Ted Tewksbury - CEO Bradley White - CFO

Colin Rusch - Oppenheimer Carter Driscoll - FBR Craig Irwin - ROTH Capital Partners Mark Miller - Benchmark Company Cindy Motz - Williams Capital Group

Good day, ladies and gentleman and welcome to the Energy Focus Fourth Quarter 2016 Earnings Conference Call. Please note this conference is being recorded. At this time, I handle this conference over to Mr. Bradley White. Please go ahead sir.

Thank you, operator, and good morning to everyone. Thank you for joining us for Energy Focus' fourth quarter 2016 earnings conference call. Today, Dr. Tewksbury Our Chairman, Chief Executive Officer and President and I will report on our results for the quarter and for the full year 2016. The news release and our annual report filed on Form 10-Q have been posted to our Web site 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 what 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'd like to turn the call over to Ted.

Thanks Bradley and good morning everyone. I like to begin with the management changes we announced earlier this week. Effective February 19, James Tu has stepped down as Chief Executive Officer and President. And both Mr. Tu and Simon Cheng have resigned from the board of Directors. As most of you know, I joined Energy Focus in December as Executive Chairman of the Board and will now be serving as Chairman, Chief Executive Officer and President. On behalf of our Board of Directors and employees of Energy Focus, I like to begin by thanking James for his contributions for the company and wishing him the best future endeavors. James sought to make Energy Focus the leading supplier of LED tubes to the U.S. Navy, which drove the exceptional growth of the company in 2015, he established the foundation on which we will build the next generation of product leadership and profitable revenue growth. It is truly a pleasure and a privilege to join the talented and hardware team here at Energy Focus. While I may be a new name in the lighting sector, I'm a very well know public company CEO, Board Director and Technologies in the semi-conductor industry. My passion is building new growth business and turning around underperforming companies, and I've a proven track record of creating extraordinary value for shareholders, customers and employee. Just to share a couple of example, as CEO I transformed IET a $600 million public semiconductor company from a declining commodity chip maker into a premier mix signal solutions provider with revenue growth and stock price outperforming the market and leadership positions and new product categories such as analog, wireless battery charging and radio frequency chips. As CEO of Entropic Communications I returned to company to profitability and so did I add a premium for Max Liner, where I now serve on the Board of Directors. My technology background and three degrees from MIT in Electrical Engineering and Architectural Design are an ideal fit to propel Energy Focus to leadership in the next generation of advance driving technologies. I joined Energy Focus for two reasons, first the company is an undisputed technology leader in LED lighting solutions, with strong core competencies and the trust reputation for excellence with top tier customers. Second, it was clear that the company was in need of experienced leadership to parley these strengths into value for stockholder. I saw an opportunity to use my turn around expertise to help put the company back on a profitable growth trajectory. We have a lot of ground to cover today. First, I'll review our fourth quarter and fiscal 2016 results, then I'll provide some color on our end markets followed by a discussion of our strategy to return the company to profitable revenue. Showing with our top-level results fourth quarter revenue came in at $7.2 million which was $1.1 million below the lower end of our guidance and a 13% decrease from the prior quarter. Net loss for the quarter was $7.8 million or $0.67 per diluted share. For fiscal 2016 revenue was $31 million down 52% from 2015 primarily due to a 68% decrease in military maritime sales. Gross margin came in at 24.8% due to lower sales and favorable products mix and right off was excess and obsolete inventory. Net loss was $16.9 million or $1.48 per diluted share. We exited the year with $16.6 million of cash and no debt on the balance sheet. Let me now provide some color on our end markets and the magnitude of the loss for the fourth quarter. The revenue decline in our military maritime business was due to slowdown in demand for our military and Intellitube products from the U.S. Navy, combined with excess inventory for our distributor. This inventory over shoot could have been avoided by a more disciplined inventory management and monitoring of end customer consumption, which we are now put in place. Our penetration rates is currently about 35% for the Intellitube and the existing U.S. Navy fleet. However we are no longer the only qualified vendor for this customer. As a result of this competitive environment and the oversupply of product in the distribution channel we are not expecting significant sales in the near-term and have made corresponding adjustments to our related equipment and inventory value. We are continuing to expand our sales in other areas of our military business. For example, in foreign navy's, military CUS command, coast guard and military basis. In addition to retrofit we were recently awarded our first win for LEDs fixtures in new ship construction. The decline in our military maritime business was partially offset by a 5% year-over-year growth in commercial sales coming primarily from healthcare and education. In healthcare, we continued to ship tube LEDs to a well-known Northeast Ohio hospital and are expanding our business with this customer to accomplish both interior and exterior LED lighting solutions. We also made initial deliveries to a number of new customer in the healthcare, education, government, retail, industrial and manufacturing segments. Despite progress in these areas, our overall financial results for the quarter and for 2016 was very disappointing, falling well short of our internal expectations and external guidance. This performance is unacceptable and I promise you that I will turn it around. I have two immediate priorities. First, to return to company to profitability and second to rejuvenate revenue growth. Beyond that our mission is toward Energy Focus the trusted leader and the complete lighting solutions for the most demanding applications. Since my arrival in December I've been working closely with the Board of Directors and the Executive team to formulate a detailed strategy to achieve these goals. Having been with the company for only two months they are bound to be some ongoing adjustment, but let me share the broad outlines of our strategy. Our first priority is to return to profitability, given the recent declining our military maritime business and the timing uncertainty of commercial sales growth, we are scaling down operating costs commercial with a conservative near term revenue outlook. Earlier this week, we announced company-wide restructuring initiatives to streamline operations and reduce the operating expenses by $10 million. In addition to lowering operating expenses, we have launched an aggressive progress to reduce our manufacturing costs through product reengineering, component cost down initiatives and reconfiguration of certain manufacturing lines. These cost reductions are being made in a highly selective and targeted matter to ensure that they do not jeopardize critical projects or future revenue stream. Following a comprehensive review of everything the company is working on, we have focused our resources on core and strategic projects, well exiting activities that are lesser essential to our business. These initiatives will enable us to conserve cash until revenue growth resumes. In addition, they were increase efficiencies and enable us for locally [ph] as a team. Our second priorities to rejuvenate revenue growth and we have permeated five-point strategy to achieve this. First we are focusing our commercial lighting business on healthcare, education, and large commercial facilities where customers need and value our unique technologies. These are large growing but underserved markets were energy focused and provide solutions to unmet customer needs. Furthermore, these are the segments in which we had the greatest success to date, though we're simply intensifying our focused on what's already working for us. Conversely we are exiting markets where we haven’t been as successful, including low end commodity segments where buying decisions are made primarily on price. The 24x7 operating hours in healthcare facilities required the long lifetime, low maintenance and high quality that our products provide. In addition, education and healthcare facilities are increasingly demanding, the elimination of Optical Flicker, which has been shown to contribute to eye strain, fatigue, headaches, inability to focus, autistic spectrum disorder and a wide range of health issues. Last quarter, Energy Focus announced that we have the first and only ultra-low flicker LED tube on the market that has been certified by underwriter's laboratories at less than 1% Optical Flicker. We are leveraging our Low Optical Flicker advantage to aggressively expand our share of this market. Second, we'll expand and diversify on military maritime business into other extremely applications that share the Navy's need for heavy duty long-lived time, low maintenance lighting solutions. We’re already shipping LED tubes into commercial shipping and we're exploring other demanding segments including heavy industry, infrastructure and hazardous environments, such as [indiscernible], mining and subways where it is difficult expensive or dangerous for technicians to change tubes, this is potentially large and untapped market for an of your folks [indiscernible]. Third, we’re expanding our portfolio into new categories of products and services in order to be a more complete solutions provider to our customers. We have a number of exciting new products in the development pipeline including innovative fixtures and trappers [ph], as well as the integrated emergency battery backup too that was discussed on previous calls. Fourth, we'll be an innovation leader in the next generation of intelligent lighting technologies. There is a revolution going on in the lighting industry, as traditional lighting convergence with the Internet of Things. Today’s lighting solutions continue increasing electronic content, such as control, connectivity and centers. In previous earnings call we've discussed our Network-Ready Damocles 2 which is just the first in the series of advance products. In order to pursue these developments, while simultaneously minimizing R&D, we will seek to augment the internal investment with partnership leveraging electronic industry background and network. All of these initiatives will grow our available market and expand our strategic value to customers. But off course strategy is nothing without execution. So the fifth point of our strategy is to put in place the team and the process to execute with speed and precision. This being with fill [ph], which off course is the most powerful method for growing our revenue in the near term. First and for most, I'll be recruiting a world class head of sale and marketing to transform our sales force from a product oriented model to a highly effective solution selling team. We've already consolidated the sales organization to align with our two-core market, military maritime and commercial, with commercial focused on health care and education. [indiscernible] we will be deploying regionally focused sales comp management team to expand our geographic coverage. In order to magnify sales productivity while minimizing SG&A we were augment to direct sales force with an energy focused trained network of distributors and sales representatives. Finally, we're implementing discipline sales processes to improve funnel management, designing and tracking, forecasting, lead generation and follow up. In addition to a head of sales and marketing, I'm actively developing the executive suite to ensure that we have the right people and the right positions to scale the company to the next level. In addition to me the company hired an experienced CFO, Bradley White in December. I'm also recruiting a world class Senior VP of product development to lead new product definition and engineering, while I'm more than qualified doing both of these functions in the short term, it’s a top priority of mine to fill this positions with best in class talent. Have built many executing teams from the ground up I anticipate that this will be swift process. Finally, Bradley and I are rolling out a set of best practice, disciplines, processes and management techniques for new product development, quality, finance, operations and HR to hold our people accountable and ensure that we meet our commitments to customers, shareholders and employees. Despite our recently challenges Energy Focus has a strong foundation with great people, making great product right here in the great state of Ohio. The strategy I outlined will enable us to return to profitability and revenue growth and beyond that to industry leadership in the LED lighting solutions. I know that we can do it, because I have done it before. I would like to thank you and all our stock holders for your commitment and patients and all of our employees for their dedication and hard work. We entered 2017 as a smaller, but liner and more focused company with a promising and exciting future ahead. With that I’ll turn it over to Bradley, to elaborate on our financials and our restructuring initiative.

Thank you, Ted. For our financial summary, I'll turn our attention to the fourth quarter activity and then move into full year results. As Ted mentioned net sales were $7.2 million for the fourth quarter, representing a decrease of 58% when compared with fourth quarter of 2015. The decrease was due to a 52% reduction in commercial products and 62% reduction in sales from our Mercury maritime products for the U.S. Navy. To recognized the 1.1 million loss from the gross profit lines for the fourth quarter compared to gross profit of $7.6 million in the fourth quarter 2015. The decrease was driven by the write off of excess inventory totally $3.8 million. To elaborate on this let me explain that during the first half of 2016 we initiated an aggressive inventory procurement plan in order to meet the expected demand based on our commercial sales growth experienced during the first six months of the year. While we did not achieve this levels of sales activity, we had already committed to inventory purchases well into the third quarter due to manufacturing and shipment lead times. Which I recognize is a matter that has been discussed during prior earnings call. As a result our inventory level increased $5.6 million as of year-end 2016 compared to 2015. It’s important to note that we have begun to take steps to address our inventory levels and as a result of our gross inventory from Q3 to Q4 2016 sequentially came down by 750,000. And we will continue to trend to lower levels as we execute our 2017 operating plan. Aside from these steps we are require to evaluate our year-end inventory quantities through excess levels and for potential obeisance and have accordingly charge $3.8 million to cost of sales from continuing operations to recognize excess inventory at year-end. Our operating loss was 7.8 million for the quarter, which included a $900,000 charge for the impairment of certain manufacturing assets, compared to operating income of $1.5 million in the of 2015. As a result to the decline in the level of expected future sales of our military maritime products and reductions in the cost of procuring components for our supplier. We reevaluated the economics of manufacturing versus purchasing certain products and have determined that we would no longer using equipment and software purchase to conduct this manufacturing. We evaluated the carrying value compared to its fair market value and determined that the equipment in software were impaired. An impairment loss of 900,000 has been recorded to adjust procuring value of equipment and software to its net realizable value as of December 31, 2016. Looking at our bottom line this activity resulted in a net loss of $7.8 million for the fourth quarter 2016 or negative $0.67 per diluted share compared to net income of $1.2 million or $0.11 per diluted share for the same period last year. For the full-year 2016 our net sales were $31 million representing a decreased of 52% compared to 2015 levels. Commercial products sales increased 5% as we continue to develop our target vertical markets for hospitals, higher education, industrial manufacturers and national retailers. Military maritime products sales decreased sharply, a 68% reductions from 2015 as a result of continued lower volume sales to distributor for the U.S. Navy. Losses from continuing operations were 16.8 million in 2016, a decrease of 26.5 million compared to income from continuing operations of 9.7 million in 2015. Lower net sales and increase in inventory throughout the year and a $4.9 million increase in operating expenses, all contributed to the diminish financial results. Focusing on cash flows, our December 31, 2016 cash on hand totaled $16.6 million, compared to $34.6 million at December 31, 2015. This change is quite primarily driven by our cash used in operating activities which totaled $16.6 million in 2016 driven by net losses, recognized during the year in addition to the impairment loss on the manufacturing assets, and the adjustment to our inventory reserve. With our 2016 results being what they were, it’s clear that we were not able to sustain the level of sales and profitability recognized in 2015 or near desired level. Due to the financial performance in 2016 and primarily focusing on our total operating expenditures of $24.5 million, a reduction of cash on hand of $18 million, we’re taking immediate steps to restructure the organization. As Ted mentioned, we announced an initiatives designed to streamline operations and our operating costs, heighten organizational focus on healthcare markets and further to [indiscernible], but the plan include an organizational consolidation of management and oversight function in a way we can better align the organization into more focused, efficient and cost effective reporting relationships. Restructuring plan includes a significant reduction of external spend on G&A. Headcount reductions represented more than 15% of our workforce and our closure of our offices in Virginia and New York City. We’re in the process of evaluating the impact of this expected actions and estimate that approximately $1 million in restructuring charges will be recorded during the first quarter of 2017. And our overall operating cost will be by $10 million by the end of the year. So as we look ahead, given the currently volatile and volatility in our military maritime sales and the timing uncertainty in commercial sales growth, it is challenging for us to provide quarterly revenue guidance at this time. Our focus is to control our operating costs so that we can reach profitability by the end of 2017. Once our revenue achieves a more predictable growth rate, we’ll provide further guidance. Now overall my message today should not be construed only as the financial summary of a disappointing year. So I'm going to be clear that we are taking the steps needed today and executing on our plans with rigorous discipline to ensure that we not only deliver on our return to profitability, but we also take full advantage of the changing industry and opposition within that industry in support of all the reasons I decided to join the company a few months ago. With that, I’ll turn the call back to Ted with some concluding thoughts and then we'll plan to respond to your questions. Thank you.

Thank you, Bradley. Turnaround situations present an extraordinary value creation opportunity. I believe that energy focused provide the idea platform for a successful turnaround. The company has unique technology to solve unmet customer needs in larger growing market. We have trusted relationships with marque customers and a reputation for excellence in delivering premier lighting products and services. There is incredible value here that can be unlocked with experienced leadership. We now have an executed upon and are on our way to unleashing the company's potential and returning to profitability revenue growth by the end of 2017. I’d like thank all of you for your continued interest in Energy Focus. Bradley and I will be at the Roth Conference on March 15th, and for those of you who are in the industry we'll be at LightFair in May. We hope to see you there. With that I'll turn it back to the operator to open the lines for question.

Thank you.[Operator Instructions] Our first question will come from Colin Rusch with Oppenheimer.

Guys one of the little growth stories here is in the commercial lighting segment and it sounds like the plans that you have are a little bit more robust in terms of the potential for the functionality of these lights and how they can really serve customer. Can you talk a little bit about sales strategy and the customer education strategy that you're planning to implement as you approach that market in fresh way?

That’s such a great question Colin, we use our complex system solutions sales and I think in the past, when we were working primarily in the public sector with the escalate [ph], the sales tended to be more on a product level and customers didn’t require or didn’t want a lot of information of value, the kind of attributes that Energy Focus brought to the market. Now that we shifted away from public sector, we're going to focus more on healthcare, education and large Fortune 500 commercial customer. They do have needs that really require Energy Focus' capability and we can solve those problems in a unique way, not only through our products, but through our service. We do auditing, we do concentration. We provided a complete system solutions sales to those customer. So the education process is important, we’ve got right now 12 sales people in the field, direct sales people which is actually too small in order to do the job, so one of the things that we're going is putting more sales account managers in place with a regional focus, so that we'll have full geographic coverage across the country to address these facilities. Our people are experts in these particular verticals and so with combined [indiscernible] with the executive management as well as the people that will be doing the installations in these facilities to educate among the merits of our product. In addition as I mentioned in my prepared remarks, I want to amplify what the direct sales people can do by brining on a more robust network of distribution and sales raps. Obviously, those people will have to be trained to sell this complex system and so we will bring them into our facility and train them on a regular basis. That’s basically the direction we're going. I hope that answer's your question.

And then on the military business, there has kind of historically been a lack of visibility to sell through and obviously we've been able to -- the company has been able to expand the end markets to start making that, but how much can you change in that-that part of the channel in terms of getting little bit there visibility obviously reducing inventory is incredibly helpful on that front but, is there way that you can get a tighter grip on that part of the business, so there is a bit more of a consistency in terms of revenue and the cash flow that comes off of it.

So we actually have a good relationship with our distributor we have one primary distributor which I'm sure has been talked about on the past earnings calls which is ADS, Atlantic Diving Supply [ph] in Virginia, and Bradley and I are headed down to Virginia in next week to meet with ADS to make sure that they've got the right level of information from them to be able to do a better job of managing our inventory levels. In addition to that we have very good relationships with the Navy and we actually have a lobbyist in Washington that would directly with the Navy and the government to collect information and analytics on end customer consumption. Actually, I'd be in Virginia next week also to meet with one of the secretaries from the Navy to better understand their demand. I think we can do a better job with the bottom line and matching inventory to the actual Navy consumption.

Alright.

Thank you. Our next question will come from Carter Driscoll with FBR.

First, maybe just going back to the high-level strategy and I realize that you are just beginning to implement this company wide and in lot of different moving parts. I guess if get your initial take on it sounded though your two priorities are obviously regaining profitability and then driving revenue growth up. Are they -- I see them as really more intertwined than separate, it sounds like Navy have a different view point. Maybe could just elaborate, how do you have one really without the other, with your priorities in terms of expanding the production offerings at the same time and trying to preserve your cash balance?

Yes, while I was just looking at that in terms of near-term and long-term. What near terms is not a lot of models that can be turned to increase revenue with the exception of sales, which I emphasized during my prepared remarks. Longer terms we're focused on in growing the revenue, building a more robust new product pipeline to get the top line growing in the right direction. But this is going to be a challenging six months which is why we didn't give you quarterly guidance, I would like to be able to give you quarterly guidance. But on account of the dynamics of and the volatility of the military segment and the timing and the certainty of when these commercial products are going to ramp, we don’t have much visibility so in the next six months we've taken a very conservative outlook for revenue and the one thing that we can control is our cost structure. So we're adjusting our cost structure in order to achieve profitability which is why I said the first priority is profitability. Obviously, we are just as focused on growth as we always have been, but that takes a little bit longer to kick in and we want to make sure that we can serve our cash until we get better visibility.

And then just shifting gears, within the military and maritime while I guess the previous year's qualified military maritime [indiscernible], but that seems to be an opportunity that the power administration thought was a big opportunity, could you talk about where, within military maritime you see the biggest opportunity and you talked about having the first new build win, I think that's they're relatively limited market in terms of total opportunities though [indiscernible]. If we kind of prioritize at least in that part of the business where we think the biggest opportunities are?

Yes, so as you mentioned, I think maybe fixtures in new ship constructions and hopefully with new chip construction accelerating under the Trump administration, there is a good opportunity there. The other opportunity is adjacencies within the military. So we talked about the U.S. coast guard, military basis, military sealift command and so forth. And then the third opportunity is they consider to retrofit the existing fleet. I did mention that we have a new competitor LED Smart, which is a Canadian company, Chinese owned company making foreign made product and shipping out into the Navy. Now what's changed here is that the Navy appears to have relaxed their requirement to buy American, which is surprising actually and, again this is one of the reasons that we have a lobbyist in Washington and we're working our contacts in Washington and I’ve got some meetings with the Navy next week, to understand how this can possibly be, particularly in the Trump administration, the emphasis of them buying American and there were some serious security risks to having foreign made components on U.S. ships. But if we can get over those obstacles and also do a little bit of cost reduction on our existing military and products I think there is still a very good opportunity to retrofit in the existing fleet. Also I should mentioned that this new competitor, while they claim to have been qualified by the military and they claim to have been awarded a contract, they have actually never delivered any product to the military and we have a strong reputation, we're actually the only company that has a track of delivering quality LED tubes to the military in volume. So I think there is these three opportunities, you got your fixtures, you’ve got your adjacencies and then you’ve got the existing retrofit. And then the fourth one that I would add in addition to that is moving into other markets that have the same types of requirement as the military, whether they be demanding industry or hazardous environments or what have you. It's a very similar set of requirements.

I appreciate that color. Maybe just couple of quick financial. So Bradley in terms of the excess or the obsolescence that you charged your book, is it possible that some of that product could be sold through in future quarters?

It is possible, but I think getting back to your earlier question, Carter, right now we don’t have that visibility, we haven’t made that evaluation and basically that judgment at the end of 2016. But I think the short answer is, yes and as you imagine we’re going to continue to certainly pursue as many alternative plans as we can with that.

Okay. And then if I -- just last question if I may, before I get back in the queue. If I heard correctly you maybe alluded to a goal of reaching or regaining profitability by year-end. I’m assuming that would EBITDA breakeven. Is that -- can you confirm that that is an internal goal at least right now with the limited amount of visibility, you currently have?

It is. Overall right now our 2017 operating plans that we've began to put in in place allows us to exit the year profitable. And I think closely to often maybe just one other point of specificity on that and it's more so a function of timing whether that’s going to be the end of the third quarter or beginning of the fourth.

Perfect. I appreciate it. All I got color. I’ll back in queue.

Our next question will come from Amit Dayal with Rodman & Renshaw. Amit your line is open please go ahead. There is no response so we'll move on to the next question in our queue. Matt Monroe with ROTH Capital Partners.

Hi thank you, actually it's Craig Irwin on the call. Historically Energy Focus was really focused to over use the word LED Tubes, they built off the original work they did many years ago for the Navy -- underfunding from the Navy and the team was aggressively looking to push the sale in other markets. Some market with some success, others with limited success. Can you update us on your strategic thinking on the importance of LED Tubes, this is something that you expect to be major a component of future growth? Or are your internal priority like to shift over for LED lighting fixtures?

Great question Craig and I think the answer is both, we still have a very good opportunity for LED Tube, and there are a lot of market that relatively move for us, where I think there is a lot of potential, I had mentioned some of those in the prepared remark. We're also increasing the functionality of the tubes, for example we mention the emergency battery backup. Today we have a separate battery backup into that, which is a big break, we're developing a product that will have an integrated battery in the tube. So this is another stretch of our product portfolio, the new function will drive additional growth. Its identical to which we introduced and that has very good growth prospects. So I think between new markets and enhanced functionality in tubes, we're going to see continue to see growth there. However for us to emphasize enough that in addition to tubes, we're working on down lights, we have down lights in our portfolio, we're working on -- not only working on, but we already have in our portfolio a number of [indiscernible] and fixtures and luminaries and so forth. So I think we will see a diversification of our portfolio going forward, not only into new markets, but into new types of lighting with greater functionality and as I mentioned in the prepared remarks, greater electronic content in the form of control, sensors and connectivity.

Okay excellent and then from your own internal assessment that you've done since you've came to the company. Where would you say the most significant miss steps were made, was this something related to the sales force, the distribution channel, product portfolio or is it the general execution issue or everything on the list? Where did they go wrong, having such a significant exposure to Energy Focus over the course of the last eighteen months?

What I have seen here is a classic problem where, I guess it's a good news, bad news situation where the company introduced the Intellitube and got it on the API with the Navy back in 2014. And then that just sky rocketed. And a lot of times when a company has success like that they tend to deemphasize portfolio management and making sure that they have a robust product portfolio that will consists of a sequence of new product introductions to keep revenue growing sustainably over the long-term. So that's I think was probably the most fatal mistake, obviously there is lots of room to improve in sales and I think they were in trying to address healthcare and public sector plus the military and education. Last year we went to a vertically oriented sales force which is great in that it provided the expertise to consult with those customers, however I think it was done at the expense of geographical coverage. And so we were unable to broaden customer reach and our market reach into other segments and other customers, dependent to be more regional focused here in the Ohio area and I think we left a lot of money on the table. And so I want to make sure that we've got the geographical reach, we're putting in place these regionally focused sales people to make sure that we're going after every possible opportunity. And then third, I think there is an opportunity to tighten up the process discipline in this company having been a public company CEO I know what works and we've been rolling out a lot of new processes as I mentioned, new product development, quality and then inventory management. Which is really the third area where we had a shortfall. In terms of our level of intelligent and information saw how much was going into inventory at our distributor and how much was actually being consumed by the Navy. So those three stand out, but I spent a lot of time working with the board the executive team and looked at all of the areas where we can improve and it's a lengthy list, but I think those are the three main [technical difficulty].

Great. Than my next question is about the elephant in the graph, that management was chasing. I was wondering if you could update us previously there were suggestions that they were two very large supermarkets that were trialing products for potential adoption across the 100s of locations that each of them served, and then there were representations about large national retailers also trialing the Intellitube. Can you update us on your assessment of the interactions with these very large customers, whether or not you see this as a priority and you would expect it to be a potential contributor to revenue in 2017 or if it's more likely to be something that could materialize in '18 and beyond?

It's a great question. We we're getting very good attraction with some of these large commercial customers, including supermarkets and department stores. And I don’t want to name names because I don’t know how much is in the public domain, but I do expect those to contribute in 2017, probably more towards the end of the year, I can’t give you the exact timing on that. I might add that we’re starting to have discussions outside of the United States as well, because I think we've been a little bit to focused as far as only focusing in the United States. There are a number of opportunities beyond our border that also value the unique value proposition that our products bring. So you'll hear more about that, but I want to be cautious about how much I say today.

Great. And then last question I have is about cash. So 16 million is actually a pretty healthy balance, it was a little higher than what I thought it would be. So obviously, there is some new discipline at Energy Forcus. Can you talk a little bit about the cash charges for the restructuring and repositioning actions to likely tempo of those over the next couple of quarters? And whether or not you would expect to have working capital as a source of cash over the next couple of quarters. Or if there are things that need CapEx and need different inventory levels than what are held now to support your growth strategy?

Thanks Craig. I think maybe just provide a few clarifying comments on the question, maybe just starting first with the question past on restructuring efforts in the use of cash. Of course any time that an organization certainly works through a restructuring action aside from the P&L impact, it does have a cash impact. I think as we’ve continued to evaluate, I think the expense portion of that. Now of the 10 million in savings, we’re looking at probably 60% to 65% of that savings to be held in the first half of the year. Now Ted and I were talking about this morning, I think the next time that we talk we will have certainly something to report on the steps that we’ve taken and the impact that it's had. Well, I think for the time we speak for the June 30th results will have even more. And it really trails off from there. But that does mean, that we will need to use some of the proceeds that we have in order to put that in place. I think overall, I mean begin to break it down. I would look at the personal related costs, basically costing us another $1 million to $2 million and at least in the first six months of the year than the otherwise would have. But I think we make-up for in the lateral half of the year. Now I think one of the positive things as we continue to evaluate in particular our facilities, is I think the overall response we’ve received is, [indiscernible] facility space is attractive and we should be in a very good position to be able to be cash neutral in some of the decisions that made back in 2016, when either expanding or moving into some of those spaces. So hopefully that provides you with a little more information relative to the restructuring piece.

Great and then, actually sorry, I have another one that pretty important. Gross margin, so I know you're not giving guidance but just [technical difficulty] negative obviously charges the [indiscernible]. Your mix of sales to the Navy has a significant impact on consolidated gross margins, with commercial markets being fairly lower. So would you expect a remediation in commercial product margins to be one of the results of your restructuring actions. Is this something that we can expect to roll on to P&L over the next few quarter?

I would give the answer from a strategic prospective, but at least I would say that’s from a numeric prospective, we're taking steps today to ensure that I would say our approach and the way in which we are managing potentially the overall operations of the organization takes full advantage of the lowest cost supply and the best strategies available to us in order to make some of those products. I think over the last three to six months, we've become aware of a number of opportunities for us to either begin to redesign or certainly at least we view how the [indiscernible] been manufacturing or purchased from our products. So as we continue to look at 2017 operating plan, I feel better about being able to hold our margins and not solely relay product mix to drive that.

Just to add a little bit to what Bradley said, there is two way you can increase gross margins, you can add more differentiation to get more pricing power or you can lower your cost and we're doing both. We've already talked about some of the differentiated products that we've got in the portfolio that will add more value, so that we can get a little bit more pricing power. And then in terms of cost we actually opened a facility in Taiwan to source component in the lowest cost regions and we have our own quality control in Taiwan, so that we can simultaneously maintain our reputation for quality and reliability while driving cost down. Also, as I mentioned earlier, we're actually doing some redesigns on our products to squeeze every possible penny out of the cost that we can keep our gross margins at the levels to which we've become accustomed.

Thank you. Our next question will come from Mark Miller with the Benchmark Company.

Perusing the margin line a bit more, you indicated you're going to be focusing on new products with a higher electronic content, so would we expect these products to offer higher margins or would they be in a more competitive space in new product.

What you'll see is margins that are higher then what we typically see in commercial segment. I don’t expect them to be higher than what we're obtained from the Navy. My point is that as Navy starts to -- as Navy margins start to come down as a result of increased competition, my hope is that we will be able to at least partially offset some of that, by introducing new products into the commercial sector which have greater value and therefore greater prices in markets.

On the obsolete inventory. Can you give us a little color why it was obsolete? Was the technology or changes in customer preferences, what caused you to obsolete the inventory?

That is really a function or decisions made early in 2016. So I think first half of the year our commercial sales were very high we've made decisions at that point in time to procure a number of the raw materials that are necessary in order to deliver into that pocket. Many of those raw materials are long lead time items, the decisions have been made early on in the year. As the sales on overall demand for those products came down we were left with essentially the, I would say the residual impact of some of these decisions from the first half to the year that's [indiscernible] latter half of the year. I think right now as we continue to look at our overall stock levels and demand that we see in 2017 on a commercial basis we have to certainly evaluate, I would say what levels of inventory we can support. So moving forward with that evaluation on a U.S. GAAP basis we essentially apply the judgment that that results in an excess inventory reserve increase.

Then the phase, your 10 million annual cost savings, is that going to be mainly -- mostly done by the middle of the year or is that finished by the end of the year?

So it does happen throughout the year Mark, but much of the cost and much of the savings will be recognized in the first half of the year. I think the components of the cost savings activities are not just personal and facility related, but certainly 50% of the 10 million is focused on our external spend. We talked this morning quite a bit about the cash used and the expense that we've incurred on our operating loans I want to make sure that we address that as we look to 2017. So certainly as I look at least 5 million of the 10 million in total that would be spread a little bit more throughout the year.

And finally, I think you mentioned you had 12 person direct sales force in the field, has that come down significantly over the last quarter report?

Just kind of rolling forward maybe where we were as an organization probably six months ago was maybe twice where we are right now. But I think as we've taken steps to understand what the focus has been what the overall performance of that team was in the second half of the year certainly the leadership they were provided and the focus that we see in 2017 there has been, I would say a numeric reduction probably by about [indiscernible] resulting in about half of the sales force which I think as Ted was saying, it certainly drives us to the first, one of the first areas and one of the first priorities just to make sure that we can rejuvenate that sales team and certainly drive growth.

I might add to Bradley's statement that part of the change is structural. As we move from the focus on the public sector through the ESCO to vertical markets in healthcare and education. Within these skills and the resources required in sales differs. We spend a lot of time in 2016 chasing public sector ESCO driven business and that requires a great deal of sales resource. A lot of time you spend time working with an ESCO and then other ESCOs come in they bid for the business, we don’t have directly control over the final customers, the end customers who's making the decision. We're several levels remove from the customers. So we spend a lot of cycles in sales chasing after that business and now that we've become more focused on segments, we can be more efficient and get more done and probably drive more revenues with fewer sales people. That said, we do have to expand our geographical footprint, which we’re working on right now.

Thank you. And at this time, we’ll take our final question from Cindy Motz with Williams Capital Group.

Thanks for taking my question. I just wanted to follow-up on what you said. So I understand what’s going on with the sales force. Can you talk a little bit, do you think, you have the product breadth and obviously you’re addressing part of Chris question with this? But in terms of attracting the market, like in how you develop the products to go after some of these other areas like healthcare and education and everything. Giving some of your constraints here, can you talk a little bit more about how you’re going to build that? And then you have mentioned at one point in your comments about IoT. How would you like sort of incorporate that, would it be on your own or would you may be involve some partners? And then I just had a last follow up on the gross margin, just you have said earlier in the call that we could probably see EBITDA breakeven maybe by the end of this year, like maybe third, fourth quarter. So that would we see, I would assume gross margin breakeven -- gross profit breakeven before that, like maybe second quarter? So thanks.

Okay. Great questions and a lot of them. So let me dive in here. As far as the products portfolio is concerned it needs more breadth, you’re correct. I think my best long range vision as to where we're taking the company. Everything that I have in my prepared marks isn’t going to happen this year. But that's a general direction we're going in. Obviously, there is new products that will have to be developed to go after to some of these emerging applications I talked about, such as IoT. That said, as far as education and healthcare are concerned, we are getting a great deal of traction from goes clients. Primarily because of our Low Flicker. This is extremely important, in schools you've got teachers who are turning off the florescence lights and bringing in their own in incandescence bulbs because the flicker from florescence is making it -- is interfering with children's ability to learn, and it's giving people headaches in commercial installations. Healthcare, the same issues, if you're bed ridden and you're looking up at the lights and you got this subtropics flicker. That has very real health issues that have been documented in a number of papers. So we already have the product, as I mentioned we have the only, the all certified low Flicker LED light. So that’s going to drive our sales in the education and the healthcare market. But we do need to sell out the product portfolio to get into some of these other markets I was talking about, for example, the higher rate [ph] applications and the IoT. Now as far as IoT, I mentioned in my prepared remarks that we're not going to do that by ourselves. We can't, we're not a chip maker, however my background is that of a chip maker. So I have a lot of contacts, a vast network in the electronics and semiconductor industry and I already have partners in mind that we could work with on some of these connected products. So hopefully that addresses some of your question, there is another one for Bradley.

Yes, Cindy on your follow on for gross margin. I think -- don’t want to just certainly set the wrong expectation. On a gross margin level, I would say the negative results that we saw from specifically Q4, or as a result for judgments that certainly accompany light hours in our industry needs to evaluate at the end of the year. Certainly, dealing throughout the year, but certainly as you can imagine we continue to focus on some of our strategies and similar things that we have within the organization, mainly inventory and the charge that we had taken relative to the imperilment of an asset. So those types of things really drove, and the onetime events driven to a negative gross margin. In 2017 our plan is to certainly improve over the year, but we are starting above the neutral point and should be positive.

If I could just come back before we finish up here to the, the question of the product portfolio and developing new product category, that is what I do. If you look at Integrated Device Technology, IDT; when I went there, their product portfolio was completed and by time I left, we were in a completely new product categories like wireless charging, analog, radio frequency, that we build from the ground up and today they are a leader in those segments. That what I'm here for, to build those new product categories that we need to get on growth.

And ladies and gentleman, I planned to call conclusion time has now been reached. This does conclude our conference for today. We thank you for your participation.