BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The condensed consolidated financial statements (“financial statements”) include the accounts of the Company and its subsidiary, Energy Focus LED Solutions, LLC (“EFLS”) in Solon, Ohio, and until its disposition, its former subsidiary Crescent Lighting Limited (“CLL”), and its subsidiary, Energy Focus Europe, Ltd, each located in the United Kingdom. All significant inter-company balances and transactions have been eliminated. On August 4, 2015, we entered into a Share Sale Agreement with John Harris, the managing director of CLL, pursuant to which Mr. Harris acquired CLL from us for nominal consideration. Additionally, during 2014, we shifted our focus away from providing turnkey solutions and stopped accepting new projects. During the quarter ended September 30, 2015, the remaining warranties for projects completed by EFLS expired, completing our exit of this business. Therefore, the results of operations and financial position of EFLS and CLL are included in the condensed consolidated financial statements as discontinued operations and previously reported financial information for the current and prior year have been adjusted. Unless indicated otherwise, the information in the Notes to the condensed consolidated financial statements relates to our continuing operations.

We have prepared the accompanying financial data for the three and nine months ended September 30, 2015 and 2014 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 2014 Annual Report.

In the opinion of management, the accompanying financial statements contain all normal and recurring adjustments necessary to present fairly our Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014, Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2015 and 2014, Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2015 and 2014, Condensed Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2015, and Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2015 and 2014.

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; revenues recognized on a percentage-of-completion basis; valuation allowance for net deferred taxes; 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 percent or more of our total net sales, or whose net trade accounts receivable balance individually represented 10 percent or more of our total net trade accounts receivable, as follows:

For the three months ended September 30, 2015, Energy Management Products, LLC, a distributor for the U.S. Navy, accounted for approximately 74 percent of net sales, and sales of products for the U.S. Navy were approximately 82 percent of net sales. For the three months ended September 30, 2014, Energy Management Products, LLC and DFAS Columbus accounted for approximately 61 percent and 11 percent of net sales, respectively, and together comprised sales of products for the U.S. Navy of approximately 72 percent of net sales.

For the nine months ended September 30, 2015, Energy Management Products, LLC accounted for approximately 79 percent of net sales, and sales of products for the U.S. Navy were approximately 85 percent of net sales. For the nine months ended September 30, 2014, Energy Management Products, LLC and DFAS Columbus accounted for approximately 51 percent and 16 percent of net sales, respectively, and together comprised sales of products for the U.S. Navy of approximately 67 percent of net sales.

At September 30, 2015, Energy Management Products, LLC and DFAS Columbus accounted for approximately 71 percent and 18 percent of net trade accounts receivable, respectively. At December 31, 2014, Energy Management Products, LLC, ES Entegral Solutions, Inc., and Johnson Controls, Inc. accounted for approximately 55 percent, 20 percent, and 11 percent of net trade accounts receivable, respectively.

Recent accounting pronouncements

In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-16, Business Combinations (Topic 805). The amendments in this ASU require that an acquiring company recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. Additionally, this ASU requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. To simplify the accounting for adjustments made to provisional amounts recognized in a business combination, the amendments in this ASU eliminates the requirement to retrospectively account for those adjustments. This ASU is effective prospectively for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The Company does not expect the guidance in this ASU to have a material impact on our consolidated financial statements and related disclosures.

In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customer (Topic 606): Deferral of the Effective Date. This ASU defers the effective date of ASU 2014-09, Revenue from Contracts with Customer (Topic 606) for all entities by one year. As a result, all entities will be required to apply the provisions of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently assessing the adoption date and impact the guidance in this ASU will have, if any, on our consolidated results of operations, cash flows, or financial position.

In April 2015, the FASB issued AASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The amendments in this update are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. We do not expect the guidance to have a material impact on the Company.

In April 2015, the FASB issued ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance will not change U.S. GAAP for a customer's accounting for service contracts. The amendments in the update are effective for interim and annual periods beginning after December 15, 2015. The Company is currently assessing the impact that adopting this new accounting guidance will have on its consolidated financial statements and footnote disclosures.

In January 2015, the FASB issued ASU No. 2015-01, Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items, which provides guidance on simplifying income statement presentation by eliminating the concept of extraordinary items from U.S. GAAP. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively and retrospectively to all periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We have evaluated the accounting guidance and determined that there is no impact of this update to our consolidated financial statements.

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results. Examples include a disposal of a major geographic area, a major line of business, or a major equity method investment. Additionally, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, expenses of discontinued operations and of the pretax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The new standard is effective for interim and annual periods beginning after December 15, 2014. We have evaluated and adopted the accounting guidance with respect to our dispositions of Energy Focus LED Solutions, LLC and Crescent Lighting Limited.

Update to significant accounting policies

There have been no material changes to our significant accounting policies, as compared to those described in our 2014 Annual Report.

Net income (loss) per share

Basic earnings (loss) per share is computed by dividing net income (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 earnings (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 is a reconciliation of the numerator and denominator of the basic and diluted net income (loss) per share computations for the periods presented below (in thousands):



	Three months ended September 30,						Nine months ended September 30,
	2015			2014			2015			2014
Numerator:
Income (loss) from continuing operations	$	4,398		$	256		$	7,814		$	(4,181	)
Loss from discontinued operations	(142		)	(659		)	(318		)	(914		)
Net income (loss)	$	4,256		$	(403	)	$	7,496		$	(5,095	)

Denominator:
Basic weighted average common shares outstanding	10,310			8,781			10,002			7,276
Potential common shares from options and warrants	355			—			340			—
Diluted weighted average shares	10,665			8,781			10,342			7,276

As a result of the net loss we incurred for the three and nine months ended September 30, 2014, approximately 175 thousand and 1 million options, warrants, and convertible securities, respectively, were excluded from the net loss per share calculation, as their inclusion would have been anti-dilutive. In addition, adjusting the denominator of diluted earnings per share would also be anti-dilutive, even if an entity has income from continuing operations after adjusting for discontinued operations. Therefore, for each of the three and nine months ended September 30, 2014, the basic weighted average shares outstanding were used in calculating diluted loss per share.

Product warranties

We warrant finished goods against defects in material and workmanship under normal use and service for periods generally between one and five years. Settlement costs consist of actual amounts expensed for warranty, which are largely a result of the cost of replacement products. A liability for the estimated future costs under product warranties is maintained for products and services outstanding under warranty. The following table summarizes warranty activity for the periods presented (in thousands):



	Three months ended September 30,						Nine months ended September 30,
	2015			2014			2015			2014
Balance at beginning of period	$	391		$	68		$	81		$	75
Accruals for warranties issued	—			23			325			27
Settlements made during the period (in cash or in kind)	(2		)	(15		)	(17		)	(26		)
Accrued warranty reserve	$	389		$	76		$	389		$	76

Geographic information

Our long-lived fixed assets are located in the United States. Net sales attributable to customers outside the United States accounted for less than 1 percent of our total net sales for the three and nine months ended September 30, 2015 and 2014.