ENERGY FOCUS, INC/DE 10-Q

ITEM 1. FINANCIAL STATEMENTS ENERGY FOCUS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts ) June 30, 2020 December 31, 2019 (Unaudited) ASSETS Current assets: Cash $ 2,727 $ 350 Trade accounts receivable, less allowances of $ 7 and $ 28 , respectively 2,518 2,337 Inventories, net 5,900 6,168 Prepaid and other current assets 677 479 Total current assets 11,822 9,334 Property and equipment, net 415 389 Operating lease, right-of-use asset 1,051 1,289 Restructured lease, right-of-use asset 214 322 Other assets 405 405 Total assets $ 13,907 $ 11,739 LIABILITIES Current liabilities: Accounts payable $ 2,617 $ 1,340 Accrued liabilities 57 186 Accrued legal and professional fees 307 215 Accrued payroll and related benefits 585 360 Accrued sales commissions 50 32 Accrued restructuring 25 24 Accrued warranty reserve 215 195 Deferred revenue 61 18 Operating lease liabilities 577 550 Restructured lease liabilities 331 319 Finance lease liabilities 3 3 Warrant liability 4,011 — Convertible notes — 1,700 Iliad note, net of discount and loan origination fees 603 885 PPP loan 263 — Credit line borrowings, net of loan origination fees 1,331 715 Total current liabilities 11,036 6,542 Other liabilities — 14 Operating lease liabilities, net of current portion 623 906 Restructured lease liabilities, net of current portion — 168 Finance lease liabilities, net of current portion 2 4 PPP loan, net of current maturities 532 — Iliad note, net of current maturities — 109 Total liabilities 12,193 7,743 STOCKHOLDERS' EQUITY Preferred stock, par value $ 0.0001 per share: Authorized: 5,000,000 shares ( 3,300,000 shares designated as Series A Convertible Preferred Stock) in 2020 and 2,000,000 shares ( no shares designated as Series A Convertible Preferred Stock) in 2019 Issued and outstanding: 2,597,470 at June 30, 2020 and no shares outstanding at December 31, 2019 — — Common stock, par value $ 0.0001 per share: Authorized: 50,000,000 shares in 2020 and 30,000,000 shares in 2019 Issued and outstanding: 3,216,345 at June 30, 2020 and 2,485,684 at December 31, 2019 — — Additional paid-in capital 131,472 128,873 Accumulated other comprehensive loss ( 3 ) ( 3 ) Accumulated deficit ( 129,755 ) ( 124,874 ) Total stockholders' equity 1,714 3,996 Total liabilities and stockholders' equity $ 13,907 $ 11,739 The accompanying notes are an integral part of these condensed consolidated financial statements. 4 ENERGY FOCUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (Unaudited) Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Net sales $ 3,335 $ 3,082 $ 7,118 $ 6,259 Cost of sales 1,992 3,191 4,743 6,270 Gross profit (loss) 1,343 ( 109 ) 2,375 ( 11 ) Operating expenses: Product development 313 318 595 844 Selling, general, and administrative 1,973 1,594 4,000 3,835 Restructuring ( 14 ) 128 ( 28 ) 262 Total operating expenses 2,272 2,040 4,567 4,941 Loss from operations ( 929 ) ( 2,149 ) ( 2,192 ) ( 4,952 ) Other expenses (income): Interest expense 87 26 220 69 Loss from change in fair value of warrants 3,300 — 2,427 — Other expenses 24 79 42 98 Net loss $ ( 4,340 ) $ ( 2,254 ) $ ( 4,881 ) $ ( 5,119 ) Net loss per share - basic and diluted Net loss $ ( 1.36 ) $ ( 0.91 ) $ ( 1.55 ) $ ( 2.09 ) Weighted average common shares outstanding: Basic and diluted * 3,192 2,467 3,139 2,446 * Shares outstanding for prior periods have been restated for the 1-for-5 reverse stock split The accompanying notes are an integral part of these condensed consolidated financial statements. 5 ENERGY FOCUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (in thousands) (Unaudited) Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Net loss $ ( 4,340 ) $ ( 2,254 ) $ ( 4,881 ) $ ( 5,119 ) Other comprehensive loss: Foreign currency translation adjustments — ( 2 ) — ( 2 ) Comprehensive loss $ ( 4,340 ) $ ( 2,256 ) $ ( 4,881 ) $ ( 5,121 ) The accompanying notes are an integral part of these condensed consolidated financial statements. 6 ENERGY FOCUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (in thousands) (Unaudited) Preferred Stock Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Loss Accumulated Deficit Total Stockholders' Equity Shares Amount Shares* Amount Balance at December 31, 2019 — $ — 2,486 $ — $ 128,873 $ ( 3 ) $ ( 124,874 ) $ 3,996 Issuance of common stock under employee stock option and stock purchase plans — — 5 — — — — — Issuance of common stock and warrants — — 688 — 2,749 — — 2,749 Offering costs on issuance of common stock and warrants — — — — ( 474 ) — — ( 474 ) Warrant liability — — — — ( 1,636 ) — — ( 1,636 ) Conversion of notes to preferred stock 2,709 — — — 1,769 — — 1,769 Stock-based compensation — — — — 20 — — 20 Net loss for the three months ended March 31, 2020 — — — — — — ( 541 ) ( 541 ) Balance at March 31, 2020 2,709 $ — 3,179 $ — $ 131,301 $ ( 3 ) $ ( 125,415 ) $ 5,883 Issuance of common stock under employee stock option and stock purchase plans — — — — 30 — — 30 Common stock withheld in lieu of income tax withholding on vesting of restricted stock units — — — — ( 3 ) — — ( 3 ) Issuance of common stock upon the exercise of warrants — — 15 — 103 — — 103 Issuance of common stock upon conversion from preferred stock ( 112 ) — 22 — — — — — Stock-based compensation — — — — 41 — — 41 Net loss for the three months ended June 30, 2020 — — — — — — ( 4,340 ) ( 4,340 ) Balance at June 30, 2020 2,597 $ — 3,216 $ — $ 131,472 $ ( 3 ) $ ( 129,755 ) $ 1,714 *Shares outstanding for prior periods have been restated for the 1-for-5 reverse stock split 7 ENERGY FOCUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (in thousands) (Unaudited) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Loss Accumulated Deficit Total Stockholders' Equity Shares* Amount Balance at December 31, 2018 2,418 $ — $ 128,368 $ ( 1 ) $ ( 117,315 ) $ 11,052 Adjustment to beginning retained earnings upon adoption of Topic 842 — — — — ( 186 ) ( 186 ) Issuance of common stock under employee stock option and stock purchase plans 30 — — — — — Common stock withheld in lieu of income tax withholding on vesting of restricted stock units ( 10 ) — ( 111 ) — — ( 111 ) Stock-based compensation — — 543 — — 543 Net loss for the three months ended March 31, 2019 — — — — ( 2,865 ) ( 2,865 ) Balance at March 31, 2019 2,438 $ — $ 128,800 $ ( 1 ) $ ( 120,366 ) $ 8,433 Issuance of common stock under employee stock option and stock purchase plans 36 — — — — — Common stock withheld in lieu of income tax withholding on vesting of restricted stock units — — ( 5 ) — — ( 5 ) Stock-based compensation — — ( 20 ) — — ( 20 ) Foreign currency translation adjustment — — — ( 2 ) — ( 2 ) Net loss for the three months ended June 30, 2019 — — — — ( 2,254 ) ( 2,254 ) Balance at June 30, 2019 2,474 $ — $ 128,775 $ ( 3 ) $ ( 122,620 ) $ 6,152 *Shares outstanding for prior periods have been restated for the 1-for-5 reverse stock split The accompanying notes are an integral part of these condensed consolidated financial statements. 8 ENERGY FOCUS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) Six months ended June 30, 2020 2019 Cash flows from operating activities: Net loss $ ( 4,881 ) $ ( 5,119 ) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 92 200 Stock-based compensation 61 523 Change in fair value of warrant liabilities 2,427 — Provision for doubtful accounts receivable ( 12 ) 38 Provision for slow-moving and obsolete inventories ( 319 ) ( 303 ) Provision for warranties 20 106 Amortization of loan discounts and origination fees 76 45 Loss on dispositions of property and equipment — 15 Changes in operating assets and liabilities: Accounts receivable ( 169 ) 358 Inventories 587 693 Prepaid and other assets ( 198 ) 447 Accounts payable 1,277 ( 1,526 ) Accrued and other liabilities 293 ( 580 ) Deferred revenue 43 ( 17 ) Total adjustments 4,178 ( 1 ) Net cash used in operating activities ( 703 ) ( 5,120 ) Cash flows from investing activities: Acquisitions of property and equipment ( 118 ) ( 28 ) Net cash used in investing activities ( 118 ) ( 28 ) Cash flows from financing activities: Proceeds from the issuance of common stock and warrants 2,750 — Proceeds from the exercise of warrants 51 — Offering costs paid on the issuance of common stock and warrants ( 474 ) — Proceeds from PPP loan 795 — Principal payments under finance lease obligations ( 2 ) ( 1 ) Proceeds from exercise of stock options and employee stock purchase plan purchases 30 — Common stock withheld in lieu of income tax withholding on vesting of restricted stock units ( 3 ) ( 116 ) Payments on the Iliad Note ( 526 ) — Net proceeds from (payment on) credit line borrowings 577 ( 568 ) Proceeds from convertible notes — 1,700 Net cash provided by financing activities 3,198 1,015 Effect of exchange rate changes on cash — 5 Net increase (decrease) in cash and restricted cash 2,377 ( 4,128 ) Cash and restricted cash, beginning of period 692 6,335 Cash and restricted cash, end of period $ 3,069 $ 2,207 Classification of cash and restricted cash: Cash $ 2,727 $ 1,865 Restricted cash held in other assets 342 342 Cash and restricted cash $ 3,069 $ 2,207 The accompanying notes are an integral part of these condensed consolidated financial statements. 9 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) NOTE 1. NATURE OF OPERATIONS Energy Focus, Inc. (“the Company”) engages 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 products and controls in the commercial and military maritime markets (“MMM”). Our mission is to enable our customers to run their facilities and offices with greater energy efficiency, productivity, and wellness through advanced LED retrofit solutions. Our goal is to be the LED lighting technology and market leader for the most demanding applications where performance, quality and health are considered paramount. We specialize in LED lighting retrofit by replacing fluorescent, high-intensity discharge (“HID”) lighting and other types of lamps in institutional buildings for primarily indoor lighting applications with our innovative, high-quality commercial and military tubular LED (“TLED”), as well as other LED products and controls. At the Company’s annual meeting of stockholders held on December 17, 2019, the Company’s stockholders approved a form of the certificate of amendment (the “Certificate of Amendment”) to the Company’s Certificate of Incorporation, as amended (the “Certificate of Incorporation”), and authorized the board of directors of the Company to amend the Certificate of Incorporation to effect a reverse stock split of the outstanding shares of the Company’s common stock, par value $ 0.0001 per share, at a ratio ranging from any whole number of at least 1-for-2 and up to 1-for-20, with the exact ratio within the foregoing range to be determined by the board of directors in its sole discretion. On June 2, 2020, our board of directors determined to set the reverse stock split ratio at 1-for-5 (the “Split Ratio”). The Certificate of Amendment to our Certificate of Incorporation was filed with the Secretary of State of the State of Delaware on June 11, 2020, upon which the reverse stock split became effective immediately (the “Effective Time”). At the Effective Time, every five shares of common stock issued and outstanding automatically combined into one validly issued, fully paid and non-assessable share of common stock. No fractional shares were issued as a result of the reverse stock split. The $ 0.0001 par value per share of common stock and other terms of the common stock were not affected by the reverse stock split. The number of authorized shares of common stock under the Certificate of Incorporation remained unchanged at 50,000,000 shares. Proportional adjustments were made to the conversion and exercise prices of our outstanding warrants and stock options, and to the number of shares issued and issuable under our stock incentive plans in connection with the reverse stock split. The current financial statements as well as prior period’s financial statements have been retroactively adjusted to reflect the reverse stock split. Preferred shares outstanding were not affected by the reverse stock split and as such, those shares have not been adjusted. NOTE 2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary in Taiwan during 2019. All significant inter-company balances and transactions have been eliminated. Unless indicated otherwise, the information in the Notes to the Consolidated Financial Statements relates to our operations. We have prepared the accompanying financial data for the three and six months ended June 30, 2020 and 2019 pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The accompanying financial data and information should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Annual Report”). The Condensed Consolidated Balance Sheet as of December 31, 2019 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary to present fairly our Condensed Consolidated Balance Sheets as of June 30, 2020 and December 31, 2019, Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2020 and 2019, Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2020 and 2019, Condensed Consolidated Statements of Changes in Stockholders’ Equity for the three and six months ended 10 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) June 30, 2020 and 2019, and Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2020 and 2019. Use of estimates The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact us in the future, actual results may vary from the estimates. Estimates include, but are not limited to, the establishment of reserves for accounts receivable, sales returns, inventory obsolescence and warranty claims; the useful lives of property and equipment; valuation allowance for net deferred taxes; the cost and offsetting income related to subleased property; and stock-based compensation. In addition, estimates and assumptions associated with the determination of the fair value of financial instruments and evaluation of long-lived assets for impairment requires considerable judgment. Actual results could differ from those estimates and such differences could be material. 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, as follows: For the three months ended June 30, 2020, sales to our primary distributor for the U.S. Navy, a regional commercial lighting retrofit company and a primary shipbuilder for the U.S. Navy, accounted for approximately 40 %, 15 % and 11 % of net sales, respectively. When sales to our primary distributor for the U.S. Navy are combined with sales to shipbuilders for the U.S. Navy, total net sales of products for the U.S. Navy comprised approximately 60 % of net sales for the same period. For the three months ended June 30, 2019, sales to our primary distributor for the U.S. Navy and a regional commercial lighting retrofit company accounted for approximately 13 % and 26 % of net sales, respectively. When sales to our primary distributor for the U.S. Navy are combined with sales to shipbuilders for the U.S. Navy, total net sales of products for the U.S. Navy comprised approximately 20 % of net sales for the same period. For the six months ended June 30, 2020, sales to our primary distributor for the U.S. Navy and a regional commercial lighting retrofit company accounted for approximately 39 % and 15 % of net sales, respectively. When sales to our primary distributor for the U.S. Navy are combined with sales to shipbuilders for the U.S. Navy, total net sales of products for the U.S. Navy comprised approximately 53 % of net sales for the same period. For the six months ended June 30, 2019, sales to our primary distributor for the U.S. Navy and a regional commercial lighting retrofit company accounted for approximately 17 % and 28 % of net sales, respectively. When sales to our primary distributor for the U.S. Navy are combined with sales to shipbuilders for the U.S. Navy, total net sales of products for the U.S. Navy comprised approximately 26 % of net sales for the same period. A regional commercial lighting retrofit company and our primary distributor for the U.S. Navy accounted for approximately 19 % and 47 % of net trade accounts receivable, respectively, at June 30, 2020. At December 31, 2019, our primary distributor for the U.S. Navy accounted for approximately 10 % of net trade accounts receivable and a large regional retrofit company accounted for 41 % of our net trade accounts receivable. Recent accounting pronouncements In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“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 rather than incurred losses. For smaller reporting companies, 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. 11 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Revenue 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. The following table provides a disaggregation of product net sales for the periods presented (in thousands): Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Net sales: Commercial $ 1,058 $ 2,131 $ 2,794 $ 4,114 MMM products 2,277 951 4,324 2,145 Total net sales $ 3,335 $ 3,082 $ 7,118 $ 6,259 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 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 certain 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. Geographic information All of our long-lived fixed assets are located in the United States. Sales attributable to customers outside the United States for both the three and six months ended June 30, 2020 were less than 1 % of net sales. There were no net sales attributable to customers outside the United States for the three months ended June 30, 2019 and less than 1 % for the six months ended June 30, 2019. The geographic location of our net sales is derived from the destination to which we ship the product. 12 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Net loss per share Basic loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period, excluding the effects of any potentially dilutive securities. Diluted loss per share gives effect to all dilutive potential common shares outstanding during the period. Dilutive potential common shares consist of incremental shares upon the exercise of stock options and warrants, unless the effect would be anti-dilutive. The following table presents a reconciliation of basic and diluted loss per share computations (in thousands): Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Numerator: Net loss $ ( 4,340 ) $ ( 2,254 ) $ ( 4,881 ) $ ( 5,119 ) Denominator: Basic weighted average common shares outstanding * 3,192 2,467 3,139 2,446 * Shares outstanding for prior periods have been restated for the 1-for-5 stock split As a result of the net loss we incurred for three and six months ended June 30, 2020, options, warrants and convertible securities representing approximately 47 thousand and 4 thousand shares of common stock were excluded from the loss per share calculation, respectively, because their inclusion would have been anti-dilutive. As a result of the net loss we incurred for the three and six months ended June 30, 2019, options, warrants and convertible securities representing approximately 28 thousand and 66 thousand shares of common stock were excluded from the loss per share calculation, respectively, because of this same reason. Product warranties Through March 31, 2016, we warranted finished goods against defects in material and workmanship under normal use and service for periods generally between one and five years . Beginning April 1, 2016, we warrant our commercial Tubular LED Lamps, (“TLEDs”), excluding RedCap ® , our Battery Backup TLED, the troffer luminaires, and certain Globe Lights for a period of ten years and all other LED products for five years per the Terms and Conditions outlined on our website. Beginning in October 2019, TLEDs (excluding Red Caps ® ) are warranted for ten years and the warranty for all of our other products is five years . Warranty settlement costs consist of actual amounts expensed for warranty, which are largely a result of the cost of replacement products provided to our customers. A liability for the estimated future costs under product warranties is maintained for products under warranty based on the actual claims incurred to date and the estimated nature, frequency, and costs of future claims. These estimates are inherently uncertain and changes to our historical or projected experience may cause material changes to our warranty reserves in the future. We continuously review the assumptions related to the adequacy of our warranty reserve, including product failure rates, and make adjustments to the existing warranty liability when there are changes to these estimates or the underlying replacement product costs, or the warranty period expires. The following table summarizes warranty activity for the periods presented (in thousands): Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Balance at beginning of period $ 240 $ 352 $ 195 $ 258 Warranty accruals for current period sales — 17 7 29 Adjustments to existing warranties ( 25 ) ( 12 ) 19 77 In kind settlements made during the period — ( 15 ) ( 6 ) ( 22 ) Accrued warranty reserve $ 215 $ 342 $ 215 $ 342 13 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Financial Instruments 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. Total offering costs of $ 474 thousand have been presented as a reduction of additional paid-in capital and have been netted within equity. In addition, we issued warrants to the placement agent to purchase up to 48,185 shares of common stock at an exercise price of $ 4.99 per share. Net proceeds to us from the sale of common stock and warrants (the “January 2020 Equity Offering”) were approximately $ 2.3 million. In accordance with the terms of the Iliad Note (as defined below in Note 7), 10 % of the gross proceeds from the January 2020 Equity Offering ($ 275 thousand) were used to make payments on the Iliad Note, of which $ 226 thousand went towards the outstanding principal amount and the balance to interest. Warrants to purchase an aggregate of 721,546 shares remain outstanding at June 30, 2020 with a weighted average exercise price of $ 3.48 per share. The exercise of warrants could provide us with cash proceeds of $ 2.5 million. During the six months ended June 30, 2020, 15 thousand warrants were exercised resulting in total proceeds of $ 51 thousand. The warrants have been classified as liabilities, as opposed to equity, due to the potential adjustment to the exercise price that could result upon late delivery of the shares or potential cash settlement and are recorded at their fair values at each balance sheet date. Please also refer to Note 9, “Stockholder’s Equity”. Fair Value Measurements The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below. We classify the inputs used to measure fair value into the following hierarchy: Level 1 Unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. Level 3 Unobservable inputs for the asset or liability. The following table provides a summary of the financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2020 (in thousands): Fair Value Measurements at June 30, 2020 Using Balance as of Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Description June 30, 2020 Warrant liability $ 4,011 $ — $ — $ 4,011 A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. In determining the appropriate levels, we perform a detailed analysis of the assets and liabilities whose fair value is measured on a recurring basis. We review and reassess the fair value hierarchy classifications on a quarterly basis. Changes from one quarter to the next related to the observability of inputs in a fair value measurement may result in a reclassification between fair value hierarchy levels. There were no reclassifications for all periods presented. The estimated fair value of warrants accounted for as liabilities, representing a level 3 fair value measure, was determined on the issuance date and subsequently marked to market at each financial reporting date. We use the Black-Scholes valuation model to value the warrant liabilities at fair value. The fair value is estimated using the expected volatility based on our historical volatility and is determined using probability weighted-average assumptions, when appropriate. 14 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) The following inputs were used for the Black-Sholes valuation model at June 30, 2020: Expected Risk-Free Expected Volatility Interest Rate Life Warrants with greater than one-year remaining term 100.17 % - 100.27 % 0.24 % - 0.26 % 4.04 - 4.54 years A roll-forward of fair value measurements using significant unobservable inputs (Level 3) for the warrants is as follows (in thousands): Six months ended June 30, 2020 Balance January 1, 2020 $ — Issuance of warrants, January 2020 1,636 Settlements from exercise ( 52 ) Loss from change in fair value of warrants 2,427 Balance June 30, 2020 $ 4,011 NOTE 3. RESTRUCTURING For the three and six months ended June 30, 2020, we recorded net restructuring credits of approximately $ 14 thousand and $ 28 thousand, respectively, and for the three and six months ended June 30, 2019, we recorded restructuring charges totaling approximately $ 128 thousand and $ 262 thousand, respectively, related to the costs and offsetting sublease income and accretion expense for the remaining lease obligation for our former New York, New York office. For additional information regarding the restructuring actions taken as part of the 2017 and 2019 restructuring plans, please refer to Note 3, “Restructuring,” included under Item 8 of our 2019 Annual Report. Our restructuring liabilities consist of estimated ongoing costs related to long-term operating lease obligations, which the Company has exited. The recorded value of the ongoing lease obligations is based on the remaining lease term and payment amount, discounted to present value. Changes in subsequent periods resulting from a revision to either the timing or the amount of estimated cash flows over the future period are measured using the credit adjusted, risk free rate that was used to measure the restructuring liabilities initially. Please also refer to Note 6, “Leases”. The following is a reconciliation of the beginning and ending balances of our restructuring liability as it relates to the 2017 and 2019 restructuring plans (in thousands): Restructuring Liability Balance at December 31, 2019 $ 38 Accretion of lease obligations 1 Payments ( 14 ) Balance at June 30, 2020 25 The following is a reconciliation of the ending balance of our restructuring liability at June 30, 2020 to the balance sheet: Restructuring Liability Balance at June 30, 2020 $ 25 Less, short-term restructuring liability 25 Long-term restructuring liability, included in other liabilities $ — As a result of the restructuring actions and initiatives described above, we have reduced our operating expenses to be more commensurate with our sales volumes. However, we continue to incur losses and have a substantial accumulated deficit, and 15 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) substantial doubt about our ability to continue as a going concern continues to exist at June 30, 2020. Since the executive transition on April 1, 2019, we have continued to evaluate and assess strategic options as we seek to achieve profitability. We plan to achieve profitability through growing our sales by continuing to execute 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 channel partnerships. We also plan to continue to develop advanced lighting and lighting control technologies and introduce impactful new products such as the EnFocus™, a breakthrough lighting control platform we officially launched during the second quarter of 2020. Furthermore, we have been developing ultraviolet (UV) disinfection technologies and products which we have filed provisional patents on and which we expect to launch by the end of 2020. In addition, we continue to apply rigorous and financial disciplines in our organizational structure, business processes and policies, and supply chain practices to help accelerate our path towards profitability. As described in Note 9, we also raised approximately $ 2.3 million of net proceeds upon the issuance of common stock and warrants in connection with the January 2020 Equity Offering. The restructuring and cost cutting initiatives implemented during 2019 as well as the January 2020 Equity Offering that significantly strengthened our balance sheet were designed to allow us to effectively execute these strategies. However, our efforts may not occur as quickly as we envision or be successful, due to the long sales cycle in our industry, the corresponding time required to ramp up sales from new products and markets into this sales cycle, the timing of introductions of additional new products, significant competition, potential sales volatility given our customer concentration, and the recent and lingering economic impact from the COVID-19 pandemic, among other factors. As a result, we will continue to review and pursue selected external funding sources to ensure adequate financial resources to execute across the timelines required to achieve these objectives 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 funding 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 rate, restrictive covenants, conversion features, refinancing demands, and control or revocation provisions, which are not acceptable to management or our board of directors; and • the current environment in capital markets combined with our capital constraints may prevent us from being able to obtain adequate debt financing. If we fail to obtain the 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 growth plans 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 funding 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. Considering both quantitative and qualitative information, we continue to believe that the combination of our plans to obtain additional external funding, timely re-organizational actions, current financial position, liquid resources, obligations due or anticipated within the next year, development and implementation of an excess inventory reduction plan, application and successful acquisition of a Paycheck Protection Program (“PPP”) loan during April 2020, plans and initiatives in our R&D, product development and sales and marketing, development of potential channel partnerships, if adequately executed, will provide us with an ability to finance our operations through the next twelve months and will mitigate the substantial doubt about our ability to continue as a going concern. 16 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) On May 15, 2019, we received a letter from the Nasdaq Stock Market (“Nasdaq”) advising us that for 30 consecutive trading days preceding the date of the letter, the bid price of our common stock had closed below the $1.00 per share minimum required for continued listing on Nasdaq pursuant to listing rules. Therefore we could be subject to delisting if we did not regain compliance within the compliance period or extend the compliance period by filing for an extension. 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 is providing temporary relief through June 30, 2020 from, among other rules, the $1.00 minimum bid price rule. As a result, we had until July 24, 2020 to come into compliance with the $1.00 minimum bid price rule. To become compliant with the $1.00 minimum bid price requirement, the Company effected a 1-for-5 reverse stock split to increase the per share trading price of the common stock. At the Company’s annual meeting of stockholders held on December 17, 2019, the Company’s stockholders approved a form of the Certificate of Amendment to the Certificate of Incorporation and authorized our board of directors to amend the Certificate of Incorporation to effect a reverse stock split of the outstanding shares of the Company’s common stock at a ratio ranging from any whole number of at least 1-for-2 and up to 1-for-20, with the exact ratio within the foregoing range to be determined by the board of directors in its sole discretion. On June 2, 2020, our board of directors determined to set the Split Ratio. The Certificate of Amendment to our Certificate of Incorporation was filed with the Secretary of State of the State of Delaware on June 11, 2020, upon which the reverse stock split became effective immediately (the “Effective Time”). At the Effective Time, every five shares of common stock issued and outstanding automatically combined into one validly issued, fully paid and non-assessable share of common stock. The common stock began trading on Nasdaq on a split-adjusted basis at the opening of trading on June 12, 2020. NOTE 4. INVENTORIES Inventories are stated at the lower of standard cost (which approximates actual cost determined using the first-in, first-out cost method) or net realizable value, and consist of the following (in thousands): Six months ended June 30, 2020 Twelve months ended December 31, 2019 Raw materials $ 3,590 $ 4,064 Finished goods 5,636 5,749 Reserves for excess, obsolete, and slow-moving inventories ( 3,326 ) ( 3,645 ) Inventories, net $ 5,900 $ 6,168 The following is a rollforward of the reserves for excess, obsolete, and slow-moving inventories (in thousands): Six months ended June 30, 2020 Twelve months ended December 31, 2019 Beginning Balance $ ( 3,645 ) $ ( 4,212 ) Provision (accrual) 112 ( 814 ) Reduction due to sold inventory 167 845 Write-off for disposed inventory 40 536 Reserves for excess, obsolete, and slow-moving inventories $ ( 3,326 ) $ ( 3,645 ) 17 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) NOTE 5. PROPERTY AND EQUIPMENT Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the related assets and consist of the following (in thousands): June 30, 2020 December 31, 2019 Equipment (useful life 3 to 15 years) $ 1,317 $ 1,297 Tooling (useful life 2 to 5 years) 203 203 Vehicles (useful life 5 years) 47 47 Furniture and fixtures (useful life 5 years) 137 137 Computer software (useful life 3 years) 1,046 1,028 Leasehold improvements (the shorter of useful life or lease life) 211 211 Finance lease right-of-use asset 13 13 Projects in progress 128 48 Property and equipment at cost 3,102 2,984 Less: accumulated depreciation ( 2,687 ) ( 2,595 ) Property and equipment, net $ 415 $ 389 Depreciation expense was $ 46 thousand and $ 95 thousand for the three months ended June 30, 2020 and 2019, respectively. For the six months ended June 30, 2020 and 2019, depreciation expense was $ 92 thousand and $ 200 thousand, respectively. NOTE 6. LEASES The Company leases certain equipment, manufacturing, warehouse and office space under non-cancellable operating leases expiring through 2024 under which it is responsible for related maintenance, taxes and insurance. The Company has one finance lease containing a bargain purchase option upon expiration of the lease in 2022. The lease term consists of the non-cancellable period of the lease, periods covered by options to extend the lease if the Company is reasonably certain to exercise the option, and periods covered by an option to terminate the lease if the Company is reasonably certain not to exercise the option. The present value of the remaining lease obligation for these leases was calculated using an incremental borrowing rate (“IBR”) of 7.25 %, which was the Company’s borrowing rate on its revolving credit agreement signed on December 11, 2018. The weighted average remaining lease term for operating, restructuring and finance leases is 2.1 years, 1.0 years, and 1.8 years, respectively. The Company had one restructured lease with sub-lease component for the New York, New York office that was closed in 2017. The lease expires in 2021. As part of the lease agreement there was $ 0.3 million in restricted cash in other long-term assets on the accompanying Condensed Consolidated Balance Sheets as of June 30, 2020 and December 31, 2019 which represents collateral against the related letter of credit issued as part of this agreement. The restructured lease and sub-lease were not scoped out of the requirements of ASC 842, Leases (“Topic 842”) and were evaluated for impairment in accordance with the asset impairment provisions of ASC 360, Property, Plant and Equipment (“Topic 360”). The Company concluded its net right-of-use assets were not impaired and the carrying amount approximates expected sublease income in future years as of June 30, 2020. The Company continues to carry certain immaterial operating expenses associated with this lease as restructuring liabilities and will continue to accrete those liabilities in accordance with Topic 420, as has been done since the cease use date in 2017. For additional information regarding treatment of leases please refer to Note 6, “Leases.” included under Item 8 of our 2019 Annual Report. 18 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Components of the operating, restructured and finance lease costs recognized in net loss for the three and six months ended June 30, 2020 and 2019, were as follows (in thousands): Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Operating lease cost (income) Sublease income $ ( 29 ) $ ( 25 ) $ ( 54 ) $ ( 50 ) Lease cost 151 171 303 318 Operating lease cost, net 122 146 249 268 Restructured lease cost (income) Sublease income ( 68 ) ( 111 ) ( 136 ) ( 223 ) Lease cost 60 107 121 216 Restructured lease income, net ( 8 ) ( 4 ) ( 15 ) ( 7 ) Finance lease cost Interest of lease liabilities — 1 — 1 Finance lease cost, net — 1 — 1 Total lease cost, net $ 114 $ 143 $ 234 $ 262 Supplemental balance sheet information related to the Company’s operating and finance leases as of June 30, 2020 and December 31, 2019 are as follows (in thousands): June 30, 2020 December 31, 2019 Operating Leases Operating lease right-of-use assets $ 1,051 $ 1,289 Restructured lease right-of-use assets 214 322 Operating lease right-of-use assets, total 1,265 1,611 Operating lease liabilities 1,200 1,480 Restructured lease liabilities 331 488 Operating lease liabilities, total 1,531 1,968 Finance Leases Property and equipment 13 13 Allowances for depreciation ( 8 ) ( 5 ) Finance lease assets, net 5 8 Finance lease liabilities 5 6 Total finance lease liabilities $ 5 $ 6 19 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Future minimum lease payments required under operating, restructured and finance leases for each of the 12-month rolling periods below in effect at June 30, 2020 are as follows (in thousands): Operating Leases Restructured Leases Restructured Leases Sublease Payments Finance Lease July 2020 to June 2021 $ 621 $ 342 $ ( 273 ) $ 3 July 2021 to June 2022 644 — — 2 July 2022 to June 2023 16 — — — July 2023 to June 2024 9 — — — Total future undiscounted lease payments 1,290 342 ( 273 ) 5 Less imputed interest ( 90 ) ( 11 ) 9 — Total lease obligations $ 1,200 $ 331 $ ( 264 ) $ 5 Supplemental cash flow information related to leases for the six months ended June 30, 2020 and 2019, was as follows (in thousands): Six months ended June 30, 2020 2020 2019 Supplemental cash flow information Cash paid, net, for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 267 $ 268 Operating cash flows from restructured leases $ 35 $ 47 Financing cash flows from finance leases $ 2 $ 1 NOTE 7. DEBT Credit facilities Borrowings under the Company’s revolving line of credit (the “Austin Credit Facility”) with Austin Financial Services (“Austin”) were $ 1.3 million at June 30, 2020 and $ 0.7 million at December 31, 2019 and are recorded in the Condensed Consolidated Balance Sheets as a current liability under the caption, “Credit line borrowings.” Outstanding balances include unamortized net issuance costs totaling $ 0.1 million as of June 30, 2020 and December 31, 2019. The Austin Credit Facility is secured by a lien on our assets. Interest on advances under the line is due monthly at the “Prime Rate,” as published by the Wall Street Journal from time to time, plus a margin of 2 %. The borrowing rate as of June 30, 2020 and December 31, 2019 was 5.25 % and 6.75 %, respectively. Overdrafts are subject to a 2 % fee. Additionally, an annual facility fee of 1 % on the entire $ 5.0 million amount of the Austin Credit Facility is due at the beginning of each of the three years and a 0.5 % collateral management fee on the average outstanding loan balance is payable monthly. We paid Austin the first year’s fee when the Austin Credit Facility was signed and the second year’s fee in December of 2019. For additional information regarding the Austin Credit Facility, please refer to Note 9 included under Item 8 of our 2019 Annual Report. In August 2020, we secured two new working capital financing facilities which replaced the Austin Credit Facility. These new facilities will significantly expand the credit capacity at a lower blended borrowing cost than the Austin Credit Facility. For details regarding the new facilities, please refer to Note 11, “Subsequent Events” as well as Part II, Item 5 of this quarterly report on Form 10-Q. 20 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Convertible Notes On March 29, 2019, we raised $ 1.7 million (before transaction expenses) from the issuance of $ 1.7 million in principal amount of subordinated convertible promissory notes to certain investors (the “Convertible Notes”). 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 our certificate of incorporation, the principal amount of all of the Convertible Notes, the accumulated interest thereon ($ 0.1 million) and unamortized issuance costs at the date of conversion ($ 0.04 million), which totaled $ 1.8 million 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 share (“Series A Preferred Stock”), which is convertible on a one-for-five basis into shares of our common stock. During the second quarter of 2020, 111,548 of the Series A Preferred Stock were converted into 22,310 shares of common stock. The purchase agreement related to the Convertible Notes contain customary representations and warranties and provide for resale registration rights with respect to the shares of our common stock issuable upon conversion of the Series A Preferred Stock. Please also refer to Note 9, “Stockholder’s Equity”. Iliad Note On November 25, 2019, we entered into a note purchase agreement (“the Iliad Note Purchase Agreement”) with Iliad Research and Trading, L.P. (“Iliad”) pursuant to which the Company sold and issued to Iliad a promissory note in the principal amount of approximately $ 1.3 million (“Iliad Note”). 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. The Iliad Note has a maturity date of November 24, 2021 and accrues interest at 8 % per annum, compounded daily, on the outstanding balance. The Company may prepay the amounts outstanding under the Iliad Note at a premium, which is 15 % during the first year and 10 % during the second year. Beginning in May 2020, Iliad may require the Company to redeem up to $ 150 thousand of the Iliad Note in any calendar month. The Company has the right on three occasions to defer all redemptions that Iliad could otherwise require the Company to make during any calendar month. As of June 30, 2020, no deferrals have been exercised. Each exercise of this deferral right by the Company will increase the amount outstanding under the Iliad Note by 1.5 %. The total liability for the Iliad Note Purchase Agreement, net of discount and financing fees, was $ 0.6 million at June 30, 2020 and $ 1.0 million at December 31, 2019. Unamortized loan discount and debt issuance costs were $ 0.2 million at June 30, 2020 and December 31, 2019. In the event our common stock is delisted from Nasdaq, the amount outstanding under the Iliad Note will automatically increase by 15 % as of the date of such delisting. Pursuant to the Iliad Note Purchase Agreement and the Iliad Note, we have, among other things, agreed that, until the Iliad Note is repaid: • 10 % of gross proceeds the Company receives from the sale of our common stock or other equity must be paid to Iliad and will be applied to reduce the outstanding balance of the Iliad Note (the failure to make such a prepayment is not an event of default under the Iliad Note, but will increase the amount then outstanding under the Iliad Note by 10 %); and • unless agreed to by Iliad, we will not engage in certain financings that involve the issuance of securities that include a conversion rights in which the number of shares of common stock that may be issued pursuant to such conversion right varies with the market price of our common stock (a “Restricted Issuance”); provided, however, if Iliad does not agree to a Restricted Issuance, the Company may on up to three occasions make the Restricted Issuance anyway, but the outstanding balance of the Iliad Note will increase 3 % on each occasion the Company exercises its right to make the Restricted Issuance without Iliad’s agreement. 21 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) 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, of which $ 226 thousand went towards the outstanding principal amount. Upon the occurrence of an event of default under the Iliad Note, Iliad may accelerate the date for the repayment of the amount outstanding under the Iliad Note and increase the amount outstanding by an amount ranging from 5 % to 15 %, depending on the nature of the default. Certain insolvency and bankruptcy related events of default will result in the automatic acceleration of the amount outstanding under the Iliad Note and the outstanding amount due will be automatically increased by 5 %. After the occurrence of an event of default, Iliad may elect to have interest accrue on the Iliad Note at a rate per annum of 22 %, or such lesser rate as permitted under applicable law. PPP Loan On April 17, 2020, the Company was granted a loan from KeyBank National Association in the amount of approximately $ 795 thousand, pursuant to the PPP under Division A of the Coronavirus Aid, Relief and Economic Securities Act (the "CARES Act"), which was enacted on March 27, 2020. The funds were received on April 20, 2020. At June 30, 2020, $ 263 thousand is classified as short-term debt and $ 532 thousand is classified as long-term debt on the Company’s balance sheet. The loan accrues interest at a rate of 1.0 % per annum and matures on April 17, 2022. We have recorded accrued interest of $ 2 thousand through June 30, 2020. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses as described in the CARES Act. The Company intends to use the loan for qualifying expenses, however there is no assurance that the Company will obtain forgiveness for any portion of the loan. NOTE 8. INCOME TAXES As a result of the operating loss incurred during each of the three and six months ended June 30, 2020 and 2019, and after the application of the annual limitation set forth under Section 382 of the Internal Revenue Code (“IRC”), it was not necessary to record a provision for U.S. federal income tax or various states income taxes. At June 30, 2020 and December 31, 2019, we had a full valuation allowance recorded against our deferred tax assets. The valuation allowance was recorded due to uncertainties related to our ability to realize the deferred tax assets, primarily consisting of certain net operating loss carry-forwards. The valuation allowance is based on management’s estimates of taxable income by jurisdiction and the periods over which the deferred tax assets will be recoverable. At December 31, 2019, we had a net operating loss carry-forward of approximately $ 108.8 million for federal income tax purposes ($ 64.5 million for state and local income tax purposes). However, due to changes in our capital structure, approximately $ 54.5 million of the $ 108.8 million is available after the application of IRC Section 382 limitations. As a result of the Tax Cuts and Jobs Act of 2017 (“Act”), net operating loss carry-forwards generated in tax years beginning after December 31, 2017 can only offset 80% of taxable income and can be carried forward indefinitely. The $ 8.3 million and $ 8.7 million in net operating losses generated in 2019 and 2018 will be subject to the new limitations under the 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. For a full discussion of the estimated restrictions on our utilization of net operating loss carry-forwards, please refer to Note 12, “Income Taxes,” included under Item 8 of our 2019 Annual Report. NOTE 9. STOCKHOLDERS’ EQUITY 1-for-5 Reverse Stock Split At the Company’s annual meeting of stockholders held on December 17, 2019, the Company’s stockholders approved a form of the Certificate of Amendment to the Certificate of Incorporation and authorized our board of directors to amend the Certificate of Incorporation to effect a reverse stock split of the outstanding shares of the Company’s common stock at a ratio ranging from any whole number of at least 1-for-2 and up to 1-for-20, with the exact ratio within the foregoing range to be determined by the board of directors in its sole discretion. 22 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) On June 2, 2020, our board of directors determined to set the Split Ratio. The Certificate of Amendment to our Certificate of Incorporation was filed with the Secretary of State of the State of Delaware on June 11, 2020, upon which the reverse stock split became effective immediately (the “Effective Time”). At the Effective Time, every five shares of common stock issued and outstanding automatically combined into one validly issued, fully paid and non-assessable share of common stock. No fractional shares were issued as a result of the reverse stock split. The fractional shares were settled in cash in an amount not material to the Company. The $ 0.0001 par value per share of common stock and other terms of the common stock were not affected by the reverse stock split. The number of authorized shares of common stock under the Certificate of Incorporation remained unchanged at 50,000,000 shares. The current financial statements as well as prior period’s financial statements have been retroactively adjusted to reflect the reverse stock split. Our outstanding shares of restricted stock and shares underlying our options and warrants entitling the holders to purchase shares of common stock have been adjusted as a result of the reverse stock split, as required by the terms of these securities. Also, the number of shares reserved for issuance under our existing 2014 Stock Incentive Plan, as amended, and our 2013 Employee Stock Purchase Plan were reduced proportionately based on the Split Ratio. Preferred shares outstanding were not affected by the reverse stock split and as such, those shares have not been adjusted. The reverse stock split was effected solely to increase the per share trading price of the common stock to satisfy the $1.00 minimum bid price requirement pursuant to Nasdaq Marketplace Rule 5550(a)(2) for continued listing on Nasdaq. The common stock began trading on Nasdaq on a split-adjusted basis at the opening of trading on June 12, 2020. Preferred Stock Pursuant to the terms of the Convertible Notes, on January 16, 2020 following approval by our stockholders of certain amendments to our certificate of incorporation, the principal amount of all of the Convertible Notes and the accumulated interest thereon in the amount of $ 1.8 million 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 share, which is convertible on a one-for-five basis into shares of our common stock. During the second quarter of 2020, 111,548 of the Series A Preferred Stock were converted into 22,310 shares of common stock. The Series A Preferred Stock was created by the filing of a Certificate of Designation with the Secretary of State of the State of Delaware on March 29, 2019, which authorized 2,000,000 shares of Series A Preferred Stock (“Original Series A Certificate of Designation”). The Original Series A Certificate of Designation was amended on January 15, 2020 following stockholder approval to increase the number of authorized shares of Series A Preferred Stock to 5,000,000 (the Original Series A Certificate of Designation as so amended, the “Series A Certificate of Designation”). Of the 5,000,000 Series A Preferred Stock, 3,300,000 shares were further designated as Series A Convertible Preferred Stock. Pursuant to the Series A Certificate of Designation, each holder of outstanding shares of Series A Preferred Stock is entitled to vote with holders of outstanding shares of common stock, voting together as a single class, with respect to any and all matters presented to the stockholders of the Company for their action or consideration, except as provided by law. In any such vote, each share of Series A Preferred Stock shall be entitled to a number of votes equal to 11.07 % of the number of shares of common stock into which such share of Series A Preferred Stock is convertible. The Series A Preferred Stock (a) has a preference upon liquidation equal to $ 0.67 per share and then participates on an as-converted basis with the common stock with respect to any additional distributions, (b) shall receive any dividends declared and payable on our common stock on an as-converted basis, and (c) is convertible at the option of the holder into shares of our common stock on a one-for-five basis. We also filed a Certificate of Elimination with respect to its authorized, but unissued, Series A Participating Preferred Stock, to return such shares to the status of preferred stock available for designation as the Series A Preferred Stock. The purchase agreement related to the Convertible Notes contain customary representations and warranties and provide for resale registration rights with respect to the shares of our common stock issuable upon conversion of the Series A Preferred Stock. 23 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) January 2020 Equity Offering Issuance of Common Stock and Warrants 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. Total offering costs of $ 474 thousand have been presented as a reduction of additional paid-in capital and have been netted within equity. In addition, we issued warrants to the placement agent to purchase up to 48,185 shares of common stock at an exercise price of $ 4.99 per share. Net proceeds to us from the sale of common stock and warrants were approximately $ 2.3 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, of which $ 226 thousand went towards the outstanding principal amount and the balance to interest. Warrants to purchase an aggregate of 721,546 shares remain outstanding at June 30, 2020 with a weighted average exercise price of $ 3.48 per share. The exercise of warrants could provide us with cash proceeds of $ 2.5 million if all warrants are exercised. During the six months ended June 30, 2020, 15 thousand warrants were exercised resulting in total proceeds of $ 51 thousand. As of June 30, 2020, we had the following outstanding non-tradeable, registered warrants to purchase shares of common stock: Number of Underlying Shares Exercise Price Expiration Investor Warrants 673,361 $ 3.3700 January 13, 2025 Placement Agent Warrants 48,185 $ 4.9940 January 13, 2025 721,546 Warrant Liabilities We account for common stock warrants as either liabilities or as equity instruments depending on the specific terms of the warrant agreement. Common stock warrants that could require cash settlement are accounted for as liabilities. We classify these warrant liabilities on the consolidated balance sheet as a current liability. The warrant liabilities are revalued at fair value at each balance sheet date subsequent to the initial issuance. Changes in the fair market value of the warrant are reflected in the consolidated statement of operations as income (expense) based upon the change in fair value of warrants. The warrants we issued in the January 2020 registered direct offering contain a provision for a cash payment in the event that the shares are not delivered to the holder within two trading days. The cash payment equals $10 per day per $1,000 of warrant shares for each day late. The warrants issued in the January 2020 private placement also contain a provision for net cash settlement in the event that there is a fundamental transaction (e.g., merger, sale of substantially all assets, tender offer, or share exchange). If a fundamental transaction occurs in which the consideration issued consists of all cash or stock in a non-public company, then the warrant holder has the option to receive cash equal to a Black-Scholes value of the remaining unexercised portion of the warrant. The warrants have been classified as liabilities, as opposed to equity, due to the potential adjustment to the exercise price that could result upon late delivery of the shares or potential cash settlement upon the occurrence of certain events as described above, and are recorded at their fair values at each balance sheet date. Stock-based compensation Stock-based compensation expense is attributable to stock options and restricted stock unit awards. For all stock-based awards, we recognize expense using a straight-line amortization method. 24 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) The following table summarizes stock-based compensation expense and the impact it had on operations for the periods presented (in thousands): Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Cost of sales $ — $ — $ 1 $ 7 Product development 1 ( 6 ) 2 22 Selling, general, and administrative 40 ( 14 ) 58 494 Total stock-based compensation $ 41 $ ( 20 ) $ 61 $ 523 Total unearned stock-based compensation was $ 0.2 million at June 30, 2020, compared to $ 0.1 million at June 30, 2019. These costs will be charged to expense and amortized on a straight-line basis in future periods. The weighted average period over which the unearned compensation at June 30, 2020 is expected to be recognized is approximately 2.9 years. Stock options The fair value of each stock option is estimated on the date of grant using the Black-Scholes option pricing model. Estimates utilized in the calculation include the expected life of the option, risk-free interest rate, and expected volatility, and are further detailed below. There were no options issued the six months ended June 30, 2019. Six months ended June 30, 2020 Fair value of options issued $ 1.18 Exercise price $ 1.55 Expected life of options (in years) 6.2 Risk-free interest rate 0.8 % Expected volatility 92.9 % Dividend yield 0.0 % A summary of option activity under all plans for the six months ended June 30, 2020 is presented as follows: Number of Options* Weighted Average Exercise Price Per Share Weighted Average Remaining Contractual Life (in years) Balance at December 31, 2019 155,031 $ 5.23 Granted 89,400 1.55 Canceled/forfeited ( 16,921 ) 11.34 Balance at June 30, 2020 227,510 $ 3.33 7.8 Vested and expected to vest at June 30, 2020 174,271 $ 3.77 7.8 Exercisable at June 30, 2020 12,370 $ 27.75 4.6 *Options have been restated for the 1-for-5 reverse stock split 25 ENERGY FOCUS, INC. NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2020 (Unaudited) Restricted stock units A summary of restricted stock unit activity under all plans for the six months ended June 30, 2020 is presented as follows: Restricted Stock Units* Weighted Average Grant Date Fair Value Weighted Average Remaining Contractual Life (in years) Balance at December 31, 2019 6,603 $ 13.17 Granted 16,000 1.50 Released ( 4,068 ) 13.65 Canceled/forfeited ( 1 ) 12.40 Balance at June 30, 2020 18,534 $ 2.99 8.5 *Restricted stock units have been restated for the 1-for-5 reverse stock split NOTE 10. COMMITMENTS AND CONTINGENCIES Purchase Commitments As of June 30, 2020, we had approximately $ 8.5 million in outstanding purchase commitments for inventory. Of this amount, approximately $ 1.9 million is expected to ship in the third quarter of 2020 with the balance expected to ship in the fourth quarter of 2020 and thereafter. NOTE 11. SUBSEQUENT EVENTS On August 11, 2020, we entered into two debt financing arrangements (together, the “New Credit Facilities”). The first arrangement is an inventory financing facility (the “Inventory Facility”) in the form of a Loan and Security Agreement (the “Inventory Loan Agreement”) between the Company and Crossroads Financial Group, LLC, a North Carolina limited liability company (the “IF Lender”). Borrowings under the Inventory Facility are permitted up to the lower of (i) $ 3,000,000 and (ii) a borrowing base determined from time to time based on the value of the Company’s eligible inventory, valued at 75 % of inventory costs or 85 % of the inventory net orderly liquidation value, less the availability reserves. The outstanding indebtedness under the Inventory Facility accrues at an annual rate equal to the greater of (i) 5.75 % and (ii) 4.00 % plus the three (3) month LIBOR rate and is also subject to a service fee of 1.00 % per month. The Inventory Facility’s interest and service fees combined amount is subject to a minimum monthly fee of $ 18,490 . The second arrangement is a receivables financing facility (the “Receivables Facility”) in the form of a Loan and Security Agreement (the “Receivables Loan Agreement”) between the Company and Factors Southwest L.L.C. (d/b/a FSW Funding), an Arizona limited liability company (the “RF Lender”). Borrowings under the Receivables Facility are permitted up to the lower of (i) $ 2,500,000 and (ii) a borrowing base determined from time to time based on the value of the Company’s eligible accounts receivable, valued at 90 % of the face value of such accounts receivable, less availability reserves, if any. Interest on outstanding indebtedness under the Receivables Facility accrues at an annual rate equal to (i) the highest prime rate announced from time to time by the Wall Street Journal plus (ii) 2.00 %. A $ 25 thousand, or 1.00 %, facility fee was charged at closing. In connection with the entry into the New Credit Facilities, on August 11, 2020 the Company terminated the existing Austin Credit Facility with Austin. For additional detail related to the New Credit Facilities, please refer to Part II, Item 5 of this quarterly report on Form 10-Q. 26