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Energy Focus Inc (NASDAQ:EFOI)

Q2 2014 Earnings Conference Call

August 13, 2014 4:30 PM ET

Executives

Frank Lamanna – Chief Financial Officer

James Tu – Executive Chairman and Chief Executive Officer

Eric Hillard – President and Chief Operating Officer

Analysts

Philip Shen – ROTH Capital Partners

Richard Greene – Centerpoint Advisors

Operator

Good day ladies and gentlemen and welcome to the Energy Focus Incorporated Second Quarter 2014 Earnings Release Conference. Today’s call is being recorded. At this time, I would like to turn the conference over to Frank Lamanna. Please go ahead sir.

Frank Lamanna

Thank you, and good afternoon. Welcome to Energy Focus’ second quarter 2014’s earnings conference call. Today James Tu our Executive Chairman, Eric Hilliard, our President and Chief Operating Officer and myself will report on our results for the second quarter of fiscal year 2014. The news release with our earnings results has been posted to our website under the investors section.

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-Qs 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 would like to turn the call over to James.

James Tu

Thanks, Frank. Good afternoon everyone and thank you for your participation in our second quarter 2014 earnings call. I like to start the call by thanking all our employees and shareholders for your continuing dedication to and support for the company over the past quarter and the past year. And this focus couldn’t have possibly achieve these transformation point over the past year without your collective efforts. Today I also like to express our warmest welcome to our new investors from our recent equity offering, just consummated on Monday this week.

As we mentioned in the press release our second quarter results clearly demonstrated our continuing process towards our goal to achieve record sustainable profitable and organic growth. During the quarter as we stated in the press release sales grew 36.2% organically from first quarter of 2014 and excluding the government R&D service revenues which we don’t pursue anymore for our restructuring during the second half of the last year, sales grew 25.8% organically from the same period a year-ago, when our gross margin was at much lower level, if we exclude the R&D contract services that we no longer pursue our product sales during the quarter grew 70.7% over the second quarter of 2013.

Meantime our gross margin reached 32.5% the highest level the company has achieved in many years. And we reduced our operating loss drastically to $552,000 from $1.1 million in the first quarter of 2014 and from $1.7 million loss in the second quarter of 2013. At this point we believe that we are on our way to achieve EBITDA possibly in the second half of 2014 as our sales continue to improve and we are continuing to improve our margin towards our 35% long-term goal.

Now I would like to turn the call to Frank Lamanna our CFO for more specifics on the financials, after which I will update with you briefly on the progress we made in various businesses.

Frank Lamanna

Thank you, James. Good afternoon everyone. Before I discuss the financial results for the second quarter of 2014, I would like to inform everyone net sales, gross profit and operating results that I will discuss will exclude the results of our pool product business which we sold in November 2013. We have eliminated all net sales and expenses associated with the pool business on a historical basis and classified those activities as discontinued operations.

For the second quarter of 2014, Energy Focus had net sales of $6.7 million an increase of $1 million or 18.5% compared to $5.7 million of net sales from continuing operation in the prior year second quarter. In the second quarter of 2014, product segment sales increased 51.7% to $5.6 million, while the solution segment sales decreased 42.9% to $1.1 million as a result of shifting our focus from turnkey LED ESCO solutions to turnkey LED commercial solutions.

Within the product segment commercial sales increased 17.1% government sales increased 125.8% and R&D services sales decreased 96% due to narrowing our focus on those projects that result in material LED lighting product opportunities. Excluding the R&D services sales, the product segment sales grew 70.7% from the prior year’s second quarter. Second quarter 2014 gross margin was 32.5% of net sales as compared to last year’s second quarter gross margin up 21.9%, a 10.6% percentage point improvement.

Gross margin increased by 3.6% percentage points over the first quarter of 2014, in the second quarter of 2014, product segment gross margin improved to 35.7% or 7.6% percentage points as compared to 28.1% of sales in the second quarter of 2013. Our improvements in gross margins, our results of our continuous efforts to improve our operational efficiency as well as the growing economies of scale from the sales volume increase.

The solution segment gross margin improved in the second quarter of 2014 by 5.8 percentage points, 16.3% of sales and operational execution improved.

For the first six months of 2014, gross profit was $3.6 million or 31% of net sales compared to $2.1 million or 21% for the same period in the prior year. Operating expenses were $2.7 million in the second quarter of 2014, compared to $3 million in the same quarter of 2013 or a decrease of 8.2%.

During the first six months of 2014, operating expense were $5.2 million compared to $5.1 million in the first six months of 2013.

For the second quarter of 2014, net loss from continuing operations was $622,000 compared to a $1.2 million net loss in the first quarter of 2013.

In the first half of 2014, net loss from continuing operations was $4.7 million compared to a net loss from continuing operations in the first half of 2013 up $2.6 million. Included in the 2014 first half net loss, our one-time expenses of $2.7 million, which were related to the conversion of convertible notes. Excluding these one time charges the net loss from continuing operations was $2 million.

Finally, I would like to discuss Energy Focus’s balance sheet. Cash and cash equivalents at June 30, 2014 were $1.6 million compared to $2.9 million at December 31, 2013, and cash used in operating activities decreased by 17.6% as compared to the first six months of 2013.

Furthermore, we reduced our long-term debt obligations by $3.8 million, due to the conversion of convertible debt in the first quarter of 2014. In an effort further strengthen our capital position on October 11, 2014 Energy Focus completed its public offering rising and estimated $5.3 million net of expenses.

These funds will be used to fund our record growth plans, including expanding our geographical and vertical sales presence, building up inventory to shorten delivery lead times, improving the efficiencies of our operating infrastructure and to strengthen our balance sheet. Giving effect to the equity raise on our June 30, 2014 balance sheet, cash and cash equivalents increased to an estimated $6.9 million and working capital improves to $9.4 million, while our shareholders equity increases $10.8 million.

This initiative coupled with our recent move from the Over-The-Counter Bulletin Board to the NASDAQ is an indication that we are continuing to focus our efforts on building a solid financial foundation as we transform energy focus into a leader in the LED lighting market.

Now I will turn the call back to James.

James Tu

Thanks, Frank. Now I would like to update with you briefly on our progress in building our sales pipelines during the second quarter of 2014. Our sales pipeline across all verticals, including military maritime, ESCO and commercial and industrial continued to grow during the quarter. Specifically, over 120 U.S. Navy Ships are now ordering our LED products up from fewer than 20 at the end of last year. Well witnessing not only broader but also stronger adoption of our LED lighting technology in the whole Navy ecosystem, from the top decision makers to the ship levels.

We sold a record of $2.7 million of our military imperative product during the quarter and we believe that this sales pace is on track to double within the next few quarters. While working on a number of marketing and sales initiatives that we believe will accelerate our penetration to this $350 million on the market over the few short years. Where we only approved LED lighting vendor, but we also can leverage our technology leadership and proven success into a broader $4 billion commercial marine market.

In the ESCO market, we have completely reoriented our focus on product sales to the federal ESCO channel rather than solutions sales to local ESCOs to avoid potential channel conflict. By serving the ESCOs as well as the lighting retrofit service companies, we will right now only to become a leading LED tube lighting provider for the ESCOs but also the standard for LED tubes in the industry.

During the quarter we won one of the largest LED lighting retrofit projects for product sales in the ESCO industries history with 57,000 LED tubes. We are now already working with six out of the super 16 ESCOs in the country.

And our pipeline over opportunities in the ESCO channel has grown multiple times over the past six months. We continue to add sales personnel diligently and we’re scheduled to open our DCL by early fourth quarter. It is our expectation that we will start seeing growing contributions from the favor ESCO channel in the second half of this year, with accelerating growth momentum into 2014 to 2015.

In the commercial market, we focused mainly on the following five verticals, national retailers, property management companies, hospitals, universities and parking garages. Each of these five verticals represent multibillion dollar opportunities for us the U.S. And outside of the national retailer vertical, where we’re now building a sales team to focus on the top 150 national retailers. We currently focused on Northeast, Midwest and mid-Atlantic regions, where the return on investments for LED retrofit projects is most attractive, due to either high power rates over better rate rebate or the combination of both.

During the quarter, we also continue to make exciting progress in expanding our sales reach to more large commercial accounts with made numerous sales contexts in the five verticals we’re pursuing. And now we’re in active final discussions with several large accounts for initial orders that we expect to start contributing to our sales in the third and fourth quarters of this year.

As we announced in press release on June 30, we have become a preferred LED lighting vendor for the largest privately held property management company in the world with 500 million square feet of space in 4000 buildings in the U.S. We’re now actively pursuing their clients in the select metropolitan areas. As another example for initial success in the commercial market, we announced, we have been selected by Wayne State University to replace our existing fluorescent lighting with 35,000 of our LED tubes.

Wayne State is the first University in Michigan and one of the first in the whole country to embark on whole LED lighting retrofit plan. The ultimate size of this opportunity along is the likely over 100,000 tubes much like our success in the Navy and in the ESCO channel, such early wins provide us strong testimonials and referrals for us to penetrate and lead in the specific vertical.

Again, we believe that we’re blazing trails in the LED light tube adoption by selling and serving the end customers directly with the highest performance and lowest cost LED products. That our static clients simply could not obtained from traditional lighting distribution channels.

This focus in the right distribution business model, we are pioneering in the lighting industry is only possible through our concerted effort by possessing proven LED technology know how. Developing and designing leading hedge technology LED technology products launching products well ahead of the curve.

Having the product available and selling them directly to clients with the most compelling solutions, when it comes to return on investments. Now, as we have transition our solutions team out of the ESCO channel to serve them our commercial clients. We now are able to provide the most comprehensive and compelling LED lighting retrofit solutions to the commercial markets.

We will continue to enhance our capability to provide a complete and leading area LED lighting life cycle solutions to the end clients. And we will have more exciting development to share with you once the additional product and services that are now under development materialize.

Last, but not least, as Frank laid out we initiated a serious of capital market ventures during the second quarter to enable us to become a fully investible and more visible publically traded company.

As you have seen from our press release over the past two weeks with shareholders approval, we have effective ten to one reverse spilt and with the underwriter’s exercise over allotment. We have successfully raised another estimated $5.3 million of capital. Net of these in our almost recent equity offerings and we began trading on the NASDAQ capital markets on August 7.

These accomplishments, we believe will not only equipped us with ample working capital, but also significantly broaden our investor base to better reflect a value of the company. As we continue to grow in fast pace.

With that I will turn the call back to the operator to open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we have a question from Philip Shen with Roth Capital.

Philip Shen – ROTH Capital Partners

Hi guys, thanks for taking my question.

James Tu

How are you doing?

Good, good you guys are making great progress here and especially with the Navy. Can you talk to us about what kind of growth you see ahead and over what kind of timeframe you guys are in 120 ships now and there is also the Sealift command available what kind of penetration or how would you describe the penetration of that addressable market in 2015 how much penetration could we get?

James Tu

I’ll let Eric answer the question.

Eric Hillard

Thanks, James. Okay I’ll try to answer your question, as best I can, our penetration so far has been very rapid as you heard from James from 26 to 120 ships in 2014 that doesn’t mean that we outfit the entire ship it means that we are starting to get traction on the United States Navy on a larger platform base. So with a total number of ships public and for making that we ascertain out there from James fighting edition that there is roughly 290ish ships in the United States Navy fleet there is another complementary of that ships in the Military Sealift Command and we’re just penetrating to 120 we expect the penetration to continue forward every quarter and into 2015 and we continue to gain ground not just on the platform but taking a better position on that platform month-over-month, quarter-over-quarter et cetera.

Philip Shen – ROTH Capital Partners

Within the 120 ships that you are involved with now what degree of the addressable market on each ship or the addressable sockets on each ship do you think you’ve already enabled.

Eric Hillard

I’m not looking at from a ship by ship basis per se as much as the general market itself we believe for the Navy at this point we’re getting close to a 5%ish addressable market that we penetrate into so we have a lot of bandwidth theaters to continue forward on and replicate our results and growth.

Philip Shen – ROTH Capital Partners

Great, thanks Eric. In terms of the ESCO space James in your remarks you talked about in the quarter you guys won one of the largest two contracts for the ESCOs I believe I heard 57,000 tubes can you talk just about your backlog in your pipeline actually and perhaps talk about the number of other those types of opportunities that are in development now that we could start to see in the quarters are ahead.

James Tu

Sure, with the – obviously satisfy exactly how much on pipeline – how much sales pipeline we have right now. But as I mentioned in the earlier presentation, we have seen multiple times growth over the past six months. So the proxy number will be from lower few million dollars to over tens of millions of dollars at this point, in terms of our sales pipeline.

Obviously, not all the sales pipeline we’re trying to sale, but we have a good percentage of wins over the past two quarters, when we just started this focus on federal ESCO product sales. So, I think that with the best way to capitalized the growth in this particular vertical is that was the something very significant in the next and especially in 2015, by those are starting to see our contribution, more meaningful contribution over 10%, 20% of our sales in the next few quarters.

Philip Shen – ROTH Capital Partners

Great, thank you James. One more and I’ll jump back in queue and this is for you James. Can you kind of talk us about the innovation that you see in the financing space for energy efficiency in first and what you guys are doing talked us about the opportunities are ahead and how you look to enabled us?

James Tu

Sure, I’ve mentioned that we are working on additional services – products and services to complete our total LED lighting retrofit package to our commercial clients. And as you can see from the solar space being able to provide the financing facilities, he is a important motivator for the commercial clients to move forward with the energy efficiency upgrade. We see that already in the ESCO channel obviously, when schools, hospital, municipalities use ESCOs as the financing mechanism.

We are working on such as solutions with multiple potential financing partners to provide complete life cycle solutions from design to product sales, installations, measurement and validation and financing. And it’s still too early to tell, few pilot projects for this particular market and but we believe that is once we have this company ability, this will lock very significant portion of the commercial markets. So I hope we have something exciting to announce in the next two quarters.

Philip Shen – ROTH Capital Partners

Okay. Thank you James, thank you Eric. I’ll jump back in queue.

Eric Hillard

Thanks, Phil.

Operator

Thank you. (Operator Instructions) And will go to David Herdman, Private Investor.

Unidentified Analyst

Yes, hi guys great report better than I expected actually, Eric, I did have a question you about the Maritime bulbs they were not going to be the military IntelliTube they are going to be more commercial tube and I was wondering you hadn’t gotten approved yet I guess it’s a different kind of approval for the Maritime industry, I was wondering if that has come true.

Eric Hillard

Okay, thanks for the question David. Yes, the lamp that we’re going to provide to the Maritime non-military it’s certainly not going to be the military base – don’t have to be that heavily specified so you’re correct in that statement. As far as getting it certified I think what [indiscernible] the ABS certification for Maritime fleet and I do believe we’re completing that very soon and be available for the fourth quarter.

Unidentified Analyst

Very good thank you. That’s it from me.

Eric Hillard

Thank you, David.

Operator

Thank you. And we’ll now hear from Richard Greene with Centerpoint Advisors.

Richard Greene – Centerpoint Advisors

Good afternoon, gentlemen.

James Tu

Hey, Rich how are you?

Richard Greene – Centerpoint Advisors

Well thank you and congratulations on the progress you’ve made in last quarter – all the hard work, but the restructuring is starting to pay dividends you mentioned the verticals that you were focused but I noticed recently on the website and there is a couple of verticals that maybe you can talk about albeit at them and perhaps the embryonic stage but there is reference on the website about oil and gas space here and then I did read it some third-party research talking about the role that LEDs can play unique in Agri business, can you comment on that and see rather it’s element of opportunity there that did you think its meaningful enough to you don’t want to be too scattered your focus, but we think market you would another vertical you want to pursue.

James Tu

Sure, Rich. Go ahead, Eric talked about the oil and gas opportunity, which is probably Military & Maritime market, and then I’ll come back and talk about the agricultural opportunity.

Richard Greene – Centerpoint Advisors

Okay, great.

Eric Hillard

Okay, thanks. Rich, let me try to hope to answer the question here. Oil and gas you referring to those platforms that are offshore obviously, we see that as a vertical market that is one that Energy Focus is going to pursue, we believe we have a good product offerings, it’s down our military heritage ability to go out an U.S. Navy and have high quality sustainable products that can survive at see, seesaw areas et cetera. We also are able to get certifications required for Maritime fleet as the prior question was for the ABS. So this allows us to take a current suite of products that we are using on Maritime fleets and in U.S. Navy and penetrate a market that we feel, we can have great success and so yes we’re going to be – moving into the market place and that channel

Richard Greene – Centerpoint Advisors

Can you just give me sense how what the size of that market is?

Eric Hillard

We are still doing a lot of the deep analytics, but it’s a very sizeable market, I mean when you go at risk, there are thousands of these types of apparatus FC plus. There is an additional market it services those markets and we learned everyday how the market functions, but there are actual refinery shifts next to these oil rate debt refined oil at the and then transfer yet in other cargo shifts that comes and bring that refined oil to land, I mean, it’s just really unique market, it’s very exciting. We looking forward to moving into this, this is a vertical and expanding our Maritime business even further as it is. As James saying earlier in the call, it is a $4 billion addressable marketplace. And we’re very excited to be playing in that marketplace.

Richard Greene – Centerpoint Advisors

Great. Thank you.

James Tu

Yes, Richard to add on to what Eric said, our approach to the market is that we once we decide to enter a market we must have done enough study in product development. So that we are sure, we could be a leader in that particular vertical. If we don’t have that kind of confidence, and believe then we will avoid getting to a new vertical. Because we are still a small company, we wanted to be very focused on spending our resources and being able to penetrate particular vertical is very powerful as we have been doing in Navy channel, while you can see and now in the federal ESCO channel. And in some sort of commercial in verticals in very-very early stage, but being a channel leader is a lot more profitable than being everywhere. So that’s our main marketing approach and sales approach, which is really differentiate us from many other LED lighting provider which usually tend to, too many things have been to many products, too many markets. I’ll give you a quick example; we have about, commercial line we have about 30 SKUs as suppose to most lighting companies having 100s or even 1000s and having a very contender is SKU give us the possibility to launch new products ahead of the market, because we are focusing on, much narrow bend of products.

So I believe that as one of our major advantages in the market but also related to your question about agricultural markets. We obviously are watching the market very closely in terms of the possibilities there in the market there. It’s a multi-billion dollar market as well we have now put that in our verticals to focus on there has been, multiple studies that with different lighting spectrums, you can improve plants and even animal, agricultural growth. And so there is definitely a role for LED lighting to play. At this point, we are not focusing on that vertical. And I don’t think, you would – you will see us being in that vertical in next two quarters. But you will eventually be one of the verticals that we getting I believe, because it is part of the commercial industrial market but also use mostly fluorescent lights at this point probably into the place.

Richard Greene – Centerpoint Advisors

Okay, I think that makes a lot of sense. So out there you get the low hanging fruit that you know its there and continue to look for opportunity. Right, thank you very much.

James Tu

Absolutely, thank you. Thank you, Richard.

Operator

Thank you, and will continue on to Ted Brown Private Investor.

James Tu

Hi Ted.

Unidentified Analyst

Hi, I didn’t have a – Ted here, Eric, am I now connect.

Eric Hillard

Yes, you are.

Unidentified Analyst

Okay, could you hear me all right? Couple of comments here, if really come a long-long way and there’s been a awful a lot of arm twisting and convincing on this way to get where you are; I am sure, can you tell a little about the nature of the buyers in this recent underwriting because the character of the buyers I don’t know – I don’t care about their names, but do you have some really substantial smart people. And the second question that I would like to pose is in the past lot of our old investors thought that we had a lot of protection in (indiscernible) and otherwise and I don’t hear that talked about anymore do we have some real edge in selling do we have some protection on the products that we’re vending and I’d love to hear about what kind of competition we get people excuse me for the fact that have spoken I don’t talk too well anymore go ahead.

James Tu

Sure, thanks Ted. We’re happy to have you along way as we transform the company. And you have a couple of questions actually the first one I like to address is in terms of the capital rates our new investors obviously like to believe that our investors are small investors. So that’s taken for granted. Most of them are institutions and they are actually pretty global their organizations from Canada and from UK as well. So we believe that this is the very good beginning for us to approach the capital markets and more institutional investors and now we’re trading on that is the right stock price to start with so we’re very excited about this new start in terms of getting additional investors to follow Energy Focus.

The second question relates to new product development absolutely we’re continuing to development our products with 79 patents right now. And we’re in the middle of preparing more patent filing and that difference now is that as a opposed to what we have is that all the products generally is focused on our end markets today which is the commercial industrial markets including it’s a broader institutional market that includes commercial, industrial and the Navy and ESCO, really anything outside of the residential market and then outdoor market. So all our product developments are focused on penetrating the broader commercial and industrial market as we said the highest performance and lowest cost product. We believe that we’re leading the market even today in 130 lumens per watt tube and we’re – and our plan to launch 150 lumens per watt product in the next few months.

In addition to that we’re developing products that can fit into our markets with more versatility with that the ability to improve return on investment by driving down the cost, but also increasing the flexibility of the technology. We don’t have anything to operate at this point, because it is under development. But I think the next three to six months you’ll see more exciting new product development that we announced.

As it related to your question about competition, I think we have said that before that we’d like to be ahead of the curve back to be able to launch products at least six months ahead of our competition they’re everywhere they could be large lighting, established lighting companies to start to major manufacturers. But we believe at this point, we’re so focused on our market and in a very narrow bend of SKUs, we are staying out of the curve. And all our product development efforts are concentrated on enabling us to stay ahead of the curve to drive down the investments needed for our clients and to drive up the return on investments on these lighting retrofit projects.

Unidentified Analyst

Thank you.

James Tu

Thank you, Ted.

Operator

Thank you. And with no additional questions, I would like to go ahead and turn things back over to Mr. James for additional or closing remarks.

James Tu

Thank you everyone again for your participation. We very much look forward to talking to you again in our third quarter 2014 earnings call. Have a good evening.

Operator

Thank you. And again ladies and gentlemen, that does conclude today’s conference. Thank you again for your participation.

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