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PowerSecure International, Inc. (NYSE:POWR)

Q4 2008 Earnings Call

March 12, 2009 5:15 pm ET

Executives

Sidney Hinton - President and Chief Executive Officer

Chris Hutter - Chief Financial Officer

Analysts

Rob Brown - Craig-Hallum Capital

Eric Stine - Northland Securities

William Bremer - Maxim Group

Analyst for Rick Haas – Roth Capital Partners

Operator

Welcome to the fourth quarter PowerSecure International Inc. earnings conference call. (Operator Instructions)

All forward-looking statements in this discussion are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are all statements other than statements of historical facts, including but not limited to statements concerning future financial performance and outlook for the company.

Forward-looking statements are not guarantees of future performance or events and are subject to a number of known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those expressed, projected or implied in this discussion. Important risks, uncertainties and other factors include, but are not limited to, those factors identified in the company’s annual report on Form 10K for 2008 which will be filed with the SEC on or before March 16, 2009 as well as reports on Forms 10Q and 8K.

Accordingly, there can be no assurance that the results expressed, projected or implied by any forward-looking statements will be achieved and listeners are cautioned not to place undue reliance on any forward-looking statement. The company assumes no duty or obligation to update or revise any forward-looking statements contained in this discussion.

I would now like to turn the presentation over to Mr. Chris Hutter, PowerSecure’s Chief Financial Officer. Sir, you may proceed.

Chris Hutter

Thank you and welcome everyone to the PowerSecure fourth quarter 2008 earnings results conference call. Thank you for your time and interest in our company. With me today I have Sidney Hinton, our Chief Executive Officer. As usual, our agenda will go like this. Sidney will provide recap of fiscal year 2008 as well as an overview of our fourth quarter and also lead the strategic business discussion. I will then review our more specific fourth quarter results as well as our revenue backlog and related to this certain key go forward financial metrics. We’ll open up the lines for Q&A and then Sidney will wrap up with a few closing remarks.

With that, I’ll turn it to Sidney.

Sidney Hinton

Thanks Chris. We appreciate our utility partners, our customers and our investors that are joining us this afternoon to hear about the results. There are five key messages we want to leave you with today. The first message is we had a terrific year in 2008. We had record revenues and we did it with operational excellence. The validation of the operational excellence is we had record gross profit margin as a percentage of revenues. We increased 1.4 points in that. We are excited about the operational excellence we have been able to build in the company the last couple of years.

The second message, we are succeeding in our growth and diversification strategy around our Smart Creative Energy Efficiency businesses. Our interactive distributive generation revenue grew at 7%. On the surface that would look like a disappointing year. The encouraging aspect of that is that the non-Publix business grew at 46% up under that. So the 7% masked the 46% growth. Our utility infrastructure revenue grew at 98% in 2008. Our energy efficiency revenue grew at 91% in 2008 and our energy services revenue, which is Southern Flow, grew at 20% in 2008.

Our culture is one that combines a deep and fundamental understanding of the marketplace with a tremendous passion for practical solutions that really add value which means we have the discipline and know how to sort out the hype from the real.

Third, we are very adept at utilizing capital. We began the company with minimal capital and minimal resources in 2000. We have overcome capital obstacles along the way to build a business with a strong balance sheet and a good deal of dry powder. We have got zero drawn on our $50 million revolver, $24 million in cash and the ability to play defense and offense with our strong financial position.

Fourth, we are succeeding in expanding our utility relationships. Without naming names I am very pleased to report that we made significant progress in 2008 in developing those relationships. Those relationships broadened our geography as we now reach out to the West coast and up into the mid-Atlantic region and have gained a foothold in the Midwestern states as well as expanding our reach inside the Southeast. We are optimistic about the fruit that will come from those efforts.

Fifth, we have built the foundation for long-term success. From a long-term perspective we strongly believe we are in the right place in the right time. We are always hammering that message internally and on these calls. We like the space we are in. We like the cards we have in our hands. Even in the current economic situation we feel good about our strategic position in the marketplace.

We are blessed to serve a fantastic and financially strong group of utilities and customers. Even in this economy we have offerings that are highly relevant and match well with our customers’ needs including our Smart Grid DG solutions, our utility infrastructure capabilities and our efficient lights technology.

The same holds true for our energy services business. Both Southern Flow and WaterSecure. Those are long-standing companies who enjoy pristine reputations with our customers and are very well managed.

Again the five messages: Great year. Operational excellence being the first one. The second message being we are succeeding in our growth diversification strategy. The third is that we are very adept at utilizing capital. Fourth, we are successfully expanding our utility relationships. Fifth, we like the spot we are in. We like the foundation we have built.

Now let’s talk more specifically about 2008.

We had our company meeting two weeks ago. We spent a lot of time recognizing the accomplishments of all of our people. As investors, utility partners and customers I can tell you that you would have been excited to be in that room and hear the leaders of each of the business units talking in detail about the accomplishment of their areas and their people. It is humbling to be on the team with such an amazing group of people.

I’m going to share a number of these right quick. First thing, our operations team installed over 350 distributed generation systems in 2008. An amazing pace during the course of the year but the real achievement there was not just that they achieved it but they were able to increase our profit margin by becoming more and more efficient during that process. As I mentioned, the record gross profit margin.

Second, we grew on our monitoring system through our Smart Grid monitoring center we grew the number of sites managed and controlled from there by 65% over 2007. For those of you who have visited those of you who are utilities on the call and customers as well as investors and analysts who have visited our facility here and you know what a great secret it is and what a competitive advantage it is. We built the technology into our switch gear and into our proprietary software that we are able to manage the entire fleet with only two to three resources at any given time. We literally have the ability to hit a button and dispatch the fleet all over the country.

Not only did we grow 65% the sites we are monitoring but our software group and our monitoring team upgraded the original legacy platforms which constituted about 20% of our sites so that we now have all of our customers on the same platform. The last point I would make about our monitoring and Smart Grid operations is that you may recall back in the summer storms Faye and Gustav as they were coming on shore we had customers that were relying on us and I have on my phone behind me a voice mail from August 21. I listened to it again before we had our employee meeting a couple of weeks ago. It is from a major customer and the voice message was singing the praises of the reliability of our system. As the storms came on board they were in full storm mode themselves trying to see where outages were occurring, what problems they were having, how they could get back in business of serving their constituency. Well the systems performed flawlessly. The voice mail was singing the praises of our people and the work the customer had invested in.

It is days like that which make you feel great.

Third, in operational excellence. Our next new business unit, another extraordinary year. They increased the number of switch gear systems by 32% up to 649 sections during 2008. I would point out they grew so quickly that we opened a second facility in late 2007 and early 2008 and they promptly filled it right up.

The fourth thing I would point out is our utility infrastructure business had a great year. Both qualitatively and quantitatively. This business unit grew to become our second largest business in just two years of operation in all of PowerSecure. The revenues are up to exceeding $20 million. Not only did they grow the top line, something we talk about all the time we are not trying to chase revenues at the expense of profits. They were successful in growing their top line while almost doubling it and at the same time increasing their rate of gross margin which is a direct reflection on their discipline for operations.

It is also exciting we were able to expand the products and services we offer under the utility infrastructure business. An area that we think holds promise under the stimulus plan. We landed our first utility maintenance agreement this past year where we have a utility that actually relies on us and the equipment we purchased and the people we retain to provide on a daily basis their needs around the expansion and repair to their utility system. We are excited about the utility infrastructure group and the huge potential that it has.

We are also proud of the accomplishments we have made all year long in the technical engineering side of our business. We have the best engineering team in the business. Day in and day out we are impressing our customers with our ability to engineer practical, quality solutions at price points that deliver tremendous value. One of the most important accomplishments related to our engineering was that in 2008 we completed 15 megawatts of data center projects, the most complex systems from distributed generation standpoint in the market. This is a significant accomplishment from a technical standpoint as well as from a customer satisfaction standpoint for us to be able to bring our engineering expertise, our manufacturing expertise and our ongoing monitoring and operating expertise to our Smart Grid center to bear for the customers.

Next, we had another first which was a prime power. All of our generator systems are peaking and back up power systems. For the first time we built a prime power, meaning that there is no grid to support as we do with peak shaving. The grid has not arrived at the site yet, the customer is building the plant and the utility is working to get the grid there. In the interim the customer will be relying upon the generating system that we have installed. It is a natural gas fired base load generating system and we are excited about it as we anticipate it coming on line here in the next few weeks.

Additionally, in 2008 we brought our new Efficient Lights product to market and in spite of strong economic headwinds by the end of the year we had installed lights at ten major grocery and drug chains, in several OEM product lines and we achieved almost $1 million in sales in each of the third and fourth quarters. I am excited to say that we anticipate that level of sales doubling in the first quarter of 2009. The hard work of bringing the product to market and proving its capabilities has been a tremendous success and the consistent feedback we get from the stores that have installed the lights is that the light provides the best quality of light in the marketplace, which is important to a retailer, has the lowest price point and is the most energy efficient light in the market.

The additional good news here is that during the fourth quarter Walgreen’s adopted our light for the majority of their new store openings in 2009 and this quarter we had the pleasure of announcing additional major grocery chain that adopted the Efficient Lights for 50 plus stores. We are encouraged by the sales and marketing activity we are seeing in this area and although we are certainly guarded about the economy the activity we are seeing gives us optimism and Efficient Lights is nearing a tipping point.

Moving on, we completed our financing in November 2009 [sic] for a $50 million credit facility with additional $20 million of leasing capacity combining us a total of $70 million of dry powder to finance our recurring revenue projects. It is amazing given that we accomplished the deal right in the teeth of the financial crisis and we are very appreciative to our banks, Citibank, Sun Trust and BB&T for their support of our company and their belief in our future.

As I mentioned earlier we finished the year in a fantastic financial position of $24 million in cash, a revolver complete un-drawn and only $6 million of debt related to some capital leasing we did at the end of December. I am pleased to say these balances are exactly the same today.

Our two energy services companies, Southern Flow and WaterSecure both had record years. Southern Flow has eagerly embraced the challenge you’ll recall that we made the decision not to sell that business back about a year and a half ago and instead decided to make an investment in growing that business. The Southern Flow and their leadership team have done an outstanding job in embracing that. This year they were successful in growing their revenues 20% as well as growing their operating income by approximately 20% as well.

Our fantastic team not only embraced the growth emotionally they executed and delivered it which was the highest growth rate in their history. We also want to thank our partners at WaterSecure, a business that we own a 40% share in. They had an extraordinary year. Their income was up by 27% obviously aided by the price of oil and natural gas but it was also the result of their fantastic leadership and operational expertise. They know the business cold and they have built a solid operation.

Now let me talk about specific highlights from 2008 and then I will move to the fourth quarter.

2008 operating results were great on every measure. We couldn’t be more proud of the entire PowerSecure team. We point out that these were achieved despite a deteriorating economy that we saw deteriorate beginning about mid-year on through the fourth quarter.

Our revenues were a record $135 million. Our EPS was a solid $0.63. In 2008 we delivered 22% increase in our revenues over 2007 with a 1.4 percentage point year-over-year increase in gross margin and a 53% increase in total non-Publix revenues to a record $90 million. Our revenue growth was across the board including 22% growth in our energy and smart solutions segment that encompasses the interactive distributed generation, utility infrastructure and energy efficiency growth areas and we accomplished 20% in our energy services segment which is Southern Flow.

Again, I emphasize one more time record gross profit margin of 33.2%.

Now let me talk about our fourth quarter. As we expected and communicated all year long our fourth quarter was down versus the prior year quarter driven by the fact that the bulk of our Publix work was completed in the second and third quarters of this year. I would also like to point out that last year’s fourth quarter was a fantastic quarter being the second best quarter in the company’s history in revenue and the most profitable quarter in the company’s history. That being the fourth quarter of 2007.

The fourth quarter of 2008 revenues were $26.4 million compared to $36.9 million in the prior year and diluted earnings per share was $0.06 this year versus $0.48 in the prior year. Our revenues from Publix in the fourth quarter were $3.1 million, a decrease of $14 million or 82% decrease versus the prior year 2007. The entire reason for our revenue was down for the quarter year-over-year.

Excluding Publix our revenue were $23.2 million which was up $3.4 million or 17.3% over 2007. I would like to point out this is the fifth consecutive strong quarter-over-quarter growth in revenue increases from customers outside of Publix. The strong demonstration of our success in our growth strategy and the progress we are making in diversifying and broadening our revenue base.

In fact in the fourth quarter 88% of our revenue came from customers other than Publix, the highest level since the first quarter of 2006. Chris is going to provide additional details as he goes through the strategic growth areas in a minute.

We also couldn’t be more pleased with our gross margin for the quarter, 34.1%, the second highest quarterly gross margin in the company’s history although admittedly the highest was the fourth quarter of 2007. This quarter’s gross margin is even more impressive when you look at the fact that it was generated on $10 million less gross margin. As we have said a number of times we have certain elements of our gross margin that tend to be rather fixed so having a lower base in sales makes it even more impressive, the gross margin that we achieved.

The last item I would like to highlight and Chris will give more details on in a minute is our cost performance. As you recall, we took proactive steps during the middle of 2008 to reduce our costs and prepare ourselves for what we anticipated would be very difficult economic headwinds and our operating expenses reflect those actions. Total operating expenses were down $0.2 million versus the prior year and they are down $1.6 million for the Q or 16% as compared to the second quarter of 2008, right before we took the cost reduction actions.

Additionally, in early February of 2009, just a few weeks ago, we took additional steps to reduce our costs which we expect those steps to yield $5-6 million in savings during 2009 as compared to 2008. Those savings will be skewed over the last three quarters versus the first quarter just due to the timing of them.

Relative to the cost reductions we have taken in the month of February we don’t want you to be confused about those actions. We remain convinced that from a long-term perspective the capabilities we have developed and continue to invest in are the right ones and are as relevant as ever in today’s energy market and that the reductions we have made have not limited our ability to execute our growth plans. We have talked about the economic headwinds and we are not immune to the deep recession and capital market crisis that is affecting the economy. We are therefore very guarded about 2009.

The steps we have taken to help mitigate our concerns relative to cost reductions position us in light of our sales adequately. We are also looking at the actions we have taken and balancing those actions against our optimism for the long-term. It would be foolish to make short-term decisions that sacrifice long-term value creation. We have attempted to balance the economic conditions to date against the exciting possibilities of tomorrow.

With that being said we do anticipate taking some near-term earnings loss. What we saw from November through late February was that decision making from our customer base came to a virtual standstill as you could probably surmise based on our lack of announcements. Reflecting on this there is no question that the uncertainty in the credit markets drove a huge concern about cash flow this quarter and customers simply deferred making decisions. We weren’t losing business, they just weren’t making decisions.

Additionally, we believe that customers anticipating the economic stimulus package over the last really couple of months have held off making expenditures to see how they may benefit from such a package. We are encouraged that we have seen the spigot of order flow and decision making open up somewhat over the past few weeks. These orders that we announced just recently are $10 million reflecting that.

Additionally, the conditions we see relative to making decisions is more favorable than it has been in the last nine months. We are prayerful those conditions will start yielding decisions at a more frequent pace.

I want to add we don’t have a crystal ball and we remain very guarded about the near-term. As I am sure you could anticipate, the reality of the November through February decrease in the economy was that the lack of order flow of impact in our backlog which stands at $87 million as we effectively lost four months of decision making. Chris will detail in a minute this will impact our early 2009 revenues particularly in Q1 2009.

However, given the recent orders we have received we are optimistic our revenue will build after Q1 albeit at lower absolute levels than 2008 given the economic situation and we will go into that with our backlog assumptions.

Before turning it back to Christ let me summarize those five key messages I hit to begin with. First we had an outstanding year in 2008 emphasizing our record revenue and our operational excellence which allowed us to get to record gross profit margins. Second, our growth and diversification strategies are working as we talked about the 98 and 91% growth rates that we experienced in several of our business units and our 46% growth rate in our non-Publix and our 20% in our Southern Flow business. Third, that we are very adept at utilizing capital. Fourth, we are succeeding in expanding our utility relationships. Fifth, we are in the right place at the right time.

We are very, very bullish on the market in front of us. Once again, before I turn it to Chris let me thank our people for all the efforts they have put forth. The credit goes to them for our performance and our strong position. They bring a steadfast focus on our customers and serving them day in and day out. We appreciate it. They are our major differentiator and the biggest asset this company has.

With that I’ll turn it to Chris.

Chris Hutter

Thanks Sidney. As I usually do I will start with revenue and work my way down the financial statements. I am really going to focus on the fourth quarter and then along the way provide some discussion about how certain elements of our P&L, how we look for them to behave over the course of 2009.

I will start with revenue. Revenue for the quarter was $26.4 million. That was down $10.5 million or 28% versus last year. As Sidney discussed, the revenue decrease was considerably due to a reduction in Publix which we anticipated and I think have talked about literally all year long. So I am sure there is no surprise there.

Taking Publix out our revenue for all of our other customers was $23.2 million which was an increase of $3.4 million or 17% over last year. Our non-Publix customer base, as Sidney mentioned, represented 88% of our revenue which we couldn’t be more proud of. We are obviously very pleased with this performance and in the contribution of the entire PowerSecure team towards all of the hard work that went into broadening, diversifying our revenue base in such a really difficult economic climate.

I know most of you have been interested in what this quarter would look like and more specifically what life without Publix would look like and I think our results this quarter demonstrate and hopefully bring some clarity to the huge progress which has been made to built a growth platform for profitable growth beyond Publix. The last couple of quarters we have been publishing our revenue for all customers outside of Publix to really help investors see and have clarity and visibility into the progress of our growth and diversification efforts. Once again, I would encourage you to take a look at the chart in our earnings release right up front. We are really proud of those consistent results.

I also want to voice over the fact that the revenue increases you have seen all year long were delivered against a backdrop of really continuously deteriorating economic conditions which is a huge testament to the excellence and the execution of our team as well as the value of our products and services in the marketplace.

Now let me step through the specific revenue results for the fourth quarter in each of our strategic growth areas. First, as Sidney helped define earlier our energy and Smart Grid solutions segment which really encapsulates our interactive distributed generation revenue, our utility infrastructure revenue and our energy efficiency revenue and those strategic growth areas for that segment revenues were down 28.5% all-in but again that decrease was entirely driven by Publix. Excluding Publix our energy and Smart Grid solutions businesses were up 15%.

Here is how it breaks out. Interactive distributed generation which again is focused on a core market for Smart Grid enabled distributed generation technology was up 45% excluding Publix. We continue to expand our customer base and capabilities and really this is our bread and butter core business unit.

Utility infrastructure, the group that is focused on our opportunities to help our utility partners with their growing infrastructure needs and includes our utility services group, our Federal business, utility engineering and power services consulting teams, those revenues were down 21% versus the prior year and that was entirely driven by decreases in revenues from large utility infrastructure projects.

Our energy efficiency area, in this area our Efficient Lights business delivered very strong year-over-year growth and posted another quarter of almost $1 million in revenue. They were about $900,000 in revenue about equal to the third quarter versus really no revenue in the fourth quarter of last year. As we discussed on the last call given the opportunities we continue to see with our Efficient Lights product we have strategically moved resources away from our Energy Lights business in order to increase our focus and attention on Efficient Lights. This action resulted in a year-over-year decrease in Energy Light revenue that more than offset our Efficient Lights gains and resulted in an overall decrease in the revenue from this area of 11%.

But to be frank we are perfectly happy with that result because we believe the movement of resources to Efficient Lights will pay off very quickly.

In our Energy Services area which really is both our Southern Flow business and our WaterSecure business from a revenue standpoint is just our Southern Flow business because our WaterSecure business is accounted for using the equity method, we saw a strong 24% increase in our revenue from our Southern Flow company and had an outstanding 30% increase in operating income. Additionally, our WaterSecure business unit which holds our investment in the water processing business serving oil and natural gas producers in Colorado in which we account for using the equity method again, levered income of $0.6 million in our fourth quarter which was 38% lower than last year as expected. We did think it would be down due to the significant declines in the prices of oil and natural gas.

Of course we have been communicating all year long the fact that our WaterSecure profit is directly correlated with the price of oil and so again we honestly expected profits to be lower. I know you all did as well. We do expect it to be lower in the first quarter of 2009 as well which if you believe the futures markets we are hopeful is the low water mark but of course again we don’t have a crystal ball on oil prices.

In terms of the profitability of our revenues, we really couldn’t have asked for a better result. Our fourth quarter gross margins were a very strong 34.1% which was the second highest quarter of gross margin in our history as Sidney mentioned. The only optically unfortunate thing is that we have to compare against a really tough comp with last year’s gross margin being our all-time record. So this year-over-year was down. However, given the fact we got those elements in our cost of sales which are somewhat fixed like personnel and other operational infrastructure when you look at the 34.1% gross margin this year frankly it really is a more impressive result.

Again, I will also reiterate the point that we increased our gross margin sequentially throughout 2008. If you look at the first quarter to the second quarter to the third quarter and the fourth you will see sequential growth every single quarter. We just are extremely proud of that given the economic climate we all find ourselves in.

Our operating expenses again continued to be another bright spot and demonstrate really a core strength of our company as being able to do more with less and operate the business efficiently below the gross margin line as well as above it. Total operating expenses of $8.4 million were down $200,000 versus last year and down $1.6 million or 16% from the second quarter of 2008. Again that was the quarter that occurred right before we made our proactive reductions in the middle of the year.

Comparing our fourth quarter to our second quarter, which I think probably is the most helpful comparison to make in terms of our operating expenses about 40% of the savings is personnel related. About 40% is reduced commission expense really due to the reduced absolute levels of revenue and the remaining 20% of the savings is sprinkled through almost all the rest of our cost categories which is a direct result of our entire organization embracing the importance of working smarter. We definitely want to recognize those efforts and success.

There are many company cultures that would view narrowing their expense items as a budget. I can assure you as investors this organization does not have that mentality.

Additionally, as Sidney discussed we expect the cost reduction actions we took this quarter to yield we believe another $5-6 million in total in cost savings in total when we ultimately compare 2009 to 2008 and it will primarily be in the areas of personnel, overhead and incentive pay. I would just make a comment here that does include executive bonuses. Given the timing of these reductions which occurred in February most of the savings will be seen from our second through our fourth quarters of 2008 [sic].

Moving down to the fourth quarter bottom line, this fourth quarter’s bottom line all this adds up to deliver diluted EPS of $0.06 which frankly we feel very good about given the state of play with the economic environment and the capital markets crisis.

Now I want to move on to talk about our revenue backlog and as I usually do I want to try to really break it down and make sure everybody has got a lot of visibility into that.

$87 million is our total revenue backlog. $34 million of this backlog is what we call near-term project based backlog and it represents project based work we expect to be completed over the course of the next three quarters. I would point out this number isn’t that far off from $39 million near-term backlog number we had at the time of our last earnings release. Basically we had some longer term projects that moved forward and helped us from a near-term perspective and some of the projects we recently announced will be completed in the near-term window.

At this point our rough estimate with all the appropriate caveats about as you guys know revenues can certainly move around on us, but we believe that about 30% of that $34 million in near-term backlog will be completed in the first quarter of 2009. That will ramp up to 35% of that number in the second quarter and 35% in the third quarter which gives you the basic shape of our revenue over the course of the next several quarters.

As you would expect this means our revenue will start out lower in the first quarter driven by the fall off in order flow from November to February that Sidney discussed. Then as you can see from our backlog it does look to pick up after that.

$21 million of our total backlog of $87 million is for longer-term project based work and that work we anticipate will be recognized fairly evenly from the fourth quarter of 2009 through 2011. $32 million of the total backlog is for recurring revenue projects which we will recognize over a 7-10 year period on average with a majority of these projects being recognized through 2015.

So the $34 million in near-term project based backlog plus the $21 million in longer-term project based backlog plus the $32 million in recurring revenue is what totals your $87 million total revenue backlog. This figure compares to $97 million from the last quarter which again is a function of the fact that the last four months have just been soft in terms of order flow.

I would also reiterate what Sidney mentioned in his remarks that while we are very guarded about the near-term our most recent activity does give us some reason to have some optimism that we are starting to see orders flow again. While obviously this doesn’t impact the first quarter much we certainly still have selling time that impacts the second quarter and beyond.

Additionally we do have generators in inventory that can allow us to turn projects quickly and to the extent of our optimism on the up take in our Efficient Lights product plays out this product line in particular is one that has quick turns from order to project completion and therefore revenue recognition.

Just a couple of more thoughts here. I just want to remind everyone of a simple rule of thumb. A very simple way to estimate our total revenue is if you take our backlog, make assumptions about what additional project sales will occur between now and whatever period you are looking at and add somewhere between $6-8 million of revenue for the combination of drop in business and other recurring and regular sales…$6 million is obviously more conservative and $8 million is obviously less conservative. Also, remember when you are thinking about our gross margin in general higher levels of revenue will deliver higher levels of gross margins and just the opposite is true. Lower levels of revenue will deliver lower levels of gross margins. Again due to the fact we do have some fixed elements to our cost of sales.

Okay, turning to our balance sheet. We really couldn’t be more pleased with that and where we stand. Our team has been extremely diligent in managing our working capital to put us in such a terrific position and we just really couldn’t feel better about it.

Our cash balance as Sidney mentioned at the end of the fourth quarter was $24.3 million. That was up $16 million from our third quarter ending balance of $8 million which this $16 million of positive cash flow was really driven by two items, primarily the $10 million of positive working capital as a result of favorability in our accounts receivable and $6 million in capital leasing we put in place in December for some recurring revenue.

Our CapEx spend for the quarter was $2.2 million. $1.7 million of that was driven by capital for new PowerSecure owned recurring revenue projects that we completed during the quarter and of course again we finished the quarter with no outstanding on our $50 million revolver and we continue to be in an un-drawn position as we speak and our current cash balance remains at $24 million.

The fact that we sit today with almost the same cash balance as a year ago while funding $18 million in CapEx over the last year I think really illustrates the strong cash flow capability of the business and while on that topic as we look forward for 2009 we are assuming a capital budget, I hate to use the word budget, but we are projecting we are going to spend $20 million in capital for recurring revenue projects that we expect to earn in 2009. You will remember this time last year we said about the same thing. We thought it would be about $20 million and it was almost right at that number.

That $20 million for 2009 we expect to be invested fairly evenly over the course of the year. Net/net we remain in a very strong financial position. We are very pleased to be able to be in this position and act strategically, proactively and opportunistically with our capital pace and be able to play both defense and offense given the economic environment we all find ourselves in.

With that I will turn it back to the operator to start the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Rob Brown - Craig-Hallum Capital.

Rob Brown - Craig-Hallum Capital

I think you said gross margins declined with lower revenues. I just wanted to get a sense of the degree you are thinking of gross margin coming in. Is it going to come in at the high 20’s or can you give us some help on where that kind of comes in and how that flows throughout the year?

Chris Hutter

I want to be careful because again I don’t want to sort of break this line of giving specific guidance but what my suggestion is if you go back and look at history you will see that when revenues are sort of in that mid $20 million range the gross margins are going to be in the upper 20%, 28% or 29%. When you start getting into the 30’s then you start getting the 30% kind of gross margins. Obviously if you are south of mid-20’s you are going to lower your margins from there. So kind of think about that mid $20 million number gives you something in the mid to upper 20% margins, try closer up to upper 20%. I think that is a pretty good rule of thumb but history will probably show you a pretty good pattern on that.

Rob Brown - Craig-Hallum Capital

Maybe help us understand, your cost reduction efforts that you indicated are they primarily operating expenses, SG&A, or is there some cost of goods sold impact there?

Chris Hutter

What we gave you, that 5-6 is just the operating expense portion of the cost reduction actions we took. We did take some that do show up in the cost of sales area. We did reduce some expenses in cost of sales but that is really because we didn’t anticipate we would have the revenues to support it. As you are thinking about the model, think about gross margins and modeling that against your absolute levels of revenue. Don’t try to put too much science into saying okay they took cost out of cost of sales and modeling that too specifically. But the $5-6 million that is a pretty good number for thinking what our year-over-year operating expense behavior should look like.

Rob Brown - Craig-Hallum Capital

On Southern Flow, that has been a stable business. How do we think about that relative to oil prices sort of at a lower level? Should that sort of stay flat this year?

Chris Hutter

I would say in the near term we are obviously incredibly pleased with how they are growing. Near-term fluctuations in natural gas and oil prices really aren’t going to affect that business a lot. Over the longer term, [protracted] movement in oil and natural gas yes maybe you can get some movement there. But we feel pretty good about that business being pretty steady for us in 2009.

Operator

The next question comes from Eric Stine - Northland Securities.

Eric Stine - Northland Securities

Just a bookkeeping question here to get it out of the way. I guess I could back into this number but could you give us the Southern Flow revenue number and also the gross margins between PowerSecure and Southern Flow?

Chris Hutter

You want it for the quarter right?

Eric Stine - Northland Securities

Yes.

Chris Hutter

I’ll give you revenues and gross margins PowerSecure and Southern Flow. Fourth quarter PowerSecure revenues were $21.1 million. Fourth quarter of last year $32.7 million. Southern Flow fourth quarter this year $5.2 million. Fourth quarter last year $4.2 million. Gross profit PowerSecure this year $7.6 million. Fourth quarter last year $12.1 million. Southern Flow gross profit fourth quarter this year $1.4 million. Fourth quarter last year $1.1 million.

Eric Stine - Northland Securities

I just wanted to touch on, I know you talked about the impact of the stimulus and people kind of expecting that to come and kind of sitting on their hands. Can you talk about how the $10 million that you just announced, did that occur the majority of that after the stimulus was announced?

Sidney Hinton

No, it occurred really almost simultaneous. It was stuff that had cued up and finally sprung loose. We do perceive there is a thawing in the decision making process in general. None of it was a direct result of the stimulus package.

Eric Stine - Northland Securities

But it was kind of a case of…I’m just trying to get a sense if it was a case that people were waiting and then had some clarity about the stimulus and that kind of drilled the decision.

Sidney Hinton

I don’t think clarity on those particular projects on the stimulus really drove those decisions. Rather, I think more clarity just in general on the financial markets as people’s concerns eased up these were prime projects and they got released to be funded.

Eric Stine - Northland Securities

Turning to the recurring revenue side, I would assume in this environment it has been good to be able to have that conversation with customers. Any sense that is cannibalizing your project revenue at all?

Sidney Hinton

We are trying to keep a very keen eye on that mainly because the salesmen could influence that unintentionally. Our goal has always been to provide whatever solution that best fits the customer from the customer’s perspective. Just given natural resistance to capital decisions, an eager salesman could push a customer in that direction and we don’t want to cannibalize those project sales. We think customers will naturally fall into them. So we would rather be a little more patient and let a capital purchase decision, if that is what the customer was inclined to make, if we have to wait a month to get that we would rather wait to get that than the cannibalize a project sale and get additional recurring in today’s credit markets or capital markets.

Eric Stine - Northland Securities

In the Efficient Lights segment, the portion of the order you just announced can you give us a sense of how large or what percentage that 50 stores is?

Chris Hutter

Of the $10 million that is not a big part of that $10 million.

Sidney Hinton

Was your question though the 50 stores what potential that…

Eric Stine - Northland Securities

Of these stores without giving away too much, 50 stores out of how many hundred?

Sidney Hinton

Let us look that up right quick because I don’t want to give you the wrong chain so we will come back to that one.

Operator

The next question comes from William Bremer - Maxim Group.

William Bremer - Maxim Group

Let’s go over some housekeeping and then I’ll hit on the pilots for Efficient Lights. First and foremost, the $6-8 million reference in terms of drop in business, this is per quarter correct?

Chris Hutter

Correct. Just to be clear, that includes all of our…it is not just drop in. It includes our Southern Flow revenue, our other recurring, our monitoring revenue and so forth.

William Bremer - Maxim Group

So that includes Southern Flow and monitoring. What type of tax rate should we use for 2009?

Chris Hutter

Truth be told we still have a lot of NOL’s on the books but in the state tax area we have seen an increase. I think that the economic climate that we are in I don’t think there is any question that states are going to get more aggressive. In fact I think there was something passed in California very recently. So I would tweak it up a bit. Most people have probably been using something mid single digits. I think I would approach double digits to be honest with that. I don’t have, again, those numbers are incredibly complex and they do move around quarter-to-quarter but as a general sort of target I think something low double digits probably makes sense.

William Bremer - Maxim Group

Stock based comp for the fourth quarter?

Chris Hutter

Fourth quarter stock based comp…

Sidney Hinton

While Chris is looking that up just to go back and answer the last question relative to the percentage that 50 stores represented about 15% of the opportunity with that particular chain.

Chris Hutter

Stock based comp fourth quarter 2008 was $800,000.

William Bremer - Maxim Group

As I look at you referenced the $5-6 million taking out costs, when I look at G&A which is below the $7 million figure so I should look at sequentially Q1 and Q2 to be a continual lower rate going forward on the G&A expense?

Chris Hutter

Yes. We do think that the cost reduction actions we have taken and [inaudible] will give you a gradually reducing operating expenses in both the first and second quarters of the year.

William Bremer - Maxim Group

And to continue throughout 2009?

Chris Hutter

Correct. Then it will level off. Once we get to the second quarter we are always going to have fluctuations but we should be at more of a stable state.

William Bremer - Maxim Group

The WaterSecure, commodity prices really had a tremendous decline in the fourth quarter and that is what is representing that 460. As I look into sequentially in 2009 a little bit of stability in the oil and gas markets but more so in the oil. Gas is still having a rough time out there. Do you expect first quarter to be sequentially below that 460?

Chris Hutter

I do. I think WaterSecure profit will be less in this coming quarter. I think we are crossing our fingers that is really the low water mark. If oil does start behavior better, but that is anyone’s guess.

William Bremer - Maxim Group

Can you talk about the pilots on the Efficient Lights? How many are still out there and maybe give us a little color on how it is being perceived in the market place. I know we just landed one but thinking about the other nine.

Sidney Hinton

You are right. You validated, I was just going to confirm the numbers you just did which was 10 pilots. We are very bullish on the opportunities that are out there. We said before that is a couple hundred million dollar opportunity. If we win all 10 and did all the locations for all the chains. I will say there is not a reason one would look and think once a chain starts retrofitting their locations it is plausible and makes sense they would continue until they completed and entire chain. The difference is which areas they started with and so forth probably driven by combinations of marketing factors, i.e. it is a better quality light, and then the other side would be savings because the higher the cost of electricity the more savings relative to prioritizing. Those would be the two focuses. The lights have been very, very well received. We are very bullish on it. We definitely perceive that we are on the cusp of getting over that tipping point.

Operator

The next question comes from Rick Haas – Roth Capital Partners.

Analyst for Rick Haas – Roth Capital Partners

On Efficient Lights, what sort of margins do you get there if you can talk about that?

Sidney Hinton

I would say it is comparable to the core business. We had at one point hoped for a little better but with the capital markets being what they are it is just competitive so it is in that comparable to the core.

Analyst for Rick Haas – Roth Capital Partners

With the expanded line of credit you mentioned some of that can be used for strategic opportunities. Obviously this is one of the best times in a long time in terms of doing potential acquisitions. What are you seeing out there? How are you viewing that right now?

Sidney Hinton

What we look for on acquisitions is stuff that fits right into our strike zone. We are not looking to deviate to the left or the right. Only if it broadens something we are already doing, i.e. some type of play on a generator that would be something we would look at. Some type of play with a utility infrastructure where it is enhancing our resources we already have and we think it is a purchase price that is more attractive than just doing it organically. It is an interesting market from acquisitions but we are trying to be very disciplined with what we look at and we are not looking to start a new business line that launches outside of our core sweet spot.

Analyst for Rick Haas – Roth Capital Partners

From what you are saying it doesn’t sound as if you have a company or two that you have been talking to in the past but they have always had expectations that were probably much greater than what you were willing to pay but now in this environment all of a sudden maybe it makes more sense?

Sidney Hinton

We are always talking with people constantly because we are trying to stay abreast of what technologies are out there and what improvements people have made and what expectations of value are. There is nothing eminent that is material. The stuff we are looking at really does, if you look over our history like Efficient Lights, technology. When we bought the Switch Gear business back when we started back in 2001 it was technology. We think we have a keen understanding of what really works. Practical solutions. We are looking for those entrepreneurs that have the innovative ideas that we can then bring marketing to.

Analyst for Rick Haas – Roth Capital Partners

Do you think with the growth that you are expecting potentially Efficient Lights that is an area versus the DG side where you would like to build out in the future?

Sidney Hinton

Definitely. I would say that in terms of time spent looking at opportunities and exciting opportunities relative to technologies that area is rife with them. Candidly, this may sound poorly or reflect poorly on myself but we are much more experienced in the DG side so it takes us…we can almost instantly assess whether or not something is a fit and if it would really work. On the lighting side we have to take more time to assess that. We figure the economics out in a New York second but figuring this product how is it going to compare with other market opportunities we are still developing that competency so we try to be a little more guarded when we look at those. That area is very rife. The efficiency side is very rife with opportunities.

Operator

There are no additional questions at this time. I would now like to turn the call over to Mr. Chris Hutter for closing remarks. Sir you may proceed.

Chris Hutter

Great. I’m just going to turn it right to Sidney.

Sidney Hinton

Thanks Chris. In closing, let me just summarize. We couldn’t be more pleased with our 2008 results. We feel we are blessed to have the opportunity to serve our customers and our utilities well into the future and to continue to deliver results like these. We are succeeding in our growth and diversification strategies with our Smart Grid and energy efficiency businesses and we will continue to push forward with those efforts including the successes we are having in expanding our utility relationships.

We have demonstrated that we are very adept at utilizing capital and we are blessed to have a strong balance sheet with lots of dry powder in this uncertain environment. Although as everyone expects we think the near-term environment will continue to be difficult, we strongly believe that we built a foundation for long-term success and we are in the right place at the right time with strong long-term prospects for positive growth.

Of course, as you have heard us say many times our people are nothing less than outstanding and that in conjunction with our terrific utility partners, customers and vendors gives us huge confidence as we move forward. We want to thank all those constituents. We want to thank you as our investors and we want to thank our Board for the continued support we receive as we move into 2009.

Thanks all of you for your time and your interest. Good night.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: PowerSecure International, Inc. Q4 2008 Earnings Call Transcript
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