Form 10-Q
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 June 30, 2012

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 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. (Check one):

 

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 Act).    Yes  ¨    No  x

As of August 1, 2012, 18,777,811 shares of the issuer’s Common Stock were outstanding.

 

 

 


Table of Contents

POWERSECURE INTERNATIONAL, INC.

FORM 10-Q

For the Quarterly Period Ended June 30, 2012

TABLE OF CONTENTS

 

          Page  

Item 1.

  

Financial Statements

  
  

Unaudited Consolidated Balance Sheets - June 30, 2012 and December 31, 2011

     3   
  

Unaudited Consolidated Statements of Operations - For the Three and Six Months Ended June 30, 2012 and 2011

     5   
  

Unaudited Consolidated Statements of Cash Flows - For the Six Months Ended June 30, 2012 and 2011

     6   
  

Notes to Unaudited Consolidated Financial Statements

     7   

Item 2.

  

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

     27   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     57   

Item 4.

  

Controls and Procedures

     58   

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

     61   

Item 6.

  

Exhibits

     62   

Signatures

        63   

 

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Table of Contents

PART I.

FINANCIAL INFORMATION

 

Item 1. Financial Statements

POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share data)

 

     June 30,
2012
     December 31,
2011
 

Assets

     

Current Assets:

     

Cash and cash equivalents

   $ 23,707       $ 24,606   

Trade receivables, net of allowance for doubtful accounts of $105 and $174, respectively

     43,124         46,163   

Assets of discontinued operations held for sale

     190         380   

Inventories

     19,530         20,290   

Income taxes receivable

     230         439   

Current deferred income taxes

     650         650   

Prepaid expenses and other current assets

     920         1,128   
  

 

 

    

 

 

 

Total current assets

     88,351         93,656   
  

 

 

    

 

 

 

Property, plant and equipment:

     

Equipment

     41,589         38,441   

Furniture and fixtures

     338         283   

Land, building and improvements

     5,901         5,885   
  

 

 

    

 

 

 

Total property, plant and equipment, at cost

     47,828         44,609   

Less accumulated depreciation and amortization

     10,048         8,281   
  

 

 

    

 

 

 

Property, plant and equipment, net

     37,780         36,328   
  

 

 

    

 

 

 

Other assets:

     

Goodwill

     12,884         7,970   

Deferred income taxes, net of current portion

     266         266   

Restricted annuity contract

     2,412         2,376   

Intangible rights and capitalized software costs, net of accumulated amortization of $3,414 and $3,070, respectively

     1,552         1,642   

Investment in unconsolidated affiliate

     —           6   

Other assets

     739         331   
  

 

 

    

 

 

 

Total other assets

     17,853         12,591   
  

 

 

    

 

 

 

Total Assets

   $ 143,984       $ 142,575   
  

 

 

    

 

 

 

 

See accompanying notes to consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited)

(in thousands, except share data)

 

     June 30,
2012
    December 31,
2011
 

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 7,193      $ 6,894   

Accrued and other liabilities

     14,861        16,129   

Liabilities of discontinued operations held for sale

     —          125   

Current unrecognized tax benefit

     287        287   

Current portion of term loan

     160        —     

Current portion of capital lease obligations

     863        840   
  

 

 

   

 

 

 

Total current liabilities

     23,364        24,275   
  

 

 

   

 

 

 

Long-term liabilities:

    

Revolving line of credit

     —          —     

Term loan, net of current portion

     2,160        —     

Capital lease obligations, net of current portion

     2,370        2,807   

Unrecognized tax benefit

     731        731   

Other long-term liabilities

     2,409        2,300   
  

 

 

   

 

 

 

Total long-term liabilities

     7,670        5,838   
  

 

 

   

 

 

 

Commitments and contingencies (Notes 8 and 10)

    

Stockholders’ Equity:

    

PowerSecure International 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 and 25,000,000 shares authorized, respectively; 18,777,811 and 18,908,412 shares issued and outstanding, respectively

     188        189   

Additional paid-in-capital

     116,384        116,803   

Accumulated deficit

     (4,399     (5,439
  

 

 

   

 

 

 

Total PowerSecure International, Inc. stockholders’ equity

     112,173        111,553   

Non-controlling interest

     777        909   
  

 

 

   

 

 

 

Total stockholders’ equity

     112,950        112,462   
  

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 143,984      $ 142,575   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)

(in thousands, except per share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

Revenues

   $ 37,867      $ 30,086      $ 71,052      $ 53,741   

Cost of sales

     25,663        20,780        49,293        36,706   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     12,204        9,306        21,759        17,035   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

General and administrative

     9,093        7,952        17,738        15,633   

Selling, marketing and service

     1,366        1,214        2,424        2,368   

Depreciation and amortization

     1,136        802        2,221        1,575   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     11,595        9,968        22,383        19,576   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     609        (662     (624     (2,541

Other income and (expenses):

        

Gain on sale of unconsolidated affiliate

     1,439        21,786        1,439        21,786   

Equity income from unconsolidated affiliate

     —          548        —          1,559   

Management fees

     —          114        —          282   

Interest income and other income

     23        22        45        42   

Interest expense

     (116     (144     (224     (286
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     1,955        21,664        636        20,842   

Income tax provision

     (621     (3,183     (228     (3,230
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     1,334        18,481        408        17,612   
  

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued operations (Note 5):

        

Income (loss) from operations, net of tax

     32        (1,388     67        (1,603

Gain on disposal, net of tax

     —          —          —          5,636   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

     32        (1,388     67        4,033   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     1,366        17,093        475        21,645   

Net loss attributable to non-controlling interest

     277        159        565        343   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to PowerSecure International, Inc.

   $ 1,643      $ 17,252      $ 1,040      $ 21,988   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts attributable to PowerSecure International, Inc. common stockholders:

        

Income from continuing operations, net of tax

   $ 1,611      $ 18,640      $ 973      $ 17,955   

Income (loss) from discontinued operations, net of tax

     32        (1,388     67        4,033   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 1,643      $ 17,252      $ 1,040      $ 21,988   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per share attributable to PowerSecure International, Inc. common stockholders:

        

Income from continuing operations

   $ 0.09      $ 0.98      $ 0.05      $ 0.96   

Income (loss) from discontinued operations

     —          (0.07     0.01        0.21   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to PowerSecure International, Inc. common stockholders

   $ 0.09      $ 0.91      $ 0.06      $ 1.17   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share attributable to PowerSecure International, Inc. common stockholders:

        

Income from continuing operations

   $ 0.09      $ 0.97      $ 0.05      $ 0.94   

Income (loss) from discontinued operations

     —          (0.07     —          0.21   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to PowerSecure International, Inc. common stockholders

   $ 0.09      $ 0.90      $ 0.05      $ 1.15   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

 

     Six Months Ended
June 30,
 
     2012     2011  

Cash flows from operating activities:

    

Net income

   $ 475     $ 21,645  

Adjustments to reconcile net income to net cash used in operating activities:

    

Gain on sale of unconsolidated affiliate

     (1,439     (21,786

Income from discontinued operations

     (67     (4,033

Depreciation and amortization

     2,221       1,575  

Stock compensation expense

     576       926  

Loss on disposal of miscellaneous assets

     45       43  

Equity in income of unconsolidated affiliate

     —          (1,559

Distributions from unconsolidated affiliate

     —          607  

Changes in operating assets and liabilities, net of effect of acquisition:

    

Trade receivables, net

     4,360       (12,580

Inventories

     861       (1,016

Deferred income taxes

     —          1,154  

Other current assets and liabilities

     416       895  

Other noncurrent assets and liabilities

     (335     1,132  

Accounts payable

     (378     (1,099

Accrued and other liabilities

     (3,067     3,525  
  

 

 

   

 

 

 

Net cash provided by (used in) continuing operations

     3,668       (10,571

Net cash provided by (used in) discontinued operations

     132       (1,152
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     3,800       (11,723
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Acquisition

     (3,523     —     

Purchases of property, plant and equipment

     (3,330     (9,037

Additions to intangible rights and software development

     (215     (268

Proceeds from sale of property, plant and equipment

     14       —     

Proceeds from sale of unconsolidated affiliate

     1,445       25,610  

Proceeds from sale of discontinued operations

     —          16,515  

Discontinued operations investing activities

     —          (3
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (5,609     32,817  
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Borrowings (payments) on revolving line of credit

     —          5,000  

Proceeds from term loan borrowings

     2,400       —     

Proceeds from sale leaseback transactions

     —          2,097  

Payments on term loan

     (80     —     

Payments on capital lease obligations

     (414     (393

Repurchases of common stock

     (1,010     (162

Proceeds from stock option exercises

     14       310  
  

 

 

   

 

 

 

Net cash provided by financing activities

     910       6,852  
  

 

 

   

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (899     27,946  

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

     24,606       8,202  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 23,707     $ 36,148  
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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POWERSECURE INTERNATIONAL, INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

As of June 30, 2012 and December 31, 2011 and

For the Three and Six Month Periods Ended June 30, 2012 and 2011

(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.

Our Utility and Energy Technologies segment includes our core business operations. It is the only segment that we have been strategically focused on investing in and growing for the last several years. Conversely, our Energy Services segment contains our non-core business operations. We divested the operations of our Energy Services segment over time, with the final divestitures competed in 2011.

Our Utility and Energy Technologies segment includes our three primary product and service offerings: our Interactive Distributed Generation products and services, our Utility Infrastructure products and services, and our Energy Efficiency products. These three groups of products and services are commonly focused on serving the needs of utilities and their commercial, institutional and industrial customers to help them generate, deliver, and utilize electricity more efficiently. Our strategy is focused on growing these three product and service areas 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. These three product and service areas share common or complementary utility relationships and customer types, common sales and overhead resources, and facilities. However, we discuss and distinguish our Utility and Energy Technologies business among the three product and service areas due to the unique market needs they are addressing, and the distinct technical disciplines and specific capabilities required for us to deliver them, including personnel, technology, engineering, and intellectual capital. Our Utility and Energy Technologies segment operates primarily out of our Wake Forest, North Carolina headquarters office, and its operations also include several satellite offices and manufacturing facilities, the largest of which are in the Raleigh, North Carolina, Randleman, North Carolina, McDonough, Georgia, and Anderson, South Carolina areas. The locations of our sales organization and field employees for this segment are generally in close proximity to the utilities and commercial, industrial, and institutional customers they serve. Our Utility and Energy Technologies segment is operated through our largest wholly-owned subsidiary, PowerSecure, Inc.

Until the divestitures of our remaining non-core business operations in 2011, our Energy Services segment operated through our two other principal operating subsidiaries, Southern Flow Companies, Inc., which we refer to as “Southern Flow”, and WaterSecure Holdings, Inc., which we refer to as “WaterSecure”. WaterSecure holds a significant non-controlling minority portion of the equity interests in an unconsolidated business, Marcum Midstream 1995-2 Business Trust, a Delaware statutory trust, which we refer to as “MM 1995-2” or as our “WaterSecure operations”. Our WaterSecure operations provided water processing, recycling, and disposal services for oil and natural gas producers in northeastern Colorado utilizing environmentally responsible technologies and processes. In June 2011, substantially all of the assets and business of MM 1995-2 were sold and the proceeds from the sale and the liquidation of its remaining assets were distributed to MM 1995-2’s shareholders, including our WaterSecure subsidiary, in 2011 and 2012. Accordingly, our WaterSecure subsidiary no longer has any on-going operating activity. Our Southern Flow business, which was sold in January 2011, provided oil and natural gas measurement services to customers involved in oil and natural gas production, transportation, and processing, with a focus on the natural gas market. Due to its sale, Southern Flow’s operations are reflected as discontinued operations in the accompanying consolidated financial statements. The sales of our WaterSecure and Southern Flow operations completed our strategy to monetize our non-core assets to focus on the businesses in our Utility and Energy Technologies business segment. As a result of these sales, our Energy Services segment ceased on-going business activities in June 2011.

 

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See Note 13 for more information concerning our reportable segments.

Basis of Presentation

Organization – The accompanying consolidated financial statements include the accounts of PowerSecure International, Inc. and its subsidiaries (“PowerSecure”), primarily, PowerSecure, Inc. (and its majority-owned and wholly-owned subsidiaries, UtilityEngineering, Inc., PowerServices, Inc., EnergyLite, Inc., EfficientLights, LLC (“EfficientLights”), Innovative Electronic Solutions Lighting, LLC (“IES”), Reid’s Trailer, Inc. (“PowerFab”), Innovation Energies, LLC, Southern Energy Management PowerSecure, LLC (“PowerSecure Solar”) and PowerPackages, LLC), Southern Flow Companies, Inc. (“Southern Flow”), WaterSecure Holdings, Inc. (“WaterSecure”), and Marcum Gas Metering, Inc. (fka Metretek International, Inc. and Metretek, Incorporated) (“Metretek Florida”), collectively referred to as the “Company” or “we” or “us” or “our”.

These consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission. The accompanying 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, 2011.

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 consolidated financial position of us and our subsidiaries as of June 30, 2012 and the consolidated results of our operations and cash flows for the three and six months ended June 30, 2012 and June 30, 2011.

Principles of Consolidation – The consolidated financial statements include the accounts of PowerSecure International, Inc. and its subsidiaries after elimination of intercompany accounts and transactions. We use the equity method to account for our investment in our unconsolidated affiliate.

Non-controlling Interest – On June 5, 2012, we acquired a 90% controlling ownership interest in PowerSecure Solar, a distributed solar energy company (see Note 4). On April 1, 2010, we acquired a 67% controlling ownership interest in IES, an LED lighting company. Both PowerSecure Solar and IES are included in our consolidated financial statements. The non-controlling ownership interests in the income or losses of PowerSecure Solar and IES are included in our consolidated statements of operations as a reduction or addition to net income to derive income attributable to PowerSecure International stockholders. Similarly, the non-controlling ownership interest in the undistributed equity of PowerSecure Solar and IES are shown as a separate component of stockholders’ equity in our consolidated balance sheets.

 

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The following is a reconciliation of the amounts attributable to the non-controlling interest in IES and PowerSecure Solar for the six months ended June 30, 2012 and 2011:

 

     Six Months Ended June 30, 2012  
     IES     PowerSecure Solar     Total  

Balance, December 31, 2011

   $ 909     $ —        $ 909  

Capital contribution

     —          433       433  

Income (loss)

     (551     (14     (565
  

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

   $ 358     $ 419     $ 777  
  

 

 

   

 

 

   

 

 

 

 

     Six Months Ended June 30, 2011  
     IES     PowerSecure Solar      Total  

Balance, December 31, 2010

   $ 1,755     $ —         $ 1,755  

Capital contribution

     —          —           —     

Income (loss)

     (343     —           (343
  

 

 

   

 

 

    

 

 

 

Balance, June 30, 2011

   $ 1,412     $ —         $ 1,412  
  

 

 

   

 

 

    

 

 

 

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 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 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 and our deferred tax valuation allowance.

Reclassifications – The assets, liabilities and operations of our discontinued PowerPackages business have been reclassified to discontinued operations for all periods presented in the accompanying consolidated financial statements. In addition, certain 2011 amounts have been reclassified to conform to current year presentation. Such reclassifications had no effect on net income or stockholders’ equity.

 

2. Summary of Significant Accounting Policies and Recent Accounting Standards

Revenue Recognition – For our distributed generation turn-key project-based sales and our utility infrastructure turn-key projects, we recognize revenue and profit as work progresses using the percentage-of-completion method, which relies on various estimates. Nearly all of our distributed generation and utility infrastructure turn-key projects are fixed-price contracts.

In applying the percentage-of-completion method to our distributed generation 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 costs incurred and the value added to the overall construction 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 turnkey 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 construction project and 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 utility infrastructure turn-key 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

 

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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 wire or other raw materials, 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 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 were 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, the effect on current period earnings would more likely be significant. In addition, certain contracts provide for cancellation provisions prior to completion of a project. The cancellation provisions generally provide for payment of costs incurred, but may result in an adjustment to profit already recognized in a prior period.

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.

Service revenue includes regulatory consulting and rate design services, power system engineering services, energy conservation 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 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 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 continuously monitor collections and payments from our customers and regularly adjust credit limits of customers based upon payment history and a customer’s current credit worthiness, as judged by us. We maintain a provision for estimated credit losses.

 

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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 it with multiple domestic financial institutions. Nevertheless, our cash in bank deposit accounts at these financial institutions frequently exceeds federally insured limits. We further limit our exposure to credit risk associated with these cash accounts by adherence to our investment policy. 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.

Warranty Reserve –We provide a standard warranty for our distributed generation equipment, switchgear equipment, utility infrastructure equipment, and our LED products, which generally range between one and five years. In addition, we offer extended warranty terms on certain distributed generation turn-key and switchgear projects. 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 extended warranties included in the contract terms are deferred as a component of our warranty reserve. The balance of our warranty reserve included in accrued and other liabilities at June 30, 2012 and December 31, 2011 was $1.3 million and $1.1 million, respectively.

Share-Based Compensation – We measure compensation cost for all stock-based awards at the 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 quoted price of our common stock on the date of the grant, and we measure the fair value of stock options using the Black-Scholes valuation model.

Pre-tax share-based compensation expense for our stock options and restricted stock awards recognized during the three months ended June 30, 2012 and 2011 was $281 thousand and $446 thousand, respectively. Pre-tax share-based compensation expense for our stock options and restricted stock awards recognized during the six months ended June 30, 2012 and 2011 was $576 thousand and $926 thousand, respectively. All share-based compensation expense is included in general and administrative expense in the accompanying consolidated statements of operations.

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.

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.

Recent Accounting Pronouncements

Fair Value Measurements – In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, which amended Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This amendment is intended to result in convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”)

 

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requirements for measurement of and disclosures about fair value. This amended guidance clarifies the concepts applicable for fair value measurement of non-financial assets and also expands the disclosures for fair value measurements that are estimated using significant unobservable inputs used in a fair value measurement. This amended guidance became effective for us on a prospective basis commencing January 1, 2012. The adoption of this standard had no effect on our financial position or results of operations.

Testing Goodwill for Impairment – In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350)—Testing Goodwill for Impairment. This standard, which amends and updates guidance on the periodic testing of goodwill for impairment, provides companies with the option to first assess qualitative factors to determine whether it is more likely than not that that the fair value of a reporting unit is less than its carrying amount. If so, then it is necessary to perform the two-step quantitative goodwill impairment test. This standard becomes effective for fiscal years beginning after December 15, 2011, with early adoption allowed. We adopted this standard effective October 1, 2011. The adoption of this standard had no effect on our financial position or results of operations.

Testing Indefinite-Lived Intangible Assets for Impairment – In July 2012, the FASB issued ASU No. 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This standard, which amends the guidance on testing indefinite-lived intangible assets, other than goodwill, for impairment, provides companies with the option to first perform a qualitative assessment before performing the two-step quantitative impairment test. If the company determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is more likely than not to exceed its carrying amount, then the company would not need to perform the two-step quantitative impairment test. This standard does not revise the requirement to test indefinite-lived intangible assets annually for impairment. This standard becomes effective for annual and interim impairment tests performance for fiscal years beginning after September 15, 2012, with early adoption allowed. We do not expect the adoption of this standard will have a material effect on our financial position or results of operations.

 

3. Earnings (Loss) per Share

Basic earnings (loss) per share is computed by dividing net income (loss) attributable to PowerSecure International, Inc. common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share attributable to PowerSecure International, Inc. common stockholders 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.

 

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The following table sets forth the calculation of basic and diluted earnings (loss) per share attributable to PowerSecure International, Inc. common stockholders:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012      2011     2012      2011  

Income from continuing operations

   $ 1,611      $ 18,640     $ 973      $ 17,955  

Income (loss) from discontinued operations

     32        (1,388     67        4,033  
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income

   $ 1,643      $ 17,252     $ 1,040      $ 21,988  
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic weighted-average common shares outstanding in period

     18,846        18,857       18,874        18,788  

Dilutive effect of stock options

     95        289       141        325  
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted weighted-average common shares outstanding in period

     18,941        19,146       19,015        19,113  
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic earnings per common share:

          

Income from continuing operations

   $ 0.09      $ 0.98     $ 0.05      $ 0.96  

Income (loss) from discontinued operations

     0.00        (0.07     0.01        0.21  
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic earnings per common share

   $ 0.09      $ 0.91     $ 0.06      $ 1.17  
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted earnings per common share:

          

Income from continuing operations

   $ 0.09      $ 0.97     $ 0.05      $ 0.94  

Income (loss) from discontinued operations

     0.00        (0.07     0.00        0.21  
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic earnings per common share

   $ 0.09      $ 0.90     $ 0.05      $ 1.15  
  

 

 

    

 

 

   

 

 

    

 

 

 

 

4. Acquisition

On June 5, 2012, we acquired a distributed solar energy business, adding this capability to our distributed generation system platform. Our new capabilities were acquired through the acquisition of the utility, commercial and industrial solar energy business of Southern Energy Management, Inc., a North Carolina corporation (the “Seller”). Our decision to offer solar solutions resulted from a thorough evaluation of the industry and of the improved economics of distributed solar energy systems. We believe the decrease in the cost of solar panels, and corresponding increases in their energy efficiency, in conjunction with our highly efficient distributed generation systems, provides us with a sustainable market opportunity to participate in the downstream segment of the solar business, and bring solar energy projects to our customers and utility partners. We began offering utilities and their large commercial and industrial customers solar energy distributed generation systems immediately after the acquisition, and took over the installation of several large projects the Seller had in process, including a 4.5 megawatt system.

We consummated the acquisition through the formation of PowerSecure Solar, which entered into, and completed the acquisition contemplated by, an Asset Contribution and Sale Agreement, dated as of June 5, 2012 (the “Contribution Agreement”), with the Seller. Pursuant to the Contribution Agreement, PowerSecure Solar completed the acquisition of substantially all of the assets and assumed certain liabilities of the Seller relating to the business of designing and selling energy efficiency and solar photovoltaic power systems and other solar power technologies for large customers, including utility, commercial and industrial customers (the “Acquired Business”).

The effective date of the acquisition of the Acquired Business was June 2, 2012. Total revenues and loss from PowerSecure Solar since the effective date of acquisition included in the accompanying consolidated statements of operations for the three and six month periods ended June 30, 2012 was $190 thousand and $144 thousand, respectively. Additional acquisition-related costs in the amount of $74 thousand were recognized as an expense during the three and six month periods ended June 30, 2012, and are included in general and administrative expense in the accompanying consolidated statements of operations.

 

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After the acquisition, we own 90% of the membership interests in, and control the management of, PowerSecure Solar. The Seller owns a 10% non-controlling interest in PowerSecure Solar and retained its business selling solar photovoltaic power systems and solar thermal energy to residential customers and small merchants and professional service providers.

Under the terms of the organizational documents for PowerSecure Solar, we have the option (the “Call Option”), commencing in June 2014, to purchase the remaining 10% membership interest in PowerSecure Solar held by the Seller or by any other non-controlling members at the time at a purchase price based on the greater of (i) a formula of five times the trailing four quarters earnings before interest, taxes, depreciation and amortization of PowerSecure Solar, excluding income attributable to sales of Company-owned projects (“Trailing 12 EBITDA”), multiplied by its percentage interest in PowerSecure Solar, or (ii) $1.0 million. The purchase price of the Call Option is payable in either cash or shares of our common stock, at our discretion. In the event of a change in control of us or the Seller, then the commencement of the Call Option will be accelerated.

In addition, the Seller has the right, commencing in June 2016, to require us to purchase its membership interest for a purchase price equal to three times PowerSecure Solar’s Trailing 12 EBITDA multiplied by its percentage interest in PowerSecure Solar, less net capital infusions by us into PowerSecure Solar after the closing, which purchase price is payable in either cash or shares of our common stock, at our discretion. The Seller also has the right to join in a sale by us of a majority of our interest in PowerSecure Solar, and we can require the Seller to join in any sale of all of its interests in PowerSecure Solar, in each case on the same terms by Seller as by us.

The Contribution Agreement contains customary representations and warranties as well as indemnification obligations by PowerSecure Solar, on the one hand, and by Seller and its two founders and shareholders (the “Seller Principals”), on the other hand, to each other. In addition, the Contribution Agreement contains a covenant not to compete by Seller and Seller Principals against PowerSecure Solar and its affiliates in the acquired business, subject to certain exceptions related to its retained solar business for residential and small commercial customers. Correspondingly, PowerSecure Solar has agreed, on behalf of itself and its affiliates, not to compete against the Seller in its retained business. These non-competition covenants continue for a period of five years after the Seller no longer holds any membership interest in PowerSecure Solar.

The following table summarizes the consideration paid to the Seller for the Acquired Business and the amounts of the assets acquired and the liabilities assumed recognized at the acquisition date, as well as the fair value at the acquisition date of the non-controlling interest in PowerSecure Solar:

 

Consideration paid to Seller:

  

Cash

   $ 3,523   
  

 

 

 

Accounts receivable

   $ 1,320   

Inventories

     3   

Property, plant and equipment

     156   

Identifiable intangible assets

     39   

Accounts payable

     (677

Accrued and other liabilities

     (1,799
  

 

 

 

Total identifiable net assets (liabilities)

     (958

Non controlling interest in PowerSecure Solar

     (433

Goodwill

     4,914   
  

 

 

 
   $ 3,523   
  

 

 

 

 

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The fair value of the acquired identifiable intangible assets of $39 thousand is provisional pending receipt of the final valuations for those assets. The goodwill of $4,914 thousand arising from the acquisition consists largely of the assembled workforce of PowerSecure Solar, and the synergies and economies of scale expected from combining the operations of our PowerSecure subsidiary and PowerSecure Solar. All of the goodwill was assigned to our Utility and Energy Technologies segment and is expected to be deductible for tax purposes. The non-controlling interest in PowerSecure Solar in the amount of $433 thousand was valued using the income approach and a market approach using assumptions, including a discount rate and a terminal value, that are not observable in the market.

Supplemental pro forma information, as if the acquisition had occurred on January 1, 2011, is as follows:

 

     Pro Forma
Six Months Ended
June 30,
 
     2012      2011  

Revenues

   $ 77,588       $ 59,675   

Earnings Attributable to PowerSecure International, Inc.:

     

Income from continuing operations

   $ 53       $ 17,301   

Net income

   $ 120       $ 21,334   

Diluted earnings per common share:

     

Income from continuing operations

   $ —         $ 0.91   

Net income

   $ 0.01       $ 1.12   

The supplemental pro forma information above is based on estimates and assumptions, which we believe are reasonable. The pro forma information presented is not necessarily indicative of the consolidated financial position or results of operation in future periods or the results that actually would have been realized had the acquisition occurred on January 1, 2011. The supplemental pro forma results above exclude any benefits that may result from the acquisition due to synergies that are expected to be derived from the elimination of any duplicative costs. In addition, the pro forma results for the period ended June 30, 2012 were adjusted to exclude $74 thousand of acquisition-related costs incurred in 2012.

 

5. Discontinued Operations

In January 2011 we sold our Southern Flow business and operations, which was part of our Energy Services segment. During the second half of 2011, we substantially completed the shutdown activities of our PowerPackages business which provided medium speed engine distributed generation products and services within our Utility and Energy Technologies segment. As a result, the sale of Southern Flow and the results of operations of PowerPackages are classified as discontinued operations in the accompanying consolidated financial statements.

 

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The results of PowerPackages discontinued operations for the three and six months ended June 30, 2012 and 2011 were as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2012     2011     2012     2011  

PowerPackages Discontinued Operations:

        

Total revenues

   $ 115      $ 131      $ 336      $ 189   

Operating expenses

     63        2,363        228        2,767   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     52        (2,232     108        (2,578

Income tax benefit (provision)

     (20     844        (41     975   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     32        (1,388     67        (1,603

Gain on disposal

     —          —          —          —     

Income tax benefit on disposal

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations

   $ 32      $ (1,388   $ 67      $ (1,603
  

 

 

   

 

 

   

 

 

   

 

 

 

The following assets and liabilities of PowerPackages were segregated and included in Assets and Liabilities of discontinued operations held for sale, as appropriate, in the accompanying consolidated balance sheets as of June 30, 2012 and December 31, 2011:

 

     June 30,
2012
     December 31,
2011
 

PowerPackages Assets and Liabilities:

     

Inventories

   $ 190       $ 380   

Other assets

     —           —     
  

 

 

    

 

 

 

Assets of discontinued operations

   $ 190       $ 380   
  

 

 

    

 

 

 

Accrued and other liabilities

   $ —         $ 125   

Other liabilities

     —           —     
  

 

 

    

 

 

 

Liabilities of discontinued operations

   $ —         $ 125   
  

 

 

    

 

 

 

The results of Southern Flow discontinued operations for the three and six months ended June 30, 2012 and 2011 were as follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Southern Flow Discontinued Operations:

           

Total revenues

   $ —         $ —         $ —         $ —     

Operating expenses

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     —           —           —           —     

Income tax benefit (provision)

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) from operations

     —           —           —           —     

Gain on disposal

     —           —           —           5,538   

Income tax benefit on disposal

     —           —           —           98   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) from discontinued operations

   $ —         $ —         $ —         $ 5,636   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no assets or liabilities of Southern Flow discontinued operations at either June 30, 2012 or December 31, 2011.

 

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6. Investment in Unconsolidated Affiliate

We own a significant non-controlling minority portion of the equity interests in MM 1995-2 through our wholly-owned WaterSecure subsidiary. We account for this investment using the equity method and receive both equity income and management fees for management services we provide to MM 1995-2 as its managing trustee. In June 2011, MM 1995-2 sold substantially all of its assets and business for cash and we recorded a pretax gain in the amount of $21.8 million from the sale in our financial statements during the three and six months ending June 30, 2011.

An amount equal to $4.0 million of the cash sales price owed by the purchaser to MM 1995-2 was held in escrow until June 1, 2012, for potential claims relating to various representations and warranties. The $4.0 million escrow had been subject to the purchaser’s rights to these funds for contingencies that were outside of our control. Upon termination of the escrow on June 1, 2012, approximately $3.9 million of the remaining escrow account balance was paid to MM 1995-2, of which we received $1.4 million, which was our share of these escrow proceeds.

We recorded a gain in the amount of $1.4 million during the three and six months ended June 30, 2012 related to this final cash distribution from the sale of the assets of MM 995-2. We do not expect to receive any additional proceeds from the sale. There were no equity income or management fees earned during the six months ended June 30, 2012 because the sale was consummated in June 2011.

 

7. Debt

Line of Credit – We have had a credit facility with Citibank, N.A. (“Citibank”), as administrative agent and lender, and other lenders since entering into a credit agreement in August 2007. At June 30, 2012 and December 31, 2011, our credit agreement with Citibank along with Branch Banking and Trust Company (“BB&T”) as additional lender, consists of a $20.0 million senior, first-priority secured revolving and term credit facility. The credit facility is guaranteed by all of our active subsidiaries and secured by all of our assets and the assets of our active subsidiaries. In addition, the credit facility provides for a five year term loan of up to $2.6 million, and we completed the financing of a $2.4 million term loan under this provision on February 7, 2012.

We have used, and intend to continue to use, the proceeds available under the credit facility to finance PowerSecure’s recurring revenue projects as well as to finance capital expenditures, working capital, and for general corporate purposes. The credit facility, as a revolving credit facility, will mature and terminate on November 12, 2014. However, we have the option prior to that maturity date to convert a portion of outstanding principal balance thereunder, in an amount not to exceed the present value of estimated annual contract revenues receivable under recurring revenue distributed generation projects, into a non-revolving term loan for a two year period expiring November 12, 2016, making quarterly payments based upon a four year fully amortized basis.

Outstanding balances under the credit facility (including under the term loan described below) 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, as defined in the credit agreement, 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%.

The credit facility is not subject to any borrowing base computations or limitations, but does contain certain financial covenants made by us. 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 trailing 12 month consolidated 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. In addition, we are required to maintain a minimum consolidated tangible net worth, computed on a quarterly basis, of not less than the sum of $80.0 million, plus an amount equal to 50% of our net income each fiscal year commencing January 1, 2012, with no reduction for any net loss in any fiscal year, plus 100% of any equity we raise through the sale of equity interests, less the amount of any non-cash charges or losses. Also, 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 25%. As of June 30, 2012, we were in compliance with these financial covenants.

 

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Under the credit agreement, upon the sale of any of our assets or the assets of our subsidiaries other than in the ordinary course of business or the public or private sale or issuance of any of our equity or our debt or the issuance or any equity or debt of our subsidiaries other than equity issuances where the aggregate net equity proceeds do not exceed $15.0 million, we are required to use the net proceeds thereof to repay any indebtedness then outstanding under the credit facility.

The credit facility contains customary terms and conditions for credit facilities of this type, including restrictions on our ability to incur additional indebtedness, create liens, enter into transactions with affiliates, make acquisitions or sales, pay dividends on or repurchase our capital stock or consolidate or merge with other entities. In addition, the credit agreement contains customary events of default which were not modified in connection with the amendment and restatement, including payment defaults, breach of representations and warranties, covenant defaults, cross-defaults, certain bankruptcy or insolvency events, judgment defaults and certain ERISA-related events, which were not modified by the amendment and restatement.

Our obligations under the credit facility are secured by guarantees (“Guarantees”) and security agreements (the “Security Agreements”) by each of our active subsidiaries, including PowerSecure, Inc. and its subsidiaries. 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 of the parties to the credit agreement.

There were no balances outstanding on the revolving portion of the credit facility at, or during the six months ended, June 30, 2012 or at December 31, 2011 or at August 6, 2012. We currently have $20.0 million available to borrow under the credit facility. However, the availability of 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.

Term Loan – The credit agreement also provides for a five year term loan of up to $2.6 million, and we completed the financing of a $2.4 million term loan under this provision on February 7, 2012. The term loan is secured by deeds of trust we granted for the benefit of the lenders on the real estate and offices of our headquarters in Wake Forest, North Carolina and on the real estate and offices of our PowerFab facility in Randleman, North Carolina. The term loan was made under the credit agreement, and upon the same terms and conditions including covenants and interest rates, except that we are required to make quarterly principal repayments of $40 thousand, plus interest, on the term of the term loan based on a 15 year amortization schedule with the remaining outstanding principal balance due and payable on November 12, 2016.

 

8. Capital Lease Obligations

We have a capital lease with SunTrust Equipment Finance and Leasing, an affiliate of SunTrust Bank, 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.

 

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The balance of our capital lease obligations shown in the consolidated balance sheet at June 30, 2012 and December 31, 2011 consist 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 and restricted stock 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, stock appreciation rights, 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 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 for the three months ended June 30, 2012 and 2011 includes $22 thousand and $56 thousand, respectively, of pre-tax compensation costs related to outstanding stock options. Net income for the six months ended June 30, 2012 and 2011 includes $59 thousand and $146 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 consolidated statements of operations.

 

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A summary of option activity for the six months ended June 30, 2012 is as follows:

 

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

Balance, December 31, 2011

     911      $ 6.98         

Granted

     10        6.88         

Exercised

     (4     3.56         

Expired

     —          —           

Forfeited

     (10     8.36         
  

 

 

   

 

 

       

Balance, June 30, 2012

     907      $ 6.98         4.52       $  n/m  (1) 
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable, June 30, 2012

     761      $ 7.18         3.95       $  n/m  (1) 
  

 

 

   

 

 

    

 

 

    

 

 

 

A summary of option activity for the six months ended June 30, 2011 is as follows:

 

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

Balance, December 31, 2010

     1,247      $ 5.98         

Granted

     10        6.21         

Exercised

     (291     1.98         

Expired

     (21     13.82         

Forfeited

     (31     6.37         
  

 

 

   

 

 

       

Balance, June 30, 2011

     914      $ 7.06         5.47       $ 0.16   
  

 

 

   

 

 

    

 

 

    

 

 

 

Exercisable, June 30, 2011

     715      $ 7.30         4.75       $  n/m  (1) 
  

 

 

   

 

 

    

 

 

    

 

 

 

 

(1) The aggregate exercise prices of the options exceed the aggregate fair value of the underlying shares of common stock based on the closing sale price of the common stock on the NASDAQ Global Select Market on June 30, 2012 and 2011.

The weighted average grant date fair value of the options granted during the six months ended June 30, 2012 and 2011 was $2.43 and $2.91, respectively. The fair value of the stock options granted during the six months ended June 30, 2012 and 2011 was measured using the Black-Scholes valuation model with the following assumptions:

 

     June 30,  
     2012     2011  

Expected stock price volatility

     39.0     52.2

Risk free interest rate

     1.0     2.0

Annual dividends

   $ —        $ —     

Expected life (years)

     5        5   

The fair value of stock option grants are amortized to expense over their respective service periods using the straight-line method and assuming a forfeiture rate of 5%. As of June 30, 2012 and December 31, 2011, there was $352 thousand and $423 thousand, respectively, of total unrecognized compensation costs related to stock options. These costs at June 30, 2012 are expected to be recognized over a weighted average period of approximately 1.5 years.

 

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During the three months ended June 30, 2012 and 2011, the total intrinsic value of stock options exercised was $3 thousand and $863 thousand, respectively. Cash received from stock option exercises during the three months ended June 30, 2012 and 2011 was $3 thousand and $80 thousand, respectively. The total grant date fair value of stock options vested during the three months ended June 30, 2012 and 2011 was $52 thousand and $169 thousand, respectively.

During the six months ended June 30, 2012 and 2011, the total intrinsic value of stock options exercised was $12 thousand and $1,642 thousand, respectively. Cash received from stock option exercises during the six months ended June 30, 2012 and 2011 was $14 thousand and $310 thousand, respectively. The total grant date fair value of stock options vested during the six months ended June 30, 2012 and 2011 was $57 thousand and $193 thousand, respectively.

Restricted Stock Awards – Net income for the three months ended June 30, 2012 and 2011 includes $258 thousand and $390 thousand, respectively, of pre-tax compensation costs related to the vesting of outstanding restricted stock awards granted to directors, certain officers and our employees. Net income for the six months ended June 30, 2012 and 2011 includes $517 thousand and $780 thousand, respectively, of pre-tax compensation costs related to the vesting of outstanding restricted stock awards granted to directors, certain officers and our employees. All of the restricted stock award compensation expense during the three and six months ended June 30, 2012 and 2011 is included in general and administrative expenses in the accompanying consolidated statements of operations.

A summary of restricted stock award activity for the six months ended June 30, 2012 is as follows:

 

     Unvested
Restricted
Shares
    Weighted
Average
Grant Date
Fair Value
 

Balance, December 31, 2011

     410      $ 11.47   

Granted

     59        4.21   

Vested

     (81     7.76   

Forfeited

     —          —     
  

 

 

   

 

 

 

Balance, June 30, 2012

     388      $ 11.13   
  

 

 

   

 

 

 

A summary of restricted stock award activity for the six months ended June 30, 2011 is as follows:

 

     Unvested
Restricted
Shares
    Weighted
Average
Grant Date
Fair Value
 

Balance, December 31, 2010

     478      $ 11.00   

Granted

     30        6.77   

Vested

     (77     8.20   

Forfeited

     —          —     
  

 

 

   

 

 

 

Balance, June 30, 2011

     431      $ 11.21   
  

 

 

   

 

 

 

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 other than officers vest in equal annual amounts over five years. A total of 323 thousand unvested restricted shares issued to officers in 2007 cliff vest in the second half of 2012. All restricted and unvested shares automatically vest upon a change in control.

The fair value of employee and director restricted shares along with the cliff vesting restricted shares granted to

 

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officers are being amortized on a straight-line basis over the vesting period. At June 30, 2012, the balance of unrecognized compensation cost related to unvested restricted shares was $371 thousand, of which we expect $228 thousand will be recognized during the remainder of 2012 and the remaining balance will be recognized in 2013.

 

10. Commitments and Contingencies

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.

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, LED and other lighting products, electrical circuit boards, power drivers, photovoltaic energy systems, and other complex 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. 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. 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. Although we believe our suppliers’ warranties cover many of these performance issues, from time to time we face disputes with our suppliers with respect to those performance issues and their warranty obligations. Additionally, the outcome of any 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, and thus there is no assurance we will not be adversely affected by these, or other performance issues with key parts and components. Moreover, from time to time performance issues are not 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 5-20% 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 are in the process of resolving: 1) a supplier of a substantial distributed generation system component indicated its warranty does not cover performance issues related to its being used in conjunction with a component from another supplier, and this configuration has been installed in many of the distributed generation systems deployed for our customers, and 2) generators from a certain supplier have had performance issues in a distributed generation 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 been actively working to correct and resolve the performance issues and have made progress, although we have not eliminated the risk related to these issues. Given that we are in the process of addressing these performance issues, and the inherent uncertainty in assessing and quantifying the costs and nature of the resolution of these types of technical issues, at present we are unable to estimate the potential negative impacts from these particular items, if any, in addition to other component part performance issues discussed above. In addition, at this time we have

 

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not recorded any adjustment to our warranty reserve for these particular performance issues, other than an immaterial amount for certain minor repairs, as the estimated cost, if any, of fulfilling our warranty obligations for these performance issues within a possible range of outcomes is not determinable as of this date.

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. 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 recorded at June 30, 2012 represents our income before taxes multiplied by our best estimate of our expected annual effective tax rate taking into consideration our expectation of future earnings, federal alternative minimum 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. Capital Stock

Stock Repurchases – On November 1, 2011, our board of directors authorized a stock repurchase program of up to $5.0 million in shares of our common stock, par value $0.01 per share. Repurchases of shares can be made from time to time in open market purchases or in privately negotiated transactions. The timing and amount of any shares repurchased is determined in the discretion of management based on its evaluation of market conditions and other factors. During the six months ended June 30, 2012, a total of 174 thousand shares were repurchased under the program at a gross purchase price, including commission costs, of $887 thousand. The stock repurchase program may continue for a period of up to 24 months, although it may be suspended from time to time or discontinued at any time, or it may be renewed or extended, in the discretion of our board of directors. As of June 30, 2012, a total of approximately $3.8 million in shares of common stock could still be purchased under the stock repurchase program.

In addition, from time to time we receive shares of our common stock from employees who tender their existing shares to pay all or part of the exercise price of stock options or we withhold shares of our common stock from employees to satisfy tax withholdings on the vesting of restricted shares. We received 20 thousand shares from employees who tendered shares at a gross purchase price of $123 thousand during the six months ended June 30, 2012. We received 20 thousand shares from employees who tendered shares at a gross purchase price of $160 thousand during the six months ended June 30, 2011. In each case, the price paid per share with respect to the shares tendered was based on the closing sales price of our common stock on the vesting date as reported on The NASDAQ Global Select Market.

Authorized Shares – On June 19, 2012, at our 2012 Annual Meeting of Stockholders, our stockholders adopted and approved an amendment to our Second Restated Certificate of Incorporation to increase the number of shares of common stock authorized for issuance by us by 25.0 million shares to a total of 50.0 million shares. We effected the increase in the number of authorized shares of our common stock by filing a Certificate of Amendment to our Second Restated Certificate of Incorporation with the Secretary of State of the State of Delaware on June 19, 2012, and the amendment became effective as of such date.

 

13. Segment Information

We conduct our operations through two business segments. Our Utility and Energy Technologies segment includes our core business operations. It is the only segment that we have been strategically focused on investing in and growing for the last several years. Conversely, our Energy Services segment contains our non-core business operations. We divested the operations of our Energy Services segment over time, with the final divestitures completed in 2011. As a result of these sales, we will no longer actively operate in the Energy Services segment.

Our reportable segments are strategic business units that offer different products and services and serve different customer bases. They are managed separately because each business requires different technology and marketing

 

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Table of Contents

strategies. Our operating segments also represent components of our business for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions.

Utility and Energy Technologies – Our Utility and Energy Technologies segment includes our three primary product and service areas: our Interactive Distributed Generation products and services, our Utility Infrastructure products and services, and our Energy Efficiency products. These three groups of products and services are commonly focused on serving the needs of utilities and their commercial, institutional and industrial customers to help them generate, deliver, and utilize electricity more efficiently. These three product and service areas share common or complementary utility relationships and customer types, common sales and overhead resources, and facilities. However, we discuss and distinguish our Utility and Energy Technologies business among the three product and service areas due to the unique market needs they are addressing, and the distinct technical disciplines and specific capabilities required for us to deliver them, including personnel, technology, engineering, and intellectual capital. Our Utility and Energy Technologies segment is operated through our largest wholly-owned subsidiary, PowerSecure, Inc.

Our PowerPackages business was previously included in this segment until its discontinuance in the fourth quarter 2011. As a result, PowerPackages’ financial results are excluded from the Utility and Energy Technologies segment for all periods presented in the information below.

Energy Services – Until the completion of the sales of our remaining non-core business operations in 2011, our Energy Services segment operated through our two other principal operating subsidiaries, Southern Flow and WaterSecure. WaterSecure holds a significant non-controlling minority portion of the equity interests in MM 1995-2. Our WaterSecure operations provided water processing, recycling, and disposal services for oil and natural gas producers in northeastern Colorado utilizing environmentally responsible technologies and processes. In June 2011, substantially all of the assets and business of MM 1995-2 were sold and we recorded a $21.8 million gain from the sale in 2011. In June 2012, we recorded an additional $1.4 million gain from the sale of our WaterSecure operations attributable to our receipt of sales proceeds that had been placed into escrow pending the outcome of contingencies related to the sale. We do not expect to receive any additional proceeds from this sale. Accordingly, our WaterSecure subsidiary no longer has any on-going operating activity. Our Southern Flow business, which was sold in January 2011, provided oil and natural gas measurement services to customers involved in oil and natural gas production, transportation, and processing, with a focus on the natural gas market. The gain on the sale of Southern Flow is reflected in discontinued operations and its activities are excluded from our Energy Services segment for all periods presented in the information below. The sales of our WaterSecure and Southern Flow operations completed our strategy to monetize our non-core assets to focus on the businesses in our Utility and Energy Technologies business segment. As a result of these sales, our Energy Services segment ceased on-going business activities in June 2011 and thus we no longer report ongoing operations in the Energy Services segment in financial periods after June 30, 2011.

 

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The accounting policies of the reportable segments are the same as those described in Note 1 of the Notes to Consolidated Financial Statements. We evaluate the performance of our operating segments based on income (loss) before income taxes. There are no intersegment sales. Summarized financial information concerning our reportable segments is shown in the following table. Unallocated corporate cost amounts include corporate overhead, other income and interest expense which, for purposes of evaluating the operations of our segments, are not allocated to our segment activities. Total asset amounts exclude intercompany receivable balances eliminated in consolidation.

 

     Three Months Ended June 30, 2012  
     Utility and
Energy
Technologies
    Energy
Services
     Unallocated
Corporate
Costs
    Total  

Revenues

   $ 37,867      $ —         $ —        $ 37,867   

Cost of Sales

     25,663        —           —          25,663   
  

 

 

   

 

 

    

 

 

   

 

 

 

Gross Profit

     12,204        —           —          12,204   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating expenses:

         

General and administrative

     7,694        —           1,399        9,093   

Selling, marketing and service

     1,366        —           —          1,366   

Depreciation and amortization

     1,136        —           —          1,136   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total operating expenses

     10,196        —           1,399        11,595   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating Income (loss)

     2,008        —           (1,399     609   

Other income and (expenses):

         

Gain on sale of unconsolidated affiliate

     —          1,439         —          1,439   

Equity income

     —          —           —          —     

Management fees

     —          —           —          —     

Interest income and other income

     —          —           23        23   

Interest expense

     (68     —           (48     (116
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

   $ 1,940      $ 1,439       $ (1,424   $ 1,955   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total capital expenditures

   $ 2,482      $ —         $ —        $ 2,482   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total investment in unconsolidated affiliate

   $ —        $ —         $ —        $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total goodwill

   $ 12,884      $ —         $ —        $ 12,884   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 122,010      $ —         $ 21,974      $ 143,984   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

     Three Months Ended June 30, 2011  
     Utility and
Energy
Technologies
    Energy
Services
    Unallocated
Corporate
Costs
    Total  

Revenues

   $ 30,086      $ —        $ —        $ 30,086   

Cost of Sales

     20,780        —          —          20,780   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

     9,306        —          —          9,306   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

General and administrative

     6,682        —          1,270        7,952   

Selling, marketing and service

     1,214        —          —          1,214   

Depreciation and amortization

     790        12        —          802   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     8,686        12        1,270        9,968   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income (loss)

     620        (12     (1,270     (662

Other income and (expenses):

        

Gain on sale of unconsolidated affiliate

     —          21,786        —          21,786   

Equity income

     —          548        —          548   

Management fees

     —          114        —          114   

Interest income and other income

     —          —          22        22   

Interest expense

     (98     —          (46     (144
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 522      $ 22,436      $ (1,294   $ 21,664   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total capital expenditures

   $ 4,369      $ —        $ —        $ 4,369   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment in unconsolidated affiliate

   $ —        $ 1,445      $ —        $ 1,445   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total goodwill

   $ 7,970      $ —        $ —        $ 7,970   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Six Months Ended June 30, 2012  
     Utility and
Energy
Technologies
    Energy
Services
     Unallocated
Corporate
Costs
    Total  

Revenues

   $ 71,052      $ —         $ —        $ 71,052   

Cost of Sales

     49,293        —           —          49,293   
  

 

 

   

 

 

    

 

 

   

 

 

 

Gross Profit

     21,759        —           —          21,759   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating expenses:

         

General and administrative

     15,143        —           2,595        17,738   

Selling, marketing and service

     2,424        —           —          2,424   

Depreciation and amortization

     2,221        —           —          2,221   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total operating expenses

     19,788        —           2,595        22,383   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating Income (loss)

     1,971        —           (2,595     (624

Other income and (expenses):

         

Gain on sale of unconsolidated affiliate

     —          1,439         —          1,439   

Equity income

     —          —           —          —     

Management fees

     —          —           —          —     

Interest income and other income

     —          —           45        45   

Interest expense

     (130     —           (94     (224
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) before income taxes

   $ 1,841      $ 1,439       $ (2,644   $ 636   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total capital expenditures

   $ 3,545      $ —         $ —        $ 3,545   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

     Six Months Ended June 30, 2011  
     Utility and
Energy
Technologies
    Energy
Services
    Unallocated
Corporate
Costs
    Total  

Revenues

   $ 53,741      $ —        $ —        $ 53,741   

Cost of Sales

     36,706        —          —          36,706   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross Profit

     17,035        —          —          17,035   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

General and administrative

     13,166        —          2,467        15,633   

Selling, marketing and service

     2,368        —          —          2,368   

Depreciation and amortization

     1,544        30        1        1,575   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     17,078        30        2,468        19,576   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Income (loss)

     (43     (30     (2,468     (2,541

Other income and (expenses):

        

Gain on sale of unconsolidated affiliate

     —          21,786        —          21,786   

Equity income

     —          1,559        —          1,559   

Management fees

     —          282        —          282   

Interest income and other income

     —          —          42        42   

Interest expense

     (187     —          (99     (286
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ (230   $ 23,597      $ (2,525   $ 20,842   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total capital expenditures

   $ 9,305      $ —        $ —        $ 9,305   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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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 and six month period ended June 30, 2012, which we refer to as the second quarter 2012 and six month period 2012, respectively, and the three and six month period ended June 30, 2011, which we refer to as the second quarter 2011 and six month period 2011, respectively, and of our consolidated financial condition as of June 30, 2012 should be read in conjunction with our 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, earnings 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, earnings 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 the sales of our non-core businesses and our ability to effectively and profitably redeploy the proceeds of those sales in our core business;

 

   

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;

 

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

 

   

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 during fiscal 2011 our tax expense in future years will likely approximate prevailing statutory tax rates;

 

   

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, 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, 2011, 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.

Our Utility and Energy Technologies segment includes our core business operations, and is the only segment that we have been strategically focused on investing in and growing for the last several years. Conversely, our Energy Services segment contained our non-core business operations. We divested the operations of our Energy Services segment over time, with the final divestitures competed in 2011.

Our Utility and Energy Technologies segment includes our three primary product and service areas: our Interactive Distributed Generation products and services, our Utility Infrastructure products and services, and our Energy Efficiency products. These three groups of products and services are commonly focused on serving the needs of utilities and their commercial, institutional and industrial customers to help them generate, deliver, and utilize electricity more efficiently. Our strategy is focused on growing these three product and service areas 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. These three product and service areas share common or complementary utility relationships and customer types, common sales and overhead resources, and facilities. However, we discuss and distinguish our Utility and Energy Technologies business among the three product and service areas due to the unique market needs they are addressing, and the distinct technical disciplines and specific capabilities required for us to deliver them, including personnel, technology, engineering, and intellectual capital. Our Utility and Energy Technologies segment operates primarily out of our Wake Forest, North Carolina headquarters office, and its operations also include several satellite offices and manufacturing facilities, the largest of which are in the Raleigh, North Carolina, Randleman, North Carolina,

 

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McDonough, Georgia, and Anderson, South Carolina areas. The locations of our sales organization and field employees for this segment are generally in close proximity to the utilities and commercial, industrial, and institutional customers they serve. Our Utility and Energy Technologies segment is operated through our largest wholly-owned subsidiary, PowerSecure, Inc.

Until the divestitures of our remaining non-core business operations in 2011, our Energy Services segment operated through our two other principal operating subsidiaries, Southern Flow Companies, Inc., which we refer to as “Southern Flow”, and WaterSecure Holdings, Inc., which we refer to as “WaterSecure”.

Interactive Distributed Generation

Our Interactive Distributed Generation business involves manufacturing, installing and operating electric generation equipment “on site” at a facility where the power is used, including commercial, institutional and industrial operations, generally on behalf of electric utilities. Our systems provide a 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.

Our Interactive 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 original business model, which is still our primary 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, 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, which we refer to as our “recurring revenue model” or “PowerSecure-owned” or “company-owned” model. Our PowerSecure-owned model represents an increasing portion of our distributed generation business. For distributed generation systems completed 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 either as a fixed monthly payment, or as a shared savings recurring revenue contract. For our shared savings recurring revenue 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 reliable standby power supporting customers in their utility systems, power distribution and transmission efficiencies, and of avoiding major 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 smaller fees over a period of years, utilities and their customers receive access to our system and the related benefits of distributed generation 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.

During the six month period 2012, 77.4% of our distributed generation revenues consisted of customer-owned sales, and 22.6% of our distributed generation 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 eighteen month timeframe depending on the size of the project, and sales of PowerSecure-owned

 

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projects are recorded over a longer time frame of five to fifteen years depending on the life of the underlying contract. Therefore, changes in the sales of customer-owned systems have significant impacts on our near-term revenues and profits and cause them to fluctuate from period-to-period. By contrast, 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 also requires us to invest our own capital in the project without any return on capital until after the project is completed, installed and successfully operating.

Our recent acquisition of PowerSecure Solar provides us with the ability to provide solar energy systems through our distributed generation business platform. These solar energy systems will be sold under the “project-based”, “customer-owned” model, and we also plan to own and operate these systems under a “PowerSecure-owned”, “recurring revenue” model.

Utility Infrastructure

Our Utility Infrastructure business is focused on helping electric utilities design, build, upgrade and maintain infrastructure that enhances the efficiency of their grid systems. Through our UtilityServices business, we provide transmission and distribution system construction and maintenance products and services, install advanced metering and efficient lighting, and provide emergency storm restoration services. Additionally, through our UtilityEngineering and PowerServices consulting engineering firms, we provide utilities with a wide range of engineering and design services, as well as consulting services for regulatory and rate design matters.

Revenues for our UtilityServices business are generally earned, billed, and recognized in two primary models. Under the first model, we have regular, on-going assignments with utilities to provide regular maintenance and upgrade services. These services are earned, billed, and recognized either on a fixed fee basis, based on the number of work units we perform, such as the number of transmission poles we upgrade, or on an hourly fee 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 lines and similar infrastructure, for utilities and their customers. In these types of projects we are generally paid a fixed price for the project, plus any modifications or scope additions. We recognize revenues from these projects on a percentage-of-completion basis as they are completed. In addition to these two primary models, in some cases, we are engaged by utilities and their customers to build or upgrade transmission and distribution infrastructure that we own and maintain. In those cases, we receive fees over a long-term contract for the customer to have access to the infrastructure to transmit or receive power.

Revenues for our UtilityEngineering and PowerServices businesses 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

Our Energy Efficiency business is focused on providing energy solutions to utilities, municipalities, and commercial, institutional and industrial customers with strong value propositions that are designed to reduce their energy costs, improve their operations, and benefit the environment. Our Energy Efficiency area includes our EfficientLights, IES and EnergyLite businesses and brands, all of which are focused on bringing light emitting diode, or “LED,” lighting solutions to the marketplace.

Our EfficientLights business is focused on developing LED-based lighting products for grocery, drug and convenience stores. These LED lighting products include our largest volume product, our EfficientLights fixture for reach-in refrigerated cases, as well as lighting for walk-in storage coolers and open refrigerated shelves. Additionally, our EfficientLights business is in the process of developing and marketing LED-based parking lot lights and security lighting for retail stores.

 

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Our IES business designs and manufactures new LED-based lighting products for commercial, industrial and consumer applications. The business of IES includes turn-key product development, engineering and manufacturing of solid state LED-based lights, including street lights, area lights, landscape lights, and other specialty lighting applications. In addition, IES’s product portfolio includes component parts, such as power drivers, light engines and thermal management solutions. IES provides its products directly to original equipment manufacturers, or OEMs, and to electronics manufacturers and retailers, either as component solutions or as turn-key products.

Additionally, through our EnergyLite business and brand we market our SecureLite and PowerLite family of area lights and street lights, as well as our SuperTube LED light replacement for fluorescent tubes. These products are marketed to utilities and municipalities directly, and through third party distribution arrangements.

We generate revenues in our EfficientLights business through the sale of our proprietary LED lights. These lights are primarily sold as retrofits for existing traditional lighting, although they are also sold for initial lighting installations. From time to time we also 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, and their installations of EfficientLights have been across various numerous stores within their store base over a diverse geographic scope. We also sell our LED lights to, and through OEMs of refrigerator and freezer cases. 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, including our LED-based parking lot light, we expect to employ a similar business model.

We also generate LED-based lighting revenues through our IES business through the sale of proprietary LED lights, as well as the sale of LED-lighting components including power drivers, light engines and thermal management solutions. Our IES business designs and manufactures these LED-based lighting products for commercial, industrial and consumer applications. IES provides its products directly to OEMs, electronics manufacturers, and retailers, either as component solutions or as turn-key products. We expect our IES business to bring additional LED lighting products and components to market, and employ a similar business and distribution model.

Additionally, through our EnergyLite business and brand we market our SecureLite and PowerLite family of area lights and street lights, as well as our SuperTube light, and we expect to market other produces in the future. We utilize the engineering and manufacturing capabilities of our IES team in the development of these products. These products are marketed to utilities, municipalities and businesses directly and through third party distribution arrangements.

Energy Services Business

We completed the sales of our two Energy Services businesses in 2011, ceasing our operations in this business segment. We previously conducted our Energy Services operations through our WaterSecure and Southern Flow businesses.

Through WaterSecure, we own a significant non-controlling minority portion of the equity interests of MM 1995-2, an unconsolidated business. Equity income at our Energy Services segment consists of our minority ownership interest in the earnings of the WaterSecure operations. In June 2011, MM 1995-2 sold substantially all of its assets and business for cash. Prior to the sale, MM 1995-2 owned and operated water processing, recycling and disposal facilities in northeastern Colorado, and the business served oil and natural gas production companies in that area.

Southern Flow, which we sold effective January 1, 2011, provides a variety of oil and natural gas measurement services principally to customers involved in the business of oil and natural gas production, gathering, transportation and processing, with a focus on the natural gas market. As a result of the sale of Southern Flow, its results of operations are now reflected as discontinued operations in our consolidated statements of operations for all periods presented in this report.

The sales of our WaterSecure and Southern Flow operations completed our strategy to monetize our non-core assets to focus on the businesses in our Utility and Energy Technologies segment. As a result of these sales, our Energy Services segment ceased business activities in 2011.

 

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Recent Developments

On August 1, 2012, we announced that our PowerSecure subsidiary had received $10 million of new awards for utility infrastructure projects and distributed generation systems. The utility infrastructure awards total $7 million, including transmission and distribution system projects to upgrade existing utility systems, and new infrastructure projects to support expanding oil and gas company production activities. The new distributed generation system awards total $3 million, and include installations for hospital, institutional, and industrial applications. The distributed generation awards include $1 million of traditional turn-key PowerSecure distributed generation projects, a $1 million turn-key distributed solar energy project, and $1 million of recurring revenue projects. The majority of the $9 million of turn-key project-based awards will be completed and recognized in 2012, and the remaining $1 million of recurring revenue will be recognized over a multi-year period.

On July 24, 2012, we announced that our PowerSecure subsidiary had received $10 million of new awards for its Interactive Distributed Generation smart grid power systems, utility infrastructure projects, and LED Area Lights. The new Interactive Distributed Generation System awards total $4 million, and include installations for manufacturing, pharmaceutical, hospital, and retail operations. The utility infrastructure awards are approximately $5 million, and include transmission and distribution projects for oil and gas companies and military bases. The new LED Area Light awards are just under $1 million and include an order from a new utility who has adopted the light to roll out across its utility system.

On June 27, 2012, we announced that our PowerSecure subsidiary had received $15 million of new awards for its Interactive Distributed Generation smart grid power systems, and utility infrastructure projects. The new Interactive Distributed Generation System awards total $10 million, and include installations for hospital, data center, pharmaceutical, and industrial facilities. The utility infrastructure awards total $5 million, and include transmission system and substation projects for utilities and large industrial customers. All of these awards are for turnkey sales of products and services, with approximately 80% of the revenue expected to be recognized in the second half of 2012, and 20% of the revenue expected to be recognized during the first half of 2013.

On June 19, 2012, at our 2012 Annual Meeting of Stockholders, our stockholders adopted and approved an amendment and restatement of our 2008 Stock Incentive Plan, including an amendment to increase the number of shares of our common stock, par value $.01 per share, authorized for issuance thereunder by 1.4 million shares to a total of 2.0 million shares.

In addition, on June 19, 2012, at our 2012 Annual Meeting of Stockholders, our stockholders adopted and approved an amendment to our Second Restated Certificate of Incorporation to increase the number of shares of common stock authorized for issuance by us by 25.0 million shares to a total of 50.0 million shares. We effected the increase in the number of authorized shares of our common stock by filing a Certificate of Amendment to our Second Restated Certificate of Incorporation with the Secretary of State of the State of Delaware on June 19, 2012, and the amendment became effective as of such date.

On June 5, 2012, we acquired a distributed solar energy business, adding this capability to our Interactive Distributed Generation system platform. Our new capabilities were acquired through the purchase of the utility, commercial and industrial solar energy business of Southern Energy Management, Inc., a North Carolina corporation. Our decision to offer solar solutions resulted from a thorough evaluation of the industry and of the new, significantly improved economics of distributed solar energy systems. The decrease in the cost of solar panels, and corresponding increases in their energy efficiency, in conjunction with our highly efficient distributed generation systems, provides us with a sustainable market opportunity to participate in the downstream segment of the solar business, and bring solar energy projects to our customers and utility partners. We began offering utilities and their large commercial and industrial customers solar energy systems immediately after the acquisition, and took over the installation of several large projects the Seller had in process, including a 4.5 megawatt system.

We consummated the acquisition through the formation of Southern Energy Management PowerSecure, LLC, a Delaware limited liability company (“PowerSecure Solar”), which entered into an asset contribution and sale agreement, dated as of June 5, 2012, with the seller. Pursuant to the contribution and sale agreement, PowerSecure Solar completed the acquisition of substantially all of the assets of the seller relating to the business of designing and selling energy

 

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efficiency and solar photovoltaic power systems and other solar power technologies for large customers, including utility, commercial and industrial customers. Total consideration paid by PowerSecure Solar to the seller for the acquired business was $3.5 million.

After the acquisition, we own 90% of the membership interests in, and control the management of, PowerSecure Solar. The seller owns a 10% non-controlling interest in PowerSecure Solar and retained its business selling solar photovoltaic power systems and solar thermal energy to residential customers and small merchants and professional service providers. Both us and the seller are subject to various buy-sell rights and obligations with respect to their equity interests in PowerSecure Solar.

In June 2012, we recorded an additional $1.4 million gain from the 2011 sale of our WaterSecure operations attributable to our receipt of sales proceeds in the same amount that had been placed into escrow pending the outcome of contingencies related to the sale. We do not expect to receive any additional proceeds from this sale.

On May 22, 2012, we announced that our PowerSecure subsidiary had received new awards for over 25,000 of its energy efficient LED lights. The new awards include our new EfficientLights®walk-in cooler lights for retailers, and our SecureLite®Area Light for utilities. The lights for these orders are expected to be shipped primarily during the remaining quarters of 2012, and we expect revenue from these orders to be approximately $5 million.

Financial Results Highlights

Our consolidated revenues during the second quarter 2012 increased by $7.8 million, or 25.9%, compared to our consolidated revenues during the second quarter 2011. The drivers of this revenue increase were the across the board increases in revenues in each of our product and service areas, including a 26.8% increase in revenues from Interactive Distributed Generation products and services, a 12.2% increase in revenues from Utility Infrastructure products and services, and a 50.7% increase in revenues from Energy Efficiency products.

Our second quarter 2012 gross margin as a percentage of revenue was 32.2% compared to 30.9% in the second quarter 2011. On a year-over-year basis, the gross margin increase was driven by a favorable mix of projects completed and a higher percentage of revenues from our higher margin Interactive Distributed Generation and Energy Efficiency products and services.

Our operating expenses during the second quarter 2012 increased by $1.6 million, or 16.3%, compared to our operating expenses during the second quarter 2011. The year-over-year increase in operating expenses is due to incremental expenses we have invested in to expand and grow each of our Interactive Distributed Generation, Utility Infrastructure, and Energy Efficiency product and service areas. These expenses support new product and customer development, engineering, personnel and equipment, as well as additional sales and marketing activities, and also include increases in depreciation from capital expenditures for our Company-owned distributed generation systems. As a percentage of revenues, operating expenses for the second quarter 2012 decreased 2.5 percentage points compared to the second quarter 2011.

Income from our Energy Services segment, which consists of the gain on the sale of our WaterSecure operations along with the management fees and equity income from our WaterSecure operations, decreased $21.0 million during the second quarter 2012 compared to the second quarter 2011, due to the sale of our WaterSecure operations in June 2011 on which we recorded a $21.8 million gain in the second quarter 2011. We recorded an additional $1.4 million gain from the sale of our WaterSecure operations in second quarter 2012 from the receipt of sales proceeds that had been placed into escrow pending the outcome of contingencies related to the sale. We do not expect to receive any additional proceeds from this sale.

Our income from continuing operations attributable to PowerSecure International, Inc. shareholders for the second quarter 2012 was $1.6 million, or $0.09 per diluted share, compared to income from continuing operations attributable to PowerSecure International, Inc. shareholders of $18.6 million, or $0.97 per diluted share, for the second quarter 2011, which included the $21.8 million gain from the sale of our WaterSecure operations.

Our income from discontinued operations for the second quarter 2012, consisting of the operating results of PowerPackages during the second quarter 2012, was negligible. Our loss from discontinued operations for the second quarter 2011 was ($1.4) million, or ($0.07) per diluted share, which consisted of the loss from discontinued operations of our PowerPackages business.

 

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In total, our consolidated net income attributable to PowerSecure International, Inc. common stockholders for the second quarter 2012 was $1.6 million, or $0.09 per diluted share, which compared to net income attributable to PowerSecure International, Inc. common stockholders of $17.3 million, or $0.90 per diluted share, for the second quarter 2011, which included the income from the gain on the sale of our WaterSecure operations.

Our consolidated revenues during the six month period 2012 increased by $17.3 million, or 32.2%, compared to our consolidated revenues during the six month period 2011. The drivers of this revenue increase were the across the board increases in revenues in each of our product and service areas, including a 20.0% increase in revenues from Interactive Distributed Generation products and services, a 36.4% increase in revenues from Utility Infrastructure products and services, and a 51.8% increase in revenues from Energy Efficiency products.

Our six month period 2012 gross margin as a percentage of revenue was 30.6% compared to 31.7% in the six month period 2011. On a year-over-year basis, gross margins were negatively impacted by the mild winter weather in the first quarter of 2012, which caused Utility Infrastructure workloads to be reduced at certain utilities and the redeployment of those crews to other utilities and projects. Therefore, although Utility Infrastructure revenues increased significantly compared to the same period in 2011, inefficiencies in cost of sales related to the demobilization and redeployment of crews negatively impacted six month period 2012 gross margin results. The lower year-over-year gross margins were also due to the overall growth of Utility Infrastructure revenue in 2012, because Utility Infrastructure is generally our lowest gross margin product and service category. In addition, variations in our quarterly gross margins always result from regular on-going differences in the mix of specific projects completed in each quarter.

Our operating expenses during the six month period 2012 increased by $2.8 million, or 14.3%, compared to our operating expenses during the six month period 2011. The year-over-year increase in operating expenses is due to incremental expenses we have invested in to expand and grow each of our Interactive Distributed Generation, Utility Infrastructure, and Energy Efficiency product and service areas. These expenses support new product and customer development, engineering, personnel and equipment, as well as additional sales and marketing activities, and also include increases in depreciation from capital expenditures for our Company-owned distributed generation systems. In addition, during the six month period 2012, we initiated a cost productivity initiative across business lines to identify opportunities to rationalize general and administrative expenses. This initiative is an on-going focus of ours over the coming quarters with a goal of reducing our costs as a percentage of revenue over time, and improving our operating profit margins. As a percentage of revenues, operating expenses for the six month period 2012 decreased 4.9 percentage points compared to the six month period 2011.

Income from our Energy Services segment, which consists of the gain on the sale of our WaterSecure operations along with management fees and equity income from our WaterSecure operations, decreased $22.2 million during the six month period 2012 compared to the six month period 2011, due to the sale of our WaterSecure operations in June 2011 on which we recorded a $21.8 million gain in the six month period 2011. In the six month period 2012, we recorded an additional $1.4 million gain from the sale of our WaterSecure operations attributable to our receipt of sales proceeds that had been placed into escrow pending the outcome of contingencies related to the sale. We do not expect to receive any additional proceeds from this sale.

Our income from continuing operations attributable to PowerSecure International, Inc. shareholders for the six month period 2012 was $1.0 million, or $0.05 per diluted share, compared to income from continuing operations attributable to PowerSecure International, Inc. shareholders of $18.0 million, or $0.94 per diluted share, for the six month period 2011, which included the $21.8 million gain from the sale of our WaterSecure operations.

Our income from discontinued operations for the six month period 2012, consisting of the operating results of PowerPackages during the six month period 2012, was negligible. Income from discontinued operations for the six month period 2011 was $4.0 million, or $0.21 per diluted share, which consisted of the gain we recorded on the sale of Southern Flow, partially offset by a loss from discontinued operations of our PowerPackages business.

In total, our consolidated net income attributable to PowerSecure International, Inc. common stockholders for the six month period 2012 was $1.0 million, or $0.05 per diluted share, which compared to net income attributable to PowerSecure International, Inc. common stockholders of $22.0 million, or $1.15 per diluted share, for the six month period 2011, which included the income from the gain on the sale of both Southern Flow and our WaterSecure operations.

 

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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, 2011 or our quarter ended June 30, 2012, will be indicative of our future results, especially in light of the current significant downturn in the economy and unfavorable credit and capital markets.

Backlog

As of the date of this report, our revenue backlog expected to be recognized after June 30, 2012 is $166 million. This includes revenue related to the new business awards described above under “—Recent Developments”. It also includes revenue from projects assumed in conjunction with our acquisition of PowerSecure Solar also described above under “—Recent Developments”. Our revenue backlog represents revenue expected to be recognized after June 30, 2012, for periods including the third quarter of 2012 onward. This backlog figure compares to the revenue backlog of $151 million we reported in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 filed on May 3, 2012 (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 to be recognized after June 30, 2012

 

Description

   Anticipated
Revenue
     Estimated Primary
Recognition Period
 

Project-based Revenue — Near term

   $ 78 Million         3Q12 through 1Q13   

Project-based Revenue — Long term

   $ 18 Million         2Q13 through 2014   

Recurring Revenue

   $ 71 Million         3Q12 through 2020   
  

 

 

    

Revenue Backlog to be recognized after June 30, 2012

   $ 166 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

We report our operations as two operating segments. Our Utility and Energy Technologies segment includes our core business operations. It is the only segment that we have been strategically focused on investing in and growing for the last several years. Conversely, our Energy Services segment contains our non-core business operations. We divested the operations of our Energy Services segment over time, with the final divestitures completed in 2011. As a result of these sales, we no longer actively operate in the Energy Services segment. Our reportable segments are strategic business units that offer different products and services and serve different customer bases. They are managed separately because each business requires different technology and marketing strategies. Our operating segments also represent components of our business for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions.

 

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Utility and Energy Technologies

Our Utility and Energy Technologies segment includes our three primary product and service areas: our Interactive Distributed Generation products and services, our Utility Infrastructure products and services, and our Energy Efficiency products. These three groups of products and services are commonly focused on serving the needs of utilities and their commercial, institutional and industrial customers to help them generate, deliver, and utilize electricity more efficiently. These three product and service areas share common or complementary utility relationships and customer types, common sales and overhead resources, and facilities. However, we discuss and distinguish our Utility and Energy Technologies business among the three product and service areas due to the unique market needs they are addressing, and the distinct technical disciplines and specific capabilities required for us to deliver them, including personnel, technology, engineering, and intellectual capital. Our Utility and Energy Technologies segment is operated through our largest wholly-owned subsidiary, PowerSecure, Inc.

Energy Services

Until the completion of the sales of our remaining non-core business operations in 2011, our Energy Services segment operated through our two other principal operating subsidiaries, Southern Flow and WaterSecure. WaterSecure holds a significant non-controlling minority portion of the equity interests in an unconsolidated business, Marcum Midstream 1995-2 Business Trust, a Delaware statutory trust, which we refer to as “MM 1995-2” or as our “WaterSecure operations.” Our WaterSecure operations provided water processing, recycling, and disposal services for oil and natural gas producers in northeastern Colorado utilizing environmentally responsible technologies and processes. In June 2011, substantially all of the assets and business of MM 1995-2 were sold and the proceeds from the sale and the liquidation of its remaining assets were distributed to MM 1995-2’s shareholders, including our WaterSecure subsidiary, in 2011 and 2012. Accordingly, our WaterSecure subsidiary no longer has any on-going operating activity. Our Southern Flow business, which was sold in January 2011, provided oil and natural gas measurement services to customers involved in oil and natural gas production, transportation, and processing, with a focus on the natural gas market. Due to its sale, Southern Flow’s operations are reflected as discontinued operations and the results of its operations are excluded from our Energy Services segment for all periods presented in the information below. The sales of our WaterSecure and Southern Flow operations completed our strategy to monetize our non-core assets to focus on the businesses in our Utility and Energy Technologies business segment. As a result of these sales, our Energy Services segment ceased on-going business activities in June 2011 and thus we no longer report ongoing operations in the Energy Services segment in financial periods after June 30, 2011.

Results of Operations

The following discussion regarding segment revenues, gross profit, costs and expenses, and other income and expenses for the second quarter 2012 compared to the second quarter 2011 excludes revenues, gross profit, and costs and expenses of our PowerPackages business and operations, which were discontinued in 2011, and of our Southern Flow subsidiary, which we sold in January 2011, the financial results of both of which are classified as discontinued operations in our financial statements.

 

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Second Quarter 2012 Compared to Second Quarter 2011

Revenues

Our consolidated revenues are generated entirely by sales and services provided by our Utility and Energy Technologies segment. We currently provide a variety of Utility and Energy Technologies products and services, including Interactive Distributed Generation products and services, Utility Infrastructure products and services, and Energy Efficiency products. The following table summarizes our Utility and Energy Technologies segment revenues for the periods indicated (dollars in thousands):

 

     Quarter Ended
June 30,
     Period-over-Period
Difference
 
     2012      2011      $      %  

Utility and Energy Technologies:

           

Interactive Distributed Generation

   $ 16,139       $ 12,725       $ 3,414         26.8

Utility Infrastructure

     12,912         11,510         1,402         12.2

Energy Efficiency

     8,816         5,851         2,965         50.7
  

 

 

    

 

 

    

 

 

    

Total

   $ 37,867       $ 30,086       $ 7,781         25.9
  

 

 

    

 

 

    

 

 

    

Our consolidated revenues for the second quarter 2012 increased $7.8 million, or 25.9%, compared to the second quarter 2011 due to an increase in sales in each of our Utility and Energy Technologies segment products and services, including increases in Interactive Distributed Generation, Utility Infrastructure, and Energy Efficiency revenues.

Our Utility and Energy Technologies segment distributed generation revenues are significantly affected by the number, size and timing of our Interactive Distributed Generation and Utility Infrastructure 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 Interactive Distributed Generation sales have fluctuated significantly in the past and are expected to continue to fluctuate significantly in the future. The increase in our Utility and Energy Technologies segment revenues in the second quarter 2012 over the second quarter 2011 consisted of a $3.4 million, or 26.8%, increase in revenues from Interactive Distributed Generation products and services, a $3.0 million, or 50.7%, increase in revenues from Energy Efficiency products, and a $1.4 million, or 12.2%, increase in revenues from Utility Infrastructure products and services. The increase in our Interactive Distributed Generation product sales and services reflects an increase in both our PowerSecure-owned recurring revenue systems and customer-owned project sales. During the second quarter 2012, 20.9% of our distributed generation revenues were derived from recurring revenue sales, an increase over the second quarter 2011 when 19.7% of our distributed generation revenues were derived from recurring revenue sales. The increase in our Energy Efficiency sales and services in the second quarter 2012 compared to the second quarter 2011 primarily reflects an increase in revenues from our portfolio of LED lighting products including existing and new products that were introduced in 2010 and 2011 as well as an increase in the number of customers. The increase in our Utility Infrastructure product sales and services was due to an increase in the number of utilities that we service, and an increase in those utilities’ spending levels on transmission and distribution system maintenance and construction.

The future level of our revenues will depend on the timing and degree of the recovery of the domestic economy, the health of the credit markets and the return to pre-recession levels of customer spending for capital improvements and energy efficiency projects, as well as our ability to secure new significant purchase orders. The level and timing of our future revenues will also be affected by the amount and proportion of revenues coming from recurring revenue projects in the future, which results in revenue being recognized over a longer period. We are particularly susceptible to changes in economic conditions due to the fact that our product offerings are largely discretionary investment items for our customers, and this factor can therefore subject new sales orders to delay or deferment especially when economic conditions are not positive.

 

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Gross Profit and Gross Profit Margin

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

 

     Quarter Ended
June 30,
    Period-over-Period
Difference
 
     2012     2011     $      %  

Utility and Energy Technologies:

         

Cost of Sales

   $ 25,663      $ 20,780      $ 4,883         23.5

Gross Profit

   $ 12,204      $ 9,306      $ 2,898         31.1

Gross Profit Margin

     32.2     30.9     

Cost of sales and services include materials, personnel and related overhead costs incurred to manufacture products and provide services. The 23.5% increase in our consolidated cost of sales and services for the second quarter 2012 compared to the second quarter 2011, was driven by the increase in costs associated with the 25.9% increase in sales, together with the factors discussed below leading to the improvement in our gross profit margin.

Our Utility and Energy Technologies segment gross profit increased $2.9 million, or 31.1%, in the second quarter 2012 compared to the second quarter 2011. As a percentage of revenue, our Utility and Energy Technologies segment gross profit margin in the second quarter 2012 was 32.2%, an increase of 1.3 percentage points compared to the second quarter 2011. An important driver in the period-over-period change in our gross profit margin is the relative gross margins we generally earn in each of our Distributed Generation, Utility Infrastructure and Energy Efficiency product and service categories. Our Distributed Generation products and services generally yield gross profit margins in the 25-45% range, our Utility Infrastructure products and services generally yield gross profit margins in the 5-30% range, and our Energy Efficiency products generally yield gross margins in the 20-40% range. The gross profit margin we realize within these ranges largely correlates to the amount of value-added product 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 product lines affect our consolidated gross profit margin results. Our gross profit margin improvement in the second quarter 2012 compared to the second quarter 2011 was driven by a higher percentage of revenues from our higher margin Distributed Generation and Energy Efficiency products and services. As is always the case, variability in our quarterly gross margins is also caused by regular on-going differences in the mix of specific projects completed in each quarter. In the long-term, we expect that gross profit margins for this segment will increase because of anticipated greater productivity, operations and manufacturing efficiencies, improvements in technology, and growth in our higher-margin recurring revenue projects.

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;

 

   

the amount of revenue achieved in each of our Distributed Generation, Utility Infrastructure and Energy Efficiency product and service categories, which have different gross profit margins;

 

   

our ability to improve our operating efficiency and benefit from economies of scale;

 

   

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

 

   

improvements in technology and manufacturing methods and processes;

 

   

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

 

   

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;

 

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

 

   

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;

 

   

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 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 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, and depreciation and amortization. The following table sets forth our consolidated operating expenses for the periods indicated (dollars in thousands):

 

     Quarter Ended
June 30,
     Period-over-Period
Difference
 
     2012      2011      $      %  

Consolidated Operating Expenses:

           

General and administrative

   $ 9,093       $ 7,952       $ 1,141         14.3

Selling, marketing and service

     1,366         1,214         152         12.5

Depreciation and amortization

     1,136         802         334         41.6
  

 

 

    

 

 

    

 

 

    

Total

   $ 11,595       $ 9,968       $ 1,627         16.3 
  

 

 

    

 

 

    

 

 

    

Costs related to personnel, including wages, benefits, stock compensation, bonuses and commissions, are the most significant component of our operating expenses. During the second quarter 2012, the year-over-year increase in operating expenses is due to incremental expenses we have invested in to expand and grow each of our Interactive Distributed Generation, Utility Infrastructure, and Energy Efficiency product and service areas. These expenses support new product and customer development, engineering, personnel and equipment, as well as additional sales and marketing activities, and also include increases in depreciation from capital expenditures for our Company-owned distributed generation systems. In the near term, we expect our operating costs, particularly our general and administrative expenses, to increase as we develop and integrate our PowerSecure Solar operations into our Interactive Distributed Generation operations. In the mid-term future, we expect the growth in our operating expenses to moderate as we implement cost reduction efforts to support our expected growth in more cost effective ways, and leverage our existing cost structure. In the longer term future, we expect our operating costs to grow to support the growth of our business, although at a lower growth rate than revenues over time, and that growth will be dependent in large part upon future economic and market conditions. Accordingly, the timing and the amount of future increases in operating expenses will depend on the timing and level of future improvements in economic and business conditions and the effects of such economic recovery on our revenues. We cannot provide any assurance as to if, when, how much or for how long economic conditions will improve, or the effects of future economic conditions on our revenues, expenses or net income.

 

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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 incurred in our Utility and Energy Technologies segment together with unallocated corporate general and administrative costs. The 14.3% increase in our consolidated general and administrative expenses in the second quarter 2012, as compared to the second quarter 2011, was due to investments in personnel, vehicles and other expenses to support our increasing levels of revenue and investments in new business opportunities. The following table provides further detail of our general and administrative expenses by segment (dollars in thousands):

 

     Quarter Ended
June 30,
     Period-over-Period
Difference
 
     2012      2011      $     %  

Segment G&A Expenses:

          

Utility and Energy Technologies:

          

Personnel costs

   $ 5,106       $ 4,609       $ 497        10.8

Vehicle lease and rental

     654         577         77        13.3

Insurance

     266         156         110        70.5

Rent-office and equipment

     256         210         46        21.9

Professional fees and consulting

     133         157         (24     (15.3 )% 

Travel

     307         240         67        27.9

Development costs

     166         141         25        17.7

Other

     806         592         214        36.1

Energy Services

     —           —           —          n/m   

Unallocated Corporate Costs

     1,399         1,270         129        10.2
  

 

 

    

 

 

    

 

 

   

Total

   $ 9,093       $ 7,952       $ 1,141        14.3
  

 

 

    

 

 

    

 

 

   

The increase in our personnel costs, vehicle lease and rental, insurance, travel and rental costs during the second quarter 2012 compared to the second quarter 2011 was due to staffing increases to support our recent and expected growth and investments in new and expanded business opportunities across each of our product and service areas of Distributed Generation, Energy Efficiency, and Utility Infrastructure. In the near-term, we expect our general and administrative expense levels to increase compared to our general and administrative expenses in the second quarter 2012 as we develop and integrate our PowerSecure Solar operations into our Interactive Distributed Generation operations. 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.

Unallocated corporate general and administrative expenses 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, public company reporting, director expenses, accounting costs, and stock compensation expense on our stock options and restricted stock grants which we do not allocate to our operating segments. These costs increased year-over-year due primarily to costs incurred in connection with the recent acquisition of our PowerSecure Solar operations. We expect our unallocated corporate costs for the remainder of 2012 to remain at approximately the same or lower levels as we incurred during the second quarter 2012.

 

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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 incurred in our Utility and Energy Technologies segment. The 12.5% increase in selling, marketing and service expenses in the second quarter 2012, as compared to the second quarter 2011, was due to increases in compensation, travel, and advertising and promotion expenses. The following table provides further detail of our segment selling, marketing and service expenses (dollars in thousands):

 

     Quarter Ended
June 30,
     Period-over-Period
Difference
 
     2012     2011      $     %  

Segment Selling, Marketing and Service:

         

Utility and Energy Technologies:

         

Salaries

   $ 742      $ 588       $ 154        26.2

Commission

     312        413         (101     (24.5 )% 

Travel

     186        121         65        53.7

Advertising and promotion

     144        46         98        213.0

Bad debt expense (recovery)

     (18     46         (64     (139.1 )% 

Energy Services

     —          —           —          n/m   
  

 

 

   

 

 

    

 

 

   

Total

   $ 1,366      $ 1,214       $ 152        12.5
  

 

 

   

 

 

    

 

 

   

In the future, we expect our near-term and long-term Utility and Energy Technologies segment selling, marketing and services expenses to grow in order to reflect, drive and support future 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. The 41.6% increase in depreciation and amortization expenses in the second quarter 2012, as compared to the second quarter 2011, primarily reflects increased depreciation and amortization resulting from capital investments at our Utility and Energy Technologies segment during 2011. These capital investments are primarily investments in PowerSecure-owned distributed generation systems for projects deployed under our recurring revenue model.

 

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Other Income and Expenses

Our other income and expenses include the gain on the sale of our WaterSecure operations, management fees and equity income earned by our Energy Services segment as managing trustee of MM 1995-2 relating to the WaterSecure operations, interest income, interest expense and income taxes. The following table sets forth our other income and expenses for the periods indicated, by segment (dollars in thousands):

 

     Quarter Ended
June 30,
    Period-over-Period
Difference
 
     2012     2011     $     %  

Other Segment Income and (Expenses):

        

Utility and Energy Technologies:

        

Interest income and other income

   $ —        $ —        $ —          n/m   

Interest expense

     (68     (98     30        (30.6 )% 
  

 

 

   

 

 

   

 

 

   

Segment total

     (68     (98     30     
  

 

 

   

 

 

   

 

 

   

Energy Services:

        

Gain on sale of unconsolidated affiliate

     1,439        21,786        (20,347     (93.4 )% 

Equity income

     —          548        (548     (100.0 )% 

Management fees

     —          114        (114     (100.0 )% 
  

 

 

   

 

 

   

 

 

   

Segment total

     1,439        22,448        (21,009  
  

 

 

   

 

 

   

 

 

   

Unallocated Corporate:

        

Interest income and other income

     23        22        1        4.5

Interest expense

     (48     (46     (2     4.3

Income tax benefit (provision)

     (621     (3,183     2,562        (80.5 )% 
  

 

 

   

 

 

   

 

 

   

Segment total

     (646     (3,207     2,561     
  

 

 

   

 

 

   

 

 

   

Total

   $ 725      $ 19,143      $ (18,418  
  

 

 

   

 

 

   

 

 

   

Gain on Sale of Unconsolidated Affiliate. Gain on sale of unconsolidated affiliate at our Energy Services segment consists of our minority ownership share of the gain recognized by our WaterSecure operations related to the sale of substantially all of the assets and business of MM 1995-2 in June 2011. At the time of the sale, MM 1995-2 deferred $4.0 million of the gain until such time as certain contingencies associated with the sale were eliminated and the associated escrowed sales proceeds were received. These contingencies expired and were resolved in the second quarter 2012 and $3.9 million of the funds that were placed into escrow were released. In June 2012, we received our share of the escrowed sales proceeds and recorded a corresponding gain in the amount of $1.4 million during the second quarter 2012.

Equity Income. Equity income at our Energy Services segment consists of our minority ownership interest in the earnings of the WaterSecure operations. Our equity income is a direct function of the net income of the WaterSecure operations. We recorded no equity income during the second quarter 2012 due to the sale of the WaterSecure operations on June 1, 2011, and due to that sale we will not record any equity income from this source in the future.

Management Fees. Management fees at our Energy Services segment consist entirely of fees we earn as the managing trustee of the WaterSecure operations. These fees, to a large extent, are based on a percentage of the revenues of the WaterSecure operations. We recorded no management fees during the second quarter 2012 due to the sale of the WaterSecure operations on June 1, 2011, we will not record any management fees from this source in the future.

Interest Income and Other Income. Interest income and other income for each segment consists primarily of interest we earn on the interest-bearing portion of our cash and cash equivalent balances. In total, interest income and other income increased slightly during the second quarter 2012, as compared to the second quarter 2011. This slight increase was attributable to an increase in interest-bearing cash and cash equivalent balances in the second quarter 2012 compared to the second quarter 2011. Our future interest income will depend on our cash and cash equivalent balances, which will increase and decrease depending upon our profit, capital expenditures, and our working capital needs, and future interest rates.

Interest Expense. Interest expense for each segment consists of interest and finance charges on our credit facilities, term loan and capital leases. In total, interest expense decreased during the second quarter 2012, as compared to the second quarter 2011. The decrease in our interest expense reflects the reduction in balances outstanding on our capital lease obligation due to regular payments made on our capital leases over the year together with a reduction in interest

 

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associated with decreased borrowings under the revolving portion of our credit facility during the second quarter 2012, partially offset by the interest associated with our term loan we completed on February 7, 2012. We expect our future interest and finance charges to increase over time as a result of anticipated borrowings under our credit facility to fund future working capital needs and recurring revenue projects at our Utility and Energy Technologies segment.

Income Taxes. The income tax provision or benefit we record is the result of applying our annual effective tax rate by our net income or loss. Our effective tax rate and our income tax provision 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 asset, 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 in the second quarter 2012 increased, as compared to the second quarter 2011, as we expect our effective tax rate in 2012 will more closely approximate statutory rates.

Non-controlling Interest. We acquired a 67% controlling ownership interest in IES on April 1, 2010 and we acquired a 90% controlling ownership interest in PowerSecure Solar effective June 2, 2012. We record the full amount of income or loss from IES and PowerSecure Solar in our consolidated statements of operations. The non-controlling ownership interests in the income or loss of IES and PowerSecure Solar is reflected as a reduction or addition to net income or losses to derive income attributable to PowerSecure International stockholders. The increase in the addition for the non-controlling interest in the loss of our majority-owned subsidiaries in the second quarter 2012, as compared to the second quarter 2011, is a result of increased development activities at IES to bring a broader complement of new lighting products to market as well as transitional expenses at our newly acquired PowerSecure Solar operations.

Six Month Period 2012 Compared to Six Month Period 2011

Revenues

The following table summarizes our Utility and Energy Technologies segment revenues for the periods indicated (dollars in thousands):

 

     Six Months Ended
June 30,
     Period-over-Period
Difference
 
     2012      2011      $      %  

Utility and Energy Technologies:

           

Interactive Distributed Generation

   $ 28,644       $ 23,870       $ 4,774         20.0

Utility Infrastructure

     26,040         19,087         6,953         36.4

Energy Efficiency

     16,368         10,784         5,584         51.8
  

 

 

    

 

 

    

 

 

    

Total

   $ 71,052       $ 53,741       $ 17,311         32.2
  

 

 

    

 

 

    

 

 

    

Our consolidated revenues for the six month period 2012 increased $17.3 million, or 32.2%, compared to the six month period 2011 due to an increase in sales in each of our Utility and Energy Technologies segment products and services, including increases in Interactive Distributed Generation, Utility Infrastructure, and Energy Efficiency revenues.

Our Utility and Energy Technologies segment distributed generation revenues are significantly affected by the number, size and timing of our Interactive Distributed Generation and Utility Infrastructure 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 Interactive Distributed Generation sales have fluctuated significantly in the past and are expected to continue to fluctuate significantly in the future. The increase in our Utility and Energy Technologies segment revenues in the six month period 2012 over the six month period 2011 consisted of a $7.0 million, or 36.4%, increase in revenues from Utility Infrastructure products and services, a $5.6 million, or 51.8%, increase in revenues from Energy Efficiency products, and a $4.8 million, or 20.0%, increase in revenues from Interactive Distributed Generation products and services. The increase in our Interactive Distributed Generation product sales and services reflects an increase in both our PowerSecure-owned recurring revenue systems and customer-owned project sales. During the six month period 2012, 22.6% of our distributed generation revenues were derived from recurring revenue sales, an increase over the six month period 2011 when 18.3% of our distributed generation revenues were

 

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derived from recurring revenue sales. The increase in our Utility Infrastructure product sales and services was due to an increase in the number of utilities that we service, and an increase in those utilities’ spending levels on transmission and distribution system maintenance and construction. The increase in our Energy Efficiency sales and services in the six month period 2012 compared to the six month period 2011 primarily reflects an increase in revenues from our portfolio of LED lighting products including existing and new products that were introduced in 2010 and 2011 as well as an increase in the number of customers. The increase in our Energy Efficiency sales and services in the six month period 2012 compared to the six month period 2011 reflects both an increase in the number of customers as well as an increase in revenues from our portfolio of LED lighting products including existing and new products that were introduced in 2010 and 2011.

Gross Profit and Gross Profit Margin

The following tables summarizes our Utility and Energy Technologies segment cost of sales along with our segment gross profit and gross profit margin for the periods indicated (dollars in thousands):

 

     Six Months Ended
June 30,
    Period-over-Period
Difference
 
     2012     2011     $      %  

Utility and Energy Technologies:

         

Cost of Sales

   $ 49,293      $ 36,706      $ 12,587         34.3

Gross Profit

   $ 21,759      $ 17,035      $ 4,724         27.7

Gross Profit Margin

     30.6     31.7     

The 34.3% increase in our consolidated cost of sales and services for the six month period 2012 compared to the six month period 2011, was driven by the increase in costs associated with the 32.2% increase in sales, together with the factors discussed below leading to the decrease in our gross profit margin.

Our Utility and Energy Technologies segment gross profit increased $4.7 million, or 27.7%, in the six month period 2012 compared to the six month period 2011. As a percentage of revenue, our Utility and Energy Technologies segment gross profit margin in the six month period 2012 was 30.6%, a decrease of 1.1 percentage points compared to the six month period 2011. An important driver in the period-over-period change in our gross profit margin is the relative gross margins we generally earn in each of our Distributed Generation, Utility Infrastructure and Energy Efficiency product and service categories. Our Distributed Generation products and services generally yield gross profit margins in the 25-45% range, our Utility Infrastructure products and services generally yield gross profit margins in the 5-30% range, and our Energy Efficiency products generally yield gross margins in the 20-40% range. The gross profit margin we realize within these ranges largely correlates to the amount of value-added product 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 product lines affect our consolidated gross profit margin results. Our lower gross profit margins in the six month period 2012 compared to the six month period 2011 were due to an increase in the growth and amount of Utility Infrastructure revenue in the six month period 2012, which is generally our lowest gross margin product and service category. In addition, gross margins were negatively impacted by the mild winter weather early in the six month period of 2012, which caused Utility Infrastructure workloads to be reduced at certain utilities and the redeployment of those crews to other utilities and projects. Therefore, although Utility Infrastructure revenues increased significantly compared to the same period in 2011, inefficiencies in cost of sales related to the demobilization and redeployment of crews negatively impacted six month period 2012 gross margin results. As is always the case, variability in our quarterly gross margins is also caused by regular on-going differences in the mix of specific projects completed in each quarter. In the long-term, we expect that gross profit margins for this segment will increase because of anticipated greater productivity, operations and manufacturing efficiencies, improvements in technology, and growth in our higher-margin recurring revenue projects.

 

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Operating Expenses

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

 

     Six Months Ended
June 30,
     Period-over-Period
Difference
 
     2012      2011      $      %  

Consolidated Operating Expenses:

           

General and administrative

   $ 17,738       $ 15,633       $ 2,105         13.5

Selling, marketing and service

     2,424         2,368         56         2.4

Depreciation and amortization

     2,221         1,575         646         41.0
  

 

 

    

 

 

    

 

 

    

Total

   $ 22,383       $ 19,576       $ 2,807         14.3
  

 

 

    

 

 

    

 

 

    

During the six month period 2012, the year-over-year increase in operating expenses is due to incremental expenses to expand and grow each of our Interactive Distributed Generation, Utility Infrastructure, and Energy Efficiency product and service areas. These expenses support new product and customer development, engineering, personnel and equipment, as well as additional sales and marketing activities, and also include increases in depreciation from capital expenditures for our Company-owned distributed generation systems. In the near term, we expect our operating costs, particularly our general and administrative expenses, to increase as we develop and integrate our PowerSecure Solar operations into our Interactive Distributed Generation operations. In the mid-term future, we expect the growth in our operating expenses to moderate as we implement cost reduction efforts to support our expected growth in more cost effective ways, and leverage our existing cost structure. In the longer term future, we expect our operating costs to grow to support the growth of our business, although at a lower growth rate than revenues over time, and that growth will be dependent in large part upon future economic and market conditions. Accordingly, the timing and the amount of future increases in operating expenses will depend on the timing and level of future improvements in economic and business conditions and the effects of such economic recovery on our revenues. We cannot provide any assurance as to if, when, how much or for how long economic conditions will improve, or the effects of future economic conditions on our revenues, expenses or net income.

General and Administrative Expenses. The 13.5% increase in our consolidated general and administrative expenses in the six month period 2012, as compared to the six month period 2011, was due to investments in personnel, vehicles and other expenses to support our increasing levels of revenue and investments in new business opportunities. The following table provides further detail of our general and administrative expenses by segment (dollars in thousands):

 

     Six Months Ended
June 30,
     Period-over-Period
Difference
 
     2012      2011      $     %  

Segment G&A Expenses:

          

Utility and Energy Technologies:

          

Personnel costs

   $ 9,917       $ 8,938       $ 979        11.0

Vehicle lease and rental

     1,322         1,080         242        22.4

Insurance

     563         304         259        85.2

Rent-office and equipment

     499         419         80        19.1

Professional fees and consulting

     315         373         (58     (15.5 )% 

Travel

     615         512         103        20.1

Development costs

     299         302         (3     (1.0 )% 

Other

     1,613         1,238         375        30.3

Energy Services

     —           —           —          n/m   

Unallocated Corporate Costs

     2,595         2,467         128        5.2
  

 

 

    

 

 

    

 

 

   

Total

   $ 17,738       $ 15,633       $ 2,105        13.5
  

 

 

    

 

 

    

 

 

   

The increase in our personnel costs, vehicle lease and rental, insurance, travel and rental costs during the six month period 2012 compared to the six month period 2011 was due to staffing increases to support our recent and expected growth and investments in new and expanded business opportunities across each of our product and service areas of

 

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Distributed Generation, Energy Efficiency, and Utility Infrastructure. Other general and administrative expenses including professional and consulting fees and development costs decreased as a result of cost control efforts undertaken earlier in the first quarter of 2012. In the near term, we expect our general and administrative expenses, to increase as we develop and integrate our recently acquired PowerSecure Solar operations into our distributed generation operations. In the longer term future, we expect our general and administrative expenses to grow to support the growth of our business, although at a lower growth rate than revenues over time as we strive to leverage our cost structure and deliver higher operating profit margins.

The increase in our unallocated corporate general and administrative expenses during the six month period 2012 as compared to the six month period 2011 was due primarily to costs incurred in connection with the recent acquisition of our PowerSecure Solar operations. We expect our unallocated corporate costs for the remainder of 2012 to remain at approximately the same or slightly lower levels as we incurred during the six month period 2012.

Selling, Marketing and Service Expenses. The 2.4% increase in selling, marketing and service expenses in the six month period 2012, as compared to the six month period 2011, was due to an increase in travel and advertising and promotion expense, partially offset by recovery of bad debt and compensation costs. The following table provides further detail of our segment selling, marketing and service expenses (dollars in thousands):

 

     Six Months Ended
June 30,
     Period-over-Period
Difference
 
     2012     2011      $     %  

Segment Selling, Marketing and Service:

         

Utility and Energy Technologies:

         

Salaries

   $ 1,402      $ 1,246       $ 156        12.5

Commission

     406        644         (238     (37.0 )% 

Travel

     377        292         85        29.1

Advertising and promotion

     291        144         147        102.1

Bad debt expense (recovery)

     (52     42         (94     (223.8 )% 

Energy Services

     —          —           —          n/m   
  

 

 

   

 

 

    

 

 

   

Total

   $ 2,424      $ 2,368       $ 56        2.4
  

 

 

   

 

 

    

 

 

   

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

Depreciation and Amortization Expenses. The 41.0% increase in depreciation and amortization expenses in the six month period 2012, as compared to the six month period 2011, primarily reflects increased depreciation and amortization resulting from capital investments at our Utility and Energy Technologies segment during 2011. These capital investments are primarily investments in PowerSecure-owned distributed generation systems for projects deployed under our recurring revenue model.

 

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Other Income and Expenses

Our other income and expenses include the gain on the sale of our WaterSecure operations, management fees and equity income earned by our Energy Services segment as managing trustee of MM 1995-2 relating to the WaterSecure operations, interest income, interest expense and income taxes. The following table sets forth our other income and expenses for the periods indicated, by segment (dollars in thousands):

 

     Six Months Ended
June 30,
    Period-over-Period
Difference
 
     2012     2011     $     %  

Other Segment Income and (Expenses):

        

Utility and Energy Technologies:

        

Interest income and other income

   $ —        $ —        $ —          n/m   

Interest expense

     (130     (187     57        (30.5 )% 
  

 

 

   

 

 

   

 

 

   

Segment total

     (130     (187     57     
  

 

 

   

 

 

   

 

 

   

Energy Services:

        

Gain on sale of unconsolidated affiliate

     1,439        21,786        (20,347     (93.4 )% 

Equity income

     —          1,559        (1,559     (100.0 )% 

Management fees

     —          282        (282     (100.0 )% 
  

 

 

   

 

 

   

 

 

   

Segment total

     1,439        23,627        (22,188  
  

 

 

   

 

 

   

 

 

   

Unallocated Corporate:

        

Interest income and other income

     45        42        3        7.1

Interest expense

     (94     (99     5        (5.1 )% 

Income tax benefit (provision)

     (228     (3,230     3,002        (92.9 )% 
  

 

 

   

 

 

   

 

 

   

Segment total

     (277     (3,287     3,010     
  

 

 

   

 

 

   

 

 

   

Total

   $ 1,032      $ 20,153      $ (19,121  
  

 

 

   

 

 

   

 

 

   

Gain on Sale of Unconsolidated Affiliate. Gain on sale of unconsolidated affiliate at our Energy Services segment consists of our minority ownership share of the gain recognized by our WaterSecure operations related to the sale of substantially all of the assets and business of MM 1995-2 in June 2011. At the time of the sale, MM 1995-2 deferred $4.0 million of the gain until such time as certain contingencies associated with the sale were eliminated and associated escrowed sales proceeds were received. These contingencies expired and were resolved in the second quarter 2012 and $3.9 million of the funds that were placed into escrow were released. In June 2012, we received our share of the escrowed sales proceeds and recorded a corresponding gain in the amount of $1.4 million during the six month period 2012.

Equity Income. We recorded no equity income during the six month period 2012 due to the sale of the WaterSecure operations on June 1, 2011, and due to that sale we will not record any equity income from this source in the future.

Management Fees. We recorded no management fees during the six month period 2012 due to the sale of the WaterSecure operations on June 1, 2011, and due to that sale we will not record any management fees from this source in the future.

Interest Income and Other Income. In total, interest income and other income increased slightly during the six month period 2012, as compared to the six month period 2011. This slight increase was attributable to an increase in interest-bearing cash and cash equivalent balances in the six month period 2012 compared to the six month period 2011. Our future interest income will depend on our cash and cash equivalent balances, which will increase and decrease depending upon our profit, capital expenditures, and our working capital needs, and future interest rates.

Interest Expense. In total, interest expense decreased during the six month period 2012, as compared to the six month period 2011. The decrease in our interest expense reflects the reduction in balances outstanding on our capital lease obligation due to regular payments made on our capital leases over the year together with a reduction in interest associated with decreased borrowings under the revolving portion of our credit facility during the six month period 2012, partially offset by the interest associated with our term loan we completed on February 7, 2012. We expect our future interest and finance charges to increase over time as a result of anticipated borrowings under our credit facility to fund future working capital needs and recurring revenue projects at our Utility and Energy Technologies segment.

Income Taxes. Our overall effective tax rate in the six month period 2012 increased, as compared to the six month period 2011, as we expect our effective tax rate in 2012 will more closely approximate statutory rates.

 

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Non-controlling Interest. The increase in the addition for the non-controlling interest in the loss of our majority-owned subsidiaries in the six month period 2012, as compared to the six month period 2011, is a result of increased development activities at IES to bring a broader complement of new lighting products to market as well as transitional expenses at our newly acquired PowerSecure Solar operations.

Fluctuations

Our revenues, expenses, margins, net income, cash flow, cash, working capital, debt balance sheet positions, and other operating results have fluctuated significantly from quarter-to-quarter, period-to-period and year-to-year during our operating history and are likely to continue to fluctuate 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 and financial conditions, including the ongoing challenges in the economy and the difficult capital and credit markets, and the potential for such economic and market challenges to continue or recur in the future, negatively impacting our business operations and our revenues and net income, 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, including 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 strategy to increase our revenues through long-term recurring revenue projects, recognizing that increasing our revenues from recurring revenue projects will require significant 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;

 

   

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 facilities and to successfully finance the recurring revenue portion of our business model;

 

   

our ability to maintain and grow our Utility Infrastructure revenues, and maintain and increase pricing, utilization rates and productivity rates, given the significant levels of vehicles, tools and labor in which we have invested and which is required to serve utilities in this business area, and the risk that our utility customers will change work volumes or pricing, or will displace us from providing services;

 

   

the sale of our non-core Southern Flow and WaterSecure businesses, including the associated loss of revenues, cash flow and income from those businesses and our ability to redeploy the sales proceeds productively and profitably into our core business;

 

   

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 Energy Efficiency business unit in relation to third party manufacturing arrangements we have with vendors in China and other component parts that originate in Japan;

 

   

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;

 

   

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

 

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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;

 

   

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 including but not limited to 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, 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 current downturn in the economy and difficult capital markets conditions on capital projects and other spending items;

 

   

changes and uncertainties in the lead times required to obtain the necessary permits and other governmental and regulatory approvals for projects;

 

   

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;

 

   

changes in the prices charged by our suppliers;

 

   

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

 

   

the effects of litigation, warranty claims and other claims and proceedings;

 

   

our ability to make and obtain the expected benefits from the development or acquisition of technology or businesses, and the costs related to such development or acquisitions; and

 

   

our ability to achieve and maintain a positive safety record, due to the importance of safety on attracting and retaining quality employees, maintaining positive financial performance, and attracting and retaining utility and customer contracts.

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 quarter-to-quarter and can result in significant operating losses or declines in profit margins in any particular quarter. If our revenues fall below our expectations in any particular quarter, 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 quarter.

 

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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 quarterly results is the amount of 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 Utility and Energy Technologies segment 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. However, we have marketing efforts focused on developing more sales under our recurring revenue model, for which the costs and capital is invested initially and the related revenue and profit is recognized over the life of the contract, generally five to fifteen years. Recurring revenue projects, compared to project-based sales, are generally more profitable over time, but 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, 2011, 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 private and public 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;

 

   

business and technology acquisitions and other growth transactions; and

 

   

stock repurchases.

Working Capital

At June 30, 2012, we had working capital of $65.0 million, including $23.7 million in cash and cash equivalents, compared to working capital of $69.4 million, including $24.6 million in cash and cash equivalents at December 31, 2011. Changes in the components of our working capital from December 31, 2011 to June 30, 2012 and from December 31, 2010 to June 30, 2011 are explained in greater detail below. At both June 30, 2012 and December 31, 2011, we had $20.0 million of available and unused borrowing capacity from our credit facility. However, 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.

 

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Cash Flows

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

 

     Six Months Ended June 30,  
       2012         2011    

Net cash provided by (used in) operating activities

   $ 3,800      $ (11,723

Net cash provided by (used in) investing activities

     (5,609     32,817   

Net cash provided by financing activities

     910        6,852   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ (899   $ 27,946   
  

 

 

   

 

 

 

Cash Provided by (Used in) Operating Activities

Cash provided by (used in) operating activities consists primarily of net income adjusted for certain non-cash items including depreciation and amortization, stock-based compensation expenses and equity income. Cash used in operating activities also include operating cash distributions from our unconsolidated affiliate, the effect of changes in working capital and other activities, and cash provided by or used by our discontinued operations.

Cash provided by operating activities of $3.8 million for the six month period 2012 included the effects of the following:

 

   

our income from continuing operations of $0.4 million;

 

   

gain on sale of unconsolidated affiliate of $1.4 million;

 

   

non-cash charges of $2.2 million in depreciation and amortization;

 

   

stock-based compensation expense of $0.6 million;

 

   

a decrease of $4.4 million in accounts receivable;

 

   

a decrease of $0.9 million in inventories;

 

   

a decrease of $0.4 million of accounts payable;

 

   

a decrease of $3.0 million of accrued expenses; and

 

   

cash provided by discontinued operations of $0.1 million.

Cash used in operating activities of $11.7 million for the six month period 2011 included the effects of the following:

 

   

our income from continuing operations of $17.6 million;

 

   

gain on sale of unconsolidated affiliate of $21.8 million;

 

   

non-cash charges of $1.6 million in depreciation and amortization;

 

   

stock-based compensation expense of $0.9 million;

 

   

non-cash equity income from our WaterSecure operations of $1.6 million partially offset by cash distributions from those operations of $0.6 million;

 

   

an increase of $12.6 million in accounts receivable;

 

   

an increase of $1.0 million in inventories;

 

   

a decrease of $1.2 million in deferred income taxes;

 

   

a net decrease of $2.0 million in other assets and liabilities;

 

   

a decrease of $1.1 million of accounts payable;

 

   

an increase of $3.5 million of accrued expenses; and

 

   

cash used in discontinued operations of $1.1 million.

Cash Provided by (Used in) Investing Activities

Cash used in investing activities was $5.6 million in the six month period 2012 and cash provided by investing activities was $32.8 million in the six month period 2011. Historically, our principal cash investments have related to the purchase of equipment used in our production facilities, the acquisitions of certain contract rights, the acquisition and installation of equipment related to our recurring revenue sales, and the acquisition of businesses or technologies. During

 

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the six month period 2012, we used $3.5 to million to acquire a 90% ownership interest in PowerSecure Solar, we used $2.3 million to purchase and install equipment at our recurring revenue distributed generation sites, we used $1.2 million principally to acquire operational assets, and we received $1.4 million from the sale of our WaterSecure operations. During the six month period 2011, we received $25.6 million from the sale of our WaterSecure operations, we received $16.5 million from the sale of our Southern Flow business, we used $7.6 million to purchase and install equipment at our recurring revenue distributed generation sites, and we used $1.7 million principally to acquire operational assets.

Cash Provided by Financing Activities

Cash provided by financing activities was $0.9 million in the six month period 2012 and cash provided by financing activities was $6.9 million in the six month period 2011. During the six month period 2012, we received $2.4 million proceeds from a term loan, we used $1.0 million to repurchase shares of our common stock and we used $0.5 million to repay our capital lease and term loan obligations. During the six month period 2011, we received $5.0 million from borrowings on our credit facility, we received $2.1 million from sale leaseback transactions, we received $0.3 million from the exercise of stock options, we used $0.2 million to repurchase our common stock, and we used $0.4 million to repay our capital lease obligations.

Capital Spending

Our capital expenditures during the six month period 2012 were approximately $3.5 million, of which we used $2.3 million to purchase and install equipment for our PowerSecure-owned recurring revenue distributed generation systems, and we used $1.2 million to purchase equipment and other capital items. Our capital expenditures during the six month period 2011 were approximately $9.3 million, of which we used $7.6 million to purchase and install equipment at our recurring revenue distributed generation sites, and we used $1.7 million to purchase equipment and other capital items.

We anticipate making capital expenditures of approximately $7-10 million for fiscal year 2012, although customer demand for our Interactive Distributed Generation systems under recurring revenue contract arrangements, and economic and financial conditions could cause us to reduce or increase those capital expenditures. The vast 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 our growth.

Indebtedness

Line of Credit. We have had a credit facility with Citibank, N.A. (“Citibank”), as administrative agent and lender, and other lenders since entering into a credit agreement in August 2007. At June 30, 2012 and December 31, 2011, our credit agreement with Citibank along with Branch Banking and Trust Company (“BB&T”) as additional lender, consists of a $20.0 million senior, first-priority secured revolving and term credit facility. The credit facility is guaranteed by all of our active subsidiaries and secured by all of our assets and the assets of our active subsidiaries. In addition, the credit facility provides for a five year term loan of up to $2.6 million, and we completed the financing of a $2.4 million term loan under this provision on February 7, 2012.

We have used, and intend to continue to use, the proceeds available under the credit facility to finance PowerSecure’s recurring revenue projects as well as to finance capital expenditures, working capital, and for general corporate purposes. The credit facility, as a revolving credit facility, will mature and terminate on November 12, 2014. However, we have the option prior to that maturity date to convert a portion of outstanding principal balance thereunder, in an amount not to exceed the present value of estimated annual contract revenues receivable under recurring revenue distributed generation projects, into a non-revolving term loan for a two year period expiring November 12, 2016, making quarterly payments based upon a four year fully amortized basis.

Outstanding balances under the credit facility (including under the term loan described below) 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, as defined in the credit agreement, 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%.

 

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The credit facility is not subject to any borrowing base computations or limitations, but does contain certain financial covenants made by us. 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 trailing 12 month consolidated 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. In addition, we are required to maintain a minimum consolidated tangible net worth, computed on a quarterly basis, of not less than the sum of $80.0 million, plus an amount equal to 50% of our net income each fiscal year commencing January 1, 2012, with no reduction for any net loss in any fiscal year, plus 100% of any equity we raise through the sale of equity interests, less the amount of any non-cash charges or losses. Also, 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 25%. As of June 30, 2012, we were in compliance with these financial covenants.

Under the credit agreement, upon the sale of any of our assets or the assets of our subsidiaries other than in the ordinary course of business or the public or private sale or issuance of any of our equity or our debt or the issuance or any equity or debt of our subsidiaries other than equity issuances where the aggregate net equity proceeds do not exceed $15.0 million, we are required to use the net proceeds thereof to repay any indebtedness then outstanding under the credit facility.

The credit facility contains customary terms and conditions for credit facilities of this type, including restrictions on our ability to incur additional indebtedness, create liens, enter into transactions with affiliates, make acquisitions or sales, pay dividends on or repurchase our capital stock or consolidate or merge with other entities. In addition, the credit agreement contains customary events of default which were not modified in connection with the amendment and restatement, including payment defaults, breach of representations and warranties, covenant defaults, cross-defaults, certain bankruptcy or insolvency events, judgment defaults and certain ERISA-related events, which were not modified by the amendment and restatement.

Our obligations under the credit facility are secured by guarantees (“Guarantees”) and security agreements (the “Security Agreements”) by each of our active subsidiaries, including PowerSecure, Inc. and its subsidiaries. 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 of the parties to the credit agreement.

There were no balances outstanding on the revolving portion of the credit facility at, or during the six months ended, June 30, 2012 or at December 31, 2011 or at August 6, 2012. We currently have $20.0 million available to borrow under the credit facility. However, the availability of 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.

Term Loan. The credit agreement also provides for a five year term loan of up to $2.6 million, and we completed the financing of a $2.4 million term loan under this provision on February 7, 2012. The term loan is secured by deeds of trust we granted for the benefit of the lenders on the real estate and offices of our headquarters in Wake Forest, North Carolina and on the real estate and offices of our PowerFab facility in Randleman, North Carolina. The term loan was made under the credit agreement, and upon the same terms and conditions including covenants and interest rates, except that we are required to make quarterly principal repayments of $40 thousand, plus interest, on the term of the term loan based on a 15 year amortization schedule with the remaining outstanding principal balance due and payable on November 12, 2016. The outstanding balance on our term loan was $2.3 million at June 30, 2012.

Capital Lease Obligations. We have a capital lease with SunTrust Equipment Finance and Leasing, an affiliate of SunTrust Bank, 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.

 

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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 June 30, 2012 and December 31, 2011 was $3.2 million and $3.6 million, respectively.

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 June 30, 2012, 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. We lease certain office space, operating facilities and equipment under long-term lease agreements; in February 2012, we completed a $2.4 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 a deferred compensation obligation; and we have a non-compete agreement providing for on-going payments. At June 30, 2012, we also had a liability for unrecognized tax benefits and related interest and penalties totaling $1.0 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 June 30, 2012, does not include the liability for unrecognized tax benefits (dollars in thousands):

 

     Payments Due by Period  

Contractual Obligations

   Total      Remainder
of 2012
     1-3 Years      4-5 Years      More than
5 Years
 

Revolving portion of credit facility (1)

   $ —         $ —         $ —         $ —         $ —     

Term loan (2)

     2,632        120        467        2,045        —     

Capital lease obligations (2)

     3,553        508        2,030        1,015        —     

Operating leases

     10,791        1,362        4,805        3,320        1,304  

Deferred compensation (3)

     2,661        —           —           2,661        —     

Non-compete agreement

     300        —           200        100        —     

Series B preferred stock

     104        104        —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,041      $ 2,094      $ 7,502      $ 9,141      $ 1,304  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Total repayments are based upon borrowings outstanding as of June 30, 2012, 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 loan at the interest rate in effect as of June 30, 2012 and on the capital lease obligation at the interest rate per the agreement.
(3) Total amount represents our expected obligation on the deferred compensation arrangement and does not include the value of the restricted annuity contract, or interest earnings thereon, that we purchased to fund our obligation.

 

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Off-Balance Sheet Arrangements

During the second quarter 2012, 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

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 the effects of the current economic and financial crisis, the timing of sales, the mix of products, the amount of recurring revenue projects, 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.

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. In addition, 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.

Accordingly, we cannot provide any assurance that sufficient additional funds will be available to us when 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

 

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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; and

 

   

stock-based compensation.

These accounting policies are described in our Annual Report on Form 10-K for the year ended December 31, 2011 in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Recent Accounting Pronouncements

Fair Value MeasurementsIn May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, which amended Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This amendment is intended to result in convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”) requirements for measurement of and disclosures about fair value. This amended guidance clarifies the concepts applicable for fair value measurement of non-financial assets and also expands the disclosures for fair value measurements that are estimated using significant unobservable inputs used in a fair value measurement. This amended guidance became effective for us on a prospective basis commencing January 1, 2012. The adoption of this standard had no effect on our financial position or results of operations.

Testing Goodwill for ImpairmentIn September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350)—Testing Goodwill for Impairment. This standard, which amends and updates guidance on the periodic testing of goodwill for impairment, provides companies with the option to first assess qualitative factors to determine whether it is more likely than not that that the fair value of a reporting unit is less than its carrying amount. If so, then it is necessary to perform the two-step quantitative goodwill impairment test. This standard becomes effective for fiscal years beginning after December 15, 2011, with early adoption allowed. We adopted this standard effective October 1, 2011. The adoption of this standard had no effect on our financial position or results of operations.

Testing Indefinite-Lived Intangible Assets for ImpairmentIn July 2012, the FASB issued ASU No. 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This standard, which amends the guidance on testing indefinite-lived intangible assets, other than goodwill, for impairment, provides companies with the option to first perform a qualitative assessment before performing the two-step quantitative impairment test. If the company determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is more likely than not to exceed its carrying amount, then the company would not need to perform the

 

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two-step quantitative impairment test. This standard does not revise the requirement to test indefinite-lived intangible assets annually for impairment. This standard becomes effective for annual and interim impairment tests performance for fiscal years beginning after September 15, 2012, with early adoption allowed. We do not expect the adoption of this standard will have a material effect on our financial position or results of operations.

 

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.

Interest Rate 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 June 30, 2012, our cash and cash equivalent balance was approximately $23.7 million and we had no outstanding balance on the revolving portion of our credit facility. On February 7, 2012, we borrowed $2.4 million on a term loan under the credit facility. Our credit facility, which is comprised of a revolving credit line and a term loan, 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 enter into interest rate swap agreements to reduce our exposure to interest rate fluctuations under the credit facility.

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. 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, a change of 1% (100 basis points) in the interest rate on either our investments or any future reasonably likely borrowings would not have a material impact on our financial condition, results of operations or cash flow. While we believe we have our cash and cash equivalents invested in relatively risk-free investments, the current capital market crisis make it difficult to accurately assess the risk of each of our holdings. This risk includes, but is not limited to, bank deposits in excess of FDIC insurance limits.

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 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 EfficientLights and PowerSecure Solar business purchases component parts manufactured in China, then to the extent international tax or tariff rates or the U.S. Dollar exchange rate with the Chinese Yuan changes significantly, our business and results of operations could be materially impacted.

We do not use derivative financial instruments to manage or hedge our exposure to interest rate changes, foreign currency exchange risks or other market risks, or for trading or other speculative purposes.

 

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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 June 30, 2012, 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 June 30, 2012, 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 June 30, 2012 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 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, 2011.

 

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, 2011, which have not materially changed as of the date of this report, except for the addition of the following risk factor:

We have recently acquired a distributed solar energy business and added solar energy systems as a product line in our distributed generation area, so we now face a variety of risks and uncertainties related to solar technologies, the industry generally, and our solar business specifically that could adversely affect our operating results if they materialize.

In June 2012, we acquired our distributed solar energy business, adding this capability to our distributed generation area, and we operate it through Southern Energy Management PowerSecure, LLC, of which we own a 90% interest. Accordingly, we have limited experience in the solar power business on which to base our prospects and anticipated results of operations. In addition, we face a number of risks inherent in the solar business, including but not limited to the following:

 

   

While the demand for solar installations is emerging and rapidly evolving, its future success is uncertain. If solar power technology proves unsuitable for widespread commercial deployment or if demand fails to develop sufficiently, we may not be able to generate enough revenues to achieve and sustain it as a profitable product line. The factors influencing the widespread adoption of solar power technology include cost-effectiveness, performance, and reliability; the availability of government subsidies and incentives; the desire of utilities and commercial, industrial, and institutional customers to invest in alternative “green” energy technology; and fluctuations in economic and market conditions which impact the viability of conventional and non-solar alternative energy sources; and the willingness and ability of customers to make significant capital expenditures to purchase the products.

 

   

The reduction, elimination, or expiration of government tax and economic incentives could adversely affect our ability to achieve sales and market share in the solar business, because we believe that the near-term growth of the solar market depends in large part on the availability and size of government and economic incentives. To encourage the adoption of solar technologies, the U.S. government and numerous state governments have provided subsidies in the form of cost reductions, tax write-offs and other incentives to end users, distributors, systems integrators and manufacturers of solar power products. Reduction, elimination and/or periodic interruption of these government subsidies and economic incentives because of policy changes, fiscal tightening or other reasons may result in the diminished competitiveness of solar energy, and materially and adversely affect the growth of these markets and our revenues. Additionally, many state governments have adopted, or endorse, or encourage utilities to achieve certain renewable portfolio standards and goals which have driven the adoption of solar and other alternative energy technologies. The reduction, elimination, or expiration of these standards could negatively impact demand for solar technology generally and our solar energy product line specifically.

 

   

The execution of our growth strategy is dependent upon the continued availability of third-party financing arrangements for our customers. Depending on the status of financial markets, companies may be unwilling or unable to finance the cost of construction of solar projects. We often act as the general contractor for our customers in connection with the installations of our solar power systems and are subject to risks associated with construction, bonding, cost overruns, delays and other contingencies, which could have a material adverse effect on our business and results of operations.

 

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Many of our customers require long-term performance guarantees by us that guarantee certain levels of energy output from the systems we install. Due to general risks inherent in the performance of solar systems, including unexpected performance problems or other events could cause us to fail to meet these performance criteria, we could face significant revenue and earnings losses and financial penalties.

 

   

Existing regulations and policies and changes to these regulations and policies may present technical, regulatory and economic barriers to the purchase and use of solar power technology, which may significantly reduce demand for our solar energy systems. These regulations and policies are being modified and may continue to be modified, including tariffs and taxes related to international trade matters involving solar panel prices. Our costs and customer purchases of solar power technology could be deterred by these regulations and policies, which could result in a significant reduction in the potential demand for our solar energy systems. Any new government regulations or utility policies pertaining to our solar energy systems may result in significant additional expenses to us and our customers and, as a result, could cause a significant reduction in demand for our solar energy systems.

 

   

These regulations and policies are being modified and may continue to be modified. Customer purchases of solar power technology could be deterred by these regulations and policies, which could result in a significant reduction in the potential demand for our solar energy systems. Any new government regulations or utility policies pertaining to our solar energy systems may result in significant additional expenses to us and our customers and, as a result, could cause a significant reduction in