Orion Energy Systems, Inc. (OESX) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Orion Energy Second Quarter Fiscal 2017 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 call maybe recorded. I would now like to introduce your host for today's conference, Mr. Gary Abbott. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining Orion Energy Systems' second quarter fiscal 2017 conference call. Participating in today's call will be John Scribante, Orion's Chief Executive Officer; and Bill Hull, Orion's Chief Financial Officer. John will open today's call by providing comments related to Orion's quarterly results and business outlook. Bill will then discuss the financial results for the second quarter of fiscal 2017 and subsequently open the call to questions from the audience. Additionally, for anyone who is not able to listen to today's entire call, an archived version will be available later this evening. Please visit the Investor Relations section of Orion's corporate to access the replay. Before John begins his commentary, I'd like to review Orion's Safe Harbor statement. This call is taking place on November 02, 2016. 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 Scribante. John?

Thank you, Gary, and thank you all for joining us today, good afternoon. So by now I hope that everybody has had an opportunity to review our financial results as we were very pleased with our performance during the second quarter. Our strong performance was the direct result of our dedication and focus over the past two years on margins, innovation and operational improvements. So now let's walk through the quarter. First, from a financial standpoint revenue was in line with our expectations of $18.7 million and we added incremental backlog for the remainder of the fiscal year ending at $14.6 million. During the quarter we did see some revenue slippage due to flooding in the south in August by Hurricane Matthew in September. Those were major impacts but revenue might have been a bit higher if those events hadn't occurred. We also exceeded our 30% gross margin target and generated strong cash flow from operating activities, specifically we achieved a 33% gross margin with about $2.9 million in positive cash flow from operations, reflecting strong adoption of our high bay product lines, and we ended the quarter with $18.7 million in cash. Our second quarter results were in line with our expectations and show that our business is structurally sound. The increased margin on operating cash flow illustrate what Orion can deliver. These results are indicative of our current operating model within the context of normal seasonality that favors the second half of our fiscal year. As we stated on a previous conference calls, we typically generate 40% to 45% of revenue in the first half of our fiscal year, and the remaining 55% to 60% in the back half. We expect this to be a normal year with the usual macroeconomic caviar and we believe that we are on-track to achieve our guidance. We previously guided to revenue growth of 10% to 20% in fiscal 2017 and remain comfortable with that target. We also expect gross margins to remain at/or near 30% for the balance of fiscal 2017. While we believe 33% gross margin is consistent with our long-term goal to show gross margin increases, we do not expect to see a repeat of this level in the back half of fiscal 2017, that is because gross margins are subject to the mix of business and will fluctuate a bit from quarter-to-quarter. And Bill will go into this further in a few moments. So right now I'd like to change gears and talk a bit about our products and sales initiatives. First, let's talk about our products; for the past two years we have focused on developing best-in-class LED fixtures as a strategy to excel in the industrial retrofit market. And for the past few years, Orion has not only delivered record breaking performance, we have maintained that through leadership position despite attempts by our competitors to catch up to us. We believe that product innovation drives pricing power, the product performance is only one thing -- to deliver our customers product cost competitively and within only a few days after the order received, that is unprecedented. Orion is uniquely serving the retrofit market and it shows in our operational performance. For the past year or so, we've generated about 75% of our product revenue from LED fixtures. This quarter we reached 81% for the first time. This is significant because it's a strong indication of the success of our technology evolution, having been a 100% fluorescent-based company just a few years ago. In terms of revenue, our total revenue grow by a respectable 19% in the second quarter. Better yet, our LED product revenue grew 33% from a year ago quarter. Our LED product sales increased from $10.6 million in last year's second quarter to $14 million in the second quarter of this fiscal year. Clearly, we are doing well. As many of you know, Orion is dedicated to excellence in the building retrofit renovation space, a $200 billion installed base. Having the highest performing products enables Orion to deliver the highest return on investment for the customer. We ship our products in less than ten days from our U.S. factories which allow our customers to realize the benefits more quickly. We also have very low job-site expenses with minimal disruption to the customer. This helps make the installer more profitable and leads to much more happy customers. Everybody wins and this gives us a real competitive advantage in the marketplace. And with regards to the return on investments, there our customer see -- we set an industry record of 200 lumens per watt with our ISON class High Bay fixtures which were just released in the second quarter. In a short period of time, we pushed the technology envelope and extended our lead from the prior efficiency benchmark that we set at 179 lumens per watt. In fact most of our competitors still sell high-end solutions that are only about 160 lumens per watt with one exception around 185. So from a customer perspective, the important thing is their financial benefits will be significantly greater by using an Orion Technology over any other brand. As it stands, we know that we have a home run with our high-end products, and you can see in our gross margin it expanded from 19% in the second quarter of last year to 33% this quarter, and we realized this margin expansion from a prior generation of High Bay product without any contribution from our new ISON product line just released. So with that said, we know there is extreme customer excitement around our new products. In fact after we made the announcement in September, Toyota, unquestionably a world-class manufacture, came to us and asked if they could be the first major company to adopt our new ISON High Bay fixtures. So naturally we obliged and they subsequently committed to a large transaction that we'll begin to deliver in this current quarter, or third quarter. Now let's discuss our sales initiatives; we're very excited to see the growth in our distribution sales. Channel revenue from both, distributors and large SKUs combined 363% of second quarter revenue. Selecting and growing revenue through channel sales is key to our growth strategy, it provides the greatest leverage of our time and resources we saw significant progress in Q2. So looking back, we put our plan into action about one year ago to transition our sales model to an indirect agency driven distribution channel starting with just a few agents. And subsequently we rolled out the plan broadly towards the end of January 2016. By late April, we had agencies in place that gave us relatively comprehensive national coverage. And in the second quarter we continue to see strong growth from our agency business which is now driving the overall growth of our channel and contributing to the total revenue growth of the company. Enterprise and government customers are also driving top line growth; we've done particularly well with automotive and retail customers in recent quarters and expect sales from this segment to continue to be strong, especially as we enter the high season of our business. So in summary, our strategies are paying off as can be seen by our top line growth. The percentage of product revenue from LED fixtures, our gross margin expansion, and the dramatic increase in revenue contribution from distributors; it is clear how far Orion has come and we see many opportunities to build on our success. As we have promised you in past quarters, we continue to focus on revenue, margins, and operational excellence, and drive incremental growth in expanding profitability. So on that note, I'll turn the call over to Bill to discuss our financials. Bill?

Thanks, John. I'm going to review our fiscal Q2 results and provide some commentary and then open the call up for questions. Orion second quarter financial results were solid. Our revenue was $18.7 million and grew by 19% over the year ago period. Product revenue was 95% of sales and services was 5%. Our product revenue from enterprise accounts was 37% and our product revenue ESCO and distribution partners was 63%. And keep in mind, that we also service enterprise accounts with distribution channel partners in many cases. During the second quarter, we shipped over 2,200 customer orders including 30 transactions over 100,000. Our average deal size was more than 8,300 and our backlog increased significantly during the quarter. At the end of the second quarter, our backlog stood at $14.6 million which was the highest level in several years. The gross margin was 33% in the second quarter. We had a very favorable product mix and we exceeded our forecast. The gross margin increased significantly from last year's Q2 when we recorded a 19% margin. While we don't expect to revert back to last year's level, we expect gross margins to remain at/or near 30% for the balance sheet of fiscal 2017. A slight moderation from the current level is the direct result of product mix and its impact on margins. Now as far as our operating expenses are concerned we maintain tight controls on our spending. We have primarily invested in building our distribution channel and our research and development efforts while keeping overhead expense increases to a minimum. As revenues continue to grow, and should benefit from operating leverage and generate improved profits. Our net loss from $3.6 million in Q2 2016 to $970,000 in Q2 2017; this was good progress and leaves us within reach of GAAP profitability. Since GAAP profitability is in sight, it's worth mentioning that we have $58.8 million in net operating losses available to potentially offset future taxable income. We plan to use them appropriately and managing our income taxes within future quarters and that should benefit our future net income and cash flow. Importantly, we had very strong cash flow in the second quarter of 2017 with $4.6 million of total positive cash flow of which $2.9 million represents cash flow from operating activities. During the quarter we have non-cash expenses of approximately $1.1 million, primarily consisting of depreciation, amortization, and stock-based compensation. With all that said, I hope you can appreciate the magnitude of our financial progress. Our team has worked hard to build a solid foundation, and we are well positioned to advance from this point. At this time, I will conclude my prepared remarks and open the call to questions.

Thank you. [Operator Instructions] Our first question is from the line of Steve Dyer of Craig-Hallum Capital.

It's actually Greg [ph] for Steve. Congrats on the good quarter though. I was hoping you could start-off by maybe bucking in the various items that led to the improvement here. I mean how much of the improvement is attributed to mix versus all these new products, versus your go-to-market strategy? Any color would be helpful.

I think a big part of the improvement to get to -- you're talking about margins I would imagine; the big part of that improvement in the margins is really a combination of the efforts of margin improvement related to supply chain designs and tooling and other measures of increasing the overall profit of the products and subsequently over the last couple quarters, we've been flushing out old inventories and inventories of some of the lower margin products from prior generation. So as we continue to innovate and bring new products to market, each and every time we're building in better designs, pulling out labor costs; going out excess of the supply chain costs and to some degree -- some of the manufacturing processes is changing in order to continuously drive profit through that innovation. And so that was a large for the improvement. Now mix does impact our sales and we had a large contribution of High Bay products compared to last quarter where we had more of a contribution from the LDR product which is a slightly lower margin. So it really -- is a combination of just the sequential improvement from the product designs, supply chain, and manufacturing process combined with a more favorable mix. And just looking forward on that -- that mix is going to bounce around a little bit as we go from -- in future quarters, and it's going to take us a little while to normalize our LDR product margins which have improved dramatically but is not at the same pace but we're focusing on that as well to help minimize that. But over the next couple of quarters you will see some variability in margins just due to that mix shift.

Got it. And I guess my question was maybe across the board, not just margins, but also top line growth via the nice improvement in the backlog sequentially. I mean -- what do you attribute that to -- is that new products? Is that go-to-market? Are you winning new customers or what would you say there?

Okay, good, thank you for clarifying that. We have had a significant increase in business that we are seeing coming through our distribution customers. As you know, about a year ago we had pivoted our sales efforts towards an agency driven distribution model. And so as we've been implementing that strategy, what we're seeing is more business coming from distributors that we never knew about before because we weren't representing those distributors. So now as -- about 50% of our channel is now coming through these distributors that -- it's pivoting and shifting and that strategy is starting to pay-off. So we would continue to see growth in top line revenue as a result of our continued expansion and progress moving more business through distribution and leveraging relationships through our distributors. I think also we saw in backlog; government projects; some of our larger automotive customers book and as a result -- that continues to fuel backlog as well as -- we have added a few more sales people, and so we're getting more run rate, smaller business. So the overall progress I think is on all fronts, sales being certainly a driver; and then we're gaining more attention because of the product initiatives. We believe that innovation drives pricing power but it also drives -- makes a statement in the marketplace from the customer point of view. When you have the highest performing products in the market you know your competitors are on the defense. And as a result, we -- we don't win every deal that we go after but we certainly have a great shot at it from a performance point of view. So I would say that those three things are -- the margin through all the innovation stuff, the performance and the sales.

Got it. I know you maintain the full year revenue guide; would you still expect the December quarter to be stronger than the March quarter, given impact of seasonality in budget flush? And then I know you've sort of mentioned GAAP profitability but do you envision getting there in either of the next two quarters or is that a fiscal year or sort of '18 thing? Any color there would be helpful.

Yes, I'll let Bill comment on some of that. I think in terms of the -- we see the back half for the year coming in line with what we have projected. Our quarter-to-quarter numbers as you know they're seasonal, and there're impacts one way or the other, but I'd like you to just concentrate on that year end number, and know that we're focused on doing everything to deliver that, we believe that we're on track and certainly this quarter gave us a boost going into the back half, and the back half is usually seasonally stronger than first half, so our year-over-year comparisons, we feel pretty good about it. Bill, do you want to comment.

Yes, I think the only thing I would really add there is, we were not given quarterly guidance. given directional guidance, and as you can see we're trying to improve on a quarterly basis, and as I said in the past if you look at our break even at 30% gross margin which we emphasize this last quarter, but we're seeing 30% maybe the rest of the year, with about $7.5 million of G&A sales marketing R&D expenses, we now would say break even around $25 million in sales. So we're still working hard to get there and that depends on where the gross margin and where we end up with our sales execution, so that's what I'll say on that.

Sounds good, congrats again and thanks for all the color.

Okay, thanks.

Thank you. [Operator Instructions] Our next question is from the line of Joyce Kasper [ph], private investor. Your line is open.

Thank you, good morning -- good afternoon, everyone. Nice progress in the quarter, no doubt about it, very pleased to you to see that. In terms of looking forward in the current quarter, how much of that backlog can you deliver in the current quarter? And I assume that all of it will be delivered in six months going forward including the current quarter and in that -- within that question, this Toyota contract I assume didn't start until this current quarter, correct me if I'm wrong on that, and how does that impact the remainder of the current fiscal year.

I think Bill has some insight on the backlog, but it as relative to Toyota, first of all Toyota have been a customer of alliances for a decade now, and continues to we continue to build on that success. And so we have had some products shipped, some LED High Bay product shipped in the last six months or so, as they got started down this road, but once we released the product that we have out now, it's really made them want to move forward and accelerate and really build out their portfolio with the new products . So that is shipping some -- a lot of this year or some of the shipping this quarter a new ship over the course of time over the next several quarters. So it's not a single thing that will just occur once in the quarter, it's going to have some tail to it, so Bill, you comment a little bit on that?

Yes John, Joyce, when we take a look at the backlog, we think we had about, let's say 70% of that what happens in this fiscal year, and the other 30% will fall in the fiscal 18, and we had that 70% as John mentioned some of that oil will fall into this year.

Okay, all right. And as you look forward in trying to get to this breaking and there's a -- breakeven number on an earnings bases. If I recall you all mentioned something about $25 million to actually bring a number to the bottom line -- and that.

Well, I did a good example math with 30% margin is 7.5 million my own, which is kind of a guidance, there's a lot of levers to pull there and for success in increasing our sales, or increasing our margin, and keeping our thoughts in check, there is possibility, yes.

Okay, I can then make that direct question toward the R&D area, and if you're moving forward beyond this wonderful development that you've come forward with now and broadening your market, where do you direct your R&D going forward from here? Which areas in the market do you see real opportunity that could really give you a momentum beyond what you've accomplished in the R&D area?

Sure, I'll give you a couple of thoughts, but I hesitate to get too deep in the call, to as really what our future plans are. But I will say that on the LDR. product line, which has been a high volume yet more from a margin perspective, a more challenging products., it's -- we have a strategy around building products, that are more that are -- that are designed more for unique applications, and so rather being that broad product that fits in everything that's out there, where there's a lot of competition, we believe there's a market niche is where we can design some custom products, shouldn't say custom, I should say some products that are uniquely fitted for certain markets, and for certain applications, that will allow us to be one of a few that in the opportunity as opposed to one of many there and where there's margin, and competitive pressure, so diversifying our product line making it more vertical specific, more application specific, we believe we can maintain some pricing power there. The High Bay line obviously is our flagship and we will continue to build performance attributes into that product. And then thirdly, we are beginning to identify some trends around Internet of Things, and smart technologies as you know we've got deep portfolio of smart building technologies, we have a portfolio of smart city technologies, and utilizing a maximizing the actual property that we have, and building upon that and bringing more techno -- more products to market that are enabled for the future, more enabled for providing business solutions as opposed to lighting products. Solving our customer’s business problems, by providing intelligence data and other analytics through lighting systems, is certainly an area that we are focused on.

Okay. Just elaboration on that John, Technology -- Smart Technology I think that's a broad area, is there a possibility for the company to move into the high B, Wi-Fi connectedness in the relating systems.

Yes, absolutely. I mean there's a lot of value. I mean we've been we certainly have been doing that since 2007, and we are ahead of our time in a lot of our smart building technology, and in high base space and we've built upon that although over the last couple years we've taken a little bit of a breather in the development, and broadened our partnerships, with other developers of this technology. For us to invest millions and millions of dollars in something that is still in so much flux, was a risk to us and besides we had we have another job to get done and that's to deliver profit margins on our core business on the lighting side. So, this has allowed us over the last couple years, to really step back take a deep breath, understand where we want to play where we can be competitive, where we can be strong and take an approach that we believe is unlike what many others are taking and I guess more to come on that in future quarters, but we're clearly focused on bringing to market all Orion based product offering that creates real value solid business problems.

Okay. And then, if I could squeeze in one additional; in terms of customer contact and the field and when you start looking at the complexity of Toyota, the size of their facilities and so on. It brings up the potential of what else is happening in the market, when you look at a quarter-to-quarter bases what Amazon is doing in terms of one quarter expansion in the United States, was really significant. Are you jumping into that kind of business? I mean you have opportunities for serving people like as Amazon also is and there is a lot of other companies that are adding a lot of the capacity, all over the place. I just drove back from Oklahoma yesterday and all along 44 -- I mean there were construction going on a large building. So, how do you -- it to seem like you're right there with the product line now that can really capture this new business.

Well, yes of course, and I think a lot of what you're seeing in our backlog and then our sales pipelines are is what exactly would what you are saying. I mean it needs a large distribution and e-commerce and data centers, that's there's a lot of construction going on in I was getting a piece of that and that's very good business for us. I think a large healthcare applications, large retail you know there are our traditional high way warehouse is that strong business, and there's good and solid in many of our old system or continue to come back to engage with us. But these new markets are also very, very interesting for us and certainly driving revenue for us.

Okay. And just a summation -- just from my perspective I look at the company, look at what you're selling for in the market and look at this positive cash flow trend that you have going here, and your book value. And relate that to your cash position to manage your business. There's just a lot of elements of the equation that are turning very positive and yet Wall Street isn't looking at that yet, but they should really start along the way and that obviously important to keep pointing these figures in the right direction but I think you're on the right track. Thank you.

Well our job is to build a business and stock will follow from the results that we deliver. We are clearly focused on delivering what we said we're going to do a couple years ago, and we had this massive transition and disruption in our business and we buckled down, we you know pull ourselves together and focused on our core, and we knew that margin was the key more so than revenue at the time because without the profit margins, the more you sell them more working capital you need, more cash burn. So we're focused on the right things on delivering the margin improvements and now that we've got the margin in that range that we need it. It's all about revenue generation right now, those are the elements and that's the sequence, that where it take place. You know the stock will follow as we deliver our performance and that's been our strategy as we go forward.

Okay, thank you very much.

Thank you.

Thank you. [Operator Instructions] We have no further questions on the line. I'd like to turn the call back over to Mr. John Scribante for any further remarks.

Okay, thank you. And I know that many of our analysts and others had conflicts today with other calls and that so I'm sure will follow within soon. So, I appreciate everybody support, continued support in Orion and our management team. We look forward to talking to you again next quarter. Thank you and have good holidays.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day.