ENERGY FOCUS, INC.

Moderator: Brion Tanous
May 12, 2011
3:30 pm CT

Following prepared remarks we’ll open it up for questions for the remainder of this call. Before we get started I’m going to read a disclaimer about forward-looking statements. This conference may contain in addition to historical information forward-looking statements within the meanings and the federal securities laws regarding Energy Focus. Forward-looking statements include statements about plans, objectives, goals, strategies, future events and performance and underlying assumptions and other statements that are different then historical facts.

These forward-looking statements are based on current management expectations and are subject to risks and uncertainties that may result in expectations not being realized and may cause actual outcomes to differ materially from expectations reflected in these forward looking statements. Potential risks and uncertainties include change in demand for the company’s products, the impact of competition and government regulations and other risks contained in statements filed from time to time with the SEC.

All such forward-looking statements whether written or oral made on behalf of the company are expressly qualified by these cautionary statements. And such forward-looking statements are subject to risks and uncertainties and we caution you not to place undo reliance on these.

With that, I’d like to turn the call over to Mr. Joe Kaveski. Joe?

So to begin our first quarter revenues at $5.5 million was clearly below our first quarter results in 2010. However, we did exceed our $5 million forecast in the first quarter. And as we discussed during our last call we forecasted lower revenues due to the timing of some of our Solutions contracts. Furthermore, we used $2.5 million in cash in our first quarter. This was slightly less then our $3 million forecast. This cash usage was the result of lower sales and extended payment terms associated with our early buy products sales promotion.

The positive news is that we’re beginning to see resolution to the contract timing issues and as a result cash inflows are increasing. Also, we achieved some significant accomplishments during our first quarter. Specifically, our overall gross profit margins improved nearly 5 percentage points when compared to our first quarter results of last year. We believe this improvement was the result of our continuing focus on reducing our material costs, increasing EFOI product content into our Solutions projects and further reductions in our manufacturing cost resulting from the consolidation of our Solon manufacturing operation into our (Maquiladora) in Mexico.

Also, we have already received several new government contracts for R&D and Navy orders for products totaling $2.5 million. We were awarded a $600,000 development contract from NASA to create a high performance LED solution as a retrofit replacement for a 1,000 watt metal allied exterior fixture. We’ve already demonstrated working prototype that uses less than half the energy and achieves superior optical performance. The company received a $1 million contract from the Ohio Third Frontier program to develop a solar powered wall pack retrofit fixtures for existing buildings.

We achieved a $475,000 increase to our very high efficiency solar cell contract for optics and coatings technologies that may also be used in our IntelliTube products. And, our military team received a $446,000 order from the U.S. Navy for retrofit lights on two destroyers. Finally, we introduced an LED retrofit kit for Wallpacks during the first quarter. Our new retrofit kit was designed specifically with existing buildings in mind as it offers a very low first cost, superior lighting performance, breeze to install and typically a less than two year simple payback. Additionally, it uses an innovative thermal management system that makes the product possible and for which Energy Focus awarded a utility patent.

We’re already utilizing and installing these kits into our Solutions projects. Initial indications and orders from distributors, building owners and lighting retrofit and maintenance contractors are very encouraging.

Now as we look to the future I’d like to reaffirm our year end forecast of $35 million in sales and to be net cash flow positive from continuing operations. For our second quarter we’re forecasting over $8 million in sales and cash utilization to be less than $1 million. Currently, cash is tight. However; as I mentioned earlier, our revenues are ramping and we’re beginning to receive cash from those revenues.

Finally, I’d like to mention that we expect our gross profit margins to continue to improve throughout the year.

Now earlier this week Energy Focus received the ASTRUM Award at the MDB Bright Light’s Conference in New York City. I’m mentioning this award because it recognizes companies on the tipping point. That is, companies with technologies that have high commercial potential as evidence by their substantial patent portfolios. We believe that the MDB Bright Lights Conference got it exactly right.

So in conclusion, I remain bullish on Energy Focus and look forward to the rest of 2011 beyond as we realize the potential of our IntelliTube^TM and other energy savings technologies.

So now I would now like to turn the call over to Eric Hilliard our Chief Operating Officer and interim Chief Financial Officer for further details on our first quarter results. Eric?

Gross margins for the first quarter were $1.2 million a decrease of 17% or $236,000 versus the first quarter in 2010. This decrease in gross profit dollars is a direct reflection of reduced sales volume. However, our gross margins as a percent of sales increased 4 1/2% to 21% of sales in the first quarter of 2011 versus the prior year period when gross margins were 16 1/2% of sales. This improvement in gross margin percentage for the quarter was driven by lower costs in our Solutions, U.S. products and government businesses.

Operating expenses for the first quarter was $3.8 million a decrease of $1 million from $4.8 million in the first quarter of 2010. Included in our 2010 results was a non cash charge of $1.4 million for the revaluation of equity instruments. Excluding this non cash charge our operating expenses would have been an increase of $400,000. This is a result of increased investments into IntelliTube, new products and channel development for the existing building markets.

Our first quarter net loss from operations narrowed to $2.7 million versus a net loss of $3.5 million in the first quarter of 2010. Finally, we ended our first quarter with cash and cash equivalents of $1.6 million as compared to finishing our first quarter of 2010 with cash and cash equivalents of $1.8 million. During the first quarter we did utilize $2.5 million of cash and cash equivalents.

And finally, the first quarter of 2011 resulted in decreased revenues and margin dollars, however; increased gross margin efficiency as a percent of sales. Controlling the cash spending is related to operating expenses and utilization of cash from operations while we continue to invest in our IntelliTube technologies.

And with that I would like to turn the call back to you Joe. Thank you.

Thanks Eric. And now at this time I’d like to open up the phone lines and invite our listeners the opportunity to offer comments and ask questions. Operator?

We’ll go first to Allan Snider.

And the last thing that we’ve done which I believe is significant is we absolutely have put a focus on increasing our visibility in terms of the investment community. In just the beginning of this year we’ve already attended and presented at four conferences, the Roth conference, the Jeffries conference, the Kauffman conference and then last Tuesday, the MDB conference to demonstrate the IntelliTube technology, talk about the real value in the company and generate some interest in our stock as well. So those are just a few top of mind things.

But overall, yes we’re concerned, we’re working on it and we do think that it is having an impact.

The U.S. Navy has extremely high barriers to entry from a technical perspective and of course our IntelliTube technology, which we are very bullish on, has been well received by the Navy as evidence by our contracts to replace T5 lighting in the Virginia class nuclear attack submarines. It has been very well received and absolutely offers the lowest cost and highest performance solution for Navy vessels as well as commercial buildings.

However, we — we believe that we will see a substantial increase in our 2011 military sales. I want to make a point of saying this we are out of the research into a new technology, convincing them it’s viable and then change their specifications stages. These are behind us now. We are actually shipping product.
Now, we continue to get R&D contracts that are for very advanced research, what I would call, lighting technologies or strategies that you would apply in the military fixtures. For example, there’s one called circadian rhythms for instance which affects the body’s circadian rhythm which affects and productivity in your sleep cycles. However, we are at the stage where we’re actually shipping products. Having said that, again we believe we’re going to see a substantial increase in our 2011 sales and have a really nice foundation for 2012 and beyond.

We are currently evaluating our options for commercializing this solar technology. We could be well named the commercializing entity. VHESC includes a consortium of other companies and I believe that we are well positioned to be named the commercialization entity should we choose to go down that path. So...

I would remind you that we have our first solar commercialization project underway. We were funded earlier this year by the State of Ohio to develop this outdoor self standing solar LED light which combines really our LED lighting low energy consuming LED lighting technology with solar. We’re going to start that with using more conventional solar but it could very well benefit our energy efficient solar technologies.

So again, we’re driving quicker than we thought towards a product that offers a great ROI over the standard best in class florescent solution. That’s number one.

And number two, tying back to the higher powered devices, Canaccord Adams also suggests that one of the early markets to transform is the exterior lighting market. Having higher powered devices and more efficacious to compete against metal halide technology is absolutely needed and excellent. So everything that we’re seeing that’s going on in the LED chip space is really just creating opportunity for Energy Focus.

The firms that you mentioned basically have focused their attention on what might appear to initially be a more ripe portion of the market. Yet, it is fraught with competition. What I’m speaking specifically to is the replacement market for the A19 incandescent lamp where today’s A19 lamp’s efficiency is maybe 12 watts per lumen.

Having said that, the A19 represents a small part of the actual commercial building market opportunity. What I mean by that is that the U.S. government suggests that there’s over 70 billion square feet of lighted space non-residential lighted space. Less than 25% of that space lighting with technology such as the A19 lamp, the PAR30 lamps, spotlights, and exterior lights. About seventy-five percent is basically what I would call linear fluorescent lamps. So linear florescent is the much larger portion of the commercial building market opportunity. And that’s where Energy Focus has clearly set its sights.

And we’ve done that because of the market opportunity itself and because – I might be a little bias — we have a better approach and that approach is IntelliTube. In the existing buildings, the value driver is not necessarily a low first cost but rather a better return on investment (total cost of ownership). And so, as we evaluated getting into the retail sector, we concluded that consumers are going to be slow to buy a $10 or $20 light bulb when they have an alternative that may be anywhere from 50 cents to two bucks for a compact florescent.

And in the retail space is clearly dominated by the major manufacturers, GE, Phillips and Sylvania. And we clearly see that they are focused on the retail market as well. Okay, so having said that, our product strategy is focused on IntelliTube and the replacement linear florescent market opportunity that exists in commercial buildings. IntelliTube is the absolute highest performance lowest cost way to get LED lighting into an existing building and offers a great return on investment.

In terms of globalization, we actually do have a subsidiary, a wholly owned subsidiary based out of the UK that does cover the rest of the world. They historically covered the construction marketplace, where they were an early adopter into decorative LED. We are now transitioning them into the existing building market where they are basically focusing on what I would call large energy services companies and lighting maintenance companies that are into existing commercial buildings where the customer will value the superior economic returns of our IntelliTube technology.

So at this point in time that is the strategy that we are actualizing to position the rest of world into for our IntelliTube technology. We do have on-going in-house discussions on how we go beyond that internationally but it’s just too early to bring forward any new strategies at this point in time.

And so a large portion of these Solutions contracts, which tend to be very large in nature, have a large portion of the revenue recognized and a receivable generated within 30 or so days of the contract being received.

I with investors publicly that IntelliTube’s price is highly dependent upon the cost of the LED chip. And over the next five years, we’re going to see the price of LED’s go way down as we are already seeing and that their performance will go way up. Why that’s important is because in areas of the country that have very high utility rates like the west coast, Texas, New England states — the economic value equation brought by IntelliTube, even at an initially higher price, will be there where it provides them a great return on investment for buildings that tend to be lighted longer than other ones.

For example, a hospital versus a school district will see the hospitals will be the earlier adopters especially in the high energy rates. So, IntelliTube will not be a product that coming right out of the shoot creates tremendous economic value across all markets. It will be for many markets and as the price of that LED comes down subsequently over the next couple years, then it becomes a product that will create more economic value then a linear florescent across what I would call all markets.

So, you know, this year IntelliTube we’ve stated is not going to be a major factor in terms of revenues but we’re very optimistic towards 2012 and beyond. And what I also what I would mention relative to the revenues is gross profit margins. Today in our Solutions business, which last year approached $20 million in sales, has product content around anywhere from 40 to 50% of the total revenue. Within that product content there is primarily two main items, florescent lamps and ballasts, that we procured from the major manufacturers.

As IntelliTube comes online we will begin to replace those outside purchased florescent tubes and ballasts with our own product, IntelliTube, and as a result Energy Focus gets a great launch pad and captive customer for the product as well as the ability to keep the manufacturing margin in-house that is currently benefitting GE, Sylvania and Phillips. So, not only will we have a significant effect on our revenues but also on our margins.

When we got into this business it was 2009, it was very challenging to be able to get bonding because of the condition of the financial markets coupled with our five plus years of financial losses. We were very fortunate to align ourselves with a company that was willing to go with us. This company had served the previous owner for many, many years. But one of the consequences was is that we had to literally take $2+ million of our cash and sit it over at our bonding company.

This was always done to initially get the bonding itself and through our discussions with the surety company it’s always been the goal that as our financial performance improves then the collateral will be coming back to the company. And so we’re working toward that end. But it is not part of the cash.

The Navy is very important to us for many reasons. The first one is it is a very nice market. Their compelling reason to reequip the U.S. fleet with LED lighting is that on non-nuclear vessels electricity cost is north of 55 cents a kilowatt hour and that florescent tubes don’t last their standard life as they would in just a stationary building because of vibration. There’s the major driver for them to want to do LED lighting. That’s why they’ve been working to develop it for so long.

Our conservative market estimate is about a $300 million opportunity that could be harvested should the Navy turn on the switch in a relatively short period of time. Three years, maybe five. It’s a great opportunity with high barriers to entry and a customer where we have demonstrated time in and time out that we can perform and have delivered these advanced lighting solutions that exceed their military specifications.

So number one is the market opportunity; number two is basically we view a navy vessel really as a large building and we see it as an opportunity to actually have someone else pay for our product development. Everything that we’re doing right now for the Navy has a direct connection to a product that we are or will be selling in the commercial market. So, having our product development paid by the Navy is absolutely huge.

Ultimately though, that brings us to the last thing which was your question about the Holy Grail which for us is the existing commercial building market. The best way to explain why it’s the Holy Grail is that it represents 70+ billion square feet of lighted space. Seventy-five percent of it lighted with linear fluorescents lamps. And, the driver for our customer to upgrade the lighting in that building is purely economics. He wants to free up cash flow that he can apply towards the core business.

And the fact of the matter is there is no other approach available to an existing building owner that provides a lower first cost then simply taking out the florescent tubes, jumpering the ballast out of the circuit, and putting in new Intelligent LED tube. In contrast, other LED manufacturers want you to pay a higher first cost for a whole new LED fixture that would require a licensed electrician to spend more time taking out the existing fixture to put in the new LED fixture. So you pay a higher wage scale and spend more time replacing the fixture then you would just replacing the tubes.

So as a result, we can match in every way the performance of a new LED fixture replacement with IntelliTube. We can bring forth features that I haven’t heard the other fixture manufacturers really talking about which is a direct result in some of the research we’ve done for the Navy. And better yet, do it with at least twice the ROI or 1/2 the simple payback of anyone else. And so that’s why we’re very excited and — and that’s why it represents the Holy Grail for us.

How do you — how do you adjust the — the correlation of the IntelliTube to match or maybe - maybe it’s just already matching very closely with what the — what is required in the commercial atmosphere whereas they don’t want to change the color of clothing or whatever that’s ((inaudible)) on the shelf? What — can you give us a little idea on that?

For example, we sell products to museums where we very closely match the color quality and low color, yellow color temperature of incandescent. We do that because that’s what museums are used to and what they desire and in fact the home environment is like that — no problem. We also have high color temperature applications which we tend to use outdoors, 6500 degrees K. Those are very useful because they take advantage of the color sensitivity of the eye which at night in particular is more sensitive to the higher color temperatures, the blue end of the spectrum if you will.

IntelliTube offers one final and really important difference for adjusting color. We can because, we deliver the light to the IntelliTube rod, that rod can mix colors. We can have a multi-colored device deliver light in whatever color proportion we would like. So we can take the same light bulb and we can actually change the color in the environment that you have. So one SKU if you will could serve a school at 4100 K, a commercial installation at 3500 K or even work in the home at 3000 K simply by itself adjusting to that environment. –We think that it’s a breakthrough kind of approach to lighting.

And the net result of that is we can dim to lower levels without an impact per say on the occupants within that building and actually get more energy savings as a result of that. So it’s a tremendously important feature for a smart grid demand response application.

But could you kind of speak to what you’re feeling is on where this is going? And by the way, I really think this was a very wise choice picking on commercial especially now understanding what we’re talking about here, the specifications of these fixtures. I’m saying that’s the differentiator, is that a clear differentiator from your standpoint or is everybody else doing it?

On the other hand, the public sector simple paybacks can be well north of that. And in fact, Johnson Controls, one of the largest energy services companies, gave a presentation last year and they showed a table where they showed the typical simple payback in their government contracts anywhere from three to ten years. So, different markets have different desires. Our existing LED based products today typically have a three year simple payback or less. And that’s really where our focus is. To beat linear florescent with IntelliTube and to make it a great ROI compared to the best in class linear fluorescents today. And that’s why we’re very excited. We see it, we see it.

So it’s a comprehensive approach to implementing these lighting solutions for our customers. And very, very successful I might add. So, the one thing I would mention to you...

So, I guess operator what I’d like to do is conclude our call today. But before I do I’d really like to thank everyone who participated for you time and your interest in Energy Focus. I’d be remiss if I didn’t recognize the tremendous contribution of all of Energy Focus’s employees worldwide whose ongoing commitment, dedication to serving their customer needs where ultimately I believe give our shareholders the return that they deserve.

So with that, I’d like to thank you again and wish you a good evening.

END