Ladies and gentlemen, thank you for standing by, good day and welcome to the Energy Focus Second Quarter 2017 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Michael Port, Chief Financial Officer. Please go ahead, sir.

Thank you, operator. Good morning and thank you for joining us for Energy Focus' Second Quarter 2017 Earnings Conference Call. Today, Ted Tewksbury, our Chairman, 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 investor 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 and our actual results may differ materially from these statements. 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. I'd like to point out that our prepared remarks this morning includes non-generally accepted accounting principles or GAAP measures to supplement our discussion of the impact of our restructuring costs on our GAAP operating results. A reconciliation of these non-GAAP measures can be found in this morning's press release. Now I'd like to turn the call over to Ted.

Thanks, Michael. Good morning everyone and thank you for joining the call today. For the benefit of anyone on the call, who may be new to the story, I'd like to begin with a brief recap of the big picture. Our mission here at Energy Focus is to enable our customers to run their facilities with greater energy efficiency, comfort and wellness or maximizing the functionality of their existing lighting infrastructure. Our vision is to be the leader in smart LED retrofit solutions. Our strategy is first to grow sales with an experienced energy-focused trained network of agents and channel partners. Second to defend our military business, while diversifying into the much larger, commercial and industrial market. And third to expand our product portfolio to higher value lighting solutions, incorporating controls, sensors and wireless connectivity. I'll begin today with a summary of our financial results for the quarter, followed by some color on our end-markets and then provide a progress update on the turnaround initiatives we announced in February. Net revenue for the second quarter of 2017 came in at $6 million, up 46% sequentially. Gross profit of 25%, increased 12 percentage points over Q1. Thanks to our cost reduction initiatives; operating expenses excluding restructuring charges fell to $3.5 million. The lowest level in 10 consecutive quarters. As a result, cash consumption decreased $200,000 sequentially to $1.5 million, the lowest level in 6 consecutive quarters and at the end of the second quarter with a cash balance of $13.5 million. In addition, we reduced inventory by $1 million quarter-over-quarter to $13.2 million. Our continuing efforts to diversify and grow our business in $13 billion commercial and industrial markets are showing encouraging results. Q2 commercial revenue grew 68% sequentially to $5.2 million, the highest level in 6 consecutive quarters. Commercial and…

Thank you, Ted. First, our second quarter results. Total net sales for the quarter were $6 million, down 16% compared to the second quarter of 2016. Net sales of our commercial products increased 57% compared to the second quarter of 2016 as we completed various projects through our ESCO partners and experienced overall increased demand. As a reminder, our commercial revenue tends to be lumpy due to the long design cycles, uncertain timing of customer orders and construction and renovation schedules. Our second quarter commercial revenue of $5.2 million extends the trend in the increase of commercial sales and is the highest level in 6 consecutive quarters. Net sales of our military maritime products decreased 78% primarily due to our distributors' ability to satisfy the US Navy's current demand from their existing inventory. As you may recall, we fulfilled the final contractually required stocking order to our distributor in December 2016 and the contract expired in March, 2017. For the quarter, sales of commercial products comprised 86% of net sales while sales of military maritime products represented 14% of net sales. This compares to a second quarter 2016 product mix of 46% and 54% for commercial and military maritime sales respectively. Our second quarter 2017 gross margin was 25%, a decline of 10 percentage points from the second quarter of 2016. The overall decline in gross margin percentage is primarily the result of lower volumes which unfavorably impacted our manufacturing and overhead absorption and product mix as the military maritime products sold in 2016 generally had a higher standard gross margin than our 2017 military maritime standard gross margins. Additionally, our second quarter 2017 gross margins were impacted by the higher cost of inventory, which was ordered in late 2016 and early 2017 to satisfy anticipated demand, which did not…

[Operator Instructions]. And first we'll go to Craig Irwin with Roth Capital Partners.

Congratulations on that nice revenue rebound. So Ted, I wanted to ask a few questions about your commercial sales in the quarter, See if maybe you could give us additional color on the character of the revenue. Can you maybe share with us, the number of deliveries over 50,000 or over 100,000 to make up that pretty respectable number that you posted, $5.2 million. And as we look longer term, the military business is a very different business than the commercial business, if you could talk a little bit about the margin profile of commercial and where you think things could settle out as volumes continue to increase?

To your first question, as far as providing more granularity on the commercial sales, we don't generally do that, it's quite fragmented and I'm not sure if it will be particularly useful information. What I can reiterate is what I said in the script, which is that approximately 40% of the commercial sales came from healthcare opportunities and those tend to be fairly large opportunities, not by 100s of 1000s of dollars in revenue. Similarly, with the schools, I mentioned a couple of schools, those generally go through our ESCO partners, but I don't want to provide any more granularity beyond what I provided in the prepared remarks. Now as far as the margin profile is concerned, there's 2 trends that are happening here. First of all you've got military margins that historically have been much higher than our average, but those are starting to come down now due to the increased competition that we're seeing. Unfortunately, our competitors have not done any favors as far as fostering gross margins in that market. Pricing basically got cut in half. So we're seeing military margins coming down and at the same time, over time, you're going to start seeing our commercial gross margins going up really for two reasons, one being that we're paying a lot of attention to reducing our cost of goods sold, but more importantly, because we're increasing the value of our commercial products. I mean products like RedCap is a unique new to the world product that nobody else in the world has today. Now we won't be able to enjoy that advantage forever and that's why we're loading up the pipeline with more high value-added lighting solutions and as we start to transition to connected lighting solutions that have occupancy sensors and daylight harvesting and other connected attributes, that will increase our value further. So to answer your question, the goal that I've got in my mind is 35% to 40% over the long haul and hopefully being the semiconductor guy, I'm used to seeing much higher margins and hopefully we can do that.

Great, that's really good to hear. So if we could talk a little bit about the past. the EBITDA breakeven. So I know when you originally put together the plan, the company was in a significant period of transition and visibility around revenues never really all that high in the lighting markets. Can you maybe comment on whether or not there are additional actions that you might take internally that could pull that forward or maybe bring the quarterly revenue breakeven down or if you're comfortable with the plan you've implemented and see this as something that's a reasonable match for what you're anticipating as far as near term demand and where you expect to execute to?

Yes, there's really two components to this. First was our announcement of the $10 million year-over-year cost reduction plan and we put out the $10 million goal back - backed them as a company for 2 months and I had been CEO for about a week. We're currently tracking to $8 million out of that $10 million, which is - to put that in perspective, that's a 30% reduction in operating expenses year-over-year, which is incredibly impressive for a company of our size, but more important than hitting the exact number is making sure that we dial in the right number to balance short term profitability with longer term revenue growth and that longer term revenue growth of course depends on making sure that we've got a robust pipeline of new products and those products get introduced on time. So now that I've had a full quarter of - well, we as a company have had a full quarter of the restructuring under our belts and we've completely reorganized sales and reformulated the new product pipeline, we're able to refine the model and strike the optimal balance between short term profitability and long term growth. And so right now, what we could tell you for certain is that year-over-year reduction is going to be somewhere between $8 million and $10 million, probably the optimal was closer to $8 million based on the information I have today, which is much better than the information that I had when we put the original goal out there, but let me emphasize that $10 million is still our goal and we're going to be sharpening our pencils and doing everything we can between now and the end of the year to get as close as we can to that number. Now, as far as…

Great, thank you for that. Another question I wanted to ask is actually on the product road map. So when we talk to the lighting agencies and your competitors, Cleveland Clinics is a great example. We understand that there were - some of the biggest players in lighting in there competing for that job and Energy Focus won the job straight and even and the company's been recognized in the past for significant innovation, the Intellitube got big highlights at Lightfair a couple of years ago shortly after it was introduced. As we look at the current status of the market today, the one product in LED tubes that seem to be getting the most attention is the products with embedded controls in the last few inches. I don't think these are big volume products yet, but a lot of the agencies we talk to say that they are mandated to include controls in a lot of the projects, particularly things like schools by the building codes and if they can just throw in the new tube that has the controls embedded in the end seems a lot of money since they don't have to change out the fixtures. It's a much more compelling product to the customers out there. Can you comment whether or not this is something you're working on? Do you have something that you're in trials with? Would you expect to be completing effectively versus the people that have introduced the products to date and are there any particular different functionalities should you see as increasing the value add in your 2 products that maybe will come out in the next year?

The answer is absolutely yes Craig. Today, if you look at the company, we are known for quality, performance and lifetime. That's our value proposition and under performance, we have lowest flicker and many other attributes in terms of efficacy, THT other attributes. In the next year or 2, we will be known as the connected lighting solutions leader and when I say solutions, that's not just lamps, but also fixtures. The connected lighting trend is very real. It hasn't gotten a lot of traction yet, but it undoubtedly will and when I look at Energy Focus, our strength is retrofit. Today we're retrofitting lighting in this industry but if you look at IoT, the best way to get IoT including sensors, daylight harvesting, tunable color temperature as well as asset tracking, non-lighting related capabilities, the quickest way to get that into an existing building is through the lighting side. You want to have the sensors and wireless nodes in every place in the building or you got people and assets and they have access to power. Well, what's ubiquitous and has access to power? Lighting side is. So this will happen, it is happening. We actually did have a connected lighting product in our portfolio. I sold it because I didn't think it was forward-looking enough. I didn't meet my criterion for being a world's first or a world's best. So I have reset that program and I assure you that when we do have the introduction of our first connected lighting product, it will be a game changer, but that is very much in our road map, so is tunable color temperature, daylight harvesting, task tuning, occupancy sensing, these are all important capabilities, but I'm not going to say more than that because as I mentioned in the prepared remarks, this company has had a tendency to get too far out of their skies and announce what they are doing to the benefit of competitors and I don't want to do that.

And moving on, we'll go to Mark Miller with The Benchmark Company.

You mentioned I believe when there will be a hospital in Puerto Rico and some schools, were there any other wins during the quarter for you?

Well, yes, many, many. To get to the price point, $2 million in commercial revenue, but I don't want to get into the minutia of rattling off the entire risk, but that gives you some general color on where the wins are coming from. Well I have certainly mentioned also in the prepared remarks, I don't think it's particularly helpful to give the investment community visibility of every win down to the $50,000 or $100,000 level every quarter. So what we will be doing is anything that's particularly large or noteworthy like Cleveland Clinic or a major retail chain, we'll certainly announce that, but we'll avoid getting into the weeds.

You mentioned you were replacing higher cost inventory with lower cost inventory. Do you expect any inventory obsolescence causes in the quarters ahead?

We continue to evaluate that on a quarter basis and our policies - accounting policies and under GAAP. Frankly, if you go back and look at the history since 2015, we've taken some pretty healthy reserves because of our anticipated demand slowdown. I think as of right now, we're back on track and we won't be experiencing the excess inventory reserves that we have in the past over the rest of the quarter. We've slowed down our buying substantially and we have that under the control and we're working very diligently to make sure that we've got a process in place that matches up our inventory purchases much closer to our anticipated demand and when these items will ship to customers.

You've done a good job on managing your cash over the first half of this year. Do you expect a similar cash drain or should that be reduced in the second half of the year?

I think what principally drives our - there's 3 - couple of things that drive our cash consumption. The most significant one of course is that top line, the revenue and how much we can - how much more we're able to drive that and tied to that is the reduction in inventory and accounts receivable. So I think this quarter is fairly representative of Q1 and again, we'll be able to either generate cash or consume cash based on sort of how we're able to drive our top line.

Carter Driscoll with FBR Capital Markets has our next question.

First question, just kind of following up, is there potentially any 0 cost inventory that you could flow through in future quarters?

So let my comments indicate that we made some strategic decisions. Again, we have to balance off all the equations and being able to move some of the inventory that we have reserved. Based on some of the inventory we have, we do have some that's fully reserved. I'm not going to get into the granularity as to how much that represents, but if you go to our 10-Q note 5 for the inventories, you'll notice we have a - as of June 30, we had about $5.3 million in inventory reserves for excess slow moving and some valuation reserves.

Okay, that's helpful. Maybe Ted, of the military segments you're targeting, obviously give a little bit of color on the retrofit and what was your conditional domination of the Navy for that segment? Which of those kind of 3 that you've identified you think could contribute more to near term growth? Would it be the bases for Navy, just trying to get a sense of how you rank those in terms of a rebound in military business going forward?

Well, going in reverse order, probably the one that's not going to be as much near term revenue would be the new ship fixtures because those cycle times tends to be very long as I pointed out depends on DoD budgets and from the time you win a bid to the time you actually ship the product can be up to a year. So that's going to be a longer term, probably 12 months plus kind of initiative. I think the wildcard in all of this is the bases - the base is the largest remaining opportunity at $165 million total available market and we've had some good initial successes. The problem as I pointed out is that we haven't had the right sales force. Now that we put the sales force in place, I'm very excited about that opportunity, but again, it's a wildcard because a lot of it depends on relationships that we haven't had in the past and that we're going to have to build, but I think that's a very promising avenue. Now I think the third opportunity, which is the one that we've historically focused on is retrofitting of existing ships. That one, we don't have a lot of visibility into. As I mentioned, there's only one bid out there now for less than 3,000 tubes and there's still a good deal of inventory in our distributor - ADS. And so once that market comes back and once the inventory is exhausted at our distributor, I think that will continue to be a revenue generator for us, but to put that in perspective, we think there's only about $50 million remaining market there due to the excellent success we've had in the past. We've penetrated about 50% of that business and now the remainder is going to be shared between 3 competitors and the price is half of what it used to be. So looking at all 3, the one I'm most excited about is the base opportunity.

And then in terms of all other channels - you've done since you've taken over, do you feel that this will help improve or reduce the amount of turns business you have in a particular quarter. Obviously you're still going to have a significant amount I would imagine for several quarters until you completely change out the product portfolio and develop the channels, but could we see increasing - I'm going to say backlog or conviction in the quarters ahead, could we reach 50% type of book to typical ship within a quarter over some time frame?

I think that's unlikely to happen. It's just the nature of our business, it's a book and ship kind of business where we don't have a lot of visibility. So I'd be surprised if we ever saw backlog coverage at the beginning of the quarter growing an extra by 20% I'm hoping it will but what will happen is that we will have more certainty on the trends side of our business simply by virtue of the fact that we've got some more opportunities in the funnel. So I mean, think of it, it's just numbers. Today if we had say 10 major opportunities, major being a few hundred thousand dollars or more in the funnel for the quarter and if 1 or 2 of those go away, well then that blows our forecast. If you got a 100 or 1,000 of those opportunities in the funnel and a few of them go away, they are likely to be offset by a few that pop up out of nowhere that you didn't forecast. And so what the agents are going to bring is just a massive increase in number of opportunities in the funnel. So that's going to make our revenue more predictable even though turns is going to remain on a high, those turns will be more predictable simply by virtue of the law of large numbers, more averaging going on.

And then, I know it's been asked a bunch of times, let me see if I can ask this slightly different way, in terms of the commercial customer base, could you quantify just the total number of customers you think you're shipping to either in this quarter over say the trailing 6 months?

You want to take a stab at that Michael?

I'd hate to guess because it is fairly lumpy. Again we get rather large orders in and then we ship some small ones. We can definitely come up with that data at some point, but it's not something that we particularly track.

More than one few hundred thousand.

Yes, if that's something that you're interested in seeing, we can start reporting those numbers. I don't want get into the granularity of disclosing customers name and that sort of thing, but we can give you some aggregate numbers on the number of opportunities. I'm not sure it's very useful because we've got small opportunities too and we've got customers who are shipping 5 to 10 tubes and then we've got customers who are shipping 200,000 tubes.

Just trying to get a sense of how many customers say might order in 1 quarter, go away for 1 quarter or 2 or come back just trying to maybe assess the change in that customer group from QtoQ, maybe that provides a little granularity since there's so many other things that are difficult in a book to ship business?

It's a good question Carter, let me go away and see if we can come back with a metric that will answer that question for you.

And just last one if I may, on the healthcare side, so obviously Cleveland Clinic was a substantial win for you a while back. Prior administration was talking about the New York City - some of the large hospitals in this area, some of the other hospital change, could you maybe talk about progress there again without necessarily naming names. Something of a - if not a similar size of Cleveland Clinic, but maybe a major win that hurdles and/or kind of competitive environment that you have to overcome to get such a large win in that segment? Thank you.

I think in general we are the tube of choice for hospital retrofits. Obviously we have very good references from Cleveland as well as some of the other well-known hospitals in the area here. The problem has simply been that we've lacked the sales coverage and we are working with virtually every notable hospital in the Ohio area here in the Midwest, but we just haven't had the coverage in Boston or San Diego or Florida or other areas where there are a lot of healthcare facilities. So we're already seeing an increase in quoting activity for - for other large hospitals as a result of our agents and net partners. [indiscernible] just to give some indication as I mentioned, of the $5.2 million that we did in commercial this quarter, 40% of it was healthcare. So it's significant.

And that will conclude today's conference. We'd like to thank everyone for their participation. You may now disconnect.