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Orion Energy Systems (NASDAQ:OESX ) is an American LED system manufacturer that offers complete LED retrofit solutions for B2B clients looking to improve their energy efficiency.

The company was operationally unprofitable for most of the past decade, including the start and abandonment of a solar power equipment leasing segment. Between 2019 and 2022, it landed enormous contracts with a single client that allowed it to reach between $6 and $10 million in net income. As those contracts slow down because the company is back into unprofitable territory.

In my opinion OESX's persistent unprofitability is caused by iron fixed SG&A expenses that cannot be justified in a company consistently losing money. In turn, I speculate that SG&A expenses are not improved because there is not a strong shareholder to lead that change.

On the positive side, OESX used the recent profits to repay all of its financial debts. It now has zero debts and $10 million in cash, as of 1Q23 (June 2022).

Note: Unless otherwise stated, all information has been obtained from OESX's filings with the SEC.

OESX is in the business of manufacturing, designing, installing and maintaining LED systems. It does so mostly in retail, office, industrial or outdoor settings for B2B clients directly. It also sells indirectly through sales agents and ESCOs.

The company offers a complete solution, whereas it evaluates the client installations and designs an improvement plan to reduce energy costs. It can then implement that plan in a short period, with minimal inconveniences for the client, across several facilities.

Although OESX also offers specialized LED equipment as separate products, and that product revenue accounts for almost 80% of revenue, it is difficult to separate service and product revenue. Given that OESX sells a significant portion directly to customers, and that the equipment is used in facility improvement projects, it is probably the service side that pulls product demand.

Let us analyze the competitive dynamics of this market.

First, about the manufacturing operation alone. LED equipment is a relatively commoditized product, and is an industry with players much bigger than OESX. The company has a relatively small manufacturing facility in Wisconsin, which probably makes it less competitive than big players operating in cheaper manufacturing markets. From a Porter's perspective, this is not a great market.

LED systems design and implementation is somewhat more protected from cheaper foreign competitors because it is a non tradable service, meaning it has to be done in place. On the negative side, design and implementation is not a very attractive market either.

D&I is a relatively undifferentiated service, that many companies can provide with insignificant differences. OESX argues that not every company is capable of providing big companies with implementation across several facilities, but I doubt that there are no other competitors with those capabilities.

The service is also capped by the gains generated by energy efficiency. Clients compare the cost of implementing a new system with the savings generated across a number of months/years. Having a price cap is terrible for competition. In the same vein, OESX sells to businesses, which is always worse than selling to consumers, because businesses are better at comparing alternatives.

In terms of supplies, OESX is benefited by having a commoditized LED market to source from. The fact that it uses mostly its own manufactured products is interesting, although we will review this later. The employees participating in the D&I portion are qualified, being electricians and energy efficiency engineers or analysts. These can be difficult and expensive to source.

OESX faces competition of other companies providing the same service but also from energy service companies, or ESCOs, that couple design and implementation with financing or performance payments. ESCOs sometimes finance the energy efficiency improvements (including lighting) and get repaid from the energy cost savings. In other situations their compensation is tied to energy cost savings.

In terms of channels, OESX sells mostly directly to end customers. Its services segment, that accounts for direct sales of solutions, accounts for 75% of revenue. The rest is derived through independent sales agents or ESCOs that compete with OESX in the system design segment but purchase the LED equipment from OESX.

The result of these dynamics? OESX revenues were stagnant at best or falling for most of the past decade. In 2019 (FY20), it landed important new contracts that accounted for 75%, 56% and 49% of revenue in FY20, FY21 and FY22, according to the company's FY22 10-K report.

Going down the income statement, two things are interesting. First, gross margins are relatively stable, despite falling and then rapidly increasing revenues. Second, operating margins are consistently negative.

The second point is a key aspect of OESX's decade long underperformance. SG&A expenses have been fixed close to or above $20 million yearly for over 15 years, despite the company being unprofitable and gross profits falling with falling revenues.

This signals a problem because it shows OESX was unable or unwilling to implement an efficiency program that reduced SG&A expenses to a level consistent with the gross profits that it was able to generate. In my opinion, that a company is not able to grow is not a problem, as long as it can generate a profit on whatever market it has. OESX posted almost twelve years of operating losses but never got to sufficiently reduce SG&A expenses.

Another interesting aspect of the company's accounting is that it has consistently spent less in capital renovation than what it expenses as depreciation. It also posts relatively low PP&E for a manufacturing heavy company, with only million $35 million gross and $11 million net.

Because of OESX's important SG&A leverage, the significant increase in revenues in FY20, 21 and 22, combined with constant gross margins, resulted in a significant increase in profits.

Profits were also increased by OESX's carryforward losses, and a reversal of tax allowances. In a regular tax basis, considering the US 21% income tax rate plus Wisconsin's 5% state income tax rate, OESX would have generated around $10, $5 and $6 million in net income in FY20, 21 and 22 respectively.

OESX used $10 million of those profits to repay its financial debts, and it also accumulated cash. This is a positive aspect for the company, now having zero financial debts, a $25 million unused credit facility and $10 million in cash as of 1Q23.

OESX also acquired a lighting installation and maintenance company called Stay-Lite Lighting. SLL has its operations concentrated in the US Northeast and Midwest. OESX has provided very little separate information for SLL, only that between January and March 2022 the company generated $2.7 million in sales and $0.2 million in operating profits. It is very little information, but the $4 million priced paid for SLL does not seem exaggerated. OESX only recorded $600 thousand as goodwill for this acquisition.

The problem is that OESX's big contracts, with a single customer, that accounted for 74%, 56% and 49% of revenues in FY20, 21 and 22, are slowing down. As you can see from the table below, OESX's revenues have been steadily falling for the past three quarters. The company has been unable to secure new contracts, and on its 1Q23 results announcement, it mentioned that its clients are slowing down on investments because of the more complicated economic context.

OESX's condensated financial figures for the past four reported quarters (OESX's 1Q23 10-Q report)

The recent quarter results relate to the situation seen in most of the past decade. The main problem with OESX is that it cannot operate under certain revenue level because its SG&A expenses are too high.

If the company can only be profitable at a revenue level that has been extraordinary for the decade, then it is not a good investment.

I speculate that OESX has been unable to improve its SG&A expenses because it does not have a significant shareholder. As of 2022, according to the company's latest proxy statement, it only has two significant shareholders, one with 11% participation and another one with 6%. If we go back to the 2016 proxy statement, the situation is not very different, with the biggest shareholder holding 15% of the capital. Back to the 2011 proxy statement and the biggest shareholder was the company's founder with 9.5%.

A strong shareholder is needed to carry out an efficiency improving strategy, that is probably difficult and that can harm people's interests. OESX operates in a small 30 thousand inhabitants town in Wisconsin.

Of course these are speculations, it may very well be that OESX cannot generate revenues with lower levels of SG&A. In that case, the company is simply unprofitable unless it receives a windfall contract.

In both cases, I do not consider OESX a buy for any individual investor. It may be interesting for an activist fund, of course doing a much more deep due diligence.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.