Workhorse Group Inc.: Form 10-Q for the period ended Mar 31, 2024

Overview

We are an American technology company with a vision to pioneer the transition to zero-emission commercial vehicles. Our primary focus is to provide sustainable and cost-effective solutions to the commercial transportation sector. We design and manufacture all-electric trucks, including the technology that optimizes the way these vehicles operate. We are focused on our core competency of bringing our electric delivery vehicle platforms to serve the last mile delivery market.

We continue to seek opportunities to grow the business organically, and by expanding relationships with existing and new customers. We believe we are well positioned to take advantage of long-term opportunities and continue our efforts to bring product innovations to market.

Recent Developments

Going Concern; Financing

As discussed more fully under Note 1, Summary of Business and Significant Accounting Principles; Liquidity, Capital Resources, and Going Concern, above, and Liquidity and Capital Resources; Going Concern, below, our ability to continue as a going concern is contingent upon successful execution of management’s intended plan over the next twelve months to improve the Company’s liquidity and working capital requirements. A vital component of such plan is the consummation of a financing to address these requirements in the short term.

Accordingly, on March 15, 2024, we entered into a securities purchase agreement (the “2024 Securities Purchase Agreement”) with an institutional investor (the “Investor”), under which we agreed to issue and sell, in one or more registered public offerings by the Company directly to the Investor, in multiple tranches over a period beginning on March 15, 2024, senior secured convertible notes for up to an aggregate principal amount of $139.0 million (the “2024 Notes”) that will be convertible into shares of the Company’s common stock, par value of $0.001 per share (the “Common Stock”) and warrants to purchase shares of Common Stock (the “2024 Warrants”). Pursuant to the 2024 Securities Purchase Agreement, on May 10, 2024, the Company issued and sold to the Investor a (i) 2024 Note in the original principal amount of $6,285,714 (the “First Additional 2024 Note”) and (ii) 2024 Warrant to purchase up to 36,785,453 shares of Common Stock (the “First Additional 2024 Warrant”). If we are not able to complete the additional closings or find another source of liquidity in the immediate future, we may be unable to continue our operations or may need to substantially reduce them.

The 2024 Securities Purchase Agreement provides additional closings of up to $123.7 million in aggregate principal amount of additional 2024 Notes and, if our share price makes such exercise feasible, the possible receipt of proceeds from the exercise of the corresponding 2024 Warrants pursuant to the 2024 Securities Purchase Agreement. Additional information concerning the 2024 Securities Purchase Agreement, the 2024 Notes, and the 2024 Warrants is set forth in Note 1 and Note 7 to the Condensed Consolidated Financial Statements.

Cost-saving Measures

Another vital component of management’s intended plan over the next twelve months to improve our liquidity and working capital requirements is reducing our operating costs to, among other things, reduce demands on the liquidity that is available to us. Accordingly, in the first quarter of 2024 we took the measures described below.

• We completed a reduction in force (the “RIF”) pursuant to which we terminated approximately 20% of our total workforce, excluding direct labor. We have not incurred and do not expect to incur material costs in connection with the RIF.
• Each of our executive officers agreed to defer payment of approximately 20% of their cash compensation into the second quarter of 2024.
• We decided to fully transition our Aero business from a design and manufacturing drone business to Drones as a Service business. This transition has resulted in, among other things, our stopping production and development of both drone product lines and the termination of employees who performed the related work.

In addition, on April 22, 2024, the Company furloughed 73 employees at its Union City manufacturing facility without pay. The Company expects the furloughs to provide operational savings and has not incurred, and does not expect to incur, material costs in connection with the furloughs. The Company is also currently working with certain of its vendors to extend or restructure the payment terms of certain of its accounts payable. The furloughs, salary deferrals and vendor discussions are part of the Company’s previously disclosed strategy to reduce costs. The Company currently intends to reinstate all furloughed employees when the Company’s financial and operational position permits. There can, however, be no assurance that all such furloughed employees will be available and willing to return to work.

Management plans to continue to seek additional opportunities to reduce costs and, in particular, cash expenditures, in a manner intended to minimize their adverse impact on our core operations. There can be no assurance that the measures described above, or any other cost-cutting measures we may implement in the future will be sufficient to address our immediate or longer-term liquidity and working capital needs. Moreover, it is possible that such measures will have an adverse effect on our operations.

Aero Drone Design and Manufacturing Operations

As previously disclosed in the Form 10-K and discussed above as part of our cost-saving measures, on February 20, 2024, our Board of Directors approved a plan to cease the production operations of our drone design and manufacturing business and transition to only operating as a Drones as a Service business. The decision to cease operation of our drone design and manufacturing product line was not considered a strategic shift having major effects on operations and therefore does not meet the criteria to qualify as a discontinued operation.

In addition to the decision to transition our Aero business to Drones as a Service business, the Company is currently working with a third party to complete the divestiture of its Aero business. The Company does not expect to realize cash proceeds upon consummation of the sale but expects the transition to a Drones as a Service business and the subsequent divestiture to provide operational savings. In addition, the Company expects that the final divestiture agreements will include limited earn-out provisions under which the Company would receive a portion of the proceeds if Aero realizes revenues from certain contingent sources. The Company expects to consummate this transaction during the second fiscal quarter of 2024.

NASDAQ Listing Requirements; Proposed Reverse Stock Split

As previously disclosed, on September 22, 2023, the Company received notice from Nasdaq indicating that the closing bid price for its common stock had fallen below the $1.00 minimum bid price for continued listing for 30 consecutive trading days and was no longer in compliance with the minimum bid requirement. In order for the Company to regain compliance, the closing bid price of its common stock must be equal to or above the $1.00 minimum bid price for a period of 10 consecutive trading days prior to March 20, 2024. As also previously disclosed, on March 21, 2024, the Company received written notification from Nasdaq granting the Company’s request for a 180-day extension to regain compliance with the minimum bid requirement. After the granting of the extension, the closing bid price of the Company's common stock must be equal to or above the $1.00 minimum bid price for a period of 10 consecutive trading days prior to September 16, 2024. Based on recent trading prices of our common stock, we believe that it is highly unlikely that we will be able to meet this requirement by that date.

Accordingly, we intend to regain compliance by effecting a reverse split of the Company’s outstanding shares of Common Stock by a ratio of any whole number between 1-for-10 and 1-for-20, at any time prior to August 30, 2024, to be determined at the discretion of the Board of Directors, for the purpose of complying with the Nasdaq Listing Rules, subject to the Board of Directors’ discretion to abandon such reverse stock split (the “Reverse Split”), following the 2024 Annual General Meeting of our stockholders. On May 14, 2024, our stockholders approved the Reverse Split. The Company is currently determining when and at what ratio to effect the Reverse Split. We may not be able to regain compliance with the NASDAQ continuing listing requirements if we do not effect the Reverse Split. The Reverse Split also presents certain other risks to the Company and its stockholders, including the risk of a decline in the aggregate market value of our outstanding common stock.

Vehicles in Production

We continue to focus on product quality, manufacturing capacity and operational planning, and engineering and design to enable increased deliveries and deployments of our products and future revenue growth. During the first three months of 2024, we continued executing our strategic product roadmap for our electric vehicle offerings, including the production of the W56 vehicle program in both strip chassis and step van variants. We continued to electrify the fleet of vehicles being used in our Stables by Workhorse initiative, which operates FedEx Ground delivery routes in the greater Cincinnati area. The electrification of the fleet provides us with firsthand data on the benefits and challenges of independent fleet operators experience while executing last-mile delivery operations. The initiative also provides valuable insights into how our customers can plan for and manage the transition to EV operations, including how to develop adequate charging infrastructure, training and maintenance services. In addition to our ongoing production ramp in 2023, we intend to continue to generate demand and brand awareness by improving our vehicles’ performance and functionality, and by developing new vehicle programs, including new W56 variants and the WNext platform. We expect to continue to benefit from ongoing electrification of the commercial vehicle market and in particular "last mile delivery" sector.

Recent Trends and Market Conditions

We continue to monitor macroeconomic conditions to remain flexible and to optimize and evolve our business as appropriate, and we will have to accurately project demand and infrastructure requirements globally and deploy our production, workforce and other resources accordingly.

Market Demand. Our sales during the first quarter of 2024 were lower than the prior year period due to slower-than-anticipated industry wide electric vehicle adoption rates and lack of government subsidies and incentives available to our dealers as well as slower than expected roll-out of additional power to electric grids and the resulting effect on roll-outs of electric vehicle charging infrastructure, nationwide. However, we expect adoption rates to accelerate through 2024 driven by more stringent state and federal emissions requirements and continued government subsidies and incentives that will continue to reduce cost barriers for EV ownership, including the approval for our W56 platform for the HVIP program through CARB, providing an $85,000 base voucher per W56 vehicle purchased. The accelerated adoption rates are related to the enforcement of California’s Advanced Clean Fleets Regulation (“ACF Regulation”) which is contingent upon the Environmental Protection Agency (“EPA”) granting a waiver or determining that a waiver is not necessary. Under the Clean Air Act, California holds the unique authority to request a waiver of preemption, which typically restricts states from setting their own emissions standards for new motor vehicles. The EPA’s role involves a thorough review of comments and an assessment to determine if the criteria for granting a waiver are satisfied. This regulatory landscape is a significant consideration for our operations and strategic planning.

Commodities. Prices for commodities remain volatile, and we expect to experience price increases for base metals and raw materials that are used in batteries for electric vehicles (e.g., lithium, cobalt, and nickel) as well as steel, aluminum and other material inputs. Global demand and differences in output across sectors have generated divergence in price movements across different commodities. We expect the net impact on us overall will be higher material costs.

Supply Chain. We continue to develop relationships with suppliers of key parts, components and raw materials to be used in the manufacture of our products such as batteries, electronics, and vehicle chassis that are sourced from suppliers across the world. As we continue to execute on our new vehicle programs, we will continue to identify supplier relationship and vehicle program synergies which may allow us to take advantage of pricing efficiencies from economies of scale. Where available, we will utilize multiple supply sources for key parts, and we will work to qualify multiple supply sources to achieve pricing efficiencies and minimize potential production risks related to supply chain. As previously disclosed, the Company is currently working with certain of its vendors to extend or restructure the payment terms of certain accounts payable. We are also currently in litigation with one of our battery suppliers, Coulomb Solutions Inc. For more information concerning this matter, see Note15, Commitments and Contingencies to the Condensed Consolidated Financial Statements attached hereto.

Inflation. Inflation continues to impact our operations, resulting from both supply and demand imbalances as economies continue to face constraints as well as the impact on the availability and cost of energy and other commodities as a result of the ongoing conflicts in Ukraine and Israel. We are seeing a near-term impact on our business due to inflationary pressure. In an effort to dampen inflationary pressures, central banks have continued to raise interest rates which will likely raise the cost of any financing the Company may undertake in the future.

The following section provides a narrative discussion about our financial condition and results of operations. The comments should be read in conjunction with our Condensed Consolidated Financial Statements and related Notes thereto included in Item 1 of this Form 10-Q and in conjunction with our Form 10-K.

Results of Operations

The following table sets forth, for the periods indicated, the components of the Company's Condensed Consolidated Statements of Operations:

Sales, net of returns and allowances

Sales, net of returns and allowances for the three months ended March 31, 2024 and 2023 were $1.3 million and $1.7 million, respectively. The decrease in sales was primarily due to lower W4 CC vehicle sales compared with the same period a year ago, which was partially offset by an increase in other service revenue generated from operating our Stables by Workhorse route, Drones as a Service and other service revenue.

Cost of sales

Cost of sales for the three months ended March 31, 2024 and 2023 were $7.4 million and $5.3 million, respectively. The increase in cost of sales was primarily due to a $2.2 million increase in inventory reserve expenses, a $1.0 million increase in depreciation expenses, and a $0.6 million increase in employee compensation and related expenses to support vehicle production during the period. The increase in cost of sales was partially offset by a $1.2 million decrease in costs related to direct materials and a $1.4 million reversal of warranty expenses previously accrued.

Selling, general and administrative expenses

Selling, general and administrative (“SG&A”) expenses during the three months ended March 31, 2024 and 2023 were $14.1 million and $14.7 million, respectively. The decrease in SG&A expenses was driven by a $1.7 million decrease in employee compensation and related expenses primarily due to a decreased headcount which was partially offset by a $0.3 million increase in non-cash stock-based compensation expense and an increase of $0.6 million in professional and other services expenses during the period.

Research and development expenses

Research and development (“R&D”) expenses during the three months ended March 31, 2024 and 2023 were $3.5 million and $7.2 million, respectively. The decrease in R&D expenses was primarily driven by a $2.1 million decrease in prototype expenses related to development expenses for new products which launched in 2023, a $0.7 million decrease in consulting expenses and a $0.8 million decrease in employee compensation and related expenses due to decreased headcount.

Interest (expense) income, net

Net interest expense for the three months ended March 31, 2024 was $5.4 million compared to net interest income $0.6 million for the three months ended March 31, 2023. Net interest expense in the current year was driven by a fair value adjustment of our 2024 Notes and 2024 Warrants during the period of $7.0 million and $1.2 million fees paid in connection with the 2024 Notes and 2024 Warrants issued during the period which were partially offset by a gain of $2.9 million from the extinguishment of our 2026 Notes and conversion of our 2023 Warrants and $0.1 million of interest earned on cash balances in our money market investment accounts. Net interest income in the prior period was primarily driven by interest earned on cash balances in our money market investment account.

Income taxes

Benefit for income taxes during the three months ended March 31, 2024 and 2023 was zero.

Liquidity and Capital Resources; Going Concern

We have financed our operations primarily through sales of equity securities and issuance of debt. We have utilized this capital for research and development to fund designing, building and delivering vehicles to customers and for working capital purposes.

We had $1.3 million of sales for the three months ended March 31, 2024. As of March 31, 2024, the Company had $6.7 million in cash and cash equivalents, accounts receivable of $1.8 million, net inventory of $49.9 million and accounts payable of $14.2 million. As of March 31, 2024, the Company had positive working capital of $24.2 million, accumulated deficit of $780.7 million, and during the three months ended March 31, 2024 incurred a loss from operations of $23.7 million and used $18.0 million of cash in operating activities.

Our ability to continue as a going concern is contingent upon successful execution of management’s intended plan over the next twelve months to improve the Company’s liquidity and working capital requirements. We have made significant progress executing on our revised strategic product roadmap for our electric vehicle offerings, and we expect to generate additional sales within the next twelve months which will help support our operations. Additionally, as previously disclosed, management has reduced its discretionary spend related to non-contracted capital expenditures, implemented cost-savings measures including a 20% reduction in force, our executive officers deferring approximately 20% of their cash compensation into the second quarter of 2024, furloughed 73 employees at our Union City manufacturing facility without pay, and fully transitioned our Aero business from a design and manufacturing drone business to Drones as a Service business. As previously disclosed, the Company is currently working with certain of its vendors to extend or restructure the payment terms of certain accounts payable. However, if the expected sales are not generated and management is not able to control capital expenditures and other expenses, we will continue to incur substantial operating losses and negative cash flows from operations. There can be no assurance that we will be successful in implementing our plans or acquiring additional funding, that our projections of our future capital needs will prove accurate, or that any additional funding would be sufficient to continue operations in future years.

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

• our ability to produce our current generation of vehicles at required scale and to sell such vehicles to customers;
• our ability to acquire or license other technologies we may seek to pursue;
• our ability to manage our growth and operational expenses; and
• competing technological and market developments.

To the extent revenues from operations are insufficient to meet our liquidity requirements, our ability to continue as a going concern will be dependent on effectively raising capital through private or public placement of our equity securities, including the continued access to the additional closings of up to $123.7 million in aggregate principal amount of additional 2024 Notes and, if our share price makes such exercise feasible, the possible receipt of proceeds from the exercise of the corresponding 2024 Warrants pursuant to the 2024 Securities Purchase Agreement and use of the ATM Agreement (as further described below), for which there can be no assurance we will be successful in such efforts. We will also rely on debt financing or other sources of capital funding such as through the sale of assets to obtain sufficient financial resources to fund our operating activities. If we are unable to maintain sufficient financial resources, our business, financial condition and results of operations, as well as our ability to continue to develop, produce and market our new vehicle programs and satisfy our obligations as they become due, will be materially and adversely affected. This could affect future vehicle program production and sales. Failure to obtain additional financing will have a material, adverse impact on our business operations. There can be no assurance that we will be able to obtain the financing needed to achieve our goals on acceptable terms or at all. Additionally, any equity or equity linked financings would likely have a dilutive effect on the holdings of our existing stockholders. The Company’s current level of cash and cash equivalents are not sufficient to execute our business plan. For the foreseeable future, we will incur significant operating expenses, capital expenditures and working capital funding that will deplete our cash on hand.

Our ability to obtain additional financing is extremely limited under current market conditions including the significant amount of capital required, the Nasdaq Listing Requirements, the market price of our stock and potential dilution from the issuance of any additional securities. If we are unable to identify other sources of funding, we may need to further adjust our operations, including and up to filing a voluntary petition for relief under the Bankruptcy Code. If this were to occur, the value available to our various stakeholders, including our creditors and stockholders, is uncertain and trading prices for our securities may bear little or no relationship to the actual recovery, if any, by holders of our securities in bankruptcy proceedings, if any.

As a result of all of the matters discussed above, including our losses, current liquidity level and our projected capital needs, substantial doubt exists about the Company’s ability to continue as a going concern over the next twelve months from the date of issuance of the accompanying Condensed Consolidated Financial Statements. The Condensed Consolidated Financial Statements do not include any adjustments to the carrying amounts and classification of assets, liabilities, and reported expenses that may be necessary if the Company were unable to continue as a going concern.

Under the ATM Agreement, we may offer and sell shares of our common stock having an aggregate sales price of up to $175.0 million, in amounts and at times determined by management. During the three months ended March 31, 2024, we issued 9.8 million shares under the ATM Agreement for net proceeds of $2.7 million. During the year ended December 31, 2023, we issued 89.3 million shares under the ATM Agreement for net proceeds of $62.2 million. As of March 31, 2024 we had approximately $95.6 million available through the issuance of shares of common stock under the ATM Agreement. Certain of our other existing financing arrangements place certain conditions and restrictions on the use of our ATM Program.

Summary of Cash Flows

Cash Flows from Operating Activities

Our cash flows from operating activities are affected by our cash investments to support the business in R&D, manufacturing, SG&A. Our operating cash flows are also affected by our working capital needs to support fluctuations in accounts receivable, inventory, accounts payable and other current assets and liabilities.

During the three months ended March 31, 2024 and 2023, net cash used in operating activities was $18.0 million and $32.7 million, respectively. The decrease in net cash used in operations was primarily attributable to a $6.9 million decrease in spend related to inventory as we slowed our inventory build due to slower than anticipated sales throughout 2023 and the first three months of 2024. The decrease is also attributable to a $4.8 million decline in employee compensation and related expenses, excluding non-cash stock-based compensation, resulting from our reduction in force actions.

Cash Flows from Investing Activities

Cash used in investing activities related primarily to capital expenditures to upgrade our production and research and development facilities, which were $3.0 million for the three months ended March 31, 2024 and $5.4 million for the three months ended March 31, 2023. The decrease is primarily driven by a decline in spending in tooling and equipment related to our vehicle programs at our Union City, Indiana manufacturing facility.

Cash Flows from Financing Activities

Net cash used in financing activities during the three months ended March 31, 2024 was $8.1 million, which was primarily attributable to the repayment of the 2026 Notes, which were fully redeemed during the period, partially offset by proceeds from our ATM Program and the issuance of our 2024 Notes.

Net cash provided by financing activities during the three months ended March 31, 2023 was $18.0 million, which was primarily attributable to the issuance of common stock under our ATM Program which provided net proceeds of approximately $18.6 million.

Off-Balance Sheet Arrangements

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

Critical Accounting Estimates

A discussion of our critical accounting estimates is contained in the Form 10-K, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Recent Accounting Pronouncements

A description of recently issued and adopted accounting pronouncements is contained in Note 14, Recent Accounting Pronouncements, of the Condensed Consolidated Financial Statements.

For a discussion of our quantitative and qualitative disclosures about market risk, see “Quantitative and Qualitative Disclosures About Market Risks” included in the Form 10-K, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” There have been no material changes to the information provided in the Form 10-K.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Exchange Act is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Annual Report was made under the supervision and with the participation of our management, including our principal executive officer and principal financial officer.

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2024, the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of such date, our disclosure controls and procedures were not effective because of a previously reported material weakness in our internal control over financial reporting, which we describe in Part II, Item 9A of our Form 10-K for the fiscal year ended December 31, 2023.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer 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 and includes those policies and procedures that (1) pertain to the maintenance of records in reasonable detail to accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and our receipts and expenditures are being made only in accordance with authorizations of our management and directors and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets could have a material effect on the financial statements.

As disclosed in our Form 10-K, management identified a material weakness in the design of one of the Company's internal controls related to the review of the fair value calculation of the convertible note and warrant liability performed by a third-party valuation expert. The controls were not designed with a level of precision that would detect the use of an inappropriate input that could have a material impact on the valuation.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting, other than the remediation actions described below, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Remediation of the Material Weakness

We have undertaken and are continuing to design and implement remediation measures intended to address the material weakness discussed above. These remediation measures are focused on our precision of review of complex valuation models performed by independent third-party valuation experts we use to value these types of complex financial instruments. The valuation procedures are to be reviewed and approved by responsible management of the Company. Under the supervision of the Audit Committee, we are working to remediate the material weakness and will continue to report regularly to the Audit Committee regarding the status of the implementation activities.

Management's Conclusion on Internal Control Over Financial Reporting

Based on the results of its evaluation and the material weakness described above, management concluded that the Company’s internal control over financial reporting was not effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with GAAP as of March 31, 2024.

For a detailed discussion of risk factors affecting us, see “Part I – Item 1A. Risk Factors” in the Form 10-K. There have been no material changes in the current period regarding our risk factors.