Orion Energy Systems, Inc. (OESX) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Orion Energy Systems’s Second Quarter Fiscal 2016 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 follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Ms. Victoria Sivrais, Investor Relations. Ma'am, you may begin.

Thank you. Good afternoon everyone and thank you for joining Orion Energy Systems’ second quarter fiscal 2016 earnings conference call. Participating in today’s call will be John Scribante, our Chief Executive Officer; Bill Hull, our new Chief Financial Officer and Scott Jensen, our Vice President and Controller who will be available during the Q&A session. John will open today’s call by providing comments related to our quarterly results and business outlook. Bill will then discuss our financial results for the second quarter in greater detail. John will then make some closing remarks and will open it up for questions. The Company has made an accompanying slide presentation available on its website at www.orionlighting.com in the Investor Relations section. Additionally, for anyone who is not able to listen to today’s entire call, an archived version of this call will be available later this evening. Please visit the Investor Relations section of Orion’s corporate website to access the replay. Before John begins his commentary, I would like to review Orion’s Safe Harbor statement. This call is taking place on November 03, 2015. Remarks that follow, including answers to questions, include statements that the company believes to be forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are generally identified as such because the context of such statements will include words such as believe, anticipate, expect or words of similar import. Similarly, statements that describe future plans, objectives, or goals are also forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that the company has described in its press release issued this afternoon and in its filings with the Securities and Exchange Commission. Except as described in these filings, the company disclaims any obligation to update these forward-looking statements, which may not be updated until the company’s next quarterly conference call, if at all. With that, I’ll now turn the call over to John. John?

Yes, good afternoon everybody. Today we reported another growth quarter with fiscal 2016 second quarter total revenues growing 17% year-over-year to $15.7 million and gross margins expanding 678 basis points year-over-year to 18.5%. Our LED lighting product sales increased 104% to $10.6 million for the second quarter and LED products have reached a record 72% of total lighting product revenue reflecting sequential LED unit growth and clearly validating that our business transformation is working. Our second quarter sales were driven primarily by customers within the education, retail and government space, particularly universities and school districts that took advantage of the downtime during the summer months to complete their maintenance projects and retailers who are rolling out store renovations. In fact, our sales in these verticals exceeded our original expectations. We now have agreements with two of the three largest school districts in the nation to supply LED products and we just received another significant federal contract which should begin shipping late in fiscal 2016 complimenting our more historic verticals like retail which now include three of the nation's largest retailers. The trade off with these newer verticals however is that this business is heavily comprised of our LDR trough or retrofit fixtures which are currently our lower priced, lower margin products. As a result, the higher LDR mix we experienced in the fiscal second quarter directed impacted our margin as well as our topline revenue due to the lower average selling prices. Our industrial sales particularly the high-bay fixtures in the quarter was impacted by the slowdown in the U.S. industrial production which was reflected in weaker than expected GDP numbers reported last week noting a slower annual growth rate to 1.5% in the quarter versus 3.9% the previous quarter. While we remain confident in the opportunity ahead of us, prolonged weakness in the industrial space could impact our growth. As we move to the second half of the year we do expect an overall revenue and margin lift as our new high-bay products gain traction and we release our new higher-margin LDR products scheduled for December both of which are high-volume product categories for Orion. For reference, our new high-bay fixtures have over twice the selling price and twice the margin as our existing LDR line. So you can see how mix can impact a quarter. However, volume increases from these new products, coupled with higher margin LDR product I just mention should offset the mix impact experienced in Q2 for the back of the year leading to a blended average margin in the mid-20s by the end of the fiscal year. While our primary value proposition and competitive advantage continues to be retrofit, our customers are increasingly seeing the value that Orion provides beneficial for construction projects, particularly our performance advantage high-bay. Furthermore now that Orion is well-positioned in the LED space along with our new channel partners and verticals we serve our historical seasonality trends are shifting. So let me walk you through this. In the past virtually all of our business was driven by industrial capital spending in our high-margin high-bay product line with about two thirds of our revenue falling in the winter months around year-end budget flushes and first of the year budget reloads. Today while industrial spending is still a significant driver, our revenues are being generated from educational institutions, government and retailers that have more of a summer impact. This shift is creating an environment where product mix is becoming much more important than past seasonal trends. The timing of this shift aligns very well for our next calendar year as our December release of our new high-margin LDR will be well established in the market by the time these summer projects get shipped. So turning back to the second quarter, roughly 30% of our sales were from new customers defined as projects greater than $5000. As we have said before, what makes us unique is not just the strength of our products but our experiencing and deep understanding of the retrofit market and what it takes to serve these unique needs of these retrofit customers. It is not just a low-cost or better performing fixture. It is also our ability to reduce jobsite installation cost, maximize one-for-one replacements, deliver custom configured product quickly, provide project financing and industry's only factory issued energy savings guaranty. On top of that we provide performance leading products to save our customers more energy than any other lighting company in our space. It is this unique value proposition that is driving all the new business. Our results this quarter underscore not only the strength of our offering but also the accelerating momentum behind the industry-wide shift to LED. A recent report by the United States Department of Energy confirmed the value and opportunity of the LED conversion underway, noting specifically that linear fixtures and high-bay applications, Orion's core competencies offer far and away the most fertile ground for future energy savings in lighting accounting for 60% of the immediate energy savings potential. And with less than 2% of the space retrofitted and momentum increasing Orion is really well-positioned. In fact if a customer purchased any high-bay fixture on the market other than Orion's, they are spending more in electricity and wasting more money that could have been used in their organization from operations. So before I turn the call over to Bill I wanted to quickly touch on our strategic priorities for the year. First, grow our LED sales; second drive innovation and third improve gross margin and operating margins. Let me begin by providing some color on our progress in driving LED sales. As I previously mentioned, during our second quarter LED product revenue comprised a record 72% of total lighting product revenue which compares to 41% a year ago and 61% in the 2016 first quarter and in fact our LED sales reached 77% in September. As we stated before, this was a tremendous opportunity within our installed base. Over the years we have sold roughly 3 million fluorescent high-bay fixtures representing an LED replacement value of roughly $850 million. Less than 5% of these 3 million fluorescent high-bays installed in more than 11,000 facilities have been upgraded to LED. And because our customers have this built-in upgrade path in place with Orion's modular fixtures, their upgrade can be done with less labor and less material cost than removing the entire fixture system and replacing it with a competitor's system. In quarter two, for the first time in the company history LED sales in the second quarter comprised a greater percentage of total high-bay sales than fluorescent. We are confident this trend will continue and add margin and revenue growth. Beyond our installed base we also see momentum within new markets such as healthcare, governments, airports and educational facilities. As I mentioned, we have had a number of key wins in these markets and believe there are more to come. While our public announcements of specific wins do not necessarily indicate broader sales trends we do like to highlight those that reflect our innovation adoption or segment wins that reflect our success with these new products. With that statement in mind we were recently awarded a three-year contract valued at $12 million to $15 million with a national grocery chain to retrofit Orion fluorescent high-bay fixtures in their distribution centers with our new ISON Class high-bay fixture. Orion delivered a significant performance and total cost advantage against two of our most notable competitors to win this business. This project alone illustrates the power of the upgrade path we had built into our last generation of fluorescent products as well as the success of our innovation hub yielding real economic benefit for the end users. Other notable wins since our last conference call include orders from a major big town [ph] university a complete district retrofit for the Goshen school district in Ohio of 3000 LDRs and county [ph] schools in Michigan with 1500 LDRs. On the industrial side, we landed the first all LED high-bay projects for two of the largest soft drink companies in the world as well as the start of a rollout of LED upgrades for one of the largest appliance companies in the world representing about 3500 high-bay fixtures at the once site alone. On the retail front we completed seven locations for one of the largest retailers in the United States as well as a complete San Francisco Metro rollout and corporate office renovation for a North American discount retailer representing over $1 million in revenue during the quarter. And on the automotive front we have $7.4 million orders with Ford, the majority of which are scheduled to be delivered in Q4, a portion of which was supposed to have been realized in Q2 but shifted out due to site access issues. About $4 million of the Ford orders were received since our last earnings call and we now have a pipeline of over $17 million with five of the largest automakers in the world. Finally the transportation vertical, we landed multiple orders with some of the largest LTL trucking companies and a complete retrofit of exterior lighting at an International Airport with the first order scheduled to ship this quarter. So you can see we've been very busy building pipeline and as well as having success converting the pipeline into long-term business relationships. And just a note about backlog, many of these wins are backed by written contracts, but not all of them booked to backlog as they are still conditioned upon individual order releases for each jobsite. So finally, we have a more productive sales structure indeed in U.S. markets division. During the second quarter we added 16 new U.S. markets ESCO resellers bringing the total number of key resellers to 123. And while additions to this list are important to us, the lighting retrofit focus of the specific reseller and the quality of their teams are much more important. So now let's turn to our second priority, innovation, not just to improve, but to be the industry leader that everybody else follows. Orion was a pioneer in the first wave of industrial high-bay energy efficient retrofits over the past two decades and we remain committed to our culture renovation. As you may know, we recently opened our innovation hub in Chicago and have added a dedicated team charged with driving the next generation of innovation and product development. This investment is already paying off as we reached a record high LED product sales in the quarter were 72% and also reached as high as 77% in September. With our unit sales of LED increasing sequentially and LED revenues growing so strongly along with some major product announcements in the next couple months we are seeing a great return on our innovation and R&D spend. Our newly introduced ISON high-bay fixture is now the most efficient high-bay in the industry well surpassing all the major brands in the marketplace. The efficiency gap between the ISON and our competitors products has never been wider, while it is upgrade paths from prior Orion product generations is unprecedented. In addition it's modular design goes one step beyond other LED products in the market meaning that as LED technology advances our customers can simply upgrade the thermal boards containing the light engines rather than replacing the fixture chassis entirely. This capability alone only available on the Orion-ISON Class product delivers one-of-a-kind technology risk reduction proposition to facility managers and owners. As LED technology evolves ISON customers can rest assured that their investment in an Orion product allows for easy technology upgrades and a greatly reduced technological and financial risk. In early October we launched our new high-bay fixture line with generation 2 products in the ISON, APOLLO and HARRIS classes and set new industry performance threshold. In fact, our lowest performing product in this lineup outperforms every single other product in the marketplace with the exception of one regardless of the pricing class. Our medium performing APOLLO class matches the top performance of that one competitor just mentioned, but yet at a much lower price and significantly outperforms all others, while our ISON Class product outperforms every product in the market by at least 17% and up to 50%. This new product portfolio breaks performance barriers never achieved in the general lighting industry, toping all of our competitors' products and standing alone at up to a 179 lumens per watt. Its future proof modular platform with an industry leading performance for industrial applications has been received with tremendous excitement and we expect our High Bay sales to accelerate going forward as we submit our dominant position in this category. High Bay fixtures have much more product differentiation than to office droppers [ph] and Kipps [ph] due to their thermal and optical design challenges and carry higher selling prices and significantly stronger margins. As we look ahead we have a robust product pipeline with many more industry breakthroughs just ahead of us. Innovation drives increase margins, margin protection, revenue and ultimately shareholder value. So let’s talk about margins. Our margin expansion initiatives that we discussed back in February where we are now realizing the results of these initiatives that we'd laid out related to gross margins, which include focusing on our core competencies, our product design, improving our long-term supply agreements and further adopting lean principles in our manufacturing. In fact this is our fourth quarter in a row of increased margins for all LED product categories. This is a trend that we expect to continue ultimately achieving sufficient margins to fuel our growth and increase shareholder value. Furthermore, this fiscal year we have realized more than $3 million in cost savings and productivity enhancements which are reflected in the gross and operating margin improvements realized today. We will further drive these initiatives throughout the balance of our fiscal year and beyond and expect to realize additional improvement and scale. As a specific February initiative we said that we were going to increase the margins in our LDR line and six months later we have seen over 23,00 basis point increase and will be announcing an LDR product line addition later this quarter that will add another 1000 basis points to this product line well exceeding our February projection of 20% gross margin. As I mentioned earlier, despite the improvement we achieved in our gross margins, our second quarter results were affected by the temporary shift in product mix in Q2 to more LDR shipments. Our second quarter shipments of lower margin LDR spiked 15% over Q1 while overall fluorescent shipments declined 29% including a 43% decline in the higher margin, High Bay fluorescent fixtures. This shift in mix combined with growth in our other LED product shipments of 17% growth resulted in somewhat lower gross margins in Q1. As I mentioned, the mix impact will diminish as our sales and gross margins get a boost from the recent launches of our new High Bay products coupled with high margin LDR expansion I discussed previously. The impact will be more meaningful in the second half of this year and throughout fiscal 17. So to sum it all up, we're making great progress in our business to capture the benefits from the secular shift from florescent to LED with lighting revenue growing for the fourth quarter in a row and margins increasing 3Qs in a row on year-over-year basis. And with our robust retrofit product line in the commercial, institutional, industrial spaces we are prepared to deliver strong finish to our fiscal year and a great start to our next fiscal year. Before I turn it over to Bill for more insight into the results, I'd first like to just thank Scott Jensen for all of his many contributions to the company over the past seven years as our Chief Financial Officer at Orion. I would also like to welcome Bill Hull our Chief Financial Officer to the Orion team. Bill brings a wealth of experience, creating and leading financial teams and has a strong track record of performance at growing public companies. Bill will be invaluable to us as we build the business and reach new heights. Bill?

Thanks, John. As John noted we established a new record for LED revenue as a percentage of lighting products sales during the quarter. Our total revenue grew 17% to $15.7 million which compares to $13.4 million in the second quarter of fiscal 2015. Product revenue increased 18.5% year-over-year to $15 million which compares to $12.6 million in the second quarter of fiscal 2015. LED sales grew 104% to $10.6 million and comprised 72% of total lighting product revenue. This compares to LED sales of $5.2 million or 41% of total lighting product revenue in the comparable period. Service revenue was essentially flat at $700,000 in the second quarter of fiscal 2016. Total gross margin was 18.5% for the second quarter of fiscal 2016 reflecting a nearly 700 basis point improvement over the adjusted 11.8% gross margin reported in the second quarter of fiscal 2015. This reflects our margin expansion initiatives that were implemented over the past several quarters. Our gross margin improved on a year-over-year basis and increased in each LED product segment. It declined sequentially from 22.7% in the fiscal 2016 first quarter as a result of the mix shift in orders John discussed, including a sizable drop in fluorescent sales. We expect continued year-over-year gross margin expansion in the second half of the year as the shift in our margin mix moderates. Total operating expenses increased – decreased 16.7% year-over-year to $6.5 million reflecting an improvement of nearly 1700 basis points as a percentage of revenue to 41.2% compared to 58.1% in the year ago period. Year-to-date total operating expenses increased 6.1% or nearly 1400 basis points as a percentage of revenue to 43%. The improvement reflects reductions in discretionary expenses resulting from our February 2015 business improvement initiatives as well as lower legal and consulting expenses. We reported a net loss of $3.6 million or $0.13 per share in the second quarter of fiscal 2016 compared to a net loss of $18.3 million or $0.84 in the prior year period. On an adjusted basis, the company reported a net loss in the prior period of $6.2 million or $0.28 per share. Now moving to the balance sheet, we ended the quarter with $13.4 million in cash which compares to $17.9 million as of June 30, 2015. We have working capital of $32 million which compares to working capital of $25.2 million at September 30, 2014. Our cash flow used in operations was $3.2 million during the fiscal 2016 second quarter which compares to a use of $3.8 million during the prior year period. The reduction in accounts payable reflecting the timing of various payments offset most of the improvement in our net loss. Our inventory turns have continued to improve during the first half of fiscal 2016 and we expect this trend to continue even as we deliver new LED products to the marketplace. With that, let me turn the call back over to John.

Great, thank you. We are very pleased with our second quarter results. Our pipeline build and product offerings leading into the back half of the year when we historically realized about two thirds of our revenue. We are really reiterating the majority of our fiscal 2016 guidance to include generating significant year-over-year revenue growth, significant gross and operating margin expansion and positive EBITDA and GAAP EPS in the second half of fiscal 2016. However due to the shift in product [Audio Gap] products during the second quarter which reduced overall gross margin percentage for that quarter. And the economic headwind and the industrial production we experienced, we now expect to generate 12 month trailing positive EBITDA by the end of our fiscal first quarter – fiscal 2017 first quarter ending June 30. Furthermore, given revenue and related accounts receivable build that we currently expect for the back half of fiscal 2016 related to our pipeline build, we now expect to generate 12 months trailing positive operating cash flow by the end of our fiscal 2017 first quarter ending June 30 as well. Longer term our outlook [Audio Gap] we are the cusp of the major inflexion in the secular shift from fluorescent lighting to LED and while this is a messy industry playing field at the moment, we are one of the true innovators in the space and fully expect to capture the potential from the many opportunities that are in front of us. We thank you for your patience and your continued support. So with that, I will be happy to take your questions.

[Operator Instructions] Our first question comes from Steve Dyer of Craig Hallum. Your line is now open.

Thanks. Good afternoon guys. I’m trying to just make heads or tails of the sort of the new commentary around guidance if you will and seasonality, it sounds like some Ford business slipped from September into now anticipated in March is that right?

Yes, there was, I think the mix had a little more of a dramatic impact on the quarter. There was some Ford business that did move to the March period due to getting access to the site. As you know and have likely heard Steve, in the past our Ford business turns to move around a lot just due to getting access. So to rely on that business in particular, we got to be very, very careful. So clearly to build the revenue without regard to Ford is very important to us, not to Ford it is not important business for us, it is just in terms of us predicting our future. We put a high risk on that business.

Yes, I guess I’m just trying to figure out, I mean you mentioned seasonality historically the December quarter is far and away your biggest and it sounds like maybe March and even June will be a little bit more balanced. Can you, I know you don’t want to get sort of pinned down on the quarters, but how you sort of think that will look in terms of the relative size of each quarter?

Yes, I think you’ll see continued strength in our December quarter as well as our March quarter. June is quite a ways out for us to predict although with what we’re seeing, what we saw this year in the adoption rate of our schools and the institutional side of our business, I suspect that June is going to come in strong as well, but we still feel very confident about our December and March quarters.

Okay.

And even with the business of Ford shifting, all that will do is just boost our March quarter.

Okay. I'll hop back in queue, thanks.

Thanks Steve.

And at this time, I’m showing no participants in the queue. I would like to turn the call over to management for any closing remarks.

Okay, great, thank you very much. Thank you for joining us. We look forward to speaking with you again when we report our next quarter in three months. Thank you and have a good day.

Ladies and gentlemen, thank you for your participation on today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day.