Earnings Call Transcript - EFOI Q2 2021

Operator, Moderator

Good day, and welcome to the Energy Focus Second Quarter 2021 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Brett Maas. Please go ahead, sir.

Operator, Operator

Thank you, operator, and good morning, everyone. Joining me on the call today is James Tu, Executive Chairman and Chief Executive Officer; and Tod 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, in addition to the forward-looking statements in our most recently filed 10-Q 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 measures 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.

James Tu, CEO

Thank you, Brett. 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 market, 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 delayed 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 cost. It has really been a perfect storm that undercut our sales and impacted our margins. That said, we believe we have not lost the key opportunities we have been pursuing. Since the 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 lighting retrofit demand, particularly in the education and health care markets, might start to stabilize and grow again. In the meantime, Energy Focus has continued to innovate in order to adapt to and grow under this new market paradigm. The pandemic has likely impacted occupancy levels and usage patterns of commercial buildings for extended periods of time. Therefore, the commercial lighting retrofit market could face challenges and uncertainty until economic life settles into a new normal. We have strategized and moved quickly in both steps, to develop new innovative products, including primarily our UVC disinfection products and the upcoming sun cycle autonomous security and lighting systems 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 home safer and more comfortable. Many of us are also converting parts of our houses into offices, and this requires introducing new equipment or technology. 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 robust sales of both online and offline retailers. 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 Focus with potential and diversified sales growth opportunities. Expected to come into the market first, later in September and October, our nUVo traveler, a personal temporized UVC air disinfection device for car and personal use as well as nUVo Tower, a portable freestanding UVC air disinfection device designed for spaces up to 500 square feet. Both devices were designed to uniquely and powerfully intercept viruses in real time and to destroy 99.9% of pathogens, including influenza and coronavirus and its variants 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. 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 advisers, through ultraviolet and our lighting distributors as well as directly to large businesses in industries such as ridesharing, hospitality, health care, financial services, 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 robots, and we expect to start selling these products later in the fourth quarter as well. Additionally, our patented sun cycle lighting system based on our in-focus 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. We are planning to launch sun cycle products in the fourth quarter of 2021 or early 2022. Circadian lighting has proven to significantly improve fleet productivity and overall health through human level and color temperature controls that correspond to the 24-hour circadian rhythm cycle. Therefore, it is particularly powerful in helping improve human well-being, experience and quality of life when people are staying at home throughout the whole day into the evening. With sun cycle, 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, commercial order delays or the ongoing pandemic that continues to impact 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 and address a whole new consumer market. We expect these could meaningfully contribute to our top and bottom line starting in the fourth quarter of 2021 and beyond. Due to continuing market uncertainties that we laid out in the earnings release, and that I described earlier, we are 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. 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 life gradually resumes to the new normal. We believe that the climate change and building energy efficiency programs to be implemented starting in the coming months and quarters by the current administration will also breathe new life into the overall lighting retrofit market. With that, I will turn the call to Tod to review our financial performance for the quarter. Tod?

Tod Nestor, CFO

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 health care, education, commercial, and industrial sectors because of the continuing macroeconomic slowdown and our customers' purchasing decisions delayed due to the COVID-19 pandemic. In addition, sales from our agency network were also lower, again, reflecting the impact of the COVID-19 pandemic on our customer base. Sales of our military products decreased mainly due to the 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% compared to the second quarter of last year. From a mix perspective, military sales were $1 million for the second quarter of 2021, representing 48% of total net sales compared to $2.3 million or 68.3% 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 lost leverage of our fixed costs due to the lower sales compared to 40.3% in the second quarter of 2020. Gross profit margin was down 21.3% in the second quarter of 2021 compared to the second quarter of 2020. Approximately 19% was driven by volume and 2% was driven by product and business mix. 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 margin 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 an 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 $0.59 per basic and diluted share based on 4.2 million fully diluted shares compared with a loss of $4.3 million or a negative $0.136 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 $0.45 per basic and diluted share of common stock in the first quarter of 2021, which was inclusive of a $0.8 million noncash pretax gain resulting 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-based and other incentive compensation, gain on forgiveness of PPP loans in the first quarter of 2021 and changes in the 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 EBC and sun cycle focused 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 30, 2021, we had cash of $1.3 million. This compares with $1.8 million as of December 31, 2020. As of June 30, 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 rate line of credit capacity by $0.5 million. Overall, we are 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. 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. Excess availability under our credit facilities was $2.8 million at the end of the second quarter of 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 non-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 30, 2021, increased by $0.4 million over December 31, 2020, primarily related to this inventory buildup.

Operator, Moderator

The first question will come from Amit Dayal with H.C. Wainwright.

Amit Dayal, Analyst

So 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?

James Tu, CEO

Yes. As I indicated, 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.

Amit Dayal, Analyst

Are the orders coming from the school market related to the UV lighting offering or are they for something else?

James Tu, CEO

The UV lighting has not started shipping yet, as I mentioned earlier in the call. It will begin in September, specifically later in September and continuing into October. We anticipate a more significant impact in the fourth quarter.

Amit Dayal, Analyst

It seems that your efforts to enter the commercial sector may have encountered some unfortunate timing issues. However, you do have a solid range of products for that market. Besides challenges related to the pandemic, are there any competitive factors that might be limiting your anticipated growth? Can you provide any insights into what might be hindering stronger uptake or interest in your current commercial offerings?

James Tu, CEO

Yes, Amit, that's a great question. The LED market has become highly commoditized, and this trend has accelerated since COVID impacted the economy. There is a significant amount of inventory available, and when demand is low, customers tend to seek cheaper options. This creates competitive pressure for us. Our commercial sales have been relatively flat over the past few quarters and are not improving. We are reorganizing internally to better distinguish ourselves in the market. Our products, particularly those highlighted in recent presentations, will be more competitive, and we are aligning our sales force to emphasize this. At the same time, we recognize the need to leverage our technologies and expand into new markets given the current market conditions. We are pursuing both strategies and look forward to seeing the outcomes of our efforts in the coming months.

Amit Dayal, Analyst

Okay. So there is no sort of need for cost cutting, et cetera, at least in a significant way to manage through the current situation?

James Tu, CEO

Yes. Our cost structure is not high per se. We're a publicly traded company. There are certain costs. We have been working on really introducing these new products, getting our sales distribution in place. 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 as the market stabilizes and for us to see the recovery in our traditional military and commercial markets.

Tod Nestor, CFO

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 cost of the more discretionary areas. We did a number of strategic sourcing activities last year, which took out a pretty significant chunk of expenses. Where you do see expense increases is either in the area of growth, whether it's R&D or sales-oriented or is 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. I think we've done a very good job of making sure we're ahead of the curve.

Amit Dayal, Analyst

Yes, I know you guys have done a lot of work on improving your cost structure and on continuing to bring out interesting products. Hopefully, the market situation turns around for you sooner rather than later.

James Tu, CEO

Thank you, Amit.

Operator, Moderator

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. It seems that a question has recently come in, and it will be from Robert Smith with the Center for Performance Investing.

Robert Smith, Analyst

Do you guys use any digital advertising or social media to get your new product potential out into the public consciousness?

James Tu, CEO

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

Robert Smith, Analyst

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 6 months or so, to more align the cost structure and assist the bottom line and maybe share the pain of some other shareholders?

James Tu, CEO

Yes, Rob, Tod and I have been very careful in managing our costs. We don't have an extensive organizational structure. As I mentioned, we are focused on developing new businesses during this challenging period. If we don't see results in the next couple of months, as we introduce new products, we will certainly adjust our cost structure, including compensation, among other areas. Many aspects of our costs will need to be reevaluated if the business model is ineffective. However, we don't believe that's the case. We are actively working on these new products and strengthening our distribution capabilities. Therefore, we are cautiously optimistic about starting to see growth in the third and fourth quarters and beyond. If things don't progress as quickly as we hope, we will adjust our cost structure. I am a significant shareholder in this company, so I understand the concerns of our shareholders. We are also navigating an unprecedented environment that has made it difficult for our core market, especially regarding retrofit. However, I believe the efforts we've made over the past 12 to 18 months will bring positive results based on our research and insight into the potential reception of our new products, and we will remain flexible. I'm not sure if Tod wants to add anything.

Tod Nestor, CFO

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

James Tu, CEO

Yes. Exactly.

Robert Smith, Analyst

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

James Tu, CEO

No, no doubt. Tod and his team and our whole company watch our liquidity very carefully. And you have heard from part of the speech that we have been working with multiple liquidity source providers. 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.

Operator, Moderator

And the next question will come from Bill Hardy, investor.

Unidentified Analyst, Analyst

My basic question is, what has been the holdup in getting these new products into manufacture and eventually into distribution to the public? And I guess, a follow-up on that is how 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?

James Tu, CEO

Good questions. Yes, it's been a challenging engineering and development process for us. If you look at the whole UVC market, it was almost nonexistent, a very small niche market before the pandemic. When the pandemic hit, we looked at the air purifier market, where our nUVo product line will compete. We believe there are many shortcomings we can address with technologies focused on individuals and businesses seeking more safety measures in this pandemic landscape. We assembled a team to develop technologies through multiple iterations. Yes, product development was delayed for several months because we weren't satisfied enough to launch the product yet, and we continued to make improvements. We are very happy with our current status. Products can always be enhanced with more features, but we're pleased with the product design. To answer your question, we've resolved nearly all issues and are ready to manufacture these products. Currently, we are going through the safety certification process for these two products, and we expect to complete it in the second half of September. However, the timing depends on third-party agencies. The products have been developed, and we are ready to sell.

Unidentified Analyst, Analyst

Okay. So what the holdup is UL approval? Or is it...

James Tu, CEO

Yes. It's EPL is the same UL standard. It's an agency called EPL that is not popular for consumer electronics.

Unidentified Analyst, Analyst

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 making them...

James Tu, CEO

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

Operator, Moderator

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.

James Tu, CEO

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.

Operator, Moderator

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