ENERGY FOCUS, INC.
NOVEMBER 14, 2016
The following are prepared remarks by James Tu, Chief Executive Officer and President,
and Michael H. Port, Interim Chief Financial Officer of Energy Focus, Inc. from the Third
Quarter 2016 earnings conference call held with investors on November 14, 2016 at
Michael Port, Interim Chief Financial Officer:
Thank you Operator and good morning to everyone. Thank you for joining us for Energy Focus’
third quarter 2016 earnings conference call. Today, James Tu, our Chief Executive Officer
and President, and I will report on our results for the quarter. The news release and our
quarterly report filed on Form 10-Q have been posted to our website under the Investors
As a reminder, today’s discussion will include forward-looking statements, including
predictions, expectations, estimates or other information that might be considered forward-
looking. These forward-looking statements are subject to numerous risks and uncertainties.
We encourage you to review our most recent filings with the Securities and Exchange
Commission including our 10-K and 10-Q’s for a complete discussion of these factors and
other risks that may affect our future results or the market price of our stock. We are not
obligating ourselves to publicly release any revisions to these forward-looking statements in
light of new information or future events.
Now I'd like to turn the call over to James.
James Tu, Chief Executive Officer and President:
Thanks Michael and good morning everyone.
I’d like to open up my 3rd quarter commentary today by thanking everyone for their flexibility
and understanding of our decision to postpone the earnings release and earnings call
originally scheduled for November 3rd. As we said in the press release, due to the very recent
issue associated with a higher than normal failure rate of our commercial Intellitube® in limited
installations, we did not have enough time before the previously scheduled call to fully assess
the adequacy of our financial statement disclosures or warranty reserve as of September 30.
And as we laid out in the press release today, we have successfully reached a resolution and
the additional accrual associated with the failures is approximately $70,000, or less than 1%
of our third quarter sales. With truly inspiring teamwork our employees have demonstrated
that, within a short period of time, we were able to provide dedicated customer service and
identify the root cause of the issue to finish development of Intellitube® 1.1, or IT1.1, which is
our further evolved version of the commercial Intellitube® that addresses the failure issues
occurring with certain ballasts and installation methods. At this point we’re planning to start
delivering IT 1.1 in mid-December to address these warranty issues and fulfill Intellitube®
demand for new projects.
I do want to point out that despite the recent incident, our commercial Intellitube® failure rate
remains far lower than the industry average of around 3%, according to the recent survey by
Facility Executive magazine, and we believe that with the strengthened design in IT1.1 we are
on track to bring the failure rate of the Intellitube® back to the level we’ve experienced
historically for our commercial products, which is less than 0.2%. In other words, our historical
product failure rate at less than 0.2% is approximately one-fifteenth of the industry average,
demonstrating the superior quality and proven track record of our technology.
Now, I’d like to share with you the highlights of our 3rd quarter 2016 results, which showed
some improvement in the financials over the 2nd quarter and clear progress in our plan to
stabilize our business with the military and to continue penetrating into the nascent commercial
markets with our exceptional LED lighting products. Our sales came in around $8.3 mm, which
was within the guided range we had provided. As we expected, our military sales continued to
stabilize over the previous two quarters, and our 3rd quarter commercial sales grew 8% over
the same quarter in 2015, and year-to-date commercial sales grew approximately 60% over
the same period last year.
The sales came at the low end of the guided range, and certainly no one, especially our
leadership team, and myself, is satisfied with our sales at this level, and we are committed to
bringing in the right people and executing our plans to maintain sustainable military sales
levels and accelerate our commercial top-line growth. As we have mentioned in the recent
press releases and investor calls, we have been making significant changes to our leadership
team and establishing stronger sales and marketing organizations to best position us to take
advantage of our ongoing business development opportunities and new opportunities that we
have been seeing in the marketplace. As we target major public and private organizations, our
sales lead times are typically long, ranging from three months to well over a year, and therefore
we have not seen significant improvement yet on our commercial sales in the third quarter.
That said, our sales opportunity pipelines have started to grow over the past few months and
we are looking forward to accelerated growth over our 2016 sales levels in 2017.
Over the past few months, we have also been undertaking a sales force transformation to
enhance our focus and capability to communicate to our customers and prospects the unique
value proposition Energy Focus offers instead of commodity selling that dwells purely upon
product prices. We have refocused our sales team into a leaner structure with plans to recruit
account executives with specific energy, lighting or technology solutions sales experience to
ensure we provide the highest quality of education and service to our customers.
In addition, we made tremendous and exciting strides in strengthening our marketing
operations and focusing our brand messages in every aspect. We have developed and will
continue to develop marketing campaigns based on our high quality, higher performance and
flicker-free product differentiation that emphasizes the triple-bottom line impact. Our products
allow our clients to achieve better long-term ROIs and maximize the reduction of their carbon
footprint through lighting, while also facilitating a healthier and more comfortable environment
for their employees, customers, students or patients.
And as we indicated in today’s earnings release, we continued to deepen our penetration on
select vertical markets. In addition to continuing the deliveries to our existing clients, which
now include 49 government agencies and municipalities, 19 healthcare institutions, 19
colleges and universities, 101 school districts and 175 various commercial and industrial
clients, the most exciting new win came from our healthcare team. After multiple months of
educating and working with various leaders and staff at a globally renowned medical research
and hospital group based in Minnesota, Energy Focus has been chosen to retrofit the group’s
hospitals and office buildings. We expect to receive initial sales orders from this new client
later this quarter or early first quarter 2017. We look forward to becoming their LED lighting
partner as we have with our Northeast Ohio-based hospital client, where we continue to
expand sales opportunities to additional product categories outside of tubular LEDs.
With these key wins and increasing sales pipeline momentum we’re experiencing in
healthcare, which not only operates long hours and thus demands more rigorous performance
and quality on LED products, but also values our flicker-free lighting from human health
perspectives, we are also seeing our average sales lead times in the healthcare industry
shorten, and we are expanding our investment in marketing and sales efforts for this particular
vertical to further cement and leverage our leadership in the vertical to drive new account wins
and sales growth.
The other aspect of our operation that is key to our future growth is product development.
During the quarter our new 2-ft military Intellitube® fixtures were approved for use in newly
constructed U.S. Navy ships, making Energy Focus the first lighting company the Navy has
approved to supply new lighting fixtures in 70 years. We have submitted our first bids for new
ship constructions and we will update with you the status of the projects as they progress. We
will also be poised to pursue any expanded Navy fleet opportunities that arise under the Trump
administration, as we very much look forward to participating in the lighting of new Navy ships
in the years to come.
During the quarter, we also formally launched 3 additional new commercial product series that
include our 500D products, with 150 lumens per watt efficiency that could save approximately
60% to 75% of the energy used today by fluorescents. We also launched our T5 LED
replacement tube series that now completes our tube offerings for all dimensions of
fluorescent sockets. We also introduced our tube-based troffer that provides a fixture option
for our clients that choose to replace existing fluorescent fixtures without losing the flexibility
to economically upgrade to the next generation LED lighting in a few years by keeping the
troffer while replacing the LED tubes.
At this point we are well on track to complete our initial product portfolio for commercial interior
and exterior retrofits by the end of this year so we would be able to provide a full line of lighting
products for our clients. The broader portfolio of products will also expand our sales
opportunities on a per-client and per-project basis, and could make significant contributions to
our sales growth in 2017 and beyond.
I’d also like to highlight the development of our training programs which are critical for us to
ensure our staff are well prepared to be the best in their fields and to represent Energy Focus
in the most professional and informed manner. Under our newly created corporate training
department, we have established Energy Focus University, encompassing training programs
and modules on new employee orientation and training, technical education, legal and
business compliance and ethics, and leadership development. Again, we believe that Energy
Focus is setting the gold standards of the LED lighting industry not only in product quality and
performance but also in advocacy and service, and such powerful and impactful human
interactions could only materialize if our employee partners receive top level training.
Therefore, we plan to continue to expand and update our training programs offered to both
Energy Focus staff and our channel partners.
For fourth quarter 2016, we are projecting similar sales level to that of the third quarter. We
expect gross margin to be in the proximity of the third quarter level as well. While some
continuing organizational expansion is necessary with the multiple large opportunities we are
pursuing or planning to pursue, we have been implementing plans to contain costs primarily
by slowing down new hires and controlling expenses. We plan to continue to hold our
overhead expenses down or expand the cost control measures further depending on the
timing and the pace of our sales growth over the next few quarters to minimize short-term
cash burns before we reach breakeven. We certainly do not see any limitation on our market
potential as the enterprise LED lighting market continues to warm up and the adoption rate is
likely to accelerate. Yet we also believe that prudent, cost effective operations will lead to more
sustainable and optimal long-term growth.
Lastly, despite of the potential threat of less friendly policies towards clean energy
technologies and products under the Trump administration, we do not anticipate much adverse
impact on our business or our particular market. LED lighting today isn’t directly subsidized by
the government and rebates offered by utilities usually favor full fixtures instead of the tubes
and lamps that Energy Focus primarily sells. Should there be reduction of rebates due to less
stringent carbon emission regulation on utilities under the new administration, our products
would likely gain competitive cost advantage against much more expensive full fixtures
particularly in the retrofit markets where budgets are more constrained.
Most importantly, payback for our products in most of the projects our clients and prospects
are working on today is already within 2-3 years without any rebate, and the economics are
only getting better as the efficiency and intelligence of LED lighting continues to follow the law
of exponential growth. We are optimistic that with our direct, vertical-focused sales and
marketing strategy, we are on the path to create valuable brand trust and leverage on the
multiplier effect from our growing number of success stories and enthusiastic client references
within particular verticals to capture multitudes of opportunities as LED adoption takes off.
Now I’ll turn the call over back to Michael to elaborate on the financials of the quarter.
Michael Port, Interim Chief Financial Officer:
Thank you James.
Before I discuss our third quarter results I wanted to provide an update with respect to our
discussion during our second quarter Earnings Call regarding the fact that certain shipments
prior to the third quarter of 2016 did not comply with our process to assemble finished products
in accordance with the applicable standard for those orders. I’m pleased to report that as of
September 30, we have resolved the issue with all the affected customers and there were no
related material adjustments during the third quarter. As we previously discussed, we’ve
implemented improvements to our sales, supply chain and manufacturing processes and
enhanced communications with our customers regarding their purchasing requirements and
have implemented internal processes to ensure that our inventory fulfillment is in line with
Turning my attention to the third quarter of 2016, net sales were $8.3 million, down 55%
compared to the third quarter of 2015. Net sales of our military maritime products decreased
$10.2 million, or 69%, compared to the prior year’s third quarter, while our commercial
products sales increased 8% from the prior year’s third quarter as we continue our efforts to
diversify and expand our commercial markets.
For the quarter, commercial products sales comprised 44% of net sales, while military
maritime products sales represented 56% of net sales. Based on this product mix, our third
quarter 2016 gross margins were 37.3%; a decline of 12.5 points from the third quarter of 2015
when military maritime product sales represented 81% of our net sales. As we’ve indicated
previously, the decline in gross margin percentage from the levels we saw in 2015 is expected
as our commercial products become a bigger part of our net sales.
Total operating expenses of $6.2 million increased by $843 thousand from the prior year’s
third quarter; due to higher SG&A expense, principally related to investments in our sales and
marketing efforts, product development and the Company’s transformation efforts James just
discussed. Our third quarter 2016 employee related expenses of salaries and related benefits,
severance and related benefits, recruiting and relocation expenses and stock based
compensation increased by $240 thousand, $352 thousand, $240 thousand and $118
thousand, respectively when compared to the third quarter of 2015. Additionally, sales
commissions increased approximately $334 thousand compared to the prior year’s third
quarter as we changed our selling relationship for our military maritime products for the U.S.
Navy effective October 1, 2015. Under this new relationship, we began using an outside sales
representative who earns a commission on these sales, rather than purchasing them at
distributor pricing. Partially offsetting these increased expenses was a decrease in consulting
expenses of $661 thousand during the third quarter of 2016 compared to the third quarter of
At the end of the third quarter 2016, we had about 45 sales, marketing and sales support
personnel, which is an increase of 5 since the beginning of the year. This compares to about
30 at the end of the third quarter of 2015. At the end of September, we had about 130 full-time
employees worldwide, which is an increase of approximately 10 since the beginning of the
year. The number of full-time personnel is expected to increase by about 5 during the fourth
quarter as we continue our investment in our sales and marketing efforts.
Due to the operating loss incurred in the quarter and after the application of the annual
limitation under Section 382 of the Internal Revenue code, we recorded no provision for U.S.
federal income taxes and have a full valuation allowance recorded against our deferred tax
The net loss for the quarter was $3.2 million, or 27 cents per share, compared to net income
of $4.3 million or 40 cents per share in the prior year’s third quarter.
Net sales for the nine months ended September 2016 of $23.8 million, decreased 50% from
the prior year’s first nine months. While sales of our commercial products increased 59% from
the prior year, our military maritime products sales decreased 69%. The gross margin for the
first nine months of 2016 was 36.7% of net sales compared with 46.1% in the same period of
the prior year with the decrease being primarily attributable to a change in product mix
between commercial and military maritime products sales. The net loss for the first nine
months of 2016 was $9.1 million, or 78 cents per share, compared to net income of $7.5 million,
or 72 cents per share in the prior year.
In regard to the balance sheet, cash decreased $5.8 million during the third quarter to $19.6
million at September 30. The decrease was due primarily to the net loss of $3.2 million and
approximately $3.9 million in accounts payable, principally related to payments for inventory
purchases, the majority of which was received during the latter half of the second quarter.
Based on our current inventory purchasing forecasts, we expect our cash payments related
to inventory purchases to be lower than the third quarter. Our inventory balance at September
30, was $14.0 million, a $577 thousand decrease from June 30 and we don’t expect inventory
levels to rise much if at all during the fourth quarter, but that is dependent upon sales levels
as the majority of inventory has long lead times and most of the purchasing of these items has
already taken place for the quarter.
Our accounts receivable balance was $5.1 million at September 30, 2016 compared to $5.2
million at the end of the second quarter. Our days sales outstanding was approximately 35 at
September 30th which is consistent with prior quarters during the year.
As we’ve indicated in prior quarterly calls we expected our operating expenses to grow as we
invest in our sales, marketing and product development infrastructures and strengthen our
management team to facilitate our efforts to grow our commercial product sales. As a result
of these investments, we saw a $1.3 million increase in operating expenses from the first to
second quarter of 2016, however we experienced an overall decrease in operating expenses
from the second to third quarter of $212 thousand. In the near-term we expect our operating
expenses to approximate our third quarter spending.
End of prepared remarks