Orion Energy Systems Inc (OESX) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Orion Energy's third quarter FY15 conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to turn the call over to Adam Prior with The Equity Group.

Thank you.

The Company issued the announcement of Orion's FY15 third-quarter and nine-month results this afternoon. The Company has made available an accompanying slide presentation on its website at www.oesx.com in the Investor Relations section. While the format of the discussion will not refer to any slides in particular, 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, includes 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 such words 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 have 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 quarter conference call, if at all.

With us from Orion is John Scribante, Chief Executive Officer, and Scott Jensen, Chief Financial Officer. With that, I will turn the call over to John.

Please go ahead.

Thank you.

Good afternoon and thank you all for joining us. This afternoon, we'll discuss Orion's current operations, including what is 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 FY15 third quarter, compared to $27.7 million in the prior-year period. Looking exclusively at lighting and excluding non-core solar revenues, a 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 of $12.7 million during our FY15 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 FY15, and higher as we move into our FY16.

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 the future quarters. We have seen customer adoption rates for our LED products improving across all of our target market.

In the short-term, our topline 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 job site 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 FY15 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 is 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 products, 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 US market's reseller partners, who are gaining significant traction. We have 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 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, with over 20,000 Orion and Harris project installations throughout North America. This built-in customer base is beginning to turn to LED products, and we are seeing it in deal acceleration throughout our markets. During the quarter, we received significant orders from major US institutions for office LDRs; a large grocery chain for LED High Bay products; and we have 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 US-based electric car manufacturer.

In addition, we recently won another $3 million contract through a US automaker in January, that we'll need to ship really 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 sizable and all moving in the right direction.

As a specific example, we prevailed over two very large competitors, with the 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 level. 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 recognized the overall value of our products that used fewer fixtures and saved both up-front costs as well as energy costs 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 are, 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 their total cost of ownership. Everything we have 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 transitioned the Company from what was almost exclusively linear fluorescent 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 have added time and cost. Not to forget longer warranties, Title 24, new customer sectors, an 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 have 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 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, as 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 at 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 would like to say that we have successfully upgraded our banking relationship with a larger and more aligned credit facility. As many of you know, we have 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 will 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 FY15 third quarter, compared to $27.7 million in the prior-year period. Lighting revenues increased 24% year over year and increased 96% over the FY15 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 have 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 FY15 third quarter compared to $1.4 million in the prior year period. Third-quarter LED lighting product sales increased 807% over the prior year third quarter. Due to recent product releases and reseller interest, Orion believes LED products sales will continue to grow and reach between 50% to 60% of total product revenues during our fourth quarter of FY15 and to greater levels during our FY16.

As John mentioned earlier, we have adjusted our expectations of total revenue for FY15 to range between $72 million and $74 million from a range of $80 million to $88 million. This revision is partially related to multi-million-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 current backlog, reseller growth, and sales pipeline support our current guidance, and are greatly looking forward to providing you all with a healthy FY16 topline and margin expectations in our next quarterly period.

Total gross margin was 14.6% for the FY15 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 FY15 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 that John has previously discussed.

Our margin challenges have now been limited to one product line. And upon completion of our planned 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 involvement 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 FY15 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 continued to pay down total debt during the FY15 first nine months, as total debt decreased by $2.2 million to $4.4 million as of December 31, 2014, and compared to $16.6 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 on a revolving basis. Borrowings under the credit facility are initially limited to $15 million and subject to borrowing base requirements based upon eligible receivables in inventory. Terms were competitive in the marketplace, and the line is structured in such a matter 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 regard 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'll 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 this 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 would 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 have 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 are 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 industry's best LED lighting experts, and it is imperative that we build one of the industry's best development and testing centers staffed with this 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 will 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 grant of our LDR patent a few weeks 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 have 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 are making should start to yield an annual reduction of approximately $10 million, even after the growth initiatives listed above, beginning in FY16.

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.

With that, Scott and I would be happy to take your questions.

(Operator Instructions)

Steve Dyer, Craig Hallum.

Thanks, good afternoon, guys.

Hi, Steve.

A couple questions. I will start with the -- with your distribution network. Are you where you want to be as it relates to distributors, ESCOs, territory leaders, and now it is just a matter of getting them fully up to speed and experienced, and so forth? Or are you still looking to add in that area?

Good question. There is still -- excuse me -- still geographic gaps that we would like to fill in. So these would be markets where either historically, or have never had coverage or good coverage, and as a result we are continuing to explore that. But in cases where we have existing partner relationships, existing ESCOs and what have you, we're pretty good shape there I think now. It is 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 can give a little bit more detail on the margin pressure in the quarter, if it was confined to a particular product line? And then, is that pretty much behind us, worked through the inventory by the end of this fiscal year, or do anticipate that will linger a little bit into next year?

No, Steve, good question. So we have really confined our margin pressure to one product line. We've identified the opportunities. We have 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 FY16 we can return to the gross margin levels that we had historically experienced, and that we are experiencing with some of our other LED products, including the new products that were recently launched.

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

Yes, we can. So I don't believe we've reached in 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 that increases. We do expect that there will be some declines on ASPs, and that some of the margin pricing that can be gained will be passed through the customer to help justify the projects and close more business. Our expectation is, we're very pleased with the progress we've made, but we also believe we'll continue to be able to take costs out of the business.

And Steve, one of the other things 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, and the curves seem to be flattening.

Okay. John, the $10 million -- I think I heard you say $10 million of costs taken out of the business, can you elaborate a little bit more on where you find that? Is it headcount, is it streamlining processes? Is that a COGS issue? Is it a operating expense event, how should we think about that into FY16?

Sure. Well, two different questions, how to think about it, and where it came from. Where it came from really is, as I 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 are going to market, and the marketing resources, the sales resources and what have you.

And as you are looking at the entire business, and looking to realign resources that historically had been in a fluorescent model, which is a more mature, a much more stable environment, and you are reinvesting those resources into more of a growth -- or I don't want to really say a start-up -- but you have got a rapidly growing sector of the business, we really look at that as two different businesses inside of 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 to 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 is the best way I can explain it. If you want to (multiple speakers) Steve.

One last question then for me, is there a particular end market where you guys are seeing some of the most traction, and what do you think will drive growth, maybe there's a couple of them out into 2016?

There is certainly new markets that we are just now really migrating into. The, I guess what I would 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 clearly is driving a lot of our business right now.

The automotive sector has found a tremendous amount of interest in the Orion products 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 suspended ceiling 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, Steve.

Craig Irwin, ROTH Capital Partners.

Evening, gentlemen. Congratulations on the really impressive LED product growth.

Thanks, Craig.

I wanted to dig in a little bit on some of your comments you made. The inventory purchase commitments that are 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 is a subset of the overall mix, and roughly how big a margin headwind is this? Is it a couple hundred basis points, bigger, smaller? How should we be looking at that, and how do you anticipate this rolling off? Is this something where we can look at a discreet 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. It's chips, it's boards. And so, we're already -- we have already negotiated improvements.

It is significant to us, more than 100 basis points. It's significant enough that we fully expect as we work through the existing inventory commitments -- and again, we are anticipating that through the end of our fiscal year, we have really worked through all of that, and we are well-positioned for FY16 -- that we are 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. In your release, you were 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, this inventory effect would that push you more into your longer-term target range? Or would you need the additional revenue coverage that you are expecting to develop over the next several quarters?

I will just comment on the 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 is 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 is going to carry margins very similar to what we have 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 won't have the buying power. We are not going to have the same level of run rates through the manufacturing facility.

But that we are going to see that inflect on the LED margins, and be able to get back up within -- well, we will give more guidance on FY16 as we get to 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 have historically run. And then, as we talked about leverage with our asset base to margins that reconcile to our longer-term targets.

Thank you. And 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 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, there are 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 is 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 the door, all the variability around construction cycles, utilities, everything that really John talked 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.

Thanks, Craig.

I am showing no further questions. I would now like to turn the call back over to John Scribante for closing remarks.

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.