Energy Focus, Inc: Form 10-Q for the period ended Mar 31, 2024

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes thereto included in Part I, Item 1, “Financial Statements” of this Quarterly Report, as well as Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our Annual Report on Form 10-K for the year ended December 31, 2023 (“2023 Annual Report”).

Overview

Energy Focus, Inc. engages primarily in the design, development, manufacturing, marketing and sale of energy-efficient lighting systems and controls. We develop, market and sell high quality light-emitting diode (“LED”) lighting and controls products in the commercial market and military maritime market (“MMM”). Our mission is to enable our customers to run their facilities with greater energy efficiency, productivity, and human health and wellness through advanced LED retrofit solutions. Our goal is to be a market leader for the most demanding applications where performance, quality, value, environmental impact and health are considered paramount. We specialize in energy efficient LED lighting retrofit product replacing fluorescent, high-intensity discharge lighting and other types of lamps in institutional buildings for primarily indoor lighting applications with our innovative, high-quality commercial and military-grade tubular LED (“TLED”) products, as well as other LED and lighting control products for commercial and consumer applications. We are also evaluating adjacent technologies, including Gallium Nitride (“GaN”) based power supplies and additional market opportunities for energy solution products that support sustainability in our existing channels.

The LED lighting industry has changed dramatically over the past several years due to increasing competition and price erosion. We have been experiencing these industry forces in both our military and commercial business since 2016, when we once commanded significant price premiums for our flicker-free TLEDs with industry leading warranties. In more recent years, we have focused on redesigning our products for lower costs and consolidated our supply chain for stronger purchasing power in an effort to price our products more competitively while not impacting the performance and quality. Despite these efforts, our legacy products continue to face extreme price competition and a convergence of product functionality in the marketplace, and we have shifted to diversifying our supply chain in an effort to increase value and remain competitive. 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 cost reductions, our strategy to combat these trends is to innovate both our technology and product offerings with differentiated products and solutions that offer greater, distinct value. Specific examples of these products we have developed include the RedCap®, our patented emergency backup battery integrated TLED, EnFocus™, our unique dimmable/color-tunable lighting and powerline control platform that we launched in 2020, and the second generation of EnFocus™ powerline control switches and circadian lighting system. We are looking forward to the continued support and growth of our existing EnFocus™ product line which is particularly attractive for its ease of install and ease of use in spaces with transient occupation. The Company have enhanced the performance of our RedCap® product providing a more user- friendly experience. We continue to evaluate our sales strategy and believe our go-to-market strategy that focuses more on direct-sales marketing, selectively expanding our channel partner network to cover territories across the country, and listening to the voice of the customer, will lead to better and more impactful product development efforts that we believe will eventually translate into larger addressable markets and greater sales growth for us.

Throughout 2023, the Company continued to make significant cost cutting efforts to address operational expenses while maintaining customer satisfaction and delivering goods on-time. Investments into Energy Focus have contributed to the ability of the Company to continue to not only provide quality products and services, but to both expand and rationalize product offerings.

It is our belief that the continued dramatic rightsizing efforts undertaken in 2023 and 2024, along with reorganization of the sales team and ongoing development of innovative, high-value products and an expanded distribution network, will over time result in improved sales and bottom-line performance for the Company.

During 2023, our MMM business continued to face challenges resulting from the delayed availability of government funding and the timing of U.S. Navy awards, with several anticipated projects facing repeated and ongoing delays. This sector also maintains very long sales cycles. The timeline between bid to order can often take at least six months, and many MMM products are built-to-order with resultant lead times before orders become revenue. We continue to pursue opportunities from the U.S. Navy and the government sector to minimize such volatility. Previously in our MMM business, significant efforts undertaken to reduce costs in our product offerings have positioned us to be more competitive along with improved production efficiencies. Such efforts allowed us to continue to win bids and proposals that helped grow our MMM sales pipeline in the second half of 2023. While we continue to aggressively seek to increase sales of our commercial products, the MMM business offers us continued sales opportunities, in addition to validating our product quality and strengthening our brand trust in the marketplace. During 2023, we thoroughly reviewed and adjusted our commercial pricing position as well as our strategic relationships and partnerships within the commercial LED market space. We believe our new pricing position will give us a greater advantage than previously held against the competition and offer a more attractive entry point for our end customer base.

Meanwhile, we continue to seek additional external funding alternatives and sources to support our growth strategies, plans and initiatives. The strategic investments in 2023 by Sander Electronics, Inc. (“Sander”), a shareholder of the Company, contributed meaningful external capital, as well as presented synergistic opportunities to improve and diversify our supply chain and product offerings.

The EnFocus™ platform offers two immediately available product lines: EnFocus™ DM, which provides a dimmable lighting solution, and EnFocus™ DCT, which provides both a dimmable and color tunable lighting solution. EnFocus™ 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 EnFocus™ switches and LED lamps, a far more secure, affordable and environmentally sustainable solution compared with replacing an entire luminaire and incorporating additional wired or wireless communication.

Despite continuing progress on cost reduction throughout 2023 and 2024, the Company’s results reflect the challenges due to long and unpredictable sales cycles, unexpected delays in MMM and commercial customer retrofit budgets and project starts, and supply chain issues. There has also been continuing aggressive price competition in the lighting industry. We continue 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 March 31, 2024.

Our Business Strategy

Demand-oriented Approach

In order to deepen our relationships with customers, we are in the process of re-establishing our service model, aiming to provide richer and more targeted customer service. We believe that by increasing opportunities for interaction with our customers, we can better understand their needs, thereby enhancing their loyalty to our brand.

To ensure that EFOI’s products, pricing, and customer service lifecycle are better aligned, we are building a comprehensive value model to ensure consistency in the products and services we provide throughout the customer journey. We have begun an in-depth analysis of our current and past top 10 customers over the last five years to identify the core factors that make them loyal customers. By analyzing this data, we hope to reveal the key elements that enhance customer stickiness, providing them with more reasons and value to stay with us. In particular, we are actively focusing on customers with high loyalty to better meet their needs. This is not only an acknowledgment of our products but also a validation of the quality of our service.

Supply-oriented Approach

EFOI is committed to adopting three main sustainable economy strategies: “Green Supply Chain”, “Green Product”, and “Green Manufacturing”, aiming to promote sustainability throughout the entire value chain. The Company is working closely with its supply chain partners to optimize recycling mechanisms and strengthen packaging design, integrating sustainable economy principles into the core of supply chain management.

Guided by the vision of “transcending traditional corporate social responsibility and creating shared value”, EFOI’s team is focusing on stakeholders, aiming to achieve a “dual profit engine” effect by combining financial performance and Environmental, Social, and Governance (ESG) practices. This strategy not only aligns with the Company’s responsibility and sustainability goals but is also expected to enhance overall performance and market competitiveness. EFOI's operational team's new strategy focuses on integrating environmental and economic benefits, aiming to create a win-win situation that benefits the company, society, and the environment.

Under the premise of a similar industrial environment and familiar relationships, our professional skills complement those of our supply chain partners. This foundation of cooperation enables us to more easily achieve common goals of cost reduction, profit sharing, and exploring new business opportunities. This not only strengthens our cooperative relationship but also lays a solid foundation for our joint efforts towards a better future.

Financial-oriented Approach

The Company applies strategic financial management in the below perspective.

Control and Monitoring of Assets and Liabilities

• Assets: Regularly evaluate all assets, especially inventory, to ensure they remain in optimal condition in terms of value and performance. Minimize or mitigate the impact of inefficient and aging assets, focusing on assets with high efficiency and return.
• Liabilities: Ensure a robust liability structure, optimize the cost of liabilities, and seek lower interest rates and more favorable repayment terms. Regularly review the liability situation to ensure the company’s level of liabilities remains within a safe range.

Structured Profitability

• Revenue Growth: Develop diversified revenue streams, reduce dependency on single business or market, continuously optimize products and services, and enhance market competitiveness.
• Cost Control: Strictly control operating costs, seek opportunities to reduce costs, and ensure the efficient use of resources to optimize operations.
• Cash Flow Management: Establish a sound accounts receivable and payable management system to ensure timely collection of receivables and reasonable arrangement of payments. Maintain sufficient cash reserves to cope with potential funding shortages.

Results of operations

The following table sets forth items in our Condensed Consolidated Statements of Operations as a percentage of net sales for the periods indicated:

28

Net sales

A further breakdown of our net sales is presented in the following table (in thousands):

Net sales of $0.8 million for the first quarter of 2024 decreased $0.1 million, or 10%, compared to first quarter of 2023 net sales of $0.9 million, driven by a decrease of $75 thousand in MMM sales and $22 thousand in commercial sales. The decrease in net MMM sales in the first quarter of 2024 compare to the same period in 2023, primarily due to the staff reduction in the MMM sales department and delayed shipments for quality inspections. Net sales of our commercial products decreased by $22 thousand, or 7% in the first quarter of 2024 due to limited product availability impacts from supply chain constraints, our inventory reduction project, increased competition, and continuing fluctuations in the timing, pace, and size of commercial projects.

Gross Profit

Gross profit margin was $120 thousand, or 14% of net sales, for the first quarter of 2024. This compares with gross margin of $17 thousand, or 2% of net sales, in the first quarter of 2023. The quarter-over-quarter increase for the first quarter of 2024 in gross margin rate was primary driven by (1) a $14 thousand, or 1.3%, of net sales, decrease in fixed costs such as production salaries (2) favorable freight-in variances of $12 thousand, or 1% of net sales, and (3) favorable price and usage variances for material and labor of $117 thousand, or 15% of net sales.

Operating expenses

Product development

Product development expenses include salaries and related benefit, testing and related cost, travel, supplies, as well as overhead items, such as depreciation and facility costs. Product development costs are expensed as they are incurred.

Product development expenses were $128 thousand for the first quarter of 2024, down 17% from the first quarter of 2023. The $26 thousand decrease primarily resulted from lower payroll-related expenses due to a reduction in headcounts of $17 thousand and lower software contracts cost of $5 thousand. Product development expenses relate to customization of product offerings for key customers.

Selling, general and administrative

Selling, general and administrative expenses were $0.6 million for the first quarter of 2024, down 45% as compared to $1.1 million in the first quarter of 2023. The decrease is comprised of a combination of $250 thousand decrease in payroll and payroll-related expenses, $20 thousand decrease in commission expenses, $300 thousand decrease in software contracts, $70 thousand decrease in accounting fee as well as $60 thousand million in director fees.

Interest expense

Interest expense was $5 thousand for the first quarter of 2024, compared to interest expense of $123 thousand for the first quarter of 2023. The decrease in interest expense is primarily related to interest attributable to the 2022 Streeterville Note. There is no actual cash interest paid in the first quarter of 2024 and of 2023.

Gain on debt extinguishment

We recognized $187 thousand of gain on debt extinguishment for the first quarter of 2024, which was related to the early termination of the 2022 Streeterville Note. There was no such gain recognized for the first quarter of 2023.

Other expenses

We recognized other expenses of $1 thousand for the first quarter of 2024, compared to other expenses of $7 thousand for the first quarter of 2023. Other expenses are mainly comprised of bank and collateral management fees.

Provision for income taxes

Due to the operating losses incurred during the three months ended March 31, 2024 and 2023, and after application of the annual limitation set forth under Section 382 of the Internal Revenue Code of 1986, as amended, it was not necessary to record a provision for U.S. federal income tax or various state income taxes as income tax benefits are fully offset by a valuation allowance recorded.

Net loss

For the three months ended March 31, 2024, our net loss of $0.4 million decreased 69% over the net loss for the three months ended March 31, 2023 of $1.3 million. The decrease is mainly due to lower fixed costs in the first quarter of 2024.

Financial condition

At March 31, 2024, we had $972 thousand in cash and no outstanding debt. We have historically incurred substantial losses, and as of March 31, 2024, we had an accumulated deficit of $153.7 million. Additionally, our sales have been concentrated among a few major customers and for the three months ended March 31, 2024, two customers accounted for approximately 25% of net sales.

In 2024 and 2023, we recommitted to building upon the transformation activities started during 2019 that sought to stabilize and regrow our business. These efforts include the following key developments that occurred during 2024 and 2023:

• We continued development of the second generation of EnFocus™ powerline control switches and circadian lighting system for commercial markets, which as a result of supply chain challenges we now plan to reintroduce in 2024. EnFocus™ powerline control enables buildings to have dimmable, color tunable and circadian-ready lighting using existing wiring, without requiring laying additional cables or any wireless communication systems, through a relatively simple upgrade with EnFocus™ switches and EnFocus™ LED lamps. This upgrade offers a simpler, more secure, affordable and environmentally sustainable solution compared with replacing entire luminaire fixtures and incorporating additional wired or wireless communication.
• We reinvested in our MMM sales channel and are pursuing existing and new sales opportunities, though the sales cycles for what are frequently made-to-order products are longer than commercial offerings.
• The Company has aggressively re-evaluated operating expenses, and reduced its workforce significantly throughout 2023 into 2024 to manage fixed costs.
• We continued to seek additional external funding alternatives and sources to support our growth strategies, plans and initiatives.

During 2023 and into 2024, we redoubled our cost control efforts to streamline our operations by closely managing all spending done throughout the Company, while carefully investing in new products and strategies that sought to reenergize sales.

We will seek to remain agile as an organization to respond to potential or continuing weakness in the macroeconomic environment and in the meantime seek to expand sales channels and enter new markets that we believe will provide additional growth opportunities. We plan to achieve profitability through developing and launching new, innovative products, such as our EnFocusTM powerline control systems, our Redcap® emergency battery backup tubular TLEDs, evaluating new growth opportunities such as GaN-based power supply circuitry and other energy solution 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 that aim to serve the commercial markets. In addition, we intend to continue to apply rigorous financial discipline in our organizational structure, decision-making, business processes and policies, strategic sourcing activities and supply chain practices to help accelerate our path towards profitability.

Liquidity and capital resources

Cash

At March 31, 2024, our cash balance was approximately $972 thousand, compared to approximately $2.0 million at December 31, 2023.

The following summarizes cash flows from operating, investing, and financing activities, as reflected in the Condensed Consolidated Statements of Cash Flows included in Part I, Item 1, “Financial Statements,” of this Quarterly Report (in thousands):

Net cash used in operating activities

The substantial decrease in cash used in operating activity in the first three months of year 2024 was primarily related to:

• efforts to collect accounts receivable led to increase in cash flow from accounts receivable during the first three months of year 2024 compared to the first three months of year 2023; offset by
• higher accounts payable as of December 31, 2023 and efforts to manage inventory levels, reflecting more purchase activities in the fourth quarter of year 2023, led to higher cash outflows in the first quarter of year 2024.

Net cash used in operating activities was $0.1 million for the three months ended March 31, 2024. The net loss for the three months ended March 31, 2024 was $0.4 million and was adjusted for non-cash items, including depreciation and amortization, stock-based compensation, provisions for inventory, warranty, accounts receivable reserves and working capital changes. During the three months ended March 31, 2024, we generated $1.4 million from collection of accounts receivable and $0.1 million due to changes in prepayment for vendors. We used $0.1 million and $0.8 million from accounts payable and accounts payable to related party, respectively due to timing of inventory receipts and payments.

Net cash used in operating activities was $1.2 million for the three months ended March 31, 2023. The net loss for the three months ended March 31, 2023 was $1.3 million and was adjusted for non-cash items, including depreciation and amortization, stock-based compensation, provisions for inventory, warranty, accounts receivable reserves and working capital changes. During the three months ended March 31, 2023, we generated $562 thousand from inventory and $44 thousand due to changes in accrued and other liabilities. We used $496 thousand through the timing of collections of accounts receivable and $27 thousand from accounts payable due to timing of inventory receipts and payments.

Net cash used in investing activities

For the three months ended March 31, 2024 and 2023, the Company did not have any activities in connection with investing activities.

Net cash (used in) provided by financing activities

Net cash used in financing activities during the three months ended March 31, 2024 was $1.0 million, related to net payments on the 2022 Streeterville Note.

Net cash provided by financing activities during the three months ended March 31, 2023 was $1.4 million, primarily related to proceeds from the private placement of common stock and warrants of $3.0 million, offset by net payments on the Credit Facilities of $1.1 million and the 2022 Streeterville Note of $0.5 million.

Contractual and other obligations

As of March 31, 2024, we had approximately $557 thousand in outstanding purchase commitments for inventory. Of this amount, approximately $478 thousand is expected to ship in the second quarter of 2023, and $79 thousand expected to ship in the third quarter of 2024 and thereafter. Included in the total of outstanding purchase commitments are orders of 42% to a related party.

There have been no other material changes to our contractual and other obligations as compared to those included in our 2023 Annual Report.

Critical accounting policies

There have been no material changes to our critical accounting policies as compared to those included in our 2023 Annual Report.

Certain risks and concentrations

We have certain customers whose net sales individually represented 10% or more of our total net sales, or whose net trade accounts receivable balance individually represented 10% or more of our total net trade accounts receivable; we have certain suppliers, which individually represent 10% or more of our total purchases, or whose trade accounts payable balance individually represented 10% or more of our total trade accounts payable balance. Please refer to Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” included under Part I, Item 1, “Financial Statements,” of this Quarterly Report.

Recent accounting pronouncements

For information on recent accounting pronouncements, please refer to Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” included under Part I, Item 1, “Financial Statements,” of this Quarterly Report.

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this item.

Evaluation of disclosure controls and procedures

We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including our Chief Executive Officer, as appropriate, to allow for timely decisions regarding required disclosure.

Pursuant to Rule 13a-15(b) under the Exchange Act, our management must evaluate, with the participation of our Chief Executive Officer, the effectiveness of our disclosure controls and procedures, as of March 31, 2024, the end of the period covered by this Quarterly Report. Management, with the participation of our Chief Executive Officer, did evaluate the effectiveness of our disclosure controls and procedures as of the end of period covered by this Quarterly Report. Based on this evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures were effective as of March 31, 2024.

Changes in internal control over financial reporting

During the quarterly period covered by this Quarterly Report, there have not been any changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this item.