Introduction
Just like second year quarterback Joe Burrow has resurrected the Cincinnati Bengals to become a Superbowl contender, we think investors should rally around James Tu and force $EFO Board to immediately reappoint Tu to his CEO position. If not, we hope Tu “goes activist” on EFOI.
Solon Ohio based Energy Focus, Inc. is a company at a crossroads, locked in a classic “Wall Street vs. Main Street'' battle that retail investors should care about. After 3 years of hard work, EFOI’s Board forced CEO James Tu out of the CEO spot for the second time in 6 years with no clear contingency plan communicated from the Board to shareholders.
We think it’s time for Tu, one of the largest investors in the company at 4.3% ownership, to play activist and prevent the risk that the company will be led by certain Board members and management personnel who we believe are misaligned with shareholders’ best interests. Despite the troubles EFOI is facing from the ongoing negative impact of COVID-19 on the company’s legacy LED lighting business, we believe that Tu was just a few quarters away from transforming the company before he was removed from his CEO position.
Sure, we are cognizant that Tu may have not hit all his objectives, but Tu faced a monster task to completely reinvent the company, and had it not been for his vision, we think there would have been a 100% chance that EFOI would have already filed for bankruptcy.
Now, we worry that the interim CEO, Stephen Socolof, who we view as having little skin in the game, will not make moves to maximize shareholder value. Without Tu leading the charge, we see subpar scenarios where the company is sold for a fraction of its real valuation, or faces bankruptcy or executes several dilutive financings.
We could possibly change our opinion on Socolof if he steps up to the plate and initiates a meaningful position in the stock on the open market, as opposed to riding his 20,500 shares, 17,000 of which appear to have been obtained through RSUs. We would also welcome an opportunity to have Socolof as a guest on our podcast to tell his side of the story.
Quite frankly, we are perplexed by the action of the Board at such a critical juncture for EFOI, right when it looked like the business was finally about to turn. Something really smells in Solon, Ohio. We call for EFOI investors AND retail investors in general, to get behind Tu.
Background
Energy Focus, Inc. sells products in two categories. The first is an LED lighting business that designs, develops, manufactures, and sells LED lighting systems to commercial and military maritime markets. The LED lighting business has all the hallmarks of a low-quality business: year-long sales cycles, lumpy revenue, being at the mercy of customers’ discretionary budgets, and downward pricing pressure. Now, with the pandemic, we need to deal with supply chain issues, cost inflation and delayed projects.
Energy Focus does not have the luxury of time to wait out volatile sales and pandemic headwinds as the company continues to lose $1.5 million quarterly, with quarterly revenue generally vacillating between $2 to $3 million. Mr. Tu joined the company for the first time in 2013 when the company was struggling to grow revenue and reach profitability. EFOI had a stellar run from 2013 to 2016.
During these 3 years, the company experienced significant growth. Specifically, after taking in account for asset sales in 2013, the remaining LED product revenues rose ~20x to around $60 million and reached significant profitability in 2015. This was reflected in the stock price which went up nearly 14x, ~$8.00 to ~$112.00, from the beginning of 2013 to August 2015.
Much of EFOI’s success during his first rodeo at the company came from Tu capitalizing on the company’s strong relationship with the U.S. Navy. However, after a big contract with the Navy was coming to an end, Tu was not confident that the state of the company’s commercial business was the answer to sustaining long term growth.
Tu viewed EFOI’s commercial business as rapidly commoditizing and that selling undifferentiated products through distributors was not an effective strategy. Furthermore, he felt that the EFOI did not do a great job of helping distributors understand EFOI’s products, resulting in suboptimal sales from these channels. He thought the best way to move forward was through building a direct sales channel, increasing the speed of product innovation and doing a better job educating the company’s distributors. That’s how you need to compete in a commodity focused industry.
The board disagreed with Tu, and he was dismissed in February 2017. After his dismissal, the business continued to suffer from unpredictable, declining revenues and consistent losses while going to market with an ineffective lighting agency distribution strategy.
In January 2019, the business was in terrible shape, down to an annual revenue run-rate of around $14 million, facing a liquidity crisis and in danger of being delisted from the NASDAQ. A group of investors turned activist, including James Tu and Gina Huang, acting together filed a 13-D as a group showing they owned 17.6% of the company and were awarded two board seats. Tu, the man once cast out from EFOI, invested $580,000 of his own money to keep the company alive.
Upon his return as CEO in April 2019, Tu turned EFOI’s focus to developing innovative technologies surrounding human centric lighting, starting with its new Enfocus lighting control system. James knew he could turn the distributor engine on once again when he had a new product line up.
Even though the LED retrofit market was somewhat of a commodity market, there are still opportunities for innovative products to grow. Despite signs of some strong progress on the financial front by the end of 2019 due to new military contract wins, when the COVID-19 pandemic hit, it decimated the retrofit LED lighting business as government and commercial customers put projects and funding on hold.
Tu pivoted quickly and started developing ultraviolet-C light disinfection (UVCD) products for commercial and consumer markets. UVCD products have been a timely addition as health conscious businesses and consumers seek to disinfect their offices and homes. According to the FDA, UVC radiation is a known disinfectant for air, water, and nonporous surfaces and destroys the outer protein coating of the SARS-Coronavirus.
The shift to UVCD has not been perfect. It required several iterations of UVCD cleaning robots, a pivot to two smaller products, and multiple inopportune capital raises. Along with a few setbacks, Tu effectively launched a new product category in less than two years that is not subject to the same risks as LED lighting. Tu’s efforts showed tangible progress in late 2021 and early 2022:
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Inked a marketing partnership with FirstEnergy Home in June 2021, a subsidiary of the third largest utility company, FirstEnergy.
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In October 2021 both the nUVo TRAVELER and nUVo TOWER were shown in independent third party testing to achieve a microbial reduction of airborne virus, bacteria, and mold, validating their effectiveness.
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In December 2021, EFOI announced its nUVO TRAVELER for small spaces was available for sale and the nUVo TOWER for spaces up to 500 square feet was available for pre-order. Shares rallied, showing that investors were excited about the direction of the company.
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A week later, EFOI raised $4.5 million, enough to fully fund the company and let the nUVo product line scale.
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In January 2022, one day after Tu was dismissed, the company put out a press release announcing a partnership with gig-driving app GRIDWISE for its nUVO TRAVELER UVC Air Disinfector, proven to destroy 99.9% of airborne pathogens.
It is our opinion that without Tu, EFOI is a sinking ship, captained by uninvested, impulsive, and inept management. Director and Interim CEO Stephen Socolof has a long venture capital background, as far as we can tell has never been a public company CEO, and has served as a director on five boards and an observer on one, all six resulting in sales.
Five of these sales were private companies and the terms of these acquisitions are not transparent. In all six sales, the acquirer gained full ownership of critical technology they already utilized from the Socolof-associated company. The setup looks eerily similar now that the nUVo product line has launched and may be beginning to gain traction. We are also not sure if COO and CFO Tod Nestor is fit to help lead EFOI, previously, working at a venture capital firm, serving as SVP and CFO for the now delisted Penn Traffic Company, and launching a hot dog and sausage restaurant that shuttered after seven months.
Outside of Tu and Huang, we calculate that the board owns an inconsequential amount of stock. Independent directors, Stephen Socolof, Phillip Politziner, and Jennifer Cheng own a combined 63,900 shares, but that does not tell the full story. Of this total, Socolof purchased 3,500 shares, Politziner 9,400 shares, and Cheng 0. The rest of ownership has come from shares the Board gave themselves, including granting each independent director 10,000 shares while the business struggled during the pandemic.
Not only do we believe the Board’s incentives are misaligned, but we also feel that this current Board does not have the necessary skills to run a public company. With the nUVo product line in place, the board dismissed Tu the day before announcing a promising partnership. The abrupt dismissal puzzled investors - why would the man who built a new product line get fired and why didn’t the company put out information for a plan moving forward?
We believe that the answer is simple: we believe this Board has breached its fiduciary duties and doesn’t feel investors’ pain because they themselves are not invested in Energy Focus with large direct purchases of stock. Since Tu’s firing, the stock has dropped ~50% in the span of a few weeks. Rather than being at an exciting inflection point, the business is at risk of becoming a zombie microcap without competent management, and is at risk of running out of money… again.
Call to Action - Hope Exists
The time is now for James Tu to turn activist and take back the company he has poured his time, energy, and personal capital into. This is a perfect case for shareholder activism. If he does come back to lead the company, In our opinion,Tu needs to accomplish three things:
- Replace Socolof, Politziner, and Cheng
- Focus on building and promoting the UVCD product line, and
- Sell off the deteriorating LED lighting business.
When it comes to EFOI, this is a game of chance. Who do you want to bet on, the man who spent nearly a decade working at the company, put his own money on the line, and transformed the business, or the leadership with no skin in the game and absent relevant experience?
