RESULTS OF OPERATIONS

Net sales decreased 6 % to $5,009,000 for the quarter ended March 31, 2007, as compared to the same quarter a year ago. The decrease was primarily a result of lower pool sales due to the slowdown in housing starts along with lower sales from Europe. These shortfalls were partially offset by higher EFO sales of $ 1,132,000 in the first quarter of 2007 compared to $263,000 in the first quarter of 2006. EFO sales in 2007 include sales from EFO fiber optic lighting, EFO LED, EFO Controls, and EFO Government products, whereas sales in 2006 include EFO fiber optic only. EFO fiber optic lighting sales in the first quarter of 2007 were $520,000. Due to higher EFO sales offsetting lower sales in the traditional fiber optic lines, pool lighting and traditional commercial, we expect overall sales to grow for fiscal 2007. However, the market for our products is highly dependent upon general economic conditions.

On March 31, 2006, we announced that we had received funding from DARPA for $2,100,000 to develop and install our high efficiency distributed lighting systems as a “commercial” product on three US Navy ships. This project resulted in revenue being recognized on a percentage of completion basis as milestones are completed between 2006 and 2007. We recognized revenue of $105,000 in the first quarter of 2007 for the completion of milestones.

During the first quarter of 2007, $234,000 of revenue was recognized on a percentage of completion basis for milestones completed as a subcontractor to the University of Delaware for continuing research on Very High Efficiency Solar Cells.

Gross profit was $1,470,000 in the first quarter of fiscal 2007, an 8% decrease compared to the same period in the prior year. The gross profit margin as a percentage of sales decreased from 30% for the first quarter of fiscal 2006 to 29 % for the first quarter of 2007. We expect gross profit margins for the full 2007 year to improve compared to 2006, assuming general economic conditions remain consistent.

Research and development expenses were $483,000 in the first quarter of fiscal 2007, an increase of $27,000 compared with the first quarter of fiscal 2006. Gross expenses for research and development decreased by 24% due to lower project costs and due to engineering costs associated with delivering the Navy ship install and University of Delaware milestones being included in cost of sales in the first quarter of 2007, whereas there were no such allocated expenses in 2006. Our research and development expense are reduced by credits received for achieving milestones under a development contract with the Department of Energy (“DOE”) that was signed in 2005 for a total of $1,500,000. The gross research and development spending along with credits from government contracts is shown in the table (in thousands): 

			Three months ended March 31,
			2007			2006
Gross expenses for research and development		$	670		$	880
Deduct: credits from DARPA & DOE contracts			(187	)		(424	)
Net research and development expense		$	483		$	456

 

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We expect research and development expense to decrease for the full year 2007 compared to 2006 due to continued inclusion of costs in costs of sales relating to revenue recognized.

Sales and marketing expenses increased by 17% to $2,620,000 in the first quarter of fiscal 2007 as compared to $2,241,000 for the same period in fiscal 2006. The increase is a result of increased sales and marketing efforts associated with the EFO product line. We expect sales and marketing expenses to be comparable to 2006 spending for the full year.

General and administrative expenses were $1,078,000 in the first quarter of fiscal 2007 and 2006. We expect general and administrative expenses to decrease in 2007 as compared to 2006.

We recorded a net loss of $2,606,000 in the first quarter of fiscal 2007 as compared to a net loss of $2,441,000 in the first quarter of fiscal 2006. The net loss in 2007 and 2006 was due primarily to soft sales in the first quarter in each period.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents

At March 31, 2007, our cash and cash equivalents were $3,923,000 as compared to $3,705,000 December 31, 2006, a net cash increase of $218,000 during the first three months of 2007. This compares to a net cash decrease of $4,739,000 for the same period in 2006. We also had $8,179,000 short-term securities at March 31, 2007 as compared to $12,263,000 in short-term securities at December 31, 2006, a decrease of $4,084,000.

Due to seasonality in the sales of our pool lighting products, our cash balances tend to decrease in the first half of the year and increase in the second half of the year. This is subject to the condition that the market for our products is highly dependent upon general economic conditions.

Cash was used in the period ended March 31, 2007 to pay accounts payable, accruals, and fund inventory additions.

Cash provided by (used in) Investing Activities

Investing activities provided cash of $ 4,011,000 during the first three months of 2007, compared to a use of cash of $837,000 for the same period of 2006. During both periods, cash was used for the acquisition of fixed assets. The sale of short-term securities in 2007 provided cash to fund fixed asset purchases and operations.

Cash Provided by Financing Activities

Financing activities contributed $185,000 to cash during the first three months of 2007. This net contribution was due primarily to the exercise of warrants and employee stock options for $302,000. For the same period in 2006, financing activities, from the exercise of warrants and employee stock options, were $245,000. $180,000 of cash was used to pay short and long-term borrowings in the period ended March 31, 2007.

 

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The Company’s bank line of credit is based on an agreement with Silicon Valley Bank dated August 15, 2005. It was further amended September 25, 2006 and extended through August 15, 2007. This credit facility is for $5,000,000. At March 31, 2007 and December 31, 2006, the interest rate was 8.75%. The rate is the same for both the term-loan and line of credit in both periods and has a minimum tangible net worth covenant which the Company must meet going forward. On December 31, 2005 this agreement was amended and restated to include an additional $3,000,000 term-loan line of credit for equipment purchases. This agreement calls for repayment of principal in equal amounts over 4 years from the date of purchase of the equipment and has an interest rate of prime plus 0.5% if the quick ratio is greater than 1.5 and prime plus 1.5% if the quick ratio is at or below 1.5. Borrowings under the Silicon Valley Agreement are collateralized by the Company’s assets and intellectual property. Specific borrowings under the revolver are tied to accounts receivable and inventory balances, and the Company is required to comply with certain covenants with respect to effective net worth and financial ratios, which the Company met as of March 31, 2007. The Company had borrowings under the revolving line of credit of $1,000,000 at March 31, 2007 and at December 31, 2006. The Company had total borrowings of $2,092,000 under the term-loan portion of the agreement as of March 31, 2007, and $2,261,000 as of December 31, 2006. The Company pays an unused line fee of 0.25% against any unused daily balance during the year.

The $1,000,000 revolving line of credit is a current liability. Future maturities of obligations under the term-loan portion are as follows: 2007, $562,000, 2008, $676,000, 2009, $676,000, and 2010, $178,000.

Through the Company’s U.K. subsidiary, it maintains a bank overdraft facility of $492,000 (in UK pounds sterling, based on the exchange rate at March 31, 2007) under an agreement with Lloyds Bank Plc. There were no borrowings against this facility as of March 31, 2007 and December 31, 2006, respectively. The facility is renewed annually on January 1. The interest rate on the facility was 7.25% at March 31, 2007 and December 31, 2006.

Through the Company’s German subsidiary, it maintains a credit facility under an agreement with Sparkasse Neumarkt Bank. This credit facility was put in place to finance our building of new offices in Berching, Germany, which is owned and occupied by our German subsidiary. As of March 31, 2007 and December 31, 2006, the Company had borrowings of $373,000 (in Euros, based on the exchange rate at March 31, 2007) and $379,000 (in Euros, based on the exchange rate at December 31, 2006), respectively, against this credit facility, all of which comes due between 2007 and 2008. The interest rate was 5.35% at March 31, 2007 and December 31, 2006. In addition, the Company’s German subsidiary has a revolving line of credit for $201,000 (in Euros, based on the exchange rate at March 31, 2007) with Sparkasse Neumarkt Bank. As of March 31, 2007 there were borrowings against this facility of $185,000 and $124,000 against this facility at December 31, 2006. The revolving facility is renewed annually on January 1. Interest rates on this line of credit were 9.75% at March 31, 2007 and December 31, 2006. The $185,000 revolving line of credit is a current liability. Future maturities of remaining borrowings are $43,000 in 2007 and $330,000 in 2008.

We believe that our existing cash balances and funds available to us through our bank lines of credit together with funds that we anticipate generating from our operations, will be sufficient to finance our currently anticipated working capital requirements and capital expenditure requirements for the next twelve months.  However, a sudden increase in product demand requiring a significant increase in manufacturing capability, or unforeseen adverse competitive, economic or other factors may impact our cash position, and thereby affect operations.  From time to time we may be required to raise additional funds through public or private financing, strategic relationships or other arrangements.  There can be no assurance that such funding, if needed, will be available on terms acceptable to us, or at all.  Furthermore, any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. Strategic arrangements, if necessary to raise additional funds, may require that we relinquish rights to certain of our technologies or products.  Failure to generate sufficient revenues or to raise capital when needed could have an adverse impact on our business, operating results and financial condition, as well as our ability to achieve intended business objectives.

 

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CRITICAL ACCOUNTING POLICIES

The preparation of our financial statements 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 revenue and expenses in the financial statements. Material differences may result in the amount and timing of revenue and expenses if different judgments or different estimates were utilized. Critical accounting policies, judgments and estimates which we believe have the most significant impact on our financial statements include allowances for doubtful accounts, returns, warranties, valuation of inventories, and stock based compensation. For the detailed discussion of the application of policies critical to our business operations, see our Annual Report Form on 10-K for the year ended December 31, 2006.

RECENTLY ADOPTED STANDARDS

In July, 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN48”), an interpretation of FASB statement No. 109, “Accounting for Income Taxes”, regarding accounting for income tax uncertainties effective for fiscal years beginning after December 15, 2006. FIN 48 applies to all tax positions related to income taxes subject to SFAS 109 on Accounting for Income Taxes. The impact of adopting the positions of this interpretation did not have a material impact on our overall financial position or results of operations.

RECENT PRONOUNCEMENTS

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This standard is effective beginning January 1, 2008. The Company is currently evaluating the impact of adoption of the standard on our financial position and results of operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of March 31, 2007, we had $661,000 in cash held in foreign currencies based on the exchange rates at March 31, 2007. The balances for cash held overseas in foreign currencies are subject to exchange rate risk. We have a policy of maintaining cash balances in local currencies unless an amount of cash is occasionally transferred in order to repay inter-company debts.

As of March 31, 2007 we had borrowings of $185,000 (in Euros, based on the exchange rate at March 31, 2007) against a credit facility secured by real property owned by our German subsidiary. As of December 31, 2006, we had $124,000 (in Euros, based on the exchange rate at December 31, 2006) borrowed against this credit facility.

 

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Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

 

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet, and management believes they meet, reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

 

(b) Changes in internal control over financial reporting.

 

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

On February 21, 2007, a lawsuit was filed in The United States District Court, Eastern District of Missouri alleging that laminar flow products in the Company’s pool and spa line have infringed upon certain United States patents owned by Robert L. Kuykendal, Ronald S. Deichmann, and David R. Usher and licensed to Splash Technologies, Incorporated. The lawsuit seeks to halt such alleged infringement and an accounting related to products sold. The Company does not believe that these proceedings will have a material adverse effect on its consolidated financial position, results of operations, or liquidity.

Item 1A. Risk Factors

There are no significant changes in risk factors from our Annual Report Form 10-K for the year ended December 31, 2006.

Item 5. Other Information

On May 8, 2007, Energy Focus, Inc., a wholly-owned subsidiary of Fiberstars, Inc., was merged into Fiberstars, Inc. As a result of this merger, the name of Fiberstars, Inc., was changed to Energy Focus, Inc. Existing certificates for share of the Company, bearing the name Fiberstars, Inc., will continue to be valid certificates for Energy Focus, Inc., and no action is required by the shareholders as a result of the name change.

Item 6. Exhibits  

 

Exhibit Number		Description of Documents
3.1		Certificate of Ownership And Merger, changing name of Registrant, effective May 8, 2007.
31.1		Rule 13a-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a) Certification of Chief Financial Officer.
32.1**		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).
32.2**		Statement of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).

 

** In accordance with item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	ENERGY FOCUS, INC.
Date: May 10, 2007	By:	/s/ John M. Davenport
		John M. Davenport Chief Executive Officer

	By:	/s/ Robert A. Connors
		Robert A. Connors Chief Financial Officer (Principal Financial and Accounting Officer)

 

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Exhibit Index

 

Exhibit Number		Description of Documents
3.1		Certificate of Ownership and Merger, changing name of Registrant, effective May 8, 2007.
31.1		Rule 13a-14(a) Certification of Chief Executive Officer.
3131.2		Rule 13a-14(a) Certification of Chief Financial Officer.
32.1**		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).
32.2**		Statement of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2003 (18 U.S.C. §1350).

 

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** In accordance with item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

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