Energy Focus, Inc.

Greetings and welcome to Energy Focus fourth quarter and fiscal year end 2020 conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Brett Moss with Hayden IR. Thank you. You may begin.

Thank you, Operator, and good morning, everyone. Joining me on the call today is James Tu, Executive Chairman and Chief Executive Officer, and Todd Nestor, President and Chief Financial Officer. Before we begin today's call, I'd like to remind everyone that we'll make certain forward-looking statements. These statements are based upon information that represents the company's current expectations or beliefs. The results realized may differ materially from those stated. For discussion of these risks, they could affect our results. Please refer to the discussion under the headings Risk Factors as well as Forward-Looking Statements in our most recent 10-K. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. Also, please note that during this call and in the accompanying press releases, any certain financial metrics are presented on both GAAP and non-GAAP adjusted basis. Reconciliation of adjusted results to the GAAP results are available in the tables attached to the earnings release, which is posted on our corporate website at energyfocus.com in the investor relations section of the site. I'll now turn the call to James. James, the floor is yours.

Thank you, Brett. Good morning, everyone, and thank you for joining our full year and fourth quarter 2020 earnings conference call. 2020 was a year filled with both extreme challenges and solid progress at Energy Focus. As the global pandemic swept across the country, and arguably still weigh heavily on daily economic activities today, more than a year after the initial breakout. Despite of the unprecedented softness of lighting retrofit activities that impacted our commercial lighting sales, our financial results for the whole year, which Thao will go into further details later, illustrate the considerable progress we have made in reigniting top-line growth, significantly improving our margins, and strengthening of our balance sheet. and prudently managing inventory and working capital to position our company for strong growth as economic life resumes towards normality and our new UVC disinfection products start to generate notable sales in the coming quarters. On the top line, the strength of our product innovation that resulted in Improved competitiveness in the military and maritime space was a significant driver of the more than 32% net sales growth we were able to achieve in 2020, which offset the weakness we experienced in our commercial business ever since March of last year. As we continue to strengthen our military engineering organization and expand our business development efforts, We are confident that we will continue to achieve high-level performance and further growth in this segment going forward. In addition, within the federal government, but outside of the Navy ecosystem, our military and commercial Buy American products were successfully added to the GSA schedule in December 2020. We have started to receive orders from the GSA channel over the past few months, and we are aggressively building out our sales and marketing infrastructure for this particular market that covers more than 361,000 buildings throughout federal government agencies. On the commercial side, as we mentioned over the past few earnings calls, we witnessed a dramatic slowdown of lighting retrofit activities in 2020. Many non-essential building improvement upgrades and retrofits were put on hold as the global pandemic forced most organizations to significantly limit building occupancy and building access and caused widespread suspension or postponements of capital improvement budgets. Although facility utilization and capital spending freezes continue to linger going into the first quarter of 2020, as vaccines become more widely available and return to shared spaces starting to pick up pace. We are cautiously optimistic that commercial sales pipeline activities will start to accelerate going into the second quarter more locally, so into the second half of the year. Meanwhile, we continue to make exciting progress in expanding our channel partnership network by adding more proven and committed lighting agents. to represent our products in various geographic territories, as well as by engaging with new national distribution partners that will take our products to new vertical markets. With our improved cost structure of our LED products on top of the in-focus, dimmable, and color-tunable control platform that has received strong industry-wide accolades, including initial orders from a state government that manages 17 million square feet of building space. We are looking forward to improving our commercial lighting sales quarter over quarter of the year 2021 progresses. As the COVID-19 pandemic brought unprecedented challenges to our commercial lighting business, it also brought potential new opportunities for energy focus by creating unprecedented needs for space disinfection. In 2020, we devoted significant amount of engineering resources and R&D dollars to develop a whole new portfolio of UVC air and service disinfection products. With the combination of our expertise and experience with lighting technology and additional new proprietary as well as patentable technologies we have developed, we have created a line of unique and powerful UVC products that can inactivate 99.9% or more of various pathogens, including coronavirus and influenza. The air disinfection product portfolio currently includes above spelled A-B-U-V, a modular troffer system that provides both flicker-free steamable and color-tunable light, as well as UVC air disinfection capability. Nuvo Tower Spill and UVO, an air disinfection device for large work and living spaces. And Nuvo Traveler, our portable and rechargeable UV disinfection device for in-car and travel applications. Over the past few months, we have incorporated into these products additional technologies and features that make them much more effective, powerful, and unique in the marketplace than when we first introduced them in the fourth quarter of 2020. And we are now scheduled to make the first deliveries for these products to customers later in the second quarter to early third quarter. Meanwhile, the feedback we received from our channel partners and potential customers over the past four to five months thinks the products were introduced has only gotten more positive and enthusiastic, and we have never been so excited about the prospects for these products. Given our belief that needs of disinfection are here to stay, regardless of how the impact from COVID-19 evolves in the coming months and years, and our innovation focus and quality positioning, we are aiming to build a leading UV disinfection brand portfolio in this new emerging market. And we expect to introduce additional products throughout 2021 and beyond to better serve the disinfection needs of various facility and consumer applications. To complement our air disinfection products, we've also developed an industry-leading autonomous UVC service disinfection robot called MOVE. While we will be selling the robot later this year to customers with larger facility footprints, such as hospitals, hotels, and retail chains, or universities and government agencies, our near-term focus is to develop our disinfection as a service, or DAAS, solution called MoveCrew. which provides robot disinfection services by the hour in the targeted territories. We're starting to pilot this service in the Cleveland area this month and are planning to officially launch our services in the second quarter. First in Cleveland, then other major metropolitan areas as we master our service operation for replication. Like our air disinfection product, The early indication of the interest is very encouraging for MOVE and MOVE Crew, even before we formally launch the product and service. Notably, we were selected by one of the top 10 universities in the country to be the service disinfection technology for NCAA National Fencing Championships, which are being held later this week, where 25 NCAA Division I colleges and their athletic directors are expected to be present. Although these products and solutions are in early stages and not expected to meaningfully contribute to our financial results until the second half of 2021, they create a potentially enormous long-term growth opportunity outside of the commercial and military lighting space. And our entrepreneurial culture and innovative DNA enable us to compete favorably in such a market where multiple technological domains of expertise have to intersect, converge, and synergize to provide the best disinfection results. Essentially, with bold positioning, organic organizational agility, and engineering ingenuity, we have taken the past 12 months to enter a whole new market that could further and completely transform the growth profile of energy focus in the coming quarters and years. Clearly, as mentioned before, challenges remain today in the broader macro environment, and in particular for the lighting retrofit industry, as remote working drastically reduces facility capital budget and project activities. With the opening of the economy in the coming months expected and our growing list of highly differentiated products, be it from military lighting, commercial lighting, in focus control platform or UV disinfection posed to penetrate their respective target markets. We believe that energy focus has never been as well positioned today to deliver long-term sustainable growth and profitability. With that, I will turn the call to Todd to review our financial performance for the year and the quarter.

Todd? Thank you, James. First, I'd like to summarize our 2020 full-year results. Net sales for the full year 2020 were $16.8 million, up 32.5% compared with $12.7 million in 2019. The year-over-year increase in net sales was primarily driven by an increase in military sales, which was partially offset by declining commercial sales as a result of fluctuations in the timing, pace, and size of commercial projects. including principally the impact from the COVID-19 pandemic that froze or delayed lighting retrofit projects across the board in the commercial sectors as James mentioned earlier. From the segment mix perspective, military sales were 11.4 million representing 67.9% of total net sales compared to 4.8 million or 38% of total net sales for 2019. Sales to commercial customers were 5.4 million in 2020 representing 32.1% of total net sales for the year, down from $7.9 million, or 62% of total net sales in 2019. The year-over-year decrease in commercial sales was mainly due to overall softness in the commercial market that began with the onset of the COVID-19 pandemic. Gross profit for 2020 was $5.2 million, compared with $2 million in 2019. an increase of 162.7 percent year-over-year that was driven by an increase in military sales dollars and mix, as well as improved efficiency in our plant operations. As a percentage of revenue, gross profit margin was 30.8 percent in 2020, compared to 15.5 percent in 2019, a nearly two-fold increase. This increase was primarily due to a more favorable product mix and the margin impact from increased military sales, which more than offset unexpected additional manufacturing costs due to supply chain challenges relating primarily to military and maritime products. Adjusted gross margin, a non-GAAP measure, was 27.1 percent for full year 2020, compared to 15.9 percent in the prior year. Operating expenses in 2020 were $9.3 million, or 54.9% of sales compared to 8.9 million or 70.3% of sales in 2019, or a 3.7% increase year-over-year, however, which was leveraged by the 32.5% increase in net sales. The increase in spending was driven by higher product development and testing costs related to the development and launch of our unfocused products and development of our UPCD products and higher SG&A due to increased salaries and benefits or headcount to support our growth initiatives. Loss from operations for 2020 was $4.1 million compared to a loss from operations of $7 million in 2019, a year-over-year improvement of $3.1 million. Our core operating business continues to improve as we remain focused on leveraging our operations as we grow and through continued diligent cost management through strategic sourcing efforts and belt tightening. Below the operating line, interest expense, including interest on borrowings and non-cash amortization of facility fees, was $481,000 in 2020 compared with $317,000 in 2019. This increase was the result of an increase in borrowings under our new short-term credit facilities that provided increased borrowing capacity. Also, below the operating line, we had non-recurring expenses of $276,000 for the extinguishment of former revolving line of credit, as well as our early payoff of the bridge financing, and a loss of $1.1 million for the market value change in our warrant liabilities. Importantly, in December, certain of the terms of our outstanding warrants were modified, such as the warrants now qualify for equity accounting treatment going forward. At the time of the modification, the liability related to the remaining warrants was fair valued with the offsetting adjustment recorded in income. The warrant liability was then reclassified into equity and the warrants are no longer subject to re-measurement at each balance sheet date. Consequently, this reclassification has added the benefit of eliminating the volatility risk to our net income that can result from periodic valuation of warrants that are classified as a liability. Net loss for 2020, inclusive of the non-operating expenses and impact of the warrant valuation, was $6 million, or $1.83 loss per basic and diluted share, based on 3.2 million fully diluted shares, compared with the loss of 7.4 million, or $2.99 loss per basic and diluted share in 2019, which is based on 2.5 million fully diluted shares. Adjusted EBITDA, a non-GAAP measure, which excludes depreciation and amortization, interest expense, stock base, and other incentive comp, was a loss of $3.5 million for 2020, compared with a loss of $5.9 million in 2019. Now, I would like to turn to a brief review of fourth quarter results. Net sales for the fourth quarter of 2020 were 3.7 million, up 6.1%, compared with 3.5 million in the fourth quarter of 2019. The year-over-year increase in net sales was primarily driven by an increase in military sales, which was partially offset by a decline in commercial sales as a result of fluctuations in the timing, pace, and size of commercial projects, including the impacts of the COVID-19 pandemic. When compared to $6 million in the third quarter of 2020, net sales were down 37.2% on a sequential basis, due in large part to decreased sales in our military business, resulting primarily from the timing of one particular military order that shifted a significant portion of sales from the second quarter of 2020 to the third quarter, resulting in an excess concentration of military sales in the third quarter, as we have previously mentioned. Sales to our top 10 customers for the total company for the fourth quarter of 2020 increased 6.1%, and sales to our top 20 customers increased 4.8%, compared to the fourth quarter of last year, reflecting further penetration in the top tier of our existing customer base. From a mixed perspective, military sales were $2.6 million for the fourth quarter of 2020, representing 69.2% of net sales compared to 1.5 million or 42.5% of total net sales for the fourth quarter of 2019. The year-over-year increase in military sales is primarily due to increased sales to one of our top 10 customers compared to last year, with one particular military customer representing most of the increase. Also, fourth quarter net sales to our top 10 military customers increased 66.9%, and net sales to our top 20 military customers increased 67.3% compared to the fourth quarter of 2019. Sales to commercial customers were 1.1 million in the fourth quarter of 2020, representing 30.8% of total net sales for the quarter. down from $2 million, or 57.5% of total net sales in the fourth quarter of 2019. The year-over-year decrease in commercial sales was mainly due to overall softness in the commercial market that began at the onset of the COVID-19 pandemic. Sequentially, net sales to commercial customers decreased 20.7%, down from 1.5 million in the third quarter of 2020. This decrease was primarily driven by the pandemic. Fourth quarter 2020 net sales to our top 10 commercial customers decreased 53.6% year-over-year, and fourth quarter net sales to our top 20 commercial customers decreased 51.8%. As a percentage of revenue, gross profit was 38.3% in the fourth quarter of 2020 compared to 27.1% in the fourth quarter of 2019, a year-over-year increase of 1,120 basis points. This increase was primarily due to a more favorable product mix and the margin impact from increased military sales as well as more favorable reserve movements in 2020. On a sequential basis, gross profit margin increased 1,520 basis points from 23.1% in the third quarter of 2020. Adjusting gross profit margins for excess and obsolete in transit and net realizable value inventory reserve resulted in the non-GAAP adjusted gross margins of 27.7% for the fourth quarter of 2020, more in line with recent historical trends compared to 28.5% in the fourth quarter of 2019 and 24.6% in the third quarter of 2020. Operating expenses in the fourth quarter of 2020 were $2.3 million, or 61.4% of sales, compared to $2.1 million, or 60.2% of sales in the fourth quarter of 2019, an increase of $173,000, or 8.1% year-over-year. The increase was largely driven by higher product development costs related to the development of our UVCD products. Loss from operations for the fourth quarter of 2020 was $866,000 compared to a loss from operations of $1.2 million in the fourth quarter of 2019, a year-over-year improvement of approximately $300,000. Sequentially, this compares to a loss from operations of $1 million in the third quarter of 2020, an improvement of $146,000. Below the operating line, interest expense was $137,000 in the fourth quarter of 2020 compared with $181,000 in the fourth quarter of 2019. This decrease was the result of a lower blended interest rate on borrowings despite the higher debt balance. Also, below the operating line, in the fourth quarter, We had non-recurring expenses of $117,000 for the extinguishment of debt and $1.2 million gain related to the valuation of the warrants. As I mentioned earlier, these warrants were reclassified to equity and will not be subject to remeasurement in subsequent periods. Net income in the fourth quarter of 2020 was a positive $65,000, or one cent per basic and diluted share, based on 4.3 million of fully diluted shares, compared with a loss of $1.3 million, or 53 cents on a loss per basic and diluted share basis, based on 3.3 million of fully diluted shares in the fourth quarter of 2019. Now I'd like to turn to the balance sheet. As of December 31st, 2020, we had cash of $1.8 million compared to $350,000 at the end of 2019. The increase in cash was primarily due to the insurance of new capital through the sale of equity in the first quarter, as well as increased borrowings. Total debt as of December 31, 2020, was $3.1 million, which was comprised of $2.3 million in short-term credit line borrowings and borrowings of $795,000 under the Paycheck Protection Program as part of the Coronavirus Aid, Relief, and Economic Security, or CARES Act. We applied for loan forgiveness in October of 2020, and it was subsequently granted in February of 2021, which included the entire principal balance and interest. In accordance with GAAP, the forgiveness income will be recorded as other income in the consolidated statements of operations during 2021. We estimate there will be a positive impact to other income of approximately $800,000 in the first quarter. For enterprise value purposes, our net debt was $1.3 million at the end of 2020, which compares to net debt of $3.1 million at the end of 2019, a $1.8 million reduction year-over-year. As of December 31, 2020, we had total availability of $3.5 million, which was comprised of $1.8 million of cash and $1.7 million of excess filing availability under our credit facilities. primarily as a result of additional capacity gained through our new credit facility, the PPP loan, and the equity offering. This compares to $1.9 million in total availability at the end of fiscal 2019. Now, I would like to discuss the full-year cash flow results. Cash used in operations was $2.5 million for 2020. The net loss was $6 million inclusive of non-cash items such as depreciation, stock-based compensation, and $1.1 million loss from the change in fair value of the warrants. We generated cash from working capital of $2.3 million in 2020 compared to being a use of $412,000 of cash in 2019. $1.1 million was generated from inventories, and $1.1 million was generated from accounts payable, both driven by timing of inventory and and that $400,000 was generated from accounts receivable, driven by timing of collections. Cash used in investing was $223,000, or approximately 1 percent of net sales. Historically, our capital spending requirements are not significant. Net cash provided by the financing activities was $4.1 million, driven primarily by the equity we issued in January, as well as the PPP loan. As I mentioned during prior earnings calls, for the time being, we would like to provide brief updates about the impact of the COVID-19 pandemic on our business. As in the past, we continue to operate under our customized COVID-19 contingency plan at the company with employees that can alternatively work from our plant and office or from their homes. James and I have already discussed the historical impact of the COVID-19 pandemic on our commercial business. While there are small signs that the commercial business might be starting to rebound a bit, it is still too early to become overly optimistic of a rapid or immediate recovery. During the fourth quarter of 2020 and through today, the impact of the pandemic has significantly impacted many businesses, including ours, and resulted in supply chain impacts such as increased wait times for products to arrive, as well as increased inbound and outbound freight and shipping costs. some of which can be passed along to customers, plus continued staffing challenges and other operational hurdles we have had to overcome. Fortunately, we continue to not see a significant impact of the COVID-19 pandemic on our military and maritime business unit. However, thankfully, the development and launch of the UBCD portfolio of products is a good countervailing influence to the pandemic's impact on our commercial business is consistent with our human health-centric approach to lighting, fits very strategically into our long-term goals, and we believe is a long-term business model that will address a lasting focus on sanitation in the workplace, consumer space, and social gathering spaces following the COVID-19 pandemic event. The UBCDE portfolio addresses all pathogens, including the coronavirus and influenza. Hence, we are entering the segment strategically and with a long-term view. With that, we would like to open up to call to questions.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Edmund. Dayal with HC Wainwright, please proceed.

Thank you. Good morning, James. Good morning, Todd. Good morning. Just with respect to this, you know, disinfection as a service solution, how many rodents do we have right now? And can you talk a little bit about the business model in terms of, you know, you said you might be charging on an hourly basis. I know it's very early, but in terms of just your thoughts on how this could scale up potentially if this picks up for you?

Yeah, sure. You are right that it's a little bit early. We're just launching the pilot service. We now have five robots that we are basically working on and providing services and training our operating technicians in the Cleveland area. It's a little bit too early to, you know, lay out the specifics, but we're excited about it. We are charging around $150 per hour on the services. Obviously, it depends on, you know, how much subscriptions, how many times you are using on a monthly basis. And we have a, you know, so-called, you know, reward card type of service. methodology towards the usage to encourage recurring uses. We will be sharing more details in the next earnings call about the index mechanism. So we just want to make an announcement that we are in the middle of the piloting services. And as I mentioned, it will be launched officially in the second quarter. So we'll have more details to share. Okay, thank you. I don't want to add anything.

I just thought on the pricing front, when we determined that level of pricing, we did extensive benchmarking and other analysis to make sure that we felt we had a very good value. And 150 is the highest price a customer would pay. If they buy more units, they get a lower price per hour.

Understood. And then it looks like going into 2021, we have a lot of drivers for the commercial segment in terms of products and renewed sort of Salesforce reorganization, et cetera. If the commercial business picks up for you in 2021, what kind of impact on the margins should we expect from this?

I'll take a step and obviously target S-Powers. We always target over 30% gross margins. In some product lines, traditional lens and fixtures product lines, the margins could be lower. It also depends on, you know, there could be one-time transactions that will have lower margins. But overall, we are looking to achieve 30% plus margins in our commercial business line, we definitely should have that in the focus line and most likely all the UBCD products. And I think that's consistent with what we have been talking about targeting over 30% margin on the commercial line. Todd, do you have anything to add on that?

I'll just say that, you know, given our current volumes, as we increase volume, that rate will be more consistent quarter to quarter because the mix will not impact it as much. But we do have a strategy of targeting the kind of margins both from a dollar basis, which is our primary driver, as well as considering percentage margins. and how we price these. So we do intend to stick in those ranges that we've mentioned before, and James just reminded everybody else.

Okay, thank you for that. And with respect to the in-focus product, it looks like this is a bigger part of the commercial efforts in 2021. Did InFocus contribute anything in the fourth quarter or you weren't really in a position to market and sell this because of COVID related reasons in that quarter?

Yeah, well, the answer is really insignificant yet at this point. And the reason is that as you are aware of the InFocus system, I've talked at the commercial facilities. And all the budgets, basically, not only new retrofit budgets, but also the existing retrofit projects were being delayed. So we haven't seen InFocus being actually sold into the market in new projects yet. What we are seeing is a lot of interest in taking InFocus into new projects once the projects start to happen again. We mentioned about a win that we had with a state government facility that will start installing InFocus in the second half of this year, and that was one of the sort of