Energy Focus Inc (EFOI) 2017 Q3 法說會逐字稿

Good day, and welcome to the Energy Focus Third Quarter 2017 Earnings Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Michael Port, CFO. Please go ahead, sir.

Thank you, operator. Good morning, and thank you for joining us for Energy Focus' third quarter 2017 earnings conference call. Today, our Chairman, Chief Executive Officer and President, Ted Tewksbury, and I will report on our results for the quarter. The news release and our quarterly report filed with the Securities and Exchange Commission on Form 10-Q have been posted to our website 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 and our actual results may differ materially from these statements. We encourage you to review our most recent filings with the SEC 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.

Our prepared remarks this morning include 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.

And now I'd like to turn the call over to Ted.

Thanks, Michael. Good morning, everyone, and thank you for joining the call today. When I rolled out our turnaround strategy back in February, I announced 3 priorities. First, reduce costs to slow down our cash burn and accelerate time to breakeven. We have achieved that. Second, put in place a nationwide sales network to grow the top line. We have accomplished that as well. Third, revitalize the new product pipeline. We have done that. As a result of these 3 initiatives, the company is well on its way to returning to growth and profitability. I'll come back to each of these 3 priorities in a moment, but first let me summarize our Q3 results.

Net revenue for the third quarter of 2017 came in at $5 million, down 17% from the second quarter. Gross margin of 23% declined slightly by 2 percentage points from Q2. Despite lower revenue and gross margin, disciplined cost management enabled us to keep our operating expenses down to $2.9 million, the lowest level in 11 quarters. As a result, our net loss of $1.8 million was the lowest in 6 quarters. In addition, our continuing low cash consumption of $1.6 million enabled us to end the quarter with $11.9 million of cash.

Commercial sales of $3.9 million grew nearly 10% year-over-year, but were down 24% quarter-over-quarter. While overall commercial revenues continue to be lumpy, we saw strength in our healthcare and education verticals. Healthcare represented 23% of Q3 commercial revenue and grew by 68% from last quarter, largely due to the first shipments of our new industrial downlight to a well-known Northeast Ohio healthcare provider.

The sequential revenue decline was primarily due to a nearly $1 million downlight shipment for this customer, shifting from Q3 to Q4 due to supply chain constraints. Our education vertical represented 35% of commercial revenues and grew 14% sequentially, driven by retrofit projects in K through 12 schools.

Sales in our military maritime vertical grew 28% quarter-over-quarter to $1.1 million, primarily due to the first shipments of our new 2-foot fixtures for the USS Fort Lauderdale amphibious transport dock ship. 59% of our military revenue came from our Navy retrofit business, while 39% was due to new ship construction, a nascent business for us. The remainder was contributed by orders from foreign navies, commercial maritime and Military Sealift Command.

Demand from the Navy for LED tubes remains robust, as evidenced by our distributor's win of 60,000 units of our military Intellitube last week. This award will deplete our distributor's stock, which was roughly 100,000 units at the beginning of 2017, thereby removing the inventory overhang from our military sales.

In our last earnings call, some of you asked for more detail on our end customers. While we can't share specific customer names for reasons of confidentiality, let me provide some statistics to help you understand our customer distribution. In Q3, 8 customers placed orders of over $100,000 each; and together they accounted for 80% of our revenue. All of these were repeat customers with whom we've done significant business in the past. Two of them placed orders for over $1 million each during the quarter. The remaining 20% of our revenue was contributed by 147 customers, each of which placed orders of $100,000 or less. This is consistent with our experience over the past 2 years when we have seen 80% to 90% of customer orders being $25,000 or less.

Our new agency-based model is likely to lead to even greater customer fragmentation, diversity and spread in order sizes while growing our overall sales. Hopefully, this helps you appreciate the difficulty of providing more granular detail on individual customers and design wins.

One of the most important achievements during Q3 was the establishment of our new sales structure. To understand the significance of this transformation, it is important to understand that historically we have been primarily a regional company. In Q3, for example, 59% of our sales came from 2 states, Ohio and Texas. We were also essentially a one customer company with 80% of our revenue coming from the U.S. Navy as recently as 2015.

We had a small hardworking group of direct sales people, who were very successful with the customers they touched as evidenced by our marquee accounts. The problem is that we didn't have the appropriate sales resources in the right places to touch enough customers. We have now eliminated this barrier to growth by assembling an experienced sales team covering 100% of the United States.

In Q3, we hired 5 regional sales managers or RSMs with a combined 120 years of experience to replace a 5-person team with 14 years of experience. The RSMs actively manage a network of sales agents to educate end customers on the value and benefits of Energy Focus' products. These agents represent not only Energy Focus products, but other manufacturers whose products complement ours.

As a result, agents provide a strong value proposition by offering customers a complete portfolio of solutions including products, energy audits, installations, financing and other services, all of which helps pull our products through. We have selected the best agencies in the industry. The agents in turn choose Energy Focus to satisfy their customers' demand for high-performance, premium-quality retrofit solutions.

Since the last earnings call, we have added 12 new agencies, an average of 1 per week, bringing the total to 21 and putting us on track to achieve our goal of 30 agents by year-end. Our network of RSMs and agencies expands our geographical coverage and customer reach in a cost-effective manner, because the agents are paid on commission and they don't get paid until we get paid. We are already seeing strong quoting activity, preliminary orders, and a building opportunity pipeline from the agents. We expect to see revenue contributions beginning in the fourth quarter of 2017 and ramping in 2018.

In addition to cost reductions and sales, our third priority is new products. I talked about our new RedCap, emergency battery backup solution, last quarter. I'm very pleased to announce that this innovative product has now passed UL certification and is on track for market launch in Q4. Feedback from customers has been overwhelmingly enthusiastic, and we expect RedCap to drive significant revenue in 2018 and beyond.

Beyond RedCap, we have a robust pipeline of new products in development to achieve our vision of being the leader in smart retrofit solutions. These products will pack greater functionality and value into tubes and fixtures to transform existing buildings into smart connected buildings. We are planning at least 2 major new product introductions in 2018 and have established a goal of 1 per quarter thereafter. In order to promote sales of new, as well as legacy products, we rolled out a new website and rebranding initiative in the third quarter.

In summary, it's an exciting time to be at Energy Focus, and I'm very pleased with our turnaround progress to date. The team has really come together and the optimism about our future is palpable. We have implemented disciplined financial, engineering and management processes to drive accountability, quality and results. We have restructured the company to reduce annual operating expenses by $8 million to $9 million from last year and have slowed our cash burn to the lowest level in 7 quarters. We have built a nation-wide network, some of the most knowledgeable and experienced sales professionals in the lighting industry. Commercial sales are gaining traction and the inventory overhang has been removed from our military business.

In addition, we have rejuvenated the company's new product pipeline, and we are on track to launch the game changing RedCap this quarter. All of these leading indicators are exceeding expectations. While revenue is a lagging indicator, we expect to see the new sales model begin to contribute to the top line in Q4 and to grow revenue through 2018 and beyond.

With that, I'll turn it back to Michael to elaborate on our financials.

Thank you, Ted. Since our third quarter and 9-month financial statements have been filed with the SEC and posted to our website, this morning I'll be providing some additional analysis and commentary on our results. Total net sales for the third quarter were $5 million, down 40% compared to the third quarter of 2016.

For the quarter, sales of commercial products comprised 79% of net sales, while sales of military products represented 21% of net sales. This compares to a third quarter 2016 product mix of 44% and 56% for commercial and military sales, respectively. Consistent with our strategy to further penetrate our commercial verticals, net sales of commercial products increased 10% compared to the third quarter of 2016 in spite of the supply chain challenges that we experienced in some of our products.

Net sales of our military products decreased 77% compared to the third quarter of 2016. As Ted mentioned, our distributor to the U.S. Navy recently won a bid that will deplete their inventory. While it's not certain when future bids will be requested, we remain committed to work with our distributor to evaluate and competitively bid on future orders.

Our third quarter 2017 gross margin was 23%, a decline of 14 percentage points from the third quarter of 2016. The overall decline in gross margin percentage is primarily the result of overall lower sales volumes unfavorably impacting our manufacturing and overhead absorption; and our product mix, specifically lower military sales, which historically had higher margins.

If you recall from my comments last quarter, we had some higher cost inventory that was ordered in late 2016 and early 2017 to satisfy anticipated demand, which did not materialize through the first 6 months of the year. Through disciplined purchasing activities, we depleted the majority of this inventory during the third quarter of 2017. Additionally, during the quarter, we identified strategic sales opportunities, allowing us to further deplete our inventory balances. As a result, our sequential quarter-over-quarter gross margin declined slightly by 2%. We continue to focus on our gross margins with continuous improvement initiatives including product reengineering and manufacturing cost and component price reductions.

Our third quarter 2017 operating expenses were $2.9 million compared to total operating expenses of $6.2 million for the third quarter of 2016. Our third quarter 2017 operating expenses include restructuring credits of $200,000, principally related to the sublease of our New York City leased office space. As of today, we have subleases in place for both our Arlington, Virginia, and New York City office spaces and we do not anticipate further major restructuring costs in the near future.

Excluding the third quarter 2017 restructuring credits, our quarter-over-quarter operating expenses decreased by $3.1 million, representing a 12% decrease from our second quarter operating expenses excluding restructuring charges.

Our net loss for the quarter was $1.8 million or $0.15 per share. This compares to a net loss of $3.2 million or $0.27 per share in the prior year's third quarter.

And now, I'll briefly discuss the first 9 months of 2017. Our total net sales for the first 9 months of 2017 were $15.1 million, down 37% compared to the first 9 months of 2016. Net sales of our commercial products increased 6% compared to the first 9 months of 2016, while our net sales of military products decreased 76%. For the first 9 months, sales of commercial products comprised 81% of net sales, while sales of military products represented 19% of net sales. This compares to a product mix of 48% and 52% for commercial and military sales, respectively, for the first 9 months of 2016.

As a result of lower year-to-date sales volumes and product mix, our gross margin for the first 9 months of 2017 was 21%, a decline of 16 percentage points from the first 9 months of 2016.

Our total operating expenses for the first 9 months of 2017 were $11.1 million, which includes a restructuring charge of $1.5 million. This compares to total operating expenses of $17.8 million for the first 9 months of 2016. Excluding the 2017 restructuring charges, our period-over-period operating expenses decreased by $6.7 million and we are on track for a total operating cost reduction of approximately $8 million to $9 million from 2016 levels.

Our net loss for the first 9 months of 2017 was $9.4 million or $0.80 per share. If we exclude the restructuring charges, our net loss for the first 9 months of 2017 would have been $7.9 million or $0.67 per share.

With regard to our cash balances, cash decreased approximately $1.6 million during the third quarter to $11.9 million at September 30, 2017. Our cash used in operating activities of $1.5 million was the lowest operational cash consumption in 7 consecutive quarters. Through our disciplined purchasing approach, we have made great strides in managing our inventory and have decreased our gross inventory balance by $3.3 million since December 31, 2016.

Given the continuing volatility in military sales and the timing uncertainty in commercial sales growth, it is challenging for us to provide quarterly revenue guidance at this time. Once our revenue achieves a more predictable growth rate, we will provide further guidance.

With that, I'll turn the call back to the operator for questions.

(Operator Instructions) We'll take our first question from Craig Irwin from ROTH Capital Partners.

So, Ted, first thing I want to ask about is a breakeven on EBITDA. I know you really want to get there, and it seems that we need revenue, right, we need revenue to make this happen. But before we dig into the revenue, is there anything at all that you see is possible to bring the company to EBITDA profitability within the next 6 to 9 months without a significant uptick in revenue?

Well, we do need revenue, and yes, I think we can get there if we even achieve the minimum revenue projections that we're contemplating. To put things in prospective, Craig, the Q4 -- the Q3 revenue is still being resolved of the pipelines -- the sales pipeline that was in place before Larry arrived and joined the company. And that's simply because of the delays that take place and any time to train the new agents. And there is just the intrinsic sales cycle time of ESCOs have to analyze customer projects, make proposals; customers have to get approvals, go through various committees, get budget approved and then sometimes put the projects out to bid. So it's typically a 6 to 12-month sales cycle time.

And that's why at the last earnings call, I told you that the [2000] revenue would be pretty much the result of the previous sales organization and the previous sales funnel. And I told you that we would expect to see relatively flat and relatively volatile quarterly revenue for the rest of 2017.

Now the actual news is better than that. The sales agents have actually kicked in to gear more quickly than we expected. And as a result, we're going to see some positive revenue contributions in Q4, which is a quarter earlier than we actually expected it. And based on the rate at which we see the sales funnel filling up with new opportunities, we are very confident that we're going to see that revenue growth throughout 2018.

But as to whether we'll achieve breakeven without revenue growth, I gave you a number, we've got roughly $12 million of cash. We're burning only about $1.5 million to $1.6 million per quarter. So, we are very comfortably positioned to wait it out if revenue is delayed for any reason.

I would definitely agree that you've stabilized things really incredibly well over the last couple quarters. So, then if we could talk a little bit about the revenue side. [Fixing] the channel as far as signing up traditional lighting agencies; hiring sales people, the five that you mentioned in the release, to manage those relationships; and then working on what you do well in other geographies, which I guess is a reference from Ohio and Texas, to bring that to other states across the country.

Can you comment about the need for additional SKUs to really execute on that strategy? Do you see that growth is achievable without the addition of significantly more SKUs? Or would that just be something that would be an incremental tailwind to your expected revenue trajectory or at least what you're planning for internally?

Good question, and no, we do not need more SKUs in order to meet our revenue projections. In fact, with the agents coming onboard, we're attempting to reduce the number of SKUs in order to be able to control inventory and better manage our business. And we've successfully done that, as we've talked about in past earnings calls, we've gone from about 160 SKUs down to about 80, where we greatly reduced the SKUs.

The revenue growth, I mean at the first order -- our first layer of revenue growth will come just by selling the products that we already have, the SKUs that we already have in the remaining 48 states. If you look at the revenue we've got today being 60% coming from Ohio and Texas, that makes me very optimistic that as soon as we open up the rest of the country, we're going to have the opportunity to drive revenue growth, even if we did nothing else, introduced no new SKUs or no new products.

The second layer beyond that that's going to contribute to revenue growth is new products like the RedCap that we just introduced. We're already receiving tremendous demand for that product. And that's going to be a major revenue driver in 2018.

And then the third layer is from the other new products that we've already defined and that are in development right now, which are more in the smart lighting category and also in the fixture category.

We will now take our next question from Colin Rusch from Oppenheimer.

Good morning, this is Luis Amadeo for Colin. Are there any areas of the supply chain where you are seeing incrementally better cost than you expected?

Well, we're actively driving cost reductions throughout our supply chain. And we made some operational improvements in Q3. On previous calls, I've talked about how I focused initially on sales and then on engineering, upgrading the team, streamlining our processes, tightening up our disciplines and so forth.

In Q3, we did the same thing in operations and particularly with respect to managing contract manufacturers and other elements of the supply chain to get our cost down. So, for example, our military Intellitube, we've greatly reduced the cost of that to make us more competitive in the Navy business. So, that's one area where we've definitely gotten our cost below -- well below where we were when I joined the company. And then we're doing the same across the supply chain.

And just from an operational perspective, where are you seeing [meaningful] opportunities just for incremental investment in R&D?

I'm sorry. I missed the first part of the question?

Areas of where you can -- you're seeing any opportunities for incremental investments in the R&D?

Basically, the strategy is to focus on more advanced retrofit solutions. We think retrofit is a very powerful capability. So anywhere in a building where you have people or you have assets, you have lights. You have lighting sockets. And where you have lighting sockets, you have electricity. So we see the tube as a very elegant and convenient way to retrofit not just light, but also other electronic functions into existing buildings to make them smart buildings.

So, a good example, the first example of that is RedCap, where we put batteries into it to create emergency backup battery. Going forward, we're looking at putting other electronic components inside tubes. These could be sensors, controls, wireless connectivity, so that tubes can attach to the Internet of Things and provide more valuable functions whether it's daylight harvesting, task tuning, color temperature tuning, what have you.

And then beyond that, there is the possibility of bringing other non-lighting functions into buildings via a retrofit. And those could be things like asset tracking, all kinds of things, smoke detectors, fire detectors, air quality monitors; all kinds of building automation functions that could be retrofit, either in a tube or in a fixture that we would sell along with the tube.

So, that's the basic direction. That's where we are spending the bulk of our R&D, but we're not spending that R&D independently on our own. We're doing it through partnerships in order to minimize our R&D and not impact our bottom line. So, we're not quite ready to name any of those partnerships yet, but that is the cost-effective way for us to be able to enhance our product portfolio with higher value-added and higher gross margin products.

That's great detail, thank you. And If I can ask just something, one more, just on the agency channel. I think you said you were on track to get to 30 agencies...

30 by the end of the year. That's correct.

By the end of the year. Is that kind of the ultimate goal, or you think you're going to add more later on? Is there any way of accelerating that process? What are your thoughts on that?

Well, we're at 21 or 22 right now. We've been adding agents at the rate of 1 per week. So achieving 30 by the end of the year is a very realistic goal. And of course, we're hitting the highest priority, largest opportunity regions first. But our ultimate goal is to get up to 40 to 50 agents, and that will happen in 2018. But we will start seeing the revenue contributions from the first 20 or 30 agents early in 2018.

Moving on, we'll take our next question from Carter Driscoll from B. Riley FBR.

So, first one is, could you talk about the -- characterize the order that your distributor (inaudible) to help them deplete the inventory, do you expect this to be one time, I mean a very minimum (inaudible) the channel potentially, at least restock, maybe at lower levels that you had in the past. But help me understand how this pull-through could help jumpstart, at least new build versus retrofit for the Navy and potentially other military applications as well.

Sure. So, a little historical background first. When I joined the company back in -- when I stepped in as CEO back in February, our distributor had about 100,000 tubes on their shelves, which they had purchased at the price back then which was significantly higher than it is today, because there was no competition. So it was difficult for our distributor to compete at a reasonable price when 2 competitors came into the market.

We have a very good relationship with our distributor and they again -- I'm not going to get into their details of their business. But suffice it to say that they reduced the price to a competitive level. And we're able to run that 100,000 units down to essentially 0 after the 60,000 unit order is shipped. Now, in addition to depleting their shelves, we will -- we have about 8,000 units that -- in addition to their inventory that we'll be shipping to the Navy.

As far as when the next quarters are going to come or the next bids from the Navy, that's something that we have very little visibility into. But suffice it to say that this is a very significant event, because now that our inventory at the distributor has been exhausted, it resets our business. Until that was done, our Navy business was essentially on hold. So, we are back in business, but the growth depends on when the bids from the Navy arrive. And then in addition to that, as I mentioned earlier, we've reduced the price of new military Intellitubes to our distributors, so that we can be competitive in the marketplace.

Can you talk about the delta of what you reduced those prices from and to, or at least a range?

I don't want to get into the details of our cost model. But what I can say and I've said in past earnings calls is that the competition came in with a price that was essentially half of what Energy Focus had been charging a year ago. Obviously, we had to get into that vicinity.

The visibility is still relatively limited at least, in particular with the Navy, which has traditionally been your largest end market of military maritime. Can you talk about some of the other opportunities longer term? I realize the focus is more on the C&I side, just trying to get a sense of what might be [applicable] run rate?

Yes, so, as far as the business, yes, the Navy back in 2015 was 80% of our revenue. Today, it switched. The results that we just announced were just the reverse of that: 78% commercial, 22% military. So commercial is where we're focusing our attention and of course that's a much bigger market. We see an $11 billion TAM in commercial just for tubes. And then by the time we add the other product categories that I talked about like fixtures and smart lighting, that comes up to about $20 billion opportunity. So, that's where we've been focused.

Now, as far as our visibility is concerned and our ability to give guidance, which is correlated, it's really dictated by 2 things. First of all, our traditional backlog entering the quarter is less than 20% and we've talked about that on previous calls. So, we have primarily a [turns] business and we book orders and ship orders during the quarter. And so we don't have a lot of visibility from that.

Secondly, as I spoke when I was talking about the customer specifics -- the customer statistics, right now we have relatively few large customers greater than $1 million and a lot of smaller customers, less than $20,000. So, if one of those large customers gets delayed or something happens during the quarter as happened in Q3, our numbers can change significantly. It's a very lumpy business, and that's why we haven't been giving guidance. If I had given guidance for Q3, I would have told you we're going to do $6 million; but because we had a supply chain issue, we did $5 million.

So that's why we're not giving guidance. We will give guidance as soon as 1 of 2 things happen: either the new sales agencies fill up the pipeline and we have a more robust opportunity pipeline; or 2, our backlog entering the quarter starts to improve and that will give us the visibility. And I think that will happen sometime in 2018.

Given that you can't -- you don't feel comfortable providing the guidance, could you at least characterize what percent of 4Q sales you think might come from the new sales channel or the sales realignment roughly?

Yes. So, right now, in Q3, 0% of our revenue comes from agents. As I mentioned, we will see those contributions begin in Q4 and our expectation is that in 2018 roughly 60% of our revenue will come from the agents.

Maybe a last question for me. So, you believe that if we have all things equal, you've gotten your burn down to, I think you said, $1.5 million to $1.6 million a quarter, obviously not providing other metrics to -- so we have to kind of -- or back into that. Do you feel comfortable that your burn has been capped at this level? I mean could you have working cap builds if you got a big order? I mean I am just trying to get the swing factors of what could the componentry of -- what could make that cash position to be less robust than you anticipate?

Carter, this is Michael. The 2 -- as we've talked about before, the 2 drivers that really drive really our cash position, you hit it on the head really, inventory requirements to be able to satisfy demand. And again, as we mentioned, we're looking at ways to improve the efficiency of the supply chain, which will allow us to better manage the inventory to make sure we have the right inventory at the right time, at the right place for the right cost.

And then the second piece is always the receivable piece for us. If you go back and look historically, those have been the 2 drivers of our cash position. And I will say that historically, based on the customer base that we have and the credit reviews that we do, our uncollectible accounts have been relatively low. We keep on top of our customers to make sure that they're paying within the expected terms. So, to answer your -- hopefully that answered your question, gave you a little bit more insight as to what the additional components of the cash burn might be.

What I guess, what I was trying to get, it's helpful, was just as you ramp up for the introduction of RedCap, your estimation of what type of working cap commitments for that specific product launch?

Yes. Based on what we're looking at right now, we think it'll be neutral, again, because of the terms that we have from some of our suppliers and based on the terms we have with our customers. It puts us in a neutral position, which is why it's so important for us to have the discipline in being able to order the right inventory at the right time. So, we don't get into that pinch.

Then maybe as my last question: in terms of your new regional managers, I'm assuming they have certain set targets. Can you talk about the variable percentage of their compensation? I'm assuming there is one, at least as a percentage of total comp?

All of our sales people work on a low -- a relatively modest base plus have a commission target. Frankly, Carter, I haven't sat down and computed the math out. But based on the quotas that we have given them, again if you kind of step back and divide it into 6 regions and put a quota on each one of our RSMs, off the top of my head, I guess that they could meet or exceed their base comp just based on the commission, on the targets that we've given them.

Moving on, we'll take our next question from Amit Dayal from H.C. Wainwright.

Good to see the execution on the cost side coming through. Most of my questions have been asked. But maybe just on the sort of the reset of the sales organization, are these 35 agencies going to be managed by the 5 regional sales heads?

Yes. The regional sales managers, of which there are 5 now, could increase in the future, but right now we think 5 is adequate to meet our growth targets. Those regional sales managers each have a specified number of agents in their territory to cover the customer accounts. And they are responsible for training those agents on the Energy Focus products and the benefits and the value proposition; and then also setting the quotas for those agents and then managing them on a weekly or a daily basis. as the case may be, to make sure that they hit those quotas. And then in addition, when and if customers need additional information or more detail on Energy Focus products, the RSMs are the experts that the agents bring in to visit those end customers.

And then finally, a very important function that both the RSMs and the agents serve is to bring back information from customers regarding their pain points, how our technologies can be used to solve their problems and ideas for new product proposals and definitions. So, that's what the RSMs do. And we've got 5 highly qualified RSMs with 24 average years of experience in the lighting industry each, which is more than sufficient horsepower to do what we need to do in the near term.

And just a follow-up on your comments earlier. You had mentioned you have very few sort of large $1 million plus type of customers and a lot of smaller $20,000 type customers. What's the mandate for the new sales strategy? Are you going to bid for everything that you come across or are you trying to focus on the larger deals going forward?

Our philosophy is pretty simple. When we develop new products, we develop them for targeted applications, primarily aimed at our verticals, like healthcare and education, where we can really leverage our unique technologies to solve specific customer problems with game-changing solutions. But once we have got those products, we sell them to as many customers as we possibly can, both inside the verticals as well as broadly horizontally outside the verticals. And that's where the agencies give us a lot more breadth.

But I think what you'll see happening as we go forward is there will be a greater number of customers at both ends of the spectrum. You'll see the number of $1 million dollar plus customers increasing, but you'll also see the number of small customer orders increasing. And they're both good and we like the big customers, because they are a bigger contribution to our revenue. But we also like those small orders, because they give us more pricing power and higher gross margins. And the proliferation of our products to a lot of smaller accounts can really be a significant driver of revenue.

Understood. Maybe just one last question on the RedCap product. How long do these batteries sort of last or like how much backup do they provide?

It's 8 hours of power, I believe, after the power is interrupted. And they will recharge as they are in the socket.

Moving on, we will take our next question from Mark Miller with The Benchmark Company.

You mentioned you -- in response to competition, you had to reduce some price in the military products. Is that roughly 50% of the products or 10%? What percent of the products are you selling now at a lower price?

Mike, do you know?

What Ted was referring to is specifically our M1 product, which was sold through our distributors. But we do have other military maritime products that we do sell, but that price reduction and the competition in that particular -- was focused on that one particular SKU.

The 22% of revenue that was due to the military this quarter was not M1 with the military Intellitube. That was other products that we sell to military. In particular, as I mentioned in the prepared remarks, the fixture -- the new fixture that we developed was the primary contribution to that revenue. So, the margin reduction only applies, as Michael said, to the military Intellitube. And on the basis of the cost reductions that we've done, when we start selling again to the Navy, our margins will still be healthy.

You mentioned that you have, I believe, medical and also education K through 12 were significant contributors, commercial. Any other areas like retail or warehousing at sizable accounts?

Yes, so I said 23% of our commercial revenue came from healthcare and then another 35% came from education. So the remaining 42% came from retail, offices -- other commercial and industrial applications. And a lot of that kind of is below our radar; it goes through ESCOs. And so we don't see a lot of the detail, but a lot of that is outside of healthcare and education.

Any of the retail or major national chain, or more regional operations?

At this time, more regional. But our hope and our expectations based on some of the preliminary feedback that we've got from the agents is that we will have the opportunity now as a result of this new sales structure to penetrate some of the larger and a more national retail chains. And so, I hope to be discussing that on future calls.

Moving on, we'll take our next question from Allan Snider from Oppenheimer.

Just 2 brief questions, I know it's late. The RedCap is available for sale at this point. Is that correct?

No, we're doing preliminary sampling with customers. We've got the UL certification. We're doing a formal market launch in the coming weeks here. It will be for sale this quarter.

And the other thing relative to the new products, just -- I guess, I'm getting old and my hearing is lapsing. You said that there would possibly be 2 major products in 2018 and possibly moving beyond that at the rate of maybe 1 new item per quarter?

That's correct. And I'm talking about significant new product -- core products that offer some true differentiation and new value to the industry that doesn't exist today. I'm not talking about derivative products, [minor] (multiple speakers).

And my last question was when we batted around, is there still a possibility or are you actively seeking business with foreign military operations?

Yes, we are. It's primarily Canada and Australia and we did have a small contribution -- very small contribution in Q3. But we continue to pursue those accounts. But really the big opportunities for us are in our traditional Navy retrofit business, in the new ship construction and then in the military basis. Those are really the big 3.

Moving on, we'll take our final question from James Liberman from Wells Fargo Advisors.

I had a question, which you may not be able to answer, but I was hoping you might give some color on the opportunities for mining -- lighting upgrades for the -- for buildings with the Department of Defense or other government buildings. I was thinking made in the USA probably could go a long way and I wondered if that's -- if I'm way off base or is that something...?

You're absolutely correct. And I should have included government buildings when I gave you the list of non-healthcare and non-education opportunities.

So, yes, government is certainly one of our target applications. We access a lot of those through the ESCOs and we continue to -- we hope to see that continue to grow.

That'll be kind of fun one day to wake up and see the Pentagon being re-lighted, but I appreciate your effort.

Absolutely, but you're absolutely correct. I mean this is the reason why we continue to emphasize buy American. We are one of the few companies that does manufacture in the United States in our Ohio facility. That's what got us -- one of the reasons in addition to our quality and performance -- but that's one of the reasons that we're in the US Navy. And government facilities continue to demand buy American. So, yes, we think there's a very healthy and large opportunity for us to grow in that segment.

At this time, that will conclude today's Q&A session. I'd like to turn the conference back over to Ted Tewksbury for any additional or closing remarks.

Thank you for joining us today and for your continued interest in Energy Focus. Michael and I will be at the Benchmark Micro Cap Discovery One-on-One Conference in Chicago on December 14 and we hope to see some of you there. Thanks again for joining us, and enjoy the rest of your day.

And that will conclude today's conference. We do thank you for your participation. You may now disconnect.