Quarterly Report
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 1-12014

 

 

POWERSECURE INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   84-1169358

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1609 Heritage Commerce Court

Wake Forest, North Carolina

  27587
(Address of principal executive offices)   (Zip code)

(919) 556-3056

(Registrant’s telephone number, including area code)

 

 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such 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 or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

As of May 1, 2015, 22,447,116 shares of the issuer’s Common Stock were outstanding.

 

 

 


Table of Contents

POWERSECURE INTERNATIONAL, INC.

FORM 10-Q

For the Quarterly Period Ended March 31, 2015

TABLE OF CONTENTS

 

         Page  
PART I.  

FINANCIAL INFORMATION

  
Item 1.  

Financial Statements

  
 

Condensed Consolidated Balance Sheets (unaudited) – March 31, 2015 and December 31, 2014

     3   
 

Condensed Consolidated Statements of Operations (unaudited) - For the Three Months Ended March 31, 2015 and 2014

     5   
 

Condensed Consolidated Statements of Comprehensive Income (Loss) (unaudited) - For the Three Months Ended March 31, 2015 and 2014

     6   
 

Condensed Consolidated Statements of Cash Flows (unaudited) - For the Three Months Ended March 31, 2015 and 2014

     7   
 

Notes to Unaudited Condensed Consolidated Financial Statements

     8   
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     28   
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

     56   
Item 4.  

Controls and Procedures

     57   
PART II.  

OTHER INFORMATION

  
Item 1.  

Legal Proceedings

     59   
Item 1A.  

Risk Factors

     59   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     59   
Item 6.  

Exhibits

     59   
Signatures        60   

 

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PART I.

FINANCIAL INFORMATION

 

Item 1. Financial Statements

POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share data)

 

 

Assets    March 31,
2015
     December 31,
2014
 

Current Assets:

     

Cash and cash equivalents

   $ 23,846       $ 33,775   

Trade receivables, net of allowance for doubtful accounts of $508 and $470, respectively

     90,287         81,381   

Inventories

     37,191         35,144   

Income taxes receivable

     317         382   

Deferred tax asset, net

     2,320         2,320   

Prepaid expenses and other current assets

     2,194         3,478   
  

 

 

    

 

 

 

Total current assets

  156,155      156,480   
  

 

 

    

 

 

 

Property, plant and equipment:

Equipment

  63,833      62,231   

Furniture and fixtures

  625      617   

Land, building and improvements

  7,630      7,413   
  

 

 

    

 

 

 

Total property, plant and equipment, at cost

  72,088      70,261   

Less accumulated depreciation and amortization

  21,933      20,392   
  

 

 

    

 

 

 

Property, plant and equipment, net

  50,155      49,869   
  

 

 

    

 

 

 

Other assets:

Goodwill

  40,210      40,210   

Restricted annuity contract

  3,137      3,137   

Intangible assets and capitalized software costs, net of accumulated amortization of $8,247 and $7,374, respectively

  13,570      13,642   

Other assets

  1,943      1,879   
  

 

 

    

 

 

 

Total other assets

  58,860      58,868   
  

 

 

    

 

 

 

Total Assets

$ 265,170    $ 265,217   
  

 

 

    

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share data)

 

 

Liabilities and Stockholders’ Equity    March 31,
2015
    December 31,
2014
 

Current liabilities:

    

Accounts payable

   $ 39,080      $ 39,699   

Accrued and other liabilities

     41,850        41,113   

Accrued restructuring liabilities

     26        114   

Current portion of long-term debt

     3,731        3,731   

Current portion of capital lease obligation

     745        986   
  

 

 

   

 

 

 

Total current liabilities

  85,432      85,643   
  

 

 

   

 

 

 

Long-term liabilities:

Revolving line of credit

  —        —     

Long-term debt, net of current portion

  16,899      17,832   

Capital lease obligation, net of current portion

  —        —     

Deferred tax liability, net

  1,433      1,460   

Other long-term liabilities

  4,040      3,913   
  

 

 

   

 

 

 

Total long-term liabilities

  22,372      23,205   
  

 

 

   

 

 

 

Commitments and contingencies (Notes 8 and 10)

Stockholders’ Equity:

Preferred stock - undesignated, $.01 par value; 2,000,000 shares authorized; none issued and outstanding

  —        —     

Preferred stock - Series C, $.01 par value; 500,000 shares authorized; none issued and outstanding

  —        —     

Common stock, $.01 par value; 50,000,000 shares authorized; 22,447,942 and 22,369,487 shares issued and outstanding, respectively

  224      224   

Additional paid-in-capital

  162,084      161,163   

Accumulated deficit

  (4,820   (4,941

Accumulated other comprehensive income (loss)

  (122   (77
  

 

 

   

 

 

 

Total stockholders’ equity

  157,366      156,369   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

$ 265,170    $ 265,217   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

(in thousands, except per share data)

 

 

     Three Months Ended
March 31,
 
     2015     2014  

Revenues

   $ 79,509      $ 52,797   

Cost of sales (excluding depreciation and amortization)

     58,180        41,756   
  

 

 

   

 

 

 

Gross profit

  21,329      11,041   
  

 

 

   

 

 

 

Operating expenses:

General and administrative

  15,634      13,044   

Selling, marketing and service

  2,748      2,009   

Depreciation and amortization

  2,477      2,178   

Restructuring charges

  —        427   
  

 

 

   

 

 

 

Total operating expenses

  20,859      17,658   
  

 

 

   

 

 

 

Operating income (loss)

  470      (6,617

Other income and (expenses):

Interest income and other income

  1      4   

Interest expense

  (269   (300
  

 

 

   

 

 

 

Income (loss) before income taxes

  202      (6,913

Income tax expense (benefit)

  81      (2,654
  

 

 

   

 

 

 

Net income (loss)

$ 121    $ (4,259
  

 

 

   

 

 

 

Earnings (loss) per share:

Basic

$ 0.01    $ (0.19
  

 

 

   

 

 

 

Diluted

$ 0.01    $ (0.19
  

 

 

   

 

 

 

Weighted average common shares outstanding during the period:

Basic

  22,385      21,979   
  

 

 

   

 

 

 

Diluted

  22,489      21,979   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)

(in thousands)

 

 

     Three Months Ended
March 31,
 
     2015     2014  

Net income (loss)

   $ 121      $ (4,259

Other comprehensive income (loss), net of tax:

    

Cash flow hedge:

    

Change in unrealized gain (loss)

     (81     (45

Reclassification adjustment for net (gains) losses included in net income (loss)

     36        41   
  

 

 

   

 

 

 

Total comprehensive income (loss), net of tax

$ 76    $ (4,263
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

 

 

     Three Months
Ended March 31,
 
     2015     2014  

Cash flows from operating activities:

    

Net income (loss)

   $ 121      $ (4,259

Adjustments to reconcile net income (loss) to net cash used in operating activities:

    

Depreciation and amortization

     2,477        2,178   

Stock compensation expense

     650        278   

(Gain) loss on disposal of miscellaneous assets

     (22     41   

Changes in operating assets and liabilities:

    

Trade receivables, net

     (8,906     7,548   

Inventories

     (2,047     (1,362

Other current assets and liabilities

     1,348        (2,731

Other noncurrent assets and liabilities

     (9     84   

Accounts payable

     (619     (7,497

Accrued and other liabilities

     737        (6,070

Accrued restructuring liabilities

     (88     (475
  

 

 

   

 

 

 

Net cash used in operating activities

  (6,358   (12,265
  

 

 

   

 

 

 

Cash flows from investing activities:

Purchases of property, plant and equipment

  (2,012   (1,334

Additions to intangible rights and software development

  (802   (151

Proceeds from sale of property, plant and equipment

  146      212   
  

 

 

   

 

 

 

Net cash used in investing activities

  (2,668   (1,273
  

 

 

   

 

 

 

Cash flows from financing activities:

Borrowings (payments) on revolving line of credit

  —        —     

Principal payments on long-term borrowings

  (933   (933

Principal payments on capital lease obligations

  (241   (229

Proceeds from stock option exercises

  271      1,995   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

  (903   833   
  

 

 

   

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

  (9,929   (12,705

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

  33,775      50,915   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$ 23,846    $ 38,210   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

As of March 31, 2015 and December 31, 2014 and

For the Three Month Periods Ended March 31, 2015 and 2014

(all amounts in thousands unless otherwise designated, except per share data)

 

1.   Description of Business and Basis of Presentation

Description of Business

PowerSecure International, Inc., headquartered in Wake Forest, North Carolina, is a leading provider of products and services to electric utilities, and their large commercial, institutional and industrial customers.

We provide products and services through four operating segments: our Distributed Generation segment, our Solar Energy segment, our Utility Infrastructure segment, and our Energy Efficiency segment. These four operating segments constitute our major product and services offerings, each of which are focused on serving the needs of utilities and their commercial, institutional and industrial customers to help them generate, deliver, and utilize electricity more reliably and efficiently. Our strategy is focused on growing these four segments, which require unique knowledge and skills that utilize our core competencies, because they address large market opportunities due to their strong customer value propositions. The segments share common or complementary utility relationships and customer types, common sales and overhead resources, and facilities. However, we distinguish our operations among these segments due to their unique products and services, differing cost structures, market needs they are addressing, and the distinct technical disciplines and specific capabilities required for us to deliver their products and services, including personnel, technology, engineering, and intellectual capital. We currently operate primarily out of our Wake Forest, North Carolina headquarters office. Our operations also include several satellite offices and manufacturing facilities, the largest of which are in the Raleigh and Greensboro, North Carolina, Atlanta, Georgia, Bethlehem, Pennsylvania, and Stamford, Connecticut areas. The locations of our sales organization and field employees for our operations are generally in close proximity to the utilities and commercial, industrial, and institutional customers they serve. Our four operating segments are operated through our principal operating wholly-owned subsidiary, PowerSecure, Inc.

Each of our four operating segments also represents a reporting segment. See Note 12 for more information concerning our reportable segments.

Basis of Presentation

Organization – The accompanying condensed consolidated financial statements include the accounts of PowerSecure International, Inc. and its subsidiaries, primarily PowerSecure, Inc. and its majority-owned and wholly-owned subsidiaries, UtilityEngineering, Inc., PowerServices, Inc., PowerSecure Lighting, LLC (“PowerSecure Lighting”), Solais Lighting, Inc. (“Solais”), EnergyLite, Inc. (“EnergyLite”), EfficientLights, LLC (“EfficientLights”), Innovative Electronic Solutions Lighting, LLC (“IES”), Reid’s Trailer, Inc. d/b/a PowerFab (“PowerFab”), Innovation Energies, LLC, and PowerSecure Solar, LLC (“PowerSecure Solar”) and PowerPackages, LLC, as well as WaterSecure Holdings, Inc. (‘WaterSecure”) which are collectively referred to as the “Company” or “PowerSecure” or “we” or “us” or “our”. On June 30, 2014, EfficientLights and IES were dissolved and merged into EnergyLite.

These condensed consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission. The accompanying condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014.

In management’s opinion, all adjustments (all of which are normal and recurring) have been made which are necessary for a fair presentation of the condensed consolidated financial position of us and our subsidiaries as of March 31, 2015 and the condensed consolidated results of our operations and cash flows for the three months ended March 31, 2015 and 2014.

Principles of Consolidation – The condensed consolidated financial statements include the accounts of PowerSecure International, Inc. and its subsidiaries after elimination of intercompany accounts and transactions.

Comprehensive Income or Loss – Comprehensive income or loss represents the changes in stockholders’ equity during a period resulting from transactions and other events and circumstances from non-owner sources. At March 31, 2015 and December 31, 2014, the balance of Accumulated other comprehensive income (loss) (“Accumulated OCI”) consisted solely of changes in the fair value of our interest rate cash flow hedge contracts, net of taxes.

 

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Use of Estimates – The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires that our management make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include, among others, percentage-of-completion estimates for revenue and cost of sales recognition, incentive compensation and commissions, allowance for doubtful accounts receivable, inventory valuation reserves, warranty reserves, deferred tax valuation allowance, purchase price allocations on business acquisitions, fair value estimates of interest rate swap contracts and any impairment charges on long-lived assets and goodwill.

Reclassifications – Certain 2014 amounts have been reclassified to conform to current year presentation. Such reclassifications had no effect on net income (loss) or stockholders’ equity as previously reported.

 

2.   Summary of Significant Accounting Policies and Recent Accounting Standards

Revenue Recognition – For our turn-key project-based revenues, we recognize revenue and profit as work progresses using the percentage-of-completion method, which relies on various estimates. These turn-key Distributed Generation, Solar Energy, Utility Infrastructure, and Energy Efficiency Services projects are nearly always fixed-price contracts. Revenues from turn-key Mission Critical Energy Services projects, which are integrated in our Distributed Generation segment since our acquisition of those operations in October 2014, are also recognized using the percentage-of-completion method.

In applying the percentage-of-completion method to our Distributed Generation and Solar Energy turn-key projects, we have identified the key output project phases that are standard components of these projects. We have further identified, based on past experience, an estimate of the value of each of these output phases based on a combination of the costs incurred and the value added to the overall project. While the order of these phases varies depending on the project, each of these output phases is necessary to complete each project and each phase is an integral part of the turn-key product solution we deliver to our customers. We use these output phases and percentages to measure our progress toward completion of our construction projects. For each reporting period, the status of each project, by phase, is determined by employees who are managers of or are otherwise directly involved with the project, and this determination is reviewed by our accounting personnel. Utilizing this information, we recognize project revenues and associated project costs and gross profit based on the percentage associated with output phases that are complete or in process on each of our projects.

In applying the percentage-of-completion method to our Mission Critical Energy Services, Utility Infrastructure turn-key projects and our Energy Efficiency Services projects, revenues and gross profit are recognized as work is performed based on the relationship between actual costs incurred and total estimated costs at completion.

In all cases where we utilize the percentage-of-completion method, revenues and gross profit are adjusted prospectively for revisions in estimated total contract costs and contract values. Estimated losses, if any, are recorded when identified. While a project is in process, amounts billed to customers in excess of revenues recognized to date are classified as current liabilities. Likewise, amounts recognized as revenue in excess of actual billings to date are recorded as unbilled accounts receivable. In the event adjustments are made to the contract price, including, for example, adjustments for additional scope, we adjust the purchase price and related costs for these items when they are identified.

Because the percentage-of-completion method of accounting relies upon estimates as described above, recognized revenues and profits are subject to revision as a project progresses to completion. Revisions in profit estimates are recorded to income in the period in which the facts that give rise to the revision become known. In the event we are required to adjust any particular project’s estimated revenues or costs, the effect on the current period earnings may or may not be significant. If, however, conditions arise that require us to adjust our estimated revenues or costs for a series of similar construction projects, or on very large projects, the effect on current period earnings would more likely be significant. In addition, certain contracts contain cancellation provisions permitting the customer to cancel the contract prior to completion of a project. Such cancellation provisions generally require the customer to pay/reimburse us for costs we incurred on the project, but may result in an adjustment to profit already recognized in a prior period.

 

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We recognize equipment and product revenue when persuasive evidence of a commercial arrangement exists, delivery has occurred and/or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. Equipment and product sales are generally made directly to end users of the product, who are responsible for payment for the product, although in some instances we can be a subcontractor, which occurs most frequently on larger jobs that involve more scope than our products and services, and in other instances we sell through distributors.

Service revenue includes regulatory consulting and rate design services, power system engineering services, energy conservation services, compliance services, and monitoring and maintenance services. Revenues from these services are recognized when the service is performed and the customer has accepted the work.

Additionally, our utility infrastructure business provides services to utilities involving construction, maintenance, and upgrades to their electrical transmission and distribution systems which is not fixed price turn-key project-based work. These services are delivered by us under contracts which are generally of two types. In the first type, we are paid a fee based on the number of units of work we complete, an example of which could be the number of utility transmission poles we replace. In the second type, we are paid for the time and materials utilized to complete the work, plus a profit margin. In both of these cases, we recognize revenue as these services are delivered.

Revenues for our recurring revenue distributed generation projects are recognized over the term of the contract or when energy savings are realized by the customer at its site. Under these arrangements, we provide utilities and their customers with access to PowerSecure-owned and operated distributed generation systems, for standby power and to deliver peak shaving benefits. These contracts can involve multiple parties, with one party paying us for the value of backup power (usually, but not always, a commercial, industrial, or institutional customer), and one party paying us a fee or credit for the value of the electrical capacity provided by the system during peak power demand (either the customer or a utility).

Sales of certain goods and services sometimes involve the provision of multiple deliverables. Revenues from contracts with multiple deliverables are recognized as each element is earned based on the selling price for each deliverable. The selling price for each deliverable is generally based on our selling price for that deliverable on a stand-alone basis, third-party evidence if we do not sell that deliverable on a stand-alone basis, or an estimated selling price if neither specific selling prices nor third-party evidence exists.

Cash and Cash Equivalents – Cash and all highly liquid investments with a maturity of three months or less from the date of purchase, including money market mutual funds, short-term time deposits, and government agency and corporate obligations, are classified as cash and cash equivalents.

Accounts Receivable – Our customers include a wide variety of mid-sized and large businesses, utilities and institutions. We perform ongoing credit evaluations of our customers’ financial condition and generally do not require collateral. We monitor collections and payments from our customers and adjust credit limits of customers based upon payment history and a customer’s current credit worthiness, as judged by us. In certain instances, from time to time, we may purchase credit insurance on our accounts receivable in order to minimize our exposure to potential credit loss. We maintain a provision for estimated credit losses.

Concentration of Credit Risk – We are subject to concentrations of credit risk from our cash and cash equivalents and accounts receivable. We limit our exposure to credit risk associated with cash and cash equivalents by placing them with multiple domestic financial institutions. Nevertheless, our cash in bank deposit accounts at these financial institutions frequently exceeds federally insured limits. We have not experienced any losses in such accounts.

From time to time, we have derived a material portion of our revenues from one or more significant customers. To date, nearly all our revenues have been derived from sales to customers within the United States.

Inventories – Inventories are stated at the lower of cost (determined primarily on a specific-identification basis for the majority of our distributed generation inventory and secondarily on a first-in first-out basis for our LED-based

 

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lighting product inventory) or market. Our raw materials, equipment and supplies inventory consist primarily of equipment with long lead-times purchased for anticipated customer orders. Our work in progress inventory consists primarily of equipment and parts allocated to specific Distributed Generation, Mission Critical Energy Services and Solar Energy turn-key projects and our Utility Infrastructure and Energy Efficiency Services project costs accounted for on the percentage-of-completion basis. Our finished goods inventory consists primarily of LED-based lighting products stocked to meet customer order and delivery requirements. Inventory also includes shipping costs incurred on incoming product shipments. We provide a valuation reserve primarily for raw materials, equipment and supplies and certain work in process inventory items that may be in excess of our needs, obsolete or damaged and requiring repair or re-work.

Property, Plant and Equipment – Property, plant and equipment are stated at cost and are generally depreciated using the straight-line method over their estimated useful lives, which depending on asset class ranges from 3 to 30 years.

Goodwill and Other Intangible Assets – We amortize the cost of specifically identifiable intangible assets that do not have an indefinite life over their estimated useful lives. We do not amortize goodwill and intangible assets with indefinite lives. We perform reviews of goodwill and intangible assets with indefinite lives for impairment annually, as of October 1, or more frequently if impairment indicators arise. We capitalize software development costs integral to our products once technological feasibility of the products and software has been determined. Purchased software and software development costs are amortized over five years, using the straight-line method. Patents and license agreements are amortized using the straight-line method over the lesser of their estimated economic lives or their legal term of existence, currently 3 to 5 years.

Debt Issuance Costs – Debt issuance costs are capitalized and included in other current and non-current assets in our condensed consolidated balance sheets. These costs are amortized over the term of the corresponding debt instrument using the straight-line method for debt issuance costs related to the revolving portion of our credit facility and the effective interest method for debt issuance costs on our term loan debt. Amortization of debt issuance costs is included in interest expense in our condensed consolidated statements of operations.

Warranty Reserve – We provide a standard one year warranty for our Distributed Generation, switchgear, Utility Infrastructure, and Energy Efficiency Services equipment and a 5 to 10 year warranty for our LED lighting-based products. In certain cases, we offer extended warranty terms for those product lines. In addition, we provide longer warranties for our Solar Energy products and services including a warranty period of generally 1 to 5 years for defects in material and workmanship, a warranty period that can extend to 10 to 20 years for declines in power performance, and a warranty period which can extend to 15 to 25 years on the functionality of solar panels which is generally backed by the panel manufacturer. We reserve for the estimated cost of product warranties when revenue is recognized, and we evaluate our reserve periodically by comparing our warranty repair experience by product. The purchase price for extended warranties or for extended warranties included in the contract terms are deferred as a component of our warranty reserve. The balance of our warranty reserve was $1.6 million and $1.7 million at March 31, 2015 and December 31, 2014, respectively, and is included in accrued and other liabilities in the accompanying condensed consolidated balance sheet.

Share-Based Compensation – We measure compensation cost for all stock-based awards at their fair value on date of grant and recognize the compensation expense over the service period for awards expected to vest, net of estimated forfeitures. We measure the fair value of restricted stock awards based on the number of shares granted and the last sale price of our common stock on the date of the grant. We measure the fair value of performance unit awards based on the underlying number of shares included in the performance units and the last sale price of our common stock on the date of the grant. We measure the fair value of stock options using the Black-Scholes valuation model.

Pre-tax share-based compensation expense for our stock options, restricted stock and performance unit awards recognized during the three months ended March 31, 2015 and 2014 was $0.7 million and $0.3 million, respectively. All share-based compensation expense is included in general and administrative expense in the accompanying condensed consolidated statements of operations.

Impairment or Disposal of Long-Lived Assets –We evaluate our long-lived assets whenever significant events or changes in circumstances occur that indicate that the carrying amount of an asset may be impaired. Recoverability of these assets is determined by comparing the forecasted undiscounted future cash flows from the operations to which the assets relate, based on management’s best estimates using appropriate assumptions and projections at the time, to the

 

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carrying amount of the assets. If the carrying value is determined not to be recoverable from future operating cash flows, the asset is deemed impaired and an impairment loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the asset or assets. We did not record any long-lived asset impairment charges during the three months ended March 31, 2015 and 2014.

Income Taxes – We recognize deferred income tax assets and liabilities for the estimated future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We have net operating loss carryforwards available in certain jurisdictions to reduce future taxable income. Future tax benefits for net operating loss carryforwards are recognized to the extent that realization of these benefits is considered more likely than not. To the extent that available evidence raises doubt about the realization of a deferred income tax asset, a valuation allowance is established.

We recognize a liability and income tax expense, including potential penalties and interest, for uncertain income tax positions taken or expected to be taken. The liability is adjusted for positions taken when the applicable statute of limitations expires or when the uncertainty of a particular position is resolved.

Derivative Financial Instruments – Our derivative financial instruments consist solely of two interest rate swap contracts that are used to hedge our interest rate risk on a portion of our variable rate debt. These interest rate swap contracts are designated as cash flow hedges. It is our policy to execute such interest rate swaps with creditworthy banks and we do not enter into derivative financial instruments for speculative purposes.

Fair Value Measurements – We measure our derivative instruments at fair value on a recurring basis. The fair value measurements standard establishes a framework for measuring fair value. The framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements), and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under the standard are described below:

 

Level 1 – Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets.
Level 2 – Inputs to the valuation methodology include:

•    

Quoted market prices for similar assets or liabilities in active markets;

•    

Quoted prices for identical or similar assets or liabilities in inactive markets;

•    

Inputs other than quoted prices that are observable for the asset or liability;

•    

Inputs that are derived principally from or corroborated by observable market data by correlation or other means.
If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.
Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

See Note 7 for more information concerning the fair value of our derivative instruments.

Subsequent Events—Subsequent events are events or transactions that occur after the balance sheet date but before the financial statements are issued or are available to be issued and are classified as either “recognized subsequent events” or “non-recognized subsequent events”. We recognize and include in our financial statements the effects of subsequent events that provide additional evidence about conditions that existed at the balance sheet date. We disclose non-recognized subsequent events that provide evidence about conditions that arise after the balance sheet date but are not yet reflected in our financial statements when such disclosure is required to prevent the financial statements from being misleading.

 

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Recent Accounting Pronouncements

Presentation of Debt Issuance Costs – In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03: Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). ASU 2015-03 specifies that debt issuance costs shall be reported in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs shall be reported as interest expense. The guidance in ASU 2015-03 is effective for fiscal years beginning after December 15, 2015. Early adoption is allowed. Application of the guidance in ASU 2015-03 is applicable retrospectively to all periods presented. We do not expect that the adoption of this standard will have a material effect on our consolidated financial statements.

Going Concern Disclosures – In August 2014, the FASB issued ASU No. 2014-15: Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. ASU 2014-15 is effective for annual and interim reporting periods ending after December 15, 2016, with early adoption permitted. We do not expect that the adoption of this standard will have a material effect on our consolidated financial statements.

Stock Compensation – In June 2014, the FASB issued ASU No. 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). ASU 2014-12 requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This standard further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which the requisite service has already been rendered. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 and can be applied either prospectively or retrospectively to all awards outstanding as of the beginning of the earliest annual period presented as an adjustment to opening retained earnings. Early adoption is permitted. We are evaluating the impact, if any, this new standard will have on our consolidated financial statements.

Revenue Recognition – In May 2014, the FASB issued ASU No. 2014-09: Revenue from Contracts with Customers (“ASU 2014-09”). This standard replaces existing accounting literature relating to how and when a company recognizes revenue. Under ASU 2014-09, a company will recognize revenue when it transfers goods or services to customers in an amount equal to the amount that it expects to be entitled to receive in exchange for those goods and services. This standard also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU 2014-09 will be effective for annual and interim periods beginning after December 15, 2016, and will be effective for us for our fiscal year that begins January 1, 2017, and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. We are in the process of determining the method of adoption and evaluating the impact, if any, the adoption of this standard will have on our consolidated financial statements and related disclosures.

Reporting Discontinued Operations – In April 2014, the FASB issued ASU No. 2014-08: Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). ASU 2014-08 changes the definition of a discontinued operation to include only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results, and changes the criteria and enhances disclosures for reporting discontinued operations. This standard is to be applied prospectively, and is effective for our fiscal year that begins January 1, 2015. The adoption of this standard had no effect on our consolidated financial statements.

 

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3.   Earnings (Loss) per Share

Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed using the weighted average number of common shares outstanding and, when dilutive, potential common shares from stock options using the treasury stock method. Diluted earnings per share excludes the impact of potential common shares related to stock options in periods in which we reported a loss from continuing operations or in which the option exercise price is greater than the average market price of our common stock during the period because the effect would be antidilutive. A total of 451 thousand common shares issuable upon the potential exercise of outstanding stock options were excluded from the calculation of diluted weighted average number of shares outstanding for the three months ended March 31, 2014, because their effect was antidilutive to our net loss for that period.

The following table sets forth the calculation of basic and diluted earnings (loss) per share:

 

     Three Months Ended
March 31,
 
     2015      2014  

Net income (loss)

   $ 121       $ (4,259
  

 

 

    

 

 

 

Basic weighted-average common shares outstanding in period

  22,385      21,979   

Dilutive effect of stock options

  104      —     
  

 

 

    

 

 

 

Diluted weighted-average common shares outstanding in period

  22,489      21,979   
  

 

 

    

 

 

 

Basic earnings (loss) per common share

$ 0.01    $ (0.19
  

 

 

    

 

 

 

Diluted earnings (loss) per common share

$ 0.01    $ (0.19
  

 

 

    

 

 

 

 

4.   Contingent Consideration Payment on 2014 Acquisition

On October 14, 2014, we acquired the mission critical energy services business and certain related assets of Power Design, Inc., a Florida corporation (“PDI”), pursuant to an Asset Purchase and Sale Agreement (the “Purchase Agreement”), between PDI, as seller, and PowerSecure, Inc., as purchaser. We refer to the acquired operations as our Mission Critical Energy Services operations and have integrated these operations within our Distributed Generation segment.

The purchase price paid for the Mission Critical Energy Services operations was $13.0 million in cash and $0.1 million cash for a working capital adjustment plus a potential additional contingent cash payment in the amount of $1.0 million if PowerSecure, Inc. obtains firm backlog after the closing in the amount of at least $5.0 million from the acquired business, or in the amount of $2.0 million if the firm backlog amount obtained after closing is at least $15.0 million. The balance of our contingent consideration liability at March 31, 2015 and December 31, 2014 was $2.0 million and $1.9 million, respectively, and we paid $1.0 million of that amount to PDI on April 3, 2015. We expect to pay an additional $1.0 million in full settlement of the contingent consideration during the remainder of 2015 as the result of additional backlog that the acquired business is expected to generate.

 

5.   Restructuring Charges

From time to time and most recently in 2013, we have engaged in restructuring programs designed to reduce our cost structure and improve productivity. These initiatives typically consist of realigning operations, reducing employee counts, rationalizing facilities, changing manufacturing sourcing, eliminating certain products, inventory writedowns and long term asset disposals, and other actions designed to reduce our cost structure and improve productivity.

 

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The following table summarizes the balance of our accrued restructuring liabilities at and for the three months ended March 31, 2015:

 

     Employee
Termination
Costs
     Inventory
Writedowns and
Long Term
Disposals
     Leasehold
Termination
Other Facility
Exit Costs
     Total  

Accrued restructuring liabilities, December 31, 2014

   $ 114       $ —         $ —         $ 114   

Costs paid or otherwise settled

     (88      —           —           (88
  

 

 

    

 

 

    

 

 

    

 

 

 

Accrued restructuring liabilities, March 31, 2015

$ 26    $ —      $ —      $ 26   
  

 

 

    

 

 

    

 

 

    

 

 

 

The balances of our accrued restructuring liabilities at March 31, 2015 and December 31, 2014 are included in current liabilities in our condensed consolidated balance sheet. We expect the majority of the balance of our accrued restructuring charges at March 31, 2015 will be paid or otherwise settled during the remainder of 2015.

 

6.   Debt and Interest Rate Swap Contracts

We have a long-term credit facility with Citibank, N.A. (“Citibank”), as administrative agent and lender, and other lenders under a credit agreement that we first entered into with our lenders in August 2007 and have amended and restated from time-to-time. At March 31, 2015 and December 31, 2014, our credit agreement with Citibank along with Branch Banking and Trust Company (“BB&T”) as additional lender, consisted of a $20.0 million senior, first-priority secured revolving line of credit maturing on November 12, 2016, a $2.6 million term loan maturing on November 12, 2016, and a $25.0 million, 7 year amortizing term loan maturing on September 30, 2020. The credit agreement is guaranteed by all our active subsidiaries and is secured by the assets of us and those subsidiaries.

The credit facility contains three basic financial covenants. First, under the credit agreement, if cash on hand does not exceed funded indebtedness by at least $5.0 million, then our minimum fixed charge coverage ratio must be in excess of 1.25, where the fixed charge coverage ratio is defined as the ratio of the aggregate of our consolidated Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) plus our lease expense minus our taxes based on income and payable in cash, divided by the sum of our consolidated interest charges plus our lease expenses plus our scheduled principal payments and dividends, computed over the previous period. For the fiscal quarter ending March 31, 2015, the fixed charge coverage ratio is based on our financial results for the third quarter 2014 and subsequent fiscal quarters. For the fiscal quarter ending June 30, 2015 and thereafter, the fixed charge coverage ratio will be based on our financial results for the previous four fiscal quarters on a rolling basis. Second, we are required to maintain a minimum consolidated net worth, computed on a quarterly basis, of not less than the sum of $142.1 million, plus an amount equal to 50% of our net income each fiscal year commencing with the year ending December 31, 2014, with no reduction for any net loss in any fiscal year, plus 90% of any equity we raise through the sale of equity interests, less the amount of any non-cash charges or losses. Under our third financial covenant, the ratio of our funded indebtedness to our capitalization, computed as funded indebtedness divided by the sum of funded indebtedness plus stockholders equity, cannot exceed 30%. As of March 31, 2015, we were in compliance with these financial covenants.

 

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The following table summarizes the balances outstanding on our long-term debt, including our revolving line of credit, with Citibank and BB&T at March 31, 2015 and December 31, 2014:

 

     March 31,
2015
     December 31,
2014
 

Revolving line of credit, maturing November 12, 2016

   $ —         $ —     

Term loan, principal of $0.04 million plus interest payable quarterly at variable rates, maturing November 12, 2016

     1,880         1,920   

Term loan, principal of $0.9 million plus interest payable quarterly at variable rates, maturing June 30, 2020

     18,750         19,643   
  

 

 

    

 

 

 

Total debt

  20,630      21,563   

Less: Current portion

  (3,731   (3,731
  

 

 

    

 

 

 

Long-term debt, net of current portion

$ 16,899    $ 17,832   
  

 

 

    

 

 

 

We have used, and intend to continue to use, the proceeds available under the credit facility to support our growth and future investments in working capital, additional UtilityInfrastructure equipment, Company-owned distributed generation projects, other capital expenditures, acquisitions and general corporate purposes.

Outstanding balances under the credit facility bear interest, at our discretion, at either the London Interbank Offered Rate (“LIBOR”) for the corresponding deposits of U.S. Dollars plus an applicable margin, which is on a sliding scale ranging from 2.00% to 3.25% based upon our leverage ratio, or at Citibank’s alternate base rate plus an applicable margin, on a sliding scale ranging from 0.25% to 1.50% based upon our leverage ratio. Our leverage ratio is the ratio of our funded indebtedness as of a given date, net of our cash on hand in excess of $5.0 million, to our consolidated EBITDA for the four consecutive fiscal quarters ending on such date. Citibank’s alternate base rate is equal to the higher of the Federal Funds Rate as published by the Federal Reserve of New York plus 0.50%, Citibank’s prime commercial lending rate and 30 day LIBOR plus 1.00%.

Scheduled remaining principal payments on our outstanding debt obligations at March 31, 2015, are as follows:

 

Scheduled Principal Payments for the Year Ending December 31:

   Revolving
Line of
Credit
     $25.0 Million
Term Loan
     $2.6 Million
Term Loan
     Total
Principal
Payments
 

Remainder of 2015

   $ —         $ 2,678       $ 120       $ 2,798   

2016

     —           3,571         1,760         5,331   

2017

     —           3,572         —           3,572   

2018

     —           3,572         —           3,572   

2019 and thereafter

     —           5,357         —           5,357   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total scheduled principal payments

$ —      $ 18,750    $ 1,880    $ 20,630   
  

 

 

    

 

 

    

 

 

    

 

 

 

In July 2013, we entered into two forward-starting interest rate swap contracts based on three-month LIBOR that effectively converted 80% of the outstanding balance of our $25 million Term Loan to fixed rate debt. As discussed further in Note 7, we have designated the interest rate swaps as a cash flow hedge of the interest payments due on our floating rate debt. Accordingly, at March 31, 2015, $15.0 million of our outstanding debt bears interest at a fixed rate of 3.73% and $5.6 million of our outstanding debt bears interest at floating rates as described above. The termination dates of the swap contracts and the maturity date of the $25 million Term Loan are both June 30, 2020.

The credit facility contains customary terms and conditions for credit facilities of this type, including restrictions or limits on our ability to incur additional indebtedness, create liens, enter into transactions with affiliates, pay dividends on our capital stock, repurchase stock, and consolidate or merge with other entities. In addition, the credit agreement contains customary events of default, including payment defaults, breach of representations and warranties, covenant defaults, cross-defaults, certain bankruptcy or insolvency events, judgment defaults and certain ERISA-related events.

Our obligations under the credit facility are secured by guarantees and security agreements by each of our active subsidiaries, including PowerSecure, Inc. The guarantees guaranty all of our obligations under the credit facility, and the security agreements grant to the lenders a first priority security interest in virtually all of the assets of each guarantor.

 

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There was an aggregate balance of $20.6 million outstanding under the two term loans under our credit facility as of March 31, 2015. There were no balances outstanding on the revolving portion of the credit facility at, or during the three months ended, March 31, 2015 or at December 31, 2014 or at May 6, 2015. In addition, there were no outstanding letters of credit reducing the amount available to borrow under the revolving portion of the credit facility at March 31 or May 6, 2015. Accordingly, we currently have $20.0 million available to borrow under the revolving portion of the credit facility. The availability this capital under our credit facility includes restrictions on the use of proceeds, and is dependent upon our ability to satisfy certain financial and operating covenants, as described above.

 

7.   Derivative Instruments and Hedging Activities

In July 2013, we entered into two forward-starting interest rate swap contracts to manage interest rate risk associated with a portion of our $25 million Term Loan floating rate debt (see Note 6). The interest rate swaps effectively converted 80% of the outstanding balance of our $25.0 million floating rate term loan to a fixed rate term loan bearing interest at the rate of 3.73%. The notional amount of the interest rate swaps at March 31, 2015 was $15.0 million. The termination dates of the swap contracts and the maturity date of the $25 million Term Loan are both June 30, 2020.

In accordance with ASC 815, Derivatives and Hedging, we have designated both of our interest rate swaps as cash flow hedges of the interest payments due on our floating rate debt. To qualify for designation as a cash flow hedge, specific criteria must be met and the appropriate documentation maintained. Hedging relationships are established pursuant to our risk management policies and are initially and regularly evaluated to determine whether they are expected to be, and have been, highly effective hedges. For our interest rate swap contracts designated as a cash flow hedge of interest on our floating rate debt, the effective portion of the change in fair value of the derivative is reported in other comprehensive income and reclassified into earnings in the period in which the hedged item affects earnings. Any amounts excluded from the effectiveness calculation and any ineffective portion of the change in fair value of the derivative are recognized currently in earnings.

The interest rate swaps are measured at Level 2 fair value on a recurring basis, using standard pricing models and market-based assumptions for all significant inputs, such as LIBOR yield curves. The fair value of the interest rate swap contracts included within our consolidated balance sheets as of March 31, 2015 and December 31, 2014, are as follows:

 

Derivative designated as hedging instrument:

  

Balance Sheet
Location

   March 31,
2015
     December 31,
2014
    

Balance Sheet
Location

   March 31,
2015
     December 31,
2014
 

Interest rate swaps

  

Other assets

   $ —         $ —        

Other long-term liabilities

   $ 218      $ 146  

The following tables present the effects of derivative instruments designated as cash flow hedges on our consolidated statements of operations and accumulated other comprehensive income (loss) (“AOCI”):

 

AOCI Component

   Amounts Reclassified from AOCI into income
Three Months Ended March 31,
     Affected Line Item in the
Consolidated Statements
of Operations
   2015      2014     

Gain (loss) on cash flow hedges:

        

Interest rate swaps

   $ 58      $ 69      Interest expense
     (22      (28    Tax expense (benefit)
  

 

 

    

 

 

    
$ 36   $ 41   Net of tax
  

 

 

    

 

 

    

 

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     Amount of gain (loss) recognized in AOCI
Three Months Ended March 31,
 

AOCI Component

   2015      2014  

Gain (loss) on cash flow hedges:

     

Unrealized gain (loss) -

     

Interest rate swaps

   $ (130    $ (75

Tax effect

     49         30   
  

 

 

    

 

 

 

Gain (loss) - net of tax

$ (81 $ (45
  

 

 

    

 

 

 

We did not realize any ineffectiveness related to our cash flow hedges during the three months ended March 31, 2015 and 2014.

 

8.   Capital Lease Obligations

We have a capital lease with SunTrust Equipment Finance and Leasing (as Lessor) from the sale and leaseback of distributed generation equipment placed in service at customer locations. We received $5.9 million from the sale of the equipment in December 2008 which we are repaying under the terms of the lease with monthly principal and interest payments of $0.1 million over a period of 84 months. At the expiration of the term of the lease in December 2015, we have the option to purchase the equipment for $1 dollar, assuming no default under the lease by us has occurred and is then continuing. The lease is guaranteed by us under an equipment lease guaranty. The lease and the lease guaranty constitute permitted indebtedness under our current credit agreement.

Proceeds of the lease financing were used to finance capital investments in equipment for our recurring revenue distributed generation projects. We account for the lease financing as a capital lease in our condensed consolidated financial statements.

The lease provides us with limited rights, subject to the lessor’s approval which will not be unreasonably withheld, to relocate and substitute equipment during its term. The lease contains representations and warranties and covenants relating to the use and maintenance of the equipment, indemnification and events of default customary for leases of this nature. The lease also grants to the lessor certain remedies upon a default, including the right to cancel the lease, to accelerate all rent payments for the remainder of the term of the lease, to recover liquidated damages, or to repossess and re-lease, sell or otherwise dispose of the equipment.

The balances of our capital lease obligations shown in the accompanying condensed consolidated balance sheet at March 31, 2015 and December 31, 2014 consists entirely of our obligations under the equipment lease described above.

 

9.   Share-Based Compensation

We recognize compensation expense for all share-based awards made to employees and directors based on estimated fair values on the date of grant.

Stock Plans – Historically, we have granted stock options, restricted stock awards and performance unit awards to employees and directors under various stock plans. We currently maintain two stock plans. Under our 1998 Stock Incentive Plan, as amended (the “1998 Stock Plan”), we granted incentive stock options, non-qualified stock options, restricted stock, performance awards and other stock-based awards to our officers, directors, employees, consultants and advisors for shares of our common stock. Stock options granted under the 1998 Stock Plan contained exercise prices not less than the fair market value of our common stock on the date of grant, and had a term of 10 years from the date of grant. Nonqualified stock option grants to our directors under the 1998 Stock Plan generally vested over periods up to two years. Qualified stock option grants to our employees under the 1998 Stock Plan generally vested over periods up to

 

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five years. The 1998 Stock Plan expired on June 12, 2008, and no additional awards may be made under the 1998 Stock Plan, although awards granted prior to such date will remain outstanding and subject to the terms and conditions of those awards.

In March 2008, our board of directors adopted the PowerSecure International, Inc. 2008 Stock Incentive Plan (the “2008 Stock Plan”), which was approved by our stockholders at the Annual Meeting of Stockholders held on June 9, 2008. The 2008 Stock Plan authorizes our board of directors to grant incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, performance awards and other stock-based awards to our officers, directors, employees, consultants and advisors for up to an aggregate of 0.6 million shares of our common stock. Stock options granted under the 2008 Stock Plan must contain exercise prices not less than the fair market value of our common stock on the date of grant, and must contain a term not in excess of 10 years from the date of grant. On June 19, 2012, at our 2012 Annual Meeting of Stockholders, our stockholders adopted and approved an amendment and restatement of the 2008 Stock Incentive Plan, including an amendment to increase the number of shares of our common stock authorized thereunder by 1.4 million shares to a total of 2.0 million shares. The 2008 Stock Plan replaced our 1998 Stock Plan.

Stock Options – Net income (loss) for the three months ended March 31, 2015 and 2014 includes $86 thousand and $44 thousand, respectively, of pre-tax compensation costs related to outstanding stock options. All of the stock option compensation expense is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

A summary of option activity for the three months ended March 31, 2015 is as follows:

 

     Shares      Weighted
Average
Exercise Price
     Weighted
Average
Remaining
Contractual
Term (years)
     Aggregate
Intrinsic
Value
 

Balance, December 31, 2014

     519       $ 9.12         

Granted

     15         11.24         

Exercised

     (50      5.44         

Expired

     —           —           

Forfeited

     (5      8.91         
  

 

 

    

 

 

       

Balance, March 31, 2015

  479    $ 9.57      5.75    $ 3.59   
  

 

 

    

 

 

    

 

 

    

 

 

 

Exercisable, March 31, 2015

  269    $ 8.66      3.54    $ 4.50   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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A summary of option activity for the three months ended March 31, 2014 is as follows:

 

     Shares      Weighted
Average
Exercise Price
     Weighted
Average
Remaining
Contractual
Term (years)
     Aggregate
Intrinsic
Value
 

Balance, December 31, 2013

     669       $ 8.59         

Granted

     —           —           

Exercised

     (218      9.18         

Expired

     —           —           

Forfeited

     —           —           
  

 

 

    

 

 

       

Balance, March 31, 2014

  451    $ 8.31      5.01    $ 15.13   
  

 

 

    

 

 

    

 

 

    

 

 

 

Exercisable, March 31, 2014

  299    $ 7.42      3.34    $ 16.02   
  

 

 

    

 

 

    

 

 

    

 

 

 

The weighted average grant date fair value of stock options granted during the three months ended March 31, 2015 was $4.73. There were no options granted during the three months ended March 31, 2014. The fair value of the stock options granted during the three months ended March 31, 2015 was measured using the Black-Scholes valuation model with the following assumptions:

 

     Three Months Ended March 31,  
     2015     2014 (1)  

Expected stock price volatility

     46.5     n/m   

Risk free interest rate

     1.6     n/m   

Annual dividends

   $ —          n/m   

Expected life (years)

     5        n/m   

 

(1) 2014 amounts are not meaningful as there were no stock options granted during the period.

The fair value of stock option grants is amortized to expense over the respective service periods using the straight-line method and assuming a forfeiture rate of 5%. As of March 31, 2015 and December 31, 2014, there was $0.7 million and $0.8 million, respectively, of total unrecognized compensation costs related to stock options. These costs at March 31, 2015 are expected to be recognized over a weighted average period of approximately 2.7 years.

During the three months ended March 31, 2015 and 2014, the total intrinsic value of stock options exercised was $0.3 million and $3.3 million, respectively. Cash received from stock option exercises during the three months ended March 31, 2015 and 2014 was $0.3 million and $2.0 million, respectively. The total grant date fair value of stock options vested during the three months ended March 31, 2015 and 2014 was $28 thousand and $5 thousand, respectively.

Restricted Stock Awards – Net income (loss) for the three months ended March 31, 2015 and 2014 includes $0.5 million and $0.2 million, respectively, of pre-tax compensation costs related to the vesting of outstanding restricted stock awards granted to directors and employees. All of the restricted stock award compensation expense during the three months ended March 31, 2015 and 2014 is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

 

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A summary of restricted stock award activity for the three months ended March 31, 2015 is as follows:

 

     Unvested
Restricted
Shares
     Weighted
Average
Grant Date
Fair Value
 

Balance, December 31, 2014

     579       $ 17.20   

Granted

     28         12.30   

Vested

     (6      7.88   

Forfeited

     —           —     
  

 

 

    

 

 

 

Balance, March 31, 2015

  601    $ 17.06   
  

 

 

    

 

 

 

A summary of restricted stock award activity for the three months ended March 31, 2014 is as follows:

 

     Unvested
Restricted
Shares
     Weighted
Average
Grant Date
Fair Value
 

Balance, December 31, 2013

     387       $ 14.37   

Granted

     184         23.33   

Vested

     (3      15.18   

Forfeited

     —           —     
  

 

 

    

 

 

 

Balance, March 31, 2014

  568    $ 17.27   
  

 

 

    

 

 

 

Restricted shares are subject to forfeiture and cannot be sold or otherwise transferred until they vest. If the holder of the restricted shares leaves us before the restricted shares vest, other than due to termination by us without cause, then any unvested restricted shares will be forfeited and returned to us. The restricted shares granted to directors vest in equal amounts over a period of one or three years, depending on the nature of the grant. The restricted shares granted to employees generally vest over five or ten years. All restricted and unvested shares automatically vest upon a change in control.

The fair value of the restricted shares is amortized on a straight-line basis over the respective vesting period. At March 31, 2015, the balance of unrecognized compensation cost related to unvested restricted shares was $8.2 million, which is expected to be recognized over a weighted average period of approximately 4.1 years.

Performance Units – Net income (loss) for the three months ended March 31, 2015 includes $35 thousand of pre-tax compensation costs related to outstanding performance units based on the number of awards that we expect will vest over the requisite service period and the probable outcome of the associated performance condition. All of the performance unit compensation expense during the three months ended March 31, 2015 is included in general and administrative expenses in the accompanying condensed consolidated statements of operations. There were no performance units issued or outstanding during the three months ended March 31, 2014.

The performance units outstanding at March 31, 2015 obligate the Company to issue a variable number of shares of its common stock in the event certain cumulative earnings per share performance thresholds are met. At March 31, 2015, the number of shares issuable upon attainment of performance thresholds ranges from 23 thousand to 68 thousand shares. The fair value of the performance units are being amortized on a straight-line basis over the requisite service period. At March 31, 2015, the balance of unrecognized compensation costs related to outstanding performance units was $0.6 million, which is expected to be recognized over a weighted average period of approximately 2.2 years.

 

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10.   Commitments and Contingencies

Securities Class Action and Related Litigation – On May 22, 2014, a putative securities class action lawsuit was filed against us and certain of our executive officers in the United States District Court for the Eastern District of North Carolina. Subsequently, in May and in July 2014, two additional purported securities class action lawsuits were filed against the same defendants in the United States District Courts, one in the Eastern District of North Carolina and the other in the Western District of North Carolina. On October 10, 2014, these lawsuits were consolidated in the United States District Court for the Eastern District of North Carolina, and a lead plaintiff was appointed. As consolidated, the lawsuit was filed on behalf of all persons or entities that purchased our common stock during a purported class period from August 8, 2013 through May 7, 2014, which is the longer of the two different purported class periods used in the pre-consolidation lawsuits. A consolidated amended complaint was filed on December 29, 2014. The action alleges that certain statements made by the defendants during the class period violated federal securities laws and seeks damages in an unspecified amount. We filed a motion to dismiss the amended complaint on February 26, 2015, to which plaintiffs responded on April 30, 2015. We expect to file our reply brief in June 2015, after which the court will rule on our motion to dismiss. We believe that the claims asserted in this class action litigation are without merit, and we intend to vigorously defend against all such allegations.

On August 15, 2014, a shareholder derivative complaint was filed against certain of our executive officers and each of our directors during the class period in the United States District Court for the Eastern District of North Carolina. The complaint alleges breach of fiduciary duty, waste of corporate assets and unjust enrichment by the named officers and directors in connection with substantially the same events as set forth in the class action lawsuit, seeking damages in an unspecified amount. Further action on the derivative complaint has been stayed by order of the court upon the mutual agreement of the parties, pending final resolution of the securities class action.

We have various insurance policies related to the risk associated with our business, including directors’ and officers’ liability insurance policies. However, there is no assurance that our insurance coverage will be sufficient or that our insurance carriers will cover all claims. The ultimate outcome of these proceedings cannot be accurately predicted due to the inherent uncertainty of litigation and the litigation is at a very early stage. Other than an immaterial amount for expected legal expenses, we have not recognized any costs for the securities class actions as we do not believe, based upon current information, that a loss relating to these matters is probable, or that an estimate of a range of potential loss relating to these matters, can reasonably be made.

Performance Bonds and Letters of Credit – In the ordinary course of business, we are required by certain customers to post surety or performance bonds or letters of credit in connection with services that we provide to them. These bonds and letters of credit provide a guarantee to the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. If we fail to perform under a contract or to pay subcontractors and vendors, the customer may demand that the surety, in the case of a performance bond, or our lenders, in the case of a letter of credit, make payments or provide services under the bond. We must reimburse the surety or our lenders for any expenses or outlays they incur. We have not been required to make any reimbursements to our sureties for bond-related costs, and we do not currently expect that we will have to fund significant claims under our surety arrangements in the foreseeable future. As of March 31, 2015, we had approximately $277.0 million in surety bonds outstanding. Based upon the current status of the completion of our contracts and projects, we estimate our exposure on these surety bonds was approximately $94.0 million at March 31, 2015.

Employee Matters – From time to time, we hire employees that are subject to restrictive covenants, such as non-competition agreements with their former employers. We comply, and require our employees to comply, with the terms of all known restrictive covenants. However, we have in the past and may in the future receive claims and demands by some former employers alleging actual or potential violations of these restrictive covenants. These claims are inherently difficult to predict, and therefore we generally cannot provide any assurance of the outcome of claims. We do not have any specific claims outstanding at this time.

Product Performance and Component Parts Matters – From time to time, in the ordinary course of business we encounter issues with component parts that affect the performance of our distributed generation systems, switchgear systems, utility infrastructure products, engines, generators, alternators, breakers, fuel systems, boilers, chillers, LED and other lighting products, electrical circuit boards, power drivers, photovoltaic energy systems, inverters, and other complex

 

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electrical products. While we strive to utilize high quality component parts from reputable suppliers, and to back-up their quality and performance with manufacturers’ warranties, even the best parts and components have performance issues from time to time, and these performance issues create significant financial and operating risks to our business, operations and financial results. In addition, because we regularly develop new products and technical designs, we often incorporate component parts into these new products in configurations, for uses, and in environments, for which limited experience exists and which exposes us to performance risks that may not be covered by warranties, or may invalidate warranties or performance certifications. As we strive to bring solutions to customers with unique capabilities that provide performance and cost advantages, from time to time we use new suppliers and new products for applications where track record of performance does not exist, or is difficult to ascertain. As a result, we can encounter situations in which the responsibility for the performance issues is unclear, or difficult to ascertain. Because of our strong focus on customer satisfaction, we often take on the cost of repairs in excess of our contractual obligations. Additionally, the outcome of any performance disputes or warranty claims is inherently difficult to predict due to the uncertainty of technical solutions, cost, customer requirements, and the uncertainty inherent in litigation and disputes generally. As a result, there is no assurance we will not be adversely affected by these, or other performance issues with key parts and components. Moreover, performance issues may not be covered by manufacturer’s warranties, certain suppliers may not be financially able to fulfill their warranty obligations, and customers may also claim damages as a result of those performance issues. Also, the mere existence of performance issues, even if finally resolved with our suppliers and customers, can have an adverse effect on our reputation for quality, which could adversely affect our business.

We estimate that from time to time we have performance issues related to component parts which have a cost basis of approximately 5-10% of our estimated annual revenues, although not necessarily limited to this amount, which are installed in equipment we own and have sold to various customers across our business lines, and additional performance issues could arise in the future. In addition, the failure or inadequate performance of these components pose potential material and adverse effects on our business, operations, reputation and financial results, including reduced revenues for projects in process or future projects, reduced revenues for recurring revenue contracts which are dependent on the performance of the affected equipment, additional expenses and capital cost to repair or replace the affected equipment, inventory write-offs for defective components held in inventory, asset write-offs for company-owned systems which have been deployed, the cancellation or deferral of contracts by our customers, or claims made by our customers for damages as a result of performance issues.

We have experienced performance issues with two types of component parts, in particular, which we have made progress in correcting or mitigating, but which continue to represent operational and financial risks to our business: 1) a component we incorporated into a distributed generation system configuration installed in many of the systems deployed for our customers has been deemed to invalidate the generator manufacturer’s warranty and may cause other customer issues and costs, and 2) generators we purchased from a certain supplier have had performance issues in a system we own, and for which we have a performance-based recurring revenue contract that is dependent on the system’s successful operation. In both of these matters, we have actively worked to correct and resolve the performance issues and have made progress in mitigating certain elements of their risk, but the risk is not eliminated. Given that we continue to have risk related to these matters, and the inherent uncertainty in assessing and quantifying the costs and certainty regarding their resolution, we are unable to estimate the potential negative impacts from these two particular items, if any, in addition to other component part performance issues discussed above. In addition, we have not recorded any specific adjustment to our warranty reserve for these particular performance issues, other than our regular reserves for minor repairs, as the estimated cost, if any, of fulfilling our obligations for these matters within a possible range of outcomes is not determinable as of this date.

Utility-Scale Solar Energy Project Contract Matters – In July 2014, we entered into two Engineering, Procurement and Construction Agreements (“EPC Contracts”) with Georgia Power Company, a large investor-owned utility customer (the “Utility”). Each of these EPC Contracts relates to a similarly sized utility-scale solar distributed generation project which will be performed for the Utility for the benefit of the Utility’s customer. We expect these solar projects to generate a total of $120 million in revenues, and be completed over the course of 2015 and 2016. We also expect that these projects, which are large in scale and carry significantly lower gross profit margins as a percentage of revenues compared to traditional projects of this type, will carry single digit gross margins as a percentage of revenues. Thus, we expect the impact of these contracts to be dilutive to our consolidated gross margins, while being accretive to our net income and earnings per share. The scheduled substantial completion and placed in service dates of each EPC Contract are no later than August 1, 2016 and December 31, 2016, respectively.

 

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The EPC Contracts, which are virtually identical in rights and obligations and differ primarily in project descriptions, provide for customary covenants, representations, warranties and indemnities to the Utility. The EPC Contracts also include terms requiring us to provide performance guarantees and indemnification to the Utility under certain circumstances, as well as provisions requiring us to pay the Utility liquidated damages upon the occurrence of certain events, including certain delays in substantial completion and when the system is placed in service. The aggregate limit on our liability to the Utility for liquidated damages related to delays under the EPC Contracts is approximately $24 million per contract, and $48 million in total. We could have additional liabilities to the Utility for any breaches of our covenants, representations or warranties in addition to these potential liquidated damages. The EPC Contracts also contain typical events of default, including material breaches of the EPC Contracts after notice and cure periods and defaults relating to bonding and surety failures. The EPC Contracts may be terminated by us upon an event of default by the Utility, in which case we would be entitled to the payment for work performed and for actual costs incurred. We also provide a warranty on each project for three years after substantial completion of the project.

In addition, the solar projects covered by the EPC Contracts are subject to bonding requirements. In connection with these requirements, we have obtained, for the benefit of the Utility, bonding arrangements in the amount of approximately $120 million. The solar panel manufacturer has provided a supply bond to us in the amount of approximately $60 million that backstops the on-time delivery of quality panels.

Other Matters – From time to time, we are involved in other disputes, claims, proceedings and legal actions arising in the ordinary course of business. We intend to vigorously defend all claims against us, and pursue our full legal rights in cases where we have been harmed. Although the ultimate outcome of these proceedings cannot be accurately predicted due to the inherent uncertainty of litigation, in the opinion of management, based upon current information, no other currently pending or overtly threatened proceeding is expected to have a material adverse effect on our business, financial condition or results of operations.

 

11.   Income Taxes

The income tax expense (benefit) for the three months ended March 31, 2015 and 2014 represents our income (loss) before income taxes multiplied by our best estimate of our expected annual effective tax rate taking into consideration our expectation of future earnings, federal income tax, state income tax for state jurisdictions in which we expect taxable income, potential effects of adverse outcomes on tax positions we have taken, true-up effects of prior tax provision estimates compared to actual tax returns, and our net operating loss carryforwards.

 

12.   Segment Information

Our operating and reportable segments are currently organized around the following products and services that we offer as part of our core business strategy:

 

    Distributed Generation solutions;

 

    Solar Energy solutions;

 

    Utility Infrastructure solutions; and

 

    Energy Efficiency solutions.

The Distributed Generation and Solar Energy reporting segments, described in greater detail below, had previously been reported on a combined basis under our Distributed Generation segment as they both utilized distributed generation technology solutions in their products and services, and they shared overhead costs. As a result of the utility-scale solar projects awarded to us in July 2014, we expect the Solar Energy operations will be a material portion of our consolidated revenues and operations in 2015 and for the foreseeable future, and it will be supported by separate overhead costs. In addition, the cost and margin structure of the Solar Energy segment differs from our traditional Distributed Generation segment. For these reasons, we determined it was appropriate to report our Distributed Generation and Solar Energy operations as separate reporting segments commencing in 2015. Our segment information for the three month period ended March 31, 2014 has been reclassified to conform to our current presentation.

 

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Our CODM reviews revenues including intersegment revenues, gross profit and operating income (loss) before income taxes when evaluating segment performance and allocating resources to each segment. Accordingly, intersegment revenue is included in the segment revenues presented in the tables below and is eliminated from revenues and cost of sales in the “Eliminations and Other” column. The “Eliminations and Other” column also includes various expense items that we do not allocate to our operating segments. These expenses include corporate overhead and corporate-wide items such as legal and professional fees as well as expense items for which we have not identified a reasonable basis for allocation. The accounting policies of the reportable segments are the same as those described in Note 2 of the notes to condensed consolidated financial statements.

Distributed Generation

Our Distributed Generation segment manufactures, installs and operates electric generation equipment “on site” at facilities where the power is used, including commercial, institutional and industrial operations. Our Distributed Generation systems typically utilize our proprietary PowerBlock units or, alternatively, generators sourced from major global generator manufacturers as the power plants for our systems. Our Distributed Generation systems provide a highly dependable backup power supply during power outages, and provide a more efficient and environmentally friendly source of power during high cost periods of peak power demand. These two sources of value benefit both utilities and their large customers.

Solar Energy

Our Solar Energy segment engineers, procures, constructs and maintains solar power generation equipment for utilities, independent power producers, developers who sell power to utilities and industrial, commercial and institutional customers for “on site” power requirements. Our Solar Energy systems use photovoltaic solar panels (which we do not manufacture) to provide utilities and their customers with environmentally friendly power to augment their core power requirements.

Utility Infrastructure

Our Utility Infrastructure segment is focused on helping electric utilities design, build, upgrade and maintain infrastructure that enhances the efficiency of their grid systems.

Our largest source of revenue within our Utility Infrastructure area is our UtilityServices products and services. We have significantly expanded our UtilityServices’ scope of utility relationships, customers and geography over the last few years. Our UtilityServices team provides utilities with transmission and distribution construction and maintenance, including substation construction and maintenance, advanced metering and lighting installations, and storm restoration. In addition to providing these services directly to utilities, we also perform this work on behalf of utilities for their large industrial and institutional customers, and directly to large oil and gas companies.

Through our Encari, UtilityEngineering and PowerServices teams, we serve the engineering and consulting needs of our utility clients, broadening our offerings to our utility partners. The scope of services that we offer through UtilityEngineering includes technical engineering services for our utility partners and their customers, including design and engineering relating to virtually every element of their transmission and distribution systems, substations and renewable energy facilities. Through PowerServices, we provide management consulting services to utilities and commercial and industrial customers, including planning and quality improvement, technical studies involving reliability analysis and rate analysis, acquisition studies, accident investigations and power supply contracts and negotiations. Our Encari business, which we acquired in October 2013, provides cybersecurity consulting and regulatory compliance services to the utility industry.

Energy Efficiency

We deliver Energy Efficiency products and services to assist our customers in the achievement of their energy efficiency goals. We have two primary product and service offerings in our Energy Efficiency segment: LED lighting

 

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fixtures and lamps, and energy efficiency upgrades for our Energy Efficiency Services customers. Our LED lighting products are primarily focused on the utility, commercial and industrial, and retail markets, while our Energy Efficiency Services solutions are focused on serving large energy services companies, referred to as ESCOs. In the future, we plan to bring our LED lighting products to our Energy Efficiency Services customer base. In both of our Energy Efficiency segment product and service lines we deliver highly engineered product solutions and upgrades with strong value propositions that are designed to reduce energy costs, improve operations and benefit the environment.

Summarized financial information concerning our reportable segments is shown in the following tables.

 

     Three Months Ended March 31, 2015  
     Distributed
Generation
     Solar
Energy
    Utility
Infrastructure
    Energy
Efficiency
     Eliminations
and Other
    Total  

Revenues

   $ 30,731      $ 6,348     $ 28,883     $ 13,562      $ (15   $ 79,509  

Cost of Sales (excluding depreciation and amortization)

     18,881        5,733       25,033       8,548        (15     58,180  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Gross Profit

  11,850     615     3,850     5,014     —        21,329  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating expenses:

General and administrative

  4,360     780     2,873     3,255     4,366     15,634  

Selling, marketing and service

  1,213     97     336     591     511     2,748  

Depreciation and amortization

  1,070     32     776     392     207     2,477  

Restructuring charges

  —        —        —        —        —        —     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total operating expenses

  6,643     909     3,985     4,238     5,084     20,859  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating income (loss)

  5,207     (294   (135   776     (5,084   470  

Other income and (expenses):

Interest income and other income

  —        —        —        —        1     1  

Interest expense

  —        —        —        —        (269   (269
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

$ 5,207   $ (294 $ (135 $ 776   $ (5,352 $ 202  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total goodwill at March 31, 2015

$ 11,403   $ 4,914   $ 2,325   $ 21,568   $ —      $ 40,210  

Total assets at March 31, 2015

$ 105,984   $ 21,935   $ 56,172   $ 41,686   $ 39,393   $ 265,170  

 

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     Three Months Ended March 31, 2014  
     Distributed
Generation
     Solar
Energy
    Utility
Infrastructure
    Energy
Efficiency
    Eliminations
and Other
    Total  

Revenues

   $ 16,990      $ 505     $ 26,828     $ 8,474     $ —        $ 52,797  

Cost of Sales (excluding depreciation and amortization)

     10,627        539       24,167       6,423       —          41,756  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

  6,363     (34   2,661     2,051     —        11,041  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

General and administrative

  3,030     507     2,923     2,071     4,513     13,044  

Selling, marketing and service

  1,051     113     305     470     70     2,009  

Depreciation and amortization

  778     24     859     360     157     2,178  

Restructuring charges

  —        —        —        427     —        427  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

  4,859     644     4,087     3,328     4,740     17,658  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

  1,504     (678   (1,426   (1,277   (4,740   (6,617

Other income and (expenses):

Interest income and other income

  —        —        —        —        4     4  

Interest expense

  —        —        —        —        (300   (300
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

$ 1,504   $ (678 $ (1,426 $ (1,277 $ (5,036 $ (6,913
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The following discussion and analysis of our consolidated results of operations for the three month period ended March 31, 2015, which we refer to as the first quarter 2015, and the three month period ended March 31, 2014, which we refer to as the first quarter 2014, and of our consolidated financial condition as of March 31, 2015 should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents incorporated into this report by reference contain forward-looking statements within the meaning of and made under the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. From time to time in the future, we may make additional forward-looking statements in presentations, at conferences, in press releases, in other reports and filings and otherwise. Forward-looking statements are all statements other than statements of historical fact, including statements that refer to plans, intentions, objectives, goals, strategies, hopes, beliefs, projections, prospects, expectations or other characterizations of future events or performance, and assumptions underlying the foregoing. The words “may,” “could,” “should,” “would,” “will,” “project,” “intend,” “continue,” “believe,” “anticipate,” “estimate,” “forecast,” “expect,” “plan,” “potential,” “opportunity” and “scheduled,” variations of such words, and other comparable terminology and similar expressions are often, but not always, used to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements about the following:

 

    our prospects, including our future business, revenues, expenses, net income (loss), earnings (loss) per share, margins, profitability, cash flow, cash position, liquidity, financial condition and results of operations, our targeted growth rate and our expectations about realizing the revenues in our backlog and in our sales pipeline;

 

    the effects on our business, financial condition and results of operations of current and future economic, business, market and regulatory conditions, including the current economic and market conditions and their effects on our customers and their capital spending and ability to finance purchases of our products, services, technologies and systems;

 

    the effects of fluctuations in sales on our business, revenues, expenses, net income (loss), earnings (loss) per share, margins, profitability, cash flow, liquidity, financial condition and results of operations;

 

    our products, services, technologies and systems, including their quality and performance in absolute terms and as compared to competitive alternatives, their benefits to our customers and their ability to meet our customers’ requirements, and our ability to successfully develop and market new products, services, technologies and systems;

 

    our markets, including our market position and our market share;

 

    our ability to successfully develop, operate, grow and diversify our operations and businesses;

 

    our business plans, strategies, goals and objectives, and our ability to successfully achieve them;

 

    the effects on our financial condition, results of operations and prospects of our business acquisitions;

 

    the sufficiency of our capital resources, including our cash and cash equivalents, funds generated from operations, availability of borrowings under our credit and financing arrangements and other capital resources, to meet our future working capital, capital expenditure, lease and debt service and business growth needs;

 

    the value of our assets and businesses, including the revenues, profits and cash flow they are capable of delivering in the future;

 

    industry trends and customer preferences and the demand for our products, services, technologies and systems;

 

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    the nature and intensity of our competition, and our ability to successfully compete in our markets;

 

    fluctuations in our effective tax rates, including the expectation that with the utilization of a significant portion of our tax net operating losses in recent years our tax expense in future years will likely approximate prevailing statutory tax rates;

 

    fluctuations in the gross margins of our Utility Infrastructure segment, as well as our ability to improve inefficiencies in that segment designed to improve those gross margins;

 

    the timing of, and our ability to successfully execute on, the large solar projects;

 

    business acquisitions, combinations, sales, alliances, ventures and other similar business transactions and relationships; and

 

    the effects on our business, financial condition and results of operations of litigation, including but not limited to the securities class action litigation, warranty claims and other claims and proceedings that arise from time to time.

Any forward-looking statements we make are based on our current plans, intentions, objectives, goals, strategies, hopes, beliefs, projections and expectations, as well as assumptions made by and information currently available to management. Forward-looking statements are not guarantees of future performance or events, but are subject to and qualified by substantial risks, uncertainties and other factors, which are difficult to predict and are often beyond our control. Forward-looking statements will be affected by assumptions and expectations we might make that do not materialize or that prove to be incorrect and by known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those expressed, anticipated or implied by such forward-looking statements. These risks, uncertainties and other factors include, but are not limited to, those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, as amended or supplemented in subsequently filed Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as other risks, uncertainties and factors discussed elsewhere in this report, in documents that we include as exhibits to or incorporate by reference in this report, and in other reports and documents we from time to time file with or furnish to the Securities and Exchange Commission. In light of these risks and uncertainties, you are cautioned not to place undue reliance on any forward-looking statements that we make.

Any forward-looking statements contained in this report speak only as of the date of this report, and any other forward-looking statements we make from time to time in the future speak only as of the date they are made. We undertake no duty or obligation to update or revise any forward-looking statement or to publicly disclose any update or revision for any reason, whether as a result of changes in our expectations or the underlying assumptions, the receipt of new information, the occurrence of future or unanticipated events, circumstances or conditions or otherwise.

Overview

PowerSecure International, Inc., headquartered in Wake Forest, North Carolina, is a leading provider of products and services to electric utilities, and their large commercial, institutional and industrial customers.

We currently provide products and services through the following operating segments: our Distributed Generation segment, our Solar Energy segment, our Utility Infrastructure segment, and our Energy Efficiency segment. These operating segments constitute our major product and services offerings, each of which are focused on serving the needs of utilities and their commercial, institutional and industrial customers to help them generate, deliver, and utilize electricity more reliably and efficiently. Each of our operating segments also represents a reporting segment.

The Distributed Generation and Solar Energy operating segments, described in greater detail below, had previously been reported on a combined basis under our Distributed Generation segment as they both utilized distributed generation technology solutions in their products and services, and they shared overhead costs. As a result of the utility-scale solar projects awarded to us in July 2014, we expect the Solar Energy operations will be a material portion of our consolidated revenues and operations in 2015 and for the foreseeable future, and it will be supported by separate overhead costs. In addition, the cost and margin structure of the Solar Energy segment differs from our traditional Distributed Generation segment. For these reasons, we determined it was appropriate to report our Distributed Generation and Solar Energy operations as separate reporting segments commencing in 2015.

 

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Our strategy is focused on growing these segments because they require unique knowledge and skills that utilize our core competencies, and because they address large market opportunities due to their strong customer value propositions. They share common or complementary utility relationships and customer types, common sales and overhead resources, and facilities. However, we discuss and distinguish our operations among these segments due to their unique products and services, market needs they are addressing, cost structure, and the distinct technical disciplines and specific capabilities required for us to deliver them, including personnel, technology, engineering, and intellectual capital.

We currently operate primarily out of our Wake Forest, North Carolina headquarters office, and our operations also include several satellite offices and manufacturing facilities, the largest of which are in the Raleigh and Greensboro, North Carolina, Atlanta, Georgia, Bethlehem, Pennsylvania, and Stamford, Connecticut areas. The locations of our sales organization and field employees for our operations are generally in close proximity to the utilities and commercial, industrial, and institutional customers they serve. Our operating segments are operated through our principal operating wholly-owned subsidiary, PowerSecure, Inc.

Distributed Generation

Our Distributed Generation segment manufactures, installs and operates electric generation equipment “on site” at a facility where the power is used, including commercial, institutional and industrial operations. Our Distributed Generation systems typically utilize our proprietary PowerBlock units or, alternatively, generators sourced from major global generator manufacturers as the power plants for our systems. Our systems provide a highly dependable backup power supply during power outages, and provide a more efficient and environmentally friendly source of power during high cost periods of peak power demand. These two sources of value benefit both utilities and their large customers. In October 2014, we acquired the Mission Critical Energy Services operations which provides full turnkey electrical infrastructure design, implementation and commissioning services to data center owners. The Mission Critical Energy Services operations have been integrated within our Distributed Generation segment.

Our Distributed Generation systems are sold to customers utilizing two basic economic models, each of which can vary depending on the specific customer and application. In our traditional business model, which is our predominant model, we sell the Distributed Generation system to the customer. We refer to this as a “project-based” or a “customer-owned” model. For Distributed Generation systems sold under the project-based model, the customer acquires ownership of the Distributed Generation assets upon our completion of the project. Our revenues and profits from the sale of systems under this model are recognized over the period during which the system is installed. In the project-based model, after the system is installed we will also usually receive a modest amount of on-going monthly revenues to monitor the system for backup power and peak shaving purposes, as well as to maintain the system.

Our second business model is structured to generate long-term recurring revenues for us, which we refer to as our “recurring revenue model” or “PowerSecure-owned” or “company-owned” model. For Distributed Generation systems deployed under this model, we retain ownership of the Distributed Generation system after it is installed at the customer’s site. Because of this, we invest the capital required to design and build the system, and our revenues are derived from regular fees paid over the life of the recurring revenue contract by the utility or the customer, or both, for access to the system for standby power and peak shaving. The life of these recurring revenue contracts is typically from five to fifteen years. The fees that generate our revenues in the recurring revenue model are generally paid to us on a monthly basis and are established at amounts intended to provide us with attractive returns on the capital we invest in installing and maintaining the Distributed Generation system. Our fees for recurring revenue contracts are generally structured as shared savings arrangements, although they can also be structured with fixed monthly payments. For our shared savings contracts, a portion or all of our fees are earned out of the pool of peak shaving savings the system creates for the customer.

In both economic models, we believe that the customer value proposition is strong. In the customer-owned model, where the customer pays for and obtains ownership of the system, the customer’s typical targeted returns on investment range from 15% to 25%, with a payback targeted at three to five years. These paybacks to the customer result from a combination of the benefits of peak shaving, which creates lower total electricity costs, and the value that the backup power provides in avoiding losses from business interruptions due to power outages. Additionally, utilities gain the benefits of smoother electricity demand curves and lower peaks, as the result of having highly reliable standby power supporting customers in their utility systems, power distribution and transmission efficiencies, and of avoiding major

 

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capital outlays that would have been required to build centralized power plants and related infrastructure for peaking needs. In our PowerSecure-owned model, where we pay for, install and maintain ownership of the system in exchange for the customer paying us fees over a period of years, and utilities and their customers receive access to our system without making a large up-front investment of capital. Under the PowerSecure-owned model, contracts can be structured between us and the utility, us and the customer, or all three parties.

In the first quarter 2015, 88.3% of our Distributed Generation systems revenues consisted of customer-owned system sales, and 11.7% of our Distributed Generation systems revenues were derived from recurring revenue sales. Sales of customer-owned systems deliver revenues and profits that are recorded on our financial statements over the course of the project, which is generally over a three to 18 month timeframe depending on the size of the project, and sales of PowerSecure-owned projects are recorded over a longer time frame of five to 15 years depending on the life of the underlying contract. Therefore, shifts in the sales of customer-owned versus PowerSecure-owned systems have significant impacts on our near-term revenues and profits and cause them to fluctuate from period-to-period. An additional contrast of the two models is that sales under the PowerSecure-owned system model generate revenues and profits that are more consistent from period-to-period and have higher gross margins, and generate revenues and profits over a longer time period, although smaller in dollar amount in any particular period because they are recognized over the life of the contract. Our PowerSecure-owned recurring revenue model requires us to invest our own capital in the project without any return on capital until after the project is completed, installed, commissioned and successfully operating.

Solar Energy

Our Solar Energy operating segment, which is operated primarily by our PowerSecure Solar subsidiary, is a natural extension of our traditional Distributed Generation product and service segment. Our Solar Energy systems use photovoltaic solar panels (which we do not manufacture) to provide utilities and their customers with environmentally friendly power to augment their core power requirements. Our PowerSecure Solar team provides us with the ability to deliver Solar Energy systems integrated with our Distributed Generation solutions platform. These Solar Energy systems are sold under the project-based, customer-owned model. In 2014, our Solar Energy distributed generation business significantly expanded under a major award from one of the largest investor-owned utilities in the U.S. to provide two utility-scale solar installations that we expect to generate approximately $120 million in revenues during 2015 and 2016.

Utility Infrastructure

Our Utility Infrastructure operating segment is focused on helping electric utilities design, build, upgrade and maintain infrastructure that enhances the efficiency of their grid systems.

Our largest source of revenue within our Utility Infrastructure segment is our UtilityServices products and services. We have significantly expanded our UtilityServices’ scope of utility relationships, customers and geography over the last few years. Our UtilityServices team provides utilities with transmission and distribution construction and maintenance, including substation construction and maintenance, advanced metering and lighting installations, and storm restoration. In addition to providing these services directly to utilities, we also perform this work on behalf of utilities for their large industrial and institutional customers, and directly to large oil and gas companies. Similar to the products and services we provide for utilities, our work for large utility customers includes turn-key design, procurement and construction services for large transmission and distribution projects, including substations. Our resources include a fleet of owned and leased utility vehicles along with experienced field personnel and engineers, and we also utilize third party resources from time to time, as needed, to supplement our internal resources on particular projects.

Through our Encari, UtilityEngineering and PowerServices teams, we serve the engineering and consulting needs of our utility clients, broadening our offerings to our utility partners. The scope of services that we offer through UtilityEngineering includes technical engineering services for our utility partners and their customers, including design and engineering relating to virtually every element of their transmission and distribution systems, substations and renewable energy facilities. Through PowerServices, we provide management consulting services to utilities and commercial and industrial customers, including planning and quality improvement, technical studies involving reliability analysis and rate analysis, acquisition studies, accident investigations and power supply contracts and negotiations. Our Encari business provides cybersecurity consulting and compliance services to the utility industry, helping large investor owned utilities (“IOUs”), municipalities and cooperative utilities assess, improve and maintain their compliance with the NERC’s CIP Reliability Standards.

 

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Revenues for our UtilityServices products and services are generally earned, billed, and recognized using two primary models. Under the first model, we have regular, on-going assignments with utilities to provide maintenance and upgrade services. These services are earned, billed, and recognized either on a fixed unit fee basis, based on the number of work units we perform, such as the number of transmission poles we upgrade, or on a time and materials basis, based on the number of hours we invest in a particular project, plus amounts for the materials we utilize and install. Under the second model, we are engaged to design, build and install large infrastructure projects, including substations, transmission and distribution lines and similar infrastructure, for utilities and their customers. In these types of projects we are generally paid a fixed contractual price for the project, plus any modifications or scope adjustments. We recognize revenues from these projects on a percentage-of-completion basis. In addition to these two primary models, in the future we could be engaged by utilities and their customers to build or upgrade transmission and distribution infrastructure that we own and maintain. In those cases, we would receive fees over a long-term contract in exchange for providing the customer with access to the infrastructure to transmit or receive power.

Revenues for our Encari, UtilityEngineering and PowerServices consulting services are earned, billed, and recognized based on the number of hours invested in the particular projects and engagements they are serving. Similar to most traditional consulting businesses, these hours are billed at rates that reflect the general technical skill or experience level of the consultant or supervisor providing the services. In some cases, our engineers and consultants are engaged on an on-going basis with utilities, providing resources to supplement utilities’ internal engineering teams over long-term time horizons. In other cases, our engineers and consultants are engaged to provide services for very specific projects and assignments.

Energy Efficiency

We deliver Energy Efficiency solutions to assist our customers in the achievement of their energy efficiency goals. We have two primary Energy Efficiency product and service offerings: light emitting diode, or LED, lighting fixtures and lamps, and energy efficiency upgrades for large energy services companies, referred to as ESCO customers, and large retailers. Our LED lighting solutions are primarily focused on the utility, commercial and industrial markets, while our energy efficiency solutions are primarily focused on serving Energy Services Companies (“ESCO”) and retail channels. We have begun including our Distributed Generation products and services in our Energy Efficiency Services solutions. In the future, we also plan to bring our LED lighting solutions to our ESCO and retail customer base. In both of our Energy Efficiency product and service lines we deliver highly engineered product solutions and upgrades with strong value propositions that are designed to reduce energy costs, improve operations and benefit the environment.

Our LED lighting products include our PowerSecure Lighting, Solais, EfficientLights, IES and EnergyLite operations and brands, all of which are focused on bringing LED lighting solutions to the marketplace. As a result of our acquisition of Solais in 2013, we realigned and consolidated these operations into PowerSecure Lighting, which is now leading all of our LED operations, although we may continue to have legacy brands in the marketplace for a period of time. In 2013, we acquired our Energy Efficiency Services business, which gives us the capability to provide general lighting, building envelope, HVAC and water efficiency solutions to ESCOs, which deliver these energy efficiency solutions to commercial, industrial and institutional facilities. On September 2, 2014, we acquired the electrical contracting business of Apex Controls, Inc. (“Apex”). The acquired business provides retrofit and electrical contracting services to major retailers, in most cases through general contractors, and provides us with the capacity to provide our Energy Efficiency Services solutions to large retailers.

Our LED lighting products, led by our PowerSecure Lighting team, include the following:

 

    Our Solais brand, which includes LED-based lamps and fixtures for department stores and other commercial applications. The 2013 acquisition of Solais strengthened and complemented our existing LED lighting business through the addition of these new product lines and customer channels. This acquisition also enhanced our skill sets around product design, product commercialization, and manufacturing and sourcing capabilities.

 

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    Our EfficientLights brand, which includes LED-based lighting fixtures for grocery, drug and convenience stores. EfficientLights products include our EfficientLights fixture for reach-in refrigerated cases, shelf and canopy lighting for open refrigerated cases, overhead lighting for walk-in storage coolers.

 

    Our IES brand, which includes LED-based lighting fixtures for utilities, commercial and industrial, and OEM applications. IES products include street lights, area lights, indoor overhead lighting, and other specialty lighting applications.

 

    Our EnergyLite brand, which is used to market our IES and EfficientLights brands primarily, but we may also use it from time to time for other LED lighting products. EnergyLite’s products are marketed to customers and utilities directly, and through third party distribution arrangements.

The primary client base for our Energy Efficiency Services business consists of large, publicly-traded ESCOs. Through our relationships with these ESCOs, we provide facility upgrades for public sector customers, including federal, state and local government agencies and educational institutions. As ESCOs are awarded project contracts with public sector clients, we assist them by providing energy efficiency expertise to develop and implement tailored solutions under their contracts. From time to time, we also serve larger retail, commercial and industrial clients for which we provide our products and services directly, when an ESCO is not involved in the customer relationship.

We focus on deploying solutions to improve the energy efficiency of large facilities, including reducing energy-related expenditures, and the impact of energy use on operations and the environment. This helps the ESCO’s customers save money, improve facilities and meet energy efficiency goals and mandates. Our solutions include energy efficient lighting upgrades, energy efficient mechanical and electrical retrofit and upgrade services, water conservation, building weatherization, and renewable energy project development and implementation. We provide energy solutions across a range of facilities, including high-rise office buildings, distribution facilities, manufacturing plants, retail sites, multi-tenant residential buildings, mixed use complexes, hospitals, universities and large government sites. We plan to continue to offer our Distributed Generation and LED lighting products as part of these solutions.

Our LED lighting revenues are generated through the sale of LED-based light fixtures and lamps. Our portfolio of products consists exclusively of our proprietary designs, which are generally focused on very specific applications. These applications require our lights to be highly engineered to maximize the quality, and amount of light produced, at the lowest cost. This formula, in turn, enables us to provide our customers with lighting that maximizes the return on investment for their lighting spend. We design and manufacture our LED-based lights for utilities, commercial and industrial customers. Our lighting generally reduces energy consumption by 60-70%, improves the quality of light, reduces maintenance expense, extends light life, lowers a facilities’ carbon footprint, and eliminates the use of traditional lighting which can contain environmental hazards.

Our LED lighting product line includes:

 

    LED-based lamps and fixtures for department stores and other commercial applications, including display and down-lighting;

 

    LED-based lighting fixtures for grocery, drug and convenience stores, including lights for reach-in refrigerated cases, shelf and canopy lighting for open refrigerated cases, and overhead lighting for walk-in storage coolers; and

 

    LED-based lighting fixtures for utilities, commercial and industrial, and OEM applications, including street lights, area lights, indoor overhead lighting, and other specialty lighting applications.

The majority of our LED lights are sold as retrofits for existing traditional lighting, and to a lesser extent for new construction lighting installations. Additionally, historically the majority of our lights have been sold by us directly to our customers, although we also have distributor relationships that serve certain product lines and are becoming an increasing part of our sales channels. Occasionally we provide installation services, although that is not a significant portion of our business. We also assist our customers in receiving utility incentives for LED lighting. Our customers are primarily large retail chains, utilities, department stores, and large commercial and industrial customers. These customers typically install

 

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LED lighting across numerous locations over a diverse geographic scope. We expect our customer base and sales channels to continue to grow and develop as LED technology continues to be more widely adopted. As we bring additional products to market, we expect to employ a similar business model with our LED lighting products with a greater portion of our sales driven through distributorship channels.

Our Energy Efficiency Services business revenues are generated through a full range of turn-key services we provide to ESCOs and retailers. We apply our engineering expertise to analyze each facility’s energy consumption and operational needs, and develop customized energy efficiency and renewable energy solutions to optimize that facility’s return on investment. We provide complete turn-key implementation services for a range of energy efficiency and renewable energy projects, including energy efficient lighting upgrades, energy efficiency mechanical and electrical retrofit and upgrade services, water conservation, weatherization, combined heat and power or cogeneration and renewable project development and implementation. We consider factors such as current facility infrastructure, best available technologies, building environmental conditions, hours of operation, energy costs, available utility rebates, tax incentives, and installation, operation and maintenance costs of various efficiency alternatives. Our extensive knowledge of energy solutions and their results in numerous environments enables us to apply some of the most appropriate, effective and proven technologies available in the marketplace.

Recent Developments

On April 29, 2015, we announced that we received approximately $35 million in new Distributed Generation business awards. These Distributed Generation awards include an approximately $20 million energy storage project, approximately $10 million in new data center projects, and approximately $5 million in new hospital projects.

On March 17, 2015, we announced that we received approximately $50 million in new business, including approximately $26 million of new Distributed Generation business awards, approximately $16 million of new Utility Infrastructure business awards and approximately $8 million of new Energy Efficiency business awards. The $26 million of new Distributed Generation business awards includes $5 million of new commercial and developer driven solar projects, $15 million of traditional Distributed Generation turnkey projects, and $6 million of company-owned Distributed Generation systems.

Financial Results Highlights

Our consolidated revenues in the first quarter 2015 were $79.5 million, an increase of $26.7 million, or 50.6%, over our consolidated revenues during the first quarter 2014. The drivers of this year-over-year revenue increase were revenue increases in each of our operating segments, as follows: a $13.7 million, or 80.9%, increase in our Distributed Generation segment revenues; a $5.8 million, or 1,157.0%, increase in our Solar Energy segment revenues; a $2.1 million, or 7.7%, increase in our Utility Infrastructure segment revenues; and a $5.1 million, or 60.0%, increase in our Energy Efficiency segment revenues. The increase in our Distributed Generation segment revenues during the first quarter 2015 was a result of an increase in traditional turn-key Distributed Generation project sales and an increase in sales from our recently acquired Mission Critical Energy Services operations. The increase in our Solar Energy segment revenues reflects an increase in the number and size of solar projects we are executing year-over-year, as well as an overall increase in customer demand for solar solutions, driven, in part, by the scheduled expiration or reduction of various alternative energy tax credits in late 2016. The increase in our Utility Infrastructure revenues was due to a $2.4 million increase in UtilityServices revenues, partially offset by a $0.4 million reduction in revenues from engineering and consulting services. The increase in our UtilityServices revenue was primarily due to our efforts in the second half of 2014 which focused on new business development activity as we improved operational performance in our UtilityServices operations. The increase in our Energy Efficiency segment revenues was due to an increase in both LED lighting product sales and revenues from our Energy Efficiency Services projects.

Our first quarter 2015 gross margin as a percentage of revenue increased to 26.8%, compared to 20.9% in the first quarter 2014, on a consolidated basis. This year-over-year gross profit margin increase was driven by improvements in each of our reporting segments. Utility Infrastructure segment gross profit margins were 13.3% in the first quarter 2015 compared to 9.9% in the first quarter 2014. Energy Efficiency segment gross profit margins were 37.0% in the first quarter 2015 compared to 24.2% in the first quarter 2014. Distributed Generation segment gross profit margins were 38.6% in the first quarter 2015 compared to 37.5% in the first quarter 2014. Solar Energy segment gross profit margins

 

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were 9.7% in the first quarter 2015 compared to a negative 6.7% in the first quarter 2014. The improvement in our Utility Infrastructure segment gross profit margin is due to improved operational efficiencies within our UtilityServices operations. The Energy Efficiency segment gross profit margin improvement was driven primarily by improvements in our LED product gross margins. Our Distributed Generation segment gross profit margins increased due to differences in the mix of projects period-to-period. Our Solar Energy segment gross profit margins increased due to improved efficiencies driven by the significant increase in revenues in the first quarter 2015 compared to the first quarter 2014. As is always the case, variability in our quarterly and year-to-date gross profit margins is also caused by regular on-going differences in the mix of specific projects completed in each period.

Our operating expenses during the first quarter 2015 increased by $3.2 million, or 18.1%, compared to our operating expenses during the first quarter 2014. The year-over-year increase in operating expenses was driven by increases in general and administrative expense due to incremental operating expenses associated with the acquisition of the Retail Energy Services business in September 2014 and Mission Critical business in October 2014. The remaining year-over-year increase in our operating expenses was driven by increases in personnel, employee benefits and insurance, stock compensation expense, and professional fees to support our growing business platforms, an increase in selling expenses due to additional sales executives, and depreciation and amortization from our investments in utility infrastructure equipment, company-owned distributed generation systems, and acquisition-related intangibles.

Our consolidated operating income for the first quarter 2015 was $0.5 million compared to an operating loss of ($6.6) million for the first quarter 2014, which included $0.7 million of restructuring charges. The following table summarizes our operating income (loss) by reporting segment for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Segment operating income (loss):

           

Distributed Generation

   $ 5,207       $ 1,504       $ 3,703         246.2

Solar Energy

     (294      (678      384         56.6

Utility Infrastructure

     (135      (1,426      1,291         90.5

Energy Efficiency

     776         (1,277      2,053         160.8

Corporate and other unallocated costs

     (5,084      (4,740      (344      (7.3 )% 
  

 

 

    

 

 

    

 

 

    

Total

$ 470    $ (6,617 $ 7,087      107.1
  

 

 

    

 

 

    

 

 

    

Our consolidated net income for the first quarter 2015 was $0.1 million, or $0.01 per diluted share, compared to a net loss of ($4.3) million, or ($0.19) per diluted share, for the first quarter 2014.

As discussed below under “—Fluctuations,” our financial results will fluctuate from quarter to quarter and year to year. Thus, there is no assurance that our past results, including the results of our year ended December 31, 2014 or our quarter ended March 31, 2015, will be indicative of our future results, especially in light of the current economic conditions and unfavorable credit and capital markets.

 

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Backlog

As of the date of this report, our revenue backlog expected to be recognized after March 31, 2015 is $402 million. This includes revenue related to the new business awards described above under “—Recent Developments”. Our revenue backlog represents revenue expected to be recognized after March 31, 2015, for periods including the second quarter of 2015 onward. This backlog figure compares to the revenue backlog of $368 million we reported in our Annual Report on Form 10-K for the year ended December 31, 2014 filed on March 4, 2015 (the date we last reported our backlog). Our revenue backlog and the estimated timing of revenue recognition is outlined below, including “project-based revenues” expected to be recognized as projects are completed and “recurring revenues” expected to be recognized over the life of the contracts:

Revenue Backlog expected to be recognized after March 31, 2015

 

Description

   Anticipated
Revenue
    

Estimated Primary
Recognition Period

Project-based Revenue — Near term

   $ 224 million       2Q15 through 4Q15

Project-based Revenue — Long term

   $ 111 million       1Q16 through 4Q16

Recurring Revenue

   $ 67 million       2Q15 through 2020
  

 

 

    

Revenue Backlog expected to be recognized after March 31, 2015

$ 402 million   

Note: Anticipated revenue and estimated primary recognition periods are subject to risks and uncertainties as indicated in “Cautionary Note Regarding Forward-Looking Statements” above. Consistent with past practice, these amounts are not intended to constitute our total revenue over the indicated time periods, as we have additional, regular on-going revenues. Examples of additional, regular recurring revenues include revenues from engineering fees, and service revenue, among others. Numbers may not add due to rounding.

Orders in our backlog are subject to delay, deferral, acceleration, resizing, or cancellation from time to time by our customers, subject to contractual rights, and estimates are utilized in the determination of the backlog amounts. Given the irregular sales cycle of customer orders, and especially of large orders, our revenue backlog at any given time is not necessarily an accurate indication of our future revenues.

Operating Segments

Our operating and reportable segments are currently organized around the following products and services that we offer as part of our core business strategy:

 

    Distributed Generation solutions;

 

    Solar Energy solutions;

 

    Utility Infrastructure solutions; and

 

    Energy Efficiency solutions.

The Distributed Generation and Solar Energy reporting segments, described in greater detail above, had previously been reported on a combined basis under our Distributed Generation segment as they both utilized distributed generation technology solutions in their products and services, and they shared overhead costs. As a result of the utility-scale solar projects awarded to us in July 2014, we expect the Solar Energy operations will be a material portion of our consolidated revenues and operations in 2015 and for the foreseeable future, and it will be supported by separate overhead costs. In addition, the cost and margin structure of the Solar Energy segment differs from our traditional Distributed Generation segment. For these reasons, we determined it was appropriate to report our Distributed Generation and Solar Energy operations as separate reporting segments commencing in 2015. Our segment information for the three month period ended March 31, 2014 has been reclassified to conform to our current presentation.

Results of Operations

The following discussion regarding segment revenues, gross profit, costs and expenses, and other income and expenses for the first quarter 2015 compared to the first quarter 2014 are entirely attributable to our reportable segments together with corporate and other unallocated cost items as noted in the tables and discussion below.

First Quarter 2015 Compared to First Quarter 2014

Revenues

Our consolidated revenues are generated entirely by product sales and services by our four reporting segments: Distributed Generation, Solar Energy, Utility Infrastructure, and Energy Efficiency. Intersegment revenues, if any, are eliminated from total segment revenues as reflected in the tables below. The following table summarizes our revenues, including intersegment revenues, by these segments for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Segment Revenues:

           

Distributed Generation

   $ 30,731       $ 16,990       $ 13,741         80.9

Solar Energy

     6,348         505         5,843         1,157.0

Utility Infrastructure

     28,883         26,828         2,055         7.7

Energy Efficiency

     13,562         8,474         5,088         60.0

Intersegment Eliminations

     (15      —           (15      n/m   
  

 

 

    

 

 

    

 

 

    

Total

$ 79,509    $ 52,797    $ 26,712      50.6
  

 

 

    

 

 

    

 

 

    

 

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Our consolidated revenues in the first quarter 2015 of $79.5 million increased $26.7 million, or 50.6%, compared to the first quarter 2014, due to an increase in sales in each of our reporting segments. The first quarter 2015 increase in revenues was driven by our acquisition of the Mission Critical Energy Services operations which we acquired in October 2014 as well as improvements in converting our pipeline of sales opportunities into contracted backlog and sales.

Our revenues are significantly affected by the number, size and timing of our Distributed Generation, Solar Energy, Utility Infrastructure and Energy Efficiency projects as well as the percentage of completion of in-process projects, and the percentage of customer-owned as opposed to PowerSecure-owned distributed generation recurring revenue projects. Our sales have fluctuated significantly in the past and are expected to continue to fluctuate significantly in the future. The increase in our revenues in the first quarter 2015 over the first quarter 2014 consisted of a $13.7 million, or 80.9%, increase in revenues from our Distributed Generation segment, a $5.8 million, or 1,157.0% increase in revenues from our Solar Energy segment, a $2.1 million, or 7.7%, increase in revenues from our Utility Infrastructure segment and a $5.1 million, or 60.0%, increase in revenues from our Energy Efficiency segment.

The year-over-year increase in our Distributed Generation segment revenues was driven primarily by a $5.1 million increase in traditional turn-key Distributed Generation project sales and an $8.7 million of revenues from our Mission Critical Energy Services operations which we acquired in October 2014. The increase in our Solar Energy segment revenues reflects an increase in the number and size of solar projects we are executing year-over-year, as well as an overall increase in customer demand for solar solutions, driven, in part, by the scheduled expiration or reduction of various alternative energy tax credits in late 2016. The year-over-year increase in our Utility Infrastructure segment revenues was due a $2.4 million increase in UtilityServices revenue, partially offset by a $0.4 million reduction in revenues from engineering and consulting services we provide to utilities. The increase in our UtilityServices revenue was primarily due to our efforts in the second half of 2014 which focused on new business development activity as we improved operational performance in our UtilityServices operations. The increase in our Energy Efficiency segment revenues was due to a $4.3 million increase in LED lighting product sales and a $0.8 million increase in revenues from our Energy Efficiency Services projects. In the near-term, based on the increases in our backlog, we expect our revenues to continue to show year-over-year growth, although our overall revenues are always subject to project completion timing and other factors.

Our future revenues will also depend on the vitality of the domestic economy, the health of the credit markets and the continuing levels of customer spending for capital improvements and energy efficiency projects, as well as our ability to secure new significant purchase orders, to expand our markets and product and service lines and to convert our sales pipeline into contract awards, and to realize the growth opportunities provided by our recent acquisitions and any future acquisitions. The amount and timing of our future revenues will also be affected by the amount and proportion of revenues generated by future PowerSecure-owned Distributed Generation recurring revenue projects, which result in revenue being recognized over a longer period. We are particularly susceptible to changes in economic conditions because our product offerings are generally considered discretionary investment items by our customers, who may delay or defer large sales orders, depending on their business requirements and capital budgets.

 

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Gross Profit and Gross Profit Margin

Our gross profit represents our revenues less our cost of sales. Our gross profit margin represents our gross profit divided by our revenues. The following table summarizes our cost of sales by segment, along with our segment gross profit and gross profit margins for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
    Period-over-Period
Difference
 
     2015     2014     $      %  

Segment Cost of Sales (excluding depreciation and amortization):

         

Distributed Generation

   $ 18,881      $ 10,627      $ 8,254         77.7

Solar Energy

     5,733        539        5,194         963.6

Utility Infrastructure

     25,033        24,167        866         3.6

Energy Efficiency

     8,548        6,423        2,125         33.1

Intersegment Eliminations

     (15     —          (15      n/m   
  

 

 

   

 

 

   

 

 

    

Total

$ 58,180    $ 41,756    $ 16,424      39.3
  

 

 

   

 

 

   

 

 

    

Segment Gross Profit:

Distributed Generation

$ 11,850    $ 6,363    $ 5,487      86.2

Solar Energy

  615      (34   649      1,908.8

Utility Infrastructure

  3,850      2,661      1,189      44.7

Energy Efficiency

  5,014      2,051      2,963      144.5
  

 

 

   

 

 

   

 

 

    

Total

$ 21,329    $ 11,041    $ 10,288      93.2
  

 

 

   

 

 

   

 

 

    

Segment Gross Profit Margins:

Distributed Generation

  38.6   37.5

Solar Energy

  9.7   (6.7 )% 

Utility Infrastructure

  13.3   9.9

Energy Efficiency

  37.0   24.2

Total

  26.8   20.9

Cost of sales includes materials, vehicles, personnel and related overhead costs incurred to manufacture products and provide services, but excludes depreciation and amortization. Cost of sales also includes inventory write-downs occurring in the normal course of business, as well as those occurring in connection with periodic restructuring and realignment actions. Intersegment cost of sales from intersegment revenues are eliminated from total cost of sales. The 39.3% increase in our consolidated cost of sales and services for the first quarter 2015 compared to the first quarter 2014 was driven by the increase in costs associated with the 50.6% increase in sales and other factors discussed below leading to the improvement in our gross profit margin.

Our consolidated gross profit increased $10.3 million, or 93.2%, in the first quarter 2015 compared to the first quarter 2014. As a percentage of revenue, our consolidated gross margin in the first quarter 2015 was 26.8%, an increase of 5.9 percentage points compared to the first quarter 2014. This year-over-year gross profit margin increase was driven by improvements in each of our reporting segments. Utility Infrastructure segment gross profit margins were 13.3% in the first quarter 2015 compared to 9.9% in the first quarter 2014. Energy Efficiency segment gross profit margins were 37.0% in the first quarter 2015 compared to 24.2% in the first quarter 2014. Distributed Generation segment gross profit margins were 38.6% in the first quarter 2015 compared to 37.5% in the first quarter 2014. Solar Energy segment gross profit margins were 9.7% in the first quarter 2015 compared to a negative 6.7% in the first quarter 2014. The improvement in our Utility Infrastructure segment gross profit margin is due to improved operational efficiencies within our UtilityServices operations. In particular, our first quarter 2014 Utility Services gross profit margins were negatively impacted by the effects of unfavorable service arrangements and work assignments from a large utility customer. In June 2014, we successfully modified the service arrangement with the utility customer to improve the terms of our ongoing service, including positive adjustments to future pricing, work assignments and expected improvements in the ongoing

 

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scope of work. The Energy Efficiency segment gross profit margin improvement was driven primarily by improvements in our LED product and service gross margins. Our Distributed Generation segment gross profit margins increased due to differences in the mix of projects period-to-period. Our Solar Energy segment gross profit margins increased due to the significant increase in year-over-year revenues in the first quarter 2015 compared to the first quarter 2014.

An important driver in the period-over-period change in our consolidated gross profit margin is the relative gross profit margins we generally earn in each of our Distributed Generation, Solar Energy, Utility Infrastructure and Energy Efficiency reporting segments. Our Distributed Generation segment products and services generally yield gross profit margins in the 25-45% range, our Solar Energy segment products and services generally yield gross profit margins that are in the 5-20% range, our Utility Infrastructure segment products and services generally yield gross profit margins in the 5-25% range, and our Energy Efficiency segment products generally yield gross profit margins in the 15-40% range (with our ESCO revenues having gross profit margins that are generally at the mid-point of this range). The gross profit margin we realize in each of our reporting segments largely correlates to the amount of value-added products and services we deliver, with highly engineered, turn-key projects realizing higher gross profit margins due to the benefits they deliver our customers and the value we deliver because we are vertically integrated. Because of these gross profit margin differences, changes in the mix of our segment revenues, and individual product lines within those segments, affect our consolidated gross profit margin results.

Our gross profit and gross profit margin have been, and we expect will continue to be, affected by many factors, including the following:

 

    the absolute level of revenue achieved in any particular period, given that portions of our cost of sales are relatively fixed over the near-term, the most significant of which is personnel and equipment costs;

 

    our ability to continue to improve and realize the financial benefits of operational efficiencies in our Utility Infrastructure segment, in particular our UtilityServices area, including increasing our revenue and improving the productivity of our personnel and equipment as well as managing our labor and asset costs during periods when work assignments, and therefore revenue, is lower or when our crews are in-between work assignments;

 

    the mix of higher and lower margin projects, products and services, and the impact of new products and technologies on our pricing and volumes;

 

    the allocation of revenue among each of our Distributed Generation, Solar Energy, Utility Infrastructure and Energy Efficiency segments, and products and services within these segments, which have different gross profit margins, and certain types of projects within each segment, such as lower margin solar projects in our Solar Energy segment;

 

    the impact of our utility-scale solar projects in our Solar Energy segment that we expect will deliver $120 million of revenues at significantly lower gross margins primarily during 2015 and 2016;

 

    our ability to execute on our customer orders efficiently and with operational excellence, to generate customer satisfaction, profitability and future additional business, especially with respect to significant awards such as the utility-scale solar projects;

 

    our ability to benefit from economies of scale, including the ability to re-source from low-cost manufacturers;

 

    our level of investments in our businesses, particularly for anticipated or new business awards;

 

    improvements in technology and manufacturing methods and processes;

 

    the impact of competition on our volumes or pricing;

 

    our ability to manage our materials and labor costs, including any future inflationary pressures;

 

    the costs to maintain and operate Distributed Generation systems we own in conjunction with recurring revenue contracts, including the price of fuel, run hours, weather, and the amount of fuel utilized in their operation, as well as their operating performance;

 

    the geographic density of our projects;

 

    the selling price of products and services sold to customers, and the revenues we expect to generate from recurring revenue projects;

 

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    the rate of growth of our new businesses, which tend to incur costs in excess of revenues in their earlier phases and then become profitable and more efficient over time if they are successful;

 

    the impact of acquisitions of businesses, assets and technologies, including differing margins of new products and services acquired and our ability to strategically benefit from cost efficiencies these acquisitions provide and to manage the costs of our related growth from acquisitions;

 

    the ability to realize gross profit margin increases from our operations that have lower gross profit margin profiles, such as our Solar Energy segment;

 

    costs and expenses of business shutdowns, when they occur; and

 

    other factors described below under “—Fluctuations”.

Some of these factors are not within our control, and we cannot provide any assurance that we can continue to improve upon those factors that are within our control, especially given the current economic climate as well as our movement to an expected higher percentage of recurring revenue projects. Moreover, our gross revenues are likely to fluctuate from quarter to quarter and from year to year, as discussed in “—Fluctuations” below. Accordingly, there is no assurance that our future gross profit and gross profit margins will improve or even remain at historic levels in the future, and will likely decrease if revenues decrease.

Operating Expenses

Our operating expenses include general and administrative expense, selling, marketing and service expense, depreciation and amortization and, from time to time, restructuring charges. The following table sets forth our consolidated operating expenses for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Consolidated Operating Expenses:

           

General and administrative

   $ 15,634       $ 13,044       $ 2,590         19.9

Selling, marketing and service

     2,748         2,009         739         36.8

Depreciation and amortization

     2,477         2,178         299         13.7

Restructuring charges

     —           427         (427      (100.0 )% 
  

 

 

    

 

 

    

 

 

    

Total

$ 20,859    $ 17,658    $ 3,201      18.1
  

 

 

    

 

 

    

 

 

    

 

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The following table sets forth our operating expenses by reportable segment for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Distributed Generation:

           

General and administrative

   $ 4,360       $ 3,030       $ 1,330         43.9

Selling, marketing and service

     1,213         1,051         162         15.4

Depreciation and amortization

     1,070         778         292         37.5
  

 

 

    

 

 

    

 

 

    

Total Distributed Generation operating expenses

$ 6,643    $ 4,859    $ 1,784      36.7
  

 

 

    

 

 

    

 

 

    

Solar Energy:

General and administrative

$ 780    $ 507    $ 273      53.8

Selling, marketing and service

  97      113      (16   (14.2 )% 

Depreciation and amortization

  32      24      8      33.3
  

 

 

    

 

 

    

 

 

    

Total Solar Energy operating expenses

$ 909    $ 644    $ 265      41.1
  

 

 

    

 

 

    

 

 

    

Utility Infrastructure:

General and administrative

$ 2,873    $ 2,923    $ (50   (1.7 )% 

Selling, marketing and service

  336      305      31      10.2

Depreciation and amortization

  776      859      (83   (9.7 )% 
  

 

 

    

 

 

    

 

 

    

Total Utility Infrastructure operating expenses

$ 3,985    $ 4,087    $ (102   (2.5 )% 
  

 

 

    

 

 

    

 

 

    

Energy Efficiency:

General and administrative

$ 3,255    $ 2,071    $ 1,184      57.2

Selling, marketing and service

  591      470      121      25.7

Depreciation and amortization

  392      360      32      8.9

Restructuring charges

  —        427      (427   (100.0 )% 
  

 

 

    

 

 

    

 

 

    

Total Energy Efficiency operating expenses

$ 4,238    $ 3,328    $ 910      27.3
  

 

 

    

 

 

    

 

 

    

Corporate and other unallocated costs:

General and administrative

$ 4,366    $ 4,513    $ (147   (3.3 )% 

Selling, marketing and service

  511      70      441      630.0

Depreciation and amortization

  207      157      50      31.8
  

 

 

    

 

 

    

 

 

    

Total corporate and other unallocated costs

$ 5,084    $ 4,740    $ 344      7.3
  

 

 

    

 

 

    

 

 

    

Total consolidated operating expenses

$ 20,859    $ 17,658    $ 3,201      18.1
  

 

 

    

 

 

    

 

 

    

Costs related to personnel, including wages, benefits, stock compensation, bonuses and commissions, are the most significant component of our operating expenses. During the first quarter 2015, we incurred an aggregate of $0.9 million of incremental operating expenses from our Mission Critical Energy Services operations, which we acquired during the fourth quarter of 2014. The remaining year-over-year increase in our operating expenses was driven by increases in general and administrative expense due to increases in personnel, employee benefits and insurance, stock compensation expense, and professional fees to support our growing business platforms and anticipated growth, an increase in selling expenses due to additional sales executives, and an increase in depreciation and amortization from our investments in utility infrastructure equipment, company-owned distributed generation systems, and acquisition-related intangibles.

Our operating expenses (excluding restructuring charges in the first quarter 2014) as a percentage of our revenues decreased by 6.4 percentage points in the first quarter 2015 compared to the first quarter 2014. This decrease reflects operating inefficiencies we experienced in the first quarter 2014 driven by lower revenue levels during that period. We anticipate that operating expenses as a percentage of revenues will remain consistent with the first quarter 2015 over the

 

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next few quarters as we anticipate that operating cost increases will be consistent with our revenue growth. We also expect over the long term that our operating expenses will decrease as a percentage of revenue due to our expected revenue growth as we leverage our cost structure. Of course, these expectations are dependent on the future success of our product and service lines, future economic and market conditions, and any future acquisitions. Accordingly, the timing and the amount of future increases in operating expenses will depend on the timing and level of future increases in our revenues and revenue backlog, as well as the impacts of economic and business conditions and capital markets conditions. We cannot provide any assurance as to if, when, how much or for how long economic conditions will continue to improve, or the effects of future economic conditions on our revenues, expenses or net income (loss).

General and Administrative Expenses. General and administrative expenses include personnel wages, benefits, stock compensation, and bonuses and related overhead costs for the support and administrative functions, together with unallocated corporate and other administrative costs.

The overall $2.6 million, or 19.9%, increase in our consolidated general and administrative expenses in the first quarter 2015, as compared to the first quarter 2014, was due primarily to an increase in personnel, stock compensation, insurance, professional fees and consulting, rent and other expenses to support our investments in new business opportunities. The following table provides further details of our general and administrative expenses by expense category for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Consolidated General and Administrative Expense:

           

Personnel costs

   $ 8,973       $ 7,416       $ 1,557         21.0

Vehicle lease and rental

     599         739         (140      (18.9 )% 

Insurance

     643         700         (57      (8.1 )% 

Rent-office and equipment

     452         413         39         9.4

Professional fees and consulting

     378         455         (77      (16.9 )% 

Travel

     679         617         62         10.0

Telephone

     213         233         (20      (8.6 )% 

Meals and entertainment

     256         278         (22      (7.9 )% 

Utilities

     112         99         13         13.1

Other

     1,070         721         349         48.4

Corporate costs

     2,259         1,373         886         64.5
  

 

 

    

 

 

    

 

 

    

Total

$ 15,634    $ 13,044    $ 2,590      19.9
  

 

 

    

 

 

    

 

 

    

Over the long-term, we expect our expenses in these areas to increase, although at lower growth rates than our revenues, as we strive to leverage our cost structure and deliver higher operating profit margins.

 

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The following table provides detail of our general and administrative expenses by segment along with unallocated corporate and other administrative costs for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Segment General and Administrative Expense:

           

Distributed Generation

   $ 4,360       $ 3,030       $ 1,330         43.9

Solar Energy

     780         507         273         53.8

Utility Infrastructure

     2,873         2,923         (50      (1.7 )% 

Energy Efficiency

     3,255         2,071         1,184         57.2

Corporate and other unallocated costs

     4,366         4,513         (147      (3.3 )% 
  

 

 

    

 

 

    

 

 

    

Total

$ 15,634    $ 13,044    $ 2,590      19.9
  

 

 

    

 

 

    

 

 

    

The 43.9% increase in our first quarter 2015 Distributed Generation segment general and administrative expense compared to the first quarter 2014, was due to $0.7 million of additional costs incurred at our Mission Critical Energy Services operations that we acquired in October 2014 along with increases in personnel costs. The 53.8% increase in Solar Energy segment general and administrative expense is due to increases in personnel and related costs that were necessary to support the growth of the Solar operations and anticipated fulfilment of the utility-scale solar projects awarded to us in July 2014. The 1.7% decrease in our first quarter 2015 Utility Infrastructure segment general and administrative expense compared to the first quarter 2014 was due to the carryover effect of cost reduction actions taken in the second half of 2014 to help offset the impact of lower revenues and gross margins in 2014. The 57.2% increase in our first quarter 2015 Energy Efficiency segment general and administrative expense compared to the first quarter 2014 was due to increases in personnel and related costs to support the growth of our LED lighting and Energy Efficiency Services operations.

Corporate and other unallocated costs include similar personnel costs as described above as well as costs incurred for the benefit of all of our business operations, such as acquisition costs, legal, Sarbanes-Oxley compliance, public company reporting, director expenses, accounting costs, and stock compensation expense on our stock options, restricted stock awards, and performance units which we do not allocate to our operating segments. The decrease in our corporate and other unallocated costs during the first quarter 2015 as compared to the first quarter 2014 was due primarily to a greater percentage of overhead costs being allocated to our operating segments in 2015 compared to 2014. We expect our corporate and other unallocated costs for the remainder of 2015 to remain at similar levels to those incurred during the first quarter 2015.

Selling, Marketing and Service Expenses. Selling, marketing and service expenses consist of personnel and related overhead costs, including commissions for sales and marketing activities, together with travel, advertising and promotion costs. The 36.8% increase in consolidated selling, marketing and service expenses in the first quarter 2015, as compared to the first quarter 2014, was due to increases in salaries due to investments in sales teams, increases in business development costs to promote growth, and commissions incurred on increased revenues. The following table provides further detail of our selling, marketing and service expenses by expense category for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Consolidated Selling, Marketing and Service:

           

Salaries

   $ 1,103       $ 741       $ 362         48.9

Commission

     489         452         37         8.2

Travel

     414         429         (15      (3.5 )% 

Advertising and promotion

     645         297         348         117.2

Bad debt expense (recovery)

     49         90         (41      (45.6 )% 

Vehicle lease and rental

     48         —           48         n/m   
  

 

 

    

 

 

    

 

 

    

Total

$ 2,748    $ 2,009    $ 739      36.8
  

 

 

    

 

 

    

 

 

    

 

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The following table provides further detail of our selling, marketing and service expenses by segment for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Segment Selling, Marketing and Service Expense:

           

Distributed Generation

   $ 1,213       $ 1,051       $ 162         15.4

Solar Energy

     97         113         (16      (14.2 )% 

Utility Infrastructure

     336         305         31         10.2

Energy Efficiency

     591         470         121         25.7

Unallocated costs

     511         70         441         630.0
  

 

 

    

 

 

    

 

 

    

Total

$ 2,748    $ 2,009    $ 739      36.8
  

 

 

    

 

 

    

 

 

    

In the future, we expect our near-term and long-term selling, marketing and services expenses to grow in order to reflect, drive and support anticipated future revenue growth.

Depreciation and Amortization Expenses. Depreciation and amortization expenses include the depreciation of property, plant and equipment and the amortization of certain intangible assets including capitalized software development costs and other intangible assets acquired in our recent acquisitions.

The following table provides detail of our depreciation and amortization expense by segment for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Segment Depreciation and Amortization:

           

Distributed Generation

   $ 1,070       $ 778       $ 292         37.5

Solar Energy

     32         24         8         33.3

Utility Infrastructure

     776         859         (83      (9.7 )% 

Energy Efficiency

     392         360         32         8.9

Unallocated costs

     207         157         50         31.8
  

 

 

    

 

 

    

 

 

    

Total

$ 2,477    $ 2,178    $ 299      13.7
  

 

 

    

 

 

    

 

 

    

The 13.7% increase in consolidated depreciation and amortization expenses in the first quarter 2015, compared to the first quarter 2014, primarily reflects increased amortization expense associated with intangible assets acquired as part of our 2014 acquisition of the Mission Critical Energy Services business as well as depreciation resulting from capital investments. These capital investments are investments in PowerSecure-owned Distributed Generation segment systems for projects deployed under our recurring revenue model as well as investments in Utility Infrastructure segment equipment to support its business. In the future, we expect our near-term and long-term depreciation and amortization expenses to grow reflecting depreciation on additional capital expenditures as well as expense associated with amortization of intangible assets acquired in connection with recent and potential future acquisitions.

Restructuring Charges. Restructuring charges consist of costs associated with realigning operations, reducing employee counts, eliminating products, exiting certain activities, changing manufacturing sourcing, and other actions designed to reduce our cost structure and improve productivity.

 

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Our 2013 acquisitions provided us with an opportunity to restructure and realign our Energy Efficiency segment operations to increase operating margins. During the fourth quarter 2013, we initiated business realignment actions to realign the LED lighting operations of our Energy Efficiency segment to gain cost and performance efficiencies. As we completed these 2013 business realignment initiatives in the first quarter 2014, we incurred pre-tax restructuring charges totaling $0.7 million in the first quarter 2014. These 2014 charges consisted of severance and related costs from the elimination of employee positions and inventory write offs. The inventory write-offs in the amount of $0.3 million in the first quarter 2014 are included in cost of sales. The expenses associated with the remaining business realignment charges totaled $0.4 million in the first quarter 2014 and are included as a separate operating expense line item in our consolidated financial statements.

There were no similar restructuring charges during the first quarter 2015.

Other Income and Expenses

Our other income and expenses include interest income, interest expense, and income taxes. None of these income or expense amounts are allocated to our operating segments for purposes of evaluating segment performance or allocating resources. The following table sets forth our consolidated other income and expenses for the periods indicated (dollars in thousands):

 

     Quarter Ended
March 31,
     Period-over-Period
Difference
 
     2015      2014      $      %  

Other Income (Expense):

           

Interest and other income

   $ 1       $ 4       $ (3      (75.0 )% 

Interest expense

     (269      (300      31         10.3

Income tax benefit (expense)

     (81      2,654         (2,735      (103.1 )% 
  

 

 

    

 

 

    

 

 

    

Total

$ (349 $ 2,358    $ (2,707
  

 

 

    

 

 

    

 

 

    

Interest and Other Income. Interest and other income consists primarily of interest we earn on the interest-bearing portion of our cash and cash equivalent balances. The amount of interest income during the first quarter 2015 was less compared to the first quarter 2014 due to a reduction in the average balance of our interest-bearing cash and cash equivalent balances. Our future interest income will depend on our cash and cash equivalent balances, which will increase and decrease depending upon our profit, capital expenditures, acquisitions, working capital needs, and future interest rates.

Interest Expense. Interest expense consists of interest and finance charges on the revolving portion of our credit facility, term loans and capital leases. Interest expense decreased during the first quarter 2015, as compared to the first quarter 2014. The decrease in our interest expense reflects the effects on interest expense of a reduction in balances outstanding on our $25.0 million term loan, capital lease obligation, and our prior existing term loan due to regular payments made on those obligations over the year. In the longer term, absent any new borrowings on our existing credit facility, we expect our future interest and finance charges to decrease slightly as the balances of our borrowings are reduced by regular monthly and quarterly installments.

Income Taxes. The income tax expense or benefit we record is the result of applying our annual effective tax rate by our pre-tax income or loss. Our effective tax rate and our income tax expense or benefit includes the effects of permanent differences between our book and taxable income, changes in our deferred tax assets and liabilities, changes in the valuation allowance for our net deferred tax assets, federal and state income taxes in various state jurisdictions in which we have taxable activities, and expenses associated with uncertain tax positions that we have taken or expense reductions from uncertain tax positions as a result of a lapse of the applicable statute of limitations. Our overall effective tax rate of 40% in the first quarter 2015 increased slightly, as compared to the 38.0% effective tax rate in the first quarter 2014. We recorded an income tax expense during the first quarter 2015 whereas we recorded an income tax benefit during the first quarter 2014 as we incurred a pre-tax loss during that period.

 

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Fluctuations

Our revenues, expenses, margins, net income, cash flow, cash, working capital, capital expenditures, debt, balance sheet positions, and other operating results have fluctuated significantly from quarter-to-quarter, period-to-period and year-to-year in the past and are expected to continue to fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. Factors that affect our operating results include the following:

 

    the effects of general economic, business and financial conditions, including the negative impact that continuing weak and uncertain economic and financial market conditions and inconsistent capital and credit markets, or their deterioration, could have on our business operations, our revenues and our ability to operate and grow profitably, including the negative impact these conditions could have on the timing of and amounts of orders from our customers, and the potential these factors have to negatively impact our access to capital to finance our business;

 

    the size, timing and terms of sales and orders, especially large customer orders, as well as the effects of the timing of phases of completion of projects for customers, and customers delaying, deferring or canceling purchase orders or making smaller purchases than expected;

 

    our ability to execute on our customer orders efficiently and profitably, to generate customer satisfaction, enhanced operating income and future additional business, especially with respect to significant awards such as the utility-scale solar projects;

 

    our ability to make strategic acquisitions of key businesses, technologies and other assets and resources, to realize the expected benefits from such acquisitions, to effectively integrate the acquired businesses, assets and personnel in our organization, to grow acquired businesses and to manage the costs related to such acquisitions, including our recent acquisitions of our retail Energy Efficiency Services business and the Mission Critical Energy Services operations;

 

    our ability to sell, complete and recognize satisfactory levels of near-term quarterly revenues and net income related to our project-based sales and product and service revenues, which are recognized and billed as they are completed, in order to maintain our current profits and cash flow and to satisfy our financial covenants in our credit facility and to successfully finance the recurring revenue portion of our business model;

 

    our ability to maintain and grow our Utility Infrastructure revenues on a profitable basis, including maintaining and improving our pricing, utilization rates and productivity rates, given the significant levels of vehicles, tools and labor in which we have invested and which are required to serve utilities, and the risk that our utility customers will change work volumes or pricing, or will displace us from providing services;

 

    our ability to maintain our safety performance and safety record at levels that meet or exceed the standards of our utility customers, the inability of which could cause us to be abruptly and immediately released from our work assignments with those utilities, and to lose the opportunity to obtain additional or new work from those utilities;

 

    our ability to obtain adequate supplies of key components and materials of suitable quality for our products on a timely and cost-effective basis, including the impact of potential supply line constraints, substandard parts, changes in environmental requirements, and fluctuations in the cost of raw materials and commodity prices, including without limitation with respect to our LED lighting products and third party manufacturing arrangements we have, and arrangements we have established to source these products and components from vendors in Asia;

 

    our strategy to increase our revenues from long-term recurring revenue projects, recognizing that increasing our revenues from recurring revenue projects will require up-front capital expenditures and will protract our revenue and profit recognition from those projects over a longer period compared to turn-key sales, while at the same time increasing our gross margins over the long-term;

 

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    the performance of our products, services and technologies, and the ability of our systems to meet the performance standards they are designed and built to deliver to our customers, including but not limited to our recurring revenue projects for which we retain the on-going risks associated with the performance and ownership of the systems;

 

    our ability to access significant capital resources on a timely basis in order to fund working capital requirements, fulfill large customer orders, finance capital required for recurring revenue projects, and finance working capital and equipment for our Utility Infrastructure products and services;

 

    our ability to develop new products, services and technologies with competitive advantages and positive customer value propositions;

 

    permitting and regulatory or customer-caused delays on projects;

 

    our ability to implement our business plans and strategies and the timing of such implementation;

 

    the pace of revenue and profit realization from our new businesses and the development and growth of their markets, including the timing, pricing and market acceptance of our new products and services;

 

    the amount of costs and expenses we incur to support our growth internally and through acquisitions, and our success in controlling and reducing our costs and expenses;

 

    changes in our pricing policies and those of our competitors, including the introduction of lower cost competing technologies and the potential for them to impact our pricing and our profit margins;

 

    variations in the length of our sales cycle and in the product and service delivery and construction process;

 

    changes in the mix of our products and services having differing margins;

 

    changes in our expenses, including prices for materials such as copper, aluminum and other raw materials, labor costs and other components of our products and services, fuel prices including diesel, natural gas, oil and gasoline, and our ability to hedge or otherwise manage these prices to protect our costs and revenues, minimize the impact of volatile exchange rates and mitigate unforeseen or unanticipated expenses;

 

    changes in our valuation allowance for our net deferred tax asset, and the resulting impact on our current tax expenses, future tax expenses and balance sheet account balances;

 

    the effects of severe weather conditions, such as hurricanes and major wind and ice storms, on the business operations of our customers, and the potential effect of such conditions on our results of operations;

 

    the life cycles of our products and services, and competitive alternatives in the marketplace;

 

    budgeting cycles of utilities and other industrial, commercial and institutional customers, including impacts of the slow economic recovery and inconsistent capital markets conditions on capital projects and other spending items;

 

    the development and maintenance of business relationships with strategic partners such as utilities and large customers;

 

    economic conditions and regulations in the energy industry, especially in the electric utility industry, including the effects of changes in energy prices, electricity pricing and utility tariffs as well as the impact of future reductions in solar tax credits and incentives;

 

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    changes in the prices charged by our suppliers;

 

    the effects of governmental regulations and regulatory changes in our markets, including emissions regulations; and

 

    the effects of litigation, warranty claims and other claims and proceedings, including the securities class action.

Because we have little or no control over most of these factors, our operating results are difficult to predict. Any adverse change in any of these factors could negatively affect our business and results of operations.

Our revenues and other operating results are heavily dependent upon the size and timing of customer orders and payments, and the timing of the completion of those projects. The timing of large individual orders, and of project completion, is difficult for us to predict. Because our operating expenses are based on anticipated revenues over the long-term and because a high percentage of these are relatively fixed, a shortfall or delay in recognizing revenues can cause our operating results to vary significantly from year-to-year and can result in significant operating losses or declines in profit margins in any particular year. If our revenues fall below our expectations in any particular period, we may not be able to or it may not be prudent to reduce our expenses rapidly in response to the shortfall, which can result in us suffering significant operating losses or declines in profit margins in that period.

As we develop new lines of business, our revenues and costs will fluctuate because generally new businesses require start-up expenses and it takes time for revenues to develop, which can result in losses in early periods. Another factor that could cause material fluctuations in our annual results is an increase in recurring, as opposed to project-based, sources of revenue we generate for our Distributed Generation and Utility Infrastructure projects. To date, the majority of our revenues have consisted of project-based Distributed Generation revenues, project-based Utility Infrastructure revenues and sales of LED lighting fixtures, which are recognized as the sales occur or the projects are completed. Recurring revenue projects, compared to project-based sales, are generally more profitable over time, and growth in this business model can result in delayed recognition of revenue and net income, especially in the short-term, as we implement an increased number of these recurring revenue projects.

Due to all of these factors and the other risks, uncertainties and other factors discussed in this report and in our Annual Report on Form 10-K for the year ended December 31, 2014, quarter-to-quarter, period-to-period or year-to-year comparisons of our results of operations should not be relied on as an indication of our future performance. Quarterly, period or annual comparisons of our operating results are not necessarily meaningful or indicative of future performance.

Liquidity and Capital Resources

Overview

We have historically financed our operations and growth primarily through a combination of cash on hand, cash generated from operations, borrowings under credit facilities, leasing, and proceeds from sales of equity. On a going forward basis, we expect to require capital primarily to finance our:

 

    operations;

 

    inventory;

 

    accounts receivable;

 

    property and equipment expenditures, including capital expenditures related to Distributed Generation PowerSecure-owned recurring revenue projects;

 

    software purchases or development;

 

    debt service requirements;

 

    lease obligations;

 

    deferred compensation obligations;

 

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    restructuring and cost reduction obligations; and

 

    acquisitions and other business transactions.

Working Capital

At March 31, 2015, we had working capital of $70.7 million, including $23.8 million in cash and cash equivalents, compared to working capital of $70.8 million, including $33.8 million in cash and cash equivalents at December 31, 2014. Changes in the components of our working capital from December 31, 2014 to March 31, 2015 and from December 31, 2013 to March 31, 2014 are explained in greater detail below. At both March 31, 2015 and December 31, 2014, we had $20.0 million of available and unused borrowing capacity from our revolving credit facility. The availability of this capacity under our credit facility includes restrictions on the use of proceeds, and is dependent upon our ability to satisfy certain financial and operating covenants including financial ratios, as discussed below.

Cash Flows

The following table summarizes our cash flows for the periods indicated (dollars in thousands):

 

     Three Months Ended March 31,  
     2015      2014  

Net cash used in operating activities

   $ (6,358    $ (12,265

Net cash used in investing activities

     (2,668      (1,273

Net cash provided by (used in) financing activities

     (903      833   
  

 

 

    

 

 

 

Net decrease in cash and cash equivalents

$ (9,929 $ (12,705
  

 

 

    

 

 

 

Cash Used in Operating Activities

Cash used in operating activities consists primarily of net income (loss) adjusted for certain non-cash items including depreciation and amortization and stock-based compensation expenses. Cash used in operating activities also includes the effect of changes in working capital and other activities.

Cash used in operating activities for the first quarter 2015 was approximately $6.4 million and consisted of $9.6 million used by changes in working capital balances, partially offset by $3.2 million of net income and non-cash operating expenses. The non-cash items consisted primarily of $2.5 million of depreciation and amortization expense and $0.7 million of stock compensation expense. Cash used by working capital and other activities consisted primarily of a $8.9 million increase in accounts receivable, a $2.0 million increase in inventories, and a $0.6 million reduction in accounts payable. The cash used by these working capital account changes were partially offset by a $0.7 million increase in accrued and other liabilities and a net $1.3 million reduction in other current and noncurrent assets and liabilities. The fluctuations in our accounts receivable, accounts payable and our accrued and other liabilities is a function of the timing of customer remittances, payments to our vendors, and our inventory, advance billings and accrued project costs on projects in process, respectively. The increase in our inventories reflects the growth in business activity in the first quarter 2015 as compared to the first quarter of the preceding year. These working capital accounts can and do fluctuate significantly from period to period, depending on the timing and size of individual projects.

Cash used by operating activities for the first quarter 2014 was approximately $12.3 million and consisted of our net loss of $4.3 million and net cash of $10.5 million used by working capital and other activities, partially offset by non-cash items of $2.5 million. The non-cash items consisted primarily of depreciation and amortization and stock compensation expense. Cash used by working capital and other activities consisted primarily of increases in inventory of $1.4 million and a net $2.6 million increase in other current and noncurrent assets and liabilities and decreases in accounts payable of $7.5 million, accrued and other liabilities of $6.1 million, and restructuring charges of $0.5 million, partially offset by a $7.5 million decrease in accounts receivable. The increase in our inventory reflects the growth in business activity in the first quarter 2014 as compared to the first quarter of the preceding year.

 

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Cash Used in Investing Activities

Cash used in investing activities was $2.7 million in the first quarter 2015 and cash used in investing activities was $1.3 million in the first quarter 2014. Historically, our principal cash investments have related to the acquisition and installation of equipment related to our recurring revenues sales, the acquisition of businesses or technologies, the purchase of equipment used in our production facilities, and the acquisitions of certain contract rights. During the first quarter 2015, we used $1.1 million to purchase and install equipment at our recurring revenue distributed generation sites, we used $1.7 million principally to acquire operational assets, and we received $0.1 million cash proceeds from the sale of property plant and equipment. During the first quarter 2014, we used $0.8 million to purchase and install equipment at our recurring revenue distributed generation sites, we used $0.7 million principally to acquire operational assets and we received $0.2 million cash proceeds from the sale of property plant and equipment.

Cash Provided by (Used in) Financing Activities

Cash used in financing activities was $0.9 million in the first quarter 2015 and cash provided by financing activities was $0.8 million in the first quarter 2014. During the first quarter 2015, we used $1.2 million to make scheduled payments on our capital lease and term loan obligations and we received $0.3 million from the exercise of stock options. During the first quarter 2014, we received $2.0 million from the exercise of stock options and we used $1.2 million to make scheduled payments on our capital lease and term loan obligations.

Capital Spending

Our capital expenditures during the first quarter 2015 were approximately $2.8 million, of which we used $1.1 million to purchase and install equipment for our PowerSecure-owned recurring revenue distributed generation systems, and we used $1.7 million to purchase equipment and other capital items. Our capital expenditures during the first quarter 2014 were approximately $1.5 million, of which we used $0.8 million to purchase and install equipment for our PowerSecure-owned recurring revenue distributed generation systems, and we used $0.7 million to purchase equipment and other capital items, primarily to support the growth of our business.

We anticipate making total capital expenditures of approximately $12 million for all of fiscal year 2015, including capital expenditures for our company-owned Distributed Generation systems deployed under long-term recurring revenue contracts, and operational assets, particularly for equipment used in our Utility Infrastructure business. Customer demand for our Distributed Generation systems under recurring revenue contract arrangements, and economic and financial conditions could cause us to reduce or increase those capital expenditures. The majority of our capital spending has to date been and will continue to be used for investments in assets related to our recurring revenue projects as well as equipment to support the growth of our businesses.

Indebtedness

Long-term credit facility. We have a long-term credit facility with Citibank, N.A. (“Citibank”), as administrative agent and lender, and other lenders under a credit agreement that we first entered into with our lenders in August 2007 and have amended and restated from time-to-time. At March 31, 2015 and December 31, 2014, our credit agreement with Citibank along with Branch Banking and Trust Company (“BB&T”) as additional lender, consisted of a $20.0 million senior, first-priority secured revolving line of credit maturing on November 12, 2016, a $2.6 million term loan maturing on November 12, 2016, and a $25.0 million, 7 year amortizing term loan maturing on September 30, 2020. The credit agreement is guaranteed by all our active subsidiaries and is secured by the assets of us and those subsidiaries.

The credit facility contains three basic financial covenants. First, under the credit agreement, if cash on hand does not exceed funded indebtedness by at least $5.0 million, then our minimum fixed charge coverage ratio must be in excess of 1.25, where the fixed charge coverage ratio is defined as the ratio of the aggregate of our consolidated Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) plus our lease expense minus our taxes based on income and payable in cash, divided by the sum of our consolidated interest charges plus our lease expenses plus our scheduled principal payments and dividends, computed over the previous period. For the fiscal quarter ending March 31, 2015, the fixed charge coverage ratio is based on our financial results for the third quarter 2014 and subsequent fiscal quarters. For the fiscal quarter ending June 30, 2015 and thereafter, the fixed charge coverage ratio will be based on our financial results for the previous four fiscal quarters on a rolling basis. Second, we are required to maintain a minimum

 

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consolidated net worth, computed on a quarterly basis, of not less than the sum of $142.1 million, plus an amount equal to 50% of our net income each fiscal year commencing with the year ending December 31, 2014, with no reduction for any net loss in any fiscal year, plus 90% of any equity we raise through the sale of equity interests, less the amount of any non-cash charges or losses. Under our third financial covenant, the ratio of our funded indebtedness to our capitalization, computed as funded indebtedness divided by the sum of funded indebtedness plus stockholders equity, cannot exceed 30%. As of March 31, 2015, we were in compliance with these financial covenants.

The following table summarizes the balances outstanding on our long-term debt, including our revolving line of credit, with Citibank and BB&T at March 31, 2015 and December 31, 2014:

 

     March 31,
2015
     December 31,
2014
 

Revolving line of credit, maturing November 12, 2016

   $ —         $ —     

Term loan, principal of $0.04 million plus interest payable quarterly at variable rates, maturing November 12, 2016

     1,880         1,920   

Term loan, principal of $0.9 million plus interest payable quarterly at variable rates, maturing June 30, 2020

     18,750         19,643   
  

 

 

    

 

 

 

Total debt

  20,630      21,563   

Less: Current portion

  (3,731   (3,731
  

 

 

    

 

 

 

Long-term debt, net of current portion

$ 16,899    $ 17,832   
  

 

 

    

 

 

 

We have used, and intend to continue to use, the proceeds available under the credit facility to support our growth and future investments in working capital, additional Utility Infrastructure equipment, Company-owned distributed generation projects, other capital expenditures, acquisitions and general corporate purposes.

Outstanding balances under the credit facility bear interest, at our discretion, at either the London Interbank Offered Rate (“LIBOR”) for the corresponding deposits of U. S. Dollars plus an applicable margin, which is on a sliding scale ranging from 2.00% to 3.25% based upon our leverage ratio, or at Citibank’s alternate base rate plus an applicable margin, on a sliding scale ranging from 0.25% to 1.50% based upon our leverage ratio. Our leverage ratio is the ratio of our funded indebtedness as of a given date, net of our cash on hand in excess of $5.0 million, to our consolidated EBITDA for the four consecutive fiscal quarters ending on such date. Citibank’s alternate base rate is equal to the higher of the Federal Funds Rate as published by the Federal Reserve of New York plus 0.50%, Citibank’s prime commercial lending rate and 30 day LIBOR plus 1.00%.

Scheduled remaining principal payments on our outstanding debt obligations at March 31, 2015, are as follows:

 

Scheduled Principal Payments for the Year Ending December 31:

   Revolving
Line of
Credit
     $25.0 Million
Term Loan
     $2.6 Million
Term Loan
     Total
Principal
Payments
 

Remainder of 2015

   $ —         $ 2,678       $ 120       $ 2,798   

2016

     —           3,571         1,760         5,331   

2017

     —           3,572         —           3,572   

2018

     —           3,572         —           3,572   

2019 and thereafter

     —           5,357         —           5,357   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total scheduled principal payments

$ —      $ 18,750    $ 1,880    $ 20,630   
  

 

 

    

 

 

    

 

 

    

 

 

 

In July 2013, we entered into two forward-starting interest rate swap contracts based on three-month LIBOR that effectively converted 80% of the outstanding balance of our $25 million Term Loan to fixed rate debt. We have designated the interest rate swaps as a cash flow hedge of the interest payments due on our floating rate debt. Accordingly, at March 31, 2015, $15.0 million of our outstanding debt bears interest at a fixed rate of 3.73% and $5.6 million of our outstanding debt bears interest at floating rates as described above. The termination dates of the swap contracts and the maturity date of the $25 million Term Loan are both June 30, 2020.

 

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The credit facility contains customary terms and conditions for credit facilities of this type, including restrictions or limits on our ability to incur additional indebtedness, create liens, enter into transactions with affiliates, pay dividends on our capital stock, repurchase stock, and consolidate or merge with other entities. In addition, the credit agreement contains customary events of default, including payment defaults, breach of representations and warranties, covenant defaults, cross-defaults, certain bankruptcy or insolvency events, judgment defaults and certain ERISA-related events.

Our obligations under the credit facility are secured by guarantees and security agreements by each of our active subsidiaries, including PowerSecure, Inc. The guarantees guaranty all of our obligations under the credit facility, and the security agreements grant to the lenders a first priority security interest in virtually all of the assets of each guarantor.

There was an aggregate balance of $20.6 million outstanding under the two term loans under our credit facility as of March 31, 2015. There were no balances outstanding on the revolving portion of the credit facility at, or during the three months ended, March 31, 2015 or at December 31, 2014 or at May 6, 2015. In addition, there were no outstanding letters of credit reducing the amount available to borrow under the revolving portion of the credit facility at March 31 or May 6, 2015. Accordingly, we currently have $20.0 million available to borrow under the revolving portion of the credit facility. The availability this capital under our credit facility includes restrictions on the use of proceeds, and is dependent upon our ability to satisfy certain financial and operating covenants, as described above.

Capital Lease Obligation. We have a capital lease with SunTrust Equipment Finance and Leasing (as lessor) from the sale and leaseback of Distributed Generation equipment placed in service at customer locations. We received $5.9 million from the sale of the equipment in December 2008 which we are repaying under the terms of the lease with monthly principal and interest payments of $85 thousand over a period of 84 months. At the expiration of the term of the lease in December 2015, we have the option to purchase the equipment for $1 dollar, assuming no default under the lease by us has occurred and is then continuing. The lease is guaranteed by us under an equipment lease guaranty. The lease and the lease guaranty constitute permitted indebtedness under our current credit agreement.

Proceeds of the lease financing were used to finance capital investments in equipment for our recurring revenue distributed generation projects. We account for the lease financing as a capital lease in our consolidated financial statements.

The lease provides us with limited rights, subject to the lessor’s approval which will not be unreasonably withheld, to relocate and substitute equipment during its term. The lease contains representations and warranties and covenants relating to the use and maintenance of the equipment, indemnification and events of default customary for leases of this nature. The lease also grants to the lessor certain remedies upon a default, including the right to cancel the lease, to accelerate all rent payments for the remainder of the term of the lease, to recover liquidated damages, or to repossess and re-lease, sell or otherwise dispose of the equipment.

Under the lease guaranty, we have unconditionally guaranteed the obligation of our PowerSecure subsidiary under the lease for the benefit of the lessor. Our capital lease obligation at March 31, 2015 was $0.7 million.

Preferred Stock Redemption. The terms of our Series B preferred stock required us to redeem all shares of our Series B preferred stock that remained outstanding on December 9, 2004 at a redemption price equal to the liquidation preference of $1 thousand per share plus accumulated and unpaid dividends. Our remaining redemption obligation at March 31, 2015, to holders of outstanding shares of Series B preferred stock that have not been redeemed, is $0.1 million.

Contractual Obligations and Commercial Commitments

We incur various contractual obligations and commercial commitments in our normal course of business, reflected in the table below including:

 

    we lease certain office space, operating facilities and equipment under long-term lease agreements;

 

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    in June 2013, we completed a $25.0 million term loan under our credit facility;

 

    to the extent we borrow under the revolving portion of our credit facility, we are obligated to make future payments under that facility;

 

    we have an obligation to make installment payments on the PowerLine acquisition;

 

    we have contingent earn-out payments potentially due on our recent acquisition of the Mission Critical Energy Services operations from Power Design, Inc. and the electrical contracting business from Apex;

 

    we have restructuring and cost reduction obligations; and

 

    we have a deferred compensation obligation.

In addition, at March 31, 2015, we had a liability for unrecognized tax benefits and related interest and penalties totaling $0.5 million. We do not expect a significant payment related to these obligations within the next year and we are unable to make a reasonably reliable estimate if and when cash settlement with a taxing authority would occur. Accordingly, the information in the table below, which is as of March 31, 2015, does not include the liability for unrecognized tax benefits (dollars in thousands):

 

     Payments Due by Period  

Contractual Obligations

   Total      Remainder
of 2015
     1 - 3 Years      4 - 5 Years      More than
5 Years
 

Revolving portion of credit facility (1)

   $ —         $ —         $ —         $ —         $ —     

Term loans (2)

     21,919         3,155         9,555         7,408         1,801   

Capital lease obligations (2)

     761         761         —           —           —     

Operating leases

     21,323         4,636         10,024         5,260         1,403   

Deferred compensation (3)

     3,137         3,137         —           —           —     

Installment payments due on acquisition

     440         110         220         110         —     

Earnout payments due on acquisition (4)

     2,450         2,000         450         —           —     

Series B preferred stock

     104         104         —           —           —     

Restructuring and cost reduction obligations

     26         26         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 50,160    $ 13,929    $ 20,249    $ 12,778    $ 3,204   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Total repayments are based upon borrowings outstanding as of March 31, 2015, not actual or projected borrowings after such date. Repayments do not included interest that may become due and payable in any future period.
(2) Repayments amounts include interest on the term loans at the interest rate in effect as of March 31, 2015 and on the capital lease obligation at the interest rate per the agreement.
(3) Total amount represents our potential obligation on the deferred compensation arrangement, based on the first date it could commence (which is earlier than the expected date of commencement), and does not include the value of the restricted annuity contract, or interest earnings thereon, that we purchased to fund our obligation.
(4) Total amount represents the undiscounted probability-weighted estimate of the earn-out payments due. Actual total payment amount ranges from $0 to $2.5 million, dependent on achievement of certain gross profit targets of the acquired business.

Performance Bonds and Letters of Credit

In the ordinary course of business, we are required by certain customers to post surety or performance bonds or letters of credit in connection with services that we provide to them. These bonds and letters of credit provide a guarantee to the customer that we will perform under the terms of a contract and that we will pay subcontractors and vendors. If we fail to perform under a contract or to pay subcontractors and vendors, the customer may demand that the surety, in the case of a performance bond, or our lenders, in the case of a letter of credit, make payments or provide services under the bond. We must reimburse the surety or our lenders for any expenses or outlays they incur. We have not been required to make any reimbursements to our sureties for bond-related costs, and we do not currently expect that we will have to fund significant claims under our surety arrangements in the foreseeable future. As of March 31, 2015, we had approximately $277.0 million in surety bonds outstanding. Based upon the current status of the completion of our contracts and projects, we estimate our exposure on these surety bonds was approximately $94.0 million at March 31, 2015.

 

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Off-Balance Sheet Arrangements

During the first quarter 2015, we did not engage in any material off-balance sheet activities or have any relationships or arrangements with unconsolidated entities established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide additional funding to any such entities.

Liquidity

At March 31, 2015, we had $23.8 million in cash and cash equivalents, total working capital of $70.7 million, and the full $20 million available for borrowing under the revolving portion of our credit facility. Based upon our plans and assumptions as of the date of this report, we believe that our capital resources, including our cash and cash equivalents, amounts available under our credit facility, along with funds expected to be generated from our operations, will be sufficient to meet our anticipated cash needs, including for working capital, capital spending and debt service commitments, for at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements” above in this report and Part II “Item 1A. Risk Factors.”

Although we believe that we have sufficient capital to fund our activities and commitments for at least the next 12 months, our future cash resources and capital requirements may vary materially from those now planned. Our ability to meet our capital needs in the future will depend on many factors, including a reduction in revenues if the demand for our products and services decreases, the timing of sales, the mix of products and services and other factors affecting our gross margins, the amount of recurring revenue projects in which we invest, our ability to meet our financial covenants under our credit facility, unanticipated events over which we have no control increasing our operating costs or reducing our revenues beyond our current expectations, and other factors listed above under “—Fluctuations” above. For these reasons, we cannot provide any assurance that our actual cash requirements will not be greater than we currently expect or that these sources of liquidity will be available when needed.

During 2015, our working capital balances, including our cash and cash equivalents, have been affected by our progress towards completion of two utility-scale Solar Energy projects that we were awarded in July 2014. Because the solar panels (which we acquire from a third-party supplier) are a material component of the project costs, there are periods when our purchase obligations are due in advance of progress payments from our customer. The timing of cash payments to our panel supplier and cash receipts from our customer have affected the balances of our cash and cash equivalents, accounts receivable, inventory, accounts payable and accrued expenses. We expect similar effects during the remainder of 2015 and beyond as we move further towards completion of these utility-scale Solar Energy projects, and the effects on our cash resources may be material.

We also continually evaluate opportunities to expand our current or to develop new products, services, technology and businesses that could increase our capital needs. In addition, from time to time we consider the acquisition of, or the investment in, complementary businesses, products, services and technology that might affect our liquidity requirements. We may seek to raise any needed or desired additional capital from the proceeds of public or private equity or debt offerings at the parent level or at the subsidiary level or both, from asset or business sales, from traditional credit financings or from other financing sources. Furthermore, we continually evaluate opportunities to improve our credit facilities, through increased credit availability, lower debt costs or other more favorable terms. However, our ability to obtain additional capital or replace or improve our credit facilities when needed or desired will depend on many factors, including general economic and market conditions, our operating performance and investor and lender sentiment, and thus cannot be assured. In addition, depending on how it is structured, a financing could require the consent of our current lending group. Even if we are able to raise additional capital, the terms of any financings could be adverse to the interests of our stockholders. For example, the terms of a debt financing could restrict our ability to operate our business or to expand our operations, while the terms of an equity financing, involving the issuance of capital stock or of securities convertible into capital stock, could dilute the percentage ownership interests of our stockholders, and the new capital stock or other new securities could have rights, preferences or privileges senior to those of our current stockholders.

 

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Accordingly, we cannot provide any assurance that sufficient additional funds will be available to us if needed or desired or that, if available, such funds can be obtained on terms favorable to us and our stockholders and acceptable to those parties who must consent to the financing. Our inability to obtain sufficient additional capital on a timely basis on favorable terms when needed or desired could have a material adverse effect on our business, financial condition and results of operations.

Critical Accounting Policies

Management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates, including those related to revenue recognition and percentage of completion, fixed price contracts, product returns, warranty obligations, bad debt, inventories, cancellations costs associated with long term commitments, incentive compensation, investments, intangible assets, assets subject to disposal, income taxes, restructuring, service contracts, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making estimates and judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on our consolidated financial statements.

We have identified the accounting principles which we believe are most critical to understanding our reported financial results by considering accounting policies that involve the most complex or subjective decisions or assessments. These accounting policies described below include:

 

    revenue recognition;

 

    allowance for doubtful accounts;

 

    inventory valuation reserve;

 

    warranty reserve;

 

    impairment of goodwill and long-lived assets;

 

    deferred tax valuation allowance;

 

    uncertain tax positions;

 

    costs of exit or disposal activities and similar nonrecurring charges;

 

    stock-based compensation; and

 

    derivative financial instruments.

The accounting policies listed above are described in our Annual Report on Form 10-K for the year ended December 31, 2014 in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Recent Accounting Pronouncements

Information about recent accounting pronouncements and their potential effects on our financial position and results of operations is included in Note 2, “Summary of Significant Accounting Policies and Recent Accounting Standards” of the notes to our condensed consolidated financial statements included elsewhere in this report.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain market risks arising from transactions we enter into in the ordinary course of business. These market risks may adversely affect our financial condition, results of operations and cash flow. These market risks include, but are not limited to, fluctuations in interest rates and commodity prices, and to a lesser extent fluctuations in currency exchange rates.

We employ interest rate swap agreements for the purpose of hedging certain specifically identified interest rates. The use of these financial instruments is intended to mitigate some of the risks associated with fluctuations in interest rates, but does not eliminate such risks. We do not use derivative financial instruments for trading or speculative purposes, and except as indicated in this item we do not use derivative financial instruments to manage or hedge our exposure to interest rate changes, commodity price risks, foreign currency exchange risks or other market risks.

Interest Rate and Market Risk. We are exposed to market risk resulting from changes in interest rates. Changes in the interest rates affect the income we receive from our investments of excess cash in short-term interest-bearing marketable securities, because that income is dependent upon the interest rate of the securities held, and the interest expenses we pay on our borrowings under our credit facility, because the interest rate on our borrowings is based on floating interest rates as described in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report. Our lease with SunTrust is at a fixed interest rate and thus not impacted by changes in interest rates.

At March 31, 2015, our cash and cash equivalents balance was approximately $23.8 million, and $20.6 million was outstanding on two term loans under the credit facility. Our credit facility, which is comprised of a revolving credit line and two term loans, bears interest at a rate based on LIBOR or an alternative base rate based on prevailing interest rates, in each case plus an applicable margin based on our leverage ratio. From time to time we may enter into interest rate swap agreements to reduce our exposure to interest rate fluctuations under the credit facility. In July 2013, we entered into two forward-starting interest rate swap contracts to manage interest rate risk on our floating rate debt. The interest rate swaps effectively converted 80% of our $25.0 million floating rate term loan to a fixed rate term loan bearing interest at the rate of 3.73%. The notional amount of the interest rate swaps at March 31, 2015 was $15.0 million.

In accordance with ASC 815, Derivatives and Hedging, we have designated the interest rate swaps as cash flow hedges of the interest payments due on that portion of our floating rate debt. Accordingly, the fair value of the interest rate swaps are recorded as an asset (other assets) or as a liability (other long-term liabilities), the effective portion of the change in fair value of the interest rate swaps is recorded in other comprehensive income (loss) and the quarterly settlements are recorded as either an addition to or reduction of our interest expense for the period. The remainder of our indebtedness under our credit facility continues to bear interest at variable rates that fluctuate.

Pursuant to the swap contracts, the three-month LIBOR rate on the term loan was swapped for a fixed rate of 1.73%. When added to the term loan’s current applicable margin, the interest rate applicable to 80% of the term loan has been effectively fixed at 3.73%, subject only to changes in the applicable margin. Notwithstanding the terms of the swap contracts, we remain fully obligated for all amounts due and payable on the term loan. The initial counterparties to the swap contracts are the financial institutions that are also lenders under our credit facility, but the swap contracts may be assigned to other counterparties. The termination dates of the swap contracts and maturity date of the term loan are both June 30, 2020. We may enter into additional swap transactions in the future from time to time.

Our cash equivalents are invested in a combination of bank deposits, money market or U.S. government mutual funds, short-term time deposits, and government agency and corporate obligations, or similar kinds of instruments, the income of which generally increases or decreases in proportion to increases or decreases, respectively, in interest rates. While we believe we have our cash and cash equivalents invested in very low risk investments, they are not risk free, as our bank deposits are generally in excess of FDIC insurance limits.

We do not believe that changes in interest rates have had a material impact on us in the past or are likely to have a material impact on us in the foreseeable future. For example, for the first quarter 2015, a hypothetical 1% (100 basis

 

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points) increase in the interest rate on the variable rate portion of our average outstanding borrowings under our credit facility would have resulted in an increase in our interest expense of $15 thousand, and an increase in our interest income from the average balance of our interest-bearing cash equivalents of approximately $10 thousand. Conversely, a hypothetical 1% (100 basis points) decrease of 1% (100 basis points) in the interest rate on the variable rate portion our average outstanding borrowings under our credit facility would have resulted in a decrease in our interest expense of $15 thousand, and a decrease in our interest income from the average balance of our interest-bearing cash equivalents of approximately $1 thousand.

Commodity Price Risk. From time to time we are subject to market risk from fluctuating commodity prices in certain raw materials we use in our products and from diesel fuel we use to power our generators. To date, we have managed this risk by using alternative raw materials acceptable to our customers or we have been able to pass these cost increases to our customers. While we do not believe that changes in commodity prices have had a material impact on us in the past, commodity price fluctuations could have a material impact on us in the future, depending on the magnitude and timing of such fluctuations. The impact of these fluctuations could result in an increase in our operating costs and expenses and reduction in our gross profit margins and income due to increases in the price and costs of engines, generators, copper, aluminum, electrical components, labor, electricity, diesel fuel, gasoline, oil and natural gas. Movements in prices of these commodities can materially impact our results in this segment.

Foreign Exchange Risk. Since substantially all of our revenues, expenses and capital spending are transacted in U.S. dollars, we face minimal exposure to adverse movements in foreign currency exchange rates. However, if our international operations expand in the future, then our exposure to foreign currency risks could increase, which could materially affect our financial condition and results of operations. In addition, because our Energy Efficiency products utilize certain component parts manufactured in China, then to the extent the U.S. Dollar exchange rate with the Chinese Yuan changes significantly, our business and results of operations could be materially impacted.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2015, the end of the period covered by this report. Based upon management’s evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of March 31, 2015, our disclosure controls and procedures were designed at the reasonable assurance level and were effective at the reasonable assurance level to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities and migrating processes. There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations in Control Systems

Our controls and procedures were designed at the reasonable assurance level. However, because of inherent limitations, any system of controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired objectives of the control system. In addition, the design of a

 

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control system must reflect the fact that there are resource constraints, and management must apply its judgment in evaluating the benefits of controls relative to their costs. Further, no evaluation of controls and procedures can provide absolute assurance that all errors, control issues and instances of fraud will be prevented or detected. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls and procedures is also based in part on certain assumptions regarding the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

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PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we are involved in disputes and legal proceedings. There has been no material change in our pending legal proceedings as described in “Item 3. Legal Proceedings” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.

 

Item 1A. Risk Factors

Our business and operating results are subject to many risks, uncertainties and other factors. If any of these risks were to occur, our business, affairs, assets, financial condition, results of operations, cash flows and prospects could be materially and adversely affected. These risks, uncertainties and other factors include the information discussed elsewhere in this report as well as the risk factors set forth in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, which have not materially changed as of the date of this report.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 6. Exhibits

 

  (31.1) Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)
  (31.2) Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)
  (32.1) Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)
  (32.2) Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)
(101.INS) XBRL Instance Document
(101.SCH) XBRL Taxonomy Extension Schema Document
(101.CAL) XBRL Taxonomy Extension Calculation Linkbase Document
(101.DEF) XBRL Taxonomy Extension Definition Linkbase Document
(101.LAB) XBRL Taxonomy Extension Label Linkbase Document
(101.PRE) XBRL Taxonomy Extension Presentation Linkbase Document

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

POWERSECURE INTERNATIONAL, INC.
Date: May 6, 2015 By:

/s/ Sidney Hinton

Sidney Hinton
President and Chief Executive Officer
Date: May 6, 2015 By:

/s/ Christopher T. Hutter

Christopher T. Hutter
Executive Vice President and Chief Financial Officer

 

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