ITEM 1A. RISK FACTORS
Risks Associated with Our Business
The COVID-19 pandemic could continue to have an adverse effect on our business.
The COVID-19 pandemic continues to have an unprecedented impact on the U.S. economy as federal, state and local governments react to this public health crisis, which continues to create significant uncertainties. These uncertainties include, but are not limited to, the adverse effect of the pandemic on the economy, our supply chain partners, transportation and logistics providers, our employees and customers. As the pandemic continues and infection rates oscillate, fear about becoming ill with the virus and recommendations and/or mandates from federal, state and local authorities to avoid large gatherings of people or self-quarantine may recur or continue to increase, which has already affected, and may continue to affect our supply chain, as well as our customer base. Continued impacts of the pandemic could materially adversely affect our near-term and long-term revenues, earnings, liquidity and cash flows, and may require significant actions in response, including, but not limited to, employee furloughs, workforce reductions, plant and operational shut-downs in Ohio, expense reductions or discounting of pricing of our products, all in an effort to mitigate such impacts. The extent of the ongoing impact of the pandemic on our business and financial results will depend largely on future developments, including the duration of the spread of the outbreak within the United States, the timing and success of vaccine programs, the impact on capital and financial markets and the related impact on consumer confidence and spending, all of which are highly uncertain and cannot be predicted. This situation is changing rapidly, and additional impacts may arise that we are not aware of currently.
We rely on equity and debt financing to operate our business and will require additional financing in the near term, which we may not be able to raise on favorable terms or at all, and our failure to obtain funding when needed may force us to delay, scale back or eliminate our business plan or even discontinue or curtail our operations.
For the year ended December 31, 2020, we reported a net loss of $6.0 million and are dependent upon the availability of financing in order to continue our business.
On August 11, 2020, we entered into $3,000,000 and $2,500,000 revolving lines of credit with Crossroads Financial Group, LLC (the “Inventory Facility”) and Factors Southwest L.L.C. (d/b/a FSW Funding) (the “Receivables Facility” and, together with the Inventory Facility, the “Credit Facilities”), respectively, which replaced our former revolving line of credit with Austin Financial Services, Inc. (the “Austin Facility”). As of December 31, 2020, we had cash of approximately $1.8 million and had debt balances of $1.3 million and $1.0 million under the Inventory Facility and the Receivables Facility, respectively. In addition, our accounts receivable balance was $2.0 million and our gross inventory balance was $5.6 million on December 31, 2020. As of February 28, 2021, our cash was approximately $0.8 million and our total outstanding net balance under the Credit Facilities was approximately $2.6 million in the aggregate. Also, our accounts receivable balance was $1.4 million and our gross inventory balance was $7.3 million on February 28, 2021. Our ability to draw on the Receivables Facility is limited based on the amount of eligible accounts receivable, and our ability to draw on the Inventory Facility is limited based on the value of our eligible inventory. The repayment of outstanding advances and interest under the Credit Facilities may be accelerated upon an event of default, including, but not limited to, failure to make timely payments or breach of any terms set forth in the loan agreements. The Credit Facilities are secured by our assets and are subject to customary affirmative and negative operating covenants and defaults, restricting indebtedness, liens, corporate transactions, dividends, and affiliate transactions, among others. The maturity date of the Credit Facilities is August 11, 2022.
Even with access to borrowings under the Credit Facilities, we may not generate sufficient cash flows from our operations or be able to borrow sufficient funds to sustain our operations. As such, we will likely need additional external financing during 2021 and will continue to review and pursue external funding sources including, but not limited to, the following:
•obtaining financing from traditional or non-traditional investment capital organizations or individuals;
•obtaining funding from the sale of our common stock or other equity or debt instruments; and
•obtaining debt financing with lending terms that more closely match our business model and capital needs.
There can be no assurance that we will obtain funding on acceptable terms, in a timely fashion, or at all. Obtaining additional financing contains risks, including:
•additional equity financing may not be available to us on satisfactory terms and any equity we are able to issue could lead to dilution for current stockholders and have rights, preferences and privileges senior to our common stock;
•loans or other debt instruments may have terms and/or conditions, such as interest rates, restrictive covenants and control or revocation provisions, which are not acceptable to management or our board of directors; and
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•the current environment in the capital markets, as well as global health risks, combined with our capital constraints may prevent us from being able to obtain adequate debt financing.
If we fail to obtain required additional financing to sustain our business before we are able to produce levels of revenue to meet our financial needs, we will need to delay, scale back or eliminate our business plan and further reduce our operating costs and headcount, each of which would have a material adverse effect on our business, future prospects, and financial condition. A lack of additional financing could also result in our inability to continue as a going concern and force us to sell certain assets or discontinue or curtail our operations and, as a result, investors in the Company could lose their entire investment.
Our independent registered public accounting firm’s opinion on our audited financial statements for the fiscal year ended December 31, 2020, included in this Annual Report, contains a modification relating to our ability to continue as a going concern.
Our independent registered public accounting firm’s opinion on our audited financial statements for the year ended December 31, 2020 includes a modification stating that our losses and negative cash flows from operations and uncertainty in generating sufficient cash to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern. In addition, Note 3 “Restructuring”, to our financial statements included in Part II, Item 8 “Financial Statements and Supplementary Data,” of this Annual Report includes disclosure describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern for a reasonable period of time.
While we continue to pursue funding sources and transactions that could raise capital, there can be no assurances that we will be successful in these efforts or will be able to resolve our liquidity issues or eliminate our operating losses. If we are unable to generate enough cash or obtain sufficient additional funding, we would need to scale back or significantly adjust our business plan, further reduce our operating costs and headcount, or discontinue or curtail our operations. Accordingly, our business, prospects, financial condition and results of operations could be materially and adversely affected, and we may be unable to continue as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our audited consolidated financial statements, and it is likely that investors will lose all or a part of their investment. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We have a history of operating losses and will incur losses in the future as we continue our efforts to grow sales and streamline our operations at a profitable level.
We have incurred substantial losses in the past and reported net losses from operations of $6.0 million and $7.4 million for the years ended December 31, 2020 and 2019, respectively. As of December 31, 2020, we had an accumulated deficit of $130.9 million and cash of approximately $1.8 million, compared to an accumulated deficit of $124.9 million and cash of approximately $0.4 million as of December 31, 2019.
In order for us to operate our business profitably, we need to grow our sales, maintain cost control discipline while balancing development of our new product pipeline and potential long-term revenue growth, continue our efforts to reduce product cost, drive further operating efficiencies and develop and execute a strategic product pipeline for profitable and compelling LED lighting and control and UVCD products. There is a risk that our strategy to return to profitability may not be as successful as we envision, or occur as quickly as we expect. We might require additional financing in the near-term and, if our operations do not achieve, or we experience an unanticipated delay in achieving, our intended level and pace of profitability, we will continue to need additional funding, none of which may be available on favorable terms or at all and could require us to sell certain assets or discontinue or curtail our operations.
While we are attempting to diversify our customer base, we have historically derived a significant portion of our revenue from a few customers, and the loss of one of these customers, or a reduction in their demand for our products, could adversely affect our business, financial condition, results of operations, and prospects.
Historically our customer base has been highly concentrated and one or a few customers have represented a substantial portion of our net sales. In 2020, two customers accounted for 62% of net sales. Total sales to our primary distributor to the U.S. Navy, and a primary shipbuilder for the U.S. Navy represented 53% of net sales. In 2019, two customers accounted for 45% of net sales and total sales to distributors to the U.S. Navy represented 23% of net sales.
We generally do not have long-term contracts with our customers that commit them to purchase any minimum amount of our products or require them to continue to do business with us. We could lose business from any one of our significant customers for a variety of reasons, many of which are outside of our control, including changes in levels of government funding and rebate
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programs, our inability to comply with government contracting laws and regulations, changes in customers’ procurement strategies or their lighting retrofit plans, changes in product specifications, additional competitors entering particular markets, our failure to keep pace with technological advances and cost reductions, and damage to our professional reputation, among others.
We are attempting to expand and diversify our customer base and reduce the dependence on one or a few customers, through the addition of sales representatives and other potential marketing partnerships and our direct-to-customer sales strategy, as well as expanding our product offerings in the UVCD-space, but we cannot provide any assurance that our efforts will be successful. We anticipate that a limited number of customers could continue to comprise a substantial portion of our revenue for the foreseeable future. If we continue to do business with our significant customers, our concentration can cause variability in our results because we cannot control the timing or amounts of their purchases. A significant customer could cease to do or drastically reduce its business with us with little or no notice, which could adversely affect our results of operations and cash flows in particular periods.
Historically, we have experienced long sales-cycles, as well as slow ramp-up by new customers to purchase large amounts of LED products from us. Given the fiercely competitive lighting market in which we operate, we are constantly trying to balance pricing with the quality-premium our products command both in brand reputation and performance. As a result, adding new customers could generally be a slow process, and getting their sales increased to more significant levels usually takes a long period of time. As we continue to develop more customer-centric new products such as EnFocusTM, we hope to both add new customers more quickly and have our customers scale their purchasing levels more quickly. Our UVCD portfolio of products also expands our traditional government and commercial markets to include the consumer market and a potential services offering for the commercial market, increasing the scope and expense of our marketing efforts. However, there is no guarantee of faster customer acceptance or performance of these new products or any other that has been or is being developed.
If we are unable to implement plans to increase sales and control expenses to manage future growth effectively, our profitability goals and liquidity will be adversely affected.
Our ability to achieve our desired growth depends on the adoption of LEDs and related controls within the general lighting market, the adoption of our UVCD products within the healthy home and workspace markets, and our ability to affect and adapt to these rates of adoption. The pace of continued growth in these markets is uncertain, and in order to grow our sales, we may need to:
•manage organizational complexity and ensure effective and timely communication;
•expand the skills and capabilities of our current management, engineering and sales teams;
•add experienced senior level managers;
•attract, retain and adequately compensate qualified employees;
•adequately maintain and adjust the operational and financial controls that support our business;
•expand research and development, sales and marketing, technical support, distribution capabilities, manufacturing planning and administrative functions and capabilities;
•maintain or establish additional manufacturing facilities and equipment, as well as secure sufficient third-party manufacturing resources, to adequately meet customer demand and/or lower manufacturing costs; and
•manage an increasingly complex supply chain to maintain a sufficient supply of materials and deliver on time to our manufacturing facilities.
These efforts to grow our business, both in terms of size and in diversity of customer bases served, may put a significant strain on our resources. Over the past few years, we have implemented comprehensive cost-saving initiatives to reduce our net loss and mitigate doubt about our ability to continue as a going concern. These initiatives have improved efficiency and streamlined our operations, but we may need additional funding, further cost-cutting may be needed to manage liquidity and future growth may exceed our current capacity and require rapid expansion in certain functional areas.
We may lack sufficient funding to appropriately expand or incur significant expenses as we attempt to scale our resources and make investments in our business that we believe are necessary to achieve short-term and long-term growth goals. Such investments take time to become fully operational, and we may not be able to expand quickly enough to exploit targeted market opportunities. In addition to our own manufacturing capacity, we are increasingly utilizing contract manufacturers and original design manufacturers (“ODMs”) to produce our products for us. There are also inherent execution risks in expanding product lines and production capacity, whether through our facilities or that of a third-party manufacturer, that could increase costs and reduce our operating results, including design and construction cost overruns, poor production process yields and reduced quality control. If we are unable to fund any necessary expansion or manage our growth effectively, we may not be able to
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adequately meet demand, our expenses could increase without a proportionate increase in revenue, our margins could decrease, and our business and results of operations could be adversely affected.
Our results of operations, financial condition and business could be harmed if we are unable to balance customer demand and capacity.
As customer demand for our products changes and as we launch new products, we must be able to adjust our production capacity to meet demand. We are continually taking steps to address our manufacturing capacity needs for our products. If we are not able to increase or decrease our production capacity at our targeted rate or if there are unforeseen costs associated with adjusting our capacity levels or there are unanticipated interruptions in our supply chain from such possibilities as the COVID-19 pandemic, we may not be able to achieve our financial targets. In addition, as we introduce new products and further refine existing products, we must balance the production and inventory of prior generation products with the production and inventory of new products, whether manufactured by us or our contract manufacturers, to maintain a product mix that will satisfy customer demand and mitigate the risk of incurring cost write-downs on the previous generation products, related raw materials and tooling.
If customer demand does not materialize at the rate forecasted, we may not be able to scale back our manufacturing expenses or overhead costs to correspond to the demand. This could result in lower margins, write-downs of our inventory and adversely impact our business and results of operations. Additionally, if product demand decreases or we fail to forecast demand accurately, our results may be adversely impacted due to higher costs resulting from lower factory utilization, causing higher fixed costs per unit produced. In addition, our efforts to improve quoted delivery lead-time performance may result in corresponding reductions in order backlog. A decline in backlog levels could result in more variability and less predictability in our quarter-to-quarter net sales and operating results.
If we are not able to compete effectively against companies with lower cost structures or greater resources, or new competitors who enter our target markets, our sales will be adversely affected.
The lighting industry is highly competitive. In the high-performance lighting markets in which we sell our advanced lighting systems, our products compete with lighting products utilizing traditional lighting technology provided by many vendors. For sales of MMM products, we compete with a small number of qualified military lighting lamp and fixture suppliers. In certain commercial applications, we typically compete with LED systems produced by large lighting companies. Our primary competitors include Philips, Osram Sylvania, LED Smart, Revolution Lighting Technologies, Orion Energy Systems, Green Creative and Keystone Technologies. Some of these competitors offer products with performance characteristics similar to those of our products. Many of our competitors are larger, more established companies with greater resources to devote to research and development, manufacturing and marketing, as well as greater brand recognition. In addition, larger competitors who purchase greater unit volumes from component suppliers may be able to negotiate lower costs, thereby enabling them to offer lower pricing to end customers. Moreover, the relatively low barriers to entry into the lighting industry and the limited proprietary nature of many lighting products also permit new competitors to enter the industry easily and with lower costs.
In each of our markets, we also anticipate the possibility that LED component manufacturers, including those that currently supply us with LEDs, may seek to compete with us. Our competitors’ lighting technologies and products may be more readily accepted by customers than our products will be. Moreover, if one or more of our competitors or suppliers were to merge, the change in the competitive landscape could adversely affect our competitive position. Additionally, to the extent that competition in our markets intensifies, we may be required to further reduce our prices in order to remain competitive. If we do not compete effectively, or if we reduce our prices without making commensurate reductions in our costs, our net sales, margins, and profitability and our future prospects for success may be harmed.
We work with independent agents and sales representatives for a portion of our net sales, and the failure to incentivize, retain and manage our relationships with these third parties, or the termination of these relationships, could cause our net sales to decline and harm our business.
In the past, we pursued an agency-driven sales channel strategy in order to expand our market presence throughout the United States. As a result, at that time, we had increased our reliance on independent sales agent channels to market and sell our products. In addition, these parties provide technical sales support to end-users. The current agreements with our agents are generally non-exclusive on the agents’ product portfolio, meaning they can sell our competitors’ products. Any such agreements we enter into in the future may be on similar terms. Our agents may not be motivated to or successfully pursue the sales opportunities available to them, or they may prefer to sell or be more familiar with the products of our competitors. If our agents do not achieve our sales objectives or these relationships take significant time to develop, our revenue may decline, fail to grow or not increase as rapidly as we intend in order to achieve profitability and grow our business. During 2019 and 2020,
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we significantly reduced our reliance on agencies for a substantial portion of our sales, and refocused and expanded our agency relationships on those that were both mutually beneficial and strategically important. Thus far, direct sales using internal sales personnel still account for a substantial portion of our sales, although we believe that our agency expansion strategy will increase the role of independent agents and sales representatives over time.
Furthermore, our agency agreements are generally short-term and can be cancelled by either party without significant financial consequence. The termination of or the inability to negotiate extensions of these contracts on acceptable terms could adversely impact sales of our products. Additionally, we cannot be certain that we or end-users will be satisfied by their performance. If these agents significantly change their terms with us, or change their end-user relationships, there could be an impact on our net sales and profits.
If our LED lighting and control technology or UVCD products fail to gain widespread market acceptance or we are unable to respond effectively as new technologies and market trends emerge, our competitive position and our ability to generate revenue, and profits may be harmed.
To be successful in our LED lighting and control technology markets and with the introduction of our UVCD products, we depend on continued market acceptance of our existing LED lighting and control technology and our new UVCD products, including in the consumer and commercial markets. Although adoption of LED lighting and air and surface sanitation products continues to grow, including in response to the COVID-19 pandemic and increased awareness of sanitation, the use of LED lighting products for general illumination and the use of UVCD products for air and surface sanitation are in their early stages, are still limited, and face significant challenges. Potential customers may be reluctant to adopt LED lighting products as an alternative to traditional lighting technology or UVCD products as an alternative to traditional chemical-based sanitation because of their higher initial costs or perceived risks relating to their novelty, reliability, usefulness, quality and cost-effectiveness when compared to other established lighting sources and sanitation processes available in the market. Changes in economic and market conditions may also make traditional lighting and sanitation technologies more appealing. For example, declining energy prices in certain regions or countries may favor existing lighting technologies that are less energy-efficient, reducing the rate of adoption for LED lighting products in those areas. Notwithstanding continued performance improvements and cost reductions of LED lighting and UVCD technologies, limited customer awareness of the benefits of LED lighting and UVCD products, lack of widely accepted standards governing LED lighting and UVCD products and customer unwillingness to adopt LED lighting and UVCD products could significantly limit the demand for LED lighting and UVCD products. Even potential customers that are inclined to adopt energy-efficient lighting technology or new or increased sanitation technologies may defer investment as LED lighting and UVCD products continue to experience rapid technological advances. Any of the foregoing could adversely impact our results of operations and limit our market opportunities.
In addition, we will need to keep pace with rapid changes in LED lighting and control technology and UVCD air and surface sanitation technology, changing customer requirements, new product introductions and cost reductions by competitors and evolving industry standards, any of which could render our existing products obsolete if we fail to respond in a timely manner. The development, introduction, and acceptance of new, re-designed or reduced cost products incorporating advanced technology is a complex process subject to numerous uncertainties, including:
•available funding to sustain adequate development efforts;
•achievement of technology breakthroughs required to make commercially viable devices, and in turn, protecting those breakthroughs through intellectual property;
•the accuracy of our predictions for market requirements;
•our ability to predict, influence, and/or react to evolving standards;
•acceptance of our new product designs;
•acceptance of new technologies in certain markets;
•the combination of other desired technological advances with lighting products, such as controls;
•the availability of qualified research and development personnel;
•our timely completion of product designs and development;
•our ability to develop repeatable processes to manufacture new products in sufficient quantities, with the desired specifications, and at competitive costs;
•our ability to effectively transfer products and technology from development to manufacturing; and
•market acceptance of our products.
We could experience delays in the introduction of these products. We could also devote substantial resources to the development of new technologies or products that are ultimately not successful.
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If effective new sources of light, other than LEDs, or effective new sanitation technologies, other than UVCD, are discovered and commercialized, our current products and technologies could become less competitive or obsolete. If others develop innovative proprietary lighting or sanitation technology that is superior to ours, or if we fail to accurately anticipate technology, pricing and market trends, address market saturation and customer confusion, respond on a timely basis with our own development of new and reliable products and enhancements to existing products, and achieve broad market acceptance of these products and enhancements, our competitive position may be harmed and we may not achieve sufficient growth in our net sales to attain or sustain profitability.
If we are unable to attract or retain qualified personnel, our business and product development efforts could be harmed.
We are highly dependent on our senior management and other key personnel due to our very lean organizational structure. Our future success will depend on our ability to attract, retain, develop and motivate qualified technical, sales, marketing, and management personnel, for whom competition is very intense. As we attempt to rapidly grow our business, it could be especially difficult to attract, retain and adequately compensate qualified personnel, especially in light of our lean cost-structure. The loss of, or failure to attract, hire, and retain any such persons could delay product development cycles, disrupt our operations, increase our costs, or otherwise harm our business or results of operations. We also do not maintain “key person” insurance policies on any of our officers or our other employees.
Our operating results may fluctuate due to factors that are difficult to forecast and not within our control.
Our past operating results may not be accurate indicators of future performance, and you should not rely on such results to predict our future performance. Our operating results have fluctuated significantly in the past and could fluctuate in the future. Factors that may contribute to fluctuations include:
•changes in aggregate capital spending, cyclicality and other economic conditions, or domestic and international demand in the industries;
•the timing of large customer orders to which we may have limited visibility and cannot control;
•competition for our products, including the entry of new competitors and significant declines in competitive pricing;
•our ability to effectively manage our working capital;
•our ability to generate increased demand in our current and targeted markets, particularly those in which we have limited experience;
•our ability to satisfy customer demands in a timely and cost-effective manner;
•pricing and availability of labor and materials;
•quality testing and reliability of new products;
•our inability to adjust certain fixed costs and expenses for changes in demand and the timing and significance of expenditures that may be incurred to facilitate our growth;
•macroeconomic, geopolitical and health concerns, including the COVID-19 pandemic;
•seasonal fluctuations in demand and our revenue; and
•disruption in component supply from foreign vendors.
Depressed general economic conditions may adversely affect our operating results and financial condition.
Our business is sensitive to changes in general economic conditions, both inside and outside the United States. Slow growth in the economy or an economic downturn, particularly one affecting construction and building renovation, or that causes end-users to reduce or delay their purchases of lighting products, services, or retrofit activities, would have a material adverse effect on our business, cash flows, financial condition and results of operations. LED lighting retrofit projects, in particular, tend to require a significant capital commitment, which is offset by cost savings achieved over time. As such, a lack of available capital, whether due to economic factors or conditions in the equity or debt markets, could have the effect of reducing demand for our products. A decrease in demand could adversely affect our ability to meet our working capital requirements and growth objectives, or could otherwise adversely affect our business, financial condition, and results of operations.
Customers may be unable to obtain financing to make purchases from us.
Some of our customers require financing in order to purchase our products, and the initial investment is higher than that which is required with traditional lighting products. The potential inability of these customers to access the capital needed to finance purchases of our products and meet their payment obligations to us could adversely impact the appeal of our products relative to those with lower upfront costs and have a negative impact on our financial condition and results of operations. There can be no assurance that third-party finance companies will provide capital to our customers.
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A significant portion of our business is dependent upon the existence of government funding, which may not be available into the future and could result in a reduction in sales and harm to our business.
Some of our customers are dependent on governmental funding, including U.S. and foreign allied navies and U.S. military bases. If any of these customers or potential customers abandon, curtail, or delay planned LED lighting retrofit projects as a result of the levels of funding available to them or changes in budget priorities, it would adversely affect our opportunities to generate product sales.
If critical components and finished products that we currently research and develop with and purchase from a small number of third-party development partners and suppliers become unavailable or increase in price, or if our development partners, suppliers or delivery channels fail to meet our requirements for quality, quantity, and timeliness, our revenue and reputation in the marketplace could be harmed, which would damage our business.
In an effort to reduce research and development and manufacturing costs, we have outsourced the research, development and production of certain parts and components, as well as finished goods in our product lines, to a small number of vendors in various locations throughout the world, primarily in the United States, Malaysia, Taiwan and China. We generally purchase these sole or limited source items with purchase orders, and we have limited guaranteed supply arrangements with such suppliers. While we believe alternative sources for these components and products are available, we have selected these particular suppliers based on their ability to provide quality products at a cost-effective price, to meet our specifications, and to deliver within scheduled time frames. We do not control the time and resources that these suppliers devote to our business, and we cannot be sure that these suppliers will perform their obligations to us. If our ability to manage third-party product development efforts are unsuccessful or our suppliers fail to perform their obligations in a timely manner or at satisfactory quality levels, we may suffer lost or delayed sales, increased costs of goods sold, reductions in revenue or margin, and damage to our reputation in the market, all of which would adversely affect our business. As demand for our products fluctuates, which fluctuations can be hard to predict, we may not need a sustained level of inventory, which may cause financial hardship for our suppliers or they may need to divert production capacity elsewhere. In the past, we have had to purchase quantities of certain components that are critical to our product manufacturing and were in excess of our estimated near-term requirements as a result of supplier delivery constraints and concerns over component availability, and we may need to do so in the future. As a result, we have had, and may need to continue, to devote additional working capital to support a large amount of component and raw material inventory that may not be used over a reasonable period to produce saleable products, and we may be required to increase our excess and obsolete inventory reserves to provide for these excess quantities, particularly if demand for our products does not meet our expectations.
We may be vulnerable to unanticipated product development delays, price increases and payment term changes. Significant increases in the prices of sourced components and products could cause our product prices to increase, which may reduce demand for our products or make us more susceptible to competition. Furthermore, in the event that we are unable to pass along increases in operating costs to our customers, margins and profitability may be adversely affected. Accordingly, the loss of all or one of these suppliers could have a material adverse effect on our operations until such time as an alternative supplier could be found.
Additionally, consolidation in the lighting industry could result in one or more current suppliers being acquired by a competitor, rendering us unable to continue purchasing key components and products at competitive prices.
We also may be subject to various import duties and tariffs applicable to materials manufactured in foreign countries and may be affected by various other import and export restrictions, as well as other considerations or developments impacting upon international trade, including economic or political instability, tariffs, shipping delays and product quotas. These international trade factors will, under certain circumstances, have an impact on the cost of components, which will have an impact on the cost to us of the manufactured product and the wholesale and retail prices of our products.
We rely on arrangements with independent shipping companies for the delivery of our products from vendors abroad. The failure or inability of these shipping companies to deliver products or the unavailability of shipping or port services, even temporarily, could have a material adverse effect on our business. We may also be adversely affected by an increase in freight surcharges due to rising fuel costs and added security costs.
Our products could contain defects, or they may be installed or operated incorrectly, which could reduce sales of those products or result in claims against us.
Despite product testing, defects may be found in our existing or future products. This could result in, among other things, a delay in the recognition or loss of net sales, the write-down or destruction of existing inventory, insurance recoveries that fail to
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cover the full costs associated with product recalls, significant warranty, support, and repair costs, diversion of the attention of our engineering personnel from our product development efforts, and damage to our relationships with our customers. The occurrence of these problems could also result in reputational and brand damage or the delay or loss of market acceptance of our lighting products and would likely harm our business. In addition, our customers may specify quality, performance, and reliability standards that we must meet. If our products do not meet these standards, we may be required to replace or rework the products. In some cases, our products may contain undetected defects or flaws that only become evident after shipment. Even if our products meet standard specifications, our customers may attempt to use our products in applications for which they were not designed or in products that were not designed or manufactured properly, resulting in product failures and creating customer satisfaction issues.
Some of our products use line voltages (such as 120 or 240 volts AC), which involve enhanced risk of electrical shock, injury or death in the event of a short circuit or other malfunction. Defects, integration issues or other performance problems in our lighting products could result in personal injury or financial or other damages to end-users or could damage market acceptance of our products. Our customers and end-users could also seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend and the adverse publicity generated by such a claim against us or others in our industry could negatively impact our reputation.
We provide warranty periods generally ranging from one to ten years on our products. The standard warranty on nearly all of our new LED lighting products, which now represent the majority of our revenue, is either five or ten years. Although we believe our reserves are appropriate, we are making projections about the future reliability of new products and technologies, and we may experience increased variability in warranty claims. Increased warranty claims could result in significant losses due to a rise in warranty expense and costs associated with customer support.
Our industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which may result in protracted and expensive litigation. We have engaged in litigation in the past and litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. Additionally, we could be required to defend against individuals and groups who have been purchasing intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies like ours. Litigation could delay development or sales efforts and an adverse outcome in litigation, or any similar proceedings, could subject us to significant liabilities, require us to license disputed rights from others or require us to cease marketing or using certain products or technologies. We may not be able to obtain any licenses on acceptable terms, if at all, and may attempt to redesign those products that contain allegedly infringing intellectual property, which may not be possible. We also may have to indemnify certain customers if it is determined that we have infringed upon or misappropriated another party’s intellectual property. The costs of addressing any intellectual property litigation claim, including legal fees and expenses and the diversion of management resources, regardless of whether the claim is valid, could be significant and could materially harm our business, financial condition, and results of operations.
From time to time, we have been and may in the future be subject to claims or allegations that we infringe upon or have misappropriated the intellectual property of third parties. Defending against such claims is costly and intellectual property litigation often involves complex questions of fact and law, with unpredictable results. We may be forced to acquire rights to such third-party intellectual property on unfavorable terms (if rights are made available at all), pay damages, modify accused products to be non-infringing, or stop selling the applicable product altogether.
We may be subject to confidential information theft or misuse, which could harm our business and results of operations.
We face attempts by others to gain unauthorized access to our information technology systems on which we maintain proprietary and other confidential information. Our security measures may be breached as the result of industrial or other espionage actions of outside parties, employee error, malfeasance or otherwise, and as a result, an unauthorized party may obtain access to our systems. In addition, these same risks to our information technology systems also apply to the third-party service providers’ information technology systems utilized by the Company. Additionally, outside parties may attempt to access our confidential information through other means, for example by fraudulently inducing our employees to disclose confidential information. We actively seek to prevent, detect and investigate any unauthorized access, which occasionally occurs despite our best efforts. We might be unaware of any such access or unable to determine its magnitude and effects. The theft, corruption and/or unauthorized use or publication of our trade secrets and other confidential business information as a result of such an incident could adversely affect our competitive position and the value of our investment in research and development could be reduced. Our business could be subject to significant disruption, widespread negative publicity and a loss of customers, and we could suffer legal liabilities and monetary or other losses.
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We have international operations and are subject to risks associated with operating in international markets.
We outsource the production of certain parts and components, as well as finished goods in certain product lines, to a small number of vendors in various locations outside of the United States, including Malaysia, Taiwan and China. Although we do not currently generate significant sales from customers outside the United States, we are targeting foreign allied navies as a potential opportunity to generate additional sales of our MMM products as well as a limited number of foreign geographic markets which we expect to expand over time.
International business operations are subject to inherent risks, including, among others:
•difficulty in enforcing agreements and collecting receivables through foreign legal systems;
•unexpected changes in regulatory requirements, tariffs, and other trade barriers, restrictions or disruptions;
•potentially adverse tax consequences;
•localized impacts of epidemics, pandemics or other contagious outbreaks, such as the COVID-19 pandemic;
•the burdens of compliance with the U.S. Foreign Corrupt Practices Act, similar anti-bribery laws in other countries, and a wide variety of other laws;
•import and export license requirements and restrictions of the United States and each other country in which we operate;
•exposure to different legal standards and reduced protection for intellectual property rights in some countries;
•currency fluctuations and restrictions; and
•political, social, and economic instability, including war and the threat of war, acts of terrorism, pandemics, boycotts, curtailment of trade, or other business restrictions.
If we do not anticipate and effectively manage these risks, these factors may have a material adverse impact on our business operations.
Risks Associated with Legal and Regulatory Matters
We may be subject to legal claims against us or claims by us that could have a significant impact on our resulting financial performance.
At any given time, we may be subject to litigation or claims related to our products, intellectual property, suppliers, customers, employees, stockholders, distributors, sales representatives and sales of our assets, among other things, the disposition of which may have an adverse effect upon our business, financial condition, or results of operations. The outcome of litigation is difficult to assess or quantify. Lawsuits can result in the payment of substantial damages by defendants. If we are required to pay substantial damages and expenses as a result of these or other types of lawsuits, our business and results of operations would be adversely affected. Regardless of whether any claims against us are valid or whether we are liable, claims may be expensive to defend and may divert time and money away from our operations. Insurance may not be available at all or in sufficient amounts to cover any liabilities with respect to these or other matters. A judgment or other liability in excess of our insurance coverage for any claims could adversely affect our business and the results of our operations.
Our business may suffer if we fail to comply with government contracting laws and regulations.
We derive a significant portion of our revenues from direct and indirect sales to U.S., state, local and foreign governments and their respective agencies. Contracts with government customers are subject to various procurement laws and regulations, business prerequisites to qualify for such contracts, accounting procedures, intellectual property processes, and contract provisions relating to their formation, administration and performance, which may provide for various rights and remedies in favor of the governments that are not typically applicable to or found in commercial contracts. Failure to comply with these laws, regulations, or provisions in our government contracts could result in litigation, the imposition of various civil and criminal penalties, termination of contracts, forfeiture of profits, suspension of payments, or suspension from future government contracting. If our government contracts are terminated, if we are suspended from government work, or if our ability to compete for new contracts is adversely affected, our business could suffer due to, among other factors, lost sales, the costs of any government action or penalties, damages to our reputation and the inability to recover our investment in developing and marketing products for MMM use.
If we are unable to obtain and adequately protect our intellectual property rights or are subject to claims that our products infringe on the intellectual property rights of others, our ability to commercialize our products could be substantially limited.
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We consider our technology and processes proprietary. If we are not able to adequately protect or enforce the proprietary aspects of our technology, competitors may utilize our proprietary technology. As a result, our business, financial condition, and results of operations could be adversely affected. We protect our technology through a combination of patent, copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements, and similar means. Despite our efforts, other parties may attempt to disclose, obtain, or use our technologies. Our competitors may also be able to independently develop products that are substantially equivalent or superior to our products or slightly modify our products. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. As a result, we may not be able to protect our proprietary rights adequately in the United States or abroad. Furthermore, there can be no assurance that we will be issued patents for which we have applied or obtain additional patents, or that we will be able to obtain licenses to patents or other intellectual property rights of third parties that we may need to support our business in the future. The inability to obtain certain patents or rights to third-party patents and other intellectual property rights in the future could have a material adverse effect on our business.
The ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
We have significant U.S. net operating loss and tax credit carryforwards (the “Tax Attributes”). Under federal tax laws, we can carry forward and use our Tax Attributes to reduce our future U.S. taxable income and tax liabilities until such Tax Attributes expire in accordance with the Internal Revenue Code of 1986, as amended (the “IRC”). Section 382 and Section 383 of the IRC provide an annual limitation on our ability to utilize our Tax Attributes, as well as certain built-in-losses, against future U.S. taxable income in the event of a change in ownership, as defined under the IRC. Share issuances in connection with our past financing transactions or other future changes in our stock ownership, which may be beyond our control, could result in changes in ownership for purposes of the IRC. Such changes in ownership could further limit our ability to use our Tax Attributes. Accordingly, any such occurrences could adversely affect our financial condition, operating results and cash flows.
The cost of compliance with environmental, health, safety, and other laws and regulations could adversely affect our results of operations or financial condition.
We are subject to a broad range of environmental, health, safety, and other laws and regulations. These laws and regulations impose increasingly stringent environmental, health, and safety protection standards and permit requirements regarding, among other things, air emissions, wastewater storage, treatment, and discharges, the use and handling of hazardous or toxic materials, waste disposal practices, the remediation of environmental contamination, and working conditions for our employees. Some environmental laws, such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980, the Clean Water Act, and comparable laws in U.S. states and other jurisdictions world-wide, impose joint and several liability for the cost of environmental remediation, natural resource damages, third-party claims, and other expenses, without regard to the fault or the legality of the original conduct, on those persons who contributed to the release of a hazardous substance into the environment. We may also be affected by future laws or regulations, including those imposed in response to energy, climate change, geopolitical, or similar concerns. These laws may impact the sourcing of raw materials and the manufacture and distribution of our products and place restrictions and other requirements on the products that we can sell in certain geographical locations.
Our net sales might be adversely impacted if our lighting systems do not meet certain certification and compliance standards.
We are required to comply with certain legal requirements governing the materials in our products. Although we are not aware of any efforts to amend any existing legal requirements or implement new legal requirements in a manner with which we cannot comply, our net sales might be adversely affected if such an amendment or implementation were to occur.
Moreover, although not legally required to do so, we strive to obtain certification for substantially all our products. In the United States, we seek certification on substantially all of our products from UL®, ETL®, or DLCTM. Where appropriate in jurisdictions outside the United States, we seek to obtain other similar national or regional certifications for our products. Although we believe that our broad knowledge and experience with electrical codes and safety standards have facilitated certification approvals, we cannot ensure that we will be able to obtain any such certifications for our new products or that, if certification standards are amended, we will be able to maintain such certifications for our existing products. Moreover, although we are not aware of any effort to amend any existing certification standard or implement a new certification standard in a manner that would render us unable to maintain certification for our existing products or obtain ratification for new products, our net sales might be adversely affected if such an amendment or implementation were to occur.
We have in the past experienced a material weakness in our internal control over financial reporting, and if we experience additional material weaknesses in the future or fail to otherwise maintain effective financial reporting systems and processes, we may be unable to accurately and timely report our financial results or comply with the requirements of being a public
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company, which could cause the price of our common stock to decline and harm our business.
As a public company reporting to the SEC, we are subject to the reporting requirements of the Exchange Act 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.
We previously identified a material weakness in our internal control over financial reporting as of March 31, 2019, which has been remediated. The material weakness was primarily due to the insufficiency of supervision and review by employees for non-routine accounting and related financial reporting matters. Moreover, we cannot be certain that we will not in the future have additional material weaknesses in our internal control over financial reporting, or that we will successfully remediate any that we find. In addition, the processes and systems of internal controls we have developed to date may not be adequate. Accordingly, there could continue to be a reasonable possibility that material weaknesses could result in a misstatement of our accounts or disclosures that would result in a material misstatement of our financial statements that would not be prevented or detected on a timely basis, or cause us to fail to meet our obligations to file periodic financial reports on a timely basis. Any of these failures could result in adverse consequences that could materially and adversely affect our business, including an adverse impact on the market price of our common stock, potential action by the SEC against us, possible defaults under our debt agreements, shareholder lawsuits, delisting of our stock, general damage to our reputation and the diversion of significant management and financial resources.
We rely heavily on information technology in our operations and any material failure, weakness, interruption or breach of security could prevent us from effectively operating our business, which could have a material adverse effect on our business, financial condition, and results of operations.
We rely heavily on our information technology systems, including our enterprise resource planning (“ERP”) and customer relationship management (“CRM”) software, across our operations and corporate functions, including for management of our supply chain, payment of obligations, data warehousing to support analytics, finance systems, accounting systems, and other various processes and procedures, some of which are handled by third parties, as well as lead generation, customer tracking, customer sourcing, etc. We also rely heavily on remote communication tools such as Microsoft Teams and Zoom to accommodate remote work environment and external meetings.
Our ability to efficiently and effectively manage our business depends significantly on the reliability and capacity of these systems. Our business and results of operations may be adversely affected if we experience system usage problems. The failure of these systems to operate effectively, maintenance problems, system conversions, back-up failures, problems or lack of resources for upgrading or transitioning to new platforms or damage or interruption from circumstances beyond our control, including, without limitation, fire, natural disasters, power outages, systems failure, security breaches, cyber-attacks, viruses or human error could result in, among other things, transaction errors, processing inefficiencies, loss of data, inability to generate timely SEC reports, loss of sales and customers and reduced efficiency in our operations. Additionally, we and our customers could suffer financial and reputational harm if customer or Company proprietary information is compromised by such events. Remediation of such problems could result in significant unplanned capital investments and any damage or interruption could have a material adverse effect on our business, financial condition, and results of operations.
Risks Associated with an Investment in Our Common Stock
As a “thinly-traded” stock with a relatively small public float, the market price of our common stock is highly volatile and may decline regardless of our operating performance.
Our common stock is “thinly-traded” and we have a relatively small public float, which increases volatility in the share price and makes it difficult for investors to buy or sell shares in the public market without materially affecting our share price. Since the beginning of 2020, our market price has ranged from a low of $0.81 to a high of $11.60 and continues to experience significant volatility. Broad market and industry factors also may adversely affect the market price of our common stock, regardless of our actual operating performance. Factors that could cause wide fluctuations in our stock price may include, among other things:
•actual or anticipated variations in our financial condition and operating results;
•general economic conditions and trends;
•addition or loss of significant customers and the timing of significant customer purchases;
•our ability to effectively implement our growth plans, including new products, and the significance and timing of associated expenses;
•unanticipated impairments and other changes that reduce our earnings;
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•overall conditions or trends in our industry;
•the entry or exit of new competitors into our target markets;
•any litigation or legal claims;
•the terms and amount of any additional financing that we may obtain, if any;
•unfavorable publicity;
•additions or departures of key personnel;
•geopolitical changes, global health concerns and macroeconomic changes;
•changes in the estimates of our operating results or changes in recommendations by any securities or industry analysts that elect to follow our common stock;
•market expectations following periods of rapid growth;
•the potential impact of increased volatility due to elevated trading on the price of our stock;
•industry-wide news events that may affect market perceptions of the value of our stock; and
•sales of our common stock by us or our stockholders, including sales by our directors and officers.
Because our common stock is thinly-traded, investors seeking to buy or sell a certain quantity of our shares in the public market may be unable to do so within one or more trading days and it may be difficult for stockholders to sell all of their shares in the market at any given time at prevailing prices. Any attempts to buy or sell a significant quantity of our shares could materially affect our share price. In addition, because our common stock is thinly-traded and we have a relatively small public float, the market price of our shares may be disproportionately affected by any news, commentary or rumors regarding us or our industry, regardless of the source or veracity, which could also result in increased volatility.
In addition, in the past, following periods of volatility in the market price of a company’s securities, securities litigation has often been instituted against these companies. Volatility in the market price of our shares could also increase the likelihood of regulatory scrutiny. Securities litigation, if instituted against us, or any regulatory inquiries or actions that we face could result in substantial costs, diversion of our management’s attention and resources and unfavorable publicity, regardless of the merits of any claims made against us or the ultimate outcome of any such litigation or action.
We could issue additional shares of common stock or preferred stock without stockholder approval, or new securities with terms or rights superior to those of our existing stockholders, which may adversely affect the market price of our common stock.
We expect to require additional financing to fund future operations, including our research, development, sales and marketing activities. We are authorized to issue 50,000,000 shares of common stock of which 3,682,728 shares were issued and outstanding as of March 22, 2021 and 5,000,000 shares of preferred stock, of which 2,597,470 were issued and outstanding as of March 22, 2021. Our board of directors has the authority, without action or vote of our stockholders, to issue authorized but unissued shares of common and preferred stock subject to Nasdaq’s rules. Additionally, if we raise additional funds by issuing equity securities, the percentage ownership of our current stockholders will be reduced, and, if the equity securities issued are preferred shares, the holders of the new preferred shares may have rights superior to those of our existing stockholders, which could adversely affect rights of our existing stockholders and the market price of our common stock. In addition, in order to raise additional capital or acquire businesses in the future, we may need to issue securities that are convertible or exchangeable for shares of our common or preferred stock. If we raise additional funds by issuing debt securities, the holders of those debt securities would have some rights senior to those of our existing stockholders, and the terms of these debt securities could impose restrictions on operations and create a significant interest expense for us which could have a materially adverse effect on our business. Any such issuances could be made at a price that reflects a discount to the then-current trading price of our common stock. These issuances could be dilutive to our existing stockholders and cause the market price of our common stock to decline.
The exercise of outstanding warrants to purchase our common stock or the conversion of shares of our Series A Convertible Preferred Stock into shares of common stock may dilute the ownership interest of our common stockholders.
The exercise of some or all of the outstanding warrants to purchase our common stock or the conversion of some or all of the outstanding Series A Convertible Preferred Stock may dilute the ownership interests of our stockholders. Any sales of our common stock issuable upon the exercise of the warrants or conversion of the Series A Preferred Stock could adversely affect prevailing market prices of our common stock. In addition, the anticipated exercise of the warrants or conversion of the Series A Convertible Preferred Stock could depress the price of our common stock.
Our failure to comply with the continued listing requirements of Nasdaq could adversely affect the price of our common stock and its liquidity.
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Our common stock is currently listed on the Nasdaq Capital Market. We must comply with Nasdaq’s continued listing requirements related to, among other things, stockholders’ equity, market value, minimum bid price, and corporate governance in order to remain so listed. There can be no assurances that we will be able to comply with the applicable listing requirements.
We have in the past received notices from Nasdaq advising us that we were not in compliance with the continued listing requirements and, in each case, we were able to subsequently regain compliance. In January 2019, we received a letter from the Nasdaq Listing Qualifications Staff (the “Staff”) notifying us that, for the prior 30 consecutive trading days, the closing bid price for our common stock was below the minimum $1.00 per share required pursuant to Nasdaq Listing Rule 5550(a)(2) (the “Bid Price Rule”). In accordance with Nasdaq Listing Rule 5810(c)(3)(A), our common stock traded above $1.00 for the required number of days within the 180-calendar day period immediately following our receipt of the notice to regain compliance with the Bid Price Rule.
On May 15, 2019, we received a letter from the Staff notifying us that our common stock had again fallen out of compliance with the Bid Price Rule. On October 15, 2019, the Company formally requested a 180-day extension beginning November 12, 2019 to regain compliance. On April 16, 2020, Nasdaq announced that, in response to the COVID-19 pandemic and related extraordinary market conditions, it had provided temporary relief through June 30, 2020 from compliance with, among other rules, the Bid Price Rule. As a result, we had until July 24, 2020 to regain compliance with the Bid Price Rule, which we accomplished by effecting a 1-for-5 reverse stock split on June 11, 2020, increasing the per share trading price of our common stock. Our common stock began trading on Nasdaq on a split-adjusted basis at the opening of trading on June 12, 2020.
On August 17, 2020, we received a letter from the Staff notifying us that we were no longer in compliance with Nasdaq Listing Rule 5550(b)(1), which requires listed companies to maintain stockholders’ equity of at least $2,500,000 if they do not meet the alternative compliance standards relating to the market value of listed securities or net income from continuing operations (the “Minimum Stockholders’ Equity Rule”). Our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2020, reflected that our stockholders’ equity as of June 30, 2020 was $1,714,000. In addition, as of August 13, 2020, we did not meet the alternative compliance standards relating to the market value of listed securities or net income from continuing operations. On October 5, 2020, based on our timely submission of our plan to regain compliance, Nasdaq granted us an extension through February 15, 2021 to regain compliance with the Minimum Stockholders’ Equity Rule, subject to our compliance with certain terms of the extension. In accordance with one part of the plan submitted to the Staff, we have successfully modified our outstanding warrants and are able to now classify the warrants within equity. In December 2020, we reclassified $1.4 million from warrant liability into equity. At December 31, 2020 our stockholders’ equity was $4,255,000. On January 20, 2021,we received a letter from the Staff notifying us that, on a conditional basis, Nasdaq has determined that we have regained compliance with the minimum stockholders’ equity requirement for continued listing on the Nasdaq Capital Market.
If we do not remain compliant with Nasdaq’s continued listing requirements, then we could be delisted from The Nasdaq Capital Market. If we were delisted, it would likely have a negative impact on the price of our common stock and our liquidity. If we are delisted from The Nasdaq Capital Market and we are not able to list our common stock on another exchange, our common stock could be quoted on the OTC Bulletin Board or in the “pink sheets.” As a result, we could face significant adverse consequences including, among others:
•a limited availability of market quotations for our securities;
•a determination that our common stock is a “penny stock,” which would require broker-dealers trading in our common stock to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for our securities;
•a limited amount of news and little or no analyst coverage of the Company;
•we would no longer qualify for exemptions from state securities registration requirements, which may require us to comply with applicable state securities laws; and
•a decreased ability to issue additional securities (including pursuant to short-form registration statements on Form S-3) or obtain additional financing in the future.
As a result of these factors, the value of our common stock could decline significantly.
We have never paid dividends on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future.
We have never declared or paid dividends on our common stock, nor do we anticipate paying any cash dividends for the foreseeable future. We currently intend to retain future earnings, if any, to finance the operations and expansion of our business. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon
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our earnings, financial condition, operating results, capital requirements, a capital structure strategy and other factors as deemed necessary by our board of directors.
The elimination of monetary liability against our directors under Delaware law and the existence of indemnification rights held by our directors and officers may result in substantial expenditures by the Company and may discourage lawsuits against our directors and officers.
Our Certificate of Incorporation eliminates the personal liability of our directors to the Company and our stockholders for damages for breach of fiduciary duty as a director to the extent permissible under Delaware law. Further, our Bylaws provide that we are obligated to indemnify any of our directors or officers to the fullest extent authorized by Delaware law and, subject to certain conditions, advance the expenses incurred by any director or officer in defending any action, suit or proceeding prior to its final disposition. Those indemnification obligations could result in the Company incurring substantial expenditures to cover the cost of settlement or damage awards against our directors or officers, which we may be unable to recoup. These provisions and resultant costs may also discourage us from bringing a lawsuit against any of our current or former directors or officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors and officers even though such actions, if successful, might otherwise benefit us or our stockholders.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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ITEM2.PROPERTIES
Our principal executive offices and our manufacturing facility are located in an approximately 117,000 square foot facility in Solon, Ohio, under a lease agreement expiring on June 30, 2022. We believe this facility is adequate to support our current and anticipated operations.
ITEM 3.LEGAL PROCEEDINGS
From time to time, we may be involved in legal proceedings arising from the normal course of business. See Note 15, “Legal Matters,” to our financial statements for the year ended December 31, 2020 included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report.
ITEM 4.MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS,ANDISSUERPURCHASES OF EQUITY SECURITIES
Market Information
Our common stock trades on The Nasdaq Capital Market under the symbol “EFOI.”
Stockholders
There were approximately 46 holders of record of our common stock as of March 22, 2021, however, a large number of our stockholders hold their stock in “street name” in brokerage accounts. Therefore, they do not appear on the stockholder list maintained by our transfer agent.
Dividends
We have not declared or paid any cash dividends, and do not anticipate paying cash dividends in the near future.
ITEM 6. SELECTED FINANCIAL DATA
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, 17 CFR § 229.10(f)(1), the Company is not required to provide this information.
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ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements (“financial statements”) and related notes thereto, included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report.
Overview
Energy Focus, Inc. engages primarily in the design, development, manufacturing, marketing and sale of energy-efficient LED lighting systems and controls and recently announced development of UVCD products. We develop, market and sell high quality LED lighting products and UVCD products and controls in the commercial market and MMM. Our mission is to enable our customers to run their facilities and offices with greater energy efficiency, productivity, and human health through advanced LED retrofit and UVCD solutions. Our goal is to be the LED and HCL technology and market leader for the most demanding applications where performance, quality, value (high quality at an affordable price), environmental impact and health are considered paramount. We specialize in LED lighting retrofit by replacing fluorescent, high-intensity discharge lighting and other types of lamps and fixtures in institutional buildings for primarily indoor lighting applications with our innovative, high-quality commercial and military TLED, as well as other LED and lighting control and UVCD products. On October 14, 2020, we announced the launch of our UVCD product portfolio.
The LED lighting industry has changed dramatically over the past several years due to increasing commoditization, competition and price erosion. We have been experiencing these industry forces in both our military business since 2016 and in our commercial segment, where we once commanded significant price premiums for our flicker-free TLEDs with primarily 10-year warranties. Since April 2019, we have focused on redesigning our products for lower costs and consolidating our supply chain for stronger purchasing power where appropriate in order to price our products more competitively. Despite these efforts, the pricing of our legacy products remains at a premium to the competitive range and we expect aggressive pricing actions and commoditization to continue to be a headwind until our more differentiated new products ramp in volume. These trends are not unique to Energy Focus as evidenced by the increasing number of industry peers facing challenges, exiting LED lighting, selling assets and even going out of business.
In addition to continuously pursuing scheduled cost reductions, our strategy to combat these trends it to move up the value chain, with more innovative and differentiated products and solutions that offer greater, distinct value to our customers. Two specific examples of theseproducts we have developed include the RedCap®, our emergency backup battery integrated TLED, and EnFocusTM, our new dimmable/color-tunable lighting and control platform that we launched in 2020. We believe our revamped go-to-market strategy that focuses more on direct-sales marketing, selectively expanding our channel partner network that covers territories across the country, and listens to the voice of the customer, has led to better and more impactful product development efforts that we believe will eventually translate into larger addressable markets and greater sales growth for us.
Leveraging and integrating a broad range of rapidly advancing technologies including LED lighting, UV-C disinfection, electronics, software, sensors, cloud and AI, the Energy Focus UVCD solutions aim to provide impactful and affordable disinfection products for businesses and homes to effectively reduce infection risks. In addition to being ozone-free, the products are designed to guard against the risks of direct human exposure to UV-C rays. abUVTM and nUVoTM include enclosed, self-contained UV-C disinfection units that continuously inactivate viruses while reducing overall pathogen levels in the air. mUVeTM incorporates advanced sensor, machine vision and autonomous technologies to avoid human exposure during disinfection operations. We believe Energy Focus UVCD solutions are capable of providing affordable continuous disinfection with optimal effectiveness and safety. We believe that the UVCD products will open up a new, emerging and sizable market for us and expand our sales and growth potential.
Since April 2019, we have experienced significant change at the Company. Prior to James Tu returning as Chief Executive Officer and Chairman at the beginning of April 2019, the Company had experienced significant sales declines, operating losses and increases in its inventory. Immediately upon Mr. Tu returning to the Company, significant additional restructuring efforts were undertaken. The Company has since then replaced the entire senior management team, significantly reduced non-critical expenses, minimized the amount of inventory the Company was purchasing, dramatically changed the composition of our board of directors, as well as adding very selectively to the executive team by hiring Tod Nestor as President and Chief Financial Officer at the beginning of July 2019, and James R. Warren as Senior Vice President, General Counsel and Corporate Secretary in September 2020, in addition to recruiting new departmental leaders across the Company. The cost savings efforts undertaken included the Company implementing phased actions to reduce costs to minimize cash usage. Our initial actions included the elimination of certain positions, restructuring of the sales organization and incentive plan, flattening of the senior management team, additional operational streamlining, management compensation reductions, and outsourcing of certain functions including
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certain elements of supply chain and marketing. In connection with these actions, we recorded severance and related benefits charges of $0.2 million during the first half of 2019. These additional restructuring charges primarily related to severance and related benefits charges as a result of eliminating three positions during the first quarter of 2019 and nine positions during the second quarter of 2019, as well as costs associated with closing our offices in San Jose, California and Taipei, Taiwan in the second quarter of 2019. With quarterly sales for the Company leveling off at its low point in the third quarter of 2019 at $2.9 million, we began to see the impact of our relaunch efforts and restructuring of our sales organization in the fourth quarter of 2019 achieving sales of $3.5 million, or a sequential quarter-over-quarter growth rate of 21.1%. In addition, losses were mitigated through the better cost management and a sharp focus on better managing pricing and inventory decisions for the last half of 2019.
During 2020, we continued to see the benefits from these relaunch efforts undertaken by the new management team, in addition to a number of strategic sourcing projects completed during 2020. It is our belief that the continued momentum of the efforts undertaken in 2019 and into 2020, along with the development and launch of new and innovative products as well as an expanded sales team and distribution network, will over time result in improved sales and bottom-line performance for the Company.
We launched our EnFocusTM platform during the second quarter of 2020 and continued to receive positive feedback from existing, new, and potential new customers. The EnFocusTM platform offers two immediately available product lines: EnFocusTM DM, which provides a dimmable lighting solution, and EnFocusTM DCT, which provides both a dimmable and color tunable lighting solution. EnFocusTM enables buildings to have dimmable, color tunable and circadian-ready lighting using existing wiring, without requiring laying additional data cables or any wireless communication systems, through a relatively simple upgrade with EnFocusTM switches and tubular LEDs, a far more affordable and environmentally sustainable solution compared with replacing entire lighting fixtures and incorporating additional wired or wireless communication.
In addition, in response to the COVID-19 pandemic and an anticipated increase in sanitation and hygiene demand for buildings, facilities and homes, we started developing advanced UVCD products for both consumer as well as the commercial and industrial markets beginning in the first quarter of 2020. We announced the following three UVCD products in October 2020: abUVTM circadian lighting and UVCD air disinfection integrated troffers controlled by the EnFocusTM platform technology; nUVoTM portable disinfection device for offices and homes; and mUVeTM autonomous robot designed for surface disinfection.
In our MMM business, significant efforts undertaken to reduce costs in our product offerings have positioned us to be more competitive in this segment. Such efforts allowed us to continue to win bids and proposals that helped grow our MMM sales during 2020, offsetting some of the weakness being experienced in our commercial business. In addition, during the fourth quarter of 2020, we became an approved supplier for the General Services Administration (“GSA”) and our products are now listed in the GSA website for all federal and military agencies to view and order our products. While we continue to aggressively seek to increase sales of our commercial products, the MMM business offers us continued sales, in addition to validating our product quality and strengthening our brand trust in the marketplace.
Meanwhile, we continue to seek additional external funding alternatives and sources to support our growth strategies, plans and initiatives. We plan to achieve profitability through developing and launching new, innovative products such as EnFocusTM and our UVCD products, as well as executing on our multi-channel sales strategy that targets key verticals, such as government, healthcare, education and commercial and industrial, complemented by our marketing outreach campaigns and expanding channel partnerships. We also plan to continue to develop advanced lighting and lighting control applications built upon the EnFocusTM platform. In addition, we intend to continue to apply rigorous financial discipline in our organizational structure, business processes and policies, strategic sourcing activities and supply chain practices to help accelerate our path towards profitability.
Despite continuing progress throughout 2020 in reducing our operating losses significantly by 18.7% from December 31, 2019, the Company’s results reflect the challenges due to long and unpredictable sales cycles, unexpected delays in customer retrofit budgets and project starts, and unexpected supply chain issues, all exacerbated by the COVID-19 pandemic since early 2020. There has also been continuing aggressive price competition in the lighting industry. We continued to incur losses and we have a substantial accumulated deficit, which continues to raise substantial doubt about our ability to continue as a going concern at December 31, 2020.
The COVID-19 pandemic in particular has, and may continue to have, a significant economic and business impact on our company. Following a slowdown in the second quarter of 2020, we have seen a continuing weakness in commercial sales as customers in the healthcare, education, and commercial and industrial sectors delayed order placements in reaction to the impacts of the COVID-19 pandemic.
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We continue to monitor the impact of the COVID-19 pandemic on our customers, suppliers and logistics providers, and to evaluate governmental actions being taken to curtail and respond to the spread of the virus. The significance and duration of the ongoing impact on us is still uncertain. Material adverse effects of the COVID-19 pandemic on market drivers, our customers, suppliers or logistics providers could significantly impact our operating results. We also plan to continue to actively follow, assess and analyze the ongoing impact of the COVID-19 pandemic and stand ready to adjust our organizational structure, strategies, plans and processes to respond.
Because the situation continues to evolve, we cannot reasonably estimate the ultimate impact to our business, results of operations, cash flows and financial position that the COVID-19 pandemic may have. Continuation of the COVID-19 pandemic and government actions in response thereto could cause further disruptions to our operations and the operations of our customers, suppliers and logistics partners and could significantly adversely affect our near-term and long-term revenues, earnings, liquidity and cash flows. We aim to stay agile as an organization to respond to potential or continuing weakness in the macro environment and in the meantime expand sales channels and enter new markets such as UVCD that might be able to provide additional growth opportunities.
Results of operations
The following table sets forth the percentage of net sales represented by certain items reflected on our Consolidated Statements of Operations for the following periods:
Operating expenses:
Product development 8.4 10.1
Selling, general, and administrative 46.9 58.6
Restructuring (0.4) 1.6
Total operating expenses 54.9 70.3
Other expenses:
Interest expense 2.9 2.5
Loss on extinguishment of debt 1.6 —
Loss from change in fair value of warrants 6.5 —
Other expenses, net 0.4 0.7
Net loss before income taxes (35.5) (57.9)
Provision for income taxes — 0.1
Net sales
A further breakdown of our net sales by product line is as follows (in thousands):
Our net sales of $16.8 million in 2020 increased 32.5% compared to 2019 mainly driven by an increase of 136.6% in MMM sales. MMM sales were lower in 2019 primarily due to two of our products that were pending evaluation by the Defense Logistics Agency, during which time the US Navy was not allowed to purchase these two products and also due to federal
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government funding restrictions. In March 2020, we won a contract worth about $3.5 million and throughout 2020, our sales from our in-house sales and inside sales accounts grew significantly. Net sales of our commercial products decreased 31.4% in 2020 as compared to 2019, reflecting fluctuations in the timing, pace, and size of commercial projects, including impacts of the COVID-19 pandemic.
International sales
We do not generate significant sales from customers outside the United States. International net sales accounted for approximately 1% of net sales in 2020 and 2019, respectively. Changes in currency exchange rates did not have an impact on net sales in 2020 or 2019, as our sales, including international sales, are denominated in U.S. dollars.
Gross profit
Gross profit was $5.2 million in 2020, compared to $2.0 million in 2019. The increase in gross profit was primarily driven by an increase in MMM sales as noted above, as well as improved efficiency in our plant operations. Our 2020 gross profit as a percent of net sales of 30.8% increased from our 2019 gross profit as a percent of net sales of 15.5%, primarily driven by product mix and margin impact from MMM sales. Gross margin for 2020 included favorable price and usage variances for material and labor of $0.9 million or 5.5% of net sales and favorable inventory reserves recorded of $0.6 million, or 3.7% of net sales, offsetting unexpected additional manufacturing cost due to supply chain challenges relating primarily to our MMM products.
Operating expenses
Product development
Product development expenses include salaries, including stock-based compensation and related benefits, contractor and consulting fees, legal fees, supplies and materials, as well as overhead items, such as depreciation and facilities costs. Product development costs are expensed as they are incurred. Cost recovery represents the combination of revenues and credits from government contracts.
Total gross and net product development spending, including credits from government contracts, is shown in the following table (in thousands):
For the year ended December 31,
Total gross product development expenses $ 1,415 $ 1,284
Gross product development expenses were $1.4 million in 2020, an increase of 10.2%, compared to $1.3 million in 2019. The increase primarily resulted from increased product development and testing costs of $0.2 million associated with the development and launch of EnFocusTM and the development of our UVCD products.
Selling, general, and administrative
Selling, general, and administrative expenses were $7.9 million, or 46.9%, of net sales in 2020, compared to $7.4 million, or 58.6%, of net sales in 2019. Of the year-over-year $0.5 million increase, approximately $0.5 million is attributable to increased headcount and salaries, including stock-based compensation and related benefits, $0.2 million to an increase in legal and professional fees, and a $0.1 million increase in recruiting and relocation fees. These increases were offset by savings of $0.2 million in sales commissions, $0.1 million in travel and related expenses as a result of COVID-19 stay-at-home orders and $0.1 million in reduced depreciation expense.
Restructuring
During 2019 and 2020, we recorded restructuring charges of approximately $0.2 million and credits of approximately $0.1 million, respectively, related to the cost and offsetting sub-lease income for the remaining lease obligation for our former New York, New York and Arlington, Virginia offices. The lease on our Arlington, Virginia office ended September 30, 2019.
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During 2020, we recorded no restructuring-related severance and related benefits charges. During the first half of 2019, we recorded severance and related benefits charges of $0.2 million with no material restructuring charges recorded during the second half of 2019.
As of December 31, 2020, we estimate that we will receive a total of approximately $0.1 million in sublease payments to offset our remaining lease obligations of $0.2 million, which extend until June 2021. We expect to incur insignificant additional costs over the remaining life of our lease obligations. Please refer to Note 3, “Restructuring,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for further information.
Otherexpenses
Interest expense
We incurred $481 thousand in interest expense in 2020, primarily related to interest on borrowings and non-cash amortization of fees related to the Austin Facility, the promissory note in the principal amount of $1.3 million (the “Iliad Note”) the Company sold and issued to Iliad Research and Trading, L.P. (“Iliad”), pursuant to a note purchase agreement (the “Iliad Note Purchase Agreement”) with Iliad, and the interest on borrowings and non-cash amortization of fees related to the Credit Facilities.
We incurred $317 thousand in interest expense in 2019, primarily related to interest on borrowings and non-cash amortization of fees related to the Austin Facility and under the Iliad Note.
Loss on extinguishment of debt
A loss of $276 thousand on the extinguishment of debt was recognized during the year ended December 31, 2020, consisting of a $100 thousand termination fee and the write-off of the remaining related debt acquisition costs of $59 thousand from the Austin Facility and the write-off of the remaining debt acquisition costs of $117 thousand relating to the Iliad Note.
Loss from change in fair value of warrants
A loss of $1.1 million was recognized during the year ended December 31, 2020 for the market value change in our warrant liabilities. The loss recognized was a result of the revaluation of the warrant liability using the market price of the Company’s common stock at December 22, 2020, versus the market price of the Company’s common stock at the time of initial issuance of the warrants (January 13, 2020). On December 22, 2020, all warrant holders agreed to a modification of the terms of their warrants that qualified the warrants for equity accounting. At that time, the liability relating to the remaining 467,306 warrants was fair-valued with the offsetting adjustment recorded in income. The $1.4 million warrant liability was then reclassified into equity and the warrants are no longer subject to re-measurement at each balance sheet date.
Other expenses, net
We recognized other expenses, net, of $73 thousand in 2020, compared to other expenses, net, of $91 thousand in 2019. Other expenses, net, in 2020 primarily consisted of bank and collateral management fees. Other expenses, net in 2019 primarily consisted of $80 thousand of collateral management fees related to the Austin Facility and a net loss on the sale and disposal of fixed assets of $24 thousand, partially offset by various refunds of $12 thousand.
Income taxes
For the years ended December 31, 2020 and 2019, our effective tax rate was 0.1% and (0.1)%, respectively.
In 2020, our effective tax rate was lower than the statutory rate due to an increase in the valuation allowance as a result of the $7.1 million additional federal net operating loss we recognized for the year. In 2019, our effective tax rate was lower than the statutory rate due to an increase in the valuation allowance as a result of the $8.3 million additional federal net operating loss we recognized for the year.
Deferred income tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred income tax assets will not be realized. In considering the need for a valuation allowance, we assess all evidence, both positive and negative, available to determine whether all or some portion of the deferred tax assets will not be realized. Such evidence includes, but is not limited to, recent earnings history, projections of future income or loss, reversal patterns of existing taxable and deductible temporary differences, and tax planning strategies. We have recorded a full valuation allowance
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against our deferred tax assets at December 31, 2020 and 2019, respectively. We had no net deferred liabilities at December 31, 2020 or 2019.We will continue to evaluate the need for a valuation allowance on a quarterly basis.
At December 31, 2020, we had net operating loss carry-forwards of approximately $115.9 million for federal income tax purposes ($72.3 million for state and local income tax purposes). However, due to changes in our capital structure, approximately $61.5 million of the $115.9 million is available after the application of IRC Section 382 limitations. As a result of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), net operating loss carry-forwards generated in tax years beginning after December 31, 2017 can only offset 80% of taxable income. These net operating loss carry-forwards can no longer be carried back, but they can be carried forward indefinitely. The $7.1 million and $8.3 million in federal net operating losses generated in 2020 and 2019 will be subject to the new limitations under the Tax Act. If not utilized, the carry-forwards generated prior to December 31, 2017 of $37.3 million will begin to expire in 2021 for federal purposes and have begun to expire for state and local purposes. Please refer to Note 12, “Income Taxes,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for further information.
Net loss
Our net loss from operations improved to $6.0 million in 2020 compared to $7.4 million in 2019. The improvement in our loss is primarily due to increased sales of $4.1 million, or 32.5% over 2019 and our continued cost control initiatives, resulting in an increase in gross margin of 162.7% over 2019. These improvements were offset slightly by an increase in operating expenses of $0.3 million over 2019.
Liquidity andcapitalresources
General
We generated a net loss of $6.0 million in 2020, compared to net loss of $7.4 million in 2019. We have incurred substantial losses in the past, and as of December 31, 2020, we had an accumulated deficit of $130.9 million.
In order for us to operate our business profitably, we need to grow our sales, maintain cost control discipline while balancing development of our new products required for long-term competitiveness and revenue growth, continue our efforts to reduce product cost, and drive further operating efficiencies. There is a risk that our strategy to return to profitability may not be successful. We will likely require additional financing to achieve our strategic plan and, if our operations do not achieve, or we experience an unanticipated delay in achieving, our intended level and pace of profitability, we will continue to need additional funding, none of which may be available on favorable terms or at all and could require us to discontinue or curtail our operations.
Considering both quantitative and qualitative information, we continue to believe that the combination of our plan to continue to ensure appropriate levels of the availability of external financing, current financial position, liquid resources, obligations due or anticipated within the next year, executive and sales reorganization, and implementation of our product development and sales channel strategy, if adequately executed, will provide us with an ability to finance our operations through 2021 and will mitigate the substantial doubt about our ability to continue as a going concern.
Credit Facilities
On August 11, 2020, we entered into the Credit Facilities. The new Credit Facilities consist of the Inventory Facility, a two-year inventory financing facility for up to $3.0 million, and the Receivables Facility, a two-year receivables financing facility for up to $2.5 million. These facilities replaced our previous credit facility, the Austin Facility. As of December 31, 2020, our cash was approximately $1.8 million and our total outstanding balance was approximately $2.3 million under the Credit Facilities. As of December 31, 2020, our additional availability under the Credit Facilities was $1.7 million.
Convertible Notes
On March 29, 2019, we issued $1.7 million aggregate principal amount of subordinated convertible promissory notes (the “Convertible Notes”) to certain investors in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. The Convertible Notes had a maturity date of December 31, 2021 and bore interest at a rate of 5% per annum until June 30, 2019 and at a rate of 10% thereafter. Pursuant to their terms, on January 16, 2020, following approval by our stockholders of certain amendments to the Certificate of Incorporation, the principal amount of all of the Convertible Notes, andthe accumulated interest thereon ($0.1 million), which totaled $1.8 million, were converted at a conversion price of $0.67 per share into an aggregate of 2,709,018 shares of the Company’s Series A Convertible Preferred Stock, par value $0.0001 per
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share (the “Series A Preferred Stock”), which is convertible on a one-for-five basis into shares of our common stock. During 2020, 111,548 shares of the Series A Preferred Stock were converted into 22,310 shares of common stock.
Iliad Note
On November 25, 2019, we entered into the Iliad Note Purchase Agreement with Iliad pursuant to which the Company sold and issued to Iliad the Iliad Note in the principal amount of $1.3 million. The Iliad Note was issued with an original issue discount of $142 thousand and Iliad paid a purchase price of $1.1 million for the issuance of the Iliad Note, after deduction of $15 thousand of Iliad transaction expenses.
On December 1, 2020, we repaid the remaining outstanding balance of $30 thousand on the Iliad Note prior to its maturity date of November 24, 2021. We wrote-off $117 thousand in remaining debt and original issue discount costs at that time. The debt acquisition and original issue discount costs written-off are reflected as a loss on extinguishment of debt in our Consolidated Statements of Operations for the year ended December 31, 2020. The Iliad Note accrued interest at 8% per annum, compounded daily, on the outstanding balance. We were able to prepay the amounts outstanding under the Iliad Note at a premium, which was 15% during the first year and 10% during the second year. Beginning in May 2020, Iliad could have required us to redeem up to $150 thousand of the Iliad Note in any calendar month. We had the right on three occasions to defer all redemptions that Iliad could otherwise require us to make during any calendar month. No such deferrals were exercised.
Pursuant to the Iliad Note Purchase Agreement and the Iliad Note, we had, among other things, agreed that, until the Iliad Note was repaid, 10% of gross proceeds the Company received from the sale of our common stock or other equity must be paid to Iliad and applied to reduce the outstanding balance of the Iliad Note.
January 2020 Equity Offering
In January 2020, we completed a registered direct offering for the sale of 688,360 shares of our common stock to certain institutional investors, at a purchase price of $3.37 per share. We also sold, to the same institutional investors, warrants to purchase up to 688,360 shares of common stock at an exercise price of $3.37 per share in a concurrent private placement for a purchase price of $0.625 per warrant. We paid the placement agent commissions of $193 thousand plus $50 thousand in expenses in connection with the registered direct offering and the concurrent private placement and we also paid legal, accounting and other fees of $231 thousand related to the offering. Proceeds to us, before expenses, from the sale of common stock and warrants (the “January 2020 Equity Offering”) were approximately $2.8 million. In accordance with the terms of the Iliad Note, 10% of the gross proceeds from the January 2020 Equity Offering ($275 thousand) were used to make payments on the Iliad Note, a large portion of which was applied to reduce the outstanding principal amount.
Need for Additional Financing
Even with access to borrowings under the Credit Facilities, we may not generate sufficient cash flows from our operations or be able to borrow sufficient funds to sustain our operations. As such, we will likely need additional external financing during 2021 and will continue to review and pursue external funding sources including, but not limited to, the following:
•obtaining financing from traditional or non-traditional investment capital organizations or individuals;
•obtaining funding from the sale of our common stock or other equity or debt instruments; and
•obtaining debt financing with lending terms that more closely match our business model and capital needs.
There can be no assurance that we will obtain funding on acceptable terms, in a timely fashion, or at all. Obtaining additional financing contains risks, including:
•additional equity financing may not be available to us on satisfactory terms and any equity we are able to issue could lead to dilution for current stockholders and have rights, preferences and privileges senior to our common stock;
•loans or other debt instruments may have terms and/or conditions, such as interest rates, restrictive covenants and control or revocation provisions, which are not acceptable to management or our board of directors; and
•the current environment in the capital markets, as well as global health risks, combined with our capital constraints may prevent us from being able to obtain adequate debt financing.
If we fail to obtain additional financing to sustain our business before we are able to produce levels of revenue to meet our financial needs, we will need to delay, scale back or eliminate our business plan and further reduce our operating costs and headcount, each of which would have a material adverse effect on our business, future prospects, and financial condition. A lack of additional financing could also result in our inability to continue as a going concern and force us to sell certain assets or discontinue or curtail our operations and, as a result, investors in the Company could lose their entire investment.
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Cash and debt
At December 31, 2020, our cash balance was $1.8 million, compared to $0.4 million at December 31, 2019.
The following is a summary of cash flows from operating, investing, and financing activities, as reflected in the Consolidated Statements of Cash Flows (in thousands):
Net cash used in operating activities $ (2,451) $ (6,624)
Net cash used in investing activities $ (223) $ (129)
Proceeds from the issuance of common stock and warrants $ 2,749 $ —
Proceeds from the exercise of warrants 918 —
Offering costs paid on the issuance of common stock and warrants (510) —
Proceeds from PPP loan 795 —
Principal payments under finance lease obligations (3) (3)
Payments for deferred financing costs & termination fees (320) (208)
Proceeds from the Iliad Note — 1,115
Payments on the Iliad Note (1,306) —
Proceeds from convertible notes — 1,700
Net proceeds from credit line borrowings - Credit Facilities 2,459 —
Net payments from credit line borrowings - Austin Facility (719) (1,400)
Net cash provided by financing activities $ 4,160 $ 1,094
Cash used in operating activities
Net cash used in operating activities of $2.5 million in 2020 resulted primarily from the net loss incurred of $6.0 million, adjusted for non-cash items, including: depreciation and amortization of $0.2 million and stock-based compensation, net of $0.1 million, change in fair value of warrant liabilities of $1.1 million and favorable provisions from inventory of $0.6 million. We generated $1.1 million in cash for an increase in accounts payable due to the timing of inventory receipts and payments, $1.1 million from a net decrease in inventories primarily due to the timing of inventory receipts, $0.4 million through the timing of collection of accounts receivable and $0.3 million through an increase of other accrued liabilities, primarily related to accrued payroll and benefits and commissions. We used $0.7 million for short-term deposits to our contract manufacturers for inventory for the new EnFocusTM platform.
Net cash used in operating activities of $6.6 million in 2019 resulted primarily from the net loss incurred of $7.4 million, adjusted for non-cash items, including: depreciation and amortization of $0.3 million and stock-based compensation, net of $0.6 million. Cash used by an increase in accounts receivable of $0.1 million and a decrease in accounts payable mainly for inventory due to the timing of inventory receipts of $2.2 million and a decrease in accrued expenses primarily for accrued payroll and benefits, severance and commissions of $0.5 million further attributed to the cash impact of the net loss incurred. The cash used by these working capital changes was partially offset by cash generated by a net decrease in inventories of $1.9 million as we sold existing inventory and reduced inventory purchasing and prepaid expenses of $(0.1) million, as the inventory for which we paid deposits to our contract manufacturers in prior quarters was received in the first quarter of 2019.
Cashused in investing activities
Net cash used by investing activities was $0.2 million in 2020 and $0.1 million in 2019, respectively, and resulted primarily from the addition of property and equipment tooling to support production operations.
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Cash provided by financing activities
Net cash provided by financing activities for the year ended December 31, 2020 of $4.2 million primarily resulted from $2.7 million in proceeds received from the January 2020 Equity Offering, partially offset by $0.5 million in offering costs. Investors in the January 2020 Equity Offering received warrants to purchase shares of our common stock, of which warrants to purchase an aggregate of 467,306 shares remain outstanding at December 31, 2020 with a weighted average exercise price of $3.51 per share. During the year ended December 31, 2020, 269,240 warrants were exercised resulting in $0.9 million of proceeds. The exercise of the warrants remaining outstanding at December 31, 2020, could provide us with cash proceeds of up to $1.6 million in the aggregate.
During the year ended December 31, 2020, we received $0.8 million in proceeds from the PPP loan, $1.4 million from borrowings under the Inventory Facility and $1.1 million from borrowings under the Receivables Facility, and paid $0.7 million, net, on the Austin Facility. Also during the year ended December 31, 2020, we paid $0.2 million in deferred financing fees on the Credit Facilities. On August 11, 2020, we paid the outstanding balance of $1.4 million to close out the Austin Facility, which included a $100 thousand termination fee.
During the year ended December 31, 2020, we repaid $1.3 million aggregate principal amount under the Iliad Note, which included a mandatory repayment pursuant to the terms of the Iliad Note in connection with the issuance of common stock in the January 2020 Equity Offering, of which $0.2 million was allocated against principal. At December 31, 2020, we had additional availability for us to borrow of $1.0 million under the Inventory Facility and $0.6 million under the Receivables Facility.
Net cash provided by financing activities for the year ended December 31, 2019 of $1.1 million primarily resulted from net proceeds from the Convertible Notes of $1.7 million and the Iliad Note of $1.1 million offset by payments to the Austin Facility of $1.4 million.
Credit facilities
On August 11, 2020, we entered into the Credit Facilities, consisting of two debt financing arrangements. The new Credit Facilities consist of the Inventory Facility, a two-year inventory financing facility for up to $3.0 million, and the Receivables Facility, a two-year receivables financing facility for up to $2.5 million. These facilities replaced our previous credit facility, the Austin Facility, substantially increasing the Company’s borrowing capacity and reducing its blended interest expense rate.
Borrowings under the Inventory Facility were $1.3 million and borrowings under the Receivables Facility were $1.0 million at December 31, 2020. These facilities are recorded in the Consolidated Balance Sheet as of December 31, 2020 as a current liability under the caption “Credit line borrowings, net or origination fees.” Outstanding balances include unamortized net issuance costs totaling $0.1 million for the Inventory Facility and $40 thousand for the Receivables Facility as of December 31, 2020.
The Credit Facilities replaced the Austin Facility which was entered into on December 11, 2018 and was secured by a lien on our assets. The Austin Facility was a three year, $5.0 million revolving line of credit. Borrowings under the Austin Facility were $0.7 million at December 31, 2019 with total availability of $1.6 million. On August 11, 2020, we paid $1.4 million to close the Austin Facility which included a $100 thousand termination fee. Additionally, we wrote off $59 thousand of the remaining related debt acquisition costs. The termination fee and the write-off of debt acquisition costs are reflected as a loss on extinguishment of debt in our Consolidated Statements of Operations for the twelve months ended December 31, 2020.
For more information, see Note 9 “Debt” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report.
Off-balancesheetarrangements
We had no off-balance sheet arrangements at December 31, 2020 or 2019.
Criticalaccountingpolicies andestimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies, and the reported amounts of net sales and expenses in the financial statements. Material differences may result in the amount and timing of net sales and expenses if different judgments or different estimates were utilized.
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Critical accounting policies, judgments, and estimates that we believe have the most significant impact on our financial statements are set forth below:
•revenue recognition,
•allowances for doubtful accounts, returns and discounts,
•impairment of long-lived assets,
•valuation of inventories,
•accounting for income taxes,
•share-based compensation, and
•leases.
Revenuerecognition
On January 1, 2018, we adopted Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), as amended by subsequently issued additional guidance (together, “ASC 606”) using the modified retrospective method. The adoption of ASC 606 did not have a material impact on our consolidated financial position or results of operations, as our revenue arrangements generally consist of a single performance obligation to transfer promised goods at a fixed price.
Net sales include revenues from sales of products and shipping and handling charges, net of estimates for product returns. Revenue is measured at the amount of consideration we expect to receive in exchange for the transferred products. We recognize revenue at the point in time when we transfer the promised products to the customer and the customer obtains control over the products. Distributors’ obligations to us are not contingent upon the resale of our products. We recognize revenue for shipping and handling charges at the time the goods are shipped to the customer, and the costs of outbound freight are included in cost of sales. We provide for product returns based on historical return rates. While we incur costs for sales commissions to our sales employees and outside agents, we recognize commission costs concurrent with the related revenue, as the amortization period is less than one year. We do not incur any other incremental costs to obtain contracts with our customers. Our product warranties are assurance-type warranties, which promise the customer that the products are as specified in the contract. therefore, the product warranties are not a separate performance obligation and are accounted for as described below. Sales taxes assessed by governmental authorities are accounted for on a net basis and are excluded from net sales.
A disaggregation of product net sales is presented in Note 13, “Product and Geographic Information,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report.
Accounts Receivable
Our trade accounts receivable consists of amounts billed to and currently due from customers. Our customers are concentrated in the United States. In the normal course of business, we extend unsecured credit to our customers related to the sale of our products. Credit is extended to customers based on an evaluation of the customer’s financial condition and the amounts due are stated at their estimated net realizable value. During the first eleven months of 2019, we evaluated and monitored the creditworthiness of each customer on a case-by-case basis. However, during December 2019, we transitioned to an account receivable insurance program with a very high credit worthy insurance company where we have the large majority of the accounts receivable insured with a portion of self-retention. This third party also provides credit-worthiness ratings and metrics that significantly assists us in evaluating the credit worthiness of both existing and new customers. We maintain allowances for sales returns and doubtful accounts receivable to provide for the estimated number of account receivables that will not be collected. The allowance is based on an assessment of customer creditworthiness and historical payment experience, the age of outstanding receivables, and performance guarantees to the extent applicable. Past due amounts are written off when our internal collection efforts have been unsuccessful, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. We do not generally require collateral from our customers.
Our standard payment terms with customers are net 30 days from the date of shipment, and we do not generally offer extended payment terms to our customers, but exceptions are made in some cases to major customers or with particular orders. Accordingly, we do not adjust trade accounts receivable for the effects of financing, as we expect the period between the transfer of product to the customer and the receipt of payment from the customer to be in line with our standard payment terms.
Allowances fordoubtfulaccounts,returns,anddiscounts
We establish allowances for doubtful accounts and returns for probable losses based on the customers’ loss history with us, the
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financial condition of the customer, the condition of the general economy and the industry as a whole, and the contractual terms established with the customer. The specific components are as follows:
• allowance for doubtful accounts for accounts receivable, and
•allowance for sales returns and discounts.
In 2020 and 2019, the total allowance was $8 thousand and $28 thousand, respectively, which was all related to sales returns. We review these allowance accounts periodically and adjust them accordingly for current conditions.
Long-livedassets
Property and equipment are stated at cost and include expenditures for additions and major improvements. Expenditures for repairs and maintenance are charged to operations as incurred. We use the straight-line method of depreciation over the estimated useful lives of the related assets (generally two to fifteen years) for financial reporting purposes. Accelerated methods of depreciation are used for federal income tax purposes. When assets are sold or otherwise disposed of, the cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in the Consolidated Statement of Operations. Refer to Note 6, “Property and Equipment,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for additional information.
Long-lived assets are reviewed for impairment whenever events or circumstances indicate the carrying amount may not be recoverable. Events or circumstances that would result in an impairment review primarily include operations reporting losses, a significant change in the use of an asset, or the planned disposal or sale of the asset. The asset would be considered impaired when the future net undiscounted cash flows generated by the asset are less than its carrying value. An impairment loss would be recognized based on the amount by which the carrying value of the asset exceeds its fair value, as determined by quoted market prices (if available) or the present value of expected future cash flows. Refer to Note 6, “Property and Equipment,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for additional information.
Valuation ofinventories
We state inventories at the lower of standard cost (which approximates actual cost determined using the first-in-first-out method) or net realizable value. We establish provisions for excess and obsolete inventories after evaluation of historical sales, current economic trends, forecasted sales, product lifecycles, and current inventory levels. During 2019, due to efforts to sell excess and obsolete inventory and better management of inventory orders, we realized a net reduction of our excess inventory reserves of $0.6 million. During 2020, we continued to apply discipline in manufacturing and supply chain management, focusing on a reduction of lead time and inventory on hand which resulted in a net reduction of our gross inventory levels of $1.2 million and excess inventory reserves of $0.6 million compared to 2019. Adjustments to our estimates, such as forecasted sales and expected product lifecycles, could harm our operating results and financial position. Refer to Note 5, “Inventories,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for additional information.
Accounting forincometaxes
As part of the process of preparing the Consolidated Financial Statements, we are required to estimate our income tax liability in each of the jurisdictions in which we do business. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items, such as deferred revenues, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets. We then assess the likelihood of the deferred tax assets being recovered from future taxable income and, to the extent we believe it is more likely than not that the deferred tax assets will not be recovered, or is unknown, we establish a valuation allowance.
Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against our deferred tax assets. At December 31, 2020 and 2019, we have recorded a full valuation allowance against our deferred tax assets in the United States due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward. The valuation allowance is based upon our estimates of taxable income by jurisdiction and the period over which our deferred tax assets will be recoverable. In considering the need for a valuation allowance, we assess all evidence, both positive and negative, available to determine whether all or some portion of the deferred tax assets will not be realized. Such evidence includes, but is not limited to, recent earnings history, projections of future income or loss, reversal patterns of existing taxable and deductible temporary differences, and tax planning strategies. We continue to evaluate the need for a valuation allowance on a quarterly basis.
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At December 31, 2020, we had net operating loss carry-forwards of approximately $115.9 million for federal income tax purposes ($72.3 million for state and local income tax purposes). However, due to changes in our capital structure, approximately $61.5 million of the $115.9 million is available to offset future taxable income after the application of IRC Section 382 limitations. As a result of the Tax Act, net operating loss carry-forwards generated in tax years beginning after December 31, 2017 can only offset 80% of taxable income. These net operating loss carry-forwards can no longer be carried back, but they can be carried forward indefinitely. The $7.1 million and $8.3 million in federal net operating losses generated in 2020 and 2019 will be subject to the new limitations under the Tax Act. If not utilized, the carry-forwards generated prior to December 31, 2017 of $37.3 million will begin to expire in 2021 for federal purposes and have begun to expire for state and local purposes. Please refer to Note 12, “Income Taxes,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for further information.
Share-based payments
The cost of employee and director stock options and restricted stock units, as well as other share-based compensation arrangements, is reflected in the Consolidated Financial Statements based on the estimated grant date fair value method under the authoritative guidance. Management applies the Black-Scholes option pricing model to options issued to employees and directors to determine the fair value of stock options and apply judgment in estimating key assumptions that are important elements of the model in expense recognition. These elements include the expected life of the option, the expected stock-price volatility, and expected forfeiture rates. The assumptions used in calculating the fair value of share-based awards under Black-Scholes represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. Although we believe the assumptions and estimates we have made are reasonable and appropriate, changes in assumptions could materially impact our reported financial results. Restricted stock units and stock options issued to non-employees are valued based upon the intrinsic value of the award. See Note 11, “Stockholders’ Equity,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for additional information.
Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes the current lease accounting requirements. Additionally, in July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which simplifies adoption of Topic 842 by allowing an additional transition method that will not require restatement of prior periods and providing a new practical expedient for lessors to avoid separating lease and non-lease components within a contract if certain criteria are met (provisions of which must be elected upon adoption of Topic 842). The new standard requires a lessee to record on the balance sheet the assets and liabilities for the rights and obligations created by leases with lease terms of more than 12 months. It also requires lessees to disclose certain key information about lease transactions. Upon implementation, an entity’s lease payment obligations will be recognized at their estimated present value along with a corresponding right-of-use asset. Lease expense recognition will be generally consistent with current practice.
The Company adopted this guidance as of January 1, 2019 using the required modified retrospective method with the non-comparative transition option. The Company applied the transitional package of practical expedients allowed by the standard to not reassess the identification, classification and initial direct costs of leases commencing before this ASU’s effective date. The Company also applied the lease term and impairment hindsight transitional practical expedients. The Company has chosen to apply the following accounting policy practical expedients: to not separate lease and non-lease components to new leases as well as existing leases through transition; and the election to not apply recognition requirements of the guidance to short-term leases.
On adoption, we recognized additional operating lease liabilities of approximately $2.9 million as of January 1, 2019, with corresponding right-of-use assets based on the present value of the remaining minimum rental payments for our existing operating leases. The operating lease right-of-use assets recorded upon adoption were offset by the carrying value of liabilities previously recorded under Accounting Standards Codification (“ASC”) Topic 420, Exit or Disposal Cost Obligations (“Topic 420”) and impairment charges totaling $0.3 million and $0.2 million, respectively. Refer to Note 4, “Leases,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for additional disclosures relating to the Company’s leasing arrangements.
Recently issued accounting pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which significantly changes the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain financial instruments, including trade receivables, and requires an entity to recognize an allowance based on its estimate of expected credit losses
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rather than incurred losses. This standard will be effective for interim and annual periods starting after December 15, 2022 and will generally require adoption on a modified retrospective basis. We are in the process of evaluating the impact of the standard.
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, 17 CFR § 229.10(f)(1), the Company is not required to provide this information.
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ITEM8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
Page
Reports of Independent Registered Public Accounting Firms 41
Consolidated Balance Sheets as of December 31, 2020 and 2019 43
Notes to Consolidated Financial Statements 50
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Energy Focus, Inc.
Solon, Ohio
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Energy Focus, Inc. (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for the years then ended, and the related notes and Schedule II (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Continuation as a Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company has experienced recurring losses from operations and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“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 audits 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 consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated 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 consolidated 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 consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Reserves for Excess, Obsolete and Slow-Moving Inventories
Description of the Matter
As described in Notes 2 and 5 to the consolidated financial statements, the Company assesses the valuation of inventories each reporting period based on the lower of cost or net realizable value. The Company establishes reserves for excess, obsolete and slow-moving inventories after evaluation of historical sales, current economic trends, forecasted sales, product lifecycles and
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current inventory levels. The assessment is both quantitative and qualitative. As of December 31, 2020, the Company had inventories of $5.6 million, net of reserves for excess, obsolete and slow-moving inventories.
Auditing management's estimates for excess, obsolete and slow-moving inventories required subjective auditor judgment and evaluation of the reasonableness of significant assumptions used in developing the reserves as detailed above, as well as the inputs and related calculations related to historical sales and on-hand inventories.
How We Addressed the Matter in Our Audit
We obtained an understanding and evaluated the design of internal controls over the Company's reserves for excess, obsolete and slow-moving inventories, including management's assessment of the assumptions and data underlying the reserve calculation.
Our substantive audit procedures included, among others, testing the logic and integrity of calculations within management’s analysis; testing the completeness and accuracy of underlying data used, including inventory quantities, carrying costs and the estimate of net realizable value by product; and evaluating the reasonableness of management’s assumptions related to demand forecasts, estimated reserve percentages and qualitative considerations involving, among others, the implications of the COVID-19 pandemic and new or revised operational strategies. Evaluating the reasonableness of management’s assumptions involved (i) comparing historical sales by product, used as a basis for future demand, to audited sales subledgers on a sample basis, (ii) performing sensitivity analyses on reserve percentages applied to categories of projected demand to evaluate the changes in the reserve that would result from changes in the assumption, (iii) holding discussions with senior management to determine whether strategic or operational changes in the business were consistent with the projections of future demand that were utilized as basis for the reserves recorded, (iv) corroborating management’s qualitative considerations through review of recent sales transactions, including those subsequent to year-end, and order backlog and deferrals on a sample basis, and (v) testing declines in the reserve and evaluating whether such declines were the result of the sale or write-off of inventory or the result of changes in the significant assumptions used to the develop the reserve.
/s/ GBQ Partners, LLC
We have served as the Company's auditor since 2019.
Columbus, Ohio
March 25, 2021
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ENERGY FOCUS, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
(amounts in thousands except share data)
ASSETS
Current assets:
Prepaid and other current assets 782 353
Property and equipment, net 420 389
Operating lease, right-of-use asset 794 1,289
Restructured lease, right-of-use asset 107 322
Other assets — 405
LIABILITIES
Current liabilities:
Accrued liabilities 45 186
Accrued legal and professional fees 149 215
Accrued payroll and related benefits 885 360
Accrued sales commissions 95 32
Accrued restructuring 11 24
Accrued warranty reserve 227 195
Deferred revenue 72 18
Operating lease liabilities 598 550
Restructured lease liabilities 168 319
Finance lease liabilities 3 3
Convertible notes — 1,700
Iliad note, net of discount and loan origination fees — 885
Credit line borrowings, net of loan origination fees 2,298 715
(continued on the following page)
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGY FOCUS, INC.
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
(amounts in thousands except share data)
Other liabilities — 14
Operating lease liabilities, net of current portion 318 906
Restructured lease liabilities, net of current portion — 168
Finance lease liabilities, net of current portion 1 4
PPP loan, net of current maturities 266 —
Iliad note, net of current maturities — 109
STOCKHOLDERS’ EQUITY
Preferred stock, par value $0.0001 per share:
Common stock, par value $0.0001 per share:
Accumulated other comprehensive loss (3) (3)
Total liabilities and stockholders' equity $ 12,397 $ 11,739
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGY FOCUS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(amounts in thousands except per share data)
Operating expenses:
Selling, general, and administrative 7,900 7,449
Other expenses:
Loss on extinguishment of debt 276 —
Loss from change in fair value of warrants 1,086 —
Loss from operations before income taxes (5,986) (7,363)
(Benefit from) provision for income taxes (5) 10
Net loss per common share - basic and diluted:
Weighted average shares of common shares outstanding:
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGY FOCUS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31,
(amounts in thousands)
Other comprehensive loss:
Foreign currency translation adjustments — (2)
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGY FOCUS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2020 AND 2019
(amounts in thousands)
AdditionalPaid-inCapital AccumulatedOtherComprehensiveLoss
Preferred Stock Common Stock AccumulatedDeficit
Shares Amount Shares* Amount Total
Stock-based compensation — — — — 616 — — 616
Foreign currency translation adjustment — — — — — (2) — (2)
Issuance of common stock and warrants — — 688 — 2,749 — — 2,749
Offering costs on issuance of common stock and warrants — — — — (510) — — (510)
Issuance of common stock upon the exercise of warrants — — 269 — 2,235 — — 2,235
Warrant liability - issuance — — — — (1,636) — — (1,636)
Warrant liability - modification — — — — 1,405 — — 1,405
Conversion of notes to preferred stock 2,709 — — — 1,769 — — 1,769
Stock-based compensation — — — — 131 — — 131
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGY FOCUS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(amounts in thousands)
Cash flows from operating activities:
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation 131 616
Change in fair value of warrant liabilities 1,086 —
Provision for doubtful accounts receivable (20) (5)
Provision for slow-moving and obsolete inventories (610) 14
Provision for warranties 31 78
Amortization of loan discounts and origination fees 395 108
Loss on dispositions of property and equipment 8 24
Change in operating assets and liabilities:
Prepaid and other assets (18) (88)
Accrued and other liabilities 349 (542)
Deferred revenue 54 (12)
Net cash used in operating activities (2,451) (6,624)
Cash flows from investing activities:
Acquisitions of property and equipment (223) (132)
Proceeds from the sale of property and equipment — 3
Net cash used in investing activities (223) (129)
Cash flows from financing activities:
Proceeds from the issuance of common stock and warrants 2,749 —
Proceeds from the exercise of warrants 918 —
Offering costs paid on the issuance of common stock and warrants (510) —
Proceeds from PPP loan 795 —
Principal payments under finance lease obligations (3) (3)
Payments for deferred financing costs & termination fees (320) (208)
Proceeds from the Iliad Note — 1,115
Payments on the Iliad Note (1,306) —
Proceeds from convertible notes — 1,700
Net payments from credit line borrowings - Austin Facility (719) (1,400)
Net proceeds from credit line borrowings - Credit Facilities 2,459 —
Net cash provided by financing activities 4,160 1,094
(continued on the following page)
The accompanying notes are an integral part of these consolidated financial statements.
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ENERGY FOCUS, INC.