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PowerSecure International, Inc. (NYSE:POWR)

M&A Call - Solais Lighting, Inc. Acquisition

April 15, 2013 08:30 AM ET

Executives

John Bluth - SVP, IR

Sidney Hinton - President and CEO

Chris Hutter - EVP and CFO

Analysts

Eric Stine - Craig-Hallum

William Bremer - Maxim Group

Rob Brown - Lake Street Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the PowerSecure International conference call. My name is Annette and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions). As a reminder this call is being recorded for replay purposes.

I would now like to turn the call over to Mr. John Bluth, Senior Vice President of Investor Relations. Please proceed, sir.

John Bluth

Thank you very much Annette and thank you all for joining us today for our conference call to discuss PowerSecure’s acquisition of Solais Lighting. Joining me on the call from the PowerSecure management team are Sidney Hinton, our Chief Executive Officer; and Chris Hutter, our Chief Financial Officer.

Before we begin, I want to remind you that during the course of the discussion today we expect to make forward-looking statements under the Safe Harbor provisions of the Federal Securities laws. These are all statements other than historical facts, including statements concerning the future business, financial results, and outlook of the company as well as statements about the acquisition to be discussed on this call.

Forward-looking statements are based on the current expectations and beliefs of management, but are not guarantees of future performance or events and they are subject to risks, uncertainties and other factors, including those discussed in the company's SEC filings as well as on the call today and in the press release which could cause actual results to differ materially from those projected or implied. The company assumes no duty to update any forward-looking statements.

Now, I’d like to turn the call over to Sidney for some remarks and then we’ll open the call to Q&A.

Sidney Hinton

Thank you, John and thanks everybody for joining us today. We’re very excited to be here share with your our thoughts and the reasoning behind the Solais acquisition. We believe that this acquisition has potential to delivery extraordinary value to us and we see this acquisition as a game changer for our LED business and we’re very excited about it.

Solais has a proprietary portfolio of LED lamps and pictures for commercial industrial applications. Solais’ innovative designs provide their products with superior light output, strong energy efficiency, strong thermal management, optics and light quality and esthetics that used in high-end retailers. In addition to the outstanding products and lighting design and the expertise of lighting design, Solais has a leading approach to sourcing and manufacturing.

The financial benefits and accelerated time to market that we expect to achieve from this sourcing and manufacturing expertise were the primary value drivers in this transaction. I want to emphasize that. That’s the savings we will gain from our own products is the primary motivation to do this acquisition and please don’t interpret that as diminishing the value of the products that they develop. We think they are awesome and we think we will be able to sell those through our channel but I want to be clear particularly to our analysts who were on the call, that is significance savings in our of lights and catalysts.

In fact, as we were conducting our due diligence on the transaction, we had Solais, we sent them several of our products and have them tear those products down and cost those products for us through their sourcing and manufacturing system. The savings that they were able to achieve were substantial by applying their sourcing and manufacturing techniques.

Their manufacturing and sourcing would have added 10 percentage points to our gross margins in our energy efficiency business in 2012, taking them from roughly 30% to roughly 40%. With this acquisition we've immediately improved significantly in these areas and we look forward to applying that to create meaningful leverage from an EPS standpoint. Let me take one second before I continue on my prepared comments to elaborate on that 10 points of accretion.

We only processed a handful of products through this methodology just due to time constraints. The savings were so substantial on those products that we could justify the entire acquisition. We also used just the savings on those products to justify the 10 point accretion. There is no reason though that the preponderance of our products wouldn't see substantial savings as well and I only say that particularly for our analysts, the savings could be up to double that.

Now we realize that as the market goes on, double the 10 points, that as the market moves forward there'll be pricing pressure. So to be conservative we have not assumed any of the additional savings on the products but it's substantial.

We expect the acquisition to transition to be slightly accretive to revenues and EPS in 2013 and substantially accretive in subsequent years. In 2014 we expect the transaction to deliver additional $0.10 in EPS.

Before I continue let me just elaborate here. We have inventory of these products. They'll be sometime to, we have to get these products skewed up, we'll have to prioritize them to put them through the new sources while at the same time ending our prior sourcing. So it’ll take some time to feather in this transition but it is substantial, the impact it has for us.

Because of our historical manufacturing structure there were products that we wouldn’t or couldn’t have brought to market because the economics weren't good enough. And specifically we're working on a niche product, I've referred to it on the last call, the customer's given us very aggressive price targets, they seem very pleased with the solution we’ve developed, but this will help us… we were committed to going forward but it would have been very, very painful, it'll still be painful because of their pricing targets but this acquisition enables us to be able to do that.

And while we think will bring the overall gross margins of our LED business up to 40%, it doesn’t mean we’ll have it on individual products such as the one I just referenced. Some of those might be now as low as 20%. Other products could be up at 50%-60%. But this is a big enabler for us to be highly competitive and leverage our creativity that we have done so well of identifying niches and developing great solutions for.

Just as it did with the ESCO acquisition, PowerSecure’s financial strength and pristine balance sheet gave us the flexibility to structure a transaction relatively quickly and efficiently for shareholders. I will just say relatively quickly, certainly not as quick as the ESCO. That was something we had to do. We were working on this deal at that same time but still able to move quickly.

The $15 million transaction was $6.5 million in cash and the other $8.5 million in stock. You recall that in late 2011 and 2012, we repurchased 862,000 shares of our stock at an average price $5.71. Today we used 675,000 shares at an average price of $12.22.

The acquisition of Solaris’ further strengthens and compliments PowerSecure’s existing LED business through the addition of additional product lines and an expanded customer base, as well as adding the strong set of skills around product design, product commercialization, contract manufacturing and material sourcing. In addition, Solaris brings the Company’s strong capabilities in marketing LED lighting through distribution channels.

Having said all that, I want to go back and reiterate, I don’t want anybody to make a mistake. They are a great company, there are wonderful company, they would have been a great acquisitions but the reason we did the acquisition was because of their manufacturing and sourcing expertise. It’s meaningful to us, very meaningful.

As we discussed, when we made the ESCO acquisition, we now have the opportunity to drive higher margin DGP shaving (ph) and LED lighting solutions through our ESCO channel to enhance the value we bring to our ESCO customers. The addition of Solaris’ products and their manufacturing capabilities fits wonderfully with that ESCO channel.

In addition, in general, the acquisition offers us the opportunity to scale our LED business and capitalize on Solaris’ exceptional sourcing and manufacturing expertise. In addition to that, we are adding some strong leadership. We are blessed to have a lot of strong leadership in our LED business today with our efficient lights business, our energy light business, and our IES business, but we’ve been blessed to add to that strong team, with James Leahy, the CEO at Solais and a strong management team up under him, very capable group that includes Steve and Chris and George up there. We’re very delighted to him and his senior team, in fact his entire team.

Our LED business has been growing and profitable and we believe that we can do even better. The work we’ve already done with Solais on our existing products confirm this and we expect the combination of sourcing and manufacturing improvements along with new channels and expanded product offerings and design will allow us to drive even more value in our energy efficiency business.

Before opening it up for comments, one comment I anticipate you asking is what about synergies. From a sales standpoint or SG&A relative to potential reductions, there maybe but we’ve not modelled in any of them. The manufacturing sourcing savings were substantial enough to justify the acquisition. That’s all this in the numbers that we’re sharing today in the insides. The rest of any additional upside, that’s what it is, its upside along with any additional savings on the border products that we didn’t even cost out, just represents upside.

With that, we’ll open it up for comments.

Question-and-Answer Session

Operator

(Operator Instruction). Your first question comes from the line of Eric Stine from Craig-Hallum. Please proceed.

Eric Stine - Craig-Hallum Capital Group

Can you just walk through, I know a big focus of the call here is the manufacturing and sourcing of Solais, but can you just walk through how that differs from current business? I mean is it more their methodology, is it volumes, is it all of the above? Any details there would be very helpful?

Sidney Hinton

Methodology, the way we do our, 10% of our manufacturing we do in-house. The other 90% has been outsourced through a broker. That broker used their Asian connections. This process allows us to move upstream and remove that broker and not only that, but they have their own direct manufacturing, some exclusive manufacturing for Asia that just gives them tremendous capabilities along with resources actually based in Asia.

Eric Stine - Craig-Hallum Capital Group

And just want to confirm, you did say 2014 you expect EPS $0.10 accretion, was that right?

Sidney Hinton

We do.

Chris Hutter

That’s right.

Eric Stine - Craig-Hallum Capital Group

Okay and then, anything on revenues? I believe it said in your filing or in the release that those would come out over the next, well, that would come out at some point in the future. Just any details there on maybe the trailing 12 month revenues of this Company?

Sidney Hinton

Yes, here is the way to think about it. It’s sort of broad brush on how this would lay out is about $2 million of revenue per quarter is what we’re expecting for 2013. The Solais business has doubled about every year. We are assuming that same, in fact we’re assuming that it’s going to do a little more than double in 2014. So be about $13 million and change of revenue in 2014. Gross margins about 40% and then of course layered on top of that are the synergies that we expect to get within our core business.

From an EPS standpoint, that ought to shake out to be about a half a cent, may be a cent for 2013. It is going to take us a little bit of time to work those synergies through. My recommendation is, I really wouldn’t move your numbers on it. It could be that - it costs a fraction of a penny in the second quarter here, maybe a penny in the second quarter, it’s to push in the third and we make a penny and a half in the third quarter. But it’s really - when the magic really starts to happen is 2014. We’ve sort of built into it through 2013 as we worked the synergies through to cost of sales in our existing LED businesses.

Eric Stine - Craig-Hallum Capital Group

Maybe, could you talk about -- you referenced in this that this is additive to your customer base and also additive to the types of products. So, maybe start just with customers and end markets, talk about places this gets you that you hadn't been before and then, maybe just talk about how some of the products might be different than what you currently have?

Sidney Hinton

Thanks, we’re glad to do that. The customer base, they are high end retailers. And basically our traditional customers have been customers that had freezer cases, they are grocery stores or convenient stores or the drug store accounts and those were our customers both for distributor generation and for our LED solutions. There customer base are the high end retailers. And their lights, or the lights, if you walked in to a high end retailer, they use these lights for merchandising.

Their screw in lamps; they have super high light output, that's kind of the niche that they have carved out, high quality, high light output; that’s how made a name for themselves in the business starting out. Along with, they have the fixtures, what you or I might call track lighting, that's actually considered a fixture but if you were trying to get a mental picture, just picture a house in track lights; they don't make it them for houses, they make them for the high end retailers, I guess high end residential, but it’s not a regular residential product. But it’s all used for illuminating and merchandising on the floors. We are not in liberty to name their customers but you would recognize and everybody on the call would recognize their customers. You could probably name 15 or 20 there I would go oh, oh, oh, I mean they are just big brand names.

Eric Stine - Craig-Hallum Capital Group

Okay and then when you talk retailers, these might be some of the same people that you would be selling to for your DG business?

Sidney Hinton

We never traditionally marketed to these customers and we are hopeful that they will open up that opportunity.

Eric Stine - Craig-Hallum Capital Group

Okay just one last question from me and then I will…

Sidney Hinton

And we have not assumed any of those synergies Eric. In other words any synergies we get through the sales side of our channels for their solutions and we definitely think, particularly like produce that we will be able to use their track lighting. Some of their technology looks like they will transfer over great for us, but we haven't assumed that. We are just…

Eric Stine - Craig-Hallum Capital Group

Yes. Okay now that's great. I appreciate the color there. Does this company have a backlog at all or anything you can discuss backlog, or pipeline in that just for me?

Chris Hutter

No Eric it’s really it’s like our other businesses. Our LED business it’s really not backlog business. It’s a turns business but again that's where our assumption of $2 million a quarter of revenue comes for. That's been the run rate.

Sidney Hinton

Eric one thing that I would just point out just to go back when Chris was talking about their business doubling and made the statement, we are assuming a little more than double. The only reason that it is, is actually not more than double; we didn't own it for the first three months of the year. If we did, if you annualize that they would be at $8 million, that’s actually slightly less than doubling, from their perspective. From ours it’s slightly more versus 12 months versus nine months, ‘13 versus ’14.

Operator

The next question comes from the line of William Bremer from the Maxim Group, please proceed.

William Bremer - Maxim Group

Now bringing ESCO as well as Solaris into the mix here year, what's your take on how much capacity you have in this field right now?

Sidney Hinton

Could you describe what do you mean by capacity, manufacturing capacity, management capacity?

William Bremer - Maxim Group

No-no, that was my second question. Their management team is quite extensive but first and foremost that their manufacturing capacity. What is your capacity on the manufacturing front at this time, bringing this acquisition into the mix?

Sidney Hinton

I literally think, this is off the table -- it was off the table as a bottleneck in any way, a tremendous manufacturing capacity. Now what we will have as a capacity issue to transition. Now where there is a finite amount of resources and bandwidth to make the transition of our existing products in the manufacturing sources of those and to consume the inventory that we have before transitioning it over. That’s more and we are estimating that’s a three to nine month transition cycle. Obviously we’re going to transition the highest volume products as fast as we can, use up our inventory and move onto the new ones but and candidly we’re going to use this manufacturing as a driver for some of our niche solutions to enable us to meet the aggressive cost or price hurdles that customers have laid out. And the customers aren’t being tough, that’s just a hurdles it takes to justify the retrofit, to move from traditional lighting to LED. So hopefully that answers your capacity question.

William Bremer - Maxim Group

Little bit yes. Does the whole management team come over to PowerSecure and what’s the take there?

Sidney Hinton

They do and I would rate them an A plus, We are blessed, we already have amazing talent in our LED business relative to the design capabilities, the sales capabilities, as demonstrated by our ability to go from scratch to find in these niches to penetrating the niches but this group brings an equally great management team and their competencies are more in the manufacturing, the design as well, everybody, you got to be good in design or you can’t be in the LED business. They are very good there and very good from a management standpoint. We are very excited about it and we thought to say great acquisition from a talent standpoint as well.

William Bremer - Maxim Group

Especially with their high-end customers, you are absolutely right. My final question, can you give us a little take on the fact that with their high-end customers, that they do have, I'm assuming a lot of them may be long-term relationships. Can you give us a sense, have you been able to look at their contracts and how long do they go out on some of these high-end customers?

Sidney Hinton

These customers, they go through distributors, they are pretty much order to order. It’s just the way that they built their businesses, to make the sure the business; you do a few stores with them and you just keep winning the business and winning the business, it’s not really a backlog type.

William Bremer - Maxim Group

And finally, was this is a company that was for auction, or did you, how did you come about finding it?

Sidney Hinton

We were blessed, we did have help from an investment bank that came in. Candidly we were looking at accessing our own business, trying to understand what’s the value of what we have, how do we maximize that value and to be perfectly honest, at the end of those conversations say we’re going to double down this business, we’re going to find the brightest talent we can find in this entire industry and the banker made a passing comment, really as we were finishing leaving, that’s easy who that is, that’s James Leahy at Solais. So he made the introduction and we chased it down.

Operator

(Operator Instructions) The next question comes from Rob Brown from Lake Street Capital Markets. Please proceed.

Rob Brown - Lake Street Capital Markets

I wondering if you can give us sense on what’s kind of the penetration rate that these guys have achieved in the high-end retailer market. Is that market still pretty nascent?

Sidney Hinton

Yes very much so. In fact I went on a tour with James, just visited multiple locations of New York City, just walking streets, walking into these major retailers and very much to say, it is in the earlier innings. Definitely a lot has taken place but there is a tremendous amount left to do. Hopefully that’s helpful Rob.

Rob Brown - Lake Street Capital Markets

Yes, I think gives a sense. And then I’m just trying to understand maybe, are there marketing synergies here or they all in the manufacturing side? I guess will there be marketing synergy?

Sidney Hinton

We anticipate there will be but we’ve modeled zero in. The only thing we’ve modeled it literally, I emphasize this again, we only modeled in the specific products that we chose and literally it was less than five products and there is nothing unique about those products that would say the savings we gained off them wouldn’t transfer to the other products but we didn’t make that assumption.

The marketing synergies that we think will be there but that we didn’t’ assume in, we’re almost certain that some of their design, if not the exact light the core design they have behind their light and some of the technology that they’re out filings for patents would be useful in our grocery store markets, any place you use track lighting, such as produce any type of specialty areas inside of grocery stores, we perceive that as an opportunity but we haven’t presumed it in our financial modeling.

Chris Hutter

Hey Rob two more thoughts there. One is the, we’ve always felt direct and we have not spent a lot of time working and developing distributor relationships. It’s something that they've got a core competency of as well. So we think there could be some nice upside there as well. Again not necessarily immediate but there could be some opportunity on the marketing side from that standpoint too.

Sidney Hinton

One thing I would add Rob, is that these people are all lighting people and you've heard me say it before, we're not, we're energy efficiency people and that when we went and acquired, when we started efficiency lights, they're experts in the grocery market, they learned the lighting, they're controls experts. They learned light, did a great job. It's wonderful.

And our IES acquisition, they had learned a lot about lighting and they’ve learned a lot about drivers but they weren't lighting the experts, that wasn't their core DNA. This whole team, their Chief Technology Officer's PhD guy in lighting; their head design guy Master's in lighting; James, an entire career in lighting; George, the guy who heads up their marketing, all lighting. It'll be a nice addition.

I know they're looking forward to the commercial knowledge that our guys have, that we excel at, which is applying this technology to niches. But by the same standpoint they're going to be very accretive to us just from an overall knowledge of lighting, the nuances of lighting industry and so forth. It's a synergy that we haven't modeled in, but that we see great potential for.

Chris Hutter

And Rob, the second thing, just in terms, it really runs through the idea that of course the ESCO business we bought a month ago, that's a brand new lighting channel for us as well. And so again down the road, the opportunity to be able to bring additional lighting fixtures through that channel as well represents opportunity.

Sidney Hinton

Thank you Chris, because this weekend I spent talking with someone out of our ESCO business, just trying to understand what type cost points we would have to achieve to be able to deliver particularly the florescent tube type replacement. And when they told me the price points we'd have to be at, based on a similar product we've already put through the channel, it's very difficult to believe we can't be there. It's very, very encouraging and that can be big upside for us because of the volume of light solutions, that they use traditional lighting today because of the price points of LEDs. The volume of that opportunity could be very significant for us.

We definitely foresee this. This acquisition is a game changer for us in LED. If we weren’t in the LED business, this might not have been the platform we built the firm from zero because their customer base is not an exact match with ours. The base we built from Efficient Lights was the right base to build from. The addition of the IES in terms of moving us forward on the driver side is the right addition.

This is the right addition at this time and we definitely believe that’s a game changer for us, just because of their ability to increase the pace, that we can go from product prototype which we have done a great job of winning big customer’s perhaps with the prototype solutions, but taking that from prototype to a manufacturable to manufactured at really attractive cost points, it’s big for us.

Chris Hutter

Rob, I’m going to let you ask another question if you have one but I don’t want to forget a point which is when we talked about the modest accretion in 2013 and then really the significant accretion in 2014, we are factoring in the additional shares, the dilution on that as well. So, its net accretive. I should have said that before but I want to make sure everybody understood that point.

Rob Brown - Lake Street Capital Markets

Okay. Good. Okay good. And then you also mentioned there were some patents you are working on or have? To what degree is this stuff you're acquiring patent protected and is that part of it as well?

Sidney Hinton

They do have some patents and they filed for some additional patents. Some of them could be intriguing but we have assigned zero value in the acquisition to those and don’t hear as we won’t be trying to protect them and leverage them but it wasn’t a cornerstone. Its upside, much like I have talked about the other products outside that we didn’t cost out is upside for us. Hopefully that’s helpful in answering the question.

Rob Brown - Lake Street Capital Markets

Okay great and then the last question on the shares and purchase price. Is there any of this that's in earn-out? Are there collars or anything? What are the terms on the purchase price?

Chris Hutter

No it’s just very straight forward. The shares, there is no earn out on the backside. We will certainly put an incentive plan in place across our LED lighting business to incentivize the achievement of both the numbers that we have shared today but also the synergies that we expect, particularly in the cost of sales but it’s very straight forward $6.5 million of cash 675,000 shares of stock.

Sidney Hinton

And Rob we will also be sending our other business units to embrace the manufacturing cost reduction through incentive as well.

Operator

Sir we have no further questions. I would now like to turn the call over to Mr. Sidney Hinton for any closing remarks.

Sidney Hinton

Well thanks to all of you’ll for seeing the notice this morning and jumping on the call to hear us talk about it. My key message would be, we are very excited about this acquisition, view it very much as a game changer. We have been working on it for a few months now and very excited to have James in his team, join us, very excited about the team we already have and the foundation that they’ve built for us to be able to bring this leverage to and we’re looking forward to bringing it all way to bottom line.

And the next time you see an investor presentation from us, when you look at those bar charts, you’re going to see that energy efficiency division is now a very material bar on that chart, that we moved it as of now from $25 million last year, that with the combined of this you are looking at somewhere between $60 million and $70 million in that division, which gets it up on scale with our other divisions.

I appreciate your support and interest and we look forward to delivering the results.

Operator

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

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