Orion Energy Systems, Inc. (OESX) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. At this time, all participants are in a listen-only model. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]. And as a reminder, this conference call maybe recorded. I would now like to introduce Mr. Keith Radeke, Director of Finance. Sir, you may begin.

Good afternoon everyone. And thank you for joining Orion Energy Systems Fiscal 2017 Conference Call. Participating in today’s call are Mike Altschaefl, Orion’s newly appointed CEO and Bill Hull, Orion’s CFO. Following a review of Orion’s Safe Harbor statement Mike will open today’s call and review Orion’s renewed focus and driving growth and implementing cost reduction to accelerate its past profitability. Bill will then briefly review Orion’s Q4 and full year financial results and then we will open the call for investor questions. An archived replay of this call will be available later this evening in the Investor Relations section of Orion’s corporate website. This call is taking place on Thursday June 8, 2017. 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 than anticipated. 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. With that, I'll now turn the call over to Mike.

Thanks, Keith. Good afternoon and thank you for joining us today. As you may know two weeks ago, today I was appointed as CEO of Orion by the Company's Board of Directors. At that time, we also postponed reporting of our Q4 results so that we had more time to work in developing our action plan and to make today's press release and call more informative. I have served on Orion's Board of Directors since 2009, and in August of last year I was appointed Board Chair. I appreciate the board placing our confidence in me to assume the executive leadership of the company. I'm also excited to join the rest of the executive team. As newly appointed CEO of Orion my charge is to build up on the strong business foundation and technology leadership we have established as a designer and producer of energy efficient lightning and retrofit solutions for commercial and industrial buildings in the LED lightening market. Equally important is to accelerate Orion's path to profitability. While we have made changes in our executive team, I want to make it very clear that Orion's sales and product growth strategies are not changing. We will remain focused on the LED lightening market with the go-to-market strategy, built around energy efficiency, best-in-class service and a nationwide network of agent based distribution partnerships. Orion competes against large players in the LED lightening market by developing cutting edge products that delivered industry leading performance and energy efficiency. Our product also incorporates smart design and features that reduced total cost of installation of ownership as well as deliver specialized capabilities to meet unique needs in certain sectors. We continue to believe that Orion is pursuing the right strategy to leverage our proven track record and broad base of customer relationships including nearly 40% of all Fortune 500 Companies. To ramp our sales activity, converting lightening systems to energy efficient LED technology over the next decade and beyond. Our renewed focused on execution including a reduction in our cost structure will accelerate Orion's path to profitability. We have identified a range of cost reduction initiatives that we have already begun implementing. Our cost reduction efforts will right size Orion's cost structure and bring our overhead more in line with our current revenue level, and accelerate our path to breakeven EBITDA as defined in our press release, which we now believe is achievable by the fourth quarter of fiscal 2018 before nonrecurring items. We decided our cost reduction efforts needed to be top to bottom, as part of our cost reduction plan Orion's executive team and outside directors have reduced their total compensation by approximately 35% compared to fiscal 2017 levels. We believe that in starting our cost initiatives at the top we've sent a very clear message to all of our stakeholders regarding our commitment to managing costs and driving the business to profitability. In total we expect to reduce operating expense levels by $3.5 million to $4 million on an annualized basis or approximately 12% to 13% versus fiscal 2017. We expect to have a majority of our cost reduction activities completed by the end of June, and the balance by the end of September 2017. As part of these initiatives we expect to record non-recurring charges totaling $1.5 million to $2 million relating to our cost cutting initiatives principally in Q1 and Q2 of fiscal 2018. Now I'd like to take a few minutes to talk about our growth strategy. Continued execution of our agent strategy which includes active efforts in supporting agents in getting up to speed on our products and providing industry leading levels of service and responsiveness from initial quotes through product shipment and after sales support should position Orion to achieve a revenue growth goal of 10% to 15% in fiscal 2018. I would like to point out that for the first nine months of fiscal 2017 prior to the fiscal 2017 fourth quarter sales slowdown in our industry, Orion had achieved total revenue growth of 12% which was within our targeted range. Combining our growth goals with our reduced cost structure and efforts to keep driving gross margin improvements we believe Orion is also well positioned to reach our goal of breakeven EBITDA by the fourth quarter of fiscal 2018. Because of our size and the variety of factors that impact our industry and business I do want to clarify that targets are goals, not financial guidance, but they are realistic given what we know today. We will update you on our progress versus these goals as the year progresses. Let me now spend a few moments on our progress in migrating our sale to an agency driven distribution model. The transition of identifying the best possible agents and then developing and managing them for our mutual success has taken longer than originally expected. Our initial agency was launched in August of 2015 and we've hired nearly 20 agents by April 2016 the beginning of our fiscal 2017. Over the balance of fiscal 2017 we assessed and fine-tuned the performance of our sales agents while also continuing to expand our knowledge of the unique characteristics of this channel particularly looking for the retrofit market and what factors make for the most successful and productive agent relationships. Ultimately, we recognize the need to make some significant changes to our agent base, and starting in November of 2017 through the end of our fiscal 2017 we have replaced nearly 75% of our original agent base while more than doubling its total size to over 40 firms. We have also moved to focus our sales personnel in smaller territories so they could spend more time working with our agents to devote more time to Orion's product line and better support their long-term success. Today we are partnered with some of the largest sales agencies in America, firms with between $20 million and $200 million in annual lighting business. Orion now reaches approximately 95% of the United States and Canada, as well as parts of the Caribbean and Latin America, putting us in a solid position to drive long term sales growth. Building agent relationships doesn't happen overnight, it requires the investment of time and resources to train and gain presence with each person within each firm and this includes multiple touches across our organization. We are filling a diverse team from engineers to sales support, customer service and even finance personal to provide unprecedent access to our organization. We have also built web pages, direct links and other collateral tailored for our agents, our interactions are ongoing. Our new agents have been impressed with the breath and extent of our engagement with many of them indicating that this is rarely present from their other lighting relationships. Our enterprise account teams serves major accounts, that are carved out from our agency channels yet they actively support to development of new business opportunities that are referred to into each agency channel through a partnership model. We intend to continue making the necessary investments in sales, marketing, sale support personal as well as providing other resources for our growing agent channel. Unfortunately, the time and expense of agency reset likely amplified the impact of the industry slowdown in our fiscal fourth quarter of 2017, yet even miss the buildings and realignment of our agent base Orion achieved strong growth in our agency channels with approximately 43% of our product sales coming from sales agents in fiscal 2017, first full year of our strategy compared to just 4% the year to prior. We are on schedule to have a base of over 50 sales agents fully in place and optimized by Q2 of fiscal 2018. In summary, while our fiscal 2017 performance fell below expectations, our full year operating result reflect the benefits of repositioning the business. Our LED business is strong. We have superior products, top customer service and our sales and distribution reach has been substantially expanded and it's gaining traction. We still need to execute on our core mission each day, but we believe Orion is now closer to realizing not only improved revenue growth, but also improved bottom line results accelerated by a renewed focus on cost management. I look forward to continue to meet our investors over the coming months. We appreciate your support and interest in Orion. And with that I’ll turn the call over to Bill to provide more color on our fiscal 2017 results.

Orion delivered its full year revenue growth despite it's decline in average selling process and further contractions of our legacy fluorescent lighting business, sales of which decreased 6.1 million or 33% from fiscal year 2016. Our fiscal 2017 revenue growth was principally driven by LED revenues which grew 16% over fiscal 2016 to 53.1 million. This represents over 80% of total lighting product sales, a record for Orion. Product revenue from our agency channel rose to 47% in fiscal Q4 2017 versus 8% in the same period a year ago and that should expand on a sequential basis as we continue to build this channel. In the fourth quarter, we converted our legacy fluorescent business and our exterior LED offerings to a soft order bases thereby reducing our risk. As part of this change the quarter includes 2.2 million of non-cash inventory charges to cost of product sales. These moves reflect our full focus on LED product line as the driver of revenue growth going forward. Turning to gross margin Orion achieved 110 basis points expansion in gross margin, 24.7% in fiscal year 2017 when compared to fiscal year 2016. This gross margin reflects the inventory adjustments discussed earlier and in today's press release. Absent these charges Orion's gross margin would have been closer to our goal of 30%. Orion's backlog rose 30% to 7.3 million at fiscal year-end 2017 versus 5.6 million at the end of fiscal 2016. As we previously noted Orion's commitment to the rapid turnaround of order to shipments our order backlog tends to vary quarter-to-quarter then principally by larger order activity. Also during the fourth quarter and full fiscal year 2017 we invested in new product developments by modestly increasing our R&D spending in order to maintain our technology leadership. From a balance sheet standpoint networking capital was 25.5 million at the end of fiscal 2017 and this includes 17.3 million in cash. At March 31st Orion had 6.8 million in long term borrowings. Operator let's open the call for question-and-answer session. Thank you. mainly due to an : Orion delivered its full year revenue growth despite it's decline in average selling process and further contractions of our legacy fluorescent lighting business, sales of which decreased 6.1 million or 33% from fiscal year 2016. Our fiscal 2017 revenue growth was principally driven by LED revenues which grew 16% over fiscal 2016 to 53.1 million. This represents over 80% of total lighting product sales, a record for Orion. Product revenue from our agency channel rose to 47% in fiscal Q4 2017 versus 8% in the same period a year ago and that should expand on a sequential basis as we continue to build this channel. In the fourth quarter, we converted our legacy fluorescent business and our exterior LED offerings to a soft order bases thereby reducing our risk. As part of this change the quarter includes 2.2 million of non-cash inventory charges to cost of product sales. These moves reflect our full focus on LED product line as the driver of revenue growth going forward. Turning to gross margin Orion achieved 110 basis points expansion in gross margin, 24.7% in fiscal year 2017 when compared to fiscal year 2016. This gross margin reflects the inventory adjustments discussed earlier and in today's press release. Absent these charges Orion's gross margin would have been closer to our goal of 30%. Orion's backlog rose 30% to 7.3 million at fiscal year-end 2017 versus 5.6 million at the end of fiscal 2016. As we previously noted Orion's commitment to the rapid turnaround of order to shipments our order backlog tends to vary quarter-to-quarter then principally by larger order activity. Also during the fourth quarter and full fiscal year 2017 we invested in new product developments by modestly increasing our R&D spending in order to maintain our technology leadership. From a balance sheet standpoint networking capital was 25.5 million at the end of fiscal 2017 and this includes 17.3 million in cash. At March 31st Orion had 6.8 million in long term borrowings. Operator let's open the call for question-and-answer session. Thank you.

[Operator Instructions] Our first question comes from the line of Amit Dayal with Rodman and Renshaw. Your line is now open. I believe his line disconnected. Our next question comes from the line of Craig Irwin with ROTH Capital Partners. Your line is now open.

First thing, I wanted to ask about is the cost savings initiative, 3.5 million to 4 million, your investors will like the participation of the executive management and the Board there, saving 1.5 million of that, but can you walk us through the other -- the balance of 2 million to 2.5 million, where that's going to come from? And traditionally in lighting companies this means lighter employment, how do you see this playing up?

Sure, Craig, I'll make couple of opening comments and then Bill will add some color to it. One, I just need you to ask you to appreciate we are still working on these plans and certain things have been implemented and certain things have not. So there are parts of it that we can share, parts we cannot. But it does go throughout the entire organization and involve programs and systems that we feel can be scaled back or changed, and others that will impact personnel also. So I’ll allow Bill to kind of give you a little bit more color, but there is only so much we are able to comment on today.

Yes. Hey, Craig. So obviously saw that Executive Management and the Board taking a substantial cut there. And so that’s where we’re starting and that something kind of ended almost immediately. Then you have things like professional services that we’re taking to look at, we have other programs in place that -- some of those we have commitments to, so they may not start right away, so it’s going to take some time to pull back on some of those commitments and programs and events, those kinds of things we have. And that’s kind of some of the major items, and we’ll get into more detail as the year goes on, I think.

What we’re being particularly careful to do is to make sure our spending in sales and marketing is staying where it needs to be. And because we do anticipate and want to continue to grow revenues as we’ve indicated. And so we’re being careful where we are applying our look at this and doing it wisely to make sure we’re not impacting our sales and marketing team.

So then the cost that you called out to implement the strategy $1.5 million to $2 million hitting primarily in the first fiscal quarter of '18. Will this be mostly cash expenses, are there other likely non-cash components to these charges and does that include charges for changes to the Executive Management team or is that something that was already reflected on the P&L?

Craig, this is Bill. So those are cash charges and they'll be reflected in our first and second quarters financially and it included all the things you’ve just mentioned.

And it does include severance for changes to the Executive Team?

Yes. This is what we think the total amount will be for everything that being the non-recurring charges, correct.

Okay excellent. Then moving on to the repositioning towards a more traditional distribution strategy, right. Putting an agency channel and sort of restructuring the way you face the market, I like it, because in the long run, I think it really will give you opportunities to drive down costs and maybe diversify the revenue mix introducing new products, et cetera. But in the short-term, it causes a little bit of turbulence. Do you feel like there was maybe any lost revenue in the quarter that was specifically related to this transition? And we would you care to guess, how much higher friction costs were during the quarter related to this transition than what you would assume, if you were pursuing the same channel approach that you were a year ago?

Let me make some comments on that. I think, I’m not sure, I would use the word turbulence in terms of the agent situation. As I stated in my remarks, we did have a bit of a false start in the approach that we took with agents when we started on this and during fiscal 2016 of the nature of agents that we decided to go after. After we learned more about going to market in that channel, we migrated to the current agent criteria and background. So we want to fulfill for our agent's models. So it's more of ramping up those agents than it is in turbulence. We ramped up some of them during '16 and '17, but then we made the change and cut back on the agents and then grew it back to over 40 agents. And we typically find that it takes three to usually six months for new agent to really get up to speed with us. We're attempting to accelerate that through training and support for them, but as those agents come up to speed during fiscal 2018, we certainly expect an uplift from that happening. So we'll not determine it as turbulent as much as getting up to speed. We also had some transition from direct relationships, we have supported those agents greatly by moving many of those direct relationships through the agencies to provide them with that business and get their support and partnership as we migrate to this strategy.

Thank you, and our next question comes from the line of Steve Dyer with Craig Hallum, your line is now open.

Hey guys this is Ryan Sigdahl on for Steve. I'd like to start with product gross margins. By my math if we exclude the inventory writeoffs and the reserves and the non-recurring stuff, are you doing adjusted gross margin of about 23% which is a little bit low than what you guys have printed the last couple of quarters here. Any additional color there would be helpful and then maybe how we should think about the inventory balance and how it looks going forward?

Sure, for fiscal 2017, one thing you need to take into account is with the sales volume dropping off in Q4 it had an impact with respect to our gross margin because of the absorption levels in the manufacturing facility, so the full year margin you know comes out perhaps what you are describing, but the margin was higher during quarters 2 and 3 of fiscal 2017 when the volume was higher, so I think you got to dissect a little bit quarters 2 and 3 from quarter 4 2017 when you look at that product gross margin analysis.

Okay that makes sense, and then been a little over two months into fiscal Q1, maybe talk about how orders are shaping up and should we assume normal seasonality in fiscal Q1 down from Q4 or was Q4 not enough headwinds in there that seasonality is kind of out the window there from a comparative perspective?

I think it's probably reasonable to continue to look at the fact that our Q1 seasonality will be there and we expect our revenue for fiscal 2018 to be somewhat backend loaded to the second half of 2018.

Alright, one more from me. Mike I know you've only been in the CEO role here for a few weeks, but from what you've seen, do you see double digit growth in over the next couple of years is reasonable or still getting in the weeds here and too early to see on that.

No, because I've been around the company since 2009 I absolutely think double digit growth is very achievable for this company. With the products that we have, the products we have in development, the development of our agency based distribution model and the members that we have here at Orion in our facilities I am confident that we can achieve double digit growth.

Thank you. [Operator Instruction] Our next question comes from line of Joseph Osha with JMP Securities. Your line is now open.

This is McCray [ph] on for Joe. I have industry question for you there have been comments across the industry about LED pricing erosion and you mentioned the demand shift in Q4 during your commentary, is price stabilizing at all or is this erosion still continuing?

This is kind of a mixture going on I would say, there certainly appears to be less price erosion from an ASP standpoint, Average Selling Price of units in their [indiscernible]. But at the same time we are experiencing that the market place is very comparative and so it's not so much driven by a reduction in some of the materials to build the product, but there is strong competitiveness in the market place to capture market share. So that what we're seeing currently and I think that’s part of what we saw in quarter four of fiscal 2017 and we are seeing that in quarter one of fiscal 2018.

Is there any product segment that experiencing more of an impact than other, I am thinking between ISON, APOLLO and HARRIS?

No, it's across the board.

Okay great. And then one final question, the lighting control portion of the business, what kind of attached rates are you guys seeing across the different end markets and do you think that customers are more interested in bringing controls in for the new construction rather than the retrofit market?

We continuing to see that building in the market place of attached controls, I think it's going to continue to grow in the future. We are looking at how we use the technology we have. What we believe is we've got the platform and the celling with our fixtures and it's going to continue to grow. We are not seeing a great difference between those segments right now. But it also still is developing, recently at Light Fair, lot of discussion about IoT and what's going to happen in the grid, on the celling and a lot of it is still just to being figured out by the market place of how to make it all work.

Thank you. And our next question comes from line of George [indiscernible], a private investor. Your line is now open.

Mike, do you see any affect since the election of less interest in saving energies than that was before?

What I've heard from our sales people is not bad particularly from a saving energy standpoint. What we are perhaps seeing since the election is there continues to be some uncertainty in the economy. While we are seeing a bit of a what we think of a boost down the road from the fact that we do manufacture and assemble in the United States and we think that’s going to give us some additional opportunities going forward. Much of our competition comes from foreign markets and we saw that somewhat again when we were at the large trade show at Light Fair in Philadelphia few weeks back. So I think that part of we are positive, but we also, on the government side you see some delays and some uncertainty of what's going on. So it's been a bit of a mixed bag from market standpoint where reaction to the economy and the political situation and hopefully that will firm up as we go forward.

Thank you. And our next question comes from the line of George Gasper [ph], a private investor. Your line is now open.

First question is regarding R&D, how are you looking at your R&D capacity out of Chicago in the current year going forward here relative to what you've had in the past, are there -- can you talk anything forward about technology developments that you don't have in the market currently?

First of all our investment in R&D is not changing significantly. As I talked earlier about our investments in sales and marketing, those are areas where you have to be very careful and make sure we're continuing to make investments. Usually we roll out product introductions in the early part of August and we'll be doing that again this fiscal year. We have a number of products that will be coming to market, some of that are very, very exciting and our ability to attract talent and have our product development team largely based out in Chicago continues to work for us. So the R&D front we think still has a strong pipeline with some really exciting products coming to market over the next couple of months.

And second question would be on the production cost reduction side in terms of manufacturing personnel. Can you highlight any change levels in terms of personnel associated with that or manufacturing approaches that you're going to try to execute as part of this cost reduction?

From the manufacturing process standpoint for the last several years we've been very closely looking at our manufacturing processes to become as efficient as we can, but always continue to make improvements. So we've shrunk the square footage that we need to assemble and produce the same amount of product and we'll continue to do those things. On the first part of your question, we're not quite at the point where we are -- can talk about numbers of personnel that might be impacted by the action that we're taking, a little bit too early to be definitive about that George.

Okay, and can you give us a thought process on this agency channel, that build up that you're accomplishing in the changeover. I assume that this agency channel is, each one of these organizations is probably handling multiple companies that are associated in the LED business, can you talk a little bit about those relationships with you versus others?

Sure, and that's somewhat of the change that we made as I talked earlier about retooling on some of our agents from fiscal 2016 to fiscal 2017. At times in our initial strategy we have been focused more heavily on agents that may not previously had a lighting fixture line, perhaps a LED line, but we actually saw it going through the channel are better off hooking up with agents that have multiple lines and then relying upon us being better to work with, having better products, having better customer service, having better information, better responsiveness and being more nimble. So in fact, what we have to do with those agencies in some situations is compete with other lines that they may be carrying. But so far, as I mentioned in my comments, we’re getting very favorable feedback from these new agents that are support, our service, our products are better than the other products that they are carrying and we believe we can carry our weight with those agents carrying multiple lines.

Okay. And if I could ask one more, just on the financial side. In terms of the indication of your cash position being 17 million I believe, it was the comment was made?

That’s right [ph].

On that, how do you see that, you’re able to handle the progress that you expect to bring forward here in the next couple of quarters and cost reduction? But also, some expense reduction -- expenses associated with that. Do you see yourself is financially capable of this double-digit growth you’re talking about and the level of cash that you have in the company currently?

Yes, George. We have looked at this and certainly forecasted and projected where our balance sheet might be with the growth that we’re expecting taking into account, the costs related to this realignment as well as our growth, and we believe we will have more than adequate cash to manage our way through that process with the -- our current financing structure.

Thank you. And I’m showing no questions in the queue. I’d like to return the call for Mr. Mike Altschaefl for any further remarks.

Thank you, operator. I simply would like to thank everybody for joining us in the call today. We appreciate your past support and look forward to keeping you informed and having you involved, because going forward. So thank you very much. Have a good evening.

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