Lime Energy (NASDAQ:LIME)
2012 Earnings Call
July 31, 2013 4:30 pm ET
John E. O'Rourke - Chief Executive Officer, President and Director
Jeffrey R. Mistarz - Chief Financial Officer, Chief Accounting Officer, Executive Vice President, Treasurer and Secretary
Good day, ladies and gentlemen, and welcome to Lime Energy Company 2012 Financial Filings and Company Update Call. My name is Carla, and I'll be your operator for today. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Glen Akselrod, spokesperson. Please proceed.
Thank you, Carla. And good afternoon and thank you, everybody, for taking the time to join Lime Energy 2012 financial results conference call. With us today is John O'Rourke, CEO; and Jeff Mistarz, CFO. I hope all of you had a chance to review the earnings announcement released earlier today, which can be accessed on Lime's website at www.lime-energy.com, or for the 10-K on the SEC website.
Before I hand the discussion over to John, I want remind everyone that call today will include some statements that will be considered forward-looking regarding the company strategy, operations and financial performance. Those statements are subject to many uncertainties in the company's operations and business environment, some of which we'll talk about on the call. I also refer you to the complete forward-looking statement disclosure in the earnings release, which is incorporated by reference for purposes of this call. I'd also like to refer you to the disclosures made in the company's quarterly and annual filings with the SEC.
Finally, before we get started I want to mention this call is being broadcast live over the Internet and can be accessed on Lime Energy website and also on the Thomson/CCBN Network. There will be a replay available on either website until October 31, 2013.
With that, I'll hand the discussion over to John.
John E. O'Rourke
Thank you, Glen. Thank you and good afternoon, everyone. It's been a while. I will begin by conveying our sincere thanks to investors, employees and supply chain partners as well as to our utility clients for their patience and continued commitment to our partnerships throughout the special committee investigation and restatement process.
Lime Energy has turned a corner today. The restatement of our fiscal year 2008 through 2011 and first quarter 2012 financials, marks the end of a thorough internal investigation and reaudit of our financials. It represents the culmination of careful evaluation of our internal controls, policies and procedures. During the investigative and restatement process, we identified material weaknesses in 3 areas: control environment, regional business operations and accounting, and method and procedural deficiencies in the timing of revenue recognition. Jeff will elaborate more on this during his remarks.
We have implemented numerous remediation steps to improve our internal financial controls and oversight. We are beginning the process of strengthening our board. And we will continue to add depths and new capabilities to our finance organization and senior management team. In addition, we have begun an extensive business improvement process focused on financial, operational and day-to-day business performance visibility. Given the extent and thoroughness of our evaluation over the last year, we are pleased to once again, turn our focus, energy and all of our efforts to the future performance of the business.
Following the divestiture of the ESCO business to PowerSecure, we have taken a deep dive into our business over the last 5 months. We've spoken with our employees, met with our entire supply chain partner network and consulted with our key clients. We have examined our challenges and evaluated our greatest opportunities in order to fully understand our future growth prospects and restore confidence to all of our stakeholders.
As a result of this continuing process, we have begun to take the necessary and critical steps to get the company on the right track and position it for gross margin expansion later this year, without buckling the foundation on which the business was built or compromising the value of the enterprise.
First and foremost, our employees are still with us and striving collectively to push the company forward. Our major suppliers have stuck with us through the entire process. And our clients continue to work with us and in some cases, expand their existing engagements. We had 8 utility program clients coming into this process. We now have 9. This speaks volumes to the strength of the business solution we provide and the continuing confidence of all of our stakeholders in the future.
Following the internal review process, we have focused the company's efforts on one business line: the administration and implementation of utility energy efficiency programs for small to midsized commercial and industrial customers. All of our talent and resources are now directed to this offering, which competes in the $6.9 billion rate-payer funded energy efficiency market. I will address the details of our offerings and the market opportunity in just a few moments.
In the past, Lime Energy was an energy solutions company pointed at large commercial and industrial and public sector markets. In the C&I business, we were regionally deployed in key geographic regions selling a return on investment solution directly to the commercial and industrial customer. It was predominantly engaged in upgrading old and inefficient lighting with new, more efficient lighting. It was open competition on a customer-by-customer basis with an average utility incentive of 30% of the solution cost. The combination of the split incentive between building owners and tenants, the economic downturn in 2008, a significant increase in competition due to the slowdown in general construction and an overall lack of available practical project finance vehicles caused us to conclude that the market growth opportunity, as originally envisioned, was not sustainable.
Our ESCO business was pointed at the public sector or MUSH market, from the vantage point of serving the ESCO community who predominantly develop, sell and finance energy solutions projects into these markets. This business was primarily an engineering and construction group built to serve the ESCO community in these larger public projects. Despite the announcements of the need to restate our financial restatements, we won $30 million of new contract awards last fall. However, during the same time, we lost the confidence of our project surety partners due to the continued delays in restating our financials. This resulted in collateral demands that were not feasible, given the financial condition of the company at that time. Without the ability to bond these new projects, we were sure to lose them. We therefore concluded that the combination of a low growth horizon, our position in the market supply chain and continued uncertainty as to the timing of the restatements supported a quick divestiture to try to realize the value of this business before it completely evaporated. We were successful in closing the sale on what we believed to be fairly favorable terms earlier this year.
In 2009, we began providing energy efficiency programs directly to utilities, leveraging the legacy experience of the commercial to C&I business and Public Sector business in sales, marketing, engineering and implementation. This diversity of in-house capabilities allowed Lime's utility business to develop unique integrated business solutions at a time when utilities were facing increasing regulatory pressure to deliver energy efficiency. We developed and harnessed the intellectual capital of our team's 20-year, 5 years of selling energy efficiency to commercial customers, along with the associated historical energy and cost data, into a powerful technology platform that enables the cost-effective acquisition of energy efficiency for utilities at scale in their hard-to-reach markets. In particular, we focused on their small business customers.
Today, this is our only business. It is focused, timely, easy to understand and easy to measure. It also plays to Lime's competitive strengths in the market. Unlike our former C&I business where we acted principally as a subcontractor, we now sell energy efficiency to utilities. And under these utility programs, we have exclusive territories, compelling incentives, and our current utility contracts average 3 years in duration. Unlike our former Public Sector business, we are at the top of the food chain and interact everyday with our utility clients, including some of the nation's largest electric utilities. Today, we are the leading direct install firm as measured by consistency in delivering on program savings goal commitments. And earlier this year, we received the prestigious Super Nova Star of Energy Efficiency Award from the Alliance to Save Energy in recognition of our innovative solutions and our contribution to utility energy efficiency.
The current $6.9 billion rate-payer funded energy efficiency market is comprised of programs promoting energy efficiency, load management, demand response and evaluation, measurement and verification. This market is forecasted to grow to between $9.5 billion and $14.3 billion by 2025. Our research into this segment indicates that current spending on direct install programs for small to mid-sized commercial customers is approximately 5% of all U.S. energy efficiency programs. Given the increasing emphasis on targeting these customers for energy efficiency resource acquisition and the associated benefits of customer engagement for our utility clients, we believe that this market could grow to 10% of all customer-funded spending by 2020.
As utilities look to utilize the direct install delivery model for other customer segments, and Lime Energy continues to add services to our utility offerings, we believe that we will increase our market opportunity across the customer-funded energy efficiency market. We plan to achieve this growth in both market and market share by deploying -- developing and deploying direct install programs in states that are driving energy efficiency programs and regulations; expanding existing programs into new territories with affiliates of existing utility clients; and expanding the product and service sets within existing programs and new program opportunities.
Now having said all of this, it is important to understand that given the experience of the past year, we are still a work in progress. We are faced with several difficult and important challenges that will require comprehensive and aggressive measures to overcome. Our margin profile has much room for improvements off of 2012 levels. Our balance sheet needs work. Our SG&A cost, as a percent of revenue is still too high. And our technology and IT infrastructure needs further investment and development.
In order to tackle these challenges head on, we have recently moved quickly to launch the focused set of initiatives that encompass cost reduction, organizational design, procurement, training and technology improvement. We are expanding our executive and finance team, relocating key personnel into our North Carolina headquarters with the intention of keeping a sustained focus on managing and executing these initiatives.
In March of this year, we began a detailed process mapping exercise of all functions inside the company. The objective being to establish a common understanding of the business for employees of every level in our organization. This generated an informed review of where the business was, how it was performing and highlighted immediate areas for improvement. We have centralized our procurement process, reorganized our operating and corporate service groups, launched an intensive employee training program and bolstered our technology platform to provide targeted lead generation sales and implementation data that provides accurate and near real time operational data that vastly improves visibility onto the business for everyone. Over time, we expect that these initiatives will move the gross margin needle.
With that, I will summarize my thoughts at the end of the presentation and hand it over to Jeff Mistarz, our CFO.
Jeffrey R. Mistarz
Good afternoon, everyone. Thanks for joining us this afternoon for this earnings call. This past year has been a difficult one for Lime Energy, our employees, our stockholders, and we appreciate everyone that has stuck with us through these difficult times.
I will start the over -- the financial overview by providing some additional information regarding the restatement process. As we stated in our earnings press release, based on an internal review of certain accounts and transactions, on July 13 of last year, I determined that revenue in our utility division had been misreported and informed John. Immediately upon coming to this conclusion, we contacted our outside securities counsel and the head of our audit committee. I won't repeat the time line that's presented in our press release, but suffice to say, this was the start of an intensive review of tens of thousands of transactions and many more e-mails. As part of this, we discovered that the issue was not isolated to our utility division.
Let me provide some background on the nature of the problems we found. Under a percentage of completion accounting, revenue was recognized based on the costs incurred relative to the total expected cost to complete a project. So for example, if 50% of the expected costs have been incurred, 50% of the revenue will be recognized. Our investigation found that costs were being recognized earlier than appropriate for the purpose of accelerating revenue recognition, and other revenue was recognized that was fictitious. As a result of our investigation and at the recommendation of the audit committee, we terminated 7 employees that we determined were colluding in various aspects of the misreporting of revenue.
To determine the proper timing of costs, with the assistance of an outside forensic accounting firm and investigating attorneys, we reviewed all significant transactions recorded during the restatement period to determine if the costs, in fact, had been incurred and if so, when. This was a tedious and time-consuming process involving the review of more than 36,000 documents and hundreds of thousands of e-mails. Once we had determined the proper timing for a project-related cost, we recalculated our revenue and related balance sheet accounts for the 17 quarterly periods from January 2008 through March 2012.
The result of all this work was the identification of $14.2 million of revenue that was reversed because it was not supported by valid customer contracts and is never expected to be realized. Adjustments to correct the timing of valid revenue that was recognized earlier than appropriate, resulted in a reduction of $301,000 of 2008 revenue, $5 million of 2010 revenue, $12.4 million of 2011 revenue and $20.7 million of 2011 revenue. Approximately $7.6 million of this revenue was pushed into the first quarter of 2012, increasing the revenue in that period. About $16.1 million more was recognized during the final 9 months of 2012. As of the end of December 2012, we still had about $0.5 million of revenue that had previously been accelerated to recognize, which we expect to be recognized in 2013. The cumulative earnings impact through March 2012 was approximately $9.6 million or about 7% of our previously reported accumulated deficit through the first quarter of 2012. About half of this will be recovered in period after March 2012 as the delayed revenue is recognized.
To reduce the risk of this ever happening again, we implemented a number of changes to our internal controls, and we plan to continue to review and improve our controls where we feel necessary. It has been a long, and painful and expensive process, but we believe we promptly took all the appropriate steps necessary to ensure the integrity of our accounting process in the future.
Today, we will be filing 2 documents with the SEC: our quarterly report on Form 10-Q for the period ended September 30, 2012 and our annual report on Form 10-K for the 12-month period ended December 31, 2012. The 10-Q is somewhat of a super 10-Q in that it contains the restated financials for the first quarter of 2012, as well as the statements we would normally include in our second and third quarter reports. This includes restated financials for the periods ended March 31, 2011, June 30, 2011, September 30, 2011, and March 31, 2012. And the notes contain comparisons of the restated financials to the financials as they were originally filed. The 10-K contains financial statements for the 12-month period ended December 31, 2012 and restated financials for the 12-month period ended December 31, 2011. Note 2 comparisons that contains -- comparisons of the restated income statement, balance sheets and cash flow statements for the years ended 2008, 2009, 2010 and 2011 to these statements as they were originally filed.
There's a lot covered in these documents, but in the interest of time, I will only provide color to the 2012 results. I will start with explaining what is continuing and discontinued operations. Our discontinued operations includes the Public Sector business, the majority of which was sold to PowerSecure in February 2013, and Lime Energy Asset Development. John has already explained the events that led up to the decision to sell the ESCO business, which made up the majority of our Public Sector business. There are a few public sector contracts that we did not transfer because they were nearly complete, though it can take months to get final sign off and close out some of these larger projects. We expect that these should all be closed out before the end of 2013.
With the sale of the Public Sector business, having an asset development business was no longer strategically important to us. So after 2 years of trying to get traction in this business, we decided to shut it down at the end of 2012. There was strong interest in the services that this business was offering, but we found it very difficult to secure financing for projects that they were working to develop.
Activities included in continuing operations are our utility business, activities related to the -- our contract with the U.S. Army Corps of Engineers under their facilities repair and renewal program; our HVAC service business located in Bethlehem, Pennsylvania; and GES-Port Charlotte, which owns the Zemel Road landfill-gas to electricity plant we own in Punta Gorda, Florida. Of these 3 businesses that remain, the utility business is expected to generate almost 90% of our 2013 revenue and to be the source of our future growth. The FRR contract is winding down. And with the uncertainty regarding our ability to obtain surety bonds for this business without posting significant collateral, we may not be able to bid on contracts under this program in the future, in which case once we've completed our existing contracts, this business will be shut down or divested as appropriate. Our service business is small, only about $1 million to $2 million in revenue and is expected to remain small. I'll discuss our plans for the landfill plant in a few moments.
The following discussion of the 2012 results will only cover the results for our continuing operations. Revenue from our continuing operations increased $1.5 million or 3.5% to $43.4 million during 2012. Contributing to this increase was higher revenue from my utility business, which saw its revenue increase about $5.7 million or 19%, and a $622,000 increase in revenue from GES-Port Charlotte, which completed its first full year of operation in 2012. This was partially offset by lower revenue derived from the FRR contract. Revenue under the FRR contract varies depending on how many projects we're working on and the phase of the project. We had fewer active projects in 2012 than we did in 2011, and these projects were either wrapping up or in the design phase for much of the year, which contributed to the lower revenue from this business.
The utility business benefited from a full year of contributions from our program with Long Island Power and the start-up of Central Hudson and NSTAR programs. But this was partially offset by lower revenue from our National Grid program. Most of our utility contracts have annual goals. During 2011, we met our goal for National Grid by early fall and were given additional goal to make up for other under performing territories being run by other companies.
During 2012, we again met our goal by early fall but did not receive as much additional goal for the year, contributing to the decline in revenue for this program over the prior year. Our New Jersey Direct program delivered consistent results in 2012 and is expected to be a material portion of our 2013 revenue. Increased revenue contributions from Central Hudson and NSTAR, and contribution -- in combination with contributions from our new AEP Ohio and Duke Energy Progress contracts and to a lesser extent, PSE&G and energy in Efficiency Maine contracts are all expected to contribute to higher revenue for the utility business in 2013.
Our consolidated gross profit increased $1.2 million or 17.7% to $7.9 million from $6.7 million earned in 2011. Our gross profit margin improved from 16% in 2011 to 18.2% in 2012. Increase in the gross margin was the result of the reduction in the portion of total consolidated revenue generated by the lower margin FRR program, combined with an increase in gross margin earned by the utility business, which benefited from improvements in operating efficiencies and increased contributions from some of our new contracts, which have higher associated margins.
Our SG&A expense increased $9.6 million or 66.1% to $24.2 million during 2012 from $14.6 million during the year-earlier period. SG&A as a percentage of revenue increased from 34.8% in '11 to 55.9% in 2012. Costs related to the restatement and related stockholder lawsuits contributed $2.8 million to the 2012 increase in SG&A. The balance of the increase in SG&A was due to the start-up of new utility programs and the annualization of costs associated with programs started in 2011.
As we entered 2012, we were operating under 3 utility programs: National Grid, which started in late 2009; New Jersey Direct, which started in the spring of 2010; and Long Island Power, which began operation during the fourth quarter of 2011. During 2012, we started up or were in the process of starting up: Central Hudson, NSTAR, AEP Ohio, Duke Energy Progress, PSE&G and Efficiency Maine. When we start up a new program, we incur several months of expenses before we start to generate any revenue as we open an office in the territory, hire a program manager and staff, train the staff, prepare our marketing plan and materials and start calling on customers. It usually takes 3 to 6 months before our program's revenue reaches the level necessary to generate a profit. During 2012, we had 6 programs in various stages of start-up, contributing to the SG&A as a percentage of revenue. We expect the SG&A as a percentage of revenue to decline in 2013 as revenue from new programs ramp up.
During 2012, we incurred impairment charges related to the Zemel Road landfill-gas to electricity facility in the Public Sector business totaling $6.7 million. During the fourth quarter, we updated our projections for the Zemel Road facility based on the first year of operating results and expect -- expectations regarding planned improvements to the gas collection system. The discounted expected future cash flows for the facility indicated that the current carrying value of asset exceeded its estimated fair value by about $3.5 million.
Also utilizing the price we received from the sale of the ESCO business in February 2013 as an indicator of its fair value, we each determined that the carrying value of assets associated with the business were impaired. In adjusting the carrying value to the fair value, we incurred a $3.2 million impairment charge during the fourth quarter of 2012, which is included in a loss from discontinued operations.
Turning our focus to liquidity. We ended the year with about $2.4 million unrestricted cash, and we received $1.8 million on the sale of the ESCO business in February 2013. This cash has carried us to the end of July and we believe that as new utility programs ramp up, we'll start to generate positive cash flow during the second half of the year. We continue to monitor our cash position closely. And we are prepared to take actions required to, but hope that our current cash balances will be sufficient to carry us to the point that the business turns cash flow positive.
Due to the significant loss we incurred last year and the cash we consumed in 2012, our auditors have modified their opinion to an express or concern about our ability to continue as a going concern. Steps we have taken to address this include shutting down the asset development business, selling the ESCO business and significantly reducing the remaining headcount. Almost all of our resources are now focused on building out our utility business, which is a business with good growth prospects and which we are a market leader. This business is also much less capital intensive than our former Public Sector business. We've experienced a marked improvement in our cash flow as we began to improve or implement this strategy and expect continued improvements as many utility programs start to achieve profitability and restatment related cost decline.
A couple of issues that I feel I should touch on include the SEC investigation and the situation with GES-Port Charlotte. The SEC has opened an investigation in connection with the restatement. And on September 11, 2012, it issued a subpoena for documents. We have been cooperating with the SEC staff and have a meeting scheduled for the middle of August to review the results of our internal investigation. It is our hope that when they see the depth and quality of the investigation, they will not feel the need to duplicate our work, which should help to expedite their investigation.
As for the GES-Port Charlotte, earlier last year, the gas flow rates at the Zemel Road landfill-gas to liquidity facility began to deteriorate, in part due to an underground fire in the well field. The well field is owned and maintained by Charlotte County. Whereas from the start-up in October 2011 until early spring 2012, the facility was receiving sufficient gas flow to run both generators at capacity. After the fire, it was only receiving sufficient gas load to run both -- After the fires, it was only receiving gas flow to operate at about 60% of capacity. There have been attempts made to correct this issue with the well field, but none were effective in improving the gas flow at any significant degree. earlier this year, the county solicited bids to expand the well field and implement other improvements, which would have increased the gas flow to levels once again, sufficient to operate both generators at capacity. But the county was not able to secure funding for this work. The decline in gas flow resulted in a reduction in revenue from the facility, causing us to trip the debt service coverage covenant on the term loan we used to fund the construction of the facility.
Earlier this month we received a notice from PNC Bank, the holder of the note, indicating that they were going to increase the interest rate on the loan to the default rate equal to the 30-day LIBOR plus 9%. We've been in discussions with the bank about entering into a forbearance agreement, in which they would agree not to accelerate the loan for a period of time, while we attempt to correct the gas flow issue and sell the facility. The bank is currently considering our request. We are in the process of reviewing quotes to implement improvements to our gas collection system with the goal of increasing the gas flow to a level sufficient to operate the generators at capacity. We expect to begin work on this shortly and anticipate we should start to see improvements in the gas flow within the next couple of months. Once the facility is operating normally, we plan to market it for sale with the hope that we'll be able to close on the sale sometime earlier next week year.
Last, I'd like to quickly cover it the timing of future filings. The 2 requirements NASDAQ imposed on us for continued listing, whether we file our 10-K and 10-Q by today, which we have done, and that we file our quarterly report for the first quarter of 2013 by next Friday. We made good progress on the 10-Q and hope to be able to file it by the required deadline.
With that, I'll hand it back to John.
John E. O'Rourke
Thanks, Jeff. I'd like to take this time to summarize our thoughts before we hand it over for questions. First, you may rest assured that the board and management will be monitoring our controls environment as we move forward. Second, we believe that Lime Energy has found its place in the energy efficiency marketplace and has a commanding lead in its niche. Our goal is to put a string of profitable quarters together starting in the fourth quarter of 2013. To meet that goal, we will need to overcome those challenges I addressed in my introductory remarks.
We have set forth the following priorities to address those challenges and meet that goal: reinforce a disciplined cost control environment; execute on the business initiatives outlined in my opening remarks; refine our strategy and growth to higher margin products and services; build on our existing client relationships; exercise patience in rebuilding our balance sheet; and continue to invest in our technology platform to secure a commanding lead in cost effective energy efficiency resource acquisition in the small to medium sized commercial sector for our utility partners.
In closing, there is a lot of work to be done. There is no doubt that 2013 is a turnaround year for Lime. To that end, we have a lot of moving pieces with different initiatives and the new strategic focus. As we make progress and gain more visibility, we will determine the right time for providing guidance. At this time, we would like to conclude our formal comments and open the call for questions.
[Operator Instructions] Our first question comes from the line -- I'm sorry, they have dropped from the queue. We have no questions at this time.
John E. O'Rourke
Okay. With that, thank you, all, for joining our conference for today. And we hope to be back on again, shortly. Thank you.
Ladies and gentlemen, thank you for your participation in today's conference. You may now disconnect. Have a great day.
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