Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________ 
FORM 10-Q
_____________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2018
OR
 ¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-33887
______________________________
Orion Energy Systems, Inc.
(Exact name of Registrant as specified in its charter)
______________________________ 
Wisconsin
 
39-1847269
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification number)
2210 Woodland Drive, Manitowoc, Wisconsin
 
54220
(Address of principal executive offices)
 
(Zip code)
Registrant’s telephone number, including area code: (920) 892-9340
_______________________________ 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).    Yes  x   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an "emerging growth company". See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
ý
Smaller reporting company
ý
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o 
 




Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

There were 29,570,086 shares of the Registrant’s common stock outstanding on October 31, 2018.



ORION ENERGY SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2018
TABLE OF CONTENTS
 
 
 
Page(s)
ITEM 1.
 
 
 
 
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 5.
ITEM 6.
Exhibit 31.1
 
Exhibit 31.2
 
Exhibit 32.1
 
Exhibit 32.2
 
EX-101 INSTANCE DOCUMENT
 
EX-101 SCHEMA DOCUMENT
 
EX-101 CALCULATION LINKBASE DOCUMENT
 
EX-101 LABELS LINKBASE DOCUMENT
 
EX-101 PRESENTATION LINKBASE DOCUMENT
 




PART I – FINANCIAL INFORMATION
Item 1: Financial Statements
ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
 
 
September 30, 2018
 
March 31, 2018
Assets
 
 
 
Cash and cash equivalents
$
5,665

 
$
9,424

Accounts receivable, net
5,778

 
8,736

Revenue earned but not billed
703

 

Inventories, net
8,327

 
7,826

Deferred contract costs

 
1,000

Prepaid expenses and other current assets
417

 
2,467

Total current assets
20,890

 
29,453

Property and equipment, net
12,281

 
12,894

Other intangible assets, net
2,664

 
2,868

Other long-term assets
102

 
110

Total assets
$
35,937

 
$
45,325

Liabilities and Shareholders’ Equity
 
 
 
Accounts payable
$
8,850

 
$
11,675

Accrued expenses and other
4,828

 
4,171

Deferred revenue, current
117

 
499

Current maturities of long-term debt
81

 
79

Total current liabilities
13,876

 
16,424

Revolving credit facility
1,419

 
3,908

Long-term debt, less current maturities
64

 
105

Deferred revenue, long-term
828

 
940

Other long-term liabilities
621

 
524

Total liabilities
16,808

 
21,901

Commitments and contingencies

 

Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value: Shares authorized: 30,000,000 at September 30, 2018 and March 31, 2018; no shares issued and outstanding at September 30, 2018 and March 31, 2018

 

Common stock, no par value: Shares authorized: 200,000,000 at September 30, 2018 and March 31, 2018; shares issued: 38,974,961 at September 30, 2018 and 38,384,575 at March 31, 2018; shares outstanding: 29,537,474 at September 30, 2018 and 28,953,183 at March 31, 2018

 

Additional paid-in capital
155,442

 
155,003

Treasury stock, common shares: 9,437,487 at September 30, 2018 and 9,431,392 at March 31, 2018
(36,090
)
 
(36,085
)
Retained deficit
(100,223
)
 
(95,494
)
Total shareholders’ equity
19,129

 
23,424

Total liabilities and shareholders’ equity
$
35,937

 
$
45,325

The accompanying notes are an integral part of these Condensed Consolidated Statements.


3


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
 
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Product revenue
$
11,590

 
$
14,109

 
$
24,398

 
$
25,890

Service revenue
1,608

 
1,313

 
2,622

 
2,090

Total revenue
13,198

 
15,422

 
27,020

 
27,980

Cost of product revenue
9,367

 
10,593

 
19,091

 
19,406

Cost of service revenue
1,289

 
1,208

 
1,931

 
2,243

Total cost of revenue
10,656

 
11,801

 
21,022

 
21,649

Gross profit
2,542

 
3,621

 
5,998

 
6,331

Operating expenses:
 
 
 
 
 
 
 
General and administrative
2,336

 
3,157

 
5,412

 
8,491

Impairment of intangible assets

 
710

 

 
710

Sales and marketing
2,135

 
2,906

 
4,713

 
6,260

Research and development
354

 
380

 
759

 
904

Total operating expenses
4,825

 
7,153

 
10,884

 
16,365

Loss from operations
(2,283
)
 
(3,532
)
 
(4,886
)
 
(10,034
)
Other income (expense):
 
 
 
 
 
 
 
Other income
15

 

 
34

 

Interest expense
(169
)
 
(139
)
 
(258
)
 
(206
)
Interest income
3

 
3

 
6

 
7

Total other expense
(151
)
 
(136
)
 
(218
)
 
(199
)
Loss before income tax
(2,434
)
 
(3,668
)
 
(5,104
)
 
(10,233
)
Income tax expense
4

 

 
26

 

Net loss
$
(2,438
)
 
$
(3,668
)
 
$
(5,130
)
 
$
(10,233
)
Basic net loss per share attributable to common shareholders
$
(0.08
)
 
$
(0.13
)
 
$
(0.18
)
 
$
(0.36
)
Weighted-average common shares outstanding
29,488,363

 
28,834,868

 
29,280,421

 
28,646,188

Diluted net loss per share
$
(0.08
)
 
$
(0.13
)
 
$
(0.18
)
 
$
(0.36
)
Weighted-average common shares and share equivalents outstanding
29,488,363

 
28,834,868

 
29,280,421

 
28,646,188

The accompanying notes are an integral part of these Condensed Consolidated Statements.


4


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Six Months Ended September 30,
 
2018
 
2017
Operating activities
 
 
 
Net loss
$
(5,130
)
 
$
(10,233
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation
679

 
701

Amortization
232

 
324

Stock-based compensation
439

 
618

Impairment of intangible assets

 
710

Provision for inventory reserves
(159
)
 
301

Provision for bad debts
85

 
21

Other
8

 
12

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, current and long-term
3,157

 
1,014

Revenue earned but not billed
1,652

 

Inventories
345

 
3,981

Deferred contract costs

 
751

Prepaid expenses and other assets
141

 
1,156

Accounts payable
(1,941
)
 
(3,816
)
Accrued expenses and other
(628
)
 
(438
)
Deferred revenue, current and long-term
(12
)
 
237

Net cash used in operating activities
(1,132
)
 
(4,661
)
Investing activities
 
 
 
Purchases of property and equipment
(66
)
 
(283
)
Additions to patents and licenses
(28
)
 
(30
)
Net cash used in investing activities
(94
)
 
(313
)
Financing activities
 
 
 
Payment of long-term debt and capital leases
(39
)
 
(111
)
Proceeds from revolving credit facility
33,011

 
34,176

Payment of revolving credit facility
(35,501
)
 
(37,722
)
Payments to settle employee tax withholdings on stock-based compensation
(6
)
 
(8
)
Net proceeds from employee equity exercises
2

 
3

Net cash used in financing activities
(2,533
)
 
(3,662
)
Net decrease in cash and cash equivalents
(3,759
)
 
(8,636
)
Cash and cash equivalents at beginning of period
9,424

 
17,307

Cash and cash equivalents at end of period
$
5,665

 
$
8,671

The accompanying notes are an integral part of these Condensed Consolidated Statements.

5


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — DESCRIPTION OF BUSINESS
Organization
Orion includes Orion Energy Systems, Inc., a Wisconsin corporation, and all consolidated subsidiaries. Orion is a developer, manufacturer and seller of lighting and energy management systems to commercial and industrial businesses, and federal and local governments, predominantly in North America.
Orion’s corporate offices and leased primary manufacturing operations are located in Manitowoc, Wisconsin. Orion leases office space in Jacksonville, Florida. Orion had leased office space in Chicago, Illinois, and Houston, Texas, but as of June 30, 2018, Orion had vacated these locations. During fiscal 2018, Orion had leased warehouse space in Manitowoc, Wisconsin and Augusta, Georgia, but as of March 31, 2018, Orion had vacated these storage locations.
NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The Condensed Consolidated Financial Statements include the accounts of Orion Energy Systems, Inc. and its wholly-owned subsidiaries.
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements of Orion have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results that may be expected for the fiscal year ending March 31, 2019 or other interim periods.
The Condensed Consolidated Balance Sheets at March 31, 2018 has been derived from the audited consolidated financial statements at that date but does not include all of the information required by GAAP for complete financial statements.
The accompanying unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in Orion’s Annual Report on Form 10-K for the fiscal year ended March 31, 2018 filed with the SEC on June 13, 2018.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during that reporting period. Areas that require the use of significant management estimates include revenue recognition, inventory obsolescence, allowance for doubtful accounts, accruals for warranty and loss contingencies, income taxes, impairment analyses, and certain equity transactions. Accordingly, actual results could differ from those estimates.
Concentration of Credit Risk and Other Risks and Uncertainties
Orion's cash is deposited with two financial institutions. At times, deposits in these institutions exceed the amount of insurance provided on such deposits. Orion has not experienced any losses in such accounts and believes that it is not exposed to any significant financial institution viability risk on these balances.
Orion purchases components necessary for its lighting products, including ballasts, lamps and LED components, from multiple suppliers. For the three and six months ended September 30, 2018, no supplier accounted for more than 10.0% of total cost of revenue. For the three and six months ended September 30, 2017, no supplier accounted for more than 10.0% of total cost of revenue.
For the three months ended September 30, 2018, one customer accounted for 14.0% of total revenue. For the six months ended September 30. 2018, no customers accounted for more than 10.0% of total revenue. For the three months ended

6


September 30, 2017, one customer accounted for 13.7% of total revenue. For the six months ended September 30, 2017, one customer accounted for 11.9% of total revenue.
As of September 30, 2018, no customer accounted for more than 10.0% of Accounts receivable. As of March 31, 2018, one customer accounted for 13.2% of Accounts receivable.
Recent Accounting Pronouncements
Issued: Not Yet Adopted
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02, "Leases" (Subtopic 842). The pronouncement, and subsequent amendments, which is included in the Accounting Standards Codification as Subtopic 842 (“ASC 842”), requires that lessees recognize right-of-use assets and liabilities on the balance sheet for the rights and obligations created by long-term leases and disclose additional quantitative and qualitative information about leasing arrangements. Under ASU 842, leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition. Similarly, lessors will be required to classify leases as sales-type, finance or operating leases, with classification affecting the pattern of income recognition. Classification for both lessees and lessors will be based on an assessment of whether risks and rewards, as well as substantive control, have been transferred through the lease contract. ASU 842 also provides guidance on the presentation of the effects of leases in the income statement and statement of cash flows. Orion will adopt this ASU and subsequent amendments on April 1, 2019 and expects to elect certain practical expedients permitted under the transition guidance. Additionally, Orion expects to elect the optional transition method that allows for a cumulative-effect adjustment in the period of adoption and will not restate prior periods. Orion has not yet completed its review of the full provisions of this ASU against its outstanding lease arrangements and is in the process of quantifying the lease liability and related right of use asset which will be recorded to its condensed consolidated balance sheets upon adoption of the ASU. In addition, management continues to assess the impact of adoption of this ASU on its condensed consolidated statements of operations, cash flows, and the related footnote disclosures.
Recently Adopted Standards
On April 1, 2018, Orion adopted ASU 2014-09 and subsequent amendments, which is included in the Accounting Standards Codification as "Revenue from Contracts with Customers" (Topic 606) (“ASC 606”) and Sub-Topic 340-40 (“ASC 340-40”), using the modified retrospective approach. ASC 606 supersedes the revenue recognition requirements in “Revenue Recognition” (Topic 605) ("ASC 605") and provides guidance on the accounting for other assets and deferred costs associated with contracts with customers. ASC 606 requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. ASC 340-40 limits the circumstances that an entity can recognize an asset from the costs incurred to obtain or fulfill a contract that are not subject to the guidance in other portions in the Accounting Standards Codification, such as those related to inventory. The provisions of ASC 606 and ASC 340-40 require entities to use more judgments and estimates than under previous guidance when allocating the total consideration in a contract to the individual promises to customers (“performance obligations”) and determining when a performance obligation has been satisfied and revenue can be recognized. The adoption of ASC 606 did not have a material effect on Orion's financial statements. Orion has updated its processes and controls necessary for implementing ASC 606, including the increased disclosure requirements.
In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments," which provided clarification and additional guidance as to the presentation and classification of certain cash receipts and cash payments in the statement of cash flows. This ASU provided guidance as to the classification of a number of transactions including: contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, and distributions received from equity method investees. This new ASU was effective for Orion in the first quarter of fiscal 2019 and has been applied through retrospective adjustment to all periods presented. The adoption of this ASU did not have a material impact on Orion’s condensed consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, “Compensation-Stock Compensation: Scope of Modification Accounting” which provides guidance about which changes to the terms or conditions of a share-based payment award would require an entity to apply modification accounting. The provisions of this ASU were effective for Orion beginning on April 1, 2018. The adoption of this ASU did not have a material impact on Orion’s condensed consolidated financial statements.

7


NOTE 3 — REVENUE
Changes in Accounting Policies
Orion adopted ASC 606 and ASC 340-40 (the “new standards”) as of April 1, 2018 for contracts with customers that were not fully complete as of April 1, 2018 using the modified retrospective transition method. The cumulative effect of initially applying the new standards was recorded as an immaterial adjustment to the opening balance of retained deficit within Orion’s Condensed Consolidated Statement of Shareholders’ Equity.
The new standards are applied separately for each contract between Orion and a customer. While the impact of the new standards vary for each contract based on its specific terms, in general, the new standards result in Orion (a) delaying the recognition of some of its Product revenue from the point of shipment until a later date during the installation period, (b) recording Service revenue associated with installing lighting fixtures as such fixtures are installed instead of recording all Services revenue at the completion of the installation, and (c) recording costs associated with installing lighting fixtures as they are incurred instead of deferring such costs and recognizing them at the time Service revenue was recorded.
The adoption of the new standards also resulted in reclassifications (a) between Product revenue and Service revenue, and between Cost of service revenue and Sales and marketing expenses in Orion’s Condensed Consolidated Statement of Operations, and (b) between Accounts receivable, net, Revenue earned but not billed, Inventories, net, Deferred contract costs, Prepaid expenses and other current assets, Accounts payable, Accrued expenses and other, Deferred revenue, current, Deferred revenue, long-term, and Other long-term liabilities in Orion’s Condensed Consolidated Balance Sheets.
For all adjustments and changes as a result of adopting the new standards for the current period, refer to the section “Impacts on Financial Statements” below. In accordance with the modified retrospective transition method, the historical information within the financial statements has not been restated and continues to be reported under the accounting standard in effect for those periods. As a result, Orion has disclosed the accounting policies in effect prior to April 1, 2018, as well as the policies applied starting April 1, 2018.

Revenue Recognition

Periods prior to April 1, 2018
Revenue is recognized in accordance with ASC 605 when the following criteria are met:
1.
persuasive evidence of an arrangement exists;
2.
delivery has occurred and title has passed to the customer;
3.
the sales price is fixed and determinable and no further obligation exists; and
4.
collectability is reasonably assured.
Revenue is recorded net of estimated provisions for returns, early payment discounts and rebates and other consideration paid to Orion’s customers. Revenues are presented net of sales tax and other sales related taxes.
Deferred contract costs consist primarily of the costs of products delivered, and services performed, that are subject to additional performance obligations or customer acceptance. These Deferred contract costs are expensed at the time the related revenue is recognized.
Deferred revenue relates to advance customer billings and investment tax grants received related to power purchase agreement contracts still outstanding related to Orion’s legacy solar business.

Period Commencing April 1, 2018
General Information
Orion generates revenues primarily by selling commercial lighting fixtures and components and by installing these fixtures in its customer’s facilities. Orion recognizes revenue in accordance with the guidance in ASC 606 when control of the goods or services being provided (which Orion refers to as a performance obligation) is transferred to a customer at an amount that reflects the consideration that management expects to receive in exchange for those goods or services. Prices are generally fixed at the time of order confirmation. The amount of expected consideration includes estimated deductions and early payment discounts calculated based on historical experience, customer rebates based on agreed upon terms applied to actual and projected sales levels over the rebate period, and any amounts paid to customers in conjunction with fulfilling a performance obligation.
If there are multiple performance obligations in a single contract, the contract’s total sales price is allocated to each individual performance obligation based on their relative standalone selling price. A performance obligation’s standalone selling price is the

8


price at which Orion would sell a promised good or service separately to a customer. Orion uses an observable price to determine the stand-alone selling price for separate performance obligations or a cost-plus margin approach when one is not available. The cost-plus margin approach is used to determine the stand-alone selling price for the installation performance obligation and is based on average historical installation margin.
Revenue derived from customer contracts which include only performance obligation(s) for lighting fixtures and components is classified as Product revenue in the Condensed Consolidated Statements of Operations. The revenue for these transactions is recorded at the point in time when management believes that the customer obtains control of the products, generally either upon shipment or upon delivery to the customer’s facility. This point in time is determined separately for each contract and requires judgment by management of the contract terms and the specific facts and circumstances concerning the transaction.
Revenue from a customer contract which includes both the sale of fixtures and the installation of such fixtures (which Orion refers to as a turnkey project) is allocated between each lighting fixture and the installation performance obligation based on relative standalone selling prices.
Revenue from turnkey projects that is allocated to the sale of the lighting fixtures is recorded at the point in time when management believes the customer obtains control of the product(s) and is reflected in Product revenue. This point in time is determined separately for each customer contract based upon the terms of the contract and the nature and extent of Orion’s control of the light fixtures during the installation. Product revenue associated with turnkey projects can be recorded (a) upon shipment or delivery, (b) subsequent to shipment or delivery and upon customer payments for the light fixtures, (c) when an individual light fixture is installed and working correctly, or (d) when the customer acknowledges that the entire installation project is substantially complete. Determining the point in time when a customer obtains control of the lighting fixtures in a turnkey project can be a complex judgment and is applied separately for each individual light fixture included in a contract. In making this judgment, management considers the timing of various factors, including, but not limited to, those detailed below:

when there is a legal transfer of ownership;
when the customer obtains physical possession of the products;
when the customer starts to receive the benefit of the products;
the amount and duration of physical control that Orion maintains on the products after they are shipped to, and received at, the customer’s facility;
whether Orion is required to maintain insurance on the lighting fixtures when they are in transit and after they are delivered to the customer’s facility;
when each light fixture is physically installed and working correctly;
when the customer formally accepts the product; and
when Orion receives payment from the customer for the light fixtures.
Revenue from turnkey projects that is allocated to the single installation performance obligation is reflected in Service revenue. Service revenue is recorded over-time as Orion fulfills its obligation to install the light fixtures. Orion measures its performance toward fulfilling its performance obligations for installations using an output method that calculates the number of light fixtures completely installed as of the measurement date in comparison to the total number of light fixtures to be installed under the contract.
Most products are manufactured in accordance with Orion’s standard specifications. However, some products are manufactured to a customer’s specific requirements with no alternative use to Orion. In such cases, and when Orion has an enforceable right to payment, Product revenue is recorded on an over-time basis measured using an input methodology that calculates the costs incurred to date as compared to total expected costs. There was no over-time revenue related to custom products recognized in the three and six months ended September 30, 2018.
Orion also records revenue in conjunction with several limited power purchase agreement (“PPA”) contracts still outstanding. Those PPA’s are supply-side agreements for the generation of electricity. The last PPA contact expires in 2031. Revenue associated with the sale of energy generated by the solar facilities under these PPA contracts is in the scope of ASC 606. Revenues are recognized over-time and are equal to the amount billed to the customer which is calculated by applying the fixed rate designated in contract to the variable amount of electricity generated each month. This approach is in accordance with the “right to invoice” practical expedient provided for in ASC 606. Orion also recognizes revenue upon the sale to third parties of tax credits received from operating the solar facilities and from amortizing a grant received from the federal government during the period starting when the power generating facilities were constructed until the expiration of the PPA contracts; these revenues are not derived from contracts with customers and therefore not under the scope of ASC 606.
When shipping and handling activities are performed after a customer obtains control of the product, Orion has elected to treat shipping and handling costs as an activity necessary to fulfill the performance obligation to transfer product to the customer

9


and not as a separate performance obligation. Any shipping and handling costs charged to customers are recorded in Product revenue. Shipping and handling costs are accrued and included in Cost of product revenue.
See Note 9, Accrued Expenses and Other for a discussion of Orion’s accounting for the warranty it provides to customers for its products and services.
Sales taxes collected from customers and remitted to governmental authorities are accounted for on a net (excluded from revenues) basis.

Contract Fulfillment Costs
Costs associated with product sales are accumulated in inventory as the fixtures are manufactured and are transferred to Cost of product revenue at the time revenue is recorded. See Note 5, Inventories, Net. Costs associated with installation sales are expensed as incurred.
  
Disaggregation of Revenue
Orion’s Product revenue includes revenue from contracts with customers accounted for under the scope of ASC 606 and revenue which is accounted for under other guidance. For the three and six months ended September 30, 2018, Product revenue included $0.3 million and $1.0 million, respectively, derived from sales-type leases for light fixtures, $0.1 million and $0.2 million, respectively, derived from the sale of tax credits generated from Orion’s legacy operation for distributing solar energy, and $18,889 and $37,777, respectively, derived from the amortization of federal grants received in 2010 and 2011 as reimbursement for a portion of the costs to construct the legacy solar facilities which are not under the scope of ASC 606. All remaining Product revenue, and all Service revenue, are derived from contracts with customers as defined in ASC 606.
The primary end-users of Orion’s lighting products and services are (a) the federal government, and (b) commercial or industrial companies.
The federal government obtains Orion products and services primarily through turnkey project sales that Orion makes to a select group of contractors who focus on the federal government. Revenues associated with government end-users are primarily included in the Orion Engineered Systems Division segment.
Commercial or industrial end-users obtain Orion products and services through turnkey project sales or by purchasing products either direct from Orion or through distributors or energy service companies ("ESCOs"). Revenues associated with commercial and industrial end-users therefore are included within each of Orion’s segments, dependent on the sales channel.
See Footnote 16, Segments, for additional discussion concerning Orion’s reportable segments.
The following table provides detail of Orion’s total revenues for the three and six months ended September 30, 2018 (dollars in thousands):
 
Three months ended September 30, 2018
 
Six Months Ended September 30, 2018
 
Product
Services
Total
 
Product
Services
Total
Revenue from contracts with customers:
 
 
 
 
 
 
 
Lighting revenues, by end user
 
 
 
 
 
 
 
  Federal government
$
18

$

$
18

 
$
115

$

$
115

  Commercial and industrial
11,110

1,608

12,718

 
23,011

2,622

25,633

Total lighting
11,128

1,608

12,736

 
23,126

2,622

25,748

  Solar energy related revenues
18


18

 
38


38

Total revenues from contracts with customers
11,146

1,608

12,754

 
23,164

2,622

25,786

Revenue accounted for under other guidance
444


444

 
1,234


1,234

Total revenue
$
11,590

$
1,608

$
13,198

 
$
24,398

$
2,622

$
27,020


Cash Flow Considerations
Customer payments for material only orders are due shortly after shipment.

10


Turnkey projects where the end-user is the federal government typically span a three to six-month period. The contracts for these sales often provide for monthly progress payments equal to ninety percent (90%) of the value provided by Orion during the month.
Turnkey projects where the end-user is a commercial or industrial company typically span between two weeks to three months. Customer payment requirements for these projects vary by contract. Some contracts provide for customer payments for products and services as they are delivered, other contracts specify that the customer will pay for the project in its entirety upon completion of the installation.
Orion provides long-term financing to one customer who frequently engages Orion in large turnkey projects that span between three and nine months. The customer executes an agreement providing for monthly payments of the contract price, plus interest, over a five-year period. The total transaction price in these contracts is allocated between product and services in the same manner as all other turnkey projects. The portion of the transaction associated with the installation is accounted for consistently with all other installation related performance obligations. The portion of the transaction associated with the sale of the multiple individual light fixtures is accounted for as sales-type leases in accordance with ASC 840, "Leases". Revenues associated with the sales-type leases are included in Product revenue and recorded for each fixture separately based on the customer’s monthly acknowledgment that specified fixtures have been installed and are operating as specified.
The payments associated with these transactions that are due during the twelve months subsequent to September 30, 2018 are included in Accounts receivable, net in Orion’s Condensed Consolidated Balance Sheets. The remaining amounts due that are associated with these transactions are included in Other long-term assets in Orion’s Condensed Consolidated Balance Sheets.
The customer’s monthly payment obligation commences after completion of the turnkey project. Orion generally sells the receivable from the customer to an independent financial institution either during, or shortly after completion of, the installation period. Upon execution of the receivables purchase / sales agreement, all amounts due from the customer are included in Revenues earned but not billed on Orion’s Condensed Consolidated Balance Sheets until cash is received from the financial institution. The financial institution releases funds to Orion based on the customer’s monthly acknowledgment of the progress Orion has achieved in fulfilling its installation obligation. Orion provides the progress certifications to the financial institution one month in arrears.
The total amount received from the sales of these receivables during the three and six months ended September 30, 2018 was $0.9 million and $2.9 million, respectively. Orion’s losses on these sales aggregated to $0.1 million and $0.2 million for the three and six months ended September 30, 2018 and is included in Interest expense in the Condensed Consolidated Statement of Operations.
  
Practical Expedients and Exemptions
Orion expenses sales commissions when incurred because the amortization period is one year or less. These costs are recorded within Sales and marketing expense. There are no other capitalizable costs associated with obtaining contracts with customers.
Orion’s performance obligations related to lighting fixtures typically do not exceed nine months in duration. As a result, Orion has elected the practical expedient that provides an exemption of the disclosure requirements regarding information about value assigned to remaining performance obligations on contracts that have original expected durations of one year or less.
Orion has also adopted the practical expedient that provides an exemption of the disclosure requirement of the value assigned to performance obligations associated with contracts that were not complete as of April 1, 2018.
Orion also elected the practical expedient that permits companies to not disclose quantitative information about the future revenue when revenue is recognized as invoices are issued to customers for services performed.
Other than the turnkey projects which result in sales-type leases discussed above, Orion generally receives full payment for satisfied performance obligations in less than one year. Accordingly, Orion does not adjust revenues for the impact of any potential significant financing component as permitted by the practical expedients provided in ASC 606.

Contract Balances
A receivable is recognized when Orion has an enforceable right to payment in accordance with contract terms and an invoice has been issued to the customer. Payment terms on invoiced amounts are typically 30 days from the invoice date.
Revenue earned but not billed represents revenue that has been recognized in advance of billing the customer, which is a common practice in Orion turnkey contracts. Once Orion has an unconditional right to consideration under a turnkey contract, Orion typically bills the customer accordingly and reclassifies the amount to Accounts receivable, net. Revenue earned but not

11


billed as of September 30, 2018 and April 1, 2018 includes $0.1 million and $0.6 million, respectively, which was not derived from contracts with customers and therefore not classified as a contract asset as defined by the new standards.
Deferred revenue, current as of September 30, 2018, included $41,425 of contract liabilities which represented consideration received from customers prior to the point that Orion has fulfilled the promises included in a performance obligation and recorded revenue.
Deferred revenue, long-term consists of the unamortized portion of the funds received from the federal government in 2010 and 2011 as reimbursement for the costs to build the two facilities related to the PPAs. As the transaction is not considered a contract with a customer, this value is not a contract liability as defined by the new standards.
The following chart shows the balance of Orion’s receivables arising from contracts with customers, contract assets and contract liabilities as of September 30, 2018, and April 1, 2018, after the adoption of the new standards (dollars in thousands):
 
September 30, 2018
April 1, 2018
Accounts receivable, net
$
5,778

$
9,020

Contract assets
$
617

$
1,773

Contract liabilities
$
41

$
13

There were no significant changes in the contract assets outside of standard reclassifications to Accounts receivable, net upon billing. There were no significant changes to contract liabilities.






















12


Impact on Financial Statements

ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
 
 
As Reported September 30, 2018
 
Adjustments
 
Balances without application of ASC 606
Assets
 
 
 
 
 
Cash and cash equivalents
$
5,665

 
$

 
$
5,665

Accounts receivable, net
5,778

 
(113
)
 
5,665

Revenue earned but not billed
703

 
(703
)
 

Inventories, net
8,327

 
(231
)
 
8,096

Deferred contract costs

 
430

 
430

Prepaid expenses and other current assets
417

 
485

 
902

Total current assets
20,890

 
(132
)
 
20,758

Property and equipment, net
12,281

 

 
12,281

Other intangible assets, net
2,664

 

 
2,664

Other long-term assets
102

 

 
102

Total assets
$
35,937

 
$
(132
)
 
$
35,805

Liabilities and Shareholders’ Equity
 
 
 
 
 
Accounts payable
$
8,850

 
$
964

 
$
9,814

Accrued expenses and other
4,828

 
(1,120
)
 
3,708

Deferred revenue, current
117

 
195

 
312

Current maturities of long-term debt
81

 

 
81

Total current liabilities
13,876

 
39

 
13,915

Revolving credit facility
1,419

 

 
1,419

Long-term debt, less current maturities
64

 

 
64

Deferred revenue, long-term
828

 
90

 
918

Other long-term liabilities
621

 
(90
)
 
531

Total liabilities
16,808

 
39

 
16,847

Commitments and contingencies

 

 

Shareholders’ equity:
 
 
 
 
 
Preferred stock, $0.01 par value: Shares authorized: 30,000,000 at September 30, 2018 and March 31, 2018; no shares issued and outstanding at September 30, 2018 and March 31, 2018

 

 

Common stock, no par value: Shares authorized: 200,000,000 at September 30, 2018 and March 31, 2018; shares issued: 38,974,961 at September 30, 2018 and 38,384,575 at March 31, 2018; shares outstanding: 29,537,474 at September 30, 2018 and 28,953,183 at March 31, 2018

 

 

Additional paid-in capital
155,442

 

 
155,442

Treasury stock, common shares: 9,437,487 at September 30, 2018 and 9,431,392 at March 31, 2018
(36,090
)
 

 
(36,090
)
Retained deficit
(100,223
)
 
(171
)
 
(100,394
)
Total shareholders’ equity
19,129

 
(171
)
 
18,958

Total liabilities and shareholders’ equity
$
35,937

 
$
(132
)
 
$
35,805







13


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
 
 
Three months ended September 30, 2018
 
Six Months Ended September 30, 2018
 
As Reported
 
Adjustments
 
Balances without application of ASC 606
 
As Reported
 
Adjustments
 
Balances without application of ASC 606
Product revenue
$
11,590

 
$
511

 
$
12,101

 
$
24,398

 
$
1,064

 
$
25,462

Service revenue
1,608

 
(406
)
 
1,202

 
2,622

 
(1,131
)
 
1,491

Total revenue
13,198

 
105

 
13,303

 
27,020

 
(67
)
 
26,953

Cost of product revenue
9,367

 

 
9,367

 
19,091

 
1

 
19,092

Cost of service revenue
1,289

 
(317
)
 
972

 
1,931

 
(738
)
 
1,193

Total cost of revenue
10,656

 
(317
)
 
10,339

 
21,022

 
(737
)
 
20,285

Gross profit
2,542

 
422

 
2,964

 
5,998

 
670

 
6,668

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
General and administrative
2,336

 

 
2,336

 
5,412

 

 
5,412

Sales and marketing
2,135

 
315

 
2,450

 
4,713

 
570

 
5,283

Research and development
354

 

 
354

 
759

 

 
759

Total operating expenses
4,825

 
315

 
5,140

 
10,884

 
570

 
11,454

Loss from operations
(2,283
)
 
107

 
(2,176
)
 
(4,886
)
 
100

 
(4,786
)
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
Other income
15

 

 
15

 
34

 

 
34

Interest expense
(169
)
 
3

 
(166
)
 
(258
)
 
1

 
(257
)
Interest income
3

 

 
3

 
6

 

 
6

Total other expense
(151
)
 
3

 
(148
)
 
(218
)
 
1

 
(217
)
Loss before income tax
(2,434
)
 
110

 
(2,324
)
 
(5,104
)
 
101

 
(5,003
)
Income tax expense
4

 

 
4

 
26

 

 
26

Net loss
$
(2,438
)
 
$
110

 
$
(2,328
)
 
$
(5,130
)
 
$
101

 
$
(5,029
)
Basic net loss per share attributable to common shareholders
$
(0.08
)
 
$
0.00

 
$
(0.08
)
 
$
(0.18
)
 
$
0.00

 
$
(0.17
)
Weighted-average common shares outstanding
29,488,363

 

 
29,488,363

 
29,280,421

 

 
29,280,421

Diluted net loss per share
$
(0.08
)
 
$
0.00

 
$
(0.08
)
 
$
(0.18
)
 
$
0.00

 
$
(0.17
)
Weighted-average common shares and share equivalents outstanding
29,488,363

 

 
29,488,363

 
29,280,421

 

 
29,280,421


















14


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Six Months Ended September 30, 2018
 
As Reported
 
Adjustments
 
Balances without application of ASC 606
Operating activities
 
 
 
 
 
Net loss
$
(5,130
)
 
$
101

 
$
(5,029
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
Depreciation
679

 

 
679

Amortization
232

 

 
232

Stock-based compensation
439

 

 
439

Provision for inventory reserves
(159
)
 

 
(159
)
Provision for bad debts
85

 

 
85

Other
8

 

 
8

Changes in operating assets and liabilities:
 
 
 
 
 
Accounts receivable, current and long-term
3,157

 
(171
)
 
2,986

Revenue earned but not billed
1,652

 
(1,652
)
 

Inventories
345

 
(456
)
 
(111
)
Deferred contract costs

 
564

 
564

Prepaid expenses and other assets
141

 
1,424

 
1,565

Accounts payable
(1,941
)
 
80

 
(1,861
)
Accrued expenses and other
(628
)
 
170

 
(458
)
Deferred revenue, current and long-term
(12
)
 
(60
)
 
(72
)
Net cash used in operating activities
(1,132
)
 

 
(1,132
)
Investing activities
 
 
 
 
 
Purchases of property and equipment
(66
)
 

 
(66
)
Additions to patents and licenses
(28
)
 

 
(28
)
Net cash used in investing activities
(94
)
 

 
(94
)
Financing activities
 
 
 
 
 
Payment of long-term debt and capital leases
(39
)
 

 
(39
)
Proceeds from revolving credit facility
33,011

 

 
33,011

Payment of revolving credit facility
(35,501
)
 

 
(35,501
)
Payments to settle employee tax withholdings on stock-based compensation
(6
)
 

 
(6
)
Net proceeds from employee equity exercises
2

 

 
2

Net cash used in financing activities
(2,533
)
 

 
(2,533
)
Net decrease in cash and cash equivalents
(3,759
)
 

 
(3,759
)
Cash and cash equivalents at beginning of period
9,424

 

 
9,424

Cash and cash equivalents at end of period
$
5,665

 
$

 
$
5,665



15


NOTE 4 — ACCOUNTS RECEIVABLE, NET
As of September 30, 2018, and March 31, 2018, Orion's Accounts receivable and Allowance for doubtful accounts balances were as follows (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
Accounts receivable, gross
$
6,013

 
$
8,886

Allowance for doubtful accounts
(235
)
 
(150
)
Accounts receivable, net
$
5,778

 
$
8,736


NOTE 5 — INVENTORIES, NET
As of September 30, 2018, and March 31, 2018, Orion's Inventory balances were as follows (dollars in thousands):
 
Cost
 
Reserve
 
Net
As of September 30, 2018
 
 
 
 
 
Raw materials and components
$
6,920

 
$
(1,260
)
 
$
5,660

Work in process
1,016

 
(282
)
 
734

Finished goods
3,386

 
(1,453
)
 
1,933

   Total
$
11,322

 
$
(2,995
)
 
$
8,327

 
 
 
 
 
 
As of March 31, 2018
 
 
 
 
 
Raw materials and components
$
6,073

 
$
(1,363
)
 
$
4,710

Work in process
1,190

 
(263
)
 
927

Finished goods
3,934

 
(1,745
)
 
2,189

   Total
$
11,197

 
$
(3,371
)
 
$
7,826


NOTE 6 — PREPAID EXPENSES AND OTHER CURRENT ASSETS
As of September 30, 2018, and March 31, 2018, Prepaid expenses and other current assets included the following (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
Unbilled accounts receivable (1)
$

 
$
1,910

Other prepaid expenses
417

 
557

   Total
$
417

 
$
2,467

(1)     As of April 1, 2018, in conjunction with the adoption of ASC 606, the balance of unbilled Accounts receivable was included in Revenue earned but not billed on the Condensed Consolidated Balance Sheets.

16


NOTE 7 — PROPERTY AND EQUIPMENT, NET
As of September 30, 2018, and March 31, 2018, Property and equipment, net, included the following (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
Land and land improvements
$
433

 
$
424

Buildings and building improvements
9,245

 
9,245

Furniture, fixtures and office equipment
7,117

 
7,096

Leasehold improvements
324

 
324

Equipment leased to customers
4,997

 
4,997

Plant equipment
11,999

 
12,106

 
34,115

 
34,192

Less: accumulated depreciation and amortization
(21,834
)
 
(21,298
)
Property and equipment, net
$
12,281

 
$
12,894

As of September 30, 2018, a triggering event occurred requiring Orion to evaluate its long-lived assets for impairment. Due to the central nature of its operations, Orion’s tangible and intangible definite-lived assets support its full operations, are utilized by all three of its reportable segments, and do not generate separately identifiable cash flows. As such, these assets together represent a single asset group. In reviewing the asset group for impairment, Orion elected to bypass the qualitative impairment assessment and went directly to performing the Step 1 recoverability test. Orion performed the Step 1 recoverability test for the asset group comparing its carrying value to the group’s expected future undiscounted cash flows. Orion concluded that the undiscounted cash flows of the definite lived asset group exceeded its carrying value. As such the asset group was deemed recoverable and no impairment was recorded.
Equipment included above under capital leases was as follows (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
Equipment
$
581

 
$
581

Less: accumulated depreciation and amortization
(415
)
 
(344
)
Equipment, net
$
166

 
$
237

Orion recorded depreciation expense of $0.4 and $0.7 million for the three and six months ended September 30, 2018, respectively, and $0.3 and $0.7 million for the three and six months ended September 30, 2017, respectively.
NOTE 8 —OTHER INTANGIBLE ASSETS, NET
As of September 30, 2018, and March 31, 2018, the components of, and changes in, the carrying amount of Other intangible assets, net, were as follows (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
Patents
$
2,664

 
$
(1,451
)
 
$
1,213

 
$
2,636

 
$
(1,370
)
 
$
1,266

Licenses
58

 
(58
)
 

 
58

 
(58
)
 

Trade name and trademarks
1,005

 

 
1,005

 
1,005

 

 
1,005

Customer relationships
3,600

 
(3,401
)
 
199

 
3,600

 
(3,326
)
 
274

Developed technology
900

 
(653
)
 
247

 
900

 
(582
)
 
318

Non-competition agreements
100

 
(100
)
 

 
100

 
(95
)
 
5

Total
$
8,327

 
$
(5,663
)
 
$
2,664

 
$
8,299

 
$
(5,431
)
 
$
2,868

As of September 30, 2017, a triggering event occurred requiring Orion to evaluate its long-lived assets for impairment. As such Orion performed a quantitative impairment review of its indefinite lived intangible assets related to the Harris trade name applying the royalty replacement method to determine the asset’s fair value as of September 30, 2017. Under the royalty replacement

17


method, the fair value of the Harris tradename was determined based on a market participant’s view of the royalty that would be paid to license the right to use the tradename. This quantitative analysis incorporated several assumptions including forecasted future revenues and cash flows, estimated royalty rate, based on similar licensing transactions and market royalty rates, and discount rate, which incorporates assumptions such as weighted-average cost of capital and risk premium. As a result of this impairment test, the carrying value of the Harris trade name exceeded its estimated fair value and an impairment of $0.7 million was recorded to Impairment of intangible assets during the quarter ended September 30, 2017 to reduce the asset’s carrying value to its calculated fair value. This fair value determination was categorized as Level 3 in the fair value hierarchy.
Amortization expense on intangible assets was $0.1 and $0.2 million for the three months ended September 30, 2018 and 2017, respectively. Amortization expense on intangible assets was $0.2 and $0.3 million for the six months ended September 30, 2018 and 2017, respectively.
As of September 30, 2018, the weighted average remaining useful life of intangible assets was 5.2 years.
The estimated amortization expense for the remainder of fiscal 2019, the next five fiscal years and beyond is shown below (dollars in thousands):
Fiscal 2019 (period remaining)
$
209

Fiscal 2020
361

Fiscal 2021
287

Fiscal 2022
190

Fiscal 2023
98

Fiscal 2024
95

Thereafter
419

Total
$
1,659

NOTE 9 — ACCRUED EXPENSES AND OTHER
As of September 30, 2018, and March 31, 2018, Accrued expenses and other included the following (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
Compensation and benefits
$
1,231

 
$
1,786

Accrued taxes
322

 
237

Contract costs
1,173

 
985

Legal and professional fees
310

 
400

Warranty
361

 
402

Sales returns reserve (1)
147

 

Credits due to customers (1)
964

 

Other accruals
320

 
361

Total
$
4,828

 
$
4,171

(1)Sales returns reserve was previously classified in Accounts receivable, net and Credits due to customers was previously classified in Accounts payable. As of April 1, 2018, in conjunction with the adoption of ASC 606, these balances are now included in Accrued expenses and other on the Condensed Consolidated Balance Sheets.
Orion generally offers a limited warranty of one to ten years on its lighting products, including the pass through of standard warranties offered by major original equipment component manufacturers. The manufacturers’ warranties cover lamps, ballasts, LED modules, chips and drivers, control devices, and other fixture related items, which are significant components in Orion's lighting products.
Changes in Orion’s warranty accrual (both current and long-term) were as follows (dollars in thousands):

18


 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Beginning of period
$
718

 
$
781

 
$
673

 
$
759

Reclassification on adoption of ASC 606

 

 
73

 

Provision to product cost of revenue
9

 
(40
)
 
(13
)
 
(15
)
Charges
(6
)
 
(2
)
 
(12
)
 
(5
)
End of period
$
721

 
$
739

 
$
721

 
$
739

NOTE 10 — NET LOSS PER COMMON SHARE
Basic net loss per common share is computed by dividing Basic net loss attributable to common shareholders by the Weighted-average number of common shares outstanding for the period and does not consider common stock equivalents.
For the three and six months ended September 30, 2018 and 2017, Orion was in a net loss position; therefore, the Basic and Diluted Weighted average shares outstanding are equal because any increase to the basic shares would be anti-dilutive. Basic and Diluted net loss per common share was calculated based upon the following:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Numerator:
 
 
 
 
 
 
 
Net loss (in thousands)
$
(2,438
)
 
$
(3,668
)
 
$
(5,130
)
 
$
(10,233
)
Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
29,488,363

 
28,834,868

 
29,280,421

 
28,646,188

Weighted-average common shares and common share equivalents outstanding
29,488,363

 
28,834,868

 
29,280,421

 
28,646,188

Net loss per common share:
 
 
 
 
 
 
 
Basic
$
(0.08
)
 
$
(0.13
)
 
$
(0.18
)
 
$
(0.36
)
Diluted
$
(0.08
)
 
$
(0.13
)
 
$
(0.18
)
 
$
(0.36
)
The following table indicates the number of potentially dilutive securities excluded from the calculation of Diluted net loss per common share because their inclusion would have been anti-dilutive. The number of shares are as of the end of each period: 
 
September 30, 2018
 
September 30, 2017
Common stock options
484,836

 
993,011

Restricted shares
1,365,678

 
1,536,506

Total
1,850,514

 
2,529,517


NOTE 11 — LONG-TERM DEBT
Long-term debt consisted of the following (dollars in thousands):
 
September 30, 2018
 
March 31, 2018
Revolving credit facility
$
1,419

 
$
3,908

Equipment lease obligations
145

 
184

Total long-term debt
1,564

 
4,092

Less current maturities
(81
)
 
(79
)
Long-term debt, less current maturities
$
1,483

 
$
4,013

Revolving Credit Agreement
As of September 30, 2018, Orion had an amended credit agreement ("Credit Agreement") that provided for a revolving credit facility ("Credit Facility") subject to a borrowing base requirement based on eligible receivables and inventory. As of September 30, 2018, Orion's borrowing base was approximately $1.5 million. The Credit Facility had a maturity date of February 6, 2021, and included a $2.0 million sublimit for the issuance of letters of credit. As of September 30, 2018, Orion had no outstanding

19


letters of credit. Borrowings outstanding as of September 30, 2018, amounted to approximately $1.4 million and were included in non-current liabilities in the accompanying Condensed Consolidated Balance Sheets. Orion estimates that, as of September 30, 2018, it was eligible to borrow an additional $0.1 million under the Credit Facility based upon its then current levels of eligible Inventory and Accounts receivable.
Subject in each case to Orion's applicable borrowing base limitations, the Credit Agreement otherwise provided for a $15.0 million Credit Facility. This limit was eligible for an increase to $20.0 million based on a borrowing base requirement, if Orion satisfied certain conditions. Orion did not meet the requirements to increase the borrowing limit to $20.0 million as of July 31, 2018, the most recent measurement date.
From and after any increase in the Credit Facility limit from $15.0 million to $20.0 million, the Credit Agreement required that Orion maintain, as of the end of each month, a minimum ratio for the trailing twelve-month period of (i) earnings before interest, taxes, depreciation and amortization, subject to certain adjustments, to (ii) the sum of cash interest expense, certain principal payments on indebtedness and certain dividends, distributions and stock redemptions, equal to at least 1.10 to 1.00. The Credit Agreement contained additional customary covenants, including certain restrictions on Orion’s ability to incur additional indebtedness, consolidate or merge, enter into acquisitions, guarantee obligations of third parties, make loans or advances, declare or pay any dividend or distribution on Orion’s stock, redeem or repurchase shares of Orion’s stock, or pledge or dispose of assets. Orion was in compliance with its covenants in the Credit Agreement as of September 30, 2018.
Each subsidiary of Orion was a joint and several co-borrower or guarantor under the Credit Agreement, and the Credit Agreement was secured by a security interest in substantially all of Orion’s and each subsidiary’s personal property (excluding various assets relating to customer Orion Throughput Agreements ("OTAs") and a mortgage on certain real property.
Borrowings under the Credit Agreement bore interest at the daily three-month LIBOR plus 3.0% per annum, with a minimum interest charge for each year or portion of a year during the term of the Credit Agreement of $0.1 million, regardless of usage. As of September 30, 2018, the interest rate was 5.40%. Orion was required to pay an unused line fee of 0.25% per annum of the daily average unused amount of the Credit Facility and a letter of credit fee at the rate of 3.0% per annum on the undrawn amount of letters of credit outstanding from time to time under the Credit Facility.
See Note 18, "Subsequent Events" for a discussion of Orion's new credit facility.
Equipment Lease Obligations
In June 2015, Orion entered into a lease agreement with a financing company in the principal amount of $0.4 million to fund certain equipment. The lease is secured by the related equipment. The lease bears interest at a rate of 3.6%, and matures in June 2020. The lease contains a one dollar buyout option.
Customer Equipment Finance Notes Payable
In December 2014, Orion entered into a secured borrowing agreement with a financing company in the principal amount of $0.4 million to fund completed customer contracts under its OTA finance program that were previously funded under a different OTA credit agreement. The loan amount was secured by the OTA-related equipment and the expected future monthly payments under the supporting 25 individual OTA customer contracts. The borrowing agreement bore an interest rate of 8.36% and matured in April 2018.
Other Long-Term Debt
In September 2010, Orion entered into a note agreement with the Wisconsin Department of Commerce that provided Orion with $0.3 million to fund Orion’s rooftop solar project at its Manitowoc facility. The note matured in June 2017 and was paid in full upon maturity.
NOTE 12 — INCOME TAXES
The income tax provision was determined by applying an estimated annual effective tax rate based upon the facts and circumstances known to book loss before income tax, adjusting for discrete items. The actual effective tax rate is adjusted each interim period, as appropriate, for changes in facts and circumstances. For the three-month period ended September 30, 2018 and 2017, Orion recorded income tax expense of $4,117 and $0, respectively, using this methodology. For the six-month period ended September 30, 2018 and 2017, Orion recorded income tax expense of $25,748 and $0, respectively, using this methodology.
As of September 30, 2018, and March 31, 2018, Orion had a full valuation allowance recorded against its deferred tax assets. Orion considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the

20


valuation allowance. In the event that Orion determines that the deferred tax assets are able to be realized, an adjustment to the deferred tax asset would increase income in the period such determination is made.
Orion continues to evaluate the impact of the Tax Cut and Jobs Act ("Act") enacted December 22, 2017. The Act significantly changed U.S tax law by, among other things, reducing the U.S. federal corporate tax rate from 35% to 21%, imposing a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign sourced earnings.
During fiscal 2018, Orion recognized a provisional reduction to its deferred tax assets of $9.9 million related to the Act. Substantially all of this decrease was offset by a corresponding decrease to the valuation allowance. Orion also provisionally estimated it would incur no transition tax. As of September 30, 2018, Orion has not adjusted its provisional estimates. Because Orion remains in a loss position and has a full valuation allowance, Orion does not anticipate an impact to the condensed income statement if there is a change to these provisional estimates.
Uncertain Tax Positions
As of September 30, 2018, the balance of gross unrecognized tax benefits was approximately $0.1 million, all of which would reduce Orion’s effective tax rate if recognized.
Orion has classified the amounts recorded for uncertain tax benefits in the balance sheet as Other long-term liabilities to the extent that payment is not anticipated within one year. Orion recognizes penalties and interest related to uncertain tax liabilities in Income tax expense. Penalties and interest are included in the unrecognized tax benefits. 
NOTE 13 — COMMITMENTS AND CONTINGENCIES
Operating Leases
Orion leases office space and equipment under operating leases expiring at various dates through 2020. Rent expense under these operating leases was $0.1 million and $0.2 million for the three months ended September 30, 2018 and 2017, respectively. Rent expense under these operating leases was $0.3 million and $0.4 million for the six months ended September 30, 2018 and 2017, respectively.
Litigation
Orion is subject to various claims and legal proceedings arising in the ordinary course of business. As of the date of this report, Orion is unable to currently assess whether the final resolution of any of such claims or legal proceedings may have a material adverse effect on our future results of operations. In addition to ordinary-course litigation, Orion was a party to the proceedings described below.
On March 27, 2014, Orion was named as a defendant in a civil lawsuit filed by Neal R. Verfuerth, a former chief executive officer who left Orion in November 2012, in the United States District Court for the Eastern District of Wisconsin (Green Bay Division). The plaintiff alleged, among other things, that Orion breached certain agreements entered into with the plaintiff, including the plaintiff’s employment agreement, and violated certain laws. The complaint sought, among other relief, unspecified pecuniary and compensatory damages, fees and such other relief as the court may deem just and proper. On January 11, 2018, a three judge panel of the United States Court of Appeals Seventh Circuit unanimously affirmed the dismissal of all of the plaintiff’s claims against Orion.
On November 10, 2017, a purported shareholder, Stephen Narten, filed a civil lawsuit in the Circuit Court for Manitowoc County against those individuals who served on Orion's board of directors during fiscal years 2015, 2016, and 2017 and certain current and former officers during the same period. The plaintiff, who purported to bring the suit derivatively on behalf of Orion, alleged that the director defendants breached their fiduciary duties in connection with granting certain stock-based incentive awards under Orion's 2004 Stock and Incentive Awards Plan and that the directors and current and former officers breached their fiduciary duties by accepting those awards. During the first quarter of fiscal 2019, the parties reached a settlement of the claims and the case was dismissed. The settlement did not have a material impact on Orion's results of operations or financial condition.
State Tax Assessment
During fiscal year 2018, Orion was notified of a pending sales and use tax audit by the Wisconsin Department of Revenue for the period covering April 1, 2013 through March 31, 2017.   Although the final resolution of Orion's sales and use tax audit is uncertain, based on current information, in the opinion of Orion's management, the ultimate disposition of these matters will not have a material adverse effect on Orion's consolidated balance sheet, statements of operations, or liquidity.
During fiscal year 2019, Orion was notified of a pending sales and use tax audit by the California Department of Tax and Fee Administration for the period covering April 1, 2015 through March 31, 2018. Although the final resolution of Orion's sales

21


and use tax audit is uncertain, based on current information, in the opinion of Orion's management, the ultimate disposition of these matters will not have a material adverse effect on the Orion's consolidated balance sheet, statements of operations, or liquidity.
NOTE 14 — SHAREHOLDERS’ EQUITY
Employee Stock Purchase Plan
In August 2010, Orion’s board of directors approved a non-compensatory employee stock purchase plan, or ESPP. Orion issued the following shares from treasury during the six months ended September 30, 2018:
 
Shares Issued Under ESPP
Plan
 
Closing Market
Price
Quarter Ended June 30, 2018
866

 
$1.10
Quarter Ended September 30, 2018
938

 
$0.96
Total issued in fiscal 2019
1,804

 
$0.96 - 1.10
In prior years, Orion issued loans to non-executive employees to purchase shares of its stock. The loan program has been discontinued and new loans are no longer issued. As of March 31, 2017, $4,000 of such loans remained outstanding and were reflected on Orion’s balance sheet as a contra-equity account. During the nine months ended December 31, 2017, Orion entered into agreements with the counterparties to these loans. In exchange for the forgiveness of their outstanding loan balance, the employees returned their shares to Orion. As a result of these transactions, 1,230 shares were recorded within treasury stock and the loan balances were eliminated.
NOTE 15 — STOCK OPTIONS AND RESTRICTED SHARES
At Orion's 2016 annual meeting of shareholders held on August 3, 2016, Orion's shareholders approved the Orion Energy Systems, Inc. 2016 Omnibus Incentive Plan (the "Plan"). The Plan authorizes grants of equity-based and incentive cash awards to eligible participants designated by the Plan's administrator. Awards under the Plan may consist of stock options, stock appreciation rights, performance shares, performance units, common stock, restricted stock, restricted stock units, incentive awards or dividend equivalent units.
Prior to shareholder approval of the Plan, the Company maintained its 2004 Stock and Incentive Awards Plan, as amended, which authorized the grant of cash and equity awards to employees (the “Former Plan”). No new awards are being granted under the Former Plan; however, all awards granted under the Former Plan that are outstanding will continue to be governed by the Former Plan. Forfeited awards originally issued under the Former Plan are canceled and are not available for subsequent issuance under the Plan. The Plan and the Former Plan also permit accelerated vesting in the event of certain changes of control of Orion as well as under other special circumstances.
Certain non-employee directors have from time to time elected to receive stock awards in lieu of cash compensation pursuant to elections made under Orion’s non-employee director compensation program.
The following amounts of stock-based compensation were recorded (dollars in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Cost of product revenue
$
1

 
$
4

 
$
2

 
$
10

Cost of service revenue

 

 
1

 

General and administrative
202

 
250

 
407

 
517

Sales and marketing
7

 
38

 
28

 
79

Research and development
1

 
6

 
1

 
12

Total
$
211

 
$
298

 
$
439

 
$
618


22



During the first six months of fiscal 2019, Orion had the following activity related to its stock-based compensation:
 
Restricted Shares
Stock Options
Balance at March 31, 2018
1,485,799

629,667

Awards granted
519,000


Awards vested
(591,659
)

Awards forfeited
(47,462
)
(144,831
)
Awards outstanding at September 30, 2018
1,365,678

484,836

Per share price on grant date
0.84


As of September 30, 2018, the amount of deferred stock-based compensation expense to be recognized, over a remaining period of 1.9 years, was approximately $1.2 million.

23


NOTE 16 — SEGMENTS
Orion has the following business segments: Orion Engineered Services Division ("OES"), Orion Distribution Services Division ("ODS"), and Orion U.S. Markets Division ("USM"). The accounting policies are the same for each business segment as they are on a consolidated basis.
Orion Engineered Systems Division
The OES segment develops and sells lighting products and provides construction and engineering services for Orion's commercial lighting and energy management systems. OES provides turnkey solutions for large national accounts, governments, municipalities and schools.
Orion Distribution Services Division
The ODS segment focuses on selling lighting products through manufacturer representative agencies and a network of broadline North American distributors.
Orion U.S. Markets Division
The USM segment sells commercial lighting systems and energy management systems to the wholesale contractor markets. USM customers include ESCOs and electrical contractors.
Corporate and Other
Corporate and Other is comprised of operating expenses not directly allocated to Orion’s segments and adjustments to reconcile to consolidated results (dollars in thousands).
 
Revenues
 
Operating Income (Loss)
 
For the Three Months Ended September 30,
 
For the Three Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Segments:
 
 
 
 
 
 
 
Orion Engineered Systems
$
5,135

 
$
6,133

 
$
(724
)
 
$
(1,185
)
Orion Distribution Services
4,874

 
6,459

 
(931
)
 
(47
)
Orion U.S. Markets
3,189

 
2,830

 
355

 
(918
)
Corporate and Other

 

 
(983
)
 
(1,382
)
 
$
13,198

 
$
15,422

 
$
(2,283
)
 
$
(3,532
)

 
Revenues
 
Operating Income (Loss)
 
For the Six Months Ended September 30,
 
For the Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Segments:
 
 
 
 
 
 
 
Orion Engineered Systems
$
8,366

 
$
11,541

 
$
(1,977
)
 
$
(3,076
)
Orion Distribution Services
14,100

 
12,219

 
(846
)
 
(788
)
Orion U.S. Markets
4,554

 
4,220

 
224

 
(2,450
)
Corporate and Other

 

 
(2,287
)
 
(3,720
)
 
$
27,020

 
$
27,980

 
$
(4,886
)
 
$
(10,034
)


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NOTE 17 — REORGANIZATION OF BUSINESS
During fiscal 2018, Orion executed on a cost reduction plan by entering into separation agreements with multiple employees. Orion's restructuring expense for the three and six months ended September 30, 2018 and 2017 is reflected within its Condensed Consolidated Statements of Operations as follows (dollars in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Cost of product revenue
$

 
$

 
$

 
$
40

General and administrative
1

 
48

 
12

 
1,815

Sales and marketing

 
86

 
17

 
183

Total
$
1

 
$
134

 
$
29

 
$
2,038

Total restructuring expense by segment was recorded as follows (dollars in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Orion Engineered Systems

 

 
5

 

Orion Distribution Systems
$

 
$
14

 
$
12

 
$
89

Corporate and Other
1

 
120

 
12

 
1,949

Total
$
1

 
$
134

 
$
29

 
$
2,038

Cash payments for employee separation costs in connection with its reorganization of its business were $6,470 and $0.2 million in the three months ended September 30, 2018 and September 30, 2017, respectively. Cash payments for employee separation costs in connection with the reorganization of its business were $0.1 million and $1.5 million in the six months ended September 30, 2018, and September 30, 2017, respectively. The remaining restructuring cost accruals as of September 30, 2018 were $0.1 million, which represents post-retirement medical benefits for one former employee which will be paid over several years.
NOTE 18 — SUBSEQUENT EVENTS
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
On October 26, 2018, Orion and its subsidiaries entered into a new secured revolving Business Financing Agreement with Western Alliance Bank, as lender (the “New Credit Agreement”). The New Credit Agreement replaced the Company’s existing Credit Agreement.
The New Credit Agreement provides for a two-year revolving credit facility (the “New Credit Facility”) that matures on October 26, 2020. Borrowings under the New Credit Facility are initially limited to $20.15 million, subject to a borrowing base requirement based on eligible receivables and inventory. The New Credit Agreement includes a $2.0 million sublimit for the issuance of letters of credit. Pursuant to the terms of the New Credit Agreement, Orion has a borrowing base of $4.0 million. On October 26, 2018, Orion borrowed $4.0 million under the New Credit Agreement.
The Credit Agreement is secured by a security interest in substantially all of Orion's and its subsidiaries’ personal property.
Borrowings under the New Credit Agreement generally bear interest at floating rates based upon the prime rate (but not be less than 5.00% per year) plus an applicable margin determined by reference to Orion’s quick ratio (defined as the aggregate amount of unrestricted cash, unrestricted marketable securities and, with certain adjustments, receivables convertible into cash divided by the total current liabilities, including the obligations under the New Credit Agreement). Among other fees, Orion is required to pay an annual facility fee equal to 0.45% of the credit limit under the New Credit Agreement due on October 26, 2018 and on each anniversary thereof. With certain exceptions, if the New Credit Agreement is terminated prior to the first anniversary of the closing date of the New Credit Agreement, Orion is required to pay a termination fee equal to 0.50% of the credit limit under the New Credit Agreement.

25


The New Credit Agreement requires Orion to maintain nine months’ of “RML” as of the end of each month. For purposes of the New Credit Agreement, RML is defined as, as of the applicable determination date, unrestricted cash on deposit with Western Alliance Bank plus availability under the New Credit Agreement divided by an amount equal to, for the applicable trailing three-month period, consolidated net profit before tax, plus depreciation expense, amortization expense and stock-based compensation, minus capital lease principal payments, tested as of the end of each month.
The New Credit Agreement also contains customary events of default and other covenants, including certain restrictions on Orion’s ability to incur additional indebtedness, consolidate or merge, enter into acquisitions, pay any dividend or distribution on Orion’s stock, redeem, retire or purchase shares of Orion’s stock, make investments or pledge or transfer assets. If an event of default under the New Credit Agreement occurs and is continuing, then Western Alliance Bank may cease making advances under the New Credit Agreement and declare any outstanding obligations under the New Credit Agreement to be immediately due and payable. In addition, if Orion becomes the subject of voluntary or involuntary proceedings under any bankruptcy or similar law, then any outstanding obligations under the New Credit Agreement will automatically become immediately due and payable.


26


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited Condensed Consolidated Financial Statements and related notes included in this Form 10-Q, as well as our audited Consolidated Financial Statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018.
Cautionary Note Regarding Forward-Looking Statements
Any statements in this Quarterly Report on Form 10-Q about our expectations, beliefs, plans, objectives, prospects, financial condition, assumptions or future events or performance are not historical facts and are “forward-looking statements” as that term is defined under the federal securities laws. These statements are often, but not always, made through the use of words or phrases such as “believe”, “anticipate”, “should”, “intend”, “plan”, “will”, “expects”, “estimates”, “projects”, “positioned”, “strategy”, “outlook” and similar words. You should read the statements that contain these types of words carefully. Such forward-looking statements are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from what is expressed or implied in such forward-looking statements. There may be events in the future that we are not able to predict accurately or over which we have no control. Potential risks and uncertainties include, but are not limited to, those discussed in “Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2018. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or uncertainties after the date hereof or to reflect the occurrence of unanticipated events.
Overview
We provide enterprise-grade light emitting diode ("LED") lighting and energy project solutions. We research, develop, design, manufacture, market, sell and implement energy management systems consisting primarily of high-performance, energy-efficient commercial and industrial interior and exterior lighting systems and related services. Our products are targeted for applications in three primary market segments: commercial office and retail, area lighting and industrial applications, although we do sell and install products into other markets. Virtually all of our sales occur within North America.
Our lighting products consist primarily of LED lighting fixtures. Our principal customers include national account end-users, electrical distributors, energy service companies ("ESCOs") and electrical contractors. Currently, substantially all of our products are manufactured at our leased production facility location in Manitowoc, Wisconsin, although as the LED market continues to evolve, we have the flexibility to source products and components from third parties in order to provide versatility in our product development.
We believe the market for lighting products has shifted to LED lighting systems, and that the customer base for our legacy high intensity fluorescent ("HIF") technology products will continue to decline. Compared to our legacy HIF lighting systems, we believe that LED lighting technology allows for better optical performance, significantly reduced maintenance costs due to performance longevity and reduced energy consumption. Due to their size and flexibility in application, we also believe that LED lighting systems can address opportunities for retrofit applications that cannot be satisfied by HIF or other legacy technologies. Although we continue to sell some lighting products using our legacy HIF technology, we do not build to stock HIF products and instead build to committed customer orders as received. We plan to maintain our primary focus on developing and selling innovative LED products.
We do not have long-term contracts with our customers that provide us with recurring revenue from period to period and we typically generate substantially all of our revenue from sales of lighting systems and related services to governmental, commercial and industrial customers on a project-by-project basis. We typically sell our lighting systems in replacement of our customers’ existing fixtures. We call this replacement process a "retrofit". We frequently engage our customer’s existing electrical contractor to provide installation and project management services. We also sell our lighting systems on a wholesale basis, principally to electrical contractors, electrical distributors, and ESCOs to sell to their own customer bases.
Our ability to achieve our desired revenue growth and profitability goals depends on our ability to effectively engage distribution and sales agents, develop recurring revenue streams, implement our cost reduction initiatives, manage pricing pressures in the LED market, and improve our marketing, new product development, project execution, customer service, margin enhancement and operating expense management, as well as other factors. In addition, the gross margins of our products can vary significantly depending upon the types of products we sell, with margins typically ranging from 15% to 50%. As a result, a change in the total mix of our sales among higher or lower margin products can cause our profitability to fluctuate from period to period.
Our fiscal year ends on March 31. We refer to our current fiscal year which will end on March 31, 2019 as "fiscal 2019". We refer to our most recently completed fiscal year, which ended on March 31, 2018, as “fiscal 2018”, and our prior fiscal year

27


which ended on March 31, 2017 as "fiscal 2017". Our fiscal first quarter of each fiscal year ends on June 30, our fiscal second quarter ends on September 30, our fiscal third quarter ends on December 31, and our fiscal fourth quarter ends on March 31.
Reportable segments are components of an entity that have separate financial data that the entity's chief operating decision maker ("CODM") regularly reviews when allocating resources and assessing performance. Our CODM is our chief executive officer. We have three reportable segments: Orion Engineered Systems Division ("OES"), Orion Distribution Services Division ("ODS"), and Orion U.S. Markets Division ("USM").
Market Shift to Light Emitting Diode Products
The rapid market shift in the lighting industry from legacy lighting products to LED lighting products has caused us to adopt new strategies, approaches and processes in order to respond proactively to this industry transition. These changing underlying business fundamentals in this transition include:
LED product end user customer pricing pressure.
Improving LED product performance and reducing customer return on investment payback periods resulting in increased customer preference for LED lighting products compared to legacy HIF lighting products.
Increasing LED lighting product customer sales compared to decreasing HIF product sales.
A broader and more diverse customer base and market opportunities compared to our historical commercial and industrial facility customers.
Increased importance of highly innovative product designs and features and enhanced product research and development capabilities requiring rapid new product introduction and new methods of product and company differentiation.
Significantly reduced product technology life cycles; significantly shorter product inventory shelf lives and the related increased risk of rapidly occurring product technology obsolescence.
Increased reliance on international component sources.
Less internal product fabrication and production capabilities needed to support LED product assembly.
Different and broader types of components, fabrication and assembly processes needed to support LED product assembly compared to our legacy products.
Expanding customer bases and sales channels.
Significantly longer end user product warranty requirements for LED products compared to our legacy products.
As we continue to focus our primary business on selling our LED product lines to respond to the rapidly changing market dynamics in the lighting industry, we face intense competition from an increased number of other LED product companies, a number of which have substantially greater resources and more experience and history with LED lighting products than we do.
Management Restructuring and Focus on Profitability
During fiscal 2018, we executed on a cost reduction plan to reduce cost and streamline operations. The cost reduction plan included a reduction in headcount, restructuring of management and board compensation, and other cost reduction measures. Restructuring expenses included severance, outplacement services and continued medical benefits for terminated employees for a limited post-employment period.
Our restructuring expense for the three and six months ended September 30, 2018 and 2017 is reflected within our Condensed Consolidated Statements of Operations as follows (dollars in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Cost of product revenue
$

 
$

 
$

 
$
40

General and administrative
1

 
48

 
12

 
1,815

Sales and marketing

 
86

 
17

 
183

Total
$
1

 
$
134

 
$
29

 
$
2,038




28


Total restructuring expense by segment was recorded as follows (dollars in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Orion Engineered Systems

 

 
5

 

Orion Distribution Systems
$

 
$
14

 
$
12

 
$
89

Corporate and Other
1

 
120

 
12

 
1,949

Total
$
1

 
$
134

 
$
29

 
$
2,038

Cash payments for employee separation costs in connection with our reorganization of our business were $6,470 and $0.2 million in the three months ended September 30, 2018 and September 30, 2017, respectively. Cash payments for employee separation costs in connection with our reorganization of our business were $0.1 million and $1.5 million in the six months ended September 30, 2018, and September 30, 2017, respectively.
Fiscal 2019 Outlook
We remain optimistic about our near-term and long-term financial performance. Our executive leadership team has developed a fiscal 2019 strategic plan to reflect our current business environment and the continuing opportunities and challenges of the LED and connected lighting marketplace. The overall goal of the plan is to build on what we achieved in fiscal 2018, both in terms or our distribution network and reinvigoration of our direct sales effort, while leveraging our achieved cost containment efforts.
Our outlook for the remainder of fiscal 2019 is positive, as we believe that the following factors will directly or indirectly drive customer spending on lighting solutions:
LED adoption continues to grow in all sectors;
Commercial and industrial sentiment remains strong;
Utility incentives continue to be available;
Capital spending is increasing;
Business profits are increasing; and
Consumer spending remains strong.
Beyond the benefits of our lighting fixtures, we believe that there is also an opportunity to utilize our platform as a “connected ceiling”, or a framework or network that can support the installation and integration of other business solutions on our digital platform. This anticipated potential growth opportunity is also known as the “Industrial Internet of Things” or IoT, and is still early in its development; however, we have already participated in a few compelling applications that deliver cost savings and efficiency in areas outside of lighting.
There is a great amount of debate regarding a wide range of policy options with respect to monetary, regulatory, and trade, amongst others, that the U.S. federal government has and may pursue, including the recent imposition of tariffs on certain imports. Certain sourced finished products and certain of the components used in our products are impacted by the recently imposed tariffs on China imports. Our efforts to mitigate the impact of added costs include a variety of activities, such as sourcing from non-tariff impacted countries and raising prices. We believe that these mitigation activities will assist to offset added costs, and we currently believe that such tariffs will have a limited adverse financial effect on our results of operations. Any future policy changes that may be implemented could have a positive or negative consequence on our financial performance depending on how the changes would influence many factors, including business and consumer sentiment.
Recently Adopted Accounting Standards
We adopted ASC 606 ("ASC 606") and ASC 340-40 (the “new standards”) as of April 1, 2018 for contracts with customers that were not fully complete as of April 1, 2018 using the modified retrospective transition method. The cumulative effect of initially applying the new standards was recorded as an immaterial adjustment to our opening balance of retained deficit within our condensed consolidated statement of shareholders’ equity.
The new standards are applied separately for each contract between us and a customer. While the impact of the new standards vary for each contract based on its specific terms, in general, the new standards result in us (a) delaying the recognition of some of our Product revenue from the point of shipment until a later date during the installation period, (b) recording Service revenue associated with installing lighting fixtures as such fixtures are installed instead of recording all Services revenue at the completion

29


of the installation, and (c) recording costs associated with installing lighting fixtures as they are incurred instead of deferring such costs and recognizing them at the time Service revenue was recorded.
The adoption of the new standards also resulted in reclassifications (a) between Product revenue and Service revenue, and between Cost of service revenue and Sales and marketing expenses in our Condensed Consolidated Statement of Operations, and (b) among Accounts receivable, Revenue earned but not billed, Inventories, net, Deferred contract costs, Prepaid expenses and other current assets, Accounts payable, Accrued expenses and other, Deferred revenue, current, Deferred revenue, long-term, and Other long-term liabilities in our Condensed Consolidated Balance Sheets.

30


Results of Operations - Three Months Ended September 30, 2018 versus Three Months Ended September 30, 2017
The following table sets forth the line items of our Condensed Consolidated Statements of Operations and as a relative percentage of our total revenue for each applicable period, together with the relative percentage change in such line item between applicable comparable periods (dollars in thousands, except percentages):
 
Three Months Ended September 30,
 
2018
 
2017
 
 
 
2018
 
2017
 
Amount
 
Amount
 
%
Change
 
% of
Revenue
 
% of
Revenue
Product revenue
$
11,590

 
$
14,109

 
(17.9
)%
 
87.8
 %
 
91.5
 %
Service revenue
1,608

 
1,313

 
22.5
 %
 
12.2
 %
 
8.5
 %
Total revenue
13,198

 
15,422

 
(14.4
)%
 
100.0
 %
 
100.0
 %
Cost of product revenue
9,367

 
10,593

 
(11.6
)%
 
71.0
 %
 
68.7
 %
Cost of service revenue
1,289

 
1,208

 
6.7
 %
 
9.8
 %
 
7.8
 %
Total cost of revenue
10,656

 
11,801

 
(9.7
)%
 
80.7
 %
 
76.5
 %
Gross profit
2,542

 
3,621

 
(29.8
)%
 
19.3
 %
 
23.5
 %
General and administrative expenses
2,336

 
3,157

 
(26.0
)%
 
17.7
 %
 
20.5
 %
Impairment of intangible assets

 
710

 
NM

 
 %
 
4.6
 %
Sales and marketing expenses
2,135

 
2,906

 
(26.5
)%
 
16.2
 %
 
18.8
 %
Research and development expenses
354

 
380

 
(6.8
)%
 
2.7
 %
 
2.5
 %
Loss from operations
(2,283
)
 
(3,532
)
 
35.4
 %
 
(17.3
)%
 
(22.9
)%
Other income
15

 

 
NM

 
0.1
 %
 
 %
Interest expense
(169
)
 
(139
)
 
21.6
 %
 
(1.2
)%
 
(0.9
)%
Interest income
3

 
3

 
 %
 
 %
 
 %
Loss before income tax
(2,434
)
 
(3,668
)
 
33.6
 %
 
(18.4
)%
 
(23.8
)%
Income tax expense
4

 

 
NM

 
 %
 
 %
Net loss
$
(2,438
)
 
$
(3,668
)
 
33.5
 %
 
(18.5
)%
 
(23.8
)%
 
*NM - Not Meaningful
Revenue. Product revenue decreased 17.9%, or $2.5 million, for the second quarter of fiscal 2019 versus the second quarter of fiscal 2018. The decrease in Product revenue was principally due to a decrease in sales through our distribution channel, as well as the timing of delivery of our turnkey projects. Service revenue increased 22.5%, or $0.3 million, primarily due to the timing of project completions. Total revenue decreased by 14.4%, or $2.2 million, primarily due to the items discussed above. Excluding the impact of the adoption of ASC 606, Product revenue decreased 14.2%, or $2.0 million, Service revenue decreased 8.5%, or $0.1 million, and Total revenue decreased by 13.7%, or $2.1 million, compared to the prior year quarter.