Earnings Call Transcript - OESX Q3 2021

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Orion Energy Systems Fiscal 2021 Third Quarter conference call. As a reminder, today's conference is being recorded. I would now like to turn the call over to Bill Jones. Sir, you may begin.

Bill Jones, Moderator

Thank you, and good morning, everyone. Orion's CEO, Mike Altschaefl, will open today's call with third quarter highlights and an update on the business outlook. Orion's CFO, Per Brodin, will then review additional financial items, after which, we will open the call to questions. An archived replay of this call will be available later today in the Investor Relations section of Orion's corporate website. This call is taking place on Thursday, February 11, 2021.

Michael Altschaefl, CEO

Thanks, Bill. Good morning, everyone, and thank you for joining today's call. As we expected, Orion's business improved substantially in Fiscal Q3 as our customers returned to stronger levels of activity following the COVID-19 related slowdown. Revenue rebounded sharply to $44.3 million in Q3 2021 from $26.3 million in Q2 2021. Our third quarter performance reflected continued significant turnkey LED lighting and controls retrofit work for our major national retail customer. The third quarter also benefited from the start of LED lighting retrofits for a new national specialty retailer during the period. Our customer has been very pleased with the results to date. Start-up inefficiencies, which are not uncommon for projects of this scale, did negatively impact our overall gross margin percentage. However, we do expect margins to improve over the balance of the project. Product development continues to play an important role in Orion's success as we are seeing very solid demand for new product lines such as our Star Line next-generation High Bay LED fixtures, exterior lighting fixtures that expand our offerings in the outdoor market with a highly competitive product design and energy efficiency as well as several linear LED fixtures, which we plan to introduce later this month. Product innovation is at the core of our strategy as we work to develop designs that deliver improved performance, safer work environments, higher quality lighting and customized solutions to meet the evolving needs of our customers, while also working to enhance our overall margin profile. I will talk about some exciting new products a bit later. Our third quarter performance also reflected certain SG&A costs for our new Orion Maintenance Services business as we build the team and create the operational infrastructure.

Per Brodin, CFO

Thank you, Mike. Orion's third quarter Fiscal 2021 revenue increased to $44.3 million from $34.2 million in Q3 Fiscal 2020 and sequentially from $26.3 million in Q2 Fiscal 2021. The growth reflects a full quarter of healthy business activity following COVID related disruptions that began last March and continued to significantly impact our business through mid-August. Revenue for the quarter included work on an LED retrofit project for a major national account that we commenced in early August as well as a significant revenue contribution from another national retrofit project for a specialty retail customer. Q3 Fiscal 2021 product revenue increased 23% and service revenue grew 47%; reflecting the installation and other service contributions principally from these two national projects. Third quarter Fiscal 2021 gross profit percentage improved to 24.9% versus 24.2% in Q3 Fiscal 2020; primarily because of improvement in product margin, partially offset by increased service revenues at lower margin rates, but declined sequentially from 27.6% in Q2, principally because of a change in customer mix and inefficiencies and startup costs related to the National Specialty Retail Project. Q3 Fiscal 2021 operating expenses increased to $6.5 million versus $5.8 million in Q3 Fiscal 2020 and $5.2 million in Q2 Fiscal 2021; mainly because of higher sales commissions on higher sales volumes, other incremental costs necessary to support higher revenue as well as start-up costs related to launching Orion's Maintenance Services business. Given the flow-through on higher revenues, Orion generated Q3 Fiscal 2021 net income of $4.3 million or $0.14 per share compared to net income of $2.3 million or $0.07 per share in Q3 Fiscal 2020 and net income of $1.9 million or $0.06 per share in Q2 Fiscal 2021. We recognized a very small level of income tax expense in each period discussed because we have a full valuation allowance recorded on our net deferred tax assets.

Operator, Operator

First question, we have Sameer Joshi from H.C. Wainwright.

Sameer Joshi, Analyst

Congratulations on a strong quarter. The first question is about this UV product, the 275 nanometer product that you probably will introduce in the fourth fiscal quarter. Do you have any sense of what kind of demand you expect? And part two of that question is, are you looking for your existing national customers or the retailer customers to add this product to the orders that we already have with you?

Michael Altschaefl, CEO

Sure. We're very excited about the product, Sameer, so thanks for asking. The product itself is going to be a trough product. So think of a dropped ceiling grid product in either 2x2 or 2x4-foot grid, and that product has air movement capabilities so that it can help to moderate the air temperature throughout a room. But in addition, as the air is being brought through that fixture, there will be a UVC kill chamber that will treat the air as it's moving through the fixture. So we're very excited about it. It's a little bit early to say what the demand will be. We certainly have had conversations, and we expect there to be good demand for this product, and it fits very well into the need in the industry and in the environment for healthy and safe solutions. So we'll probably know more about that in the future, but we're very encouraged, and we're ready to manufacture and talk with our customers about it. And yes, it is a product that we could take back to our existing customers as on to what we've done for them currently in their environment. So we see this as a possibility.

Sameer Joshi, Analyst

Okay. And as I understand, you already had a 405 nanometer product. During COVID, did you see any increased demand for that? Or was it just a forward-looking prospect for that too?

Michael Altschaefl, CEO

We have had the 405 nanometer product, which is a product that does attack mold, fungus, and bacteria. And if you think about 405, it really is addressing on contact, so on the surfaces. So it is a light that is showing on surfaces to attack those bacteria. We have seen increased interest during the COVID-19 situation. We have not experienced significant additional revenues from that product at this time, but we still think there is opportunity going forward for that product. And having the two combined, we could envision where customers might want a combination of product like the 405, which continuously attacks bacteria on a surface contact, which can be used while people are in a room. And then having that matched up with the UVC product where the UVC is completely contained within this fixture, so that it is not exposed outside, so it can be continuously operating in an occupied space because it is not shining outside of the fixture. So we see some combination of the two, perhaps, having some possibilities.

Sameer Joshi, Analyst

Understood. Just moving on to the Maintenance Services that are being launched. And then trying to figure out the margins that you could get from these services. I looked at your margin profile and quarter-over-quarter, the service margins, even though revenues, service revenues, increased around 47%. The margins actually decreased relatively from around 23% to around 19.5% levels. So how does that profitability profile look for Maintenance Services that you are launching, and are there other operating expenses that could continue to be higher for that going forward?

Per Brodin, CFO

Thanks for that question, Sameer. I think if you think about the sequential change in margin over the quarter, as we mentioned during the prepared remarks, some of that decrease was attributable to start-up costs and inefficiencies associated with a particular project. And we expect to see those improve as we move forward. I think that you could expect that the OMS service product will be in our historical range for service revenues, so it's plus or minus a little bit. I think it will be in that range, not significantly lower and not significantly higher. And then with respect to your question on expenses, we have built, started to build, the base of infrastructure for that business. I think we have that we're getting there. And the Q3 operating expenses include certainly some expenses related to that investment that will continue to build somewhat more into Fiscal 2022. As we attempt to build that business, we think we have a good core to launch that business for the time being and then based on success and building that business would potentially need more infrastructure as we move forward.

Operator, Operator

Next question, we have Eric Stine from Craig-Hallum.

Eric Stine, Analyst

There has been a significant shift with more than ten factors influencing the upcoming fiscal year compared to a more focused approach in the past. Could you provide information about your new logistics customer? It seems that this addition in the quarter will affect next fiscal year. Can you clarify whether this involves new facilities or retrofitting existing ones? Also, how does the scale of this compare to your current logistics customer?

Michael Altschaefl, CEO

We are very excited about welcoming another customer to this sector of our portfolio. As I mentioned, we believe that warehousing logistics will continue to grow and could become a significant part of our business moving forward, as it has been in the past. We were fortunate to begin working with a second large warehousing logistics company. The projects for them will be similar to those we discussed for the previously announced company and will be handled on a project-by-project basis. Most of the business will likely involve retrofit situations, as they review their existing properties and upgrade to LED lighting either during tenant turnover or on an interim basis. Additionally, they may occasionally build new facilities, providing us with opportunities to collaborate on those projects too. Overall, I think it will be a mix, but it will likely lean heavily towards retrofit activity.

Eric Stine, Analyst

Got it. And then just a follow-up on that. You mentioned that you expect, or very possibly, logistics is one of, or the largest, component of Fiscal 2022. I mean, when you think about that, since this is project to project for both customers, is that commentary based on the acceleration you see with what you currently have in hand? Or does that also include the expectation that there are others out there? Just curious what type of look you're getting at all the logistics business that's potentially out there?

Michael Altschaefl, CEO

It's a combination of the fact that we've been in the warehousing logistics space for a number of years. We have always done and worked well and have great customers in cold storage, in distribution facilities. So this really is not a new area for us. And our product line is very well suited for these, including some of the new products that we've launched over the past year. So when we are saying that we think Fiscal 2022 could start to have that warehousing logistics area of our business be one of our largest revenue segments, it’s our existing customer base with the addition of these two larger global warehousing logistics companies. We think all combined, could become a very significant part of our revenue stream going forward.

Eric Stine, Analyst

Got it. So not necessarily new targets you have out there, it's more adding these more penetration to what you already have in hand.

Michael Altschaefl, CEO

Yes.

Eric Stine, Analyst

Okay. And then one last question from me. I know you've mentioned that there hasn't been a significant impact from COVID in the third quarter. I'm curious about any potential supply chain issues and your perspective on the health of your supply chain, as well as any proactive measures you are taking in that area.

Michael Altschaefl, CEO

From a supply chain perspective, especially regarding COVID-19, we have encountered some minor challenges that required our attention. We consistently strive to maintain backup suppliers, and for high-volume products, we utilize multiple suppliers. However, we have noticed an increase in the need to adjust our approach and explore alternatives to ensure our supply chain remains robust amid COVID-19. Currently, a significant concern impacting us and others in the industry is the strain on logistics, both domestically and internationally, due to high volume. Specifically, we are facing difficulties shipping certain products from China, particularly with port congestion there and on the West Coast. These factors are contributing to increased stress on the supply chain. Additionally, there is a global supply issue concerning semiconductors that we expect will have a downstream effect. Overall, we believe we are handling the situation effectively and have not observed any major impacts on our customer base. However, we anticipate that our company, along with others in various industries, will continue to face supply chain logistics challenges in the upcoming quarters.

Operator, Operator

Thank you. Next question was have Craig Irwin from ROTH Capital Partners.

Craig Irwin, Analyst

Mike, I wanted to ask you about the guidance, right? 117 plus for the fiscal year, kind of points to a fairly significant sequential contraction. It's 117 plus that you guided to, but can you maybe scope out for us the range of things that might cause that number to be higher or possibly lower, given that we are, what, five, six weeks into the quarter? You will have basically stuff in hand that you're going to ship over the next two weeks, but there is quite a lot of business that happens in the very last two, three weeks of a quarter. How much variance can we see around that number?

Michael Altschaefl, CEO

Well, I think I go back a little bit to our last quarterly release and call, where we, in somewhat of an unusual position, decided to provide pretty specific guidance on what we thought the second half of the fiscal year would be. And if you go back and look at that, we're seeing very similar to that of saying we thought the second half of the year was going to be $80 million, and that would be at least $117 million for the year. We certainly had a very strong Q3 with the revenue that we had. And as we look at our current pipeline in our backlog, which actually was quite strong at the end of the quarter, we still feel that we're at that same level. So we really have not changed our view for the whole fiscal year. And so right now, Craig, yes, things can happen in the last few weeks of the fiscal year and move things around a little bit. But at this point, we think it's best for us to be consistent with what we had said earlier that we think the full year is likely to be somewhat in excess of $117 million.

Craig Irwin, Analyst

Understood. Understood. That makes sense. So then as we look at 2022, you were also pretty clear about doing something similar to 2020, maybe better as well. You did say a third of the revenue is going to come from your home center customer. That's clear. They obviously share their plans with you, and you've done a great job for them. The logistics customer, the anchor logistics customer that you brought on, most of those new build facilities I would kind of expect that those would be planned six months, nine months, even a year ahead of the actual completion for the lighting. So can you talk about the new logistics customer and the old logistics customer, not so old? How these contribute to the visibility that you have? I mean, have you changed your assumptions for turn business at all in the year? And there are a few other customers where there potentially are some chunky orders. I was just wondering sort of how you're handicapping different things to get to your sort of 150-plus that you're pointing to?

Michael Altschaefl, CEO

Sure. We remain confident about reaching the $150 million mark. A few quarters back, we emphasized the importance of people, investors, and the market understanding our strong belief in getting back to that level. Having around $80 million in revenue during the latter half of this year indicates that we are on track. It's also crucial to recognize that too much concentration in revenue can be detrimental for many businesses. The fact that our major customer accounted for one-third of our revenue between Fiscal 2021 and 2022, while we still maintained $150 million in revenue, is encouraging. This visibility is important and has expanded with that customer, involving not just retrofits in retail stores but also a range of projects we are handling for them, all of which appear healthy for the business. Regarding the second part of your query, I would divide it into two main areas. First, we have a project related to a global online retailer’s new facilities. This segment offers considerable visibility, as it involves planned new constructions with established timelines, giving us confidence in our revenue forecasts for this part of the business. The third aspect concerns two customers from the global warehousing logistics sector: one we announced some time ago and another recently. While we see substantial opportunities with these customers, the projects tend to be handled facility by facility, where they select which sites to retrofit. We collaborate with them to provide proposals, and those projects get awarded and advance accordingly. The drawback is that this process is less predictable compared to a nationwide rollout or new construction, yet the potential remains significant. We are making our best estimates regarding the $150 million target based on discussions with these customers and see promising opportunities here. Lastly, I want to mention that our relationship with the first customer has been developing slowly, influenced partly by COVID-19 and their operational access, but we are still optimistic about the prospects for both customers moving forward.

Craig Irwin, Analyst

Last question, if I may. Orion has secured business from some of the largest customers in the lighting market, which are very desirable clients. I assume this is attracting considerable attention from major fixture buyers as you make progress in logistics, warehousing, and big box retail sectors. Can you discuss the SKUs you may need to add to remain competitive for the upcoming wave of customers? Is it necessary for Orion to diversify its SKU mix at this time? Is this something that would be organic and potentially beneficial if it occurs, but not significant? How should we approach this?

Michael Altschaefl, CEO

It's a great question, Craig. I think, first, in our historically strong area of High Bay products, so product that can be in 20 to 40, sometimes 60-foot ceilings, but also is often used in the retail environment, particularly big box retail environment, we feel very well positioned with our product line there. We talk about our next-generation Star Line, which is a linear product for higher ceilings, which has been very well received, very price competitive, and we're seeing great traction with that product. It is the product that we are using in this specialty retailer’s stores, and we expect it to be a big part of the warehousing logistics customers that we have. In addition, we have also introduced products that are what people call a round or UFO type style of light fixture for higher ceilings; there are certain customers that prefer the round look. And we now have a very robust product line that we've introduced this past year to cover that area. We have also introduced additional outdoor lighting for parking lots, garages, area lighting in areas for parking lots or retail areas. Likewise, we have found that product to be well received. I think from an expansion standpoint, we certainly want to continue to look at both the UVC side and the air movement product potential out there, the antimicrobial that we talked about. The other area that we are actively investigating is the horticultural area. We think the combination of the likely future increase in vertical farming that getting the growing of produce and other products closer to the end user and the consumer is a trend that we think is going to be strong. There's the obvious opportunity in the cannabis market. And so we are exploring an expansion more into the horticultural side. We've always been strong, in I'll say, the farming, dairy farm, with some enclosed washable product that can be in harsher environments. And so we think that is another area also. So we're always looking to expand products. We have a very, very extensive SKU portfolio right now, but we will keep our eye open to expand where we need to. Appreciate the question.

Operator, Operator

Next, we have Marc Wiesenberger from B. Riley Securities.

Unidentified Analyst, Analyst

This is actually Amad jumping in for Marc. But I wanted to ask, can you talk about the success and progress with your new construction work? And how should we think about the traction in expanding work there? Any medium-term aspirations for how much that business could represent?

Michael Altschaefl, CEO

Thank you for joining us today. Historically, a significant portion of our business has been in the retrofit market, and we still see considerable opportunity there, especially considering the studies indicating how many building spaces still need to transition to LED. However, our products have also consistently performed well in new construction. We believe that new construction will play an important role in our future. As I mentioned previously, the work we've been doing last year and plan to continue this year through Fiscal 2022 for a global online retailer has been focused on new construction, utilizing our existing product line and custom fixtures designed for those specific applications. We are confident in the versatility of our product line for new construction. Therefore, it is essential for us to focus on market channels that cater to new construction, which can differ from those for retrofit projects. This is part of our sales strategy to ensure we capitalize on new construction opportunities.

Unidentified Analyst, Analyst

That's helpful. And then can you talk about the liquidity environment and its potential impact on the ESCO channel?

Michael Altschaefl, CEO

The Energy Service Company channel is one we have been part of for many years. It has been somewhat affected by COVID-19, but we are seeing a positive strengthening in that market. We believe we have the right products and a strong understanding of this market. ESCOs purchase our products and install them for their clients. These companies may also provide HVAC or other energy solutions. Ultimately, they typically install products at customer sites, and we are well-prepared to support them with high-quality products. From a liquidity perspective, we believe there is significant financing available in the market for energy projects. If ESCOs collaborate with larger firms on substantial projects, there are ample financing options for energy initiatives that companies might prefer to keep off their balance sheets through leases or other energy savings agreements.

Unidentified Analyst, Analyst

Understood. Last question from me. Can you just talk about the pricing environment? We're hearing and seeing that some commodity prices are starting to increase. So how quickly and easily will you be able to pass that on to your customers? And how much of an impact will that have on gross margins in this quarter?

Michael Altschaefl, CEO

There certainly is some inflation, I believe, coming through the supply chain with respect to certain components and commodities. We are seeing some price increases from our suppliers in the power supply area and somewhat in metal and in some other areas. And as I mentioned earlier in the call, there is a growing reality of some global semiconductor shortages, which are subcomponents of things that we purchase. So we don't buy semiconductors directly, but the power supplies we purchase will be using semiconductors. To react to that, we recently announced to our customer base that we would have a, generally across the board, a 6% price increase on our products, and that impact of that will start to roll out in Fiscal 2022. And so it's been announced, it's going into effect over the next few weeks as we kind of work off existing orders. It doesn't have an immediate impact in that we certainly have projects that have been ongoing that will continue before they turn over to a next phase or get re-proposed at the higher prices. But the other type of business that is coming in, any of the new business would be priced at those new levels. So we believe that that price increase, which, as I mentioned in my prepared remarks, we believe is lower than many of our larger competitors who have announced some pretty significant price increases will remain competitive, but we think that will allow us to keep the margins in the ranges that we have been and what we have talked about going forward.

Operator, Operator

Thank you, sir. That concludes the Q&A session. I will now turn the call over to Mike Altschaefl for closing remarks.

Michael Altschaefl, CEO

Thank you, Katrina. I want to thank the Orion team for their hard work and operational excellence that has allowed us to bounce back from the COVID-19 related delays and put us in a great position for a return to higher revenue and profitability going forward. During this continued period of social distancing, we have participated in several virtual conferences, the most recent of which is recorded and available on our website. We are planning to participate in a virtual ROTH conference in March. You can also contact our IR team with any questions or to schedule a call with management and the IR contact information is included on today's press release. So thank you all again for joining our call today. We look forward to updating investors on our Fiscal 2021 Q4 call. Have a good day. Thank you.

Operator, Operator

Today's conference call is now concluded. Thank you for attending this presentation. You may now disconnect your lines. Have a great day.