Energy Focus, Inc.

Ladies and Chairman, greetings and welcome to the Energy Focus third quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A brief 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jim Warren, Senior Vice President and General Counsel of Energy Focus. Please go ahead, sir.

Thank you, Operator, and good morning, everyone. Joining me on the call today is Leslie Mack, Chief Executive Officer, and Stephen Sokoloff, Chairman of the Board. Before we begin today's call, I'd like to remind everyone that we will 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 10Q filed 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 this call and in the accompanying press releases, certain financial metrics are presented on both GAAP and non-GAAP adjusted bases. Reconciliations 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 will now turn the call over to Steve.

Thank you, Jim. Good morning, everyone. This is my third earnings call with Energy Focus. With this call, I am pleased to report the accomplishment of my number one objective of the year, which has been to find a permanent chief executive officer that can help Energy Focus complete its turnaround and realize our vision to restore Energy Focus as an innovator and leader in the lighting industry. Leslie Mack lives locally in the Cleveland area where Energy Focus is based. She has been an executive in the lighting industry for a dozen years, leading marketing, sales, and operations. She has already made a tremendous impact on the company. I am happy to turn the baton over to Leslie and look forward to working closely with her, our fantastic team, and our supportive board to see through the turnaround of Energy Focus. With that, let me introduce Leslie Matt, our new CEO.

Thank you, Steve. As you are all aware, this is my first earnings call with Energy Focus since joining mid-September. I came on board with the belief that the phones here are good and that my experience in the lighting industry paired with personal determination provide me with the tools that are necessary to turn the company around. I believe that my ability to quickly analyze and execute strategy will be the driving forces for future success. While I have not been at the helm long enough to take responsibility for our third quarter results, I want to highlight some of the items that have been implemented that will allow for future improvement. I also want to thank Steve Sokoloff for his service as Interim Chief Executive Officer since January. Steve will be continuing to guiding the light for the company as chairman of the board. As a reminder of what Steve had communicated previously, we have been pursuing initiatives to improve the energy-focused business through, one, providing value-added differentiated products to the marketplace alongside expanding our lighting offering. Two, aligning our team around near-term opportunities with an emphasis on execution. And three, streamlining our expenses to reduce our cash burns. Our goal was to realize improved financial results in the second half of this year. Now let me review where we stand on each of those initiatives. First, our team is refreshed and excited with the progress and plans we have made regarding new product development, but our supply chain remains constrained. Our red cap emergency lighting products continue to see strong demand, but supply limitations continue, which impacted our results. Fortunately, we believe we are on track to alleviate that problem with additional engineering work and alternative sourcing options. Our revamped line of traditional tubular LED products, which we call white caps, will simplify and reduce inventory and improve margins. Our plans will be available for sale shortly. Finally, our in-focus control products continue to gain interest as more customers are educated around this innovative power line control technology. As more sites are deployed, we are working to build marketing case studies that highlight simplicity, security, and reliability of in-focus power line control. As we innovate and expand this product category, we're working to optimize our go-to-market plans. Second, in terms of aligning our team and emphasizing execution, I placed a significant emphasis on increasing the accountability and oversight on the sales and marketing teams. I've made changes in sales leadership and adjusted staffing to eliminate silos and work collaboratively to drive revenues and results. It's early on with these changes, and I look to the fourth quarter and 2023 as I watch for future pipeline reinvigoration that will impact results. Our military sales team continues to set the bar on what pipeline growth and development looks like as we rejuvenate the maritime marine market which unfortunately has been allowed to wither some. Third, as Steve mentioned in the last review, we have been rationalizing our team and expenses to reduce the burn through 2022. To right-size the organization for future success, I undertook a significant reorganization where we eliminated a number of positions to significantly reduce operating expenses. Although these changes are difficult, I want to create a culture that will allow remaining employees to have a future success with energy focus and build upon their careers. I expect to see the impact of these changes on operating expenses more in the fourth quarter. We have all looked at all opportunities to eliminate waste and have instilled a new mindset with employees to look at every expense to create a lean, sustainable platform. Following our shift to a reduced facility footprint in the second quarter, we have continued a large inventory management review and continued streamlining inventory to consolidate space and prepare for new products coming in. As our product lines become available in 2023, we expect that they will improve margin and we anticipate increased margin leverage with increased sales. We still have significant work to do to ramp the sales pipeline to support these levels. and believe the upcoming products will refresh our offerings with meaningful revenue opportunities. Now, before I review our quarterly financial results, I want to comment on them. Sequentially, it is early progress that we realize a modest increase in revenues, closing the quarter at $1.8 million, primarily through increased commercial sales. However, this is not year-over-year improvement on the top line, which we need to get back to. On the positive side, the sales team ended the third quarter with a healthy backlog of purchase commitments, and particularly on the military side, where the order volume is typically longer lead time made to order materials. Also, after reporting modest gross margins in Q2, I hope that we could report a complete rebound based on all of our improvements. But that remains tough with only $1.8 million of realized sales, given the impact of our fixed costs and product necks. and we slipped again into gross loss of $163,000. We are reporting negative 9.2% margins, which is a step backwards from the prior quarter. This quarter saw excess and obsolete inventory adjustment and scrap activity from us continuing to work through our inventory reduction project, as well as a product mix impact from supply chain challenges that impacted our highest margin products, which drove down margins. I'm cautiously optimistic we will see progress in our turnaround over the next six months. Now let me review our Q3 financial results. Net sales of $1.8 million for the third quarter of 2022 decreased 35.8% compared to sales of $2.7 million in the third quarter of 2021. mainly due to delayed funding related to military maritime projects utilizing our products, as well as fluctuations in the timing and pace of commercial sales projects and the lingering macroeconomic supply chain impacts as a result of the COVID-19 pandemic. The sales cycle for the military maritime products are dependent on many factors, including government funding, U.S. Navy award and U-ship construction schedules, and the timing of vessel maintenance schedules. Third quarter 2022 net sales of military products were flat when compared to half a million of sales in the second quarter of 2022. While not yet the growth we are targeting, we have stopped the bleeding of a declining sales pipeline. Our refocused military and maritime sales effort in the third quarter concentrated on rebuilding the channel, which has a longer sales cycle and lead times reflecting what is frequently a need-to-order sale. The traction we are seeing at this stage is increased pipeline, which has to be worked through before it turns into revenue in the quarters to come. Sales of our commercial products were approximately 1.3 million, or 73% of total net sales for the third quarter of 2022, down 234,000 as compared to third quarter 2021. Commercial sales increased 313,000 over the prior quarter on a sequential basis. Volatility and the opportunities and timing related to larger commercial projects as well as supply chain impacts continue to be reflected in these results. As I mentioned, we are focused on sales execution combined with the introduction of new products to improve our position in the commercial market. Growth loss for the third quarter of 2022 was $163,000 compared to gross profit of $563,000 in the third quarter of 2021. As a percentage of revenue, negative gross margin was 9.2% in the third quarter of 2022, compared to 20.5% in third quarter of 2021. The year-over-year decline in gross margin was driven by lower sales, less favorable product mix, or in other words, primarily the margin impact from decreased military and maritime market product sales, as well as the impact of our inventory reduction initiatives. Adjusting gross profit margins for excess and off inventory in transit and net reliable value inventory reserve and scrap write-offs related to our inventory reduction project contributed to the non-GAAP adjusted gross margin of 3.2% for third quarter of 2022 compared to a gross profit margin of 17.9% in the third quarter of 2021. Sequentially, adjusted gross profit improved compared to an adjusted gross loss of 5.1% in second quarter of 2022. Operating expenses in the third quarter of 2022 were 2.2 million compared to 2.3 million in the third quarter of 2021. The decrease is primarily attributed to lower SG&A expenses due to decreased payroll and payroll-related expenses. Loss from operations in the third quarter of 2022 was 2.4 million, an increase over the prior year comparable quarter loss amount of 1.8 million. Loss from operations also increased slightly as compared to the prior quarter. Net loss was 2.7 million or 29 cents per share of common stock for the third quarter of 2022 as compared with the net loss of 1.1 million or 22% per share of common stock in the prior year comparable quarter. Adjusted EBITDA, a non-GAAP measure, which excludes depreciation and amortization, interest-exped stock-based compensation, and other non-reoccurring charges and or sources of income, such as incentive compensation and the gain on forgiveness of the PPP loan in prior periods, with a loss of $2.3 million for the third quarter of 2022, compared with a loss of $1.7 million in the third quarter of 2021. The increase suggested EBITDA loss in the third quarter of 2022 was primarily due to the combination of lower sales and gross profit margin reductions. Now I'd like to turn to the balance sheet. Cash was 41,000 as of September 30th, 2022, as compared to 2.7 million as of December 31st, 2021. As of September 30th, 2022, the company had total availability of $210,000, which consisted of $41,000 of cash and additional borrowing availability of $169,000 under its credit facilities. This compares to the total availability of $4.4 million as of December 31, 2021. As a reminder, total availability is a non-GAAP measure of our access to cash at any given point in time, and we believe is a much more relevant metric than simply looking at cash balance or even net debt on the balance sheet. Excess 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. During the third quarter of 2022, cash use and operations was $0.9 million. Our net inventory balance of $6.2 million as of September 30, 2022, decreased from $7.9 million balance at December 31, 2021. As a part of our expense reduction initiatives, we have significantly decreased our warehouse space beginning in the third quarter of 2022. In connection with the space reduction, in the second quarter of 2022, we began disposing of a substantial portion of of our highly reserved excess and obsolete commercial finished goods inventory. As of September 30th, 2022, on a gross value basis, approximately 563,000 of such inventory has been disposed of with an associated release of 555,000 of excess and obsolete reserves. Additional inventory management efforts are expected to continue in the fourth quarter of 2022. On the financing side, in September 2022, we entered into a short-term unsecured bridge financing agreement and generated $450,000 in net liquidity, followed by an additional $650,000 of unsecured bridge financing in October and November. With that, I will make a few closing comments. I took on this position... understanding this is a turnaround effort that would require a new vision to set a path to success for the future. I believe that energy focus has tremendous potential, assuming we can bring to market the right products with the right partners at the right cost structure, delivered by a lean, aggressive team in order to show improved results. The entire team is focused on navigating through the storm, and we aim to provide improving news as we move forward and speak to you again in a quarter. With that, we would like to open the call to questions. Operator?

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from the line of Amit Ryle from HC Wainwright. Please go ahead.

Thank you. Good morning, everyone. Congratulations, Leslie, on the new role. You know, looking forward to hearing from you on these earnings calls going forward. You know, as you've taken over, you know, can you share with us maybe your confidence in the existing product suite at Energy Focus? Will you need to sort of reinvest in building a new set of offerings, or do current offerings have potential to gain some traction in the marketplace?

Thank you, Amit. Yes, I believe that some of the current offerings, including our webcasts and our in-focus modules, allow us to set the tone for future success. In addition to this, we will need to come up with new and aggressive products, which our product development team has been working on in the background as we work through supply chain constraints. However, in speaking with customers, They love the InFocus product and can't wait until we have more of it in stock so that they can put it in more beta applications. It's very exciting for me as someone to watch that product line grow, as power line control, I believe, is a new wave for the future. Additionally, as I mentioned in our press release, I think that Energy Focus will need to move beyond lighting products in order to have success in the future. Now, that doesn't mean that we will move away from energy efficiency, as our name is, Energy Focus. However, I believe that there's a huge market potential out there with new innovative technologies.

Can you touch on this a little bit? Where should we expect maybe your efforts on this front that may not necessarily be sort of around sort of legacy offerings?

Yeah, so there will be a tremendous amount of effort I see in the future, maybe not in the immediate quarter. However, in the future to develop new technologies to help service that market. Now, I'm not prepared to fully speak on those today, but there will be more information in future quarters.

Okay. And in terms of sort of just managing your cash burn and financing needs, how are you thinking about sort of your needs on that side and what options do you have to just get through this phase and get to a point where you are you know, position to deliver a little bit more growth, et cetera?

Yes. From a cash perspective, there was a tremendous amount of what I'll call leftover and right-sizing of the business that needed to be done. There were many things and many opportunities that were happening where we needed to make adjustments and spend and decrease, make significant decreases in our cash flow in order to sustain our current sales level. I believe that through Q4 and into early 2023, with a right-sized team and new product coming in, we will be able to start seeing the impact of those changes.

Okay. All right. That's all I have for now. Thank you so much. Thank you. Thank you. Ladies and gentlemen, if you wish to ask a question, please press star one. Again. Ladies and gentlemen, if you wish to ask a question, please press star one on your telephone keypad.

Since I don't know further questions, I would like to hand the conference over to Leslie Mack for closing comments.

Thank you. Again, there's an entire team focused on righting the ship with this moving forward. We work to make Energy Focus a sustainable company, not only for future quarters, but long into the future. We are taking this tremendously seriously and work to gain success as we move forward. And I thank you all for your time, and again, speaking with you in future quarters.

Thank you. The conference of Energy Focus has now concluded. Thank you for your participation. You may now disconnect your lines.