Energy Focus Inc (NASDAQ:EFOI) stock went ballistic today – jumping by $2 in early morning trading to settle in the $16-$17 range. The rise coincided with Roth Capital Partners’ snap decision to raise EFOI’s price target 7 bucks to $23 per share.
While bulls may argue EFOI’s business and margin improvement sparked the analyst’s write-up, we believe something less obvious may be going on here.
EFOI has in its back pocket $25 million worth of registered stock that it can freely sell to the public at any time.
With its eye on a potential stock offering and seeing the stock price trading around record levels in recent days, we believe Roth saw an opportunity to help push EFOI higher.
Indeed Roth analysts had provided an update the day after EFOI released positive earnings on Aug. 5. So it seems odd that Roth would provide a new release two weeks later with unchanged sales and EPS estimates. No real new information. Just a new head-scratcher price target.
Now that the already over-valued stock has rocketed even higher, Roth figures it’s sitting pretty in the cat-bird seat.
Roth is the only major firm covering EFOI and may be hoping to handle the stock offering that we believe will come very soon.
Indeed, in August 2014, Roth was EFOI’s lead underwriter in a 1.25 million stock offering at over $4 per share.
The looming 1.5 million or so shares, of course, would dilute stock now held by current shareholders. So, today’s $17 share might potentially sell for about $14 and change.
Here are highlights of even more risks facing EFOI and its investors:
- Materially Weak Financials
Management has found a material weakness in the way EFOI recognizes revenue. So a financial restatement could occur, as noted in the annual SEC filing here and below:
“We have identified a material weakness in our internal control over financial reporting which could, if not remediated, result in material misstatements in our financial statements.
As a public company reporting to the Securities and Exchange Commission, we are subject to the reporting requirements of the Securities Exchange Act of 1934, and the Sarbanes-Oxley Act of 2002, including section 404(a) that requires that we annually evaluate and report on our systems of internal controls.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission as of December 31, 2014. Based on this evaluation, management concluded that there was a material weaknesses identified in our internal controls as of December 31, 2014. The material weaknesses related to a lack of effective controls over revenue recognition. We are actively engaged in developing and implementing a remediation plan designed to address this material weakness. If our remedial measures are insufficient to address the material weakness, or if additional material weaknesses or significant deficiencies in our internal control are discovered or occur in the future, our financial statements may contain material misstatements and we could be required to restate our financial results.”
- Massive Competition; Unpredictable Repeat Business
The retail solar installation space is extremely competitive. The company also supplies LED lighting to the military. But its Navy product line is in competition with some fixture suppliers, as well as LED systems by giant lighting companies such as Royal Philips, Cree, Osram and GE.
EFOI won Navy contracts in 2011, 2014 and April 2015. While the Navy offers good opportunities for EFOI, contracts have been fulfilled or are nearly complete.
Unfortunately, military buying patterns are unpredictable and Navy-related revenue for 2016 and beyond is uncertain. Additionally, the company’s LEDs don’t need to be replaced for 10 year or so. That translates to limited recurring sales for replacements.
So the business is rough as a cobblestone road.
- Gross Margin Helps Catapult Stock; EFOI Warns Margin Will Drop
The stock and earnings beat expectations, thanks to the influence of 46 percent gross margin in the Navy business in the last quarter. But EFOI’s chief financial officer, Marcia Miller, warned the 46 percent Navy-driven margins would be short-lived during the recent earnings call:
“However, as our sales mix changes to include higher volume growth of our commercial product than our core Navy products, we would expect gross margins to start dropping from their current levels, although we have not seen or expect significant margin pressure yet from either military or commercial products.”
In the previous earnings call, executive chairman James Tu suggested those 41 percent margins were special to that quarter. And the long-term gross margin goal is 35 percent, he said:
“We believe that there are very large sales opportunities [indiscernible] worth margin over 35% to meet our long term goal… for the remainder of 2015.”
- Institutional Holders Cut Ownership Of EOFI
EOFI has received almost no attention from institutional holders, particularly from many recognizable institutions. And many of those who have held positions have begun cutting their positions. Decreased positions are nearly three times greater than increased positions in the stock, as shown below.
Here’s a snapshot of institutional investors that have recently decreased their positions in EFOI:
Circumstance, misunderstanding and hype appear to have turned EFOI into a massively overvalued stock.
Today’s analyst report ratcheted the risk substantially, setting up this screaming highflyer for a dive to reality.
A very fair valuation for EFOI stock would be about $7.50 per share.
Important Disclosure: The owners of TheStreetSweeper hold a short position in EFOI and stand to profit on any future declines in the stock price.