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Executives

Chris Hutter – CFO

Sidney Hinton – CEO

Analysts

Rob Brown – Craig-Hallum Capital Group

Eric Stine – Northland Securities

Rick Hoss – Roth Capital Partners

William Bremer – Maxim Group

Amit Dayal – Rodman & Renshaw

PowerSecure International, Inc. (POWR) Q1 2010 Earnings Call Transcript May 6, 2010 5:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2010 PowerSecure International’s earnings conference call. My name is Tony and I will be your coordinator 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 the conference. (Operator instructions) I will now like to read our Safe Harbor statement.

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 fact, including, but not limited to statements concerning future financial performance and the 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 most recent Annual Report on Form 10-K as well as subsequent report on Forms 10-Q and 8-K.

Accordingly, there can be no assurance that the results expressed, projected or implied by any forward-looking statement will be achieved and listeners are cautioned not to place reliance on any forward-looking statement.

The forward-looking statement in this discussion are only as of date hereof and the Company assumes no duty or obligation to update or revise any forward-looking statements contained in this discussion.

As a reminder this call is being recorded for replay purposes. I would now like to hand call over to your host for today, Mr. Chris Hutter, Chief Financial Officer. Please proceed, sir.

Chris Hutter

Thank you and welcome everyone to the PowerSecure first quarter 2010 earnings conference call. We appreciate you taking the time and your interest in our Company. With me today I have Sidney Hinton, our Chief Executive Officer. And our agenda will very similar to what we usually do in that Sidney will provide an overview of our first quarter results and then lead a strategic business discussion and work his way through the business units. I will then provide more detail on our first quarter operating results, balance sheet, and our backlog as well as talk about the other two releases that we besides the press release that we announced today. We’ll then open up the lines for Q&A and then Sidney will wrap up with a few closing remarks.

And with that, I’ll turn it to Sidney.

Sidney Hinton

Thanks, Chris. Good afternoon, everybody. Before we get started, I would just like to acknowledge our utility partners who are listening in as well as our large customers who are listening in. We appreciate your support and interest in us and also acknowledge our investors. We appreciate your support and interest as well.

The format today’s call will be the same as what we usually do. I am going to cover three basic items. I am going to cover the five key messages. I am going to summarize that again at the end of my part of this and then – and after that and before the summary at the end I am going to talk about the financial – the highlights of the financial results for Q1 and then I am going to go through each of our strategic business areas, all four of them, and give you a strategic update on those units.

Let’s start then. The five key messages that we want you to walk away from today’s call are

one, we couldn’t be more pleased with the first quarter, getting 2010 off to a strong start, both on top line and bottom line results. The major highlights included; our revenues were up 25% over last year and then we achieved our all-time record high quarterly gross margin of 38.9%, delivering $0.07 earnings per share.

Second Distributed Generation, our sales momentum has continued. Today, we announced another $15 million of new Distributed Generation and Utility Infrastructure business. This brings us to approximately $70 million of new business awards in the last six months and as result our backlog stands at a very robust $117 million.

Third, these strong results and our continued sales momentum put us in a terrific position for 2010 and beyond. Additionally we continue to see encouraging signs that the economy is recovering and that our – and business investment is increasing.

Fourth, we could have been more pleased with the strategic positions of each of our businesses in the marketplace. We think we’ve got a great hand to play, emphasize fourth one again, we like the hand we have, we are excited about it. Given our growing optimism and opportunities we are seeing in our pipeline, we made several strategic and operational decisions over the last few months to invest in our business and put us in a position to capitalize on the opportunities that we are seeing unfold in the marketplace.

These investments include, and I am going to give you three items here, they include; one, making select additions to our team and equipment to support our new businesses; two, and I hope you listen to this and give us credit for not being complacent that we really are measuring ourselves against our own expectations versus looking backward and saying are we doing well compared to numbers. We are looking forward and saying are we positioned to deliver all that we can deliver out of this Company and with that being said and I say that we – our gross margin was 38.9%. Obviously we are operating very efficiently. But during this past quarter we made the decision to realign our sales and operations structures in several of our businesses and the goals were two-fold, one, we wanted to increase the productivity of our sales and two, we want to increase our operational effectiveness.

And in the third messages up under this is that we are investing, we are continuing to invest in our LED lighting opportunity. That includes the acquisition of IES we announced in April. It also includes the completion of the one-third minority purchase of EfficientLights that we announced today as well. Again, just going back, the message is we like our hand and we are continuing to make investment decisions. The three items that we point to that funded those investment decisions are, a), additions to our team, also some investments in some equipment, two, the realigning of our sales and our operations team, and, three, investing in our LED businesses and pursuing the growth there.

Then the fifth message, and that is today we announced that we filed separate Shelf Registrations to facilitate these LED business investments and provide us with additional financial flexibility in the future. The S3 and S4 statements filed today facilitate the purchase of the one-third interest in our EfficientLights LED business and it sets us up to complete the purchase of the remaining one-third interest in our IES LED business in the future.

We took the opportunity to file the statements and the amounts which we did, which also provide us with the ability to finance additional acquisitions or raise capital in the future. I want to be really clear in this point. And we are going to repeat this a number of times during the call. I want to hammer this home. While these filings do provide us with additional financial flexibility, we do not, again, we do not have any current plans to use the Shelf to raise capital or for acquisitions outside of the two LED businesses that we’ve invested in. Let me repeat, we do not have current plans to use the Shelf to raise capital or for acquisitions outside of the two LED businesses that we’ve already announced.

Additionally, we believe that one of our core strengths is our demonstratability to prudently manage and deploy capital effectively. So, one of the big reasons we made this decision today to file is that we believe that U.S. investors would recognize this and continue to trust our track record and our commitment to be disciplined in this areas. But we also want to be positioned if the market presents an opportunity for an acquisition that we were armed to be able to pursue that.

Now, let me turn – let me turn to move into the second item. Those are the five key messages. Now I am going to dive into the Q1 financial results and then I will move to the strategic decision of the business.

Revenues for the first quarter were $24.7 million, which was up 25%. The primary drivers of our first quarter revenue growth was an increase in our EfficientLights LED business of 104% and an increase in our Distributed Generation business of 42%. These gains were partially offset by a decrease in revenues of 6% at our Southern Flow business.

As I’ve already mentioned and I am sure you noticed in the press release, gross margins, as a percentage of our revenue for the quarter were 38.9%. This is an all-time high for any quarter in our history and represents the fourth consecutive of both year-over-year increases and sequential increases in gross margin.

On a year-over-year basis, our gross margin was up nine percentage points. We are extremely proud of the statistic. It represents the results of a lot of hard work by our team to be smart in our approaches on projects and diligent in the execution of our projects. As we’ve discussed on previous calls, the primary driver of the gross margin increases are strong performance in our DG projects, Distributed Generation, and the strong performance on some specific large Utility Infrastructure projects. Several of these projects that we’ve done particularly well on were completed or are virtually complete as of the end of the first quarter. For that reason, as we’ve been consistently discussing, we expect our gross margins to return to more normalized levels in our second quarter.

Again, we expect our gross margins to return to more normalized levels in the second quarter. We do hope that U.S. investors will have a key takeaway from this and that is that our gross margin performance really represents a few things. One, it represents our ability to expand gross margins over time. We do have headroom on those. And, two, I would point out that we are very cognizant of the headroom and we are making steps and taking steps to be able to enhance and improve it. But I would say that overall a word of advice to investors today is that when you blend all of our businesses together (inaudible) and we think that the gross margins will return to more normalized levels in the second quarter and then playing out through the rest of the year.

Our operating costs for the quarter were $9 million. On a sequential basis this was lower than the fourth quarter by $300,000 and versus last year – versus Q1 of last year it was u $1.6 million. As I mentioned in my opening comments, given our strong phase of new orders as well as opportunities we see in our pipeline, now we are going to mention pipeline a couple of times today, but pipeline is the stuff that we are working on, but we have not sold yet. Obviously it’s our best indicator of our future.

But given the opportunities we are seeing in our pipeline, we’ve made some early decisions to invest in people and equipment to support this new business, and puts us in position to capitalize on the opportunities that we are seeing. The primary areas that we are investing in are Distributed Generation, investing in the sales, engineering, and operations, and our UtilityServices in crews and equipment, and in our LED businesses as we have discussed.

Tipping our hand here, frankly, it could prove, and we’ve talked about this with our own team internally, it could prove that we are one to two quarters early on these investments. But our position is this is a great quote. Chris came up with it in trying to come up with a great way to communicate this message. We’d rather be early to the party with an opportunity to get two pieces of cake than to show up late and end up hungry and envious of others. We have a consistent track record of making investments when we see opportunities and our only hand tipping here is that we may be early by a quarter or two and all we are saying is we love the hand we got, we love the position that we are in. We like the opportunities we see out there. We like the pipeline a lot. And – but if the pipeline takes an extra quarter or two to develop, we already have the expenses of these additional people, so you could see a little bit of an impact on the EPS from those investments. But they are just that they are investments and they are investments that we are confident in and excited to have made and had the opportunity to make.

Moving on, WaterSecure, it contributed $1.2 million of income for the quarter. And that’s an improving result sequentially and on a year-over-year basis. All in all it adds up to $0.07 EPS, which is a substantial increase over last year’s loss of $0.07 a share.

Let me move on and now talk about each of the strategy business units, and I won't try to remember if forget so if you hit me in the questions I won't try to throw the pieces of cake in here as I go through, in other words I talked about, look, we made some investments in people and resources, we may be a quarter or two early on those investments, but we’ve done it for more cake and I want to be sure to highlight the cake for your so if I were to slip on these next point, feel free to catch it in the question, or Chris, catch it in the financial summary.

Now first, we have four strategic areas, DG, Energy Efficiency, Utility Infrastructure, and then Energy Services, and I am going to start with Distributed Generation. As we said at the outset of this year, we expect our DG business to resume its growth in 2010 after being affected by the economy in 2009 and in our first quarter our DG business a very strong 42%, which is even better than we had expected.

You will recall that our DG business finished 2009 on a positive note and our first quarter results continue that trend. Additionally, we’ve seen a nice pick-up in orders for our DG systems over the past year. In fact, of the $70 million of new orders in the last six months, over $40 million was for new DG systems and our NexGear switchgear equipment.

Our DG revenues include both project based revenues, that’s where we sell the system as well as recurring revenues where we own the DG system and receive ongoing revenues for backup power and peak shaving benefits. I am pleased to report that the recurring revenue part of our DG business continues to grow nicely. For the first quarter, our recurring revenues related to systems that we own was $1.1 million. This was almost double the recurring revenues for the same section from a year ago, the 2009 Q1.

Additionally, as we have increased the number of system that we’ve sold, we’ve also increased the recurring revenue that comes in the form of monitoring revenues and maintenance fees. When we add that revenue, those revenues from monitoring and maintenance to our Company owned recurring, it’s a total of $1.6 million. And that’s a 50% over the first quarter as well.

As you can tell, we have focused and we will continue to focus on growing this recurring part of our Distributed Generation business. We continue to be very bullish on the outlook of our DG systems and how they are positioned in the marketplace. They address the largest Smart Grid opportunity that’s helping commercial and industrial electricity usage be more efficient, and providing the dual benefit of own site power supply. Our systems provide a proven, cost-effective way to help utilities smooth commercial and industrial electricity loads. Access to (inaudible) are not theoretical. They demonstrate their value everyday. Additionally, our bullishness comes from – that our DG business continues to broaden and extend itself in a number of different way. I am going to give you five ways here that our DG business is growing and expanding and this is giving you some view into some of the cake that we are chasing.

First, we continue to see our DG systems being installed in a growing list of partnerships with utilities. As we mentioned on our last quarter’s call, we are in the process of completing our first project in California, that’s for a data center, and we just received our first job in Colorado. In Kandaly [ph] we’ve made investments around those market opportunities because of our perception of the cake that is there to be had and we are out pursuing those opportunities.

Second, again, this is – this list is of five things relative to growing and expanding our DG business. Second, our core DG, Distributed Generation and switchgear technology is being utilized in broadening number of applications. Examples of this include the landfill gas application that we are completing this year on behalf of a utility partner and or new micro grid system.

I am pleased to report, and I hope you guys see this as cake, the – we have been awarded our second micro grid project. These projects are for a Fortune 100 company and we have another proof of concept micro grid project in the pipeline. So, I am telling you we’ve got a second one that’s now in the backlog and yet there is another one out there in the pipeline. We are intrigued about the opportunities that this micro grid opportunity represents for us for utilities and for their clients. It’s a significant market potential.

Finally, another great example of our switchgear technology inhouse being applied in complementary and accretive way to the rest of our business is in our design of our SmartStation which is a turn-key substation product. Our NexGear is developing it in conjunction with our Utility Infrastructure team, who will bring it to market.

I am also excited to say that our Utility Infrastructure, we have two components there. We have our UtilityServices business unit, which does turn-key construction projects for customers and we also have our Engineering business. And our Engineering business where we do Engineering for transmission, distribution and substations, we have literally dozens and dozens of utility clients there and that are utility engineering business has embraced the SmartStation design and sees as this something that is a prelim to the market and is out marketing it now to their own book of customers.

So it really is combining three parts of the company

NexGear’s technology and design capability, UtilityServices turnkey ability, and UtilityEngineering’s both design capability and even more importantly, their book of customers and long-standing relationships. We are excited about that potential cake.

Third, our DG business is broadening in the technology itself. We continue to improve the design and technology of our core Distributed Generation systems. These systems help bring a better quality of products to our customers at a lower cost. That’s something we’ve focused on from day one at the company. Let’s build a better product and drive cost out. It’s well within the DNA of the Company.

The obvious outcome of getting a better product with a lower cost is it maximizes the ROI and increases shareholder value. The consistent increases that we are seeing in gross margin in a lot of ways have been delivered just from as a result of this focus. While we have been able to get our cost down, we have been able to lower our price some, but we’ve also been able to increase our gross margins to justify the incremental investments we’ve made in technology and investments.

A great example of all this is our proprietary generating system that we are – that we have designed and that we talked about it in the last quarter’s call that we believe we have the ability to break the mold and that we are breaking the mold with regard to cost and performance of traditional generating systems. As we’ve discussed, we have been installing these systems over the last year and we continue to see, this is part of the cake, we continue to see growing demand for this proprietary design. Importantly, it is coming from our utilities and from our C&I, i.e., commercial and industrial customers.

Our NexGear folks are developing this technology. They are unbelievably smart. They are always looking for ways to design technology that challenges the status quo, both in terms of functionality and cost to the customer.

Fourth. The fourth way our DG business is broadening is in the diversity of customers adopting our systems. Our new orders this year include a variety of industrial manufacturers, municipal infrastructure, hospitals, data centers, waste water treatment plants, and a number of other end-use customers. We are excited about the growth and diversity of our business and how the systems are demonstrating their value to such a broad range of customers.

The fifth and final way that we are continuing to broaden our DG business is from international. We talk about, I don’t know, two – a couple of quarters ago we shared on the call that we made an investment to start an international sales effort. That would be a good example of spending early for returns later on. We are excited about the cake that we see out in the international opportunities. The – there is a number of places around the world that are short of power and that our solution we have in our power packages business, which is a medium speed, along with some other technologies that we are marketing, we found that potential buyers are interested and engaged in conversations with us. While these are at the discussion level, the discussions are encouraging.

We view the international market, we view them with hope and now I will tell you that we view it as a place where we have traction. Hopefully, when we report in the next quarter or two, we will be reporting that we have projects and that we have a backlog. But this is a great spot for you to picture and when we talk about money we were spending in exchange for cake down the road, this is the key area to look at.

Alright. That’s all on the Distributed Generation business. The next one I am going to talk about is our Utility Infrastructure business. We’ve talked about this. I will say it upfront, I will say it again, we’ve talked about – this is a huge growth opportunity for us and that we think this a $100 million opportunity in five years. We are standing by that and I am sure I will repeat it here in a couple of minutes.

Stepping back just to summarize, our Utility Infrastructure revenues for the first quarter were down 1% versus last year. Now, let me give you a little color on that. The primary growth in this area, Utility Infrastructure, is our UtilityServices business. That’s our turn-key work we do for utilities. That business was up 105% in that same Q1 versus Q1 period of time. That was offset by decline in our federal projects which were really just a couple of large federal projects. We continue to win federal business, it’s just up in other business units.

So the UtilityServices business, which was started in 2007, continues to grow, it’s up 105%. That’s the business we are talking about that we think has opportunity to be $100 million in five years and it’s – the track record looks good. In the last – this is a definite piece of cake. We are tipping a – it’s definitely a potential piece of cake. We are tipping our hand here, but doing it from a credibility standpoint. We don’t want to have this call and then bee announcing something in a few days that you might have thought we were sand-bagging and could have announced it today.

One of the things we talked about on UtilityServices is the work we do for utilities where we go out and do line construction, line maintenance and that work is similar to work in – if you were looking for a comparison to what Qantas [ph] does the – or Qanta does. The – that business has continued to grow and the relationships have solidified and just in the last 60 days we’ve seen a lot of confirmation about the investments we’ve made in this business that we think we area close and we are anticipating the – announcing some business in this market. There will be multiyear contract and will be for a material amount of money. And we are just tipping on it. This is a place we are making investments. Today, those investments are dilutive to earnings, but we see them as being potentially accretive to earnings as fast as the second quarter, i.e., the quarter that we are now in. And if not we see it as a – a likelihood enough that we are bringing up today, tipping our hand that we think we may be winning something here, certainly by the third quarter.

At this point, but we are working for the utility. But we do not have final documentation on the awards. So, we are not in a position to say anymore about it nor are we in a position to declare that we’ve been awarded the business. But we are very bullish about where we stand and to the point that we thought we needed to bring it up in today’s call.

Before I move off that cruising thing you would add at that point?

Chris Hutter

No, excuse me.

Sidney Hinton

Our UtilityServices team is winning despite a continued overall sluggishness in the utility spending arena for infrastructure projects. This is a 100% driven by the quality and strength of our people. Our folks are the best in the business and they are the reason why business is expanding while others in this space are contracting. That said, we also believe the Utility Infrastructure spending will ramp up significantly as the economy turns and as our utility partners start spending some of the stimulus money that they’ve been awarded, and we have seen signs that that’s beginning to happen or that the foundation is being laid, i.e., quotes are being solicited for work [ph] from monies that they will spend out of that pool of money.

We love the fact that we’ve had such terrific success in building this business organically from the ground up in an overall difficult market from a utility spending. It’s allowed us to build the business with great people and it’s allowed us to build the business and keep our overheads very low and have a low-cost basis in our equipment.

To summarize before I move to the next business unit, this is an area that we think has potential to be $100 million in five years.

Moving on to our Energy Efficiency area, I know this is an area that all of you are excited about and we always will. All of our business, well virtually all of our business today in Energy Efficiency relates to LED lighting, and that we have two businesses there, our flagship EfficientLights business and our recent acquisition, IES. I am going to talk about EfficientLights for quite a few minutes here and then I will move, I will briefly hit IES. The only reason for not – for being brief on IES is we just covered it when we announced the acquisition. Not that much has changed, but I will update it slightly.

Now let me step back and talk about EfficientLights. And EfficientLights is our – the company that has the refrigerating case LED that specifically targets grocery, drug, and convenience stores. Our EfficientLights product revenues grew 104% versus last year’s Q1, generating – and that’s on revenues of $4.6 million. You will remember that we had estimated revenues to be approximately $5 million, which would be down sequentially versus the fourth quarter and that the reason we had anticipate this and we were correct is that it’s just seasonally a light time of the year for retailer relative to refurbishing expenditures.

You will also recall that given our strong EfficientLights backlog, we expect our EfficientLights revenue to grow sequentially as 2010 progresses and this expectation remains very much the same, i.e., we are still expecting that to continue, we are expecting EfficientLights revenues to grow sequentially as 2010 progresses.

And I want to update you on a few key milestones for EfficientLights. For a few quarters we’ve been talking about new in-store LED products that the EfficientLights team is developing. I am pleased to report that we have two new products ready for market. And in fact we’ll be issuing a press release on Monday?

Chris Hutter

Early next week.

Sidney Hinton

Early next week, announcing this as – a marketing type press release, announcing two new products, a LED light fixture for walk-in coolers, and a LED shelf light for reach-in refrigerated cases. These products will be unveiled in the press releases around that relative to the LIGHTFAIR and FMR conferences in Las Vegas next week.

These products – so two new products. And now a key point here, these products were developed at the request of our existing customers, i.e., they saw the quality of what we were doing, the price points that we were able to do it at, the reliability of shipment that our team was able to achieve and the energy efficiency of the products our people had designed and they asked them to develop these solutions as well.

And we are very excited and optimistic about the potential of these products. We already have new lights installed and in operation at our customer stores and we expect to begin to show revenues from these products as early as the third quarter of this year, adding two more drivers to the growth of EfficientLights.

Additionally, EfficientLights is continuing to develop a parking lot light specifically aimed at the – those same customers. We couldn’t be more pleased with the way the business has progressed and the amazing efforts of our EfficientLights team and their ability to perfect great products and demonstrate strong value to the major retailers. The growth that we are realizing in this business continues to be the result of EfficientLights’ superior quality of light and the fresh look and feel it brings to customer stores and the financial and environmental benefits that the lights deliver. Importantly, making an investment in EfficientLights technology is also very flexible. Retailers can choose to install the lights in just a few of their stores and – in about half their stores or in all of them. It can be small, medium or large relative to the financial rollouts.

And before I leave the EfficientLights, I do want to point out, as we announced today, that we did complete our planned purchase of the remaining one-third interest. We did this in exchange for 1,025,641 shares. To facilitate this transaction as well as the potential similar transaction to purchase the minority interest in the IES LED business, we also filed the Shelf registration that I mentioned earlier and that Chris will talk about in a moment.

Now, just to bring you up to speed on our LED business, IES that we acquired in April. It’s only been four weeks so not a lot has changed from the conference call. I will say that the transition has gone extremely well. We had an investor last week ask us what’s the integration been like and I would tell you that the integration has been better than anticipated. We didn’t have a reason to not anticipate a good one, but we didn’t want to fool ourselves into thinking it would be easy. So, we just didn’t assume that. The EfficientLights team has very much embraced the IES team and vice versa, IES with EfficientLights and the core business relative to selling some street lights and area lights that IES is working on. The integration has been incredibly smooth and productive and this is an area I would tell you that those two new products we just talked about, those are a couple of things to think about cake. You know what we are talking about, we are investing for cake down the road. Those products are, but desire yes and it is definitely a piece of cake, a couple of pieces of cake. In fact, some of their products that they are working on may be an entire cake. Very, very nice opportunity. So big, big, market opportunities adjacent.

I was at a trade show earlier this afternoon where our newest area light was unveiled and it was unveiled to a utility and their members. And the reception was incredibly positive. In fact I received a call before we went home from the President of our IES business notifying me that we received our – a verbal order at the show for our first batch of lights and that those lights would be followed up with an order hopefully as early as next week, a written order. But it’s just a very, very well-received light. Nice profile from an aesthetic standpoint. Nice price point from an economic standpoint and an unbelievable energy efficiency. The wattage saving is just out of the ballpark compared to other lights that are in the market. It’s a win, win, win, relative to aesthetically pleasing, attractive price point, and very high efficiency compared to the traditional light sources.

Just to close up on the IES, A), we like the opportunities, we are chasing several big opportunities. We have worked with them, and really under their leadership, we’ve figured out where are the biggest opportunities and that we are focusing in on those opportunities. Much like we brag on EfficientLights having an amazing team, the IES team is an amazing group of people as well. We are really blessed to have a very strong and deep team in the LED business at both EfficientLights and IES.

I’ll come back if there is any questions more on the IES. Moving on to the fourth and final business unit, that’s our Energy Services business, Southern Flow, WaterSecure. The headline on these businesses is that although natural gas prices are down from where they were two years ago, they’ve stabilized some over the last two quarters and as – this has been – the stabilization of gas prices has been positive for both of the businesses.

Additionally, stronger oil prices had helped our WaterSecure business in particular. Southern Flow’s business delivered its first year-over-year increase in operating income in the last five quarters. Again, the year-over-year increase in operating income, it was an increase of 4% to $539,000 and as we stated earlier, the revenues were down 6%, $4.2 million versus Q1 of last year.

Our WaterSecure business delivered pre-tax income of $1.2 million. That was up 103% on a year-over-year basis and up 19% on a sequential basis versus Q4.

Finally, with respect to Southern Flow, although the situation with the oil spill in the Gulf is obviously still very much a developing situation, we did think you might be wondering what percentage of our revenues comes from offshore activity at Southern Flow. 10% of our Southern Flow revenues are involved with offshore activities and thus far those – the provision of those services has not been interrupted.

Alright, before I turn it back to Chris, just let me go back and hit the five key messages again. One, we couldn’t be more pleased with the results of Q1. We’ve got off to a great start in 2010 with strong top and strong bottom line results. Second, our sales momentum has continued and our backlog is strong. Third, our strong Q1 financial results and our continued sales momentum have put us in a great position for 2010 and beyond. The – we like what we are seeing in the marketplace.

Fourth, we couldn’t be more pleased with the strategic positions of each of our businesses n the marketplace. We’ve got a great hand and I would just echo that point with the reminder of “hey we may be a quarter or two early on some of our investments relative to things we’ve invested for, but we are really excited about the cake that we are out chasing with that.” Hopefully that will help you remember those bullet points.

And fifth, the final key message is that we announced our Shelf Registration today. That was for the purchase of the one-third of EfficientLights as well as the potential purchase of the other third of IES and it provides us with additional financial flexibility in the future. While they do provide us with additional financial flexibility, key message, you will hear this repeatedly today, we do not have current plan to use the Shelf to raise capital or for acquisitions outside of these two LED businesses.

Additionally, we’ve demonstrated a core strength around prudently managing and deploying our capital effectively. And we are committed to maintaining that track record of having discipline in this area.

With that, I will turn it over to Chris.

Chris Hutter

Great, thanks, Sidney. Before I start, as I usually do, I kind of give my standard comment that Sidney’s comments about a lot of color on the state of each of our businesses and qualitative discussion, I think there is a little bit of quantitative in there too about 2010 and the outlook, I will supplement his comments in my discussion as I usually do and try to give you a good feel for how we are looking into the future, but I also want to just reiterate that we’ll continue to stay true in policy of not giving specific financial guidance and forecast and instead we’ll let the detail and breakout of the – our backlog be the foundation that you can use to derive the specific quarterly and annual financial estimates. Obviously, overlaying all the qualitative information we are providing on this call. And thanks again to everyone for respecting our position and approach on this.

Now, as usual – I usually start with revenue, way down the financial statements. For the first quarter, revenue was $24.7 million. That was up $5 million or 25% over last year. Our year-over-year revenue increase was driven by a 94% increase in our Energy Efficiency revenues, which was really a result of the 104% in our EfficientLights product sales, and, second, a 42% increase in our Distributed Generation revenues. And we obviously love to see how that’s continuing. These increases were partially offset by a decrease in our Southern Flow revenue of 6%.

Our Utility Infrastructure area was down 1% overall but you need to look underneath that in that our UtilityServices business, as Sidney mentioned, grew 105%, but this growth was offset by decreases in revenues from a few large federal projects which were in process last year but are virtually complete at this point.

Now, I am going to move to the business units. In our Distributed Generation business, the 42% increase in revenue resulted in total DG revenue of $10.4 million for the quarter. The 42% increase was driven by a very strong 106% increase in revenues from project-based sales of DG systems and a 50% increase in recurring revenues from PowerSecure-owned DG systems. And that was partially offset by a 40% – 46% decrease in switchgear sales, a decrease, which really was just related to order flow and timing. We actually expect to have a very good year in our switchgear sales in 2010.

An interesting note on our first quarter DG results is that our recurring revenues represented 15% of our DG business and we are continuing to steadily build our recurring revenue into our P&L. Looking forward, based on our backlog and the opportunities, which are in our pipeline, we expect to see our DG results and our new business announcements contain a balanced mix of project-based on recurrent revenues with a continual – continuing gradual increase in the amount of our DG business that is recurring in nature.

While I am on the subject of recurring revenue, which is – those that follow the company know, that really is the primary driver of our capital expenditures– we continue to hold approximately $15 million in our capital budget for 2010 with approximately $3 million to $4 million of this spend expected in the first half of 2010 and the remainder in the second half of 2010. To be clear, this is a budgetary place-hold and the ultimate amount for capital (inaudible) in 2010 will depend on the amount and mix of projects we perform under the recurrent revenue model versus the project-based or a model where we sell the systems.

Now, turning to our Utility Infrastructure area. Just to add some color to the numbers that we’ve already given. The growth driver in this area is clearly our UtilityServices business. And our UtilityServices revenue in the first quarter reached another record at $4.4 million. Just a reminder that during the middle of 2009 we announced several major investment [ph] utilities have begun utilizing our crews on a regular basis and our UtilityServices revenue results reflect our growing business with these and other utilities.

Looking forward, we continue to believe that the momentum in our – our UtilityServices team is building sets us up to have a very nice year in 2010 with out-year upside once the economy really starts firing on all cylinders again and Utility Infrastructure investments spend returns to normal or could be even accelerated levels.

Moving on, revenues in our Energy Efficiency area continues to be excellent, driven by the strong growth in our EfficientLights product revenue. Our first quarter EfficientLights product revenue was in line with what we discussed quarter at $4.6 million. You will recall – I mention this again, Sidney touched on it – the last quarter we anticipate that because retailers generally don’t do a lot of refurb activity in the first quarter our revenues will reflect that fact and we’d be in that $5 million range. Additionally, we continue to expect that our EfficientLights revenues will increase sequentially from its first quarter level as move through the year. And we expect that revenue from the new in-store EfficientLights product Sidney mentioned will also contribute to that growth.

We also continue to expect that our new IES LED business will deliver revenue in a range of about $3 million this year. As similar to our EfficientLights experience in business progression these first several quarters will represent an investment period where the IES team is prioritizing and figuring out how they want to organize their work and focus on a select group of the highest potential opportunities. Additionally, during these first several quarters, we’ll be investing time and resources, securing new law [ph] listing and other activities relating to ensuring we are maximizing and protecting the value or their intellectual property and designs.

One last note on or Energy Efficiency business is that we have made a significant investment in inventory and therefore working capital in the last few months as we begin to fulfill the large orders that we receive earlier this year, and I will talk about this more in a moment.

Turning to our Energy Services segment, revenues in our Southern Flow business were down 6.5% on a year-over-year basis, but up 5.3% sequentially. This is pretty much in the range that we expected and we continue to expect that our Southern Flow revenues will gradually improve in step with the economy. We are obviously very pleased to report Southern Flow’s first quarterly year-over-year operating income increase in five quarters.

As we look forward, we expect to see similar levels of revenue to our first quarter and the near term with a potential for modest growth in the back half of 2010. Additionally, the Southern Flow team has been very focused on cost management at both the cost of sales level and the operating cost level and we expect these efforts set us up to have even greater levels of profitability as the economy recovers.

Now, turning to our WaterSecure business, which holds our investment in the water processing business serving oil and natural gas producers in Colorado, where we had just another great quarter. Our WaterSecure business delivered income of $1.2 million, which was 103% higher than last year and 18.6% higher than the fourth quarter. And this was driven by a combination of higher water processing volumes and higher oil prices.

We like the trends we are seeing in this business and we continue to be very encouraged that we have turned the corner in terms of our WaterSecure results. As we look forward, given the seasonality in this business, we are budgeting somewhat lower levels of profit in each of our second and third quarters of 2010, but still showing year-over-year growth with a return to these fourth quarter levels of profitability in the fourth quarter. Now, obviously, a key driver in that will be how the price of oil behaves.

Turning to profitability, as Sidney discussed, we are very pleased to be able to report another sequential and year-over-year increase in our gross margin and set another company record with gross margin of 38.9%. This result represents the sum value of a lot of hard work by a lot of people, and we definitely want to recognize the PowerSecure team for their strong focus on working smart, efficient, and passionately to deliver bottom line results everyday.

We continue to believe that our gross margin results illustrate the potential that we have to continue to enhance our margins over the long term, but as Sidney said, we have a few projects that are – that just produce terrific gross margins that are virtually complete at this point and so we expect gross margins to step down to the low-30% levels and we’ve been consistent in saying to expect this and we do expect this for the remainder of this year.

Moving down the P&L, as expected, our operating expenses were lower than the fourth quarter and higher than last year. Our expenses have trended somewhat higher than we expected, however, at this the beginning of the year, primarily due to the way our backlog increased so quickly and the strong pipeline we have in front of us. And Sidney really hit on this – we’ve just made some decisions to make select proactive investments to support this growth and achieve this growth.

And so as we look forward I would make sure that you expect sequential growth in our operating expenses as the year progresses. But to fold in something that Sidney mentioned, the investments we are making could prove to be slightly ahead of the corresponding revenue achievement. So I would be conservative in the quote within quotes.

Our best estimate at this point is that the investments we are making in people and equipment will step up our operating expenses in the neighborhood of $250,000 to $350,000 per quarter in the next few periods. And that these investments will be to support the growth we are expecting in each of our DG business, our UtilityServices business, and our LED business.

Also, as Sidney mentioned in his opening remarks that we’ve made some organizational changes to federal line of sales operations and leadership teams to further enhance our sales productivity and continue our progress in achievement of operational effectiveness and efficiencies. We are not going to go into detail on those changes on this call. But one net result that we will talk about is that there is a – there is going to be a severance cost in our second quarter. That number is going to be in the range of $400,000 to $450,000. So, please be sure to fill this in your cost estimates. And just one quick note on this to be clear. Just to be clear, we will not call it out as a nonrecurring item when we report our results next quarter.

Moving down to the bottom line, our EPS for the quarter was $0.07. And we just couldn’t be more pleased with this result and really just a terrific start to 2010.

So, with that, I am going to turn now to our backlog and break down our backlog as I usually do for everyone. We really have to where our backlog stands as you can imagine, right now we are in $117 million. As usual, this represents the revenue commitment that we have committed and in the hopper [ph] as of today and that included the $15 million of new business we announced today. $52 million of the backlog is what we call near term backlog. And that’s for project-based work, including our DG, Utility Infrastructure, and EfficientLights sales and projects that we expect to recognize over the course of the next three quarters starting with this second quarter, so from April on. This number has grown. This near term backlog number has grown in each of the last two quarters and as it was $35 million in November and $48 million at the beginning of March. And this is driven by the significant amounts of new orders we’ve received in the last six months. Our estimate of the spread of the revenue recognition for this $52 million of near term backlog is that approximately 40% of the $52 million will be recognized in the second quarter. 35% of the $52 million will be recognized in the third quarter and 25% of the $52 million will be recognized in the fourth quarter.

I know many of you are probably tired of hearing me say this, but I am going to do it anyway because new people are joining these calls. And that’s just a reminder for everyone that what is proven to be a pretty good, simple, three-step process to estimate what our total revenue will be for the next three quarters is that you take this near term project-based backlog of $52 million, spread it according to the percentages that I just laid out, add $7 million and $9 million or revenue to account for sales that are made and completed within the quarter as well as recurring and other regular revenue that is not in that project-based backlog. And lastly, make assumptions about additional project sales we will make and complete between now and the period you are estimating that will add to the revenues in that quarter.

Obviously, given our quicker cycle times that we’ve developed over the last couple of years, there is a window of selling time. The impact of second quarter of 2010 still and plenty of time the impact of the third quarter and fourth quarter. Also, as we think about 2010, our overall thoughts on the pace of business is that we continue to expect that our revenue results will likely improve as the economy continues to recover with a modest lag to the timing it takes to complete the construction and recognize the revenues from our larger DG and Utility Infrastructure projects.

Still into the backlog. The next component of that backlog is $13 million of longer term project-based work that we anticipate will be recognized fairly evenly from the first quarter of 2011 through the first quarter of 2012. And the last component of our backlog is the $52 million of long term recurring revenues we expect to be recognized over a seven to 10 year rough estimate sweet spot with some revenues extending beyond this period. So, $52 million of near term project-based backlog plus $13 million of longer term project-based backlog plus $52 million of long term recurrent revenue equals $117 million of total backlog.

Now, turning to our balance sheet. We continue to be pleased with the strength and position of our balance sheet and our key balance sheet stats were as follows.

Our cash balance at the end of the first quarter was $16.6 million. As expected, this number was lower than our fourth quarter, but $4 million due to working capital investments to support higher inventory to fulfill our upcoming EfficientLights orders, and additionally, as we communicated last quarter, we continue to use cash and will continue to use cash in the near term to support the short term working capital needs to fulfill these EfficientLights orders as well as the new work we’ve been awarded and anticipate being awarded in our UtilityServices business.

Finally, we used approximately $4.5 million in April for the acquisition of our interest in the IES LED lighting business. And the net of this is that we have still not drawn on our – as of today, we have still not – had not drawn on our $50 million revolving credit facility. We have about $2 million of cash as of today or yesterday. But it is possible that we could draw on our facility this quarter. And I assume that our banks are listening and I happy that they are finally going to make a little money from us. I am actually just kidding on that.

That said, we anticipate that these working capital needs will be relatively short term and we expect them to reverse themselves as we are paid for these projects and this reversal should primarily take place in our third quarter.

Moving down to talk about CapEx, our CapEx investment for the quarter was $1.1 million of which $500,000 was for recurrent revenue, capital projects. And looking forward, as I mentioned, we continue to hold approximately $15 million in the capital budget for 2010.

So now while we are on the subject of our balance sheet, I want to discuss in more detail the announcement we made today that we filed Shelf Registration statements to facilitate our LED lighting business investments and to provide financial flexibility to finance our future growth opportunities.

First, as Sidney mentioned, we completed the planned purchase of the one-third minority interest in our EfficientLights business on April 30. We issued 1,025,641 shares to the minority owners in conjunction with this transaction and incorporated these shares into the filing of a Form S-3 registration statement that was filed today.

Second, in conjunction with our recently acquired IES LED lighting business transaction, we filed a Form S-4 registration statement to prepare for the potential future issuance of shares to facilitate the purchase of the remaining one-third interest in this business as well. Just a reminder for everyone from the last phone call when we discussed this acquisition. We have a call option to purchase the remaining one-third interest in exchanged for PowerSecure stock at a formula which is accretive and we are putting this shelf in place to facilitate this transaction down the road, assuming that the business performs to the level that makes it a good use of capital.

Three, in addition to facilitating the process of registering this million shares for EfficientLights, the S-3 registration statement enables us to raise additional capital through the issuance of equity in the future and the S-4 enables us to utilize shares for additional acquisitions in the future. The S-3 was filed for a total dollar value of securities of $70 million and the S-4 was filed for a total dollar values of securities of $30 million.

Again, to be clear, we have no current plans to raise capital or issue securities for acquisitions under these shelves. However, we determined that given the need to put them in place for our LED business investments that we should take the opportunity to put them in dollar amount that provide us with additional financial flexibility in the future. Also, just in case the question popped in anybody’s mind, our $50 million line of credit is very much in place and there is nothing about the filings of these shelves that should in any way be interpreted as playing defense or that we need to raise capital.

As Sidney mentioned at the outset of the call, we believe we have demonstrated that one of our core strength is our ability to prudently manage and deploy capital to maximize shareholder value. Additionally, we want to be sure that everyone understands we remain committed to our strategy of organic growth enhanced by prudent complementary acquisitions. And that we are committed to our track record of discipline about the investment we choose to make and the requirement that they enhance shareholder value.

And at the end of the day, I guess what this really means is that we are asking you trust us and by the way not on blind faith, but with our track record in mind. We will be really smart and prudent about any use of these shelves in the future.

Ultimately, if we decide to use them for finance in the future, I would say that the most likely use is at this point would fall into two buckets. One, to finance the capital for large Distributed Generation recurrent revenue projects or a series of projects with a large utility or a large national customer. Or, two, to finance acquisitions similar to how we’ve used equity to create shareholder value for LED lighting businesses and in our EfficientLights business in particular.

And lastly, I’ll just reiterate again that besides the issuance of the one million shares for the EfficientLights buyout, we don’t have current plans, so those of you who are on the call, that have invested in making partners, tell me, you don’t need to call me.

And with that, my summary comment on the quarter and the announcements we have made today is that we remain in a very strong place financially. And we continue to enjoy terrific flexibility to be able to act strategically and opportunistically to grow our business. And with that, we’ll open up the lines for Q&A.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Rob Brown. Please proceed..

Rob Brown – Craig-Hallum Capital Group

Good afternoon. Just wanted to get a little more color on the kind of the LED lighting order pattern. You had a big announcement in – earlier in the year and then I am just wondering if that will come in chunks. How does that business work in terms of order patterns?

Sidney Hinton

Great question. It – we do anticipate it will be lumpy although we have announced some other business, we just didn’t announce it in separate releases. We bolted together what was the lower dollar amounts, we just lumped together like today’s $15 million, it was not familiar [ph], that was not in that one, and so all prior releases that had been – some of the dollars included in those. But we do believe in general those flagship announcements will be lumpy and the other standard everyday type orders will be for $50,000 to $2 million, $3 million and that just gets lumped in to the other releases. But when we win big, flagship type things that we’ll isolate those.

Rob Brown – Craig-Hallum Capital Group

Okay good and thank you. And I think your comments have kind of covered this, but just trying to understand how – things were good the last time you talked, have they gotten incrementally better or where are you in the process of sort of moving you pipeline toward actual orders is it–?

Sidney Hinton

Would that be in for the whole business or anyone segment, Rob?

Rob Brown – Craig-Hallum Capital Group

Just really the whole business in general. I think things have been getting better, but–

Sidney Hinton

I would definitely.

Rob Brown – Craig-Hallum Capital Group

– accelerated or is it still (inaudible) just the same.

Sidney Hinton

It’s very much has progressed. $15 million has gone from pipeline to backlog since we talked. And the balance of the pipeline continues to mature nicely. We are very, very bullish about the pipeline. I will say this, got a thought about it last night. We would – the pipeline is attractive enough that we would anticipate the backlog we have this call next time that we would anticipate the backlog to be higher than it is today, i.e., meaning we think we will win more business in this coming quarter than we consume in revenue out of the backlog.

Rob Brown – Craig-Hallum Capital Group

Okay.

Sidney Hinton

Hope that gives you some color into the pipeline.

Rob Brown – Craig-Hallum Capital Group

Very helpful, thank you.

Sidney Hinton

Yes, sir.

Operator

And your next question comes from the line of Eric Stine. Please proceed.

Eric Stine – Northland Securities

Everyone, thanks for taking the questions.

Sidney Hinton

Hi, Eric.

Chris Hutter

Hi, Eric.

Eric Stine – Northland Securities

I was wondering if – first, just bookkeeping, could you just break down the gross margin between the two segments?

Chris Hutter

I can, but I will have to – I haven’t right off my finger tips, Eric, so let me find it.

Eric Stine – Northland Securities

Okay, okay, that’s fine. And then may be we could just talk about the order announcements from today, first on the DG side, can you just talk about – it sounds like new location, but what the end market there is?

Sidney Hinton

The end market is both manufacturing as well as municipal type infrastructure projects and that’s specifically around the DG aspects of it and the encouraging thing was just the – more so than the dollar amounts, the source of the customers, i.e., it was new utilities or utility that we worked a long time with in one case, but not had a lot of market success with and one of the projects was a long endeavor that we think will be a tipping point in a relationship that has to the potential to be very material, very significant.

Chris Hutter

Hey, Eric, the gross profit, the PowerSecure’s Energy and Smart Grid Solutions is 41.8% so almost 42% and for the Southern Flow, which is really our Energy Services segment, 24.6%.

Eric Stine – Northland Securities

Okay, that is helpful. And then just back to the orders. The Utility Infrastructure orders, did the project in Pennsylvania, does that signify expansion to a new utility partner or is that work with one of those three large ones that you announced last year.

Sidney Hinton

No, sir, that’s – you are correct in the first, it is a new utility relationship.

Eric Stine – Northland Securities

Okay. Can you characterize–?

Sidney Hinton

I wouldn’t characterize – I would characterize that as a big market, but I wouldn’t go – and no disrespect to that utility if they are listening. Really we characterize them in investor-owned and they co-opt a municipality. And we were – we are doing what was a investor-owned. Literally the relationship could be $10 million to $25 million a year for as long as you can see. And those are the ones we call big. I don’t mean that as disrespect to the municipalities and the co-opts. If it’s a group, a state-wide group of co-opts, it could be that type business as well. But if it’s just a singe individual co-opt they may do a lot of business very material to them but it would be in the single digit millions in the span of a year and probably not that much to follow a year. So it’s a new market for us as in geography. And we are glad we’ve entered that, and we hope it helps us with other utilities up in that area. But that – the specific utility partner it was fine utility. I wouldn’t characterize it the way we have. You could tell I am dancing this time. I am not dancing for you either, obviously I am dancing from the customer standpoint.

Eric Stine – Northland Securities

No, that’s fine. And then just along the same lines, the – you mentioned the significant order that you feel pretty confident about being able to announce. Is that – can you disclose whether that’s new or an existing customer?

Sidney Hinton

That is an existing customer and it would represent the culmination of a lot work we’ve done in building a relationship and earning their trust. It really would be the prototype of what we hope that business unfolds. We think of that business in a $10 million a year scope. That relationship is our – will be our model internally that we worked hard to win their trust and respect and assuming we actually win the contract, it will be a great example of that.

Eric Stine – Northland Securities

And just to clarify, you did say that we could see something there second – maybe a second order or third?

Sidney Hinton

Yes.

Eric Stine – Northland Securities

Okay. Alright, just one last question. This is EfficientLights, you’ve talked about in the past that a lot of you revenues to this point have been concentrated with one or – I don’t know if you quantified but a small number of customers, has that started to change or expand?

Chris Hutter

Eric, it is still concentrated. By the same token, we are beginning to penetrate new customers and that’s all part of running a developing business is that it’s going to be concentrated for a period of time here. And that’s why frankly I think you know when Rob asked this question about how orders are going to flow, when you are in initial stage with the customer, those orders kind of tend to be smaller. As they get comfortable with the product, as they get – begin to roll it out in the organization, it starts, those orders start getting bigger. And that’s kind of the challenge of growing a business over time is that you’ve got customers who are starting to buy, starting to buy big. That’s what we’ve got going on. At the same time, we are working hard to market our product and get in front of new customers and get them to move down that adoption cycle.

Sidney Hinton

One thing though, Eric, that I might point out just to add color on, our big customer represents in that business several bites of the apple. And I always say that from a validation of the value proposition that is continue to expand and they re-bid the apple. The – just from a validation of – would they make the same decision again, yes, well they have.

Eric Stine – Northland Securities

Okay, that’s pretty helpful.

Sidney Hinton

It’s not – when they I can't say. Or that we – it’s not our big DG customer. I mean I know people might have wondered is it – our big DG customer is also our big lighting customer and the answer is no.

Eric Stine – Northland Securities

Okay. Thank you very much.

Sidney Hinton

Yes, sir.

Chris Hutter

Thanks, Eric.

Operator

And your next question comes from the line of Rick Hoss. Please proceed.

Rick Hoss – Roth Capital Partners

Hi, guys, good afternoon.

Sidney Hinton

Hi, Rick.

Chris Hutter

Hi.

Rick Hoss – Roth Capital Partners

So, on that last question, when does your big DG customer become your big lighting customer?

Chris Hutter

Well, yes, we are not going to – we won't go there, Rick. I mean we are very protective about identifying specific customers and their strategies and so forth and so we’ll just beg off that question.

Sidney Hinton

Yes, one thing that I would say just to add a little color on that is for some of their stores they’ve already done, we were late to the dance in terms of where we were at, developing a light and when we entered the market. So of their – they’ve already done some of the solutions that we would now be out marketing. So, however, they are committed and in fact our recent acquisition actually designed some of the solutions that that particular client used for pieces of retrofit that we are now out marketing.

Rick Hoss – Roth Capital Partners

Okay. Okay, that’s helpful. Now, Sidney, how are you organizing the two LED or I am sorry the EfficientLights versus IES and where are the lines drawn, who can sell to who and – I mean how are you designing that?

Sidney Hinton

The – we have designed it with – in a – from a entrepreneur standpoint with – I would say they are not clear lines, but we’ve had clear conversations and that the conversations are one, that all activity around groceries, grocery stores, drug stores, and convenience stores that falls in EfficientLights. No matter where the product is made, the selling of that goes through EfficientLights. And then we transfer technology from IES to support that and that EfficientLights can ask for specific product help or specific solution ideas. That’s the biggest line we have from a broader – the only area of obvious overlap is the potential to overlap on street lights. And out thought there is that the differences will be aesthetic in design in nature and that we will let both take products to market, that they work collaboratively, a great example of what’s being done right now. Our EfficientLights perceives a great opportunity to come up with a new generation of street lights, they contact me and we conferenced into the IES team and they are looking to work collaboratively to let EfficientLights take their design ideas but also get IES help relative to drivers, thermal management and so forth and take advantage of the bulk buying opportunities on the LEDs themselves. And at the same time IES has their own design ideas and they will pursue those. And I am sure they will seek the help of the EfficientLights team just relative to, well, I can't think of the word, but the optics, managing the optics. That’s something that EfficientLights has been very good at. So those are exchange of best practices there. Is that helpful, Rick.

Rick Hoss – Roth Capital Partners

Yes, sure is. And then last one from me, Sidney, earlier you talked about international markets. Would you classify Canada as international?

Sidney Hinton

I would.

Rick Hoss – Roth Capital Partners

Okay. And so possibly some power package, medium speed type of applications (inaudible)?

Sidney Hinton

Well, we – I wouldn’t give any specific applications but we have gained traction in international marketing efforts to the point that we are at table – in conversations, honestly to us they seem like negotiations, but at the same time, just acknowledging that we are not that experienced in the international market, we don’t want to over categorize the state of the discussions. But we did want to mention it because we feel guilty not – or it would be awkward if we ended up winning something a month from now that – and we hadn’t tipped our hand that we working in the area. That being said, may be six months as well. But we have gained traction.

Rick Hoss – Roth Capital Partners

Okay, that makes sense. Appreciate it guys. Thank you.

Sidney Hinton

Yes sir.

Chris Hutter

Thanks, Rick.

Operator

(Operator instructions) And your next question comes from the line of William Bremer. Please proceed.

William Bremer – Maxim Group

Good evening, gentlemen.

Sidney Hinton

Good evening.

Chris Hutter

Hi, Bill, how are you?

William Bremer – Maxim Group

Okay. First question, let’s start of with Ronie’s division in the T&D line here. $4.4 million in Q1 here. Can you give me an idea was there anything low voltages, low voltage transmissions, may be the 69 kilovolt type of voltage that was performed or was this primarily distribution work?

Sidney Hinton

There was some transmission work in that, primarily distribution work. But there is some transmission work in there.

William Bremer – Maxim Group

Okay, that’s good to hear. Will there be some of this $15 million of CapEx deployed there, maybe possibly buying some cranes to help out margins in that space?

Sidney Hinton

You know there is definitely a – that’s a very insightful question. And that actually applies both in the distribution as well as in transmission. I would say as something that we are looking at is actually something we’ve had discussions with particularly one of our utility clients, because we think we can make money and save them money. But it’s a little early to tell. And if we do it, it would be used against the same criteria we used to measure others – other uses of capital against, i.e., we calculate the IRR, you know we have to be the highest in best use of capital to do it. But that is very insightful as it certainly as thought for potential use of capital.

William Bremer – Maxim Group

Okay. Let’s move over to the LEDs now. The two new products, the walk-in light for the coolers as well as the shelf light, now, through IES will they be actually manufacturing the lights or these would be bought from Cree and then properly rearranged by your expertise to fulfill what the client is looking for.

Chris Hutter

Well, let me just clarify for a minute. We buy the actual LEDs and yes we do use Cree they make great LED but the fact of the matter is everything else about those lights is ours, in other words the design, the light engine, the driver, we are sourcing that. Those component parts and designing that ourselves so the only thing we buy from Cree is the LED itself and the optics are all ours. And so it would be exactly the same way that we’d source the LED but it’s our design, our proprietary design that we bring to market that we think we’ve got a couple of good lights so we can have a good competitive advantage with that.

William Bremer – Maxim Group

Chris, will these be manufactured here in – domestically down in (inaudible) woods down there or will this be manufactured abroad?

Sidney Hinton

We actually are looking at manufacturing these domestically. That will be compared to the cost of doing it internationally. It’s certainly a premium from a marketing standpoint of being manufactured domestically today as well as IES one of the competencies they bring to the dance is manufacturing. But at this point it’s not resolved where the final manufacturing will rest, but it is an active question.

William Bremer – Maxim Group

So, these will be in third quarter revenues, both of these products?

Sidney Hinton

We anticipate that.

William Bremer – Maxim Group

Okay good. Alright. That’s all from me. Thank you, Sidney, thanks, Chris.

Chris Hutter

Sure.

Operator

And your next question comes from the line of Amit Dayal. Please proceed.

Amit Dayal – Rodman & Renshaw

Thank you, good evening, Chris, Sidney, congrats on another good quarter.

Sidney Hinton

Hi, Amit.

Amit Dayal – Rodman & Renshaw

First question to you Chris, in regards to the margin improvements, this is the second or third quarter you’ve basically come in, really beat us pretty nicely on the margins expectations. I know you have been conservative in managing those expectations. But do you think it’s time that we took margins out from a modern perspective or do you think there are areas where potential margins could come down going forward?

Chris Hutter

I definitely would not bring the margins out. I think you’ve got to stick, I think most people are in that low 30% range and I think that’s – that is the right answer now that you’ve gotten past this first quarter and have seen the – basically the virtual completion of those projects that we are – that we were doing such a great job on and drive – well really driving the gross margins and we will return to normalized levels here starting in this our second quarter. So, I definitely would not bring those out. I just add the word – I mean we do, we try to be conservative with what – we want people to be excited about the business, but we also want them to be grounded in reality of what it takes to execute a business successfully and so we have – I will – granted we are fortunate in our ability to beat some of those numbers recently but I certainly don’t hope that people don’t count on that as a pattern because that is not what we are trying to accomplish. We are trying to be as straightforward as we can in terms of what we see and what we expect.

Sidney Hinton

I would add though to Chris’ comments on gross margin. We definitely think they are coming down in the second and third quarters, but I don’t want you to hear that as that’s our goal. I mean that’s just looking at our backlog, looking at the components of it and modeling it out. This is not a theoretical guess and nor is it a goal. I mean we work every single day, everyday. That’s what our conversations are about, everyday, how do we get the margins thicker, how do we get them thicker. How do we add enough value to get more compensation from customers. That is the nature of what we do everyday, so our goals is to get them back up. But at this point we don’t think that – we know they are not sustainable at this level. We were blessed to get there through hard work, innovation and great engineering and great execution and we’ve done things that we hope lay the groundwork, to get back to these levels in the future, but we don’t anticipate that being the case in Q2, Q3. Not that we think those margins will be healthy. It’s just – the projects are in the queue, that’s just what’s coming.

Amit Dayal – Rodman & Renshaw

Okay. Thanks for the color. And in regards to your comment on the cash position $2 million as of today.

Chris Hutter

Correct. Correct, we’ve definitely invested particularly in inventory. That’s really the driver and it’s – and made an investment in the inventory, particularly for our EfficientLights orders that we are fulfilling as well as the purchase of our IES business, which was about $4.5 million of cash upfront.

Sidney Hinton

That’s cleaning up some receivables, traditional cash as part of the purchase.

Chris Hutter

Yes, we did put some working capital in the – yes, as well.

Amit Dayal – Rodman & Renshaw

I see. So, in the context of potentially having to take up some of the credit line, how should we be looking at operating margins for the next few quarters?

Chris Hutter

I don’t think – I mean we’ll – it’s possible that we could see some interest expense, some additional interest expense, but I frankly don’t think it will be a lot. I mean I don’t anticipate we’ll be into that line for really I mean it may be five or ten most million dollars. I doubt that we will be that high frankly, and we may not even go into it. I mean it really just depends on you know how the payment cycle works over the next month or so and that’s not going to generate a huge amount of additional interest expense in the next couple of quarters.

Amit Dayal – Rodman & Renshaw

Perfect, thank you. And in regards to the IES acquisition, when does your call option on the (inaudible) expire?

Chris Hutter

Well we have – basically the way the deal is set out we can exercise that call option starting in 2012 and then – but there is no limit to when we can exercise, so it basically provides protection for the IES team to grow and develop their business I mean have a period here to really ramp up and frankly we are obviously fine with that because that’s actually what we wanted and how it will happen as well.

Sidney Hinton

And there is put though at the end of it during 2014. There is kind of a – I mean if their view of the value of that business is different than ours they can force us to go through to sell the whole company in 2014, which obviously if we thought the company was worth buying that, the third, we would do, we have an unilateral right to do that at an agreed on formula for those 24 months starting in – at the first of 2012.

Amit Dayal – Rodman & Renshaw

Can you disclose that strike rate?

Chris Hutter

Well –

Sidney Hinton

It’s a formula.

Chris Hutter

Yes, I think, yes, basically, I think I can do it this way. It’s based on our earnings multiple and it’s at a significant discount to our – to basically our earnings multiple.

Sidney Hinton

They do get credit in the formula for some earnings that might not be readily apparent if you looked at our books. In other words, when we transfer our product to EfficientLights that’s done at cost. Yet they would get for the segments they serve under the formula they would get credit for the market value of that added back.

Amit Dayal – Rodman & Renshaw

Perfect.

Sidney Hinton

In other words, if we were saving $1 million on purchases between the two companies, they would get credit for that at the end of the day.

Amit Dayal – Rodman & Renshaw

Okay. Just two housekeeping question. You know, Chris, if you don’t mind, could you please go over the breakdown for the backlog, for the first – for the project based near term revenue? I couldn’t catch all of the percentages that you broke that out into – in terms of the quarters.

Chris Hutter

Sure. The $52 million of near term backlog, it breaks down as we think 40% will be in this quarter, or second quarter, again, it’s $52 million. 35% will be in the third quarter and 25% will be in the fourth quarter.

Amit Dayal – Rodman & Renshaw

Perfect. And one last question. The diluted share count going forward, do we just add another million shares to that?

Chris Hutter

Yes, that’s exactly right. You should pro rate it for this second quarter because we exercised, we completed a transaction on April 30th where you a month with this – with the lower share count and then you have two months with the million shares, but then for the third quarter you just add four million shares in the fourth quarter as well and then of course the year will be pro rated.

Amit Dayal – Rodman & Renshaw

Okay, perfect. That’s all I have. Thank you so much.

Chris Hutter

Great. Thanks, Amit.

Operator

Thank you. Ladies and gentlemen, there are no more questions in the queue. I would now like to hand the call back over to Mr. Chris Hutter for closing remarks.

Chris Hutter

Great, and I am just going to turn to Sidney for some closing remarks.

Sidney Hinton

Thanks, Chris. In summary, we are excited about our start to 2010, both in terms of the strong Q1 results as well as the pace of our new business awards. We are blessed to have an awesome team of people. We are hugely proud of their efforts and the strategic and the strong financial position that they have put us in. It’s great to see the business beginning to pick up and we will take steps to ensure that we are out in front as our pipeline grows. We want to thank our utility partners, our customers, our vendors, our banks, our Board of Directors, for their support and their belief in us. And we want to thank you, our investors for your support and financial commitment as well. We do not take your support likely and we are strongly focused everyday on serving our customers with excellent products and services, which ultimately is the driver of shareholder value.

Thanks all for your time. We appreciate your time this evening and we appreciate your interest in our company. Good night.

Operator

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

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Source: PowerSecure International, Inc. Q1 2010 Earnings Call Transcript
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