Energy Focus, Inc.

Good day and welcome to the Energy Focus second quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the start key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. And to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Brett Moss. Please go ahead, sir.

Thank you, operator, and good morning, everyone. Joining me on the call today is James Tu, Executive Chairman, 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 a discussion of these risks that could affect our results, please refer to the section under the headings Risk Factors as well as forward-looking statements in our most recent 10-K. Okay. in addition to the forward-looking statements in our most recently filed 10Q with the SEC. 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, certain financial metrics are presented on both GAAP and non-GAAP-adjusted basis. Reconciliations of the 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 over to James. James, the floor is yours.

Thank you, Brad. Good morning, everyone, and thank you for joining our second quarter 2021 earnings conference call. As we lay out in the earnings release, our second quarter results were impacted by the ongoing challenges for our customers in the lighting retrofit markets, particularly for the commercial markets that continue to face highly uncertain building occupancy and suspended or reduced capital budgets. Simultaneously, our military business was also impacted by delay opportunities due to funding availability of the Navy corresponding to the new defense budget and priority under the new administration. Last but not least, conditions of the global logistics continued to be challenging during the quarter and caused not only shipment delays but also significant increases in our freight costs. It has really been a perfect stone that undercut our sales and impacted our margins. That said, we believe we have not lost the key opportunities we have been pursuing, and since beginning of the third quarter, we have received a few commercial orders that were delayed from the first half of 2021. As vaccinations continue to expand and lockdowns become a thing of the past, We are cautiously optimistic that overall lining retrofit demand, particularly in the education and healthcare markets, might start to stabilize and grow again. In the meantime, NHFocus has continued to innovate in order to adapt to and grow under this new market paradigm. The pandemic has likely impacted occupancy level and usage patterns of commercial buildings for extended periods of time. And therefore, the commercial lighting retrofit market could face challenges and uncertainty until economic lives settle into a new normal. We have strategized and moved quickly and in both steps to develop new innovative products, including primarily our UVC disinfection products and the upcoming SunCycle autonomous circadian lighting system that could address both commercial and consumer markets. in this new paradigm. Fast forward to today, while many commercial buildings are still sitting partially, if not largely, empty, and property owners and tenants are temporarily tabling retrofit projects, consumers are now spending more time at home and are therefore actively seeking ways to make their homes safer and more comfortable. Many of us are also converting parts of our houses into offices, and this requires introducing new equipment or technologies. Remote and hybrid work, a tight labor market, high savings rate and low interest rates are all fueling the spending on home improvement, as we have already seen by the buoyant sales of both online and offline retailers. And we believe that our new lines of products surrounding human-centric lighting that we have been developing over the past 12 to 18 months and are entering the market in the next few months can make homes and offices healthier, more joyful, and more productive while providing energy-focused potential and diversified sales growth opportunities. Expected to come into the market first later in September and October are Nuvo Traveler, a personal tumbler-sized UVC air disinfection device for car and personal use, as well as Nuvo Power, a portable freestanding UVC air disinfection device designed for spaces up to 500 square feet. Those devices were designed to uniquely and powerfully intercept virus in real time and to destroy 99.9% plus of pathogens including influenza and coronavirus and its variants, passing through the devices. These products leverage the scientifically proven germicidal power of ultraviolet light, or UVC, our proprietary aerodynamic designs, and our patent-pending UV blocking technology, and are designed to safely capture and eliminate many contagious pathogens. And unlike traditional air purifiers, they do not require frequent filter changes that could be costly and hazardous. We plan to offer these products initially on our own as well as third-party e-commerce platforms through our channel partners such as First Energy Home and First Energy Advisors, 3UV, and our lighting distributors. as well as directly to large businesses in industries such as ride-sharing, hospitality, healthcare, financial service, and retail franchises. In the meantime, we continue to improve the designs of our above human-centric lighting UVC troffer, as well as MOVE disinfection robot, and we expect to start selling these products later in the fourth quarter as well. In addition, Our patented SunCycle lighting system based on our InFocus lighting control platform won Product of the Year Award from E&E, a prestigious and influential environment and energy technology publication. Due to its ease of installation, use, and maintenance in providing energy-efficient, high-quality, and autonomous circadian lighting capabilities. And we are planning to launch SunCycle products in the fourth quarter of 2021 or early 2022. Circadian lighting has proven to significantly improve sleep, productivity, and overall health through human lumen level and color temperature controls that correspond to the 24-hour circadian rhythm cycle. It is therefore particularly powerful to help improve human well-being experience and quality of life when people are staying at home throughout the whole day into the evening. With SunCycle, we look forward to bringing cost-effective and user-friendly human-centric lighting to both homes and workplaces for the first time. To be sure, regardless of the unexpected military funding delays and the commercial order delays or the ongoing pandemic that continues to impact on our overall business. We are not satisfied with the second quarter results we reported today. That said, we believe the new lines of UV and circadian lighting products that are slated to enter the market over the coming months will enable us to both expand our offerings for the commercial markets, but also address a whole new consumer market. And we expect these could meaningfully contribute to our top and bottom lines starting in the fourth quarter of 2021 and beyond. Due to continuing myriad market uncertainties that we lay out in the earnings release and that I described earlier, we're still not in a position to provide specific financial guidance. However, at this point, we anticipate that sales for the third quarter will be better than the first and the second quarter. And as the UVC products gain sales traction, we expect sales for the second half of 2021 to be better than the first half. Schools, hospitals, and government businesses are already leading the recovery of facility utilization, which should accelerate as daily lives gradually resume to the new normal. And we believe that the climate change and building energy efficiency programs to be implemented starting the coming months and quarters by the current administration will also breathe new life to the overall lighting retrofit market. With that, I'll turn the call to Todd to review our financial performance for the quarter. Todd?

Thank you, James. Net sales of $2.1 million for the second quarter of 2021 decreased 37.8% compared to sales of $3.3 million in the second quarter of 2020. driven by decreases in both commercial and military sales. When compared to 2.6 million for the first quarter of 2021, net sales were down 21.4% on a sequential basis. Sales of our commercial products decreased mainly due to project delays for our customers in the healthcare, education, commercial, and industrial sectors because of the continuing macroeconomic slowdown and our customers' purchasing decisions delayed to the COVID-19 pandemic. In addition, sales from our agency network were also lower, again reflecting the impact from the COVID-19 pandemic on our customer base. Sales of our military products decreased mainly due to availability of government funding for certain projects and the continued delayed timing of orders. Sales to our top 10 customers for the total company for the second quarter of 2021 decreased 45.4% and sales to our top 20 customers decreased 41.9 percent compared to the second quarter of last year. From a mixed perspective, military sales were $1 million for the second quarter of 2021, representing 48 percent of total net sales, compared to $2.3 million or 68.3 percent of total net sales for the second quarter of 2020. Sales to commercial customers were $1.1 million in the second quarter of 2021, representing 52% of total net sales for the quarter, flat as compared to 1.1 million or 31.7% of total net sales in the second quarter of 2020. Gross profit for the second quarter of 2021 was $0.4 million compared with $1.3 million in the second quarter of 2020, a decrease of 70.7% year-over-year. On a sequential basis, gross profit declined compared to gross profit of $0.6 million in the first quarter of 2021. As a percentage of revenue, gross profit margin was 18.9% in the second quarter of 2021 reflecting less leverage of our fixed costs due to the lower sales compared to 40.3 percent in the second quarter of 2020. Gross profit margin was down 21.3 percent in the second quarter of 2021 compared to the second quarter of 2020. Approximately 19 percent was driven by volume and 2 percent was driven by product and business mix. Also, gross profit dollars were down $1 million versus prior year and $0.7 million driven by volume and $0.3 million driven by product and business mix. Adjusting gross profit margins for the excess and obsolete in-transit and net realizable value inventory reserve resulted in a non-GAAP adjusted gross margins of 17.6% for the second quarter of 2021 compared to 33% in the second quarter of 2020 and 24.3% in the first quarter of 2021. Due to fixed costs at quarterly sales levels of 3.5 million or more, we continue to expect our overall gross margins to be in the mid-20s in the near term. As we move forward, we anticipate we will begin to approach the high 20s percentage range as we introduce new products and negotiate better pricing to accompany our increased sales volume and depending on our sales mix and inventory valuations. However, we may see some fluctuations quarter to quarter. Operating expenses in the second quarter of 2021 were $2.6 million, or 127.1% of sales, compared to $2.3 million, or 68.2% of sales in the second quarter of 2020. The increase is attributable to increase in payroll and payroll-related expenses due to our growth initiatives and an increase in stock expense. as well as travel and marketing-related expenses for growth, offset by lower legal expenses driven by efforts to lower costs. Operating expenses were $2.9 million in the first quarter of 2021, $0.3 million higher than the second quarter of 2021, driven by a decrease in product development-related expenses. Loss from operations for the second quarter of 2021 was $2.2 million as compared to an operating loss of $0.9 million in the second quarter of 2020. Sequentially, this compares to a loss from operations of $2.3 million in the first quarter of 2021, a decrease of $100,000. Net loss for the second quarter of 2021 was $2.5 million, or a negative 59 cents per basic and diluted share based on $4.2 million fully diluted shares compared with a loss of 4.3 million or a negative 1.36 cents loss per share per basic and diluted share based on 3.2 million fully diluted shares in the second quarter of 2020. On a sequential basis, we reported a net loss of $1.6 million or negative 45 cents per basic and diluted share of common stock in the first quarter of 2021. which was inclusive of a $0.8 million non-cash pre-tax gain resulted from the forgiveness of the PPP loan during the first quarter of 2021. Adjusted EBITDA, a non-GAAP measure, which excludes depreciation and amortization, interest expense, stock dates, and other incentive compensation, gained on forgiveness of PPP loan in the first quarter of 2021 and changes in fair value of warrant liabilities in prior year periods was a loss of $2 million for the second quarter of 2021 compared with a loss of $0.7 million in the second quarter of 2020 and a loss of $2 million in the first quarter of 2021. The increased adjusted EBITDA loss from the second quarter of 2020 was primarily due to a combination of gross margin reductions from lower sales and higher operating expenses due to our investment for future growth, primarily in the areas of sales and engineering personnel important to our UBC and Sun Cycle and focus efforts. The increased adjusted EBITDA loss for the first quarter of 2021 was primarily due to gross margin reductions. Now I'd like to turn to the balance sheet. As of June 30th, 2021, we had cash of $1.3 million. This compares with $1.8 million as of December 31st, 2020. As of June 30th, 2021, the company had total availability of $4.1 million, which consisted of $1.3 million of cash and $2.8 million of additional borrowing availability under our credit facilities. This compares to total availability of $3.9 million as of June 30, 2020, and a total availability of $1.2 million as of March 31, 2021. We also strengthened our balance sheet with our net proceeds of $4.5 million from an equity financing and net proceeds of $1.5 million from a bridge financing during the second quarter of 2021, while also increasing the inventory-based line of credit capacity by $0.5 million, overall increasing our liquidity. As a reminder, total availability is a non-GAAP measurement of our access to cash at any given point in time, and we believe it is a much more relevant metric than simply looking at cash balance or even net debt on the balance sheet. Access borrowing availability on our credit facilities represents the difference between the maximum borrowing capacity of the credit facilities and our actual borrowings under the credit facilities. Access availability under our credit facilities was 2.8 million at the end of the second quarter 2021, 1.1 million at the end of the second quarter of 2020, and 0.1 million at the end of the first quarter of 2021. During the second quarter of 2021, cash used in operations was 3.3 million. of which $1.1 million was attributable to working capital investments, cash used in operating activities was $102,000, and we generated $4.2 million in cash from financing activities. Our net inventory balance of $8.1 million as of June 30, 2021, increased $2.4 million over December 31, 2020. This increase primarily relates to global supply chain challenges which are impacting our inventory purchasing strategy, leading to a buildup of inventory and inventory components in an effort to manage both shortages of available components and longer lead times in obtaining components. Our accounts payable balance as of June 30th, 2021 increased by $0.4 million over December 31st, 2020, primarily related to this inventory buildup. With that, we would like to open the call to questions. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw your question, please press star then 2. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Amit Dayal with HC Wainwright. Please go ahead.

Thank you. Good morning, everyone. Good morning, Amit. So, you know, you said you saw some pickup in some orders from the commercial segment. Can you share which end markets you got some of those orders from?

Yes. As I indicated, you know, the school market seems to be the one that's recovering earlier. So we have seen those orders that were delayed in the past coming into the third quarter, which is why we are confident that the third quarter will be better than the second quarter and the first quarter.

Are these coming from the school side? Are these for the UV lighting offerings or something else that you are seeing?

No, no. The UV lighting have not started shipping yet. As I said in the call earlier, it will start. in September, later in September, and going into October, and we expect a more meaningful impact from the fourth quarter.

It seems, you know, your timing, you know, your push towards the commercial sector, you know, you're a little bit unlucky with the timing, but at the same time, you do have a pretty strong lineup of offerings for that market. I mean... outside of pandemic-related pressures, is there any competitive reasons that you may not be getting the traction you were anticipating? Any color on what is preventing a little bit more stronger uptake or interest in the commercial lineup of offerings you guys have right now?

Yeah, I mean, that's a great question. Obviously, as you know, the whole OED market has been very commoditized and that whole commoditization accelerated since COVID hit the economy. There are a lot of inventory in the market and also when the end demand is soft, people are looking for cheap alternatives. So we definitely also have that type of competitive pressure. But if you look at our commercial sales over the past few quarters, it's been kind of flat. It's just not picking up. And we are obviously also internally reorganizing how we can better differentiate ourselves in the marketplace. As you know, our patented products like RedCap in focus will be much more competitive, and that is how we are reorienting our sales force to focus on. And in the meantime, as you said, we have to you know, diversify into, you know, leveraging our technologies, diversifying into new markets in this sort of new market paradigm in the meantime. So we are doing both. And we are very much looking forward to seeing, you know, the results of these efforts in the next few months.

Okay. So, you know, so there's no sort of need for cost-cutting, et cetera, at least in a significant way to manage through the current situation?

Yeah, our cost structure is not high per se. We're a public traded company. There are certain costs. And obviously, we have been working on introducing these new products, getting our sales distribution in place. And if we don't see the results we like, obviously, we have to be very agile in adjusting our cost structure. That's definitely something that we constantly look at. On the other hand, we are preparing to grow the company, hopefully significantly, with these new products coming on board in the next few months and the market stabilizing for us to see the recovery in our traditional military and commercial markets.

And, Amit, I'm just going to build on James' comments a little bit. With the pandemic last year and seeing the slowdown, we were very proactive, and fortunately, and we're seeing some of that in the reduced costs of the more discretionary areas. We did a number of strategic sourcing activities last year, which took out a pretty significant chunk of expenses. So, Where you do see expense increases is either in the area of growth, where it's R&D or sales-oriented, or it's fees related to product testing, which you have to do before you bring out new products. So we are very conscious of every penny we spend, and I think that's one area where

Hi. Good morning, James. Good morning, Rob. Do you guys use any digital advertising or social media to get your new product potential out into the public consciousness?

Yes, that's definitely in our plan that you will be seeing starting September as we launch the products.

Okay. And in order to kind of stay in business in the current environment, would you consider some kind of a rollback in executive compensation for a relatively brief period of time, maybe six months or so, to more align the cost structure and assist the bottom line and maybe share the pain of some... of us as shareholders. Thanks.

Yeah, Rob, as Todd and I said, we've been very diligent in managing our costs. We definitely don't have a bloated organizational structure. And as I said, we've been trying to really develop new businesses out of this very challenging period. If we are not seeing the results, as I said, in the next couple of months as we launch new products, We definitely will be adjusting our cost structure. And it's not an exact compensation, just one of them. There are going to be many aspects of the cost in the company that have to be readjusted if the business model doesn't work. We don't think that's the case. We are working on all these new products. We are continuing to strengthen our distribution capabilities. So we are, as I said, cautiously optimistic that we could be starting growth from third quarter, fourth quarter, and beyond. If things don't happen as fast as we like, we definitely will be adjusting our cost structure. I'm one of the largest shareholders myself of this company, so I share the pain of shareholders. We are also in this very unprecedented situation. environment that hit our core market, which is retrofit, pretty hard. But as I said, I think our efforts that we put in over the first 12 to 18 months should be paying off based on our research and observation about the potential reception of our new products. But we'll stay very agile. I don't know if Pat has anything to add.

It's well said. I think it's a fair ask if we're not seeing the results we expect. And I'm also a large shareholder. I'm one of the largest individual shareholders. So not through grants, but both of us purchased our share.

Yep, exactly.

Yeah, I thank you for that. But while the new products really are quite interesting and have significant potential in money, in my view, I mean, you have to get over this chasm, so to speak, of liquidity, and that was one of the possibilities to achieve that.

No doubt, and I think Todd and his team and our whole company watch our liquidity very carefully, and you have heard from Todd's speech that we have been working with multiple liquidity source providers, and I think we're ready to grow, but if we don't see that we're hitting our targets on the top line to help us minimize losses in the next quarter or two, then we have to make changes, and we'll be the first to want to make those changes to sustain the company. Thanks again. Thank you, Rob.

Again, if you have a question, please press star, then 1. And the next question will come from Bill Hardy, investor. Please go ahead.

Hi, guys. Good morning, Bill. Good morning. Good morning from Dallas. It's a little warm down here. We'll get through it.

That's where one of our biggest customers is.

I sure hope so. My basic question is, what has been the holdup in getting these new products into manufacture and eventually into distribution to the public? And again, a follow-up on that is, have those problems been solved, and are you now in a manufacturing mode where you are bringing these products into some type of inventory in anticipation of selling them?

Yeah, Bill, good question. Yes, it's been a challenging engineering and development process for us, and the reason is that When we, if you look at this whole UVC market, it was almost non-existent. I mean, very, very small niche market before the pandemic. When we look at when the pandemic hit and we look at the whole air purifier market, for example, where the Nuvo product line is going to be competing in, we believe that there are a lot of shortcomings that we could resolve with technologies that focus on individuals and consumers and businesses that seek more safety measures in this whole pandemic landscape. And so we put together the team to develop technologies through multiple, multiple iterations. And yes, the product development was delayed for a number of months. And the reason was that we just were not happy enough to launch the product and we continue to make changes to make it better and better. And I have to say that we are very, very happy about where we are. I mean, products can always get better, can always have more features, but we are very happy where we are on the product design. To your question, we have resolved pretty much all the problems, and we are ready to manufacture these products. What we are at right now is really going through the safety certification process of these two products, and we're expecting to have it, you know, second half of September. Obviously, we cannot have precise timing. It's going through third-party agencies. But the products have been developed, and we're ready to sell. Finally, to your point.

Okay, so what the holdup says is UL approval?

Yeah, ETL is the same UL standard. It's an agency called ETL that is more popular for consumer electronics.

Okay, so in other words, parts flow. You do have access to inventory, so you can make the products. It's just a matter of paying them.

Yeah, we are expecting to start shipping the product the moment we get the certification.

Okay. Okay. Well, thank you very much for your comment. I appreciate it. And good luck. Thank you.

Thank you. Thank you, Bill. We're with you. All right.

This will conclude our question and answer session. I would like to turn the conference back over to management for any closing remarks. Please go ahead.

Thanks, everyone, again, for your participation in our quarterly earnings call. We look forward to speaking with you in our third quarter 2021 earnings call. Have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.