       Outstanding Stock Options 
   Options Available for Grant   Number of Options   Weighted
Average
Exercise Price
per Option
   Weighted
Average Grant
Date Fair Value
 per Option
   Weighted
Average
Remaining
Exercise Term
in Months
 
Balance December 31, 2016   1,045,774    2,321,782   $2.31   $1.49    43 
Additional stock reserved   5,000,000    -    -    -    - 
Granted   (1,900,000)   1,900,000    5,01    3.41    72 
Exercised   -    (74,109)   1.13    0.95    - 
Forfeited   -    (296,302)   -    -    - 
Expired   -    -    -    -    - 
Balance December 31, 2017   4,145,774    3,851,371    3.11    1.84    43 
Additional stock reserved   -    -    -    -    - 
Granted   (340,000)   340,000    1.18    0.54    56 
Exercised   -    (52,500)   1.24    0.68    - 
Forfeited   -    -   -    -    - 
Expired   -    (271,250)   3.22    1.58    - 
Balance December 31, 2018   3,805,774    3,867,621   $4.05   $1.84    64 

 

 F-23

 

 

The Company recorded approximately $1.1 million and $1.4 million of compensation expense for stock options to directors, officers, consultants and employees for the years ended December 31, 2018 and 2017, respectively. As of December 31, 2018, unrecognized compensation expense of $2.4 million is related to non-vested options granted to directors, officers, consultants and employees which is anticipated to be recognized over the next 60 months, commensurate with the vesting schedules.

 

Warrants

 

In addition to the stock options above and the stock warrants associated with the Arosa Loan and Marathon Credit Facility previously discussed, the Company has outstanding warrants with certain Accredited Investors. There are 2,618,307 of these warrants outstanding, which were issued in November 2015 with a five-year life and an exercise price of $5.28. These warrants were initially accounted for as equity instruments and as such, no amounts have been recorded as compensation expense or mark to market adjustment for the years ended December 31, 2018 and December 31, 2017.

 

The Company recorded no compensation expense for stock warrants to the placement agent and consultants for the years ended December 31, 2018 and 2017, respectively. There is no unrecognized compensation expense for the placement agent warrants because they are fully vested at date of grant.

 

9. RECENT PRONOUNCEMENTS

 

Accounting Guidance Adopted in 2017

 

Effective September 30, 2017, we early-adopted FASB ASU 2017-11, “Earnings per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features. Part I of ASU 2017-11 simplifies the accounting for certain financial instruments with down round features, a provision in an equity-linked financial instrument (or embedded feature) that provides a downward adjustment of the current exercise price based on the price of future equity offerings. Previous accounting guidance created cost and complexity for organizations that issue financial instruments with down round features by requiring, on an ongoing basis, fair value measurement of the entire instrument or conversion option. The new standard requires companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability of equity classification. Companies that provide earnings per share (“EPS”) data will adjust their diluted EPS calculation for the effect of the feature when triggered (i.e., when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down round feature) and will also recognize the effect of the trigger within equity. We applied this guidance on a prospective basis. The primary impact of adoption is that equity-linked financial instruments are less likely to be liability classified than prior to the adoption of this standard. The adoption of the new standard resulted in warrants issued in September 2017 not being classified as liabilities in our Consolidated Financial Statements.

 

Accounting Guidance Adopted in 2018

 

Effective January 1, 2018, we adopted FASB ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, and affects the guidance in ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU No. 2016-10 clarifies the following two aspects of Topic 606: evaluating whether promised goods and services are separately identifiable and determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property, which is satisfied at a point in time, or a right to access the entity’s intellectual property, which is satisfied over time. The Company adopted ASU No. 2016-10, using the modified retrospective approach, which did not have a material impact on the Company’s condensed consolidated financial statements. Additional information is available in Note 4, “Revenue.”

 

Effective January 1, 2018, we adopted FASB ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), and affects the guidance in ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. When another party is involved in providing goods or services to a customer, ASU No. 2014-09 requires an entity to determine whether the nature of its promise is to provide the specified good or service itself (that is, the entity is a principal) or to arrange for that good or service to be provided by the other party (that is, the entity is an agent). The amendments in ASU No. 2016-08 are intended to improve the operability and understandability of the implementation guidance in ASU No. 2014-09 on principal versus agent considerations by offering additional guidance to be considered in making the determination. The Company adopted ASU No. 2016-08, using the modified retrospective approach, which did not have a material impact on the Company’s condensed consolidated financial statements. Additional information is available in Note 4, “Revenue.

 

 F-24

 

 

Accounting Guidance Not Yet Adopted

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires a lessee to recognize in the statement of financial position a liability to make lease payments (“the lease liability”) and a right-of-use asset representing its right to use the underlying asset for the lease term, initially measured at the present value of the lease payments. When measuring assets and liabilities arising from a lease, the lessee should include payments to be made in optional periods only if the lessee is reasonably certain, as defined, to exercise an option to the lease or not to exercise an option to terminate the lease. Optional payments to purchase the underlying asset should be included if the lessee is reasonably certain it will exercise the purchase option. Most variable lease payments should be excluded except for those that depend on an index or a rate or are in substance fixed payments. A lessee shall classify a lease as a finance lease if it meets any of five listed criteria: 1) The lease transfers ownership of the underlying asset to the lessee by the end of the lease term. 2) The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise. 3) The lease term is for the major part of the remaining economic life of the underlying asset. 4) The present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset. 5) The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. For finance leases, a lessee shall recognize in the statement of comprehensive income interest on the lease liability separately from amortization of the right-of-use asset. Amortization of the right-of-use asset shall be on a straight-line basis, unless another basis is more representative of the pattern in which the lessee expects to consume the right-of-use asset’s future economic benefits. If the lease does not meet any of the five criteria, the lessee shall classify it as an operating lease and shall recognize a single lease cost on a straight-line basis over the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term. The amendments in this update are to be applied using a modified retrospective approach, as defined, and are effective for public business entities for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018. Early application is permitted. The Company does not expect the adoption of the new guidance to have a material impact on the consolidated financial statements.

 

10. STOCK OFFERINGS

 

On February 1, 2017, the Company announced the completion of its underwritten public offering of 6,500,000 shares of its common stock at a public offering price of $3.00 per share. In addition, the underwriters exercised an option to purchase an additional 975,000 shares of common stock at the public offering price, less the underwriting discounts and commissions.

 

All of the shares in the offering were sold by the Company, with gross proceeds to the Company of approximately $22.4 million and net proceeds of approximately $20.5 million, after deducting underwriting discounts and commissions and estimated offering expenses.

  

On June 22, 2017, the Company entered into an at the market issuance sales agreement (the “Cowen Agreement”) with Cowen and Company, LLC (“Cowen”) under which the Company may offer and sell, from time to time at its sole discretion, shares of its Common Stock having an aggregate offering price of up to $25.0 million through Cowen as its sales agent. As of December 31, 2018, the Company issued 2,855,404 shares from this facility for proceeds of approximately $7.2 million.

 

On September 14, 2017, the Company entered into an underwriting agreement (the “Underwriting Agreement”) with Cowen relating to the public offering and sale (the “Offering”) of 3,749,996 shares of the Company’s common stock, and five-year warrants (exercisable beginning on the date of issuance) to purchase up to an aggregate of 2,812,497 shares of the Company’s common stock.  Each investor received a warrant to purchase 0.75 shares of the Company’s common stock at an exercise price of $3.80 per share, for each share of common stock purchased.

  

On April 26, 2018, the Company entered into and closed Subscription Agreements with accredited investors (the “April 2018 Accredited Investors”) pursuant to which the April 2018 Accredited Investors purchased 531,066 shares of the Company’s common stock (“April 2018 Shares”) for a purchase price of $1.4 million or $2.72 per share. Stephen Burns, Benjamin Samuels, Gerald Budde and Julio Rodriguez, executive officers and/or directors of the Company, participated in this offering.

 

 F-25

 

 

Pursuant to the Underwriting Agreement, Cowen purchased 3,749,996 shares of the Company’s common stock and accompanying warrants at a price per share of $3.20.  The net proceeds to the Company were approximately $10.9 million after deducting underwriting discounts and commissions and offering expenses.  The sale of such shares and accompanying warrants closed on September 18, 2017. The warrants contained full ratchet anti-dilution protection upon the issuance of any common stock, securities convertible into common stock or certain other issuances at a price below $3.20, with certain exceptions.

 

On June 4, 2018, the Company and holders of all outstanding Warrants to Purchase Common Stock of the Company issued September 18, 2017 (collectively, the “Warrants”) entered into separate, privately-negotiated exchange agreements (the “Exchange Agreements”), pursuant to which the Company issued to such holders an aggregate of 1,968,736 shares of the Company’s common stock in exchange for the Warrants. The closing of the exchanges contemplated by the Exchange Agreements occurred on June 5, 2018. In addition, the “Down Round” feature of the Warrants was triggered in the second quarter of 2018, causing the strike price to decrease from $3.80 per share to $2.62 per share. As a result, the Company recorded approximately $765,179 as a deemed dividend which represents the value transferred to the Warrant holders due to the Down Round being triggered. The deemed dividend was recorded as a reduction of Retained Earnings and increase in Additional Paid-in-Capital and reduced net income available to common shareholders by the same amount.

  

On August 9, 2018, the Company entered into an Underwriting Agreement (the “Underwriting Agreement”) with National Securities Corporation (the “Underwriter”), relating to the public offering and sale (the “2018 Offering”) of 9,000,000 shares of our Common Stock at a price per share of $1.15 for aggregate gross proceeds of $10.4 million. This offering closed on August 13, 2018.  Pursuant to the Underwriting Agreement, the Company granted the Underwriter a 45-day option to purchase from the Company up to an additional 1,350,000 shares of Common Stock at the offering price to cover over allotments, if any. On August 14, 2018, the Underwriter exercised its over-allotment option and acquired an additional 1,288,800 shares of Common Stock at a price per share of $1.15 for aggregate gross proceeds of $1.4 million. The over-allotment closing occurred on August 14, 2018. The Company used the net proceeds from this offering for working capital, general corporate purposes and repayment of debt and other obligations.

 

The 2018 Offering was made pursuant to the Company’s effective shelf registration statement on Form S-3 (Registration No. 333-213100), including the prospectus dated December 23, 2016 contained therein, as the same was supplemented, as well as a preliminary prospectus supplement and final prospectus supplement filed with the SEC on August 8, 2018 and August 9, 2018, respectively, in connection with the Company’s takedown relating to the Offering. 

 

The Underwriting Agreement contains customary representations, warranties and agreements by the Company, customary conditions to closing, indemnification obligations of the Company and the Underwriters, including for liabilities under the Securities Act of 1933, as amended, other obligations of the parties and termination provisions.  The representations, warranties and covenants contained in the Underwriting Agreement were made only for purposes of such agreement and as of specific dates, were solely for the benefit of the parties to such agreement and may be subject to limitations agreed upon by the contracting parties.

 

Pursuant to the Underwriting Agreement, subject to certain exceptions, the Company, its directors and officers have agreed not to sell or otherwise dispose of any of the Company’s securities held by them for a period ending 90 days after the date of the Underwriting Agreement without first obtaining the written consent of National Securities Corporation, as representative of the Underwriters, subject to certain exceptions.

 

11. RELATED PARTIES 

 

The Company obtains its business and casualty insurance through Assured Partners LP, which one of our directors, Gerald Budde, is the CFO of the Eastern Region. Mr. Budde did not oversee the transaction as the transaction was not in his region nor was he paid any portion of the brokerage fee. Assured Partners LP received revenue of approximately $79 thousand on insurance policies totaling approximately $658 thousand in premiums in 2018. 

 

 F-26

 

 

12.

SUBSEQUENT EVENTS 

 

The company has evaluated subsequent events for potential recognition and disclosures through the date the consolidated financial statements were filed.

 

Subscription Agreement

 

Commencing February 11, 2019, the “Company entered into and closed Subscription Agreements with accredited investors (the “February 2019 Accredited Investors”) pursuant to which the February 2019 Accredited Investors purchased 1,499,684 shares of the Company’s common stock for a purchase price of $1,365,000. If, prior to the six month anniversary, the Company issues shares of its common stock for a purchase price per share less than the purchase price paid by the February 2019 Accredited Investors subject to standard carve-outs (a “Down Round”), the Company will issue additional shares of common stock (for no additional consideration) to the February 2019 Accredited Investors such that the effective purchase price per share is equal to the purchase price per share paid in the Down Round. Benjamin Samuels and Gerald Budde, directors of the Company, acquired 841,928 and 26,310 shares of common stock, respectively, as part of this offering, provided, however, their per share purchase was $0.9501, which was above the closing price the date prior to close and they did not receive the Down Round protection.

  

13. QUARTERLY FINANCIAL DATA (UNAUDITED) 

 

   Sales   Gross Loss   Net Loss   Basic and diluted loss per share 
2018                
First Quarter  $560,229   $(1,154,141)  $(6,417,806)  $(0.16)
Second Quarter   170,684    (1,485,221)   (6,909,297)   (0.18)
Third Quarter   10,997    (1,465,825)   (5,485,553)   (0.12)
Fourth Quarter   21,263    (11,085,205)   (17,689,660)   (0.28)
2017                    
First Quarter   1,570,037    (2,742,051)   (7,920,606)   (0.24)
Second Quarter   252,000    (743,925)   (9,178,700)   (0.26)
Third Quarter   3,066,000    (4,492,082)   (12,412,088)   (0.35)
Fourth Quarter   5,150,423    (6,500,345)   (11,705,394)   (0.32)

 

 F-27

 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

(a) Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Annual Report. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of the period covered by this Annual Report, our disclosure controls and procedures were not effective because of material weaknesses in our internal control over financial reporting as discussed below.

 

Notwithstanding these material weaknesses, our Chief Executive Officer and Chief Financial Officer have concluded that the Consolidated Financial Statements included in this Annual Report on Form 10-K present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 and the consolidated results of operations and cash flows for each of the fiscal years presented herein in conformity with U.S. generally accepted accounting principles.

 

(b) Management’s Annual Report on Internal Control Over Financial Reporting

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as required by Sarbanes-Oxley (“SOX”) Section 404(a). The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Principal Executive Officer and Principal Financial Officer and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external purposes in accordance with United States generally accepted accounting principles.

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with US GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is 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.

 

34

 

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. In connection with management’s assessment of our internal control over financial reporting as required under SOX, we identified the following material weaknesses in our internal control over financial reporting as of December 31, 2018:

 

  The Company has not established adequate financial reporting monitoring activities to mitigate the risk of accounting errors.

 

  The lack of a fully implemented enterprise resource planning (“ERP”) system caused over reliance on manual entries.

 

Because of the material weaknesses noted above, management has concluded that it did not maintain effective internal control over financial reporting as of December 31, 2018, based on Internal Control over Financial Reporting - Guidance for Smaller Public Companies issued by COSO.

 

Remediation of Material Weaknesses in Internal Control over Financial Reporting

 

As a response, the company believes the following measures will adequately address the weakness:

 

  Complete implementation of the ERP system modules covering purchase orders and inventory.

 

  Hire an international accounting firm to assist the company with a broad-based review of our internal control environment including the identification of controls gaps and implementation of controls to remediate those gaps.

 

The independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report has issued an attestation report on the Company’s internal control over financial reporting attestation report which appears herein.

 

(c) Changes in Internal Control over Financial Reporting

 

Except as noted above, there were no changes in our internal control over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the year ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The officers and director of the Company are as follows:

 

Name   Age   Position
Raymond J. Chess   61   Director, Chairman
Harry DeMott   52   Director
H. Benjamin Samuels   51   Director
Gerald B. Budde   57   Director
Michael L. Clark   46   Director
Stephen S. Burns   58   Former Director, Chief Executive Officer, Secretary and Treasurer
Duane A. Hughes   55   President and Chief Executive Officer
Paul Gaitan   59   Chief Financial Officer

 

Officers are elected annually by the Board of Directors (subject to the terms of any employment agreement) to hold such office until an officer’s successor has been duly appointed and qualified, unless an officer sooner dies, resigns or is removed by the Board.

 

Our officers and directors have not been the subject of any order, judgment, or decree of any court of competent jurisdiction, or any regulatory agency permanently or temporarily enjoining, barring, suspending or otherwise limiting them from acting as an investment advisor, underwriter, broker or dealer in the securities industry, or as an affiliated person, director or employee of an investment company, bank, savings and loan association, or insurance company or from engaging in or continuing any conduct or practice in connection with any such activity or in connection with the purchase or sale of any securities.

 

Our officers and directors have not been convicted in any criminal proceeding (excluding traffic violations) and are not the subject of any criminal proceedings which are currently pending.

 

Background of Executive Officers and Directors

 

Raymond J. Chess, Director Chairman

 

Prior to joining the Company, Mr. Chess served as a Global Vehicle Line Executive for General Motors Co. (“GM”), where he was responsible for global, cross functional general management of the GM crossover market segment from May 2009 through December 2012. Prior to that, from August 2001 until April 2009, Mr. Chess was responsible for GM’s commercial truck segment. Previous GM assignments included leadership roles in the full-size truck segment, metal fabrication and body assembly. Mr. Chess is currently an independent director for Rush Enterprises (ticker: RUSHA). Mr. Chess’s background includes broad, hands-on manufacturing leadership roles with manufacturing engineering and manufacturing floor operations. Mr. Chess holds a Bachelor of Science degree in Mechanical Engineering from Kettering University and an MBA from Indiana University.

 

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H. Benjamin Samuels, Director

 

Mr. Samuels served as CEO of Victory Packaging from May 2007 through 2015, during which time he led an executive team which currently manages more than 1,500 employees. In 2015, Mr. Samuels was appointed as Co-President after Victory Packaging was acquired by KapStone Paper and Packaging Corporation. From 1997 through 2007, Mr. Samuels served as Vice Chairman and leader of Victory Packaging’s national accounts group, real estate, finance and legal departments, achieving a period of unprecedented growth in sales and revenues. Mr. Samuels joined Victory Packaging in 1995 as its regional operating manager of Texas. Mr. Samuels is an active member in the community, where he served as the Chairman of the Houston Food Bank. Samuels serves on the boards of and holds leadership positions with Teach For America, Children at Risk, Brighter Bites, Move For Hunger, American Jewish Committee, Leo Baeck Education Center Foundation, and Jewish Federation of Greater Houston. Mr. Samuels received a Bachelor’s Degree in American studies and economics from Amherst College in Massachusetts well as an MBA from the Harvard Graduate School of Business Administration.

 

Gerald Budde, Director

 

Mr. Budde is currently the Eastern Regions Chief Financial Officer of AssuredPartners, Inc. Mr. Budde started his career in public accounting with EY after graduating with a Bachelor of Science degree in Accounting from the University of Dayton. After almost eleven years with EY as a licensed CPA, Mr. Budde was hired in April 1994 by Cincinnati Milacron Inc. Mr. Budde was appointed as Machine Tool Group Controller in January 1995, became the Vice President of Finance for Cincinnati Machine, a successor company, in October 1998, and was subsequently appointed as Vice President of Finance and Administration for UNOVA Manufacturing Technologies in 2002. Mr. Budde left UNOVA in 2003 to become the Chief Financial Officer at Neace Lukens, who was acquired by AssuredPartners in 2011.  Prior to his current role, Mr. Budde was previously the Chief Financial Officer of AssuredPartners NL, LLC overseeing multiple AssuredPartners entities.  Mr. Budde is currently a member of the Board of Trustees and the Finance Committee for Mount Notre Dame high school and is also a member of the Finance Commission for St Margaret of York parish and school. Mr. Budde’s business, management, and accounting knowledge and experience led to the conclusion he should serve on the Board of Directors, given the Company’s business and structure.

 

Harry DeMott, Director

 

Mr. DeMott, has more than 25 years of experience in the investment community, having worked as an analyst and portfolio manager at leading brokerage firms and investment management firms. He has also served on the boards of several companies. He is a long-time operator and investor in the media, sports and entertainment industries. He is the co-founder of Raptor Ventures I LP, where he has been a General Partner since February 2011. In addition, Mr. DeMott is a member of the Board of Directors of Proper (where he also serves as executive Chairman), Hi.Fi, SecurityPoint Media and Ticket Evolution.

 

He also serves as founder and managing partner for Hamerle Investments, a family investment company. Prior to co-founding Raptor Ventures, Mr. DeMott served on the Board of Directors of Pandora Media, Inc. from 2006 through 2011. Earlier, he served as senior analyst at Knighthead Capital Management, analyst at King Street Capital Management, portfolio manager at Bourgeon Capital Management and managing member and founder at Gothic Capital Management. During this 16-year period, Mr. DeMott focused on finding, fostering and investing in disruptive technology companies. He previously spent nine years at First Boston (now Credit Suisse), where he was a director in the equity research division specializing in radio, TV, outdoor advertising and cell towers. He earned a Bachelor of Arts in economics from Princeton University in 1988 and a MBA in finance from New York University in 1991.

 

37

 

 

Michael Clark, Director

 

Mr. Clark has served as a director of Halcón Resources (NYSE: HK) since September 2016 and currently serves as Chairman of the Nominating and Corporate Governance Committee and as a member of the Compensation Committee.  He also currently serves as a director of privately-held Laws Whiskey House, an award-winning craft distiller.  Mr. Clark has also served as a director of Paragon Offshore Ltd., as Chairman of the Corporate Governance and Compensation Committee and a member of its Audit Committee from July 2017 until its sale to Borr Drilling Limited in March 2018. Mr. Clark is a Chartered Financial Analyst (CFA) Charterholder with over seventeen years of investment valuation and capital markets experience investing experience focused on energy equities and basic materials. Mr. Clark was a Retired Partner of SIR Capital Management, LLC from 2014 until his departure in 2016 and from 2008 to 2013 served as a Portfolio Manager and Partner. Prior to that, Mr. Clark valued equities as a Portfolio Manager at Satellite Asset Management, LLC from 2005 to 2007 and as an Equity Research Analyst at SAC Capital Management, LLC from 2003 to 2005 and at Merrill Lynch from 1997 to 2002. Mr. Clark began his career at Deloitte & Touche, LLP, progressing to Senior Auditor. He is a Certified Public Accountant licensed in New York State and also holds the Accredited in Business Valuation (ABV) credential awarded by the American Institute of Certified Public Accountants. The National Association of Corporate Directors (NACD) recognizes him as a NACD Governance Fellow in 2017. Mr. Clark graduated cum laude from the University of Pennsylvania with a Bachelor of Arts in Economics and earned a Master of Business Administration in Finance and Economics with Distinction (top 10%) from New York University’s Stern School of Business.  Mr. Clark’s qualifications to serve on the board include his public company board service and his wealth of accounting, valuation and capital markets experience.

 

Stephen S. Burns, Former Director, Chief Executive Officer, Treasurer and Secretary 

 

Mr. Burns is a Co-Founder in the Company and has served as the Company’s CEO since inception. Mr. Burns was appointed as CEO, and Secretary of the Company on December 28, 2009. Mr. Burns had founded several companies, most recently iTookThisOnMyPhone.com, a mobile photo and video-sharing technology company, MobileVoiceControl, Inc. a developer of high-end speech recognition software for smartphones sold to Nuance Communications (NASDAQ:NUAN), Inc. in 2006, AskMeNow [OTC:AKMN] a mobile search and information delivery system sold to Ocean West Holdings in 2005, PocketScript, the leading mobile electronic prescription system in the world which was sold to ZixCorp [NASDAQ:ZIXI] in 2002, Over The Line/AdLink, sold to Gannett Co. Inc. (NYSE:GCI) in 1994 and the design and development of Suspension Parameter Measurement Machines. Mr. Burns resigned his positions with the Company as of January 30, 2019.

 

Duane A. Hughes, President and Chief Executive Officer

 

Mr. Hughes is a senior-level executive with more than 20 years of experience including direct business relationships in the automotive, advertising, and technology segments and is currently serving as our President and Chief Executive Officer. Prior to that, Mr. Hughes was the President and Chief Operating Officer of Workhorse from 2015 to 2019. Prior to joining Workhorse/AMP Electric Vehicles, Duane served as Chief Operating Officer for Cumulus Interactive Technologies Group. As COO, Duane was responsible for managing the company’s day-to-day sales and operations. He was responsible for all operations of the business unit. Prior to Cumulus ITG, Duane spent nearly fifteen years in senior management positions with Gannett Co., Inc., including his duties as Vice President of Sales and Operations for Gannett Media Technologies International.

 

38

 

 

Paul Gaitan, Chief Financial Officer

 

Mr. Gaitan is a finance executive with over 30 years of experience working for manufacturing companies in the automotive, building products and consumer products space. Paul has led business integrations, developed strategy, and implemented advanced product costing approaches. He has held roles such as Production Manager, Controller, VP of Finance and CFO driving change by addressing both systems and personnel. Paul works collaboratively to design and deliver insightful information that leads to high quality decisions by the executive team. He earned a Bachelor of Science degree in finance from the University of Southern California and an MBA from the Stanford Graduate School of Business.

 

Family Relationships

 

There are no family relationships among our directors and executive officers. There is no arrangement or understanding between or among our executive officers and directors pursuant to which any director or officer was or is to be selected as a director or officer.

 

Involvement in Certain Legal Proceedings

 

To our knowledge, during the last ten years, none of our directors and executive officers has:

 

  Had a bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time.
     
  Been convicted in a criminal proceeding or been subject to a pending criminal proceeding, excluding traffic violations and other minor offenses.
     
  Been subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities.
     
  Been found by a court of competent jurisdiction (in a civil action), the SEC, or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
     
  Been the subject to, or a party to, any sanction or order, not subsequently reverse, suspended or vacated, of any self-regulatory organization, any registered entity, or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

 

39

 

 

CORPORATE GOVERNANCE

 

Governance Policies of the Board of Directors

 

The Board of Directors has adopted Governance Policies of the Board of Directors to assist the Board in the exercise of its duties and responsibilities and to serve the best interests of the Company and its stockholders. These policies provide a framework for the conduct of the Board’s business.

 

Committees

 

Establishment of Board Committees and Adoption of Charters

 

On December 17, 2015, the Company established a Nominating and Corporate Governance Committee, a Compensation Committee and an Audit Committee (collectively, the “Committees”) and approved and adopted charters to govern each of the Committees. 

 

In connection with the establishment of the Nominating and Corporate Governance Committee, Compensation Committee and Audit Committee, the Board of Directors of the Company appointed members to each such committee. Currently, all three committees are comprised of at least three (3) directors meeting the requirements set forth in each applicable charter. The membership of these three standing committees of the Board of Directors of the Company is as follows: 

 

Nominating and Corporate Governance Committee   Compensation Committee   Audit Committee
         
Raymond Chess (Chairman)   Harry DeMott (Chairman)   Gerald Budde (Chairman)
Gerald Budde   Gerald Budde   Raymond Chess
Harry DeMott   Benjamin Samuels   Benjamin Samuels
    Michael Clark   Michael Clark

 

40

 

 

Nominating and Corporate Governance Committee.

 

Our board of directors has determined that each of the members of the Governance Committee is an “independent director” as defined by the rules of The NASDAQ Stock Market, Inc. The Governance Committee is generally responsible for recommending to our full board of directors’ policies, procedures, and practices designed to help ensure that our corporate governance policies, procedures, and practices continue to assist the board of directors and our management in effectively and efficiently promoting the best interests of our stockholders. The Governance Committee is also responsible for selecting and recommending for approval by our board of directors and our stockholders a slate of director nominees for election at each of our annual meetings of stockholders, and otherwise for determining the board committee members and chairmen, subject to board of directors ratification, as well as recommending to the board director nominees to fill vacancies or new positions on the board of directors or its committees that may occur or be created from time to time, all in accordance with our bylaws and applicable law. The Governance Committee’s principal functions include:

 

  developing and maintaining our corporate governance policy guidelines;

 

  developing and maintaining our codes of conduct and ethics;

 

  overseeing the interpretation and enforcement of our Code of Conduct and our Code of Ethics for Chief Executive Officer and Senior Financial and Accounting Officers;

 

  evaluating the performance of our board of directors, its committees, and committee chairmen and our directors; and

 

  selecting and recommending a slate of director nominees for election at each of our annual meetings of the stockholders and recommending to the board director nominees to fill vacancies or new positions on the board of directors or its committees that may occur from time to time.

 

During 2018, the Governance Committee met one time. The Governance Committee is governed by a written charter approved by our board of directors. A copy of the Governance Committee’s charter is posted on the Company’s website at www.workhorse.com in the “Investors” section of the website. In identifying potential independent board of directors’ candidates with significant senior-level professional experience, the Governance Committee solicits candidates from the board of directors, senior management and others and may engage a search firm in the process. The Governance Committee reviews and narrows the list of candidates and interviews potential nominees. The final candidate is also introduced and interviewed by the board of directors and the lead director if one has been appointed. In general, in considering whether to recommend any particular candidate for inclusion in our board of directors’ slate of recommended director nominees, the Governance Committee will apply the criteria set forth in our corporate governance guidelines. These criteria include the candidate’s integrity, business acumen, commitment to understanding our business and industry, experience, conflicts of interest and the ability to act in the interests of our stockholders. Further, specific consideration is given to, among other things, diversity of background and experience that a candidate would bring to our board of directors. The Governance Committee does not assign specific weights to particular criteria and no particular criterion is a prerequisite for each prospective nominee. We believe that the backgrounds and qualifications of our directors, considered as a group, should provide a composite mix of experience, knowledge and abilities that will allow our board of directors to fulfill its responsibilities. Stockholders may recommend individuals to the Governance Committee for consideration as potential director candidates by submitting their names, together with appropriate biographical information and background materials to our Governance Committee. Assuming that appropriate biographical and background material has been provided on a timely basis, the Governance Committee will evaluate stockholder recommended candidates by following substantially the same process, and applying substantially the same criteria, as it follows for candidates submitted by others.

 

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Audit Committee.

 

We have a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our board of directors has determined that the members are all “independent directors” as defined by the rules of The NASDAQ Stock Market, Inc. applicable to members of an audit committee and Rule 10A-3(b)(i) under the Exchange Act. In addition, Mr. Budde is an “audit committee financial expert” as defined in Item 407(d)(5) of Regulation S-K and demonstrates “financial sophistication” as defined by the rules of The NASDAQ Stock Market, Inc. The Audit Committee is appointed by our board of directors to assist our board of directors in monitoring (1) the integrity of our financial statements, (2) our compliance with legal and regulatory requirements, and (3) the independence and performance of our internal and external auditors. The Audit Committee’s principal functions include:

 

  reviewing our annual audited financial statements with management and our independent auditors, including major issues regarding accounting and auditing principles and practices and financial reporting that could significantly affect our financial statements;
     
  reviewing our quarterly financial statements with management and our independent auditor prior to the filing of our Quarterly Reports on Form 10-Q, including the results of the independent auditors’ reviews of the quarterly financial statements;
     
  recommending to the board of directors the appointment of, and continued evaluation of the performance of, our independent auditor;
     
  approving the fees to be paid to our independent auditor for audit services and approving the retention of our independent auditor for non-audit services and all fees for such services;
     
  reviewing periodic reports from our independent auditor regarding our auditor’s independence, including discussion of such reports with the auditor;
     
  reviewing the adequacy of our overall control environment, including internal financial controls and disclosure controls and procedures; and
     
  reviewing with our management and legal counsel legal matters that may have a material impact on our financial statements or our compliance policies and any material reports or inquiries received from regulators or governmental agencies.

 

During 2018, the audit committee met four times. A copy of the Audit Committee’s charter is posted on the Company’s website at www.workhorse.com in the “Investors” section of the website.

 

Meetings may be held from time to time to consider matters for which approval of our Board of Directors is desirable or is required by law.

 

Compensation Committee.

 

A full discussion of our compensation committee can be found under Item 11 – Executive Compensation.

 

Company Policies

 

The Company has established the following written policies that have been distributed and reviewed with all Company employees: Approval policy, Purchase Requisition policy, Conflict of Interest policy, “Do the Right Thing” (ethics) policy and a Travel and Expense policy.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers and persons who own more than 10% of the issued and outstanding shares of our common stock to file reports of initial ownership of common stock and other equity securities and subsequent changes in that ownership with the SEC. Officers, directors and greater than ten percent stockholders are required by SEC regulation to furnish us with copies of all Section 16(a) forms they file. To our knowledge, based solely on a review of the copies of such reports furnished to us and written representations that no other reports were required, during the fiscal year ended December 31, 2018 all Section 16(a) filing requirements applicable to our officers, directors and greater than 10% beneficial owners were complied with.

 

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ITEM 11. EXECUTIVE COMPENSATION

 

Compensation Discussion and Analysis 

 

Oversight of Executive Compensation Program

 

Compensation Committee.

 

Our compensation committee consists of Harry DeMott, Gerald Budde, Michael Clark and Benjamin Samuels. Our board of directors has determined that each of the members are an “independent director” as defined by the rules of The NASDAQ Stock Market, Inc. applicable to members of a compensation committee. The Compensation Committee is responsible for establishing the compensation of our senior management, including salaries, bonuses, termination arrangements, and other executive officer benefits as well as director compensation. The Compensation Committee also administers our equity incentive plans. During 2018, the Compensation Committee meet one time. The Compensation Committee is governed by a written charter approved by the board of directors. A copy of the Compensation Committee’s charter is posted on the Company’s website at www.workhorse.com in the “Investors” section of the website. The Compensation Committee works with the Chairman of the Board and Chief Executive Officer and reviews and approves compensation decisions regarding senior management including compensation levels and equity incentive awards. The Compensation Committee also approves employment and compensation agreements with our key personnel and directors. The Compensation Committee has the power and authority to conduct or authorize studies, retain independent consultants, accountants or others, and obtain unrestricted access to management, our internal auditors, human resources and accounting employees and all information relevant to its responsibilities.

  

The responsibilities of the Compensation Committee, as stated in its charter, include the following:

 

  review and approve the Company’s compensation guidelines and structure;
     
  review and approve on an annual basis the corporate goals and objectives with respect to compensation for the Chief Executive Officer;
     
  review and approve on an annual basis the evaluation process and compensation structure for the Company’s other officers, including salary, bonus, incentive and equity compensation; and
     
  periodically review and make recommendations to the Board of Directors regarding the compensation of non-management directors.

 

The Compensation Committee is responsible for developing the executive compensation philosophy and reviewing and recommending to the Board of Directors for approval all compensation policies and compensation programs for the executive team.

 

Overview of Executive Compensation

 

The Company recognizes that people are our primary asset and our principal source of competitive advantage. In order to recruit, motivate and retain the most qualified individuals as senior executive officers, the Company strives to maintain an executive compensation program that is competitive in the commercial transportation industry, which is a competitive, global labor market.

 

The Compensation Committee’s compensation objective is designed to attract and retain the best available talent while efficiently utilizing available resources. The Compensation Committee compensates executive management primarily through base salary and equity compensation designed to be competitive with comparable companies, and to align management’s compensation with the long-term interests of shareholders. In determining executive management’s compensation, the Compensation Committee also takes into consideration the financial condition of the Company and discussions with the executive.

 

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In order to accomplish our goals and to ensure that the Company’s executive compensation program is consistent with its direction and business strategy, the compensation program for our senior executive officers is based on the following objectives:

 

  to attract, motivate, retain and reward a knowledgeable and driven management team and to encourage them to attain and exceed performance expectations within a calculated risk framework; and
     
  to reward each executive based on individual and corporate performance and to incentivize such executives to drive the organization’s current growth and sustainability objectives.

 

The following key principles guide the Company’s overall compensation philosophy:

 

  compensation is designed to align executives to the critical business issues facing the Company;
     
  compensation should be fair and reasonable to shareholders and be set with reference to the local market and similar positions in comparable companies;
     
  an appropriate portion of total compensation should be equity-based, aligning the interests of executives with shareholders; and
     
  compensation should be transparent to the Board of Directors, executives and shareholders.

 

Compensation Elements and Rationale

 

There are two basic components to the Company’s executive compensation program: base salary and long-term incentive equity compensation. The Compensation Committee determined that it would continue evaluating and evolving the compensation program design against best market practices as the Company experiences further growth. We intend to add short-term incentive cash awards in the near future.

 

Base Salary

 

Base salary is the foundation of the compensation program and is intended to compensate competitively relative to comparable companies within our industry and the marketplace where we compete for talent. Base salary is a fixed component of the compensation program and is used as the base to determine elements of incentive compensation and benefits.

 

Long-Term Incentive (Equity)

 

The Company’s long-term incentive program provides for the granting of stock options to executive officers to both motivate executive performance and retention, as well as to align executive officer performance to shareholder value creation. In awarding long-term incentives, the Company compares the long-term incentive program to that of comparable companies within our industry and evaluates such factors as the number of options available under its Stock Incentive Plan and the number of options outstanding relative to the number of shares outstanding. The Company has historically sought to award stock options on a competitive basis based on a comparison with comparable companies.

 

Each long-term incentive grant is based on the level of the position held and overall market competitiveness. The Compensation Committee takes into consideration previous grants when it considers new grants of options.

 

The Board of Directors fixes the exercise price of stock options at the time of the grant based on the market price on the Nasdaq.

 

During the year ended December 2017, long-term equity incentive plan awards were awarded to the executive officers in the form of stock options. There were no long-term equity incentive plan awards for the year ended December 31, 2018.

 

Our Board of Directors adopted the Company’s 2017 Stock Incentive Plan. On August 7, 2017 our shareholders ratified the 2017 Stock Incentive Plan.

 

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The following table summarizes the pay mix for the executive officers and illustrates the percentage of fixed versus at-risk pay for the fiscal year ended December 31, 2018:

 

Name and Principal Position  Base Salary   Stock Options (LTIP) 
Stephen S. Burns   100%         0%
CEO and Director          
           
Duane Hughes   100%   0%
President and Chief Operating Officer          
           
Paul Gaitan   100%   0%
Chief Financial Officer          

 

Non-Cash Compensation

 

The Company provides standard health benefits to its executives, including medical, dental and disability insurance.

 

The Company’s non-cash compensation is intended to provide a similar level of benefits as those provided by comparable companies within our industry.

 

Review of Executive Officer Performance

 

On an annual basis, the Compensation Committee reviews the overall compensation package for our executive officers and evaluates executive officer performance relative to corporate goals. The Compensation Committee has the opportunity to meet with the executive officers at various times throughout the year, which assists the Compensation Committee in forming its own assessment of each individual’s performance. The executive officers are not present during voting or deliberations of the Compensation Committee relating to executive compensation.

 

In determining the compensation for the executive officers, the Compensation Committee considers compensation paid to executive officers of other companies within the industry, the executive’s performance in meeting goals, the complexity of the management position and the experience of the individual. During 2018, the Company’s operations were still in development and no significant portion of the executive’s pay was linked to performance goals.

 

Executive and Director Compensation

 

Director Compensation 

 

On October 24, 2013, Raymond J. Chess was appointed as a director of the Company. Prior to joining the Board of Directors, Mr. Chess served on our advisory board pursuant to which he received a stock option to acquire 10,000 shares of common stock at an exercise price of $2.50 per share. On October 24, 2013, Mr. Chess entered into a letter agreement with the Company pursuant to which he was appointed as a director of the Company in consideration of an annual fee of $40,000. Additionally, the Company granted Mr. Chess options to purchase 50,000 shares of the Company’s common stock at $2.60 per share. The options will expire five years from the vesting period with 10,000 options vesting upon the signing of the agreement and 4,000 every six months thereafter for a total of 50,000 shares.

  

On December 17, 2015, Messrs. Budde and Samuels entered into letter agreements with the Company pursuant to which they were each appointed as directors of the Company in consideration of an annual fee of $40,000.  Additionally, the Company granted Messrs. Budde and Samuels options to purchase 50,000 shares of the Company’s common stock at $7.01 per share.  The options will expire five years from the vesting period with 10,000 options vesting upon the signing of the agreement and 4,000 every June 30 and December 31 thereafter for a total of 50,000 shares.

 

On September 14, 2016, Mr. DeMott entered into a letter agreement with the Company pursuant to which he was appointed as a director of the Company in consideration of an annual fee of $40,000. Additionally, the Company granted Mr. DeMott an option to purchase 50,000 shares of the Company’s common stock at $8.20 per share. The option will expire five (5) years from the vesting period with 10,000 options vesting upon the signing of the agreement and 4,000 every June 30 and December 31 thereafter for a total of 50,000 shares.

 

On July 6, 2018, the Company, as borrower, entered into a Loan Agreement with a fund managed by Arosa Capital Management LP (“Arosa”), as lender, providing for a term loan in the principal amount of $6,100,000 (the “Loan Agreement”). Pursuant to the Loan Agreement, the Company is required to appoint to the Board of Directors a person designated in writing by Arosa for a period of no less than 12 months. Mr. Clark was designated by Arosa. Except as set forth herein, there is no understanding or arrangement between Mr. Clark and any other person pursuant to which Mr. Clark was selected as a director of the Company.  Mr. Clark does not have any family relationship with any director, executive officer or person nominated or chosen by us to become a director or an executive officer.  Since January 1, 2016, Mr. Clark has not had a direct or indirect material interest in any transaction or proposed transaction, in which the Company was or is a proposed participant exceeding $120,000.  On September 28, 2018, Mr. Clark entered into letter agreements with the Company pursuant to which he was appointed as director of the Company in consideration of an annual fee of $40,000.  Additionally, the Company granted Mr. Clark options to purchase 50,000 shares of the Company’s common stock at $1.10 per share.  The options will expire five years from the vesting period with 10,000 options vesting upon the signing of the agreement and 4,000 every June 30 and December 31 thereafter for a total of 50,000 shares.

 

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The Company’s compensation policy for the above directors was based on comparisons of other companies’ remunerations made to their Chairman and other directors and the value of their expertise to the Company.

 

Executive Compensation

 

Messrs. Burns, Hughes and Gaitan are retained according to employment agreements with our Company, and each individuals’ compensation for serving as an executive officer of the Company is disclosed below in the “Summary Compensation Table”. The compensation committee is presently contemplating amending and/or restating the employment agreements to provide for a uniform structure and in order to appropriately update such agreements.

 

The Company’s compensation policy for each of the above parties is based on comparisons of other companies’ remunerations made to each of the respective positions and the value of each executive’s expertise to the Company.

 

Pension Benefits

 

None.

 

Non-Qualified Deferred Compensation

 

None.

 

Retirement, Resignation or Termination Plans

 

Each of the Company’s executive employment agreements with Messrs. Burns, Hughes and Gaitan contemplates the case of termination due to various provisions whereby the named executive officers will receive severance payments, as described below.

 

Compensation and Risk

 

We do not believe that our compensation policies and practices are reasonably likely to have a material adverse effect on us. We have taken steps to ensure our executive compensation program does not incentivize risk outside the Company’s risk appetite. Some of the key ways that we currently manage compensation risk are as follows:

 

  appointed a Compensation Committee which is composed entirely of independent directors to oversee the executive compensation program;
     
  the use of deferred equity compensation in the form of stock options to encourage a focus on long-term corporate performance versus short-term results; and
     
  disclosure of executive compensation to stakeholders;

 

Consideration of Most Recent Shareholder Advisory Vote on Executive Compensation

 

As required by Section 14A of the Exchange Act, at our 2018 Annual Meeting of Stockholders our stockholders voted, in an advisory manner, on a proposal to approve our named executive officer compensation. This was our most recent stockholder advisory vote to approve named executive officer compensation. The proposal was approved by our stockholders, receiving approximately 91% of the vote of the stockholders present in person or represented by proxy and voting at the meeting. We considered this vote to be a ratification of our current executive compensation policies and decisions and, therefore, did not make any significant changes to our executive compensation policies and decisions based on the vote.

 

Compensation Committee Interlocks and Insider Participation

 

No person who served as a member of our Compensation Committee during Fiscal 2018 was a current or former officer or employee of our Company or engaged in certain transactions with our Company required to be disclosed by regulations of the SEC. Additionally, during Fiscal 2018 there were no Compensation Committee “interlocks,” which generally means that no executive officer of our Company served: (a) as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity which had an executive officer serving as a member of our Company’s Compensation Committee; (b) as a director of another entity which had an executive officer serving as a member of our Company’s Compensation Committee; or (c) as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity which had an executive officer serving as a director of our Company.

 

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Compensation Committee Report

 

The Compensation Committee has reviewed and discussed the foregoing compensation discussion and analysis with Company management. Based on that review and those discussions, the Compensation Committee recommended to the Board of Directors that the compensation discussion and analysis be included in this Annual Report. This report is provided by the following independent directors, who comprise the Compensation Committee: Harry DeMott, Benjamin Samuels and Gerald Budde.

 

The following summary compensation table sets out details of compensation paid to (a) our principal executive officer; (b) each of our two most highly compensated executive officers who served as executive officers during the fiscal year ended December 31, 2018; and (c) up to two additional individuals for whom disclosure would have been provided under (b) but for the fact that the individual was not serving as our executive officer at the end of the fiscal year ended December 31, 2018, except that no disclosure is provided for any named executive officer, other than our principal executive officer, whose total compensation did not exceed $100,000 for the fiscal year ended December 31, 2018:

 

Summary Compensation Table

 

Name and Principal Position   Year     Salary
($)
  Bonus
($)
  Stock Awards
($)
Option Awards
($)
    Non-equity Incentive Plan Compensation     Change in Pension Value and Non Qualified Preferred Compensation Earnings
($)
    All Other Compensation
($)
    Total
($)
 
Stephen S. Burns   2018       350,000           -                               350,000  
CEO and Director   2017       343,750           1,991,000                               2,334,750  
    2016       275,000           231,231                               506,231  
                                                           
Duane Hughes   2018       275,000           -                               275,000  
President and Chief Executive Officer   2017       253,750           796,400                               1,050,150  
    2016       144,000           125,063                               269,063  
                                                           
Paul Gaitan   2018       200,000           -                               200,000  
Chief Financial Officer   2017       200,000           322,200                               522,200  

 

Employment Agreements

 

On May 19, 2017, Stephen S. Burns and the Company entered into an Executive Retention Agreement whereby Mr. Burns was retained as Chief Executive Officer in consideration of an annual salary of $325,000. Further, the Company entered Executive Retention Agreements with Duane Hughes as President and Chief Operating Officer at an annual salary of $275,000. The Company also granted stock options exercisable at $5.28 per share to Mr. Burns and Mr. Hughes to acquire 1,000,000 and 400,000 shares of common stock of the Company, respectively, which are exercisable for a period of ten years. The Stock Options vest in 16 equal quarterly tranches. On August 9, 2017, the Company and Mr. Rodriguez entered a letter agreement amending certain terms of his Executive Retention Agreement dated May 19, 2017, pursuant to which Mr. Rodriguez agreed to serve as the Chief Information Officer at a salary of $250,000 per year with stock options exercisable at $5.28 per share to acquire 300,000 shares of common stock of the Company, which are exercisable for a period of ten years vesting over four years in instalments of 18,750 shares. On August 9, 2017, Paul Gaitan and the Company entered into an Executive Retention Agreement whereby Mr. Gaitan was retained as Chief Financial Officer in consideration of an annual salary of $200,000. The Company also granted stock options exercisable at $2.74 per share to Mr. Gaitan to acquire 200,000 shares of common stock of the Company, which are exercisable for a period of ten years. The Stock Options vest in 16 equal quarterly tranches.

 

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For each executive, the Company has agreed to provide a bonus of 25% of their base salary upon the Company achieving 75% of annual revenue targets established by the Board of Directors and management. The cash bonus will be increased to 37.5% and 50% of the base salary in the event that 100% or 125% of the revenue target is achieved, respectively. The Company and the executives also each entered into an Indemnification Agreement. The employment of each of the executives is at will and may be terminated at any time, with or without formal cause.

 

Pursuant to the terms of the executive retention agreements in certain circumstances, the Company has agreed to provide specified severance and bonus amounts and to accelerate the vesting on their equity awards upon termination upon a change of control or an involuntary termination, as each term is defined in the agreements. In the event of a termination upon a change of control or an involuntary termination, the executives are entitled to receive an amount equal to 12 months of their base salary and the target bonus then in effect for the executive officer for the year in which such termination occurs, such bonus payment to be pro-rated to reflect the full number of months the executive remained in the Company’s employ. In addition, the vesting on any equity award held by the executive officer will be accelerated in full upon a change of control or an involuntary termination. In the event the executive is terminated for cause, then the vesting of all equity awards shall cease and such equity awards will be terminated. In the event the executive leaves for any reason that is not considered a good reason, then the vesting of equity award shall cease. At the election of the executive officer, the Company will also continue to provide health related employee insurance coverage for twelve months, at the Company’s expense upon termination upon a change of control or an involuntary termination.

 

Grants of Plan Based Awards

 

There were no awards award to Named Executive Officers in 2018. We granted awards to the Named Executive Officers in the fiscal year ended December 31, 2017, as follows:

 

Name   Grant date   Threshold     Target     Maximum     All Other Stock Awards: Number of Shares of Stock or Units     All Other Stock Awards: Number of Securities Underlying     Exercise Price of Options Awards     Grant Data Fair Value of Stock and Options Awards  
Stephen S. Burns   5/22/2017             1,000,000               1,000,000               5.28       1.99  
CEO and Director                                                            
                                                             
Duane Hughes   5/19/2017             400,000               400,000               5.28       1.99  
President and Chief Operating Officer                                                            
                                                             
Julio Rodriguez   5/16/2017             300,000               300,000               5.28       1.99  
Chief Information Officer                                                            
                                                             
Paul Gaitan   8/6/2017             200,000               200,000               2.74       1.61  
Chief Financial Officer                                                            

 

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Option Exercises and Stock Vested

 

For the year ended December 31, 2018, 52,500 options were exercised for $65,250.

 

Outstanding Equity Awards

 

The following table sets forth information with respect to the outstanding equity awards of our principal executive officers and principal financial officer during 2018, and each person who served as an executive officer of the Company as of December 31, 2018:

 

Outstanding Equity Awards at Fiscal Year-End
Option Awards     Stock Awards  
Name and Principal Position     Number of Securities underlying unexercised options (#) Exercisable       Number of securities underlying unexercised options (#) Unexercisable       Equity Incentive Plan awards: Number of securities underlying unexercised options (3)       Options exercise price ($)     Option Expiration date     Number of shares or units of stock that have not vested (#)       Market value of shares or units of stock that have not vested ($)       Equity incentive plan awards: Number if unearned shares other rights that have not vested (#)       Equity incentive awards: Market or payout value of unearned shares, units or other rights that have not vested ($)  
Stephen S. Burns     437,500       562,500       0       5.28     5/17/2027     562,500       -       -       -  
CEO and Director     10,000       -       0       7.21     8/15/2021     -       -       -       -  
      35,000       -       0       7.21     8/15/2021     -       -       -       -  
      40,000       -       0       4.99     2/1/2021     -       -       -       -  
      50,000       -       0       1.75     8/11/2020     -       -       -       -  
      50,000       -       0       1.40     12/18/2019     -       -       -       -  
      16,667       -       0       0.10     6/30/2019     -       -       -       -  
      40,000       -       0       0.10     6/30/2019     -       -       -       -  
      50,000       -       0       0.10     6/30/2019     -       -       -       -  
      174,773       -       0       0.10     6/30/2019     -       -       -       -  
      30,000       -       0       7.20     12/5/2020     -       -       -       -  
                                                                     
Duane Hughes     200,000       200,000       0       5.28     5/17/2027     200,000       -       -       -  
President and Chief Operating Officer     22,000       -       0       7.21     8/15/2021     -       -       -       -  
      25,000       -       0       4.99     2/1/2021     -       -       -       -  
      20,000       -       0       1.75     8/11/2020     -       -       -       -  
                                                                     
Julio Rodriguez     150,000       150,000       0       5.28     5/18/2021     150,000       -       -       -  
Chief Information Officer     22,000       -       0       7.21     8/15/2021     -       -       -       -  
      25,000       -       0       4.99     2/1/2021     -       -       -       -  
      25,000       -       0       1.75     8/11/2020     -       -       -       -  
      15,000       -       0       1.40     12/18/2019     -       -       -       -  
      49,323       -       0