ENERGY FOCUS, INC/DE 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes thereto, included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report. Overview Energy Focus, Inc. engages primarily in the design, development, manufacturing, marketing and sale of energy-efficient lighting systems and controls. We develop, market and sell high quality light-emitting diode (“LED”) lighting and controls products in the commercial market and military maritime market (“MMM”). Our mission is to enable our customers to run their facilities with greater energy efficiency, productivity, and human health and wellness through advanced LED retrofit solutions. Our goal is to be a market leader for the most demanding applications where performance, quality, value, environmental impact and health are considered paramount. We specialize in energy efficient LED lighting retrofit product replacing fluorescent, high-intensity discharge lighting and other types of lamps in institutional buildings for primarily indoor lighting applications with our innovative, high-quality commercial and military-grade tubular LED (“TLED”) products, as well as other LED and lighting control products for commercial and consumer applications. We are also evaluating adjacent technologies, including Gallium Nitride (“GaN”) based power supplies and additional market opportunities for energy solution products that support sustainability in our existing channels. The LED lighting industry has changed dramatically over the past several years due to increasing competition and price erosion. We have been experiencing these industry forces in both our military and commercial business since 2016, when we once commanded significant price premiums for our flicker-free TLEDs with industry leading warranties. In more recent years, we have focused on redesigning our products for lower costs and consolidated our supply chain for stronger purchasing power in an effort to price our products more competitively while not impacting the performance and quality. Despite these efforts, our legacy products continue to face extreme price competition and a convergence of product functionality in the marketplace, and we have shifted to diversifying our supply chain in an effort to increase value and remain competitive. These trends are not unique to Energy Focus as evidenced by the increasing number of industry peers facing challenges, exiting LED lighting, selling assets and even going out of business. In addition to continuously pursuing cost reductions, our strategy to combat these trends is to innovate both our technology and product offerings with differentiated products and solutions that offer greater, distinct value. Specific examples of these products we have developed include the RedCap ® , our patented emergency backup battery integrated TLED, EnFocus™, our unique dimmable/color-tunable lighting and powerline control platform that we launched in 2020, and the second generation of EnFocus™ powerline control switches and circadian lighting system. We are looking forward to the continued support and growth of our existing EnFocus™ product line which is particularly attractive for its ease of install and ease of use in spaces with transient occupation. The Company have enhanced the performance of our RedCap® product providing a more user- friendly experience in 2023. We continue to evaluate our sales strategy and believe our go-to-market strategy that focuses more on direct-sales marketing, selectively expanding our channel partner network to cover territories across the country, and listening to the voice of the customer, will lead to better and more impactful product development efforts that we believe will eventually translate into larger addressable markets and greater sales growth for us. Throughout 2023, the Company continued to make significant cost cutting efforts to address operational expenses while maintaining customer satisfaction and delivering goods on-time. Investments into Energy Focus have contributed to the ability of the Company to continue to not only provide quality products and services, but to both expand and rationalize product offerings. It is our belief that the continued dramatic rightsizing efforts undertaken in 2022 and 2023, along with reorganization of the sales team and ongoing development of innovative, high-value products and an expanded distribution network, will over time result in improved sales and bottom-line performance for the Company. During 2022 and into 2023, our MMM business continued to face challenges resulting from the delayed availability of government funding and the timing of U.S. Navy awards, with several anticipated projects facing repeated and ongoing delays. This sector also maintains very long sales cycles. The timeline between bid to order can often take at least six months, and many MMM products are built-to-order with resultant lead times before orders become revenue. We continue to pursue opportunities from the U.S. Navy and the government sector to minimize such volatility. Previously in our MMM business, significant efforts undertaken to reduce costs in our product offerings have positioned us to be more competitive along with improved production efficiencies. Such efforts allowed us to continue to win bids and proposals that helped grow our MMM sales pipeline in the second half of 2023. While we continue to aggressively seek to increase sales of our commercial products, 28 Table of Contents the MMM business offers us continued sales opportunities, in addition to validating our product quality and strengthening our brand trust in the marketplace. During 2023, we thoroughly reviewed and adjusted our commercial pricing position as well as our strategic relationships and partnerships within the commercial LED market space. We believe our new pricing position will give us a greater advantage than previously held against the competition and offer a more attractive entry point for our end customer base. We are pleased to see a growth during the fiscal year ended December 31, 2023 in quotation opportunities in both MMM and commercial product lines. Meanwhile, we continue to seek additional external funding alternatives and sources to support our growth strategies, plans and initiatives. The recent strategic investments in 2023 by Sander Electronics, Inc. (“Sander”), a shareholder of the Company, contributed meaningful external capital, as well as presented synergistic opportunities to improve and diversify our supply chain and product offerings. We plan to achieve profitability through increasing sales in our innovative products such as EnFocusTM powerline control technology and further leveraging our unique and proprietary technology such as RedCap®, as well as executing on our multi-channel sales strategy that targets key verticals, such as government, healthcare, education and commercial and industrial, complemented by our marketing outreach campaigns and expanding channel partnerships. We also plan to continue to develop advanced lighting and lighting control applications built upon the EnFocusTM platform that aim to serve the commercial market. We are also evaluating adjacent technologies including ruggedized industrial retrofit lighting applications and GaN-based power supplies and other market opportunities in energy solutions products that support sustainability in our existing channels. In addition, we intend to continue to apply rigorous financial discipline to our organizational structure, business processes and policies, strategic sourcing activities and supply chain practices to help accelerate our path towards profitability. The EnFocus™ platform offers two immediately available product lines: EnFocus™ DM, which provides a dimmable lighting solution, and EnFocus™ DCT, which provides both a dimmable and color tunable lighting solution. EnFocus™ enables buildings to have dimmable, color tunable and circadian-ready lighting using existing wiring, without requiring laying additional data cables or any wireless communication systems, through a relatively simple upgrade with EnFocus™ switches and LED lamps, a far more secure, affordable and environmentally sustainable solution compared with replacing an entire luminaire and incorporating additional wired or wireless communication. Despite continuing progress on cost reduction throughout 2023 and 2022, the Company’s results reflect the challenges due to long and unpredictable sales cycles, unexpected delays in MMM and commercial customer retrofit budgets and project starts, and supply chain issues. There has also been continuing aggressive price competition in the lighting industry. We continued to incur losses and we have a substantial accumulated deficit, which continues to raise substantial doubt about our ability to continue as a going concern at December 31, 2023. On June 28, 2023, the Company received notices of resignation from the following four members of the Board of Directors: Jennifer Cheng, Brian Lagarto, Jeffery Parker, and Stephen Socolof. Their terms as directors would have otherwise expired at the 2024 annual meeting of stockholders of the Company. These resignations did not involve any disagreement with the Company. On July 2, 2023, the remaining members of the Board of Directors unanimously appointed the following four new members to the Board of Directors: Kin-Fu Chen, Shou-Jang Lee, Jason Tien-Chia Tsai, and Chiao Chieh (Jay) Huang. The Board of Directors affirmatively determined that, at the time of his appointment, each of the new members of the Board of Directors is an independent director under the corporate governance standards of the Nasdaq. On August 24, 2023, the Board of Directors approved the termination of the Company’s chief executive officer and appointed Chiao Chieh (Jay) Huang to serve as the Company’s new chief executive officer. In line with this decision, Mr. Huang discontinued his role as Chairman of the Board. As part of this transition, the Board appointed Kin-Fu Chen as the Chairman of the Board. Our Business Strategy Demand-oriented Approach In order to deepen our relationships with customers, we are in the process of re-establishing our service model, aiming to provide richer and more targeted customer service. We believe that by increasing opportunities for interaction with our customers, we can better understand their needs, thereby enhancing their loyalty to our brand. To ensure that EFOI’s products, pricing, and customer service lifecycle are better aligned, we are building a comprehensive value model to ensure consistency in the products and services we provide throughout the customer journey. We have begun an in-depth analysis of our current and past top 10 customers over the last five years to identify the core factors that make them 29 Table of Contents loyal customers. By analyzing this data, we hope to reveal the key elements that enhance customer stickiness, providing them with more reasons and value to stay with us. In particular, we are actively focusing on customers with high loyalty to better meet their needs. This is not only an acknowledgment of our products but also a validation of the quality of our service. Supply-oriented Approach EFOI is committed to adopting three main sustainable economy strategies: “Green Supply Chain”, “Green Product”, and “Green Manufacturing”, aiming to promote sustainability throughout the entire value chain. The Company is working closely with its supply chain partners to optimize recycling mechanisms and strengthen packaging design, integrating sustainable economy principles into the core of supply chain management. Guided by the vision of “transcending traditional corporate social responsibility and creating shared value”, EFOI’s team is focusing on stakeholders, aiming to achieve a “dual profit engine” effect by combining financial performance and Environmental, Social, and Governance (ESG) practices. This strategy not only aligns with the Company’s responsibility and sustainability goals but is also expected to enhance overall performance and market competitiveness. EFOI's operational team's new strategy focuses on integrating environmental and economic benefits, aiming to create a win-win situation that benefits the company, society, and the environment. Under the premise of a similar industrial environment and familiar relationships, our professional skills complement those of our supply chain partners. This foundation of cooperation enables us to more easily achieve common goals of cost reduction, profit sharing, and exploring new business opportunities. This not only strengthens our cooperative relationship but also lays a solid foundation for our joint efforts towards a better future. Financial-oriented Approach The Company applies strategic financial management in the below perspective. Control and Monitoring of Assets and Liabilities • Assets: Regularly evaluate all assets, especially inventory, to ensure they remain in optimal condition in terms of value and performance. Minimize or mitigate the impact of inefficient and aging assets, focusing on assets with high efficiency and return. • Liabilities: Ensure a robust liability structure, optimize the cost of liabilities, and seek lower interest rates and more favorable repayment terms. Regularly review the liability situation to ensure the company’s level of liabilities remains within a safe range. Structured Profitability • Revenue Growth: Develop diversified revenue streams, reduce dependency on single business or market, continuously optimize products and services, and enhance market competitiveness. • Cost Control: Strictly control operating costs, seek opportunities to reduce costs, and ensure the efficient use of resources to optimize operations. • Cash Flow Management: Establish a sound accounts receivable and payable management system to ensure timely collection of receivables and reasonable arrangement of payments. Maintain sufficient cash reserves to cope with potential funding shortages. 30 Table of Contents Results of operations The following table sets forth the percentage of net sales represented by certain items reflected on our Consolidated Statements of Operations for the following periods: 2023 2022 Net sales 100.0 % 100.0 % Cost of sales 96.1 105.3 Gross profit (loss) 3.9 (5.3) Operating expenses: Product development 10.3 25.0 Selling, general, and administrative 63.1 119.8 Loss on impairment — 5.6 Total operating expenses 73.4 150.4 Loss from operations (69.5) (155.7) Other expenses: Interest income (57) ( 57 ) — Interest expenses 380 954 Other income (0.5) (0.5) Other expenses, net 0.5 0.9 Net loss before income taxes (68.5) (172.2) Benefit from income taxes 0.1 0.2 Net loss (75.1) % (172.3) % Net sales A further breakdown of our net sales by product line is as follows (in thousands): 2023 2022 Commercial products $ 1,593 $ 3,746 MMM products 4,124 2,222 Total net sales $ 5,717 $ 5,968 Our net sales of $5.7 million in 2023 decreased 4.2% compared to 2022, mainly driven by an increase of 85.6% in MMM sales and a decrease of 57.5% in commercial sales. The increase in net MMM product sales in 2023 as compared to 2022 was mainly due to an increased military sales pipeline during the year and our strategic focus on our loyal military customers. Net sales of our commercial products decreased in 2023 due to limited product availability impacts from supply chain constraints, our inventory reduction project, increased competition, and continuing fluctuations in the timing, pace, and size of commercial projects. Gross profit (loss) Gross profit was $0.2 million, or 3.9% of net sales, for 2023, compared with gross loss of $(0.3) million, or (5.3)% of net sales for 2022. The increase in gross margin resulted from our cost reduction plan related to a cut down of headcounts and was driven primarily by a reduction of scrap, freight in and out variances, which were partially offset by an increased cost of material and temporary labor. In 2022, significant amounts of previously reserved inventories were scrapped over the course of the year. Freight and logistics expenses were notably higher at the beginning of 2022 as national imports faced backlogs at the ports. Beginning in the second quarter of 2023, the Company terminated several employees, and the result was a significant reduction in payroll-related expenses. Due to the termination of employees, the need for temporary workers was increased. 31 Table of Contents Operating expenses Product development Product development expenses include salaries and related benefits, product testing and related costs, travel, supplies, as well as overhead items, such as depreciation and facilities costs. Product development costs are expensed as they are incurred. Gross product development expenses were $0.6 million in 2023, a decrease of 60.6%, compared to $1.5 million in 2022. The $0.9 million decrease primarily resulted from lower payroll-related expenses due to a reduction in headcounts of $0.8 million and lower product development and testing cost of $0.1 million. Beginning in the second quarter of 2023, the Company terminated several employees, and the result was a significant reduction in payroll-related expenses. Selling, general, and administrative Selling, general, and administrative expenses were $3.6 million, or 63.1% of net sales, in 2023, compared to $7.1 million, or 119.8% of net sales, in 2022. The year-over-year $3.5 million decrease is comprised of a combination of a $2.1 million decrease from a reduction in headcount for salaries, severance, and commissions, a $0.5 million decrease from trade show, marketing, and travel expenses, a $0.2 million decrease from a reduction of software costs, a $0.2 million from reduced recruiting and relocation expenses, a $0.2 million decrease from consultant and professional fees, and remaining from a decrease of all other general expenses. Loss on impairment No loss on impairment was recorded in 2023. As a result of the Company’s impairment analysis, in the third quarter of 2022, a loss on impairment of $76 thousand was recorded on the write-off of the UV-Robots. An additional $262 thousand loss on impairment was recorded in the fourth quarter of 2022, which consisted of tooling, equipment, software, hardware, and construction-in-progress. Other expenses (income) Interest expenses (income) We incurred $380 thousand in interest expenses and $57 thousand in interest income in 2023. Interest expenses primarily related to the interest on borrowings and non-cash amortization of fees related to the Credit Facilities and promissory notes in the principal amount of $2.0 million (the “2022 Streeterville Note”), that the Company issued to Streeterville Capital, LLC (“Streeterville”) pursuant to separate note purchase agreements. Interest income primarily related to the gain recognized through the pay-off of the Credit Facilities to Crossroads Financial Group, LLC. In 2022, we incurred $954 thousand in interest expense, primarily related to the interest on borrowings and non-cash amortization of fees related to the Credit Facilities, interest on promissory notes in the principal amounts of $1.7 million (the “ 2021 Streeterville Note”) and $2 million (the “2022 Streeterville Note”) the Company sold and issued to Streeterville pursuant to separate note purchase agreements, and interest on the short-term bridge financing in the aggregate principal amount of $1.45 million pursuant to promissory notes sold and issued by us to certain private parties, including one of our directors. Other income and expenses We recognized other income of $30 thousand each in 2023 and 2022. Other income in 2023 and 2022 primarily consisted of tax refunds and miscellaneous adjustments from accounts receivable, respectively. We recognized other expenses of $26 thousand in 2023, compared to other expenses of $56 thousand in 2022. Other expenses in 2023 and 2022 primarily consisted of bank and collateral management fees. Provision for income taxes For each of the years ended December 31, 2023 and 2022, our effective tax rate was 0.0%. In 2023, our effective tax rate was lower than the statutory rate due to an increase in the valuation allowance as a result of the $6.3 million additional federal net 32 Table of Contents operating loss we recognized for the year. In 2022, our effective tax rate was lower than the statutory rate due to an increase in the valuation allowance as a result of the $9.2 million additional federal net operating loss we recognized for the year. Deferred income tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred income tax assets will not be realized. In considering the need for a valuation allowance, we assess all evidence, both positive and negative, available to determine whether all or some portion of the deferred tax assets will not be realized. Such evidence includes, but is not limited to, recent earnings history, projections of future income or loss, reversal patterns of existing taxable and deductible temporary differences, and tax planning strategies. We have recorded a full valuation allowance against our deferred tax assets at December 31, 2023 and 2022, respectively. We had no net deferred liabilities at December 31, 2023 or 2022. We will continue to evaluate the need for a valuation allowance on a quarterly basis. At December 31, 2023, we had net operating loss carry-forwards of approximately $138.7 million for federal income tax purposes ($48.0 million for state and local income tax purposes). However, due to changes in our capital structure, approximately $84.30 million of the $138.7 million is available after the application of IRC Section 382 limitations. As a result of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), net operating loss carry-forwards generated in tax years beginning after December 31, 2017 can only offset 80% of taxable income. These net operating loss carry-forwards can no longer be carried back, but they can be carried forward indefinitely. The $6.3 million and $9.2 million in federal net operating losses generated in December 31, 2023 and 2022, respectively, will be subject to the new limitations under the Tax Act. If not utilized, the carry-forwards generated prior to December 31, 2017 of $0.9 million will begin to expire in 2024 for federal purposes and have begun to expire for state and local purposes. Please refer to Note 11, “Income Taxes,” included in Item 8, “Financial Statements and Supplementary Data,” of this Annual Report for further information. Net loss Net loss was $4.3 million for 2023. This compares with a net loss of $10.3 million for 2022, mainly driven by reduction of cost of goods sold, product development, selling, general, and administrative expenses as well as interest expenses. Financial condition At December 31, 2023, we had $2.0 million in cash and a total of $1.3 million of debt, net of discounts and unamortized debt costs, related to the 2022 Streeterville Note outstanding. We have historically incurred substantial losses, and as of December 31, 2023, we had an accumulated deficit of $153.3 million. Additionally, our sales have been concentrated among a few major customers and for the twelve months ended December 31, 2023, two customers accounted for approximately 48% of net sales. In 2023 and 2022, we recommitted to building upon the transformation activities started during 2019 that sought to stabilize and regrow our business. These efforts include the following key developments that occurred during 2023 and 2022: • We continued development of the second generation of EnFocus™ powerline control switches and circadian lighting system for commercial markets, which as a result of supply chain challenges we now plan to reintroduce in 2024. EnFocus™ powerline control enables buildings to have dimmable, color tunable and circadian-ready lighting using existing wiring, without requiring laying additional cables or any wireless communication systems, through a relatively simple upgrade with EnFocus™ switches and EnFocus™ LED lamps. This upgrade offers a simpler, more secure, affordable and environmentally sustainable solution compared with replacing entire luminaire fixtures and incorporating additional wired or wireless communication. • We reinvested in our MMM sales channel and are pursuing existing and new sales opportunities, though the sales cycles for what are frequently made-to-order products are longer than commercial offerings. • Beginning in July 2022, we reduced our warehouse square footage, and undertook an inventory reduction project throughout 2022 focused on reducing our highly reserved commercial finished good inventory. • The Company has aggressively re-evaluated operating expenses, and reduced its workforce significantly throughout 2022 and into 2023 to manage fixed costs. • We continued to seek additional external funding alternatives and sources to support our growth strategies, plans and initiatives. In September 2023, we entered into a security purchase agreement, pursuant to which we raised aggregate gross proceeds of $1.8 million. Please refer to Note 9 included under Part II, Item 8 “Financial Statements and Supplementary Data,” of this Annual Report for the details. 33 Table of Contents During 2022 and into 2023, we redoubled our cost control efforts to streamline our operations by closely managing all spending done throughout the Company, while carefully investing in new products and strategies that sought to reenergize sales. We will seek to remain agile as an organization to respond to potential or continuing weakness in the macroeconomic environment and in the meantime seek to expand sales channels and enter new markets that we believe will provide additional growth opportunities. We plan to achieve profitability through developing and launching new, innovative products, such as our EnFocusTM powerline control systems, our Redcap® emergency battery backup tubular TLEDs, evaluating new growth opportunities such as GaN-based power supply circuitry and other energy solution products, as well as executing on our multi-channel sales strategy that targets key verticals, such as government, healthcare, education and commercial and industrial, complemented by our marketing outreach campaigns and expanding channel partnerships. We also plan to continue to develop advanced lighting and lighting control applications built upon the EnFocusTM platform that aim to serve the commercial markets. In addition, we intend to continue to apply rigorous financial discipline in our organizational structure, decision-making, business processes and policies, strategic sourcing activities and supply chain practices to help accelerate our path towards profitability. Liquidity and capital resources Cash At December 31, 2023, our cash balance was $2.0 million, compared to $52 thousand at December 31, 2022. The following is a summary of cash flows from operating, investing, and financing activities, as reflected in the Consolidated Statements of Cash Flows (in thousands): 2023 2022 Net cash used in operating activities $ (2,439) $ (6,713) Net cash used in investing activities $ (69) $ (16) Proceeds from the issuance of common stock and warrants $ 6,079 $ 3,500 Costs related to reverse stock-split (16) — Offering costs paid on the issuance of common stock and warrants — (334) Principal payments under finance lease obligations — (1) Proceeds from exercise of stock options and purchases through employee stock purchase plan — 6 Payments on the 2022 Streeterville Note (625) — Payments for deferred financing costs — (114) Payments on the 2021 Streeterville Note — (1,640) Proceeds from the 2022 Streeterville Note — 2,000 Proceeds from related party promissory notes payable — 800 Proceeds from promissory notes payable — 650 Net payments on credit line borrowings - Credit Facilities (1,402) (768) Advanced capital contribution 450 — Net cash provided by financing activities $ 4,486 $ 4,099 Net cash used in operating activities Net cash used in operating activities of $2.4 million in 2023 resulted primarily from the net loss incurred of $4.3 million, adjusted for non-cash items, including: depreciation and amortization of $0.3 million, stock-based compensation, net of $44 thousand, non-favorable provisions from inventory of $25 thousand and from accounts receivable of $6 thousand, and favorable provisions from warranty of $33 thousand and gain from paid-off of Credit Facilities of $40 thousand. We used $1.1 million through the timing of collection of accounts receivable, $0.2 million for prepayments to vendors, and $47 thousand through a decrease of other accrued liabilities. We generated $0.6 million in cash for an increase in accounts payable due to the timing of inventory receipts and payments, $0.5 million from the change in prepaid and other current assets, and $1.0 million in inventory as we sold off a substantial portion of the stock on hand. 34 Table of Contents Net cash used in operating activities of $6.7 million in 2022 resulted primarily from the net loss incurred of $10.3 million, adjusted for non-cash items, including: depreciation and amortization of $0.5 million, stock-based compensation, net of $0.1 million, and non-favorable provisions from inventory of $32 thousand and a loss on impairment of property and equipment of $0.3 million, and favorable provisions from warranty of $0.1 million. We used $0.6 million through a decrease of other accrued liabilities and $0.3 million from changes in deferred revenue. We generated $0.8 million through the timing of collection of accounts receivable, $0.2 million from the change in prepaid and other current assets, $0.1 million for short-term deposits, and $2.4 million in inventory as we sold off a substantial portion of the stock on hand. Cash used in investing activities Net cash used in investing activities was $69 thousand in 2023, primarily from the acquisition of property and equipment. Net cash used in investing activities was $16 thousand in 2022, primarily from the acquisition of property and equipment and partially offset by the proceeds from the sale of property and equipment. Cash provided by financing activities Net cash provided by financing activities for the year ended December 31, 2023 of $4.5 million primarily resulted from the proceeds from the issuance of common stock and warrants of $6.1 million and advanced capital contribution of $0.5 million. The increases in cash were partially offset by payments on the 2022 Streeterville Note of $0.6 million and Credit Facilities of $1.4 million. Net cash provided by financing activities for the year ended December 31, 2022 of $4.1 million primarily resulted from the proceeds from the issuance of common stock and warrants of $3.5 million, proceeds from promissory notes payable of $0.7 million, related party promissory notes payable of $0.8 million, and the issuance of the 2022 Streeterville Note provided net proceeds of $2.0 million. The increases in cash were partially offset by payments on the 2021 Streeterville Note of $1.6 million, Credit Facilities of $0.8 million, and the deferred financing cost of $0.1 million. Off-balance sheet arrangements We had no off-balance sheet arrangements during the years ended December 31, 2023 and 2022. Contractual and other obligations As of December 31, 2023, we had approximately $0.5 million in outstanding purchase commitments for inventory, of which the majority is expected to ship in the first quarter of 2024. We have 49% of the outstanding purchase commitments with a related party. There have been no other material changes to our contractual and other obligations as compared to those included in our 2022 Annual Report. Critical accounting policies and estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingencies, and the reported amounts of net sales and expenses in the financial statements. Material differences may result in the amount and timing of net sales and expenses if different judgments or different estimates were utilized. Critical accounting policies, judgments, and estimates that we believe have the most significant impact on our financial statements are set forth below: • revenue recognition, • allowances for doubtful accounts, returns and discounts, • impairment of long-lived assets, • valuation of inventories, • accounting for income taxes, • share-based compensation, and • leases. 35 Table of Contents Recently adopted accounting guidance For information on recently adopted accounting guidance, please refer to Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” included under Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a “smaller reporting company” as defined by Item 10 of Regulation S-K, 17 CFR § 229.10(f)(1), the Company is not required to provide this information. 36 Table of Contents