Orion Energy Systems Inc (OESX) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Orion Energy Systems Second Quarter Fiscal 2018 conference call. (Operator Instructions) As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Mr. David Collins. You may begin, sir.

Good morning, everyone, and thank you for joining Orion Energy Systems Second Quarter Conference Call. Participating today are Orion's CEO, Michael Altschaefl; and CFO, Bill Hull. Mike will open today's call to discuss Orion's strategy, goals and recent progress on driving revenue while managing margins and reducing overhead. Bill will then provide some highlights on Orion's Q2 results and the company's financial position, and then we will open the call to investor questions. An archived replay of this call will be available later today in the Investor Relations section of Orion's corporate website. This call was taking place on Thursday, November 2, 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 generally will include words such as believe, anticipate, expect or words of similar import. Likewise, 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. Such risks include, among others, matters that the company has described in its press release issued this morning and in its filings with the Securities and Exchange Commission. Except as described in these filings, the company disclaims any obligation to update forward-looking statements. With that, I'll now turn the call over to Mike.

Thanks, David. Good morning, and thank you for joining us in today's call. Orion's second quarter revenue of $15.4 million represented a 22.2% sequential improvement over first quarter revenue of $12,600,000. This was below both our prior expectations and our strong performance in last year's second quarter. We did see some weather-related impact on our business in the second quarter as approximately $1.1 million in projects were delayed in Texas and Florida due to storm-related events. But we believe these projects will be completed in fiscal 2018. Nevertheless, there are several positive trends in the business I will review today relating to revenue, progress on gross margin and operating cost reduction efforts, which demonstrate progress toward our goal of achieving breakeven EBITDA before non-recurring items by the fourth quarter of fiscal 2018. We continue to see many potential customers reengage in their review of LED lighting opportunities. The performance and value proposition of our product lines are being very well received by both our national accounts in our agent-driven distribution channel. We remain excited and optimistic regarding Orion's business performance for the balance of fiscal 2018. We are experiencing increasing request for proposals as well as being awarded business from our large national accounts. In August of 2017, we disclosed that we expected approximately $10 million of business in fiscal 2018 and approximately $10 million in fiscal 2019 from 2 of our long-standing automotive industry customers. Our first 6 months of fiscal 2018 included $5.5 million in revenue from these 2 customers who are upgrading legacy fluorescence systems to our more energy-efficient LED lighting solutions. We now expect at least $13 million in revenue from these 2 customers in fiscal 2018, which implies at least $7.5 million of revenue in the second half of fiscal 2018, and we have good visibility on achieving at least $10 million in revenue from these customers in fiscal 2019.

Our national account sales effort is focusing on large potential customers who have facilities with long hours of operation. In these venues, the energy efficiency and quality of LED lighting makes the greatest financial and environmental impact. Hospitals, healthcare, industrial manufacturing, distribution and retail are just some examples of where we are focusing. These type of venues are also providing Internet of Things or IoT opportunities where they are looking to implement automated functions that create added value and ROI for the customers. A significant part of our longer-term growth strategy is developing our agent-driven distribution model. At the end of the second quarter, we had approximately 50 agencies with about 700 sales agent representatives providing coverage of substantially all of North America. While we are seeing steady progress in this effort, it is taking longer than we had planned for new agencies to ramp revenue generation with Orion solutions.

At the same time, we are becoming better versed in the opportunities and challenges in building out this sales channel. Through a variety of new strategies and products designed to support the needs of our agents, we believe we are positioning Orion to accelerate its future penetration of a much broader base of sales opportunities for both retrofit and new construction projects across North America.

As part of our investment in developing this sales channel, Kevin Grayson joined Orion in August of 2017 as Senior Vice President for Channel Sales. Kevin brings broad experience and understanding of the agent-driven sales model and we are already seeing benefits from his insights and leadership. Kevin and his team are improving our branding, marketing, project management and sales efforts in support of our existing agent relationships.

We are also working to expand the reach and effectiveness of this channel while also optimizing our agent partners with some selected additions and replacements. The agent channel contributed 44% of our second quarter product sales reflecting solid progress since we embarked on this strategy about 2 years ago.

On the product development front, long and key strength of Orion, we recently launched a number of products centered around 3 main objectives: one, increasing our competitive product footprint with agents and entry-level focus buyers; two, leveraging existing platforms and expanding options to increase our market opportunity; and three, leveraging our experience and controls in IoT solution adaptability through new modular, plug-and-play solutions. During the second quarter, we introduced our new Patriot Slimline LED high and low bay fixture series for use in commercial, industrial and retail facilities. The design and development of a lightweight, modular design on the Patriot Slimline was driven by the goal of providing end-users with an Orion solution including (inaudible) and energy savings at a competitive cost.

To achieve this goal, we developed a streamlined but very high-quality solution with many of the advanced features of our higher-priced, high-performing lines. However, to differentiate our solution, we made the Patriot line easily upgradable by adding different sensors, engines or other modules in a plug-and-play fashion. This technology and approach allows the customer to deploy sensor technology exactly where and when they want in their facility. Further, the customers are able to meet a strict budget with a solid system and industry-leading components while also providing an easy-to-implement path for future upgrades, letting the lighting solution grow with the needs and the budget of the customer. At the end of the day, it's this type of smart design combined with high-quality components, excellent service, U.S. manufacturing and rapid turnaround on order shipments that separate Orion from the competition. Our core value proposition remains unchanged and is centered around 4 pillars of commitment that differentiate Orion in the market: one, industry-leading product performance, energy efficiency and thought leadership, which leads to delivering more rapid ROI and future proofing lighting options; two, genuine, high-quality, high-touch customer service; three, flexibility and nimbleness in responding to customer's needs including specialty design, development, prototyping and production, which larger competitors cannot match; and four, rapid response with local-to-local production operations delivering the quality and reliability our customers expect, typically, in 10 days or less. As we mentioned on our last call, our market and product strategy has not changed. We're renewing our focus on execution through improvements to our agent-driven distribution model, driving our national accounts business and actively seeking ways to enhance our gross profit margin and to reduce our overall cost structure. Our cost reduction efforts are largely complete as of the close of the second quarter. The effort was broad-based and just starting to deliver benefits with approximately $900,000 in cost reduction realized in our second quarter versus our first quarter, excluding one-time items. And we expect the full benefit of our cost initiatives by the fourth quarter of the current fiscal year. Importantly, we had initially estimated annual operating expense reductions to be $3.5 million to $4 million. Based on our progress so far ,we now estimate these annual savings to be $4 million to $4.5 million. All in all, we've made significant progress on the cost side.

Turning to our fiscal 2018 outlook. Based on our performance to date and the limited visibility we have on the balance of the year, we have revised our fiscal 2018 revenue goal to be flat with fiscal 2017 revenues of $70.2 million as compared to our prior goal of 10% to 15% growth. The reduction of revenue goal reflects the slower than expected pace of revenue in the first half of fiscal 2018 but somewhat slower-than-anticipated pace of engagement in our agent-driven distribution model, balanced with the solid momentum we are achieving with national accounts. We continue to believe Orion will be able to achieve its goals of breakeven earnings before interest, taxes, depreciation and amortization, EBITDA, before non-recurring items and the achievement of a 30% gross margin both by our fiscal 2018 fourth quarter.

In summary, despite a few challenges, we are achieving forward progress in the business on several fronts. From what we are seeing in the market and in our business, we believe Orion is very well structured to leverage our position as a customer focused, high-quality provider of innovative, US-made LED lighting solutions for commercial and industrial buildings. Based on the very clear illumination, cost, management and environmental benefits of a state-of-the-art LED lighting solutions, we believe our product line and value propositions support the achievement of our growth goals. With that, I will turn the call over to Bill to provide more detail on our second quarter results. Bill?

Thanks, Mike. As you should have access to today's release, I will focus on providing some additional metrics in perspective on our financial performance and financial strength. Our Q2 revenue rose 22% sequentially to $15.4 million over Q1 revenue of $12.6 million but was $3.2 million lower than Q2 of fiscal 2017. Fluorescent sales were $1.3 million in Q2, versus $3.3 million in the year-ago period. As Orion focuses on LED solutions while continuing to provide fluorescent products based solely on customer requests. LED product revenue declined 10% to $12.7 million versus LED product revenue of $14.1 million last year. But it increased as a percentage of total product sales to 91% in this second quarter versus 81% in the year-ago period, continuing an upward trend as a percent of sales.

Orion achieved solid raw gross margin profits across the majority of our product lines as we continue to focus on cost controls and sourcing efforts to reduce our cost of goods sold. These margins were hampered however, by lower sales and production volume and the impact of cost absorption on our fixed manufacturing overhead. As a result, Orion's Q2 gross margin was 23.5% versus 33.4% in the second quarter a year ago. However, our second quarter gross margin did reflect a sequential improvement over our first quarter gross margin of 21.6%. Total operating expenses, excluding one-time items decreased by approximately $900,000 to $6.3 million in Q2 compared to $7.2 million in Q2 of fiscal 2017.

Our second quarter operating expenses included approximately $800,000 in non-recurring costs including $100,000 related to our cost-reduction initiatives and a noncash $700,000 intangible asset impairment related to the Harris trade name. General and administrative expenses decreased to $3.2 million in the second quarter compared to $3.6 million in the second quarter of fiscal 2017. We have recognized $100,000 and $2 million of total restructuring expenses during the 3 and 6 months ended September 30, 2017, respectively.

Importantly, the second quarter reflected a solid performance from efforts to optimize Orion's working capital position. Orion generated $1.1 million of positive cash from operating activities in the second quarter of fiscal 2018. And that was driven, principally, by a $3 million reduction in inventories during the second quarter. We paid down approximately $800,000 of debt in the second quarter, bringing us to a total of $3.5 million in debt reduction to date in fiscal 2018. At the close of the second quarter, Orion had total long-term debt of $3.2 million, including $3.1 million under our revolving credit facility compared to total long-term debt of $6.8 million at year-end fiscal 2017 including $6.6 million under our revolving credit facility.

We ended the quarter with $8.7 million in cash, up from $8.5 million at the close of the first quarter. Our working capital position including our cash combined with potential borrowing under our revolving credit facility should provide Orion with sufficient financial resources to execute our business plan and progress the business to EBITDA breakeven in the fourth quarter of this fiscal year. Again, as Mike mentioned, we expect the full benefit of our cost reduction efforts to be reflected fully beginning in our fiscal fourth quarter, and our current estimate for total annual savings has increased to $4 million to $4.5 million, up from $3.5 million to $4 million, estimated at the outset of the effort. And with that, operator, let's open the call for questions. Thank you.

(Operator Instructions) And our first question comes from Craig Irwin with Roth Capital Partners.

Congratulations on very clearly, getting things operationally aligned. So I wanted to ask first about your restructuring. You upped the targets there. I think you said in the release $0.9 million in the quarter achieved already. So we've surpassed the bottom end of the range for your original expectations already and there's more to go. Can you talk a little bit about what's going better than expected? And what's allowed you to bump the range up from $3.5 million to $4 million, to 4 -- sorry, $4 million to $4.5 million. Sorry.

Thanks for your comments. Well, first of all, as you said, we initially estimated $3.5 million to $4 million, which we did very soon after the management changed and working with the management team to put together the goals what we possibly could do.

And as the couple of months moved forward, and we looked at other opportunities and executed on those steps. We just found a couple of additional things that we felt that we could do as a team. So what I want to comment on is that we feel that substantially all of those cost initiatives are implemented as of the end of quarter #2, there may be some amounts yet of quarter #3, but we would expect the full run rate of those reductions to be in effect for quarter #4 and the $900,000 that you referred to, that was the change in operating costs absent one-time cost between quarter #1 and quarter #2.

And to just add a little bit to what Mike has said. Specifically, if we take a look at some of the back-office type functions, we've been able to absorb some costs across the organization and not replace certain headcount that's left. And I think we've been a little bit more successful in some of the areas while we continue to be focused on making sure that we have robust sales effort going on.

Okay. Excellent. So then the other thing that you upped, as far as expectations in the quarter, it was the outlook for revenue from your automotive customers. $13 million, before you were saying $10 million. Can you, maybe, update us on the scope with these 2 different customers? Are we still looking at something like some facilities, which is greater, fixture participation in the facilities? Or are they adding new facilities to the refurbishment program?

Sure. Couple of comments: first, we're certainly pleased that these numbers have continued to grow. The primary reason is the addition of facilities with both of these customers, particularly, with one of them and others with some expansion within the facility but also some additional opportunities. The growth -- the fact that what we had actually recorded as revenue during the first 6 months gave us the confidence with what we also saw going forward. I also should point out that with these 2 customers, we don't usually get one purchase order or one contract for the entire project. As things evolve, they add facilities, provide purchase orders or contracts for specific facilities, and that's why these things will grow as those companyies go through and continue to roll out their plan throughout their facilities. And secondly, we also wanted to reaffirm that we had earlier commented that $10 million was likely in fiscal 2019 from just these 2 automotive customers, and we feel even more confidence with respect to that than we did in our prior call.

Great. So I also wanted to ask for a little bit more color on your agencies, the update there. So this is the first quarter where I've seen very clear growth, sequentially, up more than 10% sequentially. It's nice progress given the headwinds in the market. Can you, maybe, update us on what's driving that specifically at these agencies? Is this now the fact that you've had more on for a longer period of time? And last quarter, you shared some specific metrics about the updated number. And the numbers that have been with you for more than a year. If you could share those with us again, please?

Sure. I say it's a combination of things on the agency side of things. And number one, just having more time with these agents, as we commented back in August, we have a fairly young tenure with a number of these agencies, and it takes a while for us to work with them to fully provide guidance and education on our products to help them -- in the sales function. And also as you take on new agencies, they often sometimes while replacing another supplier for them, and it takes some time for them to kind of get the new channel going and the new pipeline going with our product. So what I would say, as we continue to see these agencies age out, if you will, we expect them to ramp up business as we go forward. Secondly, we have specifically targeted some of our new product development for that more entry-level buyer out there, which is some of that business coming through from an agent standpoint, and so the product that we've developed over the last 6 months has been focused in that area, has been responsive to what we're hearing from those agencies.

And third, I would say that as we added additional resources in this area, we commented that we added a very senior executive to head up our Channel Sales area, which means for us spending this time with those agencies as well as with the regional sales managers that worked with them in that area.

We've also allowed us to take other people who were spending some time in that area, and spend it back in our national accounts. So the sequential growth between quarters is really a combination of getting some traction on the agency side. But it's also the robust activity that we've been seeing on our national account business also.

And our next question comes from Eric Stine with Craig-Hallum.

It's Aaron [Spal] on for Eric Stine. Maybe first, on the Patriot line. You kind of talked about it a little bit on the entry-level side of things. But how has the response been relative to your expectations when you launched the product? And outside of entry-level, I mean, are there any other areas of the market that this product may open up for you?

Great question. First of all, we've seen the response from the agencies that we have introduced this to be very positive. They like it for a variety of reasons. They feel it has the right amount of quality built into the product, and it's a piece that fits into their market very, very well. We also engineered it so that while it's still had high-quality, we can introduce it at a price point, which is under $100 for this fixture that we thought would catch a lot of interest in the marketplace. We supported that by some marketing activities at the distribution level to help the agencies drive some product through distributors who make decisions on what to supply on a day-to-day basis. But at the same time, it is a fixture that is not a cheap fixture. It has very high-quality components to it. It has a great look to it. It's lightweight. It's easy to install. So it's our ability to take some of our high-end features and in a smart way engineer those into a fixture that might be at a little different price point to expand our market a little bit.

We think this fixture is going to have some great off-shoots to it. In terms of either other sizes related to it or other technologies that we can incorporate into it. So we're very optimistic of how this will roll out. I think, we'll have a much better feel at our next quarterly call as to how it is ramping up throughout the sales channel. But early reports have been very positive for us related to it.

Good. And then maybe on gross margins, can you just kind of give us an update on the outlook. I know you talked about 30% at the end of the fiscal year here. But any other update on further -- looking out further with these cost-cutting initiatives and may be the launch of this new product.

Well I guess I'll start on that. We continue to feel confident that we can achieve 30% gross margins by quarter 4. And that's a combination of looking at the likely sales levels that we are forecasting for that period of time. Part of the drain or drag on margins in quarter 1 and quarter 2 has been the fact that one of our, we believe, one of our strategic advantages is that we have a U.S.-based manufacturing facility and that carries with it certain direct fixed cost related to it and we know that as our revenues get up into the areas that we expect to hit in quarter 3 and quarter 4, that will have much better absorption of this overhead costs, and so we'll have a more significant impact from a margin standpoint. And we kind of talked about our raw margins, which is sort of our standard cost margins. We are very -- we feel they're strong. But we're getting hampered by just the volume that we're pushing through our manufacturing facilities. So we feel good about 30% for quarter #4, and as we're going to ramp revenues higher on a quarterly basis, we should see improvements from there.

Yes, I would agree that when you take a look at the margins -- look at the raw margins, we are in pretty good shape. We're very comfortable with what we're seeing there. But at this volume of production, if you take the absorption out of it, and then we're continuing to clean up some inventories so that's a small impact too. But we're very comfortable with what we said about the 30% margins.

All right. And then maybe last on free cash flow, good to see the positive cash flow there in the quarter. You mentioned a little bit of the working capital stuff. Is this something you think can continue from here given kind of the ramp we expect in the back half of revenues and these restructuring efforts that you're seeing?

Yes. A couple of different comments related to that: first, we certainly have been focused very heavily on cash management and working capital management. We obviously, burned quite a bit of cash in quarter #1. And we wanted to make sure that we stop that flow and we did. So having our cash balance higher at the end of this quarter than it was at the end of the first quarter. Having our debt level lower. Having our inventory's level lower. And generating $1.1 million of operating cash from the quarter was a good advance for us. There are still opportunities on working capital, and I'll let Bill comment a little bit further on other activities we're able to do.

Yes. We're very pleased with how our operating people have been able to really focus on leaning out the business, both from a cost side and working capital side. All those components of working capital, we've -- and some of them we've surpassed what we thought we could do. So we continue to push. We think we have more opportunities to just continue to put us in a great position as the business ramps, we're going to be more cash flow generative and be able to bring numbers to the bottom line. So very pleased where we've gone and where we've come from. And we think there is more opportunity.

And our next question comes from Amit Dayal with H.C. Wainwright.

Just going back to the outlook side of things. This revision, is it primarily due to sort of the agencies maybe not coming through in line with what you might have been expected going into the year versus softness in the market you're seeing?

Well, I would say a couple of things. It's a great question. First of all, we've said a couple of times that the ramp up of the agent model is taking a little longer than we originally anticipated. Perhaps, we were overly optimistic about how long it takes to get people up to speed, introduce them to our product, clear out the pipeline and replace with our product. But we're seeing nice momentum in that area. We're confident it's the right strategy, we believe, to get a much larger access to the marketplace across North America, we believe, you have to operate through the agent-driven distribution model. We've talked before, it opens up, what we think, somewhere around may be going after 13% of the market going direct and now we're up to 3/4 of the market by having the agencies also involved witnesses as a company. Secondly, Amit, I think, we -- last quarter, we decided -- it's always tough visibility in our industry, and what was looking out forward from us, and we had some big opportunities. And some of those things hit and some get delayed and you get pluses and minuses. We just don't think it was appropriate last quarter to change our expectations. Now that we have the 2 full quarters underneath us and have a very optimistic view of the second half of the year, we really feel that we're trying to look forward on this. And so, while it's both disappointing for us to say it's going to be flat sales with '17, we also think people should look at what the second half looks like when you say that, and our sequential growth from quarter 1 to quarter 2 is what we would expect in quarter 3 and quarter 4. And then secondly, part of our optimism for the second half of the year is that, as previously mentioned, we just even since our last call, the activity level for large potential projects, not just the automotive that has been very good for us but in other verticals for us and some prior customers that we're starting to do business again with and some large amounts that -- we're seeing that size really heat up. We also just think the marketplace seems to be continuing to embrace LED and understanding the value of it and the energy savings and the technology they can tie into it. So all those things seem to be -- are giving us some additional optimism about the second half of the year.

Understood. And in terms of your mid- to sort of long-term expectations from contributions from the agency side. We came in at around 44% this quarter. Do you have a target in mind of the way you think the agents should be coming in as a part of the revenue mix?

We really haven't, at this point, had just the specific mix between the 2. And one of the reasons is that it's not always completely black-and-white whether some business is coming through the agency channel or whether it might be something that we were working on directly, and then we worked with the agencies in those territories to help them through those sales efforts. And so it's not as a clear-cut line between those 2 as we have. But overall, we really want to keep growing both sides of it and try to have them keep pace. So maybe we say it's going to be 50-50 but we want both sides of those to grow. And we really expect both sides of her. Both the national account business as well as the agent side of the business.

Understood. On the automotive client front, these 2 customers, looks like they are really anchoring some of the revenues for you guys. What in terms of additional deployment opportunities with these guys remains? I mean do you have some sort of estimate on what the potential opportunity with these 2 customers is? And how much of it you may have sort of already deployed?

Sure. Well, again, we are commenting that we believe we'll have $13 million from just these 2 automotive customers this year. We expect at least $10 million in 2018 -- I'm sorry, 2019, from these 2 customers. There is still room to go with those 2 customers of additional facilities that they may work with us with our product. And -- but we have not put a number around that, that we are presenting at this point in time. We also have opportunities developing with other automotive customers that we think will fit in the rest of this year and then into '19 also. So I would say, we're not suggesting that we think our automotive business is going to be $10 million in 2019, it will likely be larger than that. But we're not quite at the point where we can predict what that might be.

(Operator Instructions) And our next question comes from George Gaspar.

Just to follow up on the research and development side. Moving forward from what you've accomplished. Can you talk a little bit about what you're going to try to do in the near term to continue to enhance on the R&D side or your offerings in the marketplace. Is there anything new and different that you're going to try to accomplish to broaden your market?

Sure. Yes, a few comments. First, as we commented previously, we continue to make, what we think are the necessary and resources available for our product and development areas and research and development areas and we launched some products in August, in about 12 different product families. We had additional add-on launches in October and November, and we continue to have a pipeline of product that we review and continue to work on. I think going forward, I would say it's going to be a combination of things across all of our fronts. We are certainly very well known for our high bay product and our industry-leading fixtures that we have produced in that area. But we haven't stopped in that front. So we continue to research how we can push that bar even higher, to stay ahead of our competition, we're at 214 lumens per watt and we're not stopping there. So we'll continue on that very high-end product. And we also have a suite of products related to what we would call entry-level, little more cost-conscious customers. Some of the contractor type business that tends to flow through the distributors and the agent channels. So we try to keep it as broad as we can. And then, lastly, George, I would say, we've talked in the past about controls and IoT and sensors. And we are a company that, 10-plus years ago, we were probably ahead of the pack of research in that area, developing sensors related to that area, and so we still fall back in some of that IP that we have and are working to continue to upgrade those things to fit them into our product. Our approach on this has been, in my opinion, talking with others and watching the market, the whole controls area and IoT, is -- it's developing, but it's developing slow, and our approach is to be agnostic related to it from a specific supplier. And so we make our fixtures and our controls that we can interact with the various other technologies that are out there in the marketplace, and that way our customer has choices if they pick a system for their facilities, we can integrate it into our fixtures to capture the data that you need. But we will continue to invest in that area because it will continue to evolve but it is evolving a little bit slowly in the marketplace.

Okay. All right. And then one question on going on the charges that you're still looking at going forward, and trying to get to your objective, I assume, by the end of the current fiscal year, March next year. What are we looking at in bulk charges that could still hit the financial statements in the next couple of quarters?

George, those costs are basically all behind us. So as we said (inaudible) possibly [$2 million] maybe it's going to be another $100,000, give or take, but those -- that happened mostly in the first quarter, some in the second. I think that's behind us and we're ready to reap the benefits of that in the next couple of quarters.

Thank you. This includes our Q&A portion of today's call. I would now like to turn the call back to Mr. Mike Altschaefl...

Thank you, operator. Thank you. I would like to thank everyone for joining us on today's call. We appreciate the opportunity to update everyone. Look forward to talking with you in a few months after our next quarter. We continue to feel confident about things as we move forward, and appreciate everyone's support and with that, everyone, have a good day. Thank you.

Ladies and gentlemen, this now concludes our conference call. You may all disconnect. Everyone, have a great day.