Greetings, and welcome to the Energy Focus Second Quarter 2019 Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tod Nestor, President and Chief Financial Officer. Thank you, sir. You may begin.

Thank you. Good morning, everyone. Joining me today for our prepared remarks is James Tu, Chairman and Chief Executive Officer at Energy Focus. Before we begin today's call, I need to remind you that we will make certain forward-looking statements. These statements are based upon information that represents the company's current expectations or beliefs. The results actually realized may differ materially. For a discussion of the risks that could affect our results, please refer to the discussion under the heading, risk factors in our most recent Form 10-K filed with the SEC. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Also, please note that during this call and any accompanying press releases, certain financial metrics are presented on both a GAAP and a non-GAAP adjusted basis. Reconciliations of adjusted results to the GAAP results are available in the tables attached to the earnings release, which is posted on our corporate website at www.energyfocus.com in the Investor Relations section. And now I'd like to turn the call over to James.

Thanks, Tod. Good morning, everyone, and thank you for your participation in our second quarter 2019 earnings call. This is the first earnings call since Energy Focus started its re-launch back in April this year when I rejoined the company. And we're excited to share with you what we have been doing on the re-launch and why. While the transformation work undertaking will take some time to complete and is a work in progress, we believe we're on the path to be a leading LED lighting company when it comes to quality, innovation and brand trust. I understand that for those investors that have been with Energy Focus over the years and they'll stick with us, it's been quite a roller coaster and disappointing experience over the past few years. I'd like to thank you for your continuing support and patience with the company. I would not have come back to the company and invested my own money in arguably the toughest moment of this company's history if I don't believe its future. So I'm 100% aligned with you for the company now to comeback from almost failing, but also return to the point where we once again can make significant and positive financial, environmental and human impact as we have always set out to do when I first joined the company as Chairman and CEO in 2013. For those who are new to the company's story we don't promise an easy way out from here, but we surely will put forward our best efforts to build an exciting and different kind of LED lighting company that could reward not only shareholders, but also all the stakeholders involved, be it our customers, channel partners, suppliers or communities we operate in. We will also make sure we communicate our strategy and…

Thank you, James. I'm excited about partnering with you to drive shareholder value to Energy Focus, and re-launching the company in a manner that places the customers' voice first, which generally is the best way to create innovative technology that can quite often sell itself. Now I'd like to summarize the results for the second quarter of fiscal 2019. Despite not being with the company for the quarter, I have had the opportunity to understand the business drivers for the performance and would like to communicate them now. History is just that, the past, not an indication of the future or how we expect to operate in the future under our re-launch, but we are obligated to explain the performance of the company for the second quarter of fiscal 2019. I would like to refer everyone to our earnings release and 10-Q issued this morning for more details surrounding our results I'm going to summarize shortly. Generally, the second quarter of fiscal 2019 saw significant decline versus prior year in both sales and gross margins, primarily due to a decline in the government sector, but the company also experienced a significantly less decline in the commercial sector. The diversion of government budgets to alternative uses likely contributed to some of the decline in the government sector as well as the lack of sales to a key customer in the commercial sector. Specifically, second quarter fiscal 2019 sales declined by $2.1 million or 40.4% versus same period in 2018. But on a sequential basis comparing the second quarter to the first quarter of fiscal 2019, the sales decline slowed dramatically to a negligible amount of $100,000 or down 3%. A 29% decline in volumes drove this decline in sales year-over-year with a 5.5:1 ratio of military to commercial sales contributing to…

Thank you. [Operator Instructions] Our first question comes from the line of Amit Dayal with H.C. Wainwright.

Thank you. Good morning, James, good morning, Tod. You guys have a lot on your plate. So I will limit my questions in light of all of the commentary already provided. Just going into sort of how the sales force is going to be reorganized with this new customer-centric focus, can you walk us through how you are going to potentially use the agency channel versus building potentially organically over here?

Sure. I mean, so we do have an agency network, and we have been [reviewing] [ph] the agency network, and we have consolidated the agency network. So we have less than 20 agencies now, and we are working with them. And as I mentioned earlier, we want to be able to educate and nurture these network. We have -- regardless of agency or contractors partner -- contracting partners we work with or directly with large customers. As we mentioned, the customer centricity is what drives our sales activity. So we are channel agnostic, but we want to be able to serve the end customers as best as we can even if we got brought into a new relationship by the intermediary, we want to be able to educate the end customers and help our customers solve their lighting problems. And that's what we're doing every day now. So in terms of the sales organization, we have a direct sales force that also opens other channel partners, as I mentioned, primarily the agencies and the contracting partners, and we're expanding that right now. And in addition, we are also working on inside sales organization, we are building up our inside sales capability. We also have particular specialty distribution partners, again these are considered the agencies of the world, but not necessarily lighting agency. And we have a few leaders in sales organizations, which -- we will be expanding our sales organization pretty aggressively obviously in the next few months. So at the end of the day, the agency network, the contracting network, the end customers, we are organizing our sales force to approach all of them with our product. And we have leaders in different channels to help us to support the sales -- regional salespeople.

So just to build on that a little bit whether we approach them directly or through an intermediary, we're going to partner, and do it through education and with our customer-centric view in a manner so that we're educating them about our products and what they can do. It won't be a hands-off approach, it'll be a very partnership approach.

Are you going to potentially bring in somebody to head this operation? Or are you working with the team in place already?

Both. As the company grows, definitely we will be hiring more leaders. As I mentioned, Tod just joined us last -- this quarter actually -- during this quarter. And we're actually recruiting additional leaders in sales, marketing, every aspect.

Understood. And you highlighted, you've got around 30% of the workforce, but you are also kind of rebuilding on that front. On that perspective, like operating costs, I know you've provided some color, but is this going to ramp aggressively? Or will it be sort of a moderate ramp over the next few quarters?

We don't believe that the costs will ramp significantly. Yes, we are rebuilding our staff -- but we believe that we can leverage the existing staff and grow significantly from here without adding a lot of overhead. I would say that the operating expenses will be relatively flat, but obviously trending up over time as we hire more people, but we expect sales to -- top line to grow faster, much faster than the operating expenses.

I would say that the compensation structures are much more rational too, and they'll be much more aligned. The line of sight will be much more aligned with pay-for-performance as well. So the bases are much lower than they were historically even as we add people.

Understood. Yeah, I think that's all I have for now. I will take my other questions offline. Thank you so much.

Thanks Amit.

[Operator Instructions] Our next question comes from the line of Allan Snider with Oppenheimer. Please proceed with your question.

Hello?

Yes, good morning Al.

I have a couple of questions that are brief. I noticed in the literature that you provided recently, you showed a couple of big-box stores, mentioned some other hospitals, these are the kind of things that create interest on the part of investors. Could you give me an indication of the time frame that is generally involved to go beyond a minimal involvement to one of major consideration with this type of facility, be it a hospital, big-box store or schools, universities as an example. You've mentioned a number of those as well. What do you foresee in that area because that represents an exciting area to an investor? They can smell that, they can taste that; that looks like dollars in the bottom line. So it's a long-winded question, but I just wonder how you feel about that.

Sure. So as you know our primary vertical that we have been focusing on are government, military, health care, higher education and K-12, these are pretty much contributing most of our sales today, and it's still very, very early in penetration. If you look at, there are 5,000 hospitals across the country, there are about 5,000 colleges and universities across the country, there are 12,000 school districts across the country. They are very, very penetrated in LED lighting and I can -- you can go back to your kids and your grandkids and look at their schools, the hospitals just not LEDs, LED is still very much on the new construction side. On the retrofit side, it's very, very lowly penetrated. So we want to be able to [indiscernible] the partnership that we have achieved. I would say that one thing that is notably different today versus say three, four, five years ago when we first started out, was that in the past we have to sell against fluorescent lighting, and we have to sell against, because of our quality positioning, sell against the large incumbent brand and both these two major, I guess, barrier to getting new customers have been removed. Today, there is no doubt that every facility manager wants to do LED lighting, and we're also not being the GE and the Philips of the world. And they're not considered so-called the premium lighting anymore. Obviously, watching the whole industry, they have been -- all been bought out or retreated and much smaller today. So those we're focusing on the institutions that value quality and performance. I think we have a very good odd these days to actually turn a new prospect into a customer within a few months. If you look at that back in 2013, '14, '15, it takes us a year to two years to - from the initial introduction to get...

Sure. That's understandable.

And now we're talking about a few short months. And that's because customers are much more educated on LED lighting now. They have all tried LED lighting products before, and they've all got bad experiences because -- and that's the fundamental misconception in the market where the enterprise lighting functions need much more rigorous quality on the lighting. And that is very different from the residential market. So we believe that the timing is very good now, and as we have mentioned we are seeing more activities. We are seeing faster -- much faster lead times, which is why it is important for us to build marketing and sales force to approach the market today that is very ready for us.

I will add one item to what James said. I think the customer-centricity approach, the customer referrals we do receive and the track record we have established with quality goes a long way too in accelerating that sales cycle. So when they talk to each other, it closes a deal for us. And I mentioned that early in my comments, those referrals help a lot and our quality and track record helps a lot.

Well, that's the way it should be ideally. And hopefully, the time frame for getting these orders will be narrowed a bit as the increase in the word gets passed around about who you guys are and what you do. I know competitively it must be awkward at times to run into a wall where someone is adamant about some other known quantity, and they're not familiar with you. And you have to have people who can speak up and make your case, and as I assume what you are doing and hopefully, may be sooner than later that we see some really good results and I'm hoping that's the case. And that's all I have to say, and I appreciate your time.

Thank you. Mr. Tu, it appears we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Thank you, everybody, for your participation on the earnings call. And we look forward to talking to you again in the third quarter 2019 earnings call. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.