Earnings Call Transcript - OESX Q2 2022

Operator, Operator

Good day, ladies and gentlemen. And welcome to the Orion Energy Systems Fiscal 2022 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. 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, Introducer

Thank you, and good morning, everyone. Mike Altschaefl, Orion’s CEO and Board Chair will open today’s call to provide highlights and to discuss the current business outlook. Orion’s CFO, Per Brodin will then review additional items after which we will open the call to questions. An archived replay of this call will be available after today in the Investor Relations section of Orion’s corporate website. This call is taking place on Tuesday, November 9th, 2021. Remarks that follow and 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 include words such as anticipate, believe, expect, or words of similar import. Likewise, statements that describe future plans, objectives, or goals are also forward-looking. These forward-looking statements are subject to various risks that could cause actual results to be materially different than expected. 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, which are made as of today’s date. Reconciliations of certain non-GAAP financial metrics to the corresponding GAAP measures are also provided in today’s press release, which will be available on Orion’s website at www.orionlighting.com. With that, let me turn the call over to Mike Altschaefl. Mike?

Mike Altschaefl, CEO

Thanks, Bill. Good morning, and thank you all for joining us today. Today, I will touch on a few areas of importance related to our second quarter, the current business environment, and our expectations moving forward through the balance of our fiscal '22. We provided a detailed overview of our strategy, market positioning, and outlook in our year-end call in June, which you can access on our Investor page. We had another good quarter with our fiscal Q2 '22 revenues improving substantially over last year versus Q2 '21 and sequentially versus Q1 '22. We’re also pleased with the gross margin performance we achieved both in Q2 and year-to-date, despite supply chain headwinds we referenced in our press release. The strength of our performance to date reflects the resourcefulness, hard work, and nimbleness of our talented, experienced team in responding to business challenges and opportunities in a fluid marketplace. Certainly, the global supply chain has represented the greatest source of challenges both for our customers and Orion. Our team has been developing a variety of proactive strategies to navigate supply chain issues, including proactive supplier management, expanding sourcing for key materials, components, and shipping, and advanced components and finished goods purchasing, all designed to position Orion to deliver on customer requirements. Though all these efforts have been successful, they have required substantial time and attention from our team. Fortunately, given the success of our strategies, we believe Orion is generally well-positioned to substantially achieve our production goals for the balance of the year, assuming conditions do not deteriorate further. Importantly, as a U.S.-based manufacturer of most of our LED fixtures, Orion has a significant advantage over many of our larger competitors that have experienced significant delays and challenges in sourcing fixtures from Asia. As a result of these supply issues, we have been able to pick up some business from competitors who were not able to deliver product, and we expect there could be more of these opportunities going forward. Though Orion does import certain components and finished goods, active sourcing management and proactive planning have enabled us to largely mitigate many procurement delays to date, including power supplies, which is where we have faced the greatest supply challenges. The decision-making and project timeframes of our customers have had the greatest impact on our business so far with respect to supply chain challenges. Some customers have slowed or delayed projects as they managed through their own supply and sourcing issues. These delays had a modest impact on our Q2 top line and do represent a potential headwind for the balance of the fiscal year. However, our customer dialogues so far confirm that while the timeline of certain projects could slide due to issues outside of our control, the projects remain ours to complete when the customer is ready. Our outlook is supported by expected customer projects across the business, particularly from customers in retail, logistics, the public sector, healthcare, academic institutions, automotive, and our developing turnkey lighting installation, and maintenance services business. To address inflationary pressures from raw materials, components, labor, and logistics we recently implemented our second price increase of the year. We believe our price increases were in line with similar moves we have observed in the industry and will allow our value proposition to remain very competitive in the market. Our senior sales team continues to work on expanding our customer base and revenue sources with some solid progress on several large opportunities. As we have noted in the past, large national account opportunities generally develop slowly over the course of several quarters through a year or more, in step with their unique design requirements, review, and budgeting processes. With the added complexity posed by supply chain challenges, these dialogues are generally progressing more slowly, as projected project timelines extend. Fortunately, Orion has a strong and growing track record executing customized, large scale turnkey LED lighting project solutions that deliver compelling returns on investment and meet important ESG goals such as reducing carbon emissions and creating better, safer work environments. In addition to large national account revenue opportunities, we are achieving solid growth in our ESCO and electrical contractor channel revenues, which are up over 100% year-to-date. Given the industry-leading energy efficiency and high quality of products, our customer service focus, and U.S. manufacturing, we feel that Orion is well-situated to grow our market penetration in this channel. For example, last month, we announced new LED lighting retrofit projects for two New York area school districts in partnership with one of our ESCO customers. We have now supplied fixtures for a total of four school districts for LED retrofit projects with our customer. We are confident in the potential to build upon this partnership and in the public education sector, particularly with the additional funding for school safety and improvement projects available through the CARES Act as well as part of refreshed programs within the Education Stabilization Fund. We also see the potential for CARES funding for education facilities to create opportunities for our PureMotion UVC Air Movement Solutions, which are designed to sanitize air and eliminate airborne viruses, including COVID-19 and variants in addition to LED fixture sales. We are seeing a growing base of interest, dialogues, and product evaluation for our PureMotion product line, although sales have been modest so far. Based on PureMotion’s unique ability to create healthier indoor environments for schools, medical facilities, offices, and other shared spaces, we see significant potential for this product line. With any new product, there’s typically a four to six-month process from introduction to beginning to see a sales ramp. However, because this is a new product category for Orion and our customers, and we are focusing on academic institutions and medical facilities with extensive review approval and budgeting processes, the sales cycle has proven to be a bit more extended. Last week, we announced that we have combined our new Orion Maintenance Services business with our existing Orion Engineered Systems business to create the Orion Services Group. The Orion Services Group includes turnkey lighting installation and maintenance services. We are pleased with the steady progress in customer engagement that is being achieved so far in fiscal '22 for the lighting maintenance component of this business. The Orion Services Group now has the capability to serve our customers’ needs through the complete lifecycle of initial project engineering, product design, lighting fixture installation, commissioning of control systems, and ongoing maintenance services. We have begun to provide maintenance services to a few customers, including our largest national retail customer, as well as one of our specialty retail customers. Results so far confirm our optimism for the potential of this business and the customer synergies and its ability to provide a meaningful and recurring contribution to our results in fiscal '23 and beyond. To support the long-term growth and expansion of our business, we also continued to build out our executive management team. Last week, we announced the appointment of Mike Jenkins as our new Chief Operating Officer. Mike has over 25 years of operations, sales, and marketing experience and accomplishment with industrial-focused companies. We think he has the ideal skill set to help us achieve our growth and profitability goals. In a related move, our prior COO, Scott Green, has been promoted to president of the Orion Services Group, focusing on turnkey lighting installation and maintenance services, as well as his continued leadership of our new product development team. Earlier this year, lighting industry veteran, Tim Rooney joined us to lead all of our sales functions in the newly created position of Executive Vice President of Sales. These executive additions and changes are designed to support our goal to build Orion into a company generating $500 million in annual revenue over approximately the next five years. This plan assumes internal growth of at least 10% annually, supplemented by acquisitions and new business partnerships. With respect to our current fiscal year outlook, as referenced in today’s announcement, Orion remains committed to its goal of achieving fiscal '22 full year revenue of at least $150 million. However, achievement of this goal has become increasingly less certain because of the broad-based supply chain challenges impacting all aspects of the economy, including us, our customers, and our vendors. And with that, I’ll turn the call over to Per to review financial performance highlights and insights, before we proceed to take investor questions.

Per Brodin, CFO

Thanks Mike. Orion’s second quarter fiscal '22 revenue grew by $10.2 million to $36.5 million on continued strong business activity for national accounts. This compares to sales levels in Q2 '21 that were significantly impacted by COVID-related disruptions but represented the period in which customers began to restart their projects. Q2 '22 sales also increased sequentially from the Q1 '22 level of $35.1 million. Revenue for the first half of fiscal '22 increased $34.5 million to $71.6 million as our business rebounded since the onset of the pandemic. Our gross margin improved to 29.5% in Q2 '22 from 27.6% in Q2 '21, with Q2 '22 benefiting by $800,000 from the recognition of an employee retention tax credit under the American Rescue Plan Act, an element of COVID-19 stimulus legislation. Excluding the credit, gross margin would have been 27.4%, which we consider a good result in a challenging environment and saw some impact from product mix shifts compared to the first quarter this year. We recently implemented our second price increase of the year to mitigate the impact of component, logistics, labor, and other cost increases going forward. We believe our pricing moves were in line with actions taken throughout the industry. Our gross margin percentage typically fluctuates quarterly due to changes in our revenue mix, the timing of larger projects, and other factors. In the current environment, we’re working to focus our product offerings on the most compelling and popular solutions that provide production and margin efficiencies. Second quarter fiscal '22 operating expenses increased to $5.8 million versus $5.4 million in Q2 '21, due to ramping business volume offset by $800,000 in worker retention tax credits. To be clear, the total worker retention tax credit was $1.6 million, half of which benefited cost of sales and half of which reduced operating expenses. Orion generated EBITDA of $5.4 million in the second quarter of fiscal '22 compared to $2.3 million in the second quarter of fiscal '21 with the improvement due to flow-through on higher revenue and retention tax credit. Q2 '22 net income improved to $3.7 million from $1.9 million in Q2 '21. Net income for the first six months of fiscal '22 grew to $6.2 million from a net loss of $300,000 in the first half of fiscal 2021. Orion’s effective tax rate was 26.8% in Q2 '22 and 26.4% for the first half of fiscal year 2022. However, we do not expect to pay meaningful cash taxes for several years because of net operating loss carry-forwards of nearly $70 million as of the prior fiscal year-end. Also, as Mike mentioned, Orion remains in a strong financial position. Orion ended Q2 '22 with approximately $40 million of liquidity, including $14.7 million of cash and cash equivalents, and the full $25 million available on our credit facility. Net working capital improved to $34.7 million at September 30, 2021, compared to $26.2 million at our fiscal year-end, March 31, 2021. Orion used $4 million of cash in operating activities in the first half of fiscal '22, as compared to a use of $14.1 million in the first half of fiscal '21. The improvement is attributable to greater business volume and improved bottom line performance in the current year period. And with that, I will turn the call back over to the operator for the Q&A session.

Operator, Operator

Our first question comes from Sameer Joshi from H.C. Wainwright.

Sameer Joshi, Analyst

Yes. Hey, Mike. Hey, Per. Thanks for taking my questions.

Mike Altschaefl, CEO

Yes. Good morning.

Sameer Joshi, Analyst

Good morning. So, you mentioned power supplies were one of the items that you are dependent on for the supply chain that are subject to supply chain issues. In your inventory, how much of power supplies are there, and what level of revenues would they be able to support going forward?

Mike Altschaefl, CEO

Well, I’m not sure I’m going to be able to be that specific to your initial question, Sameer. But, let me provide some context. So, for power supplies, there are two primary electronic components to the LED fixtures: the power supplies and the LED chips and modules. Many of our power supplies are supplied to us by suppliers based in Mexico. We have certain power supplies that we do purchase from suppliers in Asia. Those suppliers have been impacted by the ongoing chip shortages in the world, which means certain of those suppliers might have some allocations going on. Additionally, from an Asia standpoint, we have logistical issues. To date, we feel that we have had very minimal impact on our revenues from some of those. We actively manage it with additional suppliers and we had built up our inventory of those as we could throughout the spring and summer. We wanted to mention that this has probably been one of the more noticeable supply chain challenges for us, but so far we’ve been able to manage it very well. In some respects, it’s starting to improve as we go forward, so we feel okay about it.

Sameer Joshi, Analyst

Got it. Okay. And then, you mentioned you have implemented the second pricing increase recently. When should these start reflecting in revenues? Because I can hear you would be selling now or recognizing revenues from the previous prices, right?

Mike Altschaefl, CEO

Yes. So, for us, our price increase was, for the most part, effective for shipments that we make after December 15, 2021. We will begin seeing those impacts very modestly in Q2 and more significantly in quarter number three a little bit in quarter three, and more prominently in quarter number four of fiscal 2022. For us, there’s a variety of rollouts. Those orders that come in from one-off projects and from ESCOs and electrical contractors, those price increases start immediately. Then we have some project-based business, which might take a little time for either the next project to come up or in certain projects we have a period where our pricing was being held. It will roll in impacting very modestly in Q3, more significantly in quarter number four, and certainly fully implemented by Q1 of 2022. Our price increases were in a range of 5% to 14% across our product categories, just depending on where our costs were, what the logistics were, and what we felt was competitive in the industry.

Sameer Joshi, Analyst

Understood. Thanks for that color. One last one, you highlighted the contribution from maintenance services, and we can see a quarter-over-quarter increase in the overall services revenues by around 45%. Is this almost all of these increased quarter-over-quarter attributable to increases in maintenance services?

Mike Altschaefl, CEO

Well, our services line in our public reporting and our Qs and K includes both our installation services as well as our maintenance services at this time. But, you are correct, it had very nice growth. This quarter, sequentially, our service revenue grew about 27% and year-over-year grew 44%. What we’re really excited about is that a portion of that growth did come from our large national retail customer, from which we are beginning to provide quite a bit of services to them from a maintenance standpoint. We think that has a lot of potential for us in the next couple of years. We are getting our systems aligned with theirs and rolling things out. We’ll certainly have more to say about that in our February timeframe, but we’re making good progress with that as well as with other customers. Our goal has always been to build recurring revenues through both preventative and reactive maintenance services. We feel like we’re on track with where we want it to be this year, and really see the ability for substantial growth going forward.

Per Brodin, CFO

Sameer, maybe just to put slightly more color on that based on your question. It would not be fair to characterize the sequential quarter growth solely to the maintenance services business. It is a component of that sequential increase, but there’s also other installation service business included in that sequential growth.

Sameer Joshi, Analyst

Thanks for that color, Per. I’ll get back in queue. Thanks.

Mike Altschaefl, CEO

Thank you, Sameer.

Operator, Operator

Our next question comes from the line of Alex Rygiel from B. Riley.

Alex Rygiel, Analyst

Thank you. Good morning, gentlemen.

Mike Altschaefl, CEO

Good morning, Alex.

Alex Rygiel, Analyst

Can you expand upon the negative product mix shifts in the quarter a little bit more?

Mike Altschaefl, CEO

Yes. I think, we touched on this a little bit in the first quarter from the opposite angle regarding the benefit we got in the first quarter. If you look at the components of our sales for the quarter, we did have a shift out of some of our distribution services business which tends to be at a higher margin. So, it was a shift in the type of product as well as the channel into which we sell that product.

Alex Rygiel, Analyst

That is helpful. And then, can you remind us what your price increase was earlier in the year? And in conjunction with the December price increase, do you think we’re at a point where we’re fully offsetting the rise in the cost?

Mike Altschaefl, CEO

Well, as we mentioned, this is our second price increase of the year. The first price increase in the year was in a similar range, higher single digits, a little more. We were able to implement this increase across most of our product whereas this time we had a range of 5% to 14%. So, when you combine both, it’s probably at about the same level of the high single digits. We feel that we are taking the right steps at the right time. We think that our margins that we are seeing internally and with our quarterly results indicate we are staying aligned with the inflationary pressures we are experiencing, Alex. So, we continue to feel confident that we can keep our margins where they are, and hopefully continue to boost them as we increase volume, improve our mix, improve our pricing, etc. So far, we feel like we’ve taken the appropriate steps at the right time to address our price increases.

Alex Rygiel, Analyst

Great. Thank you very much.

Mike Altschaefl, CEO

Thank you, Alex.

Operator, Operator

Our next question comes from the line of Bill Dezellem from Tieton Capital.

Bill Dezellem, Analyst

Thank you. Two questions. First of all, would you discuss the challenges that your customers are experiencing, where they are slowing down, requesting you to slow down implementation?

Mike Altschaefl, CEO

Absolutely, Bill. That’s a great question. I’ll provide a relatively specific answer without mentioning names, but we have certain businesses that might be in the new construction area. For instance, in a distribution or fulfillment center, our customers are having trouble getting steel, or they’re having trouble getting systems in place within that facility. This has caused them to sometimes slow down their process and timing for the light fixtures, which typically come in towards the end of a project. It’s the supply chain challenges our customers are facing in new construction that are mostly responsible for this. However, it is a little less relevant when it comes to retrofit applications, but this illustrates what is causing delays on their end. Importantly, we haven’t lost those projects; they are still going to be completed, but the timeline may shift as they catch up with their own supply chains.

Bill Dezellem, Analyst

Great. Thank you. And then, how about 10% customers? How many of those did you have in the quarter?

Per Brodin, CFO

We had one during the quarter.

Bill Dezellem, Analyst

Thank you, both.

Mike Altschaefl, CEO

All right, Bill. Thank you for your questions.

Operator, Operator

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

Mike Altschaefl, CEO

Thank you, Marjorie. And thanks again to everyone who joined us today for your interest in Orion. We will be participating in the Craig-Hallum Alpha Select conference, which will be held virtually on November 16th. In recent months, we have participated in several other virtual conferences, all of which are recorded and available on our website. You can also contact our IR team with any questions or to schedule a call with management. The IR contact information is included in today’s press release. So, thanks again. We look forward to updating investors on our fiscal '22 Q3 call. Have a great day.

Operator, Operator

Today’s conference call is now concluded. Thank you. You may now disconnect your lines.