Orion Energy Systems, Inc. (OESX) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Orion Energy’s Third Quarter Fiscal 2015 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] And as a reminder, today’s conference is being recorded. I’d now like to turn the call over to Adam Prior with The Equity Group.

Thank you. The company issued the announcement of Orion’s fiscal 2015 third quarter and nine months results this afternoon. The company has made available on accompanying slide presentation on its Web site at www.oesx.com in the Investor Relations section. While the format of the discussion will not refer to any slides, particularly, we encourage investors to use the document during today’s presentation. I will now read the Safe Harbor statement. Remarks that follow, including answers to questions, include statements that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are generally identified as such because of the context of such statements will include words, such as believe, anticipate, expect, or words of similar import. Similarly, the statements that describe future plans, objectives, or goals are also forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different. Those risks include among others matters that we’ve described in our press release issued this afternoon and in our filings with the Securities and Exchange Commission. Except as described in these filings, we disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly conference call, if at all. With us from Orion is John Scribante, Chief Executive Officer; and Scott Jensen, Chief Financial Officer. With that, I’ll turn the call over to John. Please go ahead, John.

Thank you, and good afternoon. And thank you all for joining us. This afternoon we will discuss Orion’s current operations including what’s driving our sales namely the increasing market adoption for our LED products, after which Scott Jensen, our CFO, will detail our financial results, and our new financing that we announced today. Then, I will return to discuss a number of growth initiatives that we are implementing to best position Orion for growth in the years ahead. Our total revenue for the quarter was $26.1 million for the fiscal 2015 third quarter compared to $27.7 million in the prior year period. Looking exclusively at lighting and excluding non-core solar revenues, the sector that we no longer pursue, lighting revenues increased 24% year-over-year and 96% over the fiscal second quarter, all of this during a period of massive transition in the industry. Product revenue from our LED products increased to a record $12.7 million during our fiscal ’15 third quarter compared to $1.4 million in the prior year period, an increase of 807%. Due to recent product releases, during the middle of last quarter and customer demand, we believe LED product sales will continue to grow and reach between 50% and 60% of total product revenues during the fourth quarter of fiscal ’15 and higher as we move into our 2016 fiscal year. We continue to see strong LED sales growth across all of our product categories. We have executed on strong quarter-over-quarter growth in LED and with an increasing array of product offerings, we only expect to see this continuing into future quarters. We have seen customer adoption rates for our LED products improving across all of our target markets. In the short-term, our top line results were within our expectations for the quarter with the exception of a few orders shifting into January of this year. And in the short-term, we expect some of these ebbs and flows when it comes to certain contracts as a result of customer controlled labor, delayed utility approvals, and jobsite access, especially in our growing automotive and federal government business. As we look forward to our fiscal year-end and evaluate the potential for project delays due to the above reasons, we tightened our annual revenue range for fiscal ’15 to include a range that we believe is achievable given this risk with the potential to increase revenue back into the originally provided range. Our legacy business has been overtaken by LED growth. Our solar business has wound down as expected, and with our newly launched products now in the marketplace, we are well positioned to take advantage of the growing LED market. So what's driving our sales? New LED chip efficiencies and increased capital spending by our customers have provided the momentum in our sales. As we have stated before, due to the nature of retrofit projects, many purchasing decisions are often concentrated later in our fiscal year making our third and fourth quarters generally heavier than the first half in terms of revenue. For the third quarter, our revenues came in at $26.1 million and this included several large projects along with a consistent stream of business in our core High Bay, Retail, Office, and Parking Lot markets. We achieved several large customer wins, which can be attributed to our U.S markets reseller partners who are gaining significant traction. We’ve continued to strengthen partnerships with these ESCO resellers and have supported this effort by the hiring of several territory managers that are geographically focused throughout North America. We believe this focus will allow us to better cultivate our relationships with existing ESCOs and attract new levels of resellers who command large markets and represent growth potential for Orion. Our pipeline among this growing network is increasing, both in terms of number of deals and also in size of orders. Our average deal size is growing in the double digits and with the support of our production capacity strategy; this is exactly the kind of trend that we want. We recently achieved a large-scale order for our LDR product at a children's hospital in the Southeast through a brand-new reseller who is quickly becoming a large partner for us, with orders of approximately $1 million just this last quarter alone. We were able to win the business based on product features, but more importantly being able to deliver product with Orion, within only a few days illustrating that our customer promise strategy helps to drive new business and retain existing. We are also winning large-scale national business leveraging our history at over 20,000 Orion and Harris project installations throughout North America. This built in customer base is beginning to turn over LED products -- turn to LED products and we’re seeing it in deal acceleration through our markets. During the quarter, we received significant orders from major U.S institutions for LDR -- for office LDRs, large grocery chain for LED, High Bay products and we’ve carved out a market leading niche in the automotive space with four of the top five automakers having placed large orders with us over the past six months as well as orders from a notable U.S based electric car manufacturer. In addition, we recently won another $3 million contract through a U.S automaker in January that will need to ship early in our next fiscal year, due to the delays caused by utility approvals. Again, while the exact timing of shipments on projects such as these may affect our short-term revenue range, the long-term impact on how we are able to deploy our products is sizeable and all moving in the right direction. As a specific example, we prevailed over two very large competitors with a recently awarded project for the earlier mentioned large grocery chain utilizing our ISON Class High Bay product line. Our exclusive ISON technology allowed us to use 30% fewer fixtures than the competitors and deliver the same required light levels. This win was a great example of how our ISON technology is a competitive advantage, that is providing a premium priced product that yields a lower total package cost. This customer recognize the overall value of our products that is fewer fixtures and save both upfront cost as well as energy cost due to our innovative technology. The overall customer LED adoption rate in the retrofit market is still developing. But as I mentioned before, the market is massive. As chip efficiencies are increasing and input costs are dropping, new markets are opening up as ASPs move into the range of acceptance. We estimate that in each of our markets the adoption for LED is still incredibly small, but we’re in fact seeing an accelerated rate of this adoption. The market now understands what LED is and the superior performance capabilities that it offers and these buyers are looking to purchase from a company like ours one that can deliver best-in-class products in the most cost efficient manner to decrease the total cost of ownership. Everything we’ve accomplished over the past two years has been to position this Company to take advantage of this LED market and be able to execute on its potential. During the past three quarters, we transition the company from what was almost exclusively linear for us and to a company that is on a path to become almost exclusively LED focused within 12 months. This transition has fundamentally changed our operations. I cannot state that strongly enough. We have gone from a world where product life-cycles were five years to one that is five months, dealing with four foot form factors of bent metal to a customer base that demands a multitude of shapes and sizes not to mention having to deal in plastics, castings, extrusions, lenses, optics, board substrates and chips. In addition, certifications went from UL and NEC to the addition of DLC and others, all of which is -- have added time and cost. Not to forget longer warranties, Title 24, new customer sectors, and entirely new supply chain as well as tolerating new competitors who have never been in the traditional lighting space. Despite all of this noise, we've stabilized the business and will be prepared to deliver stronger revenues and margins over the next several quarters. We are now achieving a scale that is allowing us to gain margin advantage and in component costs and our gross margin pressure is now limited to only one product line. While we believe it may take a few quarters to cycle through our existing inventory purchase commitments, the necessary steps have been taken to ensure that we are progressing to the point where our sales growth can begin to realize substantial profitability. Outside of one-time items that Scott will speak to shortly, we have achieved monthly increases in margins across each of our product lines, again with only one today that is creating a drag. We currently are receiving a regular supply of the necessary materials to integrate into these products that lower cost than what we initially began with. These materials are moving quickly through the sales cycles and no longer are remaining in inventory at the same duration either. We believe that this is a positive trend and we are prepared to begin delivering the increased margins that our shareholders are expecting. Before I turn the call over to Scott, for details on our quarterly results, I'd like to say that we’ve successfully upgraded our banking relationship with a larger and more aligned credit facility. As many of you know, we’ve worked diligently to change our primary banking partner to one who can better provide us with the best capital structure and flexibility to grow our operations. Under our previous line of credit, we had never borrowed against it, however, other than for some customer projects financing. We were pleased today to announce a new credit line with Wells Fargo, with an asset based lending structure that best suits the expected growth in our business and will provide the liquidity and flexibility needed for our working capital going forward. We believe the terms are very competitive and provide us with the operational and financial leverage to expand our operations as needed in advance of the LED market growth. With that, I'll turn it to Scott.

Thank you, John. I’ll briefly discuss our financials, but I encourage each investor to review our press release and our third quarter 10-Q. Orion’s total revenue was $26.1 million for the fiscal 2015 third quarter, compared to $27.7 million in the prior year period. Lighting revenues increased 24% year-over-year and increased 96% over the fiscal 2015 second quarter. Total revenue declined only as a result of the year-over-year decline in our non-core solar business of $6.5 million for the quarter, which is a sector that Orion no longer pursues. However, we’ve been encouraged by a solid backlog and pipeline of new product orders, specifically growth in our LED product sales. Lighting backlogs have increased 282% on a trailing 12 month basis and we expect to see continued growth in bookings which will help, but not eliminate the quarter-to-quarter variability. Product revenue from Orion’s LED products increased to a record $12.7 million or 54% of our total lighting products during the fiscal 2015 third quarter compared to $1.4 million in the prior year period. Third quarter LED lighting product sales increased 807% over the prior year’s third quarter. Due to recent product releases and reseller interest, Orion believes LED product sales will continue to grow and reach between 50% to 60% of total product revenues during our fourth quarter of fiscal 2015 and to greater levels during our fiscal 2016. As John mentioned earlier, we’ve adjusted our expectations of total revenue for fiscal 2015 to range between $72 million and $74 million from a range of $80 million to $88 million. This revision is partially related to a multimillion dollar order that was delayed due to a utility approval that with construction time will not complete in the fourth quarter as we had originally expected. We do expect to at a minimum achieve the lower end of our range based on orders and contracts in hand plus a reasonable run rate and depending on shipments of certain other products we could be back in the original range we previously provided. We are confident that the Company's credit backlog, reseller growth, and sales pipeline support our current guidance and are greatly looking forward to providing you all with a healthy fiscal 2016 top line and margin expectations in our next quarterly period. Total gross margin was 14.6% for the fiscal 2015 third quarter compared to 29.4% for the prior year period, largely as a result of the accelerated pace of LED lighting product revenue and the related impact of fixed expenses within our manufacturing facility. Our supply chain has caught up with our sales and as John stated, we expect our gross margins will be increasing once we work through our existing inventory purchase commitments. Our lower than expected gross margin was impacted by a $600,000 charge or 240 margin basis points in relation to a warranty reserve. We discovered an assembly line work construction error contained in a single batch of Apollo LED product during a contained period of time. It has been corrected. The customer relationship was not affected by the change and we do not expect any negative financial impact in future quarters. We continue to aggressively focus on cost containment initiatives related to material product costs, service margin expansion and the implementation of lean manufacturing methodologies to reduce production costs. We are now targeting gross margins for fiscal 2015 to range between 16.3% and 16.6% and before the impact of the warranty and the previously announced impairment charge related to our wireless controls. Our estimate is based upon the current cost and production improvements which John has previously discussed. Our margin challenges have now been limited to one product line and upon completion of our plant improvement costs; we expect to be operating at a level consistent with our earlier projections. Company expects gross margins to improve as our supply chain strategy is fully implemented within the next few quarters. Our operating margins were impacted by increasing research and development expenses related to our launch of new LED products and ongoing initiatives related to further new product development and testing. We do expect this trend in our R&D expenses to continue during our fourth quarter. We reported a net loss for the fiscal 2015 third quarter of $4.7 million or $0.21 per share. In the prior year period we reported net income of $1 million or $0.05 per diluted share. Quickly moving through the balance sheet, we remain in a solid financial position to carry out all of our initiatives. Before I detail the recently signed line of credit with Wells Fargo, let me provide a quick note on our balance sheet at December 31, 2014. Company had working capital of $21.6 million compared to $33.1 million at March 31, 2014. We continue to pay down total debt during the fiscal 2015 first nine months as total debt decreased by $2.2 million to $4.4 million as of December 31, 2014 and compared to $6.6 million as of March 31, 2014. Today we announced that Orion has entered into a three-year loan and security agreement with Wells Fargo to borrow up to $20 million under revolving basis. Borrowings under the credit facility are initially limited to $50 million and subject to borrowing base requirements based upon eligible receivables and inventory. Terms were competitive in the marketplace and the line is structured in such a manner that is better aligned to Orion’s current working capital growth needs. With that, let me turn the call back to John, for a brief discussion on growth strategy. John?

Thanks, Scott. With regards to our strategy, last quarter we outlined our continued expansion of the Orion brand and launch of several new products. Our newly released line of Orion products have been favorably received by our customers as is reflected in the significant increase in Q3 sales. We offer and develop top-of-the-line products in terms of efficiency, performance, modularity and fixture life, and we will continue to do so. To achieve rapid sales growth, we needed to develop and sell the best products with the easiest method to install and then ultimately delivering the lowest cost of install and the lowest total cost of ownership, but our products are only part of our strategy. The industry we built our business on no longer exists. Speed to market, mass customization of the customer experience, incessantly creating new forms of marketing and rapidly flexing design, assembly, and inventories, heavily present today and which did not exist for Orion the same time last year. We recognize that in order to stay ahead of a rapidly changing and growing market, we need to be ahead of these curves. I like to announce a couple of specific longer-term changes in support of our new brand and in response to the market paradigms that we believe will better position Orion to grow well into the future, as well as be in front of this market demand. First, we’ve always been known for our innovative products. And to dominate in the LED world, we must elevate our capabilities with the finest resources available. With this objective in mind, we're announcing the creation of a unique innovation hub to be located in Chicago, Illinois. Our innovation hub will be charged with developing our next generation of ISON technology, as well as the new products that will define our future and position Orion to dominate our primary markets. The hub will be staffed with some of the industries best LED lighting experts and it is imperative that we build one of the industries best development and testing center staffed with its best talent. Second, we are announcing that we will be taking steps to increase flexibility in our manufacturing operations. While I will not comment on the specific measures, we will be maximizing our efficiencies and ability to maneuver by utilizing a best made or best fit approach, leveraging our current manufacturing capabilities as well as the capabilities of others when it is a better fit for the component being manufactured. Meaning, that our operations will begin to scale toward the things that we do best and must control and rely on others who have better capabilities for the components being demanded. Our rationale is that if we were to invest in new manufacturing equipment in support of the new materials and form factors required by the market, they would likely be obsolete before the current product cycles conclude. So we'll pursue those things internally that we must control to deliver our customer promise and rely on others externally who have the resources and capabilities that we need. Thus providing Orion the flexibility needed to perform while not being constrained to a four foot bent metal form factor for example. And finally with the grants of our LDR patents a few ago, we are unleashing our marketing resources with the full intent of driving the specification for retrofit Troffers. We will defend our patents vigorously, yet not rely simply on the PTO for our success. We’ve planned an aggressive sales and marketing campaign designed to drive sales from new customers, new markets, and new verticals. All of these initiatives will be funded primarily through existing resources freed up through internal budgets. The investments we’re making should start to yield an annual reduction of approximately $10 million even after the growth initiatives listed above, beginning in fiscal ’16. In a short amount of time, we repositioned our Company. We developed a productive sales structure, expanded and repositioned our product line with the right products targeting the right markets and have aggressively engaged and cultivated our network of well-established resale partners. The last initiatives I just announced will further drive growth and margin enhancements. To sum up, let me close with a brief discussion on M&A. We have the operational capacity to achieve greater gains as a larger organization. We feel that it is important to consistently be ready in the event that an acquisition would make sense for Orion, both in terms of operating capabilities, product design, revenue, accretive earnings, and customer support. We have focused our efforts through our own market research and outreach and have continued to maintain levels of dialogue with a number of attractive companies. However, we will remain cautious only looking into potential opportunities that are complementary to Orion and its shareholders. With the Harris acquisition, we successfully purchased and integrated a company that became critical to our future development. We will leverage our experience in this regard and be diligent in the process going forward. Our goals remain consistent. We must continue to outpace the market in innovation and execution, while also being transparent to each of you, our shareholders. We believe this is the best method to create a culture that will ultimately improve shareholder value. So with that, Scott and I’d be happy to take your questions.

[Operator Instructions] The first question comes from Steve Dyer from Craig-Hallum.

Thanks. Good afternoon, guys.

Hi, Steve.

Hi, Steve.

Couple questions. I'll start with the -- with your distribution network. Are you sort of where you want to be as it relates to distributors, ESCOs, territory leaders and now just sort of a matter of getting them fully up to speed and experience and so forth or are you still looking to add in that area?

Good question. There is still geographic gaps that we’d like to fill in. So these would be markets were either historically or never had coverage or good coverage, and as a result we’re continuing to explore that. But in cases where we had existing partner relationships, existing ESCOs and what have you, we’re in pretty good shape I think there now. It’s a matter of building scale and helping them see greater value and representing Orion’s products to their customers and providing them with sales resources and marketing efforts and really building upon what we have. I don’t think our need right now is in necessarily more of these distributors’ partners other than to fill in geographic gaps.

Okay. That’s helpful. Wondering if you could give a little bit more detail on the margin pressure in the quarter, if it was confined to a particular product line and then, I mean, is that pretty much behind us work through the inventory by the end of this fiscal year or do you anticipate that will linger a little bit in the next year?

Steve, good question. So we have really confined our margin pressure to one product line. We have identified the opportunities we’ve already negotiated, lower costs on a go forward basis as we see the volumes increasing. But as we discussed on the call, we do need to work through our existing purchase commitments. We expect to be able to do that in our fourth quarter here so that as we head into fiscal ’16, we can return to the gross margin levels that we’ve had historically experienced and that we’re experiencing with some of our other LED products including the new products that were recently launched.

Okay. And then, kind of brings to my next question with the cost of components decreasing in this area given the scale and so forth. And then I'm guessing ASPs will fall over time, they certainly are in a residential level. Do you have the ability to sort of lock in margins as you go such that you're not kind of stuck between the time you book an order and various costs in that -- in filling that particular order?

Yes, we can. So I don’t believe we’ve reached the bottom either on pricing and some of that will be as we gain increases in volume and we get a little leverage in terms of buying power and net [ph] increases. We do expect that there will be some declines on ASPs and that some of the margin pricing that can’t be gained will be passed to the customer to help justify the projects and close more business. Our expectation is we are very pleased with the progress we’ve made, but we also believe we will continue to be able to take cost out of the business.

And Steve, one other thing is, the electronics, the chips primarily are becoming a smaller and smaller portion of the total cost where other materials, metals, labor and things of the sort which are much more in our control provide some opportunity as well in the curve just seem to be flattening.

Okay. John, the $10 million I think I heard you say kind of $10 million of costs taken out of the business. Could you elaborate a little bit more on kind of where you find that? Is it headcount is it streamlining processes, is that a COGS issue, is it an operating expense event? How should we think about that into fiscal ’16?

Sure. Well, two different questions. I had to think about it where it came from. Where it came from early is as I had laid out some of the initiatives in the latter part of our comments, when you realign your manufacturing to create more of a variable cost model and you look at how you’re going to market in the marketing resources and sales resources, what have you, and as you are looking at the entire business and looking to realign resources that historically had been in a florescent model, which is a much more mature, much more stable environment and you’re investing those resources into more of a growth or I don’t want to really say a start-up, but you get a rapidly growing sector of the business. We really look it as two different businesses inside Orion. So as you go through the exercise of reallocating and realigning your investments, you find efficiencies and you create opportunity to where you don’t have to spend money in the same way you did before. So it will come out of COGS, it will come out of the SG&A, primarily those two areas and it impacts the whole business. There is just -- again, as you look at -- if you were to start-up an LED business, you would allocate resources differently than if you were managing a more maturing business. So I guess that's the best way I can explain it [multiple speakers].

Okay. One last question then for me, is there a particular end market where you guys are seeing sort of the most traction and what kind of you think will drive growth? Maybe there is a couple of them out into ’16?

Yes. There is certainly new markets that we are just now really migrating into the -- I guess, what I’d call the more professional office space and retail as well as hospitals and schools and I guess to some degree the office side of the federal government, that -- that's clearly is driving a lot of our business right now. The automotive sector has found a tremendous amount of interest in the Orion product on both sides of the world, both over in Asia as well as in the domestic. We believe retail is clearly a growth sector for us both due to the exterior product line as well as our interior. It’s a splendid feeling and I’m and strip fixtures. So I think those are some of the greatest growth markets that we see. I think in terms of exterior, that’s still strong, but our presence in High Bay, I believe is going to become a strong growth driver possibly later in the fiscal year.

Great. I will hop back in the queue. Thanks.

Thanks, Steve.

The next question comes from Craig Irwin from ROTH Capital Partners.

Good evening, gentlemen. Congratulations on the really impressive LED product growth.

Great. Thank you.

Thank you, Craig.

I wanted to dig in a little bit on some of your comments you’ve made. The inventory purchase commitments that are a little bit of a headwind for gross margins, can you clarify for us that whether or not this is in the LED products if it's a subset of the overall mix and roughly how big a margin headwind is this? Is this couple of hundred basis points bigger or smaller? How should we be looking at that and how do you anticipate this rolling off? Is this something where we can look at discrete timeline or is this likely to taper over time?

Yes, Craig, so good questions. The opportunity on material input costs is really across all LED products. Its chips, it's boards, and so we’re already -- we’ve already negotiated improvements from it is significant to us, more than 100 basis points. Its significant enough that we fully expect as we work through the existing inventory commitments and again we’re anticipating that through the end of our fiscal year we’ve really worked through all of that and we’re well positioned for fiscal ’16, that we’re going to be able to return margins around LED products to similar levels that we’ve experienced with fluorescent.

Okay, excellent. And then that's a segue into my next question. So in your release you’re very clear, stripping out the effect of some of the warranty charges on margin sequentially you saw an improvement from 11.5% to 17%. How wide a delta do you see for the linear fluorescent products versus LED products today? And if we were to completely normalize this inventory effect, would that push you more into your longer-term target range or would you need the additional revenue coverage that you're expecting to develop over the next several quarters?

I'll just comment on first part of that and then Scott can. The delta, there is two types of products that we sell. One is much more of a commodity, broader product line with lots of demand that's going to carry a lower margin than our historical fluorescent. But then there is another side of our business that we expect to be equally as strong that’s going to carry margins very similar to what we’ve done in fluorescent. So Scott?

Yes. And so the shift Craig, we do anticipate that our fluorescent margins are going to decline as volumes decline on that side of our business. We want to have the buying power, we're not going to have the same level of run rate through the manufacturing facility, but that we are going to see that influx on the LED margins and be able to get back up within -- we will give more guidance on fiscal ’16 as we get through our year-end call in a couple of months. But we see a clear path to being able to get margins back to where we’ve historically run and then as we’ve talked about leverage with our asset base to margins that reconcile to our longer-term targets.

Thank you. And then, my last question if I may, in your outlook commentary, Scott, you mentioned that certain other products, sales volumes of certain other products could potentially result in revenue more consistent with the original range, the original revenue guidance range for 2015. Can you give us more color about what products these might be? What might determine whether or not we actually see the revenue there and if this is something that helps contribute to the trajectory next year?

Yes, Craig, they’re really projects in nature. So there are several large opportunities in our pipeline. They are predominantly all LED products. But our ability to hit the original guidance as a function of the timing of those project orders coming in and giving us enough time to be able to manufacture the product get it out [technical difficulty] variability around construction cycles, utilities, everything that really John talk to about some of the challenges that we continue to see with some of these larger projects.

Great. Thank you for that and congratulations again on the strong LED growth.

Right.

Thanks, Craig.

Thanks, Craig.

I’m showing no further question. I’d now like to turn the call back over to John Scribante for closing remarks. End of Q&A

Well, thank you very much for being with us here today. We appreciate you taking the time and we look forward to talking to you again next quarter. Thank you and have a good day.

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.