Dragonfly Energy Holdings Corp. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS References in this report (the “ Quarterly Report ”) to “we,” “us,” “our” or the “Company” refer to Dragonfly Energy Holdings Corp., a Nevada corporation. References to “Legacy Dragonfly” refer to Dragonfly Energy Corp., a Nevada corporation and our wholly-owned subsidiary. The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto contained elsewhere in this Quarterly Report. Certain information contained in the discussion and analysis set forth below includes forward-looking statements that involve risks and uncertainties. As a result of the completion of the Business Combination (as defined herein), the financial statements of Legacy Dragonfly are now the financial statements of us. Prior to the Business Combination, we had no operating assets but, upon consummation of the Business Combination, the business and operating assets of Legacy Dragonfly acquired by us became our sole business and operating assets. Accordingly, the financial statements of Legacy Dragonfly and their respective subsidiaries as they existed prior to the Business Combination and reflecting the sole business and operating assets of the Company going forward, are now the financial statements of us. The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and the related notes and the other financial information included elsewhere in this Quarterly Report and with our audited consolidated financial statements (and notes thereto) for the year ended December 31, 2022 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “ SEC ”) on April 17, 2023, as amended May 1, 2023 (the “ Annual Report ”), particularly those under “Risk Factors.” This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Quarterly Report. We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes. Cautionary Note Regarding Forward Looking-Statements This Quarterly Report on Form 10-Q contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 under Section 27A of the Securities Act of 1933, as amended (the “ Securities Act ”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “can,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential” and other similar words and expressions of the future. There are a number of important factors that could cause the actual results to differ materially from those expressed in any forward-looking statement made by us. These factors include, but are not limited to: ● our ability to recognize the anticipated benefits of our Business Combination, which may be affected by, among other things, the factors listed below; ● our ability to successfully increase market penetration into target markets; ● the addressable markets that we intend to target do not grow as expected; ● the loss of any members of our senior management team or other key personnel; ● the loss of any relationships with key suppliers, including suppliers in China; ● the loss of any relationships with key customers; ● our ability to protect our patents and other intellectual property; 28 ● the failure to successfully optimize solid-state cells or to produce commercially viable solid-state cells in a timely manner or at all, or to scale to mass production; ● the failure to produce lithium battery cells in the United States in a timely manner or at all, or to scale to mass production; ● changes in applicable laws or regulations; ● our ability to maintain the listing of our common stock on the Nasdaq Global Market and our public warrants on the Nasdaq Capital Market; ● the possibility that we may be adversely affected by other economic, business and/or competitive factors (including an economic slowdown or inflationary pressures); ● our ability to sell the desired amounts of shares of common stock at desired prices under our equity facility; ● the potential for events or circumstances that result in our failure to timely achieve the anticipated benefits of our customer arrangements with THOR Industries and its affiliate brands (including Keystone RV Company (“ Keystone ”)), including Keystone’s decision in July 2023, that, due to weaker demand for its products and their subsequent focus on reducing costs, it would no longer install our storage solutions as standard equipment, but rather return to offering those solutions as an option to dealers and consumers; ● our ability to raise additional capital to fund our operations; ● our ability to generate revenue from future product sales and our ability to achieve and maintain profitability; ● the accuracy of our projections and estimates regarding our expenses, capital requirements, cash utilization, and need for additional financing; ● developments relating to our competitors and our industry; ● our ability to engage target customers and successfully retain these customers for future orders; ● the reliance on two suppliers for our lithium iron phosphate cells and a single supplier for the manufacture of our battery management system; and ● our current dependence on a single manufacturing facility. The foregoing does not represent an exhaustive list of matters that may be covered by the forward-looking statements contained herein or risk factors that we are faced with that may cause our actual results to differ from those anticipated in such forward-looking statements. Please see “ Part I—Item 1A—Risk Factors ” of our Annual Report, for additional risks which could adversely impact our business and financial performance. All forward-looking statements are expressly qualified in their entirety by this cautionary notice. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Quarterly Report or the date of the document incorporated by reference into this report. We have no obligation, and expressly disclaims any obligation, to update, revise or correct any of the forward-looking statements, whether as a result of new information, future events or otherwise. We have expressed our expectations, beliefs and projections in good faith and believe they have a reasonable basis. However, we cannot assure you that our expectations, beliefs or projections will result or be achieved or accomplished. 29 Overview Our Business We are a manufacturer of non-toxic deep cycle lithium-ion batteries that are designed to displace lead acid batteries in a number of different storage applications and end markets including recreational vehicle (“ RV ”), marine vessel, and solar and off-grid industries, with disruptive solid-state cell technology currently under development. Since 2020, we have sold over 281,000 batteries. For the quarters ended September 30, 2023, and September 30, 2022, we sold 14,886 and 31,375 batteries, respectively, and had $15.9 million and $26.1 million in net sales, respectively. We currently offer a line of batteries across our “Battle Born” and “Dragonfly” brands, each differentiated by size, power and capacity, consisting of seven different models, four of which come with a heated option. We primarily sell “Battle Born” branded batteries directly to consumers (“ DTC ”) and “Dragonfly” branded batteries to original equipment manufacturers (“ OEMs ”). We currently source the lithium iron phosphate cells incorporated into our batteries from a limited number of carefully selected suppliers that can meet our demanding quality standards and with whom we have developed long-term relationships. To supplement our battery offerings, we also offer our line of proprietary Wakespeed alternator regulation products which are necessary to ensure that the alternator does not get unduly stressed during the current delivery to the batteries, and that the current delivery remains within the operating limits of the onboard battery bank. In addition to our own accessories we are also a reseller of accessories for battery systems. These include chargers, inverters, monitors, controllers, solar panels and other system accessories from brands such as Victron Energy, Progressive Dynamics, REDARK, Rich Solar, and Sterling Power. In addition to our conventional lithium iron phosphate (“ LFP ”) batteries, we are currently developing the next generation of LFP solid-state cells. Since our founding, we have been developing proprietary battery cell manufacturing processes and solid-state battery cell technology for which we have issued patents and pending patent applications, where appropriate. Solid-state lithium-ion technology eliminates the use of a liquid electrolyte, which addresses the residual heat and flammability issues arising from lithium-ion batteries. The unique competitive advantage of our cell manufacturing process is highlighted by our dry deposition technology, which completely displaces the need for toxic solvents in the manufacturing process and allows for the rapid and scalable production of chemistry-agnostic cells. Additionally, our internal production of battery cells will streamline our supply chain, allowing us to vertically integrate our cells into our batteries, thereby lowering our production costs. In October 2023, we announced the successful dry deposition of anode and cathode electrodes at scale using our patented battery manufacturing process. We expect to begin producing LFP cells in the United States by the end of 2023. As of September 30, 2023, we had cash totaling $13.2 million. Our net loss for the quarter ended September 30, 2023 was $10.0 million and our net loss for the quarter ended September 30, 2022 was $3.7 million. As a result of becoming a publicly traded company, we continue to need to hire additional personnel and implement procedures and processes to address public company regulatory requirements and customary practices. We expect to incur additional expenses as a public company for, among other things, directors’ and officers’ liability insurance, director fees and additional internal and external accounting and legal and administrative resources, including increased audit and legal fees. As discussed under “ Liquidity and Capital Resources ” below, we expect that we will need to raise additional funds, including through the use of our $150 million equity facility (the “ ChEF Equity Facility ”) with Chardan Capital Markets LLC (“ CCM LLC ”) and the issuance of equity, equity-related or debt securities or by obtaining additional credit from financial institutions to fund, together with our principal sources of liquidity, ongoing costs, such as research and development relating to our solid-state batteries, expansion of our facilities, and new strategic investments. If such financings are not available, or if the terms of such financings are less desirable than we expect, we may be forced to take actions to reduce our capital or operating expenditures, including not seeking potential acquisition opportunities, eliminating redundancies, or reducing or delaying our production facility expansions, which may adversely affect our business, operating results, financial condition and prospects. 30 The Business Combination On October 7, 2022, Chardan NexTech 2 Acquisition Corp., a Delaware company (“ Chardan ”), and Legacy Dragonfly consummated the merger pursuant to the Agreement and Plan of Merger, dated as of May 15, 2022 (as amended, the “ Business Combination Agreement ”), by and among Chardan, Bronco Merger Sub, Inc., a Delaware corporation and wholly-owned subsidiary of Chardan (“ Merger Sub ”), and Legacy Dragonfly. Pursuant to the Business Combination Agreement, Merger Sub merged with and into Legacy Dragonfly (the “ Merger ” and, together with the other transactions contemplated by the Business Combination Agreement, the “ Business Combination ”), with Legacy Dragonfly continuing as the surviving corporation in the Merger and as our wholly owned subsidiary. In connection with the Business Combination, Chardan changed its name to Dragonfly Energy Holdings Corp. Legacy Dragonfly is deemed the accounting acquirer, which means that Legacy Dragonfly’s financial statements for previous periods will be disclosed in our future periodic reports filed with the SEC. Following the Business Combination, our business is the business of Legacy Dragonfly. The Business Combination was accounted for as a reverse recapitalization. Under this method of accounting, Chardan was treated as the acquired company for financial statement reporting purposes. June 2023 Offering On June 20, 2023, we entered into an underwriting agreement (the “ Underwriting Agreement ”) with Roth Capital Partners, LLC, as representative of the several underwriters (the “ Underwriters ”), pursuant to which we sold to the Underwriters, in a firm commitment underwritten public offering (the “ June 2023 Offering ”), an aggregate of (i) 10,000,000 shares of our common stock, par value $0.0001, and (ii) accompanying warrants to purchase up to 10,000,000 shares of common stock (the “ Investor Warrants ”), at the combined public offering price of $2.00 per share and accompanying Investor Warrant, less underwriting discounts and commissions, and (iii) warrants to purchase up to an aggregate of 570,250 shares of common stock (the “ Underwriters’ Warrants ”). In addition, we granted the Underwriters a 45-day over-allotment option to purchase up to an additional 1,500,000 shares of common stock and/or Investor Warrants to purchase up to an aggregate of 1,500,000 shares of common stock at the public offering price per security, less underwriting discounts and commissions. The Investor Warrants are exercisable for five years from the closing date of the Offering, have an exercise price of $2.00 per share and are immediately exercisable. In the event of certain fundamental transactions, holders of the Investor Warrants will have the right to receive the Black Scholes Value (as defined in the Investor Warrants) of their Investor Warrants calculated pursuant to the formula set forth in the Investor Warrants, payable either in cash or in the same type or form of consideration that is being offered and being paid to the holders of common stock. The Underwriters’ Warrants are exercisable upon issuance and will expire on June 20, 2028. The initial exercise price of the Underwriters’ Warrants is $2.50 per share, which equals 125% of the per share public offering price in the Offering. As part of the June 2023 Offering, the Underwriters partially exercised their over-allotment option in the amount of 1,405,000 shares of common stock and Investor Warrants to purchase 1,405,000 shares of common stock. The June 2023 Offering closed on June 22, 2023. The aggregate net proceeds from this offering, including the partial over-allotment option, was approximately $21.1 million. Key Factors Affecting Our Operating Results Our financial position and results of operations depend to a significant extent on the following factors: End Market Consumers The demand for our products ultimately depends on demand from consumers in our current end markets. We generate sales through (1) DTC and (2) through OEMs, particularly in the RV market. An increasing proportion of our sales has been and is expected to continue to be derived from sales to RV OEMs, driven by continued efforts to develop and expand sales to RV OEMs with whom we have longstanding relationships. Our RV OEM sales have been on a purchase order basis, without firm revenue commitments, and we expect that this will likely continue to be the case. Therefore, future RV OEM sales will be subject to risks and uncertainties, including the number of RVs these OEMs manufacture and sell, which in turn may be driven by the expectations these OEMs have around end market consumer demand. 31 Demand from end market consumers is impacted by a number of factors, including fuel costs and energy demands (including an increasing trend towards the use of green energy), as well as overall macro-economic conditions, such as interest rates and inflation. Sales of our batteries have benefited from the increased adoption of the RV lifestyle, the demand for and inclusion of additional appliances and electronics in RVs, and the accelerating trend of solar power adoption among RV customers. However, in recent months rising fuel costs and other macro-economic conditions, such as inflation and rising interest rates, have caused a downward shift in decisions taken by end market consumers around spending in the RV market and in July of 2023, we were notified by our largest RV OEM customer that, due to weaker demand for its products and their subsequent focus on reducing costs, it would no longer install our storage solutions as standard equipment, but rather return to offering those solutions as an option to dealers and consumers. While this customer is not moving to a different solution or competitor, this change had a material adverse impact on our OEM sales for the quarter ended September 30, 2023. Furthermore, we expect this change to continue to have a material limiting effect on our revenue throughout the remainder of 2023 and potentially into 2024. Our strategy includes plans to expand into new end markets that we have identified as opportunities for our LFP batteries, including long-haul and fleet trucking, industrial, rail, specialty and work vehicles, material handling, solar integration, and emergency and standby power in the medium term, and data centers, telecom and distributed on-grid storage in the longer term. We believe that our current LFP batteries and, eventually, our solid-state batteries, will be well-suited to supplant traditional lead-acid batteries as a reliable power source for the variety of low power density uses required in these markets (such as powering the increasing number of on-board tools needed in emergency vehicles). The success of this strategy requires (1) continued growth of these addressable markets in line with our expectations and (2) our ability to successfully enter these markets. We expect to incur significant marketing costs understanding these new markets, and researching and targeting customers in these end markets, which may not result in sales. If we fail to execute on this growth strategy in accordance with our expectations, our sales growth would be limited to the growth of existing products and existing end markets. Supply We currently rely on two carefully selected cell manufacturers located in China, and a single supplier, also located in China, to manufacture our proprietary battery management system, and we intend to continue to rely on these suppliers going forward. Our close working relationships with our China-based LFP cell suppliers, reflected in our ability to increase our purchase order volumes (qualifying us for related volume-based discounts) and order and receive delivery of cells in anticipation of required demand, has helped us moderate increased supply-related costs associated with inflation, currency fluctuations and U.S. government tariffs imposed on our imported battery cells and to avoid potential shipment delays. To mitigate against potential adverse production events, we opted to build our inventory of key components, such as battery cells. However, as many of the supply chain challenges and delays that were prevalent over the last several years have eased, we are now actively working down our inventory to more appropriate safety stock levels. As a result of our battery chemistry and active steps we have taken to manage our inventory levels, we have not been subject to the shortages or price impacts that have been present for manufacturers of nickel manganese cobalt and nickel cobalt aluminum batteries. As we look toward the production of our solid-state cells, we have signed a Commercial Offtake Agreement with a lithium mining company located in Nevada for the supply of lithium, which we expect will enable us to further manage our cost of goods over time. Product and Customer Mix Our product sales consist of sales of seven different models of LFP batteries, along with accessories for battery systems (individually or bundled). These products are sold to different customer types (e.g., consumers, OEMs and distributors) and at different prices and involve varying levels of costs. In any particular period, changes in the mix and volume of particular products sold and the prices of those products relative to other products will impact our average selling price and our cost of goods sold. Despite our work to moderate increased supply-related costs, the price of our products may also increase as a result of increases in the cost of components due to inflation, currency fluctuations and tariffs. OEM sales typically result in lower average selling prices and related margins, which could result in margin erosion, negatively impact our growth or require us to raise our prices. However, this reduction is typically offset by the benefits of increased sales volumes. Sales of third-party sourced accessories typically have lower related margin. We expect accessory sales to increase as we further develop full-system design expertise and product offerings and consumers increasingly demand more sophisticated systems, rather than simple drop-in replacements. In addition to the impacts attributable to the general sales mix across our products and accessories, our results of operations are impacted by the relative margins of products sold. As we continue to introduce new products at varying price points, our overall gross margin may vary from period to period as a result of changes in product and customer mix. 32 Production Capacity All of our battery assembly currently takes place at our 99,000 square foot headquarters and manufacturing facility located in Reno, Nevada. We currently operate three LFP battery production lines. Consistent with our operating history, we plan to continue to automate additional aspects of our battery production lines. Our existing facility has the capacity to add up to four additional LFP battery production lines and construct and operate a pilot production line for domestic cell manufacturing, all designed to maximize the capacity of our manufacturing facility. Although our automation efforts are expected to reduce our costs of goods, we may not fully recognize the anticipated savings when planned and could experience additional costs or disruptions to our production activities. In addition, we have entered into a lease for an additional 390,240 square foot warehouse in Reno, Nevada, which is expected to be completed in early 2024. This facility, combined with our existing facility, will allow further scaling of our increasingly automated battery pack assembly capabilities, expand our warehousing space, and allow for deployment of our solid-state cell manufacturing. Competition We compete with traditional lead-acid battery manufacturers and lithium-ion battery manufacturers, who primarily either import their products or components or manufacture products under a private label. As we continue to expand into new markets, develop new products and move towards production of our solid-state cells, we will experience competition with a wider range of companies. These competitors may have greater resources than we do, and may be able to devote greater resources to the development of their current and future technologies. Our competitors may be able to source materials and components at lower costs, which may require us to evaluate measures to reduce our own costs, lower the price of our products or increase sales volumes in order to maintain our expected levels of profitability. Research and Development Our research and development is primarily focused on the advanced manufacturing of domestic battery cells and solid-state lithium-ion battery cells using our proprietary and patented dry deposition battery cell manufacturing process. The Company has announced that its pilot line successfully produced both anode and cathode material, at pilot scale, using this patented process. The Company currently expects to deliver full sample battery cells from its pilot line before the end of 2023. The next stage in our technical development is to construct the battery to optimize performance and longevity to meet and exceed industry standards for our target storage markets. Ongoing testing and optimizing of more complicated batteries incorporating layered pouch cells will assist us in determining the optimal cell chemistry to enhance conductivity and increase the number of cycles (charge and discharge) in the cell lifecycle. This is expected to require significant additional expense, and we may need to raise additional funds to continue these research and development efforts. Components of Results of Operations Net Sales Net sales are primarily generated from the sale of our LFP batteries to OEMs and consumers, as well as chargers and other accessories, either individually or bundled. Cost of Goods Sold Cost of goods sold includes the cost of cells and other components of our LFP batteries, labor and overhead, logistics and freight costs, and depreciation of manufacturing equipment. Gross Profit Gross profit, calculated as net sales less cost of goods sold, may vary between periods and is primarily affected by various factors including average selling prices, product costs, product mix and customer mix. 33 Operating Expenses Research and development Research and development costs include personnel-related expenses for scientists, experienced engineers and technicians as well as the material and supplies to support the development of new products and our solid-state technology. As we work towards completing the development of our solid-state lithium-ion cells and the manufacturing of batteries that incorporate this technology, we anticipate that research and development expenses will increase significantly for the foreseeable future as we continue to invest in product development and optimizing and producing solid-state cells. General and administrative General and administrative costs include personnel-related expenses attributable to our executive, finance, human resources, and information technology organizations, certain facility costs, and fees for professional services. Selling and marketing Selling and marketing costs include outbound freight, personnel-related expenses, as well as trade show, industry event, marketing, customer support, and other indirect costs. We expect to continue to make the necessary sales and marketing investments to enable the execution of our strategy, which includes expanding into additional end markets. Total Other Income (Expense) Other income (expense) consists primarily of interest expense, the change in fair value of the warrant liability and amortization of debt issuance costs. Results of Operations Comparisons for the Three months ended September 30, 2023 and September 30, 2022 The following table sets forth our results of operations for the three months ended September 30, 2023, and September 30, 2022. This data should be read together with our financial statements and related notes included elsewhere in this Quarterly Report, and is qualified in its entirety by reference to such financial statements and related notes. Three months ended September 30, 2023 % Net Sales 2022 % Net Sales (in thousands) Net Sales $ 15,889 100.0 $ 26,117 100.0 Cost of Goods Sold 11,317 71.2 19,079 73.1 Gross profit 4,572 28.8 7,038 26.9 Operating expenses Research and development 1,385 8.7 753 2.9 General and administrative 6,005 37.8 6,336 24.3 Sales and marketing 3,083 19.4 3,358 12.9 Total Operating expenses 10,473 65.9 10,447 40.0 Loss From Operations (5,901 ) (37.1 ) (3,409 ) (13.1 ) Other Income (Expense) Interest expense, net (3,977 ) (25.0 ) (1,166 ) (4.5 ) Change in fair market value of warrant liability (145 ) (0.9 ) — — Total Other Expense (4,122 ) (25.9 ) (1,166 ) (4.5 ) Loss Before Taxes (10,023 ) (63.1 ) (4,575 ) (17.5 ) Income Tax Benefit — — (886 ) (3.4 ) Net Loss $ (10,023 ) (63.1 ) $ (3,689 ) (14.1 ) 34 Three months ended September 30, 2023 2022 (in thousands) DTC 10,305 12,249 % Net Sales 64.9 46.9 OEM 5,584 13,868 % Net Sales 35.1 53.1 Net Sales $ 15,889 26,117 Net Sales Net sales decreased by $10.2 million, or 39.2%, to $15.9 million for the three months ended September 30, 2023, as compared to $26.1 million for the quarter ended September 30, 2022. This decrease was primarily due to lower OEM and DTC battery and accessory sales compared to the three months ended September 30, 2022. For the quarter ended September 30, 2023, OEM revenue decreased by $8.3 million. In July of 2023, we were notified by our largest RV OEM customer that, due to weaker demand for its products and their subsequent focus on reducing costs, it would no longer install our storage solutions as standard equipment, but rather return to offering those solutions as an option to dealers and consumers. While this customer is not moving to a different solution or competitor, this change in strategy had a material adverse impact on our OEM sales for the quarter ended September 30, 2023. Furthermore, we expect this change to continue to have a material limiting effect on our revenue throughout the remainder of 2023 and potentially 2024. DTC revenue decreased by $1.9 million as a result of decreased customer demand for our products due to ongoing macro-economic factors such as rising interest rates and inflation. Cost of Goods Sold Cost of revenue decreased by $7.8 million, or 40.7%, to $11.3 million for the three months ended September 30, 2023, as compared to $19.1 million for the three months ended September 30, 2022. This decrease was primarily due to lower unit volumes sold in the three months ended September 30, 2023. Gross Profit Gross profit decreased by $2.5 million, or 35.0%, to $4.6 million for the three months ended September 30, 2023, as compared to $7.0 million for the three months ended September 30, 2022. The decrease in gross profit was primarily due to lower overall sales and unit volumes offset by a change in revenue mix that included a smaller percentage of lower margin OEM sales and a higher percentage of higher margin DTC sales. Research and Development Expenses Research and development expenses increased by $0.6 million or 84.2%, to $1.4 million for the three months ended September 30, 2023, as compared to $0.8 million for the three months ended September 30, 2022. The increase was primarily due to higher patent expenses, increased wages associated with increased headcount, and higher materials and supply costs associated with development work. General and Administrative Expenses General and administrative expenses decreased by $0.3 million, or 4.7%, to $6.0 million for the three months ended September 30, 2023, as compared to $6.3 million for the three months ended September 30, 2022. This decrease was primarily due to lower fees related to the Company’s Business Combination expenses in 2022 partially offset by higher compliance, insurance and investor relation expenses. Selling and Marketing Expenses Sales and marketing expenses decreased by $0.3 million, or 8.1%, to $3.1 million for the three months ended September 30, 2023, as compared to $3.4 million for the three months ended September 30, 2022. This decrease was primarily due to lower shipping costs on lower unit volumes partially offset by higher spend on wage-related expenses and general marketing expenses. 35 Total Other Expense Other expense totaled $4.1 million for the three months ended September 30, 2023 as compared to total other expense of $1.2 million for the three months ended September 30, 2022. Other expense in the quarter ended September 30, 2023 is comprised of $4.0 million in interest expense related to our debt securities, and a $0.1 million expense due to the change in fair market value of our warrants. The $1.2 million expense in the quarter ended September 30, 2022 was comprised of interest expense related to the senior secured notes of $45 million which were retired as a result of the Business Combination. Income Tax (Benefit) Expense There was no tax expense recorded for the three months ended September 30, 2023, as compared to a $0.9 million benefit for the three months ended September 30, 2022. The income tax benefit of $0.9 million for the quarter ended September 30, 2022 was expected to be used against future tax obligations. Based on available evidence as of September 30, 2023, management believes it is more likely than not that some or all the deferred tax assets will not be realized. Accordingly, the Company established a 100% valuation allowance. As a result of the full valuation allowance, the Company did not record a tax benefit during the quarter ended September 30, 2023. Net Loss We generated a net loss of $10.0 million for the three months ended September 30, 2023, as compared to a net loss of $3.7 million for the three months ended September 30, 2022. As described above, this result was driven lower sales and increased other expense. Comparisons for the Nine months ended September 30, 2023 and September 30, 2022 The following table sets forth our results of operations for the nine months ended September 30, 2023, and September 30, 2022. This data should be read together with our financial statements and related notes included elsewhere in this Quarterly Report, and is qualified in its entirety by reference to such financial statements and related notes. Nine months ended September 30, 2023 % Net Sales 2022 % Net Sales (in thousands) Net Sales $ 53,954 100.0 $ 66,042 100.0 Cost of Goods Sold 40,541 75.1 46,481 70.4 Gross profit 13,413 24.9 19,561 29.6 Operating expenses Research and development 3,332 6.2 1,951 3.0 General and administrative 23,114 42.8 13,778 20.9 Sales and marketing 11,075 20.5 9,331 14.1 Total Operating expenses 37,521 69.5 25,060 37.9 (Loss) From Operations (24,108 ) (44.7 ) (5,499 ) (8.3 ) Other Income (Expense) Interest expense, net (11,905 ) (22.1 ) (3,657 ) (5.5 ) Change in fair market value of warrant liability 19,182 35.6 — — Total Other Income (Expense) 7,277 13.5 (3,657 ) (5.5 ) (Loss) Before Taxes (16,831 ) (31.2 ) (9,156 ) (13.9 ) Income Tax Benefit — — (1,700 ) (2.6 ) Net Loss $ (16,831 ) (31.2 ) $ (7,456 ) (11.3 ) Nine months ended September 30, 2023 2022 (in thousands) DTC 30,314 41,755 % Net Sales 56.2 63.2 OEM 23,640 24,287 % Net Sales 43.8 36.8 Net Sales $ 53,954 66,042 36 Net Sales Net sales decreased by $12.1 million, or 18.3%, to $54.0 million for the nine months ended September 30, 2023, as compared to $66.0 million for the nine months ended September 30, 2022. This decrease was primarily due to lower DTC battery and accessory sales. DTC revenue decreased by $11.4 million as a result of decreased customer demand for our products due to ongoing macro-economic factors such as rising interest rates and inflation. OEM revenue decline by $0.6 million for the nine months ended September 30, 2023 compared to the nine-months ended September 30, 2022 primarily due to weaker overall demand in the RV market. As described above, the change in strategy by our largest RV OEM customer in July of 2023 had a material adverse impact on our OEM sales for the quarter ended September 30, 2023 and we expect this change to continue to have a material limiting effect on our revenue throughout the remainder of 2023. Cost of Goods Sold Cost of revenue decreased by $6.0 million, or 12.8%, to $40.5 million for the nine months ended September 30, 2023, as compared to $46.5 million for the nine months ended September 30, 2022. This decrease was primarily due to lower unit volumes partially offset by higher material costs associated with consuming higher-priced inventory. Gross Profit Gross profit decreased by $6.1 million, or 31.4%, to $13.4 million for the nine months ended September 30, 2023, as compared to $19.6 million for the nine months ended September 30, 2022. The decrease in gross profit was primarily due to lower unit volumes sold and a change in revenue mix that included a larger percentage of lower margin OEM sales and a lower percentage of higher margin DTC sales, combined with the aforementioned higher material costs. Research and Development Expenses Research and development expenses increased by $1.4 million or 70.8%, to $3.3 million for the nine months ended September 30, 2023, as compared to $2.0 million for the nine months ended September 30, 2022. The increase was primarily due to increased wages in the amount of $0.6 million associated with higher headcount, higher materials and supply costs associated with development work and higher patent expenses. General and Administrative Expenses General and administrative expenses increased by $9.3 million, or 67.8%, to $23.1 million for the nine months ended September 30, 2023, as compared to $13.8 million for the nine months ended September 30, 2022. This increase was primarily due a $4.8 million increase in stock-based compensation costs, a $2.2 million increase in compliance and insurance expenses, a $1.6 million increase in investor relations expenses and a $0.8 million increase in professional services related to the June 2023 Offering. Selling and Marketing Expenses Sales and marketing expenses increased by $1.8 million, or 18.7%, to $11.1 million for the nine months ended September 30, 2023, as compared to $9.3 million for the nine months ended September 30, 2022. This increase was primarily due to a $2.8 million increase in wage-related expenses, partially offset by $1.2 million in lower shipping costs due to the decline in DTC sales. Total Other Income (Expense) Other income totaled $7.3 million for the nine months ended September 30, 2023 as compared to total other expense of $3.7 million for the nine months ended September 30, 2022. Other income for the nine months ended September 30, 2023 is comprised of a change in fair market value of our warrants in the amount of $19.2 million of income, offset by $11.9 million in interest expense related to our debt securities. The $3.7 million expense for the nine months ended September 30, 2022 was comprised of interest expense related to the senior secured notes of $45 million which were retired as a result of the Business Combination. 37 Income Tax (Benefit) Expense There was no tax expense recorded for the nine months ended September 30, 2023, as compared to a $1.7 million benefit for the nine months ended September 30, 2022. The income tax benefit of $1.7 million for the nine months ended September 30, 2022 was expected to be used against future tax obligations. Based on available evidence as of September 30, 2023, management believes it is more likely than not that some or all the deferred tax assets will not be realized. Accordingly, the Company established a 100% valuation allowance. As a result of the full valuation allowance, the Company did not record a tax benefit during the nine months ended September 30, 2023. Net Loss We generated a net loss of $16.8 million for the nine months ended September 30, 2023, as compared to a net loss of $7.5 million for the nine months ended September 30, 2022. As described above, this result was driven primarily by lower sales, increased material costs due to the absorption of higher-priced inventory, and higher operating expenses, partially offset by increased other income (due to the change in fair market value of the Company’s warrants treated as liabilities). Critical Accounting Estimates Our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these condensed consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions. On a recurring basis, we evaluate our judgments and estimates in light of changes in circumstances, facts, and experience. The effects of material revisions in an estimate, if any, will be reflected in the consolidated financial statements prospectively from the date of the change in the estimate. We believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements. Inventory Valuation We periodically review physical inventory for excess, obsolete, and potentially impaired items and reserves. Any such inventory is written down to net realizable value. The reserve estimate for excess and obsolete inventory is dependent on expected future use and requires management judgement. Warrants We apply relevant accounting guidance for warrants to purchase our stock based on the nature of the relationship with the counterparty. For warrants issued to investors or lenders in exchange for cash or other financial assets, we follow guidance issued within ASC 480, Distinguishing Liabilities from Equity (“ ASC 480 ”), and ASC 815, Derivatives and Hedging (“ ASC 815 ”), to assist in the determination of whether the warrants should be classified as liabilities or equity. Warrants that are determined to require liability classifications are measured at fair value upon issuance and are subsequently remeasured to their then fair value at each subsequent reporting period with changes in fair value recorded in current earnings. Warrants that are determined to require equity classifications are measured at fair value upon issuance and are not subsequently remeasured unless they are required to be reclassified. See “ Note 9—Warrants ” in our accompanying condensed consolidated financial statements for information on the warrants. Equity-Based Compensation We use the Black-Scholes option-pricing model to determine the fair value of option grants. In estimating fair value, management is required to make certain assumptions and estimates such as the expected life of units, volatility of our future share price, risk-free rates, future dividend yields and estimated forfeitures at the initial grant date. RSU awards are valued based on the closing trading price of the Company’s common stock on the date of grant. Changes in assumptions used to estimate fair value could result in materially different results. 38 Income Taxes We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities using enacted rates. The effect of a change in tax rates on deferred taxes is recognized in income in the period that includes the enactment date. We recognize the financial statement effect of an uncertain income tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. Recognized income tax positions are measured at the largest amount that is greater than 50% likely to be realized. A valuation allowance is recorded to reduce deferred income tax assets to an amount, which in the opinion of management is more likely than not to be realized. Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our deferred tax assets. We consider factors such as the cumulative income or loss in recent years; reversal of deferred tax liabilities; projected future taxable income exclusive of temporary differences; the character of the income tax asset, including income tax positions; tax planning strategies and the period over which we expect the deferred tax assets to be recovered in the determination of the valuation allowance. In the event that actual results differ from these estimates or we adjust our estimates in the future, we may need to adjust our valuation allowance, which could materially impact our financial position and results of operations. Non-GAAP Financial Measures This Quarterly Report includes a non-generally accepted account principles within the United States (“ U.S. GAAP ”) measure that we use to supplement our results presented in accordance with U.S. GAAP. Earnings before interest tax and amortization (“ EBITDA ”) is defined as earnings before interest and other income (expenses), income taxes, and depreciation and amortization. Adjusted EBITDA is calculated as EBITDA adjusted for stock-based compensation, employee separation expenses, costs associated with the June 2023 Offering, promissory note forgiveness, and change in the fair market value of warrant liabilities. Adjusted EBITDA is a performance measure that we believe is useful to investors and analysts because it illustrates the underlying financial and business trends relating to our core, recurring results of operations and enhances comparability between periods. Adjusted EBITDA is not a recognized measure under U.S. GAAP and is not intended to be a substitute for any U.S. GAAP financial measure and, as calculated, may not be comparable to other similarly titled measures of performance of other companies in other industries or within the same industry. Investors should exercise caution in comparing our non-GAAP measure to any similarly titled measure used by other companies. This non-GAAP measure excludes certain items required by U.S. GAAP and should not be considered as an alternative to information reported in accordance with U.S. GAAP. The table below presents our adjusted EBITDA, reconciled to net loss for the three and nine months ended September 30, 2023, and September 30, 2022. Three months ended September 30, Nine months ended September 30, 2023 2022 2023 2022 (in thousands) (in thousands) Net loss $ (10,023 ) $ (3,689 ) $ (16,831 ) $ (7,456 ) Interest Expense 3,977 1,166 11,905 3,657 Taxes — (886 ) — (1,700 ) Depreciation and Amortization 316 259 909 648 EBITDA (5,730 ) (3,150 ) (4,017 ) (4,851 ) Adjusted for: Stock-Based Compensation (1) 946 436 6,387 1,155 Separation Agreement (2) — — 720 — June 2023 Offering Costs (3) — — 904 — Promissory Note Forgiveness (4) — — — 469 Change in fair market value of warrant liability (5) 145 — (19,182 ) — Adjusted EBITDA $ (4,639 ) $ (2,714 ) (15,188 ) (3,227 ) 39 (1) Stock-Based Compensation is comprised of costs associated with option and RSU grants made to our employees, consultants and board members. (2) Separation Agreement is comprised of $720 in cash severance associated with separation agreement dated April 26, 2023, between us and our former Chief Legal Officer. (3) June 2023 Offering Costs are comprised of fees and expenses, including legal, accounting, and other expenses associated with our secondary offering. (4) Promissory Note Forgiveness is comprised of the loan that was forgiven, prior to the Business Combination, in connection with the promissory note, with a maturity date of March 1, 2026, between us and John Marchetti, our former Chief Financial Officer and current Senior Vice President, Operations. (5) Change in fair market value of warrant liabilities represents the change in fair value for the three and nine month period ended September 30, 2023. Liquidity and Capital Resources Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations, including working capital needs, debt service, acquisitions, contractual obligations and other commitments. We assess liquidity in terms of our cash flows from operations and their sufficiency to fund our operating and investing activities. As of September 30, 2023, we had cash totaling $13.2 million. We expect our capital expenditures and working capital requirements to increase materially in the near future, as we continue our research and development efforts (particularly those related to solid-state lithium-ion battery development), expand our production lines, scale up production operations and look to enter into adjacent markets for our batteries (with operating expenses expected to increase across all major expense categories). We expect to deploy a significant amount of capital to continue our optimization and commercialization efforts dedicated to our solid-state technology development, as well as continued investment to automate and increase the production capacity of our existing assembly operation, expansion of our facilities and new strategic investments. To date, our focus has been on seeking to prove the fundamental soundness of our manufacturing techniques and our solid-state chemistry. Moving forward, our solid-state related investments will focus on chemistry optimization and establishing a pilot line for pouch cell production. Over the next two to three years, we expect to spend in excess of $50 million on solid-state development and cell manufacturing technologies. We expect that we will need to raise additional funds, including through the use of the ChEF Equity Facility and the issuance of equity, equity-related or debt securities or by obtaining additional credit from financial institutions to fund, together with our principal sources of liquidity, ongoing costs, such as research and development relating to our solid-state batteries, expansion of our facilities, and new strategic investments. If such financings are not available, or if the terms of such financings are less desirable than we expect, we may be forced to take actions to reduce our capital or operating expenditures, including by not seeking potential acquisition opportunities, eliminating redundancies, or reducing or delaying our production facility expansions, which may adversely affect our business, operating results, financial condition and prospects. Further, any future debt or equity financings may be dilutive to our current stockholders. Financing Obligations and Requirements On November 24, 2021, we issued $45 million of fixed rate senior notes, secured by among other things, a security interest in our intellectual property. As part of the Business Combination, we entered into a senior secured term loan facility in an aggregate principal amount of $75 million (the “ Term Loan ”) pursuant to the Term Loan, Guarantee and Security Agreement (the “ Term Loan Agreement ”), the proceeds of which were used to repay the $45 million fixed rate senior notes, and ChEF Equity Facility. 40 The Term Loan proceeds were used to: (i) support the Business Combination, (ii) prepay the fixed rate senior notes at closing of the Business Combination, (iii) pay fees and expenses in connection with the foregoing, (iv) to provide additional growth capital and (v) for other general/corporate purposes. The Term Loan will mature on October 7, 2026, or the Maturity Date, and will be subject to quarterly amortization of 5% per annum beginning 24 months after issuance. The definitive documents for the Term Loan incorporate certain mandatory prepayment events and certain affirmative and negative covenants and exceptions hereto. The financial covenants for the Term Loan include a maximum senior leverage ratio covenant, a minimum liquidity covenant, a springing fixed charge coverage ratio covenant, and a maximum capital expenditures covenant. On March 29, 2023 and September 29, 2023, we obtained waivers from Alter Domus (US) LLC, as the administrative agent for the lenders (the “ Administrative Agent ”) and EICF Agent LLC and certain third-party financing source of our failure to satisfy the fixed charge coverage ratio and maximum senior leverage ratio with respect to the minimum cash requirements under the Term Loan during the quarters ended March 31, 2023 and September 30, 2023. We were in compliance with the covenants as of June 30, 2023. However, it is probable that we will fail to meet these covenants within the next twelve months. In accordance with U.S. GAAP, we reclassified our notes payable from a long-term liability to a current liability. The Term Loan accrues interest (i) until April 1, 2023 at a per annum rate equal to adjusted secured overnight financing rate (“ SOFR ”) is a margin equal to 13.5%, of which 7% will be payable in cash and 6.5% will be paid in-kind, (ii) thereafter until October 1, 2024, at a per annum rate equal to adjusted SOFR plus 7% payable in cash plus an amount ranging from 4.5% to 6.5%, depending on the senior leverage ratio of the consolidated company. In each of the foregoing case, adjusted SOFR will be no less than 1%. We may elect to prepay all or any portion of the amounts owed prior to the Maturity Date, provided that we provide notice to the Administrative Agent and the amount is accompanied by the applicable prepayment premium, if any. Prepayments of the Term Loan are required to be accompanied by a premium of 5% of the principal amount so prepaid if made prior to the October 7, 2023, 3% if made on and after October 7, 2023 but prior to October 7, 2024, 1% if made after October 7, 2024 but prior to October 7, 2025, and 0% if made on or after October 7, 2025. If the Term Loan is accelerated following the occurrence of an event of default, Legacy Dragonfly is required to immediately pay to lenders the sum of all obligations for principal, accrued interest, and the applicable prepayment premium. Pursuant to the Term Loan Agreement, we have guaranteed the obligations of Legacy Dragonfly and such obligations will be guaranteed by any of Legacy Dragonfly’s subsidiaries that are party thereto from time to time as guarantors. Also pursuant to the Term Loan Agreement, the Administrative Agent was granted a security interest in substantially all of the personal property, rights and assets of us as and Legacy Dragonfly to secure the payment of all amounts owed to lenders under the Term Loan Agreement. In addition, we entered into a Pledge Agreement pursuant to which we pledged to the Administrative Agent our equity interests in Legacy Dragonfly as further collateral security for the obligations under the Term Loan Agreement. At the closing of the Business Combination, we issued to the Term Loan Lenders (i) the Penny Warrants exercisable to purchase an aggregate of 2,593,056 shares at an exercise price of $0.01 per share, and (ii) warrants exercisable to purchase 1,600,000 shares of our common stock at an exercise price of $10.00 per share. From January 1, 2023 to September 30, 2023, we issued and sold approximately 98,500 shares of our common stock under the ChEF Equity Facility, resulting in net cash proceeds of $670,593. During the nine months ended September 30, 2023, the Company issued additional Penny Warrants to purchase 501 shares of common stock to the Term Loan Lenders in accordance with the anti-dilution provisions of the Penny Warrants with respect to certain sales made by the Company under the ChEF Equity Facility. Subsequent to the quarter ended September 30, 2023, we issued and sold approximately 490,000 shares of our common stock under the ChEF Equity Facility, resulting in net cash proceeds of $607,973. As a result, subsequent to the quarter ended September 30, 2023, we issued additional Penny Warrants to purchase 4,277 shares of Common Stock to the Term Loan Lenders in accordance with the anti-dilution provisions of the Penny Warrants with respect to certain sales made by the Company under the ChEF Equity Facility. On March 5, 2023, we issued a note in the principal amount of $1.0 million (the “ Principal Amount ”) to Brian Nelson, one of our directors, in a private placement in exchange for cash in an equal amount (the “ Note ”). The Note became due and payable in full on April 1, 2023. We were also obligated to pay a fee in the amount of $100,000 (the “ Loan Fee ”) to Mr. Nelson on April 4, 2023. The Principal Amount of the Note was paid in full on April 1, 2023 and the Loan Fee was paid in full on April 4, 2023. In June 2023, we completed the June 2023 Offering which provided net proceeds to us, including the partial over-allotment option exercise, of approximately $21.1 million. In July 2023, upon a request from the Company’s lenders under the Term Loan Agreement, the Company repaid $5.3 million to satisfy a portion of its outstanding principal. Going Concern For the quarter ended September 30, 2023, we generated a net loss of $16.8 million and had a negative cash flow from operations. As of September 30, 2023, we had approximately $13.2 million in cash and cash equivalents and working capital of $22.0 million. 41 Under the Term Loan Agreement, we are obligated to comply with certain financial covenants, which include maintaining a maximum senior leverage ratio, minimum liquidity, a springing fixed charge coverage ratio, and maximum capital expenditures. On March 29, 2023 and September 29, 2023, we obtained waivers from our Administrative Agent and the Term Loan Lenders of our failures to satisfy the fixed charge coverage ratio and maximum senior leverage ratio with respect to the minimum cash requirements under the Term Loan during the quarters ended March 31, 2023 and September 30, 2023. While the Company was in compliance with its covenants for the quarter ended June 30, 2023, it is probable that we will fail to meet these covenants within the next twelve months. If we are unable to comply with the financial covenants in our loan agreement, the Term Loan Lenders have the right to accelerate the maturity of the Term Loan. These conditions raise substantial doubt about our ability to continue as a going concern. In addition, we may need to raise additional debt and/or equity financing to fund our operations and strategic plans and meet our financial covenants. We have historically been able to raise additional capital through issuance of equity and/or debt financing and we intend to use the ChEF Equity Facility and raise additional capital as needed. However, we cannot guarantee that we will be able to raise additional equity, contain expenses, or increase revenue, and comply with the financial covenants under the Term Loan. If such financings are not available, or if the terms of such financings are less desirable than we expect, we may be forced to take actions to reduce our capital or operating expenditures, including by not seeking potential acquisition opportunities, eliminating redundancies, or reducing or delaying our production facility expansions, which may adversely affect our business, operating results, financial condition and prospects. Further, future debt or equity financings may be dilutive to our current stockholders. Cash Flows for the Nine months ended September 30, 2023, and September 30, 2022 Nine months ended September 30, 2023 2022 Net Cash (used in)/provided by: (in thousands) Operating Activities $ (16,727 ) $ (24,711 ) Investing activities $ (6,507 ) $ (6,065 ) Financing activities $ 18,688 $ 15,707 Operating Activities Net cash used in operating activities was $16.7 million for the nine months ended September 30, 2023, primarily due to a net loss of $16.8 million partially offset by a $0.1 million increase as a result of other operating adjustments. Net cash used in operating activities was $24.7 million for the nine months ended September 30, 2022, due to a net loss during the period and a $17.3 million decrease in other operating adjustments. Investing Activities Net cash used in investing activities was $6.5 million for the nine months ended September 30, 2023, as compared to net cash used in investing activities of $6.1 million for the nine months ended September 30, 2022. The increase in cash used in investing activities was primarily due to an increase in capital equipment expenses. Financing Activities Net cash provided by financing activities was $18.7 million for the nine months ended September 30, 2023, as compared to net cash provided by financing activities of $15.7 million for the nine months ended September 30, 2022, and was primarily due to net proceeds of $21.1 million from the June 2023 Offering partially offset by a $5.3 million principal payment of our notes payable. Contractual Obligations Our estimated future obligations consist of short-term and long-term operating lease liabilities. As of September 30, 2023, we had $1.3 million in short-term operating lease liabilities and $2.6 million in long-term operating lease liabilities. As disclosed above, we have a Term Loan. As of September 30, 2023, the amount outstanding under the Term Loan was $74.7 million, which consists of $69.7 million in principal and $4.9 million in PIK interest. 42 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.