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Edited Transcript of OESX earnings conference call or presentation 13-Nov-18 3:00pm GMT

Q2 2019 Orion Energy Systems Inc Earnings Call

Manitowoc Dec 5, 2018 (Thomson StreetEvents) -- Edited Transcript of Orion Energy Systems Inc earnings conference call or presentation Tuesday, November 13, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael W. Altschaefl

Orion Energy Systems, Inc - CEO & Board Chair

* William T. Hull

Orion Energy Systems, Inc - CFO, Executive VP, CAO & Treasurer

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Conference Call Participants

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* Amit Dayal

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Craig Edward Irwin

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Eric Andrew Stine

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* William R. Jones

Catalyst Global LLC - VP

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Orion Energy's Fiscal 2019 Second Quarter Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the call over to Bill Jones. Sir, you may begin.

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William R. Jones, Catalyst Global LLC - VP [2]

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Good morning, and thank you for joining Orion Energy Systems' fiscal second quarter call. Participating today are Orion CEO, Mike Altschaefl; and CFO, Bill Hull. Mike will review Orion's second quarter and year-to-date performance and its goals for the full fiscal year. Bill will then provide some added financial highlights, and then 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 Tuesday, November 13, 2018.

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 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 turn the call over to Mike. Mike?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [3]

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Thanks, Bill. Good morning, and thank you for joining our call today. Our second quarter revenue came in below expectations, principally due to delays in the start of some customer projects and lower sales through our agent-driven distribution channel. Our cost management discipline enabled Orion to deliver improved results on the bottom line. Importantly, we have seen a continued strengthening in large national account activity, which makes us confident in delivering a strong second half performance on the top and bottom line. Given our revenue shortfall in the first half of fiscal 2019 and the potential variability of timing in large customer orders and contracts, we have revised our fiscal 2019 revenue growth goal to be in the range of 5% to 10% from our earlier goal of 10%.

Our positive outlook for the balance of fiscal 2019 and for fiscal 2020 is supported by ramping order activity achieved during the first half of fiscal year and dialogues with the national account customers concerning retrofit opportunities through calendar 2019 and beyond.

In particular, these discussions lead us to believe that there's strong demand and a defendable market position for Orion in delivering turnkey LED lighting upgrades for very large customers seeking one source procurement. These customers are engaged with Orion not just because of the industry-leading quality, high performance and energy efficiency of our LED lighting solutions but because of our ability to deliver start-to-finish project management on a national scale. Our services range from site surveys, energy audits, custom design and prototyping through U.S. manufacturing and delivery and installation.

While Orion is being recognized by large national and regional accounts for our turnkey capabilities, our quality, energy efficiency, quick turnaround, U.S. manufacturing and customer service commitment also resonates in our other sales channels, including energy service companies, or ESCOs, and electrical contractors as well as our agent-driven distribution channel. We saw a modest but continued sales improvement in the second quarter from the refocus on our ESCO sales relationships, while our agent-driven sales channel delivered results that were somewhat below our expectations for the period.

Moving to product innovation. We continue to see very strong demand for our ISON LED High Bay lighting systems, our premium interior fixture, delivering industry-leading energy efficiency with up to 214 lumens per watt. Our ISON High Bay is the preferred choice for industrial and commercial applications that require optimal light distribution, the highest level of energy efficiency and ISON's superior thermal design. Importantly, when our customers look at total lifetime cost of ownership, the investment they make to deploy the industry's most energy-efficient High Bay solution is well worth the cost as we believe our ISON solution delivers the most compelling, long-term return on investment of any LED high bay lighting solution.

Accordingly, we are successful in our sales and marketing efforts when we engage knowledgeable buyers because they are most likely to make a purchase decision based on total return on investment criteria rather than just upfront costs. Our current success with national accounts is a direct reflection of our focus on this type of customer, and as a result, we continue to make significant investments in ongoing product development to ensure we are able to provide the strongest, most cost-effective solutions to our customers.

On prior calls, we have discussed how are HARRIS Patriot-branded LED lighting product line is targeted to the value-oriented segment of the market. The HARRIS Patriot line is a lightweight, sleek and lower-cost design ideal for new construction in more price-sensitive procurements. The line's modular design makes it easily upgradable should the customer need advanced controls, more efficient light engines or other enhancements later on. It allows us to be very competitive on price and functionality while providing the opportunity for additional revenues after installation. This line is particularly important for our ESCO, electrical contractors and agent-driven distribution channels in providing the ability to penetrate more price-sensitive deployments.

Our strategy is to build products that meet our customers' current and future needs, and as a result, we offer modular, upgradable systems designed for those with budget constraints so that they can address their near-term cost requirements while also providing them a cost-effective upgrade path for their future needs and budget.

We pride ourselves in our ability to develop customized products in a matter of weeks, a timetable that our competitors generally cannot match. In this regard, our design enhancements focus not just on illumination and energy efficiency but also on the ease and the cost of installation or retrofit.

We have made some solid traction with some customers based on our unique plug-and-play designs that substantially enhance the speed and ease of retrofit installation, often making it possible for a customer to complete upgrades without the need or cost of a licensed electrician. Such design innovation, combined with other areas of strength, provides Orion with the leg up on projects with a variety of small and large customers.

Before turning the call over to Bill, I do want to touch on the topic of tariffs and the impact we're seeing in our business. Certain of our finished products and certain components used in our products are sourced from China and, therefore, are impacted by the recently imposed tariffs. However, we estimate that these products and components are a modest amount of our total product sales. Beyond tariffs, we have also seen some impact from increases in labor, transportation and certain other component costs.

Our efforts to mitigate the impact of tariffs and rising labor, transportation and certain other component costs includes a variety of activities such as sourcing from nontariff-impacted countries as well as select price increases in the range of 8% to 15%. We believe that these mitigation activities will help us to largely offset the impact of rising costs, and therefore, we currently believe these issues will have a limited adverse financial effect on our results of operations over the next few quarters.

With that overview, I will turn the call over to Bill to provide more detail on our Q2 financials.

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William T. Hull, Orion Energy Systems, Inc - CFO, Executive VP, CAO & Treasurer [4]

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Thanks, Mike. As we previously discussed during fiscal 2018, Orion enacted a wide range of cost-cutting efforts that eliminated approximately $6 million or 20% in annual overhead expense versus prior year levels. We have also continued to exercise cost discipline across the company such as centralizing and consolidating front and back-office functions for efficiency and savings and where possible, deferring personnel replacements. We saw the direct benefit of these efforts in our fiscal second quarter and first half results as we were able to achieve improved bottom line results despite the revenue shortfall.

Turning to a few highlights from today's press release. Total revenue decreased to $13.2 million in Q2 of '19 compared to $15.4 million in Q2 of '18, reflecting the anticipated start of some large projects with national accounts being pushed to the second half and lower sales volumes through our agent-driven distribution channel.

Gross margin was 19.3% in Q2 of '19 compared to 23.5% in Q2 of '18, principally related to fixed cost absorption on lower revenues in Q2 of '19.

More than offsetting the decline in gross profit, we were able to reduce operating expenses to $4.8 million in Q2 of '19 versus $7.2 million in Q2 of '18. This improvement included the full quarterly benefit of Orion's prior cost reduction initiatives, the absence of $700,000 in a nonrecurring, noncash intangible asset impairment recorded in Q2 of '18 and continued cost control efforts.

Reflecting lower costs, Orion's EBITDA loss narrowed by $1.2 million to $1.8 million in this quarter versus $3 million in Q2 of '18.

From a cash flow perspective, we used $1.1 million in cash and operating activities through the first 6 months of 2019 versus $4.7 million in the prior year period. Again, the improvement reflects the benefit of cost cutting combined with ongoing working capital management.

At the close of Q2 2019, Orion had positive net working capital of $7 million, including $5.7 million of cash and cash equivalents, and we had $1.4 million in borrowings under our revolving credit facility.

In late October, we secured a new $21.15 million revolving credit facility with Western Alliance Bank that replaced our prior $15 million credit facility with Wells Fargo. Under the new facility, our borrowing base has been increased by approximately $2.4 million to $4 million compared to a borrowing base of $1.6 million under the prior facility. We view the new facility and its increase in our borrowing capacity as a vote of confidence for our business and its outlook from our new banking partner.

And with that, let's open the call to questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Eric Stine from Craig-Hallum.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

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Maybe we can just start with the agent channel. I know on last quarter's call, you were increasingly optimistic about that, and I know you've got things just a little slower than anticipated in Q2. Just wondering, is this something that you view as structural? Or is it just more of timing than anything else?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [3]

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We actually view it as more of timing, Eric, than anything else. As we had mentioned in our last call, we were pleased with the results in quarter 2 in that channel. They were just a little softer than we had expected in this quarter. We continue to have the quantity of agencies that we would like to have. We continue to work closely with them, and we think it was more timing and just, frankly, saw somewhat of an unusual slowdown in some activity during the summer in the quarter number 2 in that channel. So we don't think it's anything structural.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

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Got it. And then just an update. I think in terms of number of agents that have been in place for less than a year as kind of a key threshold, I think last time, you might have -- last time you gave an update, you might have been at 70% or somewhere in that range. Just wondering if you could give an update on that number and where you think things stand in terms of just getting that agent channel fully up to speed.

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [5]

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Sure. It's been quite a while since we actually broke out the length of term with our agency relationships. So I'm not going to do that today. What I can tell you is that we continue to be at approximately 50 agencies, which is where we have been for the last few quarters. We continue to feel that we have a good selection of agencies. We continue to make modifications on a situation-by-situation basis when we find what's working in different areas of the country. But the aging of our agencies has gotten larger and longer, and we do find that as they are longer with us, there is more productivity from those agencies. So we continue to be encouraged by the buildup of business on the agency network and feel optimistic about it going forward.

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Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

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Okay, good. And then last one, just -- and I can appreciate that there's some uncertainty given some of the delays and things getting pushed to the second half. But I mean, just quick doing the numbers, it looks like your EBITDA breakeven goal is doable, and I know, obviously, gross margin is going to dictate that. But maybe -- I guess, you didn't necessarily reiterate those but just maybe your thoughts on whether you think those are achievable in the second half.

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [7]

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Yes, on our last call, we said that we expected to be EBITDA breakeven or positive at least by the end of this fiscal year, and we continue to have that as a goal and believe it's achievable.

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Operator [8]

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Our next question comes from Craig Irwin from Roth Capital Partners.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [9]

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So your backlog was the highest it's been in a couple of years, $8.4 million. You usually don't carry a whole lot of backlog. Can you maybe break out for us if there were any large orders or single customers that made up a big piece of that $8.4 million?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [10]

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Well, we are pleased that the backlog grew quite a bit, and it ties in with my comments that we are feeling optimistic about the second half, Craig, because of the order activity that we had during quarter number 1 and quarter number 2. We had originally anticipated that more of that backlog would have been shipped during quarter number 2, but we did have situations with some larger customers where things pushed out into the third or fourth quarter from an installation standpoint. The ones in particular I could point out is our automotive side of our business. I guess, for a good reason, because the plants themselves have been very, very busy, the availability for the installation crews in those facilities has been more limited than expected, and therefore, our larger automotive customers are somewhat behind in the installation timetable, but we expect all of that timing to clear out by the end of fiscal 2019. So that's probably the biggest impact, I'd say, that drove some of that. But we also just had some positive improvements in our backlog during this quarter.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [11]

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Great. My second question is about the Patriot fixtures -- Patriot line of fixtures. I know it's a relatively recent introduction versus some of your legacy products. Can you maybe comment for us on the mix contribution, both on the top line and in the backlog today?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [12]

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I think for competitive reasons, I'm not going to give specific percentages, Craig. But the Patriot line is continuing to contribute to our revenue, and it is -- I would say, it's probably a growing percentage of our revenue. And as we've introduced and will introduce additional products, we plan to introduce them under that Patriot brand. It's a brand that we think has caught on in the marketplace and it's gone well for us in terms of the area that's filling for us. And partly, for us, it was trying to design a more sleek, streamlined product that could be used in some various applications. And it's a good-looking fixtures. It's cost effective. It's upgradable. We made our recent improvement to it where we made it more cost-effective to add sensor technology to that fixture, which was a good plus for us, and we have other improvements coming behind it. So as we get into the next quarter, and as we head to LIGHTFAIR, we will likely be introducing additional products under that Patriot brand name.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [13]

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Great. I also wanted to ask about gross margins. So everybody understands the challenging market out there and how fixed overhead coverage compresses margins a little bit. So with the expected delivery on that handsome order book in the second half, is it fair to expect margins to climb to the mid- or upper 20s before the end of the fiscal year?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [14]

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I think that's a reasonable range to be thinking about, Craig, as they climb. For us, as we discussed in the past, we, being a U.S.-based manufacturer, which we are thankful for and proud of, it comes with it certain fixed manufacturing costs. And so we know as our volumes fit to a certain level, we have incremental margin improvement. So in a combination of volume that we expect in the second half and the mix that we foresee, we would expect to have improving margins in the second half of the year and think those ranges you've talked about are reasonable.

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Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [15]

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Great. And then the last question is about your new facility. So you really have carried very little debt. Looking backwards, I guess, what, you're about $1.5 million this quarter. Can you maybe comment about the discussion that led to a larger facility? And maybe if you could share with us what the total available borrowing capacity is today on that facility if you were to see an acquisition that was attractive or something else strategic in the market that you wanted to take action on.

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William T. Hull, Orion Energy Systems, Inc - CFO, Executive VP, CAO & Treasurer [16]

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Craig, it's Bill. So the -- so obviously, the facility increased from $15 million to $20 million. It's a pretty standard asset-based loan. So it's based on assets we have. And really, the reason we put it in place is to give us room to grow, right, so as the business were to grow. The facility at the end of September was $1.4 million under Wells Fargo. And if we had the same facility under Western Alliance, it would be $4 million. So we picked up roughly $2.5 million in borrowing capacity.

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Operator [17]

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(Operator Instructions) Our next question comes from Amit Dayal from H.C. Wainwright.

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Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [18]

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In regards to your 5% to 10% growth expectations for this fiscal year, how much of this is dependent on the agents and the external channels versus your internal efforts?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [19]

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Well, when we factor everything in, we really are looking at our national account activity, our ESCO relationships and our distribution channel in arriving at that revenue range, Amit. So I really wouldn't break it into any of them. We expect performance out of all 3 of those areas. And the reason for the range is simply that given the size of some of our customer relationships and the expectations of some possible projects, it can move the needle for us rather quickly. So we thought it would be better to lay out a possible range of growth during that second half of the year.

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Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [20]

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And in line with this, are you continuing to expect sort of backlog to grow from these levels or come in at the levels seen in this quarter?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [21]

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Amit, it's kind of hard to predict because as you've heard us say on several quarters and when we look at our customer base, there are often things that are unfortunately outside of our control from a timing aspect as to when the customer can take delivery of product or when they can have it available for installation, as I've mentioned earlier, with some of our automotive customers being very busy. And so while we are confident about the second half because we've seen this nice buildup in backlog but also the order input activity on a year-over-year basis, which we talked about in our press release being up 18% when we compare our order activity for the first 6 months of this fiscal year versus last fiscal year, that actually is, to me, as significant, maybe even more than looking at the backlog. So depending on timing aspects of customer rollouts, that backlog could go up or down, but it could also not be totally connected with the revenue during a particular quarter if we have great order input activity. We have a certain amount and quite a bit of order activity that comes in, in a quarter and gets shipped in a quarter, so that's where you can have quite a bit of variability.

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Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [22]

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Understood. Maybe just one last one for me. In terms of new product development, where are you trying to focus more efforts on? Is it more towards the value side of things or more towards the premium side of things? It looks like you have a pretty decent portfolio covering all these segments, but where do you think there is more interest and more opportunity for you?

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [23]

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Yes, it's a great question, Amit. I would actually say that it's really on both ends of those spectrum and probably a little bit less in the middle category. What I mean by that is that we are seeing very nice activity and success with our higher-end product with certain customers who need to and want to think really long term of what their investment in lighting does for them as an organization, how can we bring controls to the situation and provide payback for them over the long term. But we also are seeing a very robust business on that more entry-level product that gets sold sometimes through distribution, maybe through ESCOs, where the product needs to be good, needs to have high quality, but it may not have the same type of need in some other higher-end applications. So our product development activities are directed both the high end and towards that entry-level product and probably a little less towards, I'm going to say, the middle ground of product that we've had in the past. Secondly, I would say it's primarily focused on interior high bay product as well as commercial drop ceiling product and our ability to compete both in that commercial market also, which we see a lot of opportunity in.

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Operator [24]

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

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Michael W. Altschaefl, Orion Energy Systems, Inc - CEO & Board Chair [25]

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Thank you, Dalem, and thank you for joining us today. We look forward to updating you on our business progress and the outlook on our next call. Have a good day.

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Operator [26]

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Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may all disconnect. Good day.