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Executives

Dan Pfeffer – Treasurer

Robert Chiste – Chairman, President, CEO

Michael Picchi – Executive Vice President, CFO

Analysts

Sanjay Shrestha – Lazard Capital Markets

Steve Sanders – Stephens Inc.

Robert Stone – Cowen and Company

Michael Carboy – Signal Hill

Elaine Clay – Piper Jaffray

Paul Clegg – Jefferies

Jeff Osborne – Thomas Weisel Partners

Richard Baxter – Ardour Capital

Michael Goodrich – B&G Capital

Comverge Inc. (COMV) Q4 2008 Earnings Call March 10, 2009 5:00 PM ET

Operator

Welcome to the Comverge fourth quarter and year end 2008 financial results conference call. Today's call is being recorded. Now for opening remarks and introductions I would like to turn the call over to Dan Pfeffer, Treasurer.

Dan Pfeffer

Welcome everyone and thanks for joining me today on the call and with us are Bob Chiste, Chairman, CEO and President and Mike Picchi, Executive Vice President and CFO.

I'd like to begin today's call by reminding you that the remarks on this call will contain forward-looking statements. These forward-looking statements include among other things statements regarding the business strategy, plans and objectives of Comverge. More specifically, these statements will include discussions about the amount of future contracted revenue we expect, the amount of megawatts we expect to be generated by long term contracts in the open markets, the potential for AMI contracts, various regulatory and open market rule changes and the amount of revenue we expect to recognize for fiscal 2009.

Although Comverse believes that the expectations reflected in these forward-looking statements are reasonable, they do involve assumptions, estimates and other risks and uncertainties that could cause our expectations to prove to be incorrect. The actual results for Comverse could differ materially from those anticipated in these forward-looking statements as a result of a variety of factors including market conditions, regulatory approval of contracts, other risks typically associated with our business and the risks and uncertainties discussed in Comverge's annual report on Form 10-K which was filed today with the Securities and Exchange Commission and is available from the SEC, online at Edgar and our web site.

You should consider these forward-looking statements in light of the related risks and we encourage you not to otherwise place undue reliance on these forward-looking statements which speak only as of the date of this conference call. Other than as required under the Securities Laws Comverge does not assume a duty to update these forward-looking statements if circumstances change or otherwise.

With that said, I'll turn the call over to our Chairman, President and CEO, Bob Chiste.

Robert Chiste

Thank you everyone for joining us on Comverge's fourth quarter 2008 earnings call. Despite the strong economic headwinds the county is experiencing, the macro drivers for our industry remain firm and continue to strengthen. Comverge attained annual revenue growth in excess of 35% in each of the past four years and we anticipate this momentum will continue.

I'll take a moment to focus on the big picture and long term prospects of our industry generally and then Comverge specifically. First, demand response and energy efficiency provide the fastest, cleanest and most economic megawatts. Second, regulators and legislators at the Federal and State level are encouraging and approving funding for increased investment in energy efficiency and demand management.

Major examples are the Federal Economic stimulus legislation which provides $4.5 million for Smart Grid projects including demand response devices and Pennsylvania Act 129 which requires all utilities in the Commonwealth to implement aggressive demand management and energy efficiency programs through the use of third party providers.

We have established internal teams to leverage our comprehensive program capabilities to capture our share of these opportunities. A major Comverge strength is that we have now attained the critical mass in our support structure which is enabling considerable operating leverage.

And third, to be part of a national drive for energy independence, a given solution must have significant impact. Electric Power Research Institute or EPRI, has signed the achievable demand management and energy efficiency opportunity at a staggering 156 gigawatts over the next two decades. That is 78 gigawatts of peak electric energy used and 78 gigawatts of base load reduction. That's the equivalent of eliminating the need for over 1,500 100 megawatt power plants.

To put this into perspective, the demand response and energy efficiency opportunity has the potential of far greater impact on energy independence than other alternatives such as solar and wind. In fact, wind and solar projects have slowed considerably because the financial and transmission constraints in the current install base of solar power in the United States is about 2 gigawatts.

By comparison, demand response currently accounts for over 20 gigawatts or ten times the size of the entire solar installed base in the United States.

Think of this as a potential efficiency surge which could provide relief as the non fossil fuel energy infrastructure is pursued over the coming decades while presenting a huge market opportunity to Comverge. Unlike other renewables, demand management and energy efficiency need to government subsidies to be economical.

Comverge has a comprehensive portfolio of demand side solutions for all customer classes and we are well positioned with our 500 utility customer base as these macro trends play out over the next decade. Our broad offering provides strong strategic utility management through innovation and technology, allowing utilities to reach new heights in their Smart Grid deployments.

After I discuss some of our fourth quarter business highlight and recent events, Mike Picchi will provide more detail and information about the company's financial and operational results for the fourth quarter. We will open the call afterwards and we have ample time for questions from analysts and investors.

Comverge now exceeds 2600 megawatts under management and we recently announced that our future contracted revenues surpassed $.5 billion driven by major AMI related and enabled and virtual peaking capacity contract awards. Our pipeline in each business segment continues to grow as does our large customer base.

In January alone, we responded to 14 utility RFP's worth more than $500 million in long term opportunities, by far our most active month ever. Although we don't expect that torrid monthly pace to continue, it clearly shows that Comverge business prospects are accelerating and we are poised for long term growth.

Comverge continues to focus on creating long term shareholder value. We have consistently used the following three metrics to measure our progress in creating long term value.

First, megawatts owned under long term capacity contracts which generate our highest gross margins and recurring revenues. We targeted a 2008 goal of adding 250 to 300 megawatts.

Second, megawatts managed under open market programs in our commercial and industrial business. Here our annual goal was to add 450 to 500 megawatts.

And third, future revenues from long term contracts. This goal was to add at least a net $150 million to $175 million. Including the contracts and megawatts awaiting regulatory approval, we met or exceeded all three of these major internal goals for 2008 and will continue to pursue and report on these three metrics in the future.

The result is that 828 megawatts were added in 2008 an increase of 63% compared to where we began the year. These megawatts, whether they be bilateral BPC contracts with utilities, contracts with end user C&I customers, or large multi-year turn key projects are valuable assets which we continually attempt to leverage for additional revenue streams.

Certainly winning outsource BPC contracts increases the value of the company and will remain a focus of Comverge, but we have seen an exciting new trend develop in the past three months which has the potential of long term contracts for the hardware, software and services components in anticipation of some of the large advance mirroring infrastructure for AMI projects.

These are coming in the form of large scale AMI ready demand management programs which are a hybrid approach between the traditional one year straight product sale compared to the totally outsourced virtually peaking capacity contracts.

Under this hybrid approach, the utility customer that wants to purchase Comverge hardware and software also wants to outsource to our services such as installation, marketing and program management. Often these programs are structured with a flexible migration path to a full scale AMI deployment. Based on recent RFP activity, we expect you'll see more of these large turn key contracts from us in the future.

We were awarded three of these major long term turn key contracts in the past three months that we expect to significantly boost our product and services revenue in the next few years. First, Comverge won its initial AMI enabled contract with Pepco Holdings. This large turn key contract deploys our hardware and software solution, utilizes our installation and marketing services and is expected to manage 200 megawatts over the next five years.

Second, we were awarded a new turn key contract with our long term customer, Austin Energy for the purchase of additional Comverge energy management devices including Comverge's Super Stats along with the installation of those devices in residential and commercial properties through Austin Energy's coverage area.

This contract is expected to generate nearly $20 million in revenue to Comverge over a five year period and will provide Austin Energy customers with the opportunity to optimize their energy usage.

And third, we signed a major new exclusive five year agreement with Progress Energy of Carolina, or PEC to provide energy management hardware and software solutions to implement PEC's new energy wise residential demand response and energy efficiency program. When fully implemented, the program is expected to provide up to 170 megawatts of peak load reduction.

These wins and our growing pipeline demonstrate the significant traction in our AMI ready demand response programs which are compatible with current or future utility AMI initiatives and bring immediate value. This traction is also a direct result of AMI enabled products which have been developed by Comverge.

Last fall we introduced the Power Portal in home display, a product that provides customers with current energy usage, energy price information and utility messaging. This in home display product is part of our growing portfolio of AMI solutions which includes our Smart Programmable Thermostat and enhanced software suite.

Our software provides homeowners with an energy portal to view and manage home energy consumption. With the rapid projected growth of AMI programs in North America, coupled with our leadership position in the demand response market, we believe Comverge will be a major beneficiary in the generation of Smart Grid investment by utilities.

And to help our utility customers further leverage their existing and future Smart Grid investment, Comverge recently announced the release of the Apollo Demand Response Management System, a state of the art open architecture software platform capable of handling the traditional demand response systems of today, while integrating AMI and Smart Grid systems of the future.

This system, using web technologies will manage residential and commercial demand management resources such as demand response control devices, programmable communicating thermostats and in home displays. It also has the ability to manage and integrate commercial and industrial systems, plug in hybrid electric vehicles and renewable energy resources.

For the first time, Apollo users will be able to deploy an integrated experience ranging from customer service, utility operations, customer portals and program administration that enable scalable utility operations for the Smart Grid.

In addition to our products and services market growth, Comverge continues to grow its residential and commercial segment business and continues to expand its pipeline of VPC programs. All of our sales activity throughout the company are geared initially towards educating our utility customers on the virtues of our outsourced VPC programs.

As the credit crunch has expanded to impact utilities, going the route of an outsource VPC program with Comverge should become even more attractive, given the utilities current capital constraints.

Our business model is a straight forward one. Comverge provides strategic utility management through innovation and technology. With the latest two way communication devices, our Apollo software platform or our C&I remote dispatchable software Comverge is a leader in technology focused on both providing state of the art cost effective advanced technology and capital free pay for performance capacity programs. This allows the utilities to reduce costs and enhance reliability by providing demand management programs for all classes of the utilities customers.

Comverge remains focused on successfully executing its business plan and vision which is to increase our market penetration, expand the market for a clean energy solutions and pursue strategic opportunities that will build long term value for our shareholders.

No other single company public or private, can offer as comprehensive of a solution set in demand management and energy efficiency as we do. This comprehensive approach to the entire spectrum of customers both expands our addressable market and mitigates business risk.

The industry and Comverge are poised for growth. Federal and State legislative and regulatory movement to decrease demand on our nation's existing infrastructure are wide spread. Demand response and energy efficiency are generally viewed as the most expedient and cost effective resource. Again, the cleanest, most efficient and economic megawatt is still the megawatt never produced.

Comverge is fortunate to have an $84 million liquidity position because in these difficult economic times, cash is king. As we look out through 2009, our focus is on preserving our substantial cash and liquidity position while we leverage our knowledge, expertise and leadership for profitable growth and significant increases in shareholder value.

Because of our strong financial and industry leadership position however, we will not bury our heads and wait for the economic storm to pass. Rather, we will continue to aggressively pursue and grow our business so that when the storm does pass, we will be even larger and stronger.

With that said, I'll turn the call over to Mick Picchi, our CFO who will talk about Comverge's fourth quarter financial and operational highlights.

Michael Picchi

As we have stated in previous earnings calls, under our residential VPC contracts, we defer significant portion of our consolidated revenues, our most profitable revenues until the fourth quarter of the year. We are required to defer revenue until the fourth quarter when we true up our estimates for megawatt capacity available to our utility customers during the peak summer cooling season in light of actual capacity that was made available to the utility over the summer.

Accordingly, our fourth quarter revenues will be the greatest of the year and are not meant to be taken as our annualized run rate.

For the year, revenues totaled $77.2 million, up 40% from $55.2 million in 2007. Revenues for the fourth quarter of 2008 were $33 million compared to $#34.8 million in the fourth quarter of 2007.

Broken down by business segment, $6.7 million of our total revenues in the fourth quarter of 2008 came from our utility products and services segment, which we call the Smart Grid solutions group. This compared to $4.8 million in revenue in the fourth quarter of 2007, a 40% increase and our highest quarter ever for this segment.

Our products and services business segment, the future looks real promising based on the large AMI implementation being planned in 2009 and beyond.

The residential business segment which has our VPC contracts and our energy efficiency contracts with Con Ed recognized revenues of $24 million for the fourth quarter of 2008 compared to $25.5 million for last year. $800,000 of VPC revenues that relate to the 2008 contract year were not recognized in Q4 of 2008 because a portion of the final settlement wasn't made until last month. Accordingly, this $800,000 of VPC revenue will be recognized in Q1 2009.

Also contributing to the revenue decrease in Q4 2008 was the lower lighting installations at our energy efficiency business.

Deferred revenue on the balance sheet from the VPC contracts was $4.3 million as of December 31, 2008 compared to $2.4 million in the year ended 2007, an increase of $1.9 million.

Under GAAP accounting rules, the proxy payments and the associated costs of the VPC contracts are not recognized in the income statement until after the summer cooling season, when we and our utility customers perform measurement and verification or M&V tests to statistically determine the capacity that was available to these utilities during the summer cooling season.

Remember we get paid whether the utility uses the demand response system or not. After the M&V test has occurred, we then do a true up calculation to determine the final settlement of the actual revenue earned for the contract year and recognize the deferred revenue from the previous three quarters generally during our fourth quarter.

Accordingly, during the first three quarters of 2008 we recognized no revenue and no profit from the residential VPC contracts but in the fourth quarter after completing the M&V tests, we recognized $18.8 million of revenue and $13.6 million of gross profit on the VPC contracts, a gross margin of 72%. This compares to gross margin on the VPC contracts of 66% last year, a nice improvement.

The M&V adjustments or true ups for 2008 were a net negative $300,000 in the aggregate for a total 2008 contract year consideration. That's less that 2% of the VPC revenues that we had for the year, but based on the timing of when the final settlement was obtained, in Q4, we actually recorded $1.1 million in downward adjustments offset by the $800,000 positive adjustments we will report in the first quarter of 2009.

As we win additional VPC contacts, Comverge is building a portfolio of contracts which diversity the risk of any one contract having a large impact on the annual M&V true up process.

Of the 701 megawatts under our capacity contracts approximately 319 megawatts are built out. During the fourth quarter of 2008, we incrementally built out 40 megawatts of capacity under our long term contracts. For all of 2008 we built out 126 megawatts of capacity. This represents a 62% increase from 2007 when we built out 78 megawatts during the year.

Revenues for the commercial and industrial business segment were $2.3 million in the fourth quarter of 2008 down from $4.5 million in 2007. Important to note, we recognized all of the capacity revenues during the third quarter of 2008 from the P&V capacity program that began June 1, 2008.

In 2007, we were recognizing the capacity revenues over 12 months, so Q4 2007 included capacity revenues where as Q4 2008 did not.

Our C&I business had 894 megawatts of commercial and industrial load under contract. Important to note during the first quarter of 2009 we've added almost another 200 megawatts of capacity primarily in PJM so the year is off to a good start.

Turning now to margins, consolidated gross profit for the fourth quarter was $18.4 million compared to $19 million for the fourth quarter of 2007. Consolidated gross margin for the fourth quarter of 2008 was 56% compared to 55% for the same quarter last year. For full year 2008 gross margin was 44% compared to 48% for 2007.

This decrease was primarily due to having the lower C&I margin business for a full year in 2008 compared to only five months in 2007. Let me add, we believe gross margin comparisons are only meaningful in looking at the entire year because of the deferred revenue recognition of the residential VPC contracts until the fourth quarter.

In total, the result was an adjusted EBITDA for the fourth quarter of $12.7 million compared to $13.3 million in the same period last year.

Capital expenditures for the fourth quarter were $4.1 million compared to $2.7 million in the same period last year and for all of 2008 they were $13.3 million compared to $5.5 million in 2007 as we have ramped up our build out in the residential VPC contracts.

Turning to our balance sheet, total unrestricted cash and cash investments as of year end were $47.8 million. We used $4.2 million of our cash in the fourth quarter to repay a portion of our convertible acquisition debt. We did enter into a new five year $25 million senior credit facility with Silicon Valley Bank to refinance $15 million of our convertible notes maturing on April 1, 2009 and to provide up to $10 million to grow the business.

This new facility combined with our strong cash position and our GE Capital credit facility which is used to fund the build out under the VPC contracts gives us $84 million of capital available to grow our business.

We were very pleased to obtain the SVB financing in the midst of these tight credit markets. We do not anticipate any need to access the capital markets in the coming year. It's no secret that we've been able to survive and thrive in this economic environment if cash and liquidity. We're pleased to be well positioned on both fronts.

Total debt was $28.1 million as of December 31, 2008. This consisted of $12.5 million under our GE Capital credit facility, $15 million under our new Silicon Valley Bank facility and $600,000 of subordinated convertible debt relating to our acquisition of Enerwise. You'll recall that at September 30, the amount of our debt due in the next 12 months was $20 million.

With the refinancing of the acquisition debt in the fourth quarter, the amount of debt due within the next 12 months is now down to $3 million. In December, we retired $19.2 million of the almost $20 million subordinated convertible debt that was due in April 2009 by offering the note holders a 2% early prepayment discount. We saved the company $328,000 with the 2% discount.

Now, I'd like to talk about our expectations for 2009. As was made clear last year, it is very challenging to predict quarter to quarter or even annual revenues due to a number of factors including the lumpiness of the quarter revenue in our hardware business, uneven installation activity in our energy efficiency business, uncertain timing of when the VPC contract and the settlements will be finalized and the unpredictability of regulators and long times to receive regulatory approval before we can start building out our VPC programs.

These uncertainties are further compounded by the tenuous market we are all experiencing. Accordingly, we expect our full 2009 revenues will exceed $90 million taking into consideration the items I just noted. What we are seeing is that the contracts that we are signing are larger in scale, particularly on the hardware side of our business.

Furthermore, we are uncertain as to the potential benefits of the stimulus bill and the timing, as any benefit received most likely will have a greater impact on 2010 compared to 2009.

While revenues are an important measure of progress in growing the business, at this stage of our company' development, management and the Board of Directors focus on growing the long term value creation metric that we announced last year. These three metrics measure the company's operational progress; megawatts owned under long term contracts, megawatts managed under open market programs and estimated future revenues from our long term contracts.

These metrics are the most important to management and investors as we continue to build a strong, viable company focused on creating long term shareholder value. Our 2009 internal goals for these three metrics are; to add at least a net 275 megawatts of capacity under long term contracts, add at least a net 225 megawatts in open market programs and to add at least $150 million in net estimated future revenues from long term contracts.

This concludes our prepared comments. At this point. we'll open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sanjay Shrestha – Lazard Capital Markets.

Sanjay Shrestha – Lazard Capital Markets

When you talk about this 275 megawatt capacity on the long term contracts, can you give us a sense as to what type of pricing you're getting those contracts sort of the profitability going forward? Is it down versus what you used to get on a per megawatt basis or has it remained flat or given the incremental benefit on the VPC side, has the pricing gone up? Can you talk about that a bit?

Michael Picchi

I guess what we saw in 2008 in our VPC business, if you consider the average install megawatts during the course of the year as a function of the VPC contract revenue, we got about $80,000 per megawatt per year under our long terms contracts. In the population of our existing contracts I have good news because the pricing that's fixed in those contracts for the remaining seven or eight or nine years of duration of those contracts.

In terms of new contracts that we're looking to sign in 2009, based on the RSP's we've responded to, we do not see any change in that pricing at that $80,000 a megawatt per year level, so we're seeing the utilities are valuing this asset, and again, that's the benefit of long term contracts. Our pricing is fixed. It's a benefit to Comverge and it's a benefit to the utility.

Sanjay Shrestha – Lazard Capital Markets

When you talked about this 14 RFP's in the month of January representing some $500 million over the long term revenue opportunity, can you help us understand in terms of the near opportunity that might sort of materialize rather than an RFP actual sales visibility. What's the timing on that?

Robert Chiste

Well first of all it was just a dramatic month for our RFP's obviously and we have already entered negotiations on one of the major RFP's so we were short listed and selected. So some of these are happening very rapidly, but what we're noticing, the RFP's are getting much, much larger and there's already an action plan in place to execute contracts, move toward regulatory approval.

So we are seeing a much shorter cycle than we've seen in the past, and it appears that what many of the utilities are doing are preparing for an AMI deployment into the future, but want to be AMI ready today, and what that means is, we're putting in DR devices, demand response devices which will be enabled and capable of talking to that AMI meter most likely a Zigby meter in the future if and when that AMI program is rolled out.

So in the past, we've been waiting for the AMI deployments, meaning the first big roll out of the metering aspect of the AMI deployment. Now what we're seeing interestingly is the DR part of an AMI deployment is rolled out so long as it's enabled to talk to those AMI enabled meters one or two or five years down the road.

Sanjay Shrestha – Lazard Capital Markets

So you have gone from being a lagging indicator from the AMI business to a leading indicator for all the AMI opportunity that's materializing down the road.

Robert Chiste

Interesting, I wouldn't say it's across the board, but it is an interesting phenomena that's happened and we're seeing it happen. It's clearly not an anomaly so it is happening across the country and in more than a handful of utilities that we're seeing interest in this aspect of moving forward.

Sanjay Shrestha – Lazard Capital Markets

Clearly we are in a recession and demand for electricity tends to tie with the GDP dynamics and there's also a lot of talk about the CapEx on the utility side, potential push out for some AMI projects, but you certainly don't seem to be seeing any of the negative impact from that. Can you tie all of that together for us as to one, what are the key drivers of all this opportunities that are coming your way, and two, if some of these larger AMI projects were to get pushed out, how could that potentially impact your near term opportunity

Robert Chiste

What we've talked about in the past is that virtually nothing in our business model was based on the success of the large AMI deployments which have been announced, and that still stands, but for these leading indicators as I mentioned on the DR side. We are seeing very, very few cases, primarily on the C&I side of our business where the economic impact is having very, very slight affects on us.

But our long term, obviously our long term contracts are really the support that gives us that long term visibility and we're not affected by the current economic situation. So we're seeing virtually not slow down. As a matter of fact, we're seeing an acceleration of business on these large DR deployments like we're doing with Pepco and PEC and these are RFP's, I think that what we're seeing is moneys were budgeted, in some cases were budgeted for large AMI deployments.

Well, as we understand it, the demand response piece of the AMI deployments generally are the, what puts the economics business case over the goal line. So utilities are coming back even though they're massive $2 million to $3 million budgets might be cut somewhat, they're falling back to the DR and energy efficiency piece because they are so economic.

Operator

Your next question comes from Steve Sanders – Stephens Inc.

Steve Sanders – Stephens Inc.

A follow up on the January RFP activity, can you distinguish between what you saw in terms of VPC deals and hardware and hybrid deals that would be more tied to AMI?

Robert Chiste

What we're seeing, and I'd like to make this very clear. We're seeing our VPC activity at least as good as it's been in the past and accelerating. What we're seeing is way more turn key projects versus just our traditional one year sale of products and software and hardware.

So what appears to be happening is utilities are taking a longer term vision of their infrastructure and as opposed to just for example 10,000 or 20,000 digital control units from us, or thermostats which is still going to be a substantial part of our business, we're seeing those types of orders turning into long term contracts and turn key projects.

So we are seeing a lot of strength in the VPC side of the business and then a lot of strength in this turn key side of the business and I would say that that's the trend that we're seeing is the shorter term one year purchase orders are turning into longer term contracts including not only our hardware and software but other services like installation and marketing.

Steve Sanders – Stephens Inc.

In sticking with the turn key projects, it seems like the hardware gross margins are relatively stable at historical levels. I would think you're layering in some incremental software sales which would be higher margin but that the installation and sales and marketing might offset that a bit, so how should we think about the gross margin on the turn key projects over the next couple of years? Would we still expect to see something around the 40% level?

Michael Picchi

Our historical gross margins in our hardware business have been in that 40% to 41% range and that's what we would expect kind of be flat going forward. As you said, the better margin is on the software will offset perhaps some lower margins on the marketing and installation services. But in total we see kind of a flat level on gross margins.

Steve Sanders – Stephens Inc.

In sticking again the with RSP activity, can you just comment on the competitive environment as more of these big deals come down the pipeline and then what have you seen in February, March, your expectations over the next few months in terms of RFP's. It sounds like January was a surge, but are you still seeing a decent level of activity?

Robert Chiste

Yes we are seeing activity at least as strong as 2008 in addition to the January. As far as the competitive environment, one of the advantages that we have is because we bring such a full suite of products both on a demand response energy efficiency side, some of these large RFP's do include both demand response and energy efficiency.

And then we bring the large suite of services such as installation, marketing, measurement and verifications so on a bundle basis, the broad nature of our business in the comprehensive nature of our portfolio of services and products is allowing us to go in an maintain those margins that Mike talked about and still be very competitive on pricing, we believe.

But this is a competitive business that we're in. We see quite a bit of competition on the C&I side of the business where our margins are lower, but one true advantage we have is the broad breadth of services, so yes we see a strong pipeline of RFP's coming down the road and we think that we're in a good competitive position, but this is capitalism. We do have competitors.

Steve Sanders – Stephens Inc.

Thinking about VPC megawatt installations in 2009 you did a little bit under 130 megawatts in 2008, just two questions there. One, how should we think about that in 2009 and what are the things that could move that significantly higher or lower than 2008? And then second, you've made some good progress over the course of 2008 on lowering your costs, sales and marketing, installation and I'm assuming a little bit on hardware as well. Could you just revisit the cost side as well as talk a little bit about the installation levels.

Robert Chiste

I'll just touch on that call side because that's something that we're pretty proud of. We really have reached a level of critical mass where we feel that we're now getting significant operating leverage and just anecdotally we will continue to hire people out in the field on a project specific basis, but literally the only hire that we have at a director level above is a new installation manager for the entire country.

So we have put in place our entire infrastructure and have our support group fully built out so that's why you're seeing the costs now are starting to come down vis a vis on the percentage of revenue basis.

Michael Picchi

In terms of level megawatt installation for 2009, you're correct we did about 126 megawatts installed in 2008 and we didn't even have the benefit of having a full year build out in some of our programs like southern Maryland. So I think as we internally project, we're just saying in 2009 we can do the same level of installation, and then knowing that we have better built out in some of our contracts or have a full year benefit in southern Maryland, and presuming southern California contract is approved, have the ability to that build out in 2009, perhaps that could be upside to our model. But to manage expectations, we would say just flat level of megawatts installed in '09.

Steve Sanders – Stephens Inc.

On the non cash expenses, the D&A and the stock comp how should we thing about those in 2009 relative to '08?

Michael Picchi

The stock comp will be level in 2009 compared to 2008. The depreciation number though will be going up in 2009. We are in the last year of our Nevada DPC contract so everything thing that we install this year we have to fully depreciate this year, so there'll be a pretty meaningful jump in depreciation this year. The amortization number will be pretty level year over year.

Operator

Your next question comes from Robert Stone – Cowen and Company.

Robert Stone – Cowen and Company

You talked about comparing demand response potential in nameplate megawatts or gigawatts to other sources, but to put that on an apples to apples basis, what do you think is the capacity factor for demand response?

Robert Chiste

That's always a hard question because it's at the peak but the capacity factor at the peak is that 78 gigawatts, and just interestingly and coincidentally, the capacity factor is the same for energy efficiency according to EPRI so if you think about it the way we thing about it, if you bring down through energy efficiency base load by those 78 gigawatts, it's also cumulative with the 78 gigawatts on top of it for the peak. So on a fully deployed basis, we think of that as a capacity factor at the peak.

Robert Stone – Cowen and Company

I was thinking in terms of the number of watt hours per name plate watt that are produced by various sources. I feel like you're making a not very accurate comparison to for example solar power.

Robert Chiste

I think that solar power is sort of a hybrid. It's somewhat between the peak and base load capacity because the sun doesn't always shine obviously and it's certainly not available at the night time. So I think that if you look at that 70 gigawatts at energy efficiency capability, and I would just throw away the 78 gigawatts of demand response capability, I think that is much more an apples to apples.

So if you have 78 gigawatts of demand or energy efficiently capacity, clearly the solar market won't get anywhere near that size in the foreseeable future. Of course energy efficiency we're talking about a two decade build out also.

So I think the point I'm trying to make is certainly solar and wind are going to be an important part of the equation. The problem is that there's a financial and economic problem at least in the short term and probably in the intermediate term there's a transmission problem. So my only point was not on an absolute basis over the next two decades but certainly over the next three or four or five years I believe that we're going to have a lot more opportunity in the demand response energy efficiency arena than we will in solar or wind.

Robert Stone – Cowen and Company

Who do you think is the strongest competitor for Apollo?

Robert Chiste

We certainly think that we have competitors and some of them could even be on this call, so I don't think I'll go into that.

Robert Stone – Cowen and Company

You don't want to name who's the strongest, who do you think are competitors to it?

Robert Chiste

I'd rather pass on that and we'll talk to you about it.

Robert Stone – Cowen and Company

What was the weighted average share count in Q4?

Michael Picchi

21.4 million on a fully diluted basis. 21.2 million on a basic basis.

Robert Stone – Cowen and Company

What was the item other income item in the quarter?

Michael Picchi

I mentioned that we prepaid the acquisition debt and asked the holders to take a 2% discount, so we saved the company $328,000 by prepaying the debt four months early.

Robert Stone – Cowen and Company

So that was retirement of the debt.

Michael Picchi

Yes, Retirement of the debt.

Operator

Your next question comes from Michael Carboy – Signal Hill.

Michael Carboy – Signal Hill

Let's touch on the whole measurement and verification issue. Do you have the sense that we're dealing with a patchwork of rules and regs? Do we need to see a greater degree of standardization in the whole measurement and verification process for a more rapid deployment of demand response?

Robert Chiste

I don't think so. Obviously where we're going with AMI and two way communications systems, that's the ultimate answer. But our one way verification on the statistical basis is approved by ICO in New England, California ISO and all the state utility commissions that we operate in.

Michael Carboy – Signal Hill

What exactly happened with the M&V shortfall this past quarter?

Robert Chiste

The M&V shortfall for the past quarter is, the measurement was accurate. It was a cooler summer than we expected so there were some less measurement of kilowatts per home that we got than we had expected. But the measurement and verification worked fine. It's just that results were not as good as we had hoped. So maybe I don't understand your question.

Michael Carboy – Signal Hill

You're dealing across multiple jurisdictions. Some of these utilities are burdened with having to deal with multiple PUC jurisdictions and you end up getting a variety of different sets of M&V rules that need to be applied and sometimes they're not always consistent, and thus there's no other transparency to them, and I'm trying to get a handle on how much change still has to happen within the utilities and within the utility planning groups and the PUC's before you get a standardized set of M&V rules that can be relied on across jurisdictions.

Robert Chiste

We would certainly like that too, but as far as being relied on, the actual M&V, these are contractual terms with each one and within each of one of our VPC's so these people in the past that probably in the M&V section of these contracts in some cases are one third of the entire contact, so they're very, very well laid out.

So the rules work, but I agree with you 100% they're not standard. But they are acceptable. They are statistically proven and they're accepted by the regulatory authorities and the ISO's.

Michael Carboy – Signal Hill

With regard to the economic programs for the commercial and industrial customers, can you elaborate a little bit on how you see the margin trends for those voluntary programs unfolding here in the next couple of quarters?

Robert Chiste

First of all the economic program has been a program where we had a regulatory surprise last year, so there are not many of those revenues that we had certainly in the first quarter. What is happening though, the recommendation has gone back to the FERC and there's hearing I believe in March and the expectation is that there will be rules on the economic program in early spring or early summer.

But as far as the margins on the economic program if we have those revenues we're fairly comfortable with. However the C&I programs margins are getting significantly impacted by the competitive nature of that business and particularly in PJN we've seen other providers of capacity and aggregators of capacity are putting deals out on the table for some of the large C&I customers and these are usually the smaller players that are taking very small percentage of the revenue split and large percentages going back to the commercial or industrial customers.

So we're seeing a lot of anecdotal evidence where smaller players which probably will not be around in the future. I mean some of the players will be dropping out. So anecdotally there's pressure on industrial and commercial margins.

Michael Carboy – Signal Hill

I think for last year 2008 VPC revenues actually sort of spanned for five quarters. You picked up some of the Q4 '078 revenues in '08, is that right?

Michael Picchi

Partially right. It is only 12 months of revenue in each of our contracts that's reflected in our income statement. So some of our contracts started up in the middle of Q4 in '07 and drop off in the middle of Q4.

Michael Carboy – Signal Hill

I wasn't referring to the timing of start up, I was referred to the deferred revenue process. Looking at '08, there's a subtle change going on here isn't there?

Michael Picchi

No, there's not. Each of our contract, there's a contract year. But that year does not run necessarily on a calendar year. It may run from October 1 of one year to October 1 of the next year, so what's reflected in our income statement is only 12 months of revenue for each of the VPC contracts, which is why if you look at December 31,2008 we carry a deferred revenue balance of I think it's $4.6 million or $4.8 million.

That's the portion of Q4 revenues from 2008 that we carry into 2009 and won't be recognized until the fourth quarter of next year. The one contract that does run on a calendar year is Nevada Power. That one will have no deferred revenue at December 31. We start a brand new contract year on January 1.

Operator

Your next question comes from Elaine Clay – Piper Jaffray.

Elaine Clay – Piper Jaffray

Could you give us an update on the status of the regulatory approval for the SoCal Ed and the APS contracts.

Robert Chiste

The regulatory approval we are looking in both cases at the second quarter of 2009 and we have no reason to be pessimistic about that approval coming through. We've worked with the consumer advocate group on the Southern California Edison contract and I know Arizona Power has been working with their utility commission in preparation for the review. So we expect both of those and we expect them both to be positive in the second quarter of 2009.

Elaine Clay – Piper Jaffray

You're guiding to 277 megawatts of additional long term contracts in '09 and just wanted to check to see what you've added so far this year and how the road map is looking.

Michael Picchi

We've not announced any VPC contracts signed in the first two months of the year. But there's certainly VPC contracts part of that January RFP activity so we're still optimistic of reaching our internal goal.

Elaine Clay – Piper Jaffray

Do you have any sense of what percentages those might require, some type of regulatory approval? Is that virtually all of that or are there some that wouldn't?

Michael Picchi

There's a mix. Some of them already have approval and they're coming in after the fact. So it's the general range and mix that we see.

Elaine Clay – Piper Jaffray

What kind of trajectory do you think we could see on the C&I revenue over the next couple of years?

Michael Picchi

Well the C&I revenue trajectory is going to be a function of two things; one is we do have VPC contracts on the C&I side, three of them now; Pacific Gas and Electric, Southern California Edison and Arizona Public Service. So a key part to the revenue ramp will be getting regulatory approval on Southern California Edison and Arizona and by the way Arizona is our largest contract. It's 125 megawatts over $100 million in potential revenues to us in a 15 year deal.

So getting those two approved and starting to build out under those will add a tremendous amount of revenue and then the second aspect of our C&I revenue growth will be adding megawatts in open market programs and we've historically been very strong in PJM, but we are now in 2008 I guess I should say we branched out and are now adding megawatts in Texas, ISO New England and ISO New York as well.

So we are continuing to grow the C&I business on both VPC contract side and the open market megawatt side.

Elaine Clay – Piper Jaffray

Do expect to see stimulus spending helping out or improving the timing on some of the RP's and proposals that you're presenting with utilities.

Robert Chiste

We're obviously excited about it. Whenever you're talking about $4.5 billion coming into your industry, but we're not counting on it, and I think it's going to take awhile for that money to flush through the system, but we're preparing. We're developing projects that we think will be worth of submitting although we don't know the rules of the game yet.

The Department of Energy is expected to announce rules over the next 30 to 60 days. So we're preparing. We're ready to go. We have this comprehensive portfolio and we're putting together potential projects and programs that might fit under the stimulus plan. So we're just going to have to all sit back and wait and see.

Operator

Your next question comes from Paul Clegg – Jefferies.

Paul Clegg – Jefferies

I'm trying to work through how conservative your greater than $90 million revenue guidance is for 2009, what sort of upside or downside triggers you can see in there. You talked a little bit about the VPC build out maybe having some upside to it depending on approvals. I'm wondering how much your M&V testing experience this year had an impact on guidance so you're assuming net short falls from M&V or I guess maybe trying to be somewhat conservative on the megawatt results of those tests.

Michael Picchi

The M&V in the aggregate ended up only being less than a 2% adjustment so that didn't color our view of our revenue expectations. Really, there's a number of items that could impact our revenues this year and quite frankly could impact them very positively.

For instance, the timing under our new large hardware contract with Petco, the ramp up of that contract will play out as we go through the year and could have a very significant impact. The good news is we have the contract in hand and it has regulatory approval. We're already executing under the contract with some of the marketing services.

The installation activity in our energy efficiency contracts with Con Ed could impact. The New York metro area as you well know has been substantially impacted with this recession and customers on the commercial and industrial side spending money on energy efficiency lighting upgrade, things like that is a more difficult proposition in this economy.

The build out of megawatts under VPC contracts could be a positive factor if we beat the number of megawatts we built out last year. The new megawatts we were awarded in open market programs, especially PJM could be an impact. You saw our goal. Our goal is to add 225 megawatts per year and we seem to be off to a good start in the first two months of the year.

And then finally, the stimulus bill. So we think we have a number of catalysts that could play to our advantage. The installation activity and the energy efficiency business could be a concern, but in total we feel like it's going to be a good 2009 for Comverge.

Paul Clegg – Jefferies

Does your revenue guidance assume that you hit each one of those megawatt addition goals?

Michael Picchi

It's interesting. The first megawatt addition goal in terms of long term contracts probably won't have any impact on revenue. The 275 megawatts in long term contracts we signed this year won't have any impact on '09 revenue because by the time we get regulatory approval and then start to build out, the year will be pretty close to over.

Certainly the revenue does include what we're counting on getting in the 225 megawatts we're hoping to get into the open market part. You know our large contracted back log of $520 million gives us good visibility on where our revenues are going. It hasn't proven to be the most reliable indicator of exactly which period those revenues will hit, but the good news is we know the revenue is out there and it's going to come and be cash in our pocket.

Paul Clegg – Jefferies

Would you mind commenting on the M&A opportunities developing out there. The credit crisis has hit a lot of companies. Do you think any of them could be more interested in a take out and is it possible to do a deal without too much dilution at these equity prices.

Robert Chiste

That's an interesting question. I made the remark cash is king so we would be looking more for using our stock as a currency and at our current prices, we think that it's tremendously undervalued. So we would be extremely careful before we used any of our cash and before we used any of our stock as currency.

There are some attractive acquisitions but we see they're coming to us continually because of the strong position we're in, but I doubt very much that you'll see anything happen from an M&A standpoint in 2009 unless there's something very attractive and compelling that comes our way.

Operator

Your next question comes from Jeff Osborne – Thomas Weisel Partners.

Jeff Osborne – Thomas Weisel Partners

I just wanted to make sure I understood you right. You're talking about adding 225 megawatts on the open market and I think you commented you already added 200 in the first two months of the year.

Michael Picchi

Just under 200. But important to note, we will add most of our megawatts in the first quarter of the year because that's getting megawatts lined up for the peak jam capacity which begins June 1. So it's not meant to be taken as a run rate. You can't annualize what we've done in Q1.

Jeff Osborne – Thomas Weisel Partners

And that would put the revenue over the late 2Q but mostly in the third quarter time frame?

Michael Picchi

No revenue in Q2. We recognize all the capacity revenues in Q3.

Jeff Osborne – Thomas Weisel Partners

What would be a good kind of internal target. Is it 50 to 100 megawatts for Texas and New England and New York. Is that unachievable, achievable? How do you look at those three markets that you highlighted that you're attacking now?

Michael Picchi

I think we'll just stick with the 225 megawatts in total as our goal as we move through the year rather than providing clarity down at the individual market level.

Jeff Osborne – Thomas Weisel Partners

Any commentary you can provide on the R&D line. If I remember right, you talked in the past about ramping up your efforts there. How should we think about that expense level going through the year?

Michael Picchi

I think as we move into 2009 you will see the R&D line increase by a $2 million compared to '08 and that is largely related to our software development efforts on Apollo. So we are making an investment in AMI and you'll see it reflected in the R&D line this year. So that's good news to our utility customers as well because they pay attention to that line and want to know that we're investing in the product.

Robert Chiste

It should be noted with Apollo, we have about 125 to 150 customers current running on our load management system so that's a built in market for our Apollo program, so we feel very confident from an R&D standpoint we have a built in customer base, and then it's going to bring so many more aspects and functionality. That's why we're putting a lot of our R&D efforts into the Apollo program.

Operator

Your next question comes from Richard Baxter – Ardour Capital.

Richard Baxter – Ardour Capital

If you're looking to migrate some of your existing clients to your Apollo platform, so the follow up would be, what's involved?

Robert Chiste

What's involved, we're actually introducing I believe it's in March our version one or version two or version three, I don't remember the actual version, but it's the version which is capable of replacing our current LMS program. So we will be out already have notified all of our customers what's coming.

We have a customer focus group that's looked at the functionality, so we're in a position almost immediately to start moving customers over in the second quarter of this year.

Operator

Your next question comes from Michael Goodrich – B&G Capital.

Michael Goodrich – B&G Capital

Obviously it's been a tough economic climate for everyone and to see you guys continue to perform is a great thing. I've got a question regarding your existing relationships with utilities and I think this is something that might be overlooked. Can you go into that a little bit and how you think that might help you in the future?

Robert Chiste

As we've always talked about we have 500 or more utility customers and as we go back just to demonstrate over the past 18 months or so, we had sold something to approximately 200 to 250 of those customers. So those 500 customers literally are active customers and in a two or three year period, there's actually a contact and they're buying something.

I have always seen that customer based as being probably our number one asset after our people. It's just a remarkable opportunity to have assembled such a large customer base, particularly in this space. Utility customer is a difficult customer to get. Once you get that customer, they could be very good allies, however.

So we've leveraged in many, many cases off of that customer base and a perfect example is what I'm just talking about with Apollo. In the past when we secured our customer base and provided them with the load management system, these systems were in a lot of cases almost given away because Comverge viewed itself as a hardware company.

Now as we have such a broad breadth of opportunities and such a comprehensive approach, utilities are recognizing that the software component that we're providing is much more valuable and frankly understand now the software business is much more valuable.

So for example now when we got back to these 125 or 150 customers already under load management system, we have a better opportunity for selling Apollo at a much more attractive price let's say. So that's one example.

We've already converted some of our customers to a VPC program. For example, we've expanded three or four of our VPC programs already from the initial contract. So I'm glad you asked the question because I think a lot of people do miss that really phenomenal asset that we have and that's that very, very vibrant customer base.

Michael Goodrich – B&G Capital

It amazes me that you guys came public at $18.00. I feel like the company is ten times better than you were when you came public yet the market doesn't really reflect it yet, and your cash is better than it's ever been.

Robert Chiste

Thank you. We see it very much like that I guess.

Michael Picchi

It's funny, the megawatts when we came public we had under management were 362, and now here we are less than two years later at 2600 megawatts under management, a seven fold increase in megawatts under management. But you're right. We're in a great liquidity position with our $84 million of capital available, and that's important because utilities, when they sign long term contracts want to know that you're going to be around.

And some of them now are actually requiring more financial assurance in the forms of letters of credit or performance bonds, so there's only a few companies that have a balance sheet that can compete for these projects. So it is a competitive advantage to already be public, to be well funded, to be fully funded and be able to show a utility here's our financial where with all.

Michael Goodrich – B&G Capital

What the actual cash on hand as of today?

Michael Picchi

As of today, I'll answer it in two ways. As of year end it was $48 million unrestricted cash and investments. As of today, it's a higher number than that so we've had a good quarter in terms of working capital management. So we have $48 million at least of cash on hand, and then we have $37 million of borrowing availability under our two credit facilities.

We have $10 million available to us under the Silicon Valley Bank deal. We still have another $27 million of borrowing availability under our GE Capital facility. So add those three numbers together, $48 million plus $10 million of borrowing availability plus $27 million of borrowing availability, that's the $84 million of liquidity we're talking about which is why I said in my prepared remarks we do not see a scenario where we would have to go back and access the capital markets for any more capital.

We're in a very good, and like I said, full funded position.

Operator

That concludes our question and answer session. I'd like to turn the conference back to Mr. Chiste for any closing remarks.

Robert Chiste

Thank you for staying on the call for quite awhile. We just kept it open for all questioners so hopefully that was helpful and we always have an open door for you to call us and we'll answer your questions.

So it's been a very exciting time to be a technology leader in demand management obviously. The stimulus plan in utilities focus on Smart Grids created an unprecedented opportunity for our company. Our megawatts under management and future expected contract revenues are increasing dramatically. The acceptance of our demand response solutions across all customer classes is increasing and powerful market drivers continue to create more opportunities for our company.

We have solid liquidity and capital in place to grow our business as we execute on all of the recent contract wins. We look forward to speaking to you again in two months to update you on the first quarter results. This concludes our call for today and thank you very very much for joining us.

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Source: Comverge Inc. Q4 2008 Earnings Call Transcript
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