Orion Energy Systems, Inc. F1Q11 (Qtr End 06/30/10) Earnings Call Transcript

Aug. 5.10 | About: Orion Energy (OESX)

Orion Energy Systems, Inc. (NYSEMKT:OESX)

F1Q11 (Qtr End 06/30/10) Earnings Call

August 05, 2010 5:30 p.m. ET


Victoria Paris - IR

Neal Verfuerth - CEO

Scott Jensen - CFO


Glenn Wortman - Sidoti & Company

Brian Kremer - Roth Capital Partners

Jeff Osborne - Thomas Weisel Partners


Welcome to Orion Energy Systems First Quarter 2010 Earnings Conference Call. (Operator Instructions). This call is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the call over to Victoria Zebras. Victoria, you may begin.

Victoria Paris

Thank you JJ, and thank you for joining us for Orion Energy Systems fiscal 2010 first quarter conference call. With me today on the call today are Neal Verfuerth, Chairman and CEO and Scott Jensen, CFO. Please note a copy of the presentation used on today's call is available in the investor relations section of Orion's website at www.oriones.com.

Before we begin, I will read the Safe Harbor statement. Our remarks that follow including answers to your questions include statements that we believe to be forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are generally as such because the context of such statements will include words such as believe, anticipate, expect or words of similar import.

Similarly, statements that describe future plans or objectives or goals are also forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. These risks include among others, matters that we have described in our press release issued this afternoon and in our filings with the Securities and Exchange Commission. Except as described in these filings, we disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly conference call if at all.

Now I'd like to turn the call over to Neal.

Neal Verfuerth

Thank you Victoria. Welcome everybody to the Orion Energy Systems' fiscal 2011 first quarter conference call. As you saw on the press release we issued this afternoon, we are pleased to report first quarter contracted revenues or bookings of 18.8 million, up 22% from the 15.4 million in the prior year's period. First quarter contracted revenues or bookings included 14.7 million in cash deals and 4.1 million in finance deals from OTA and PPA technology contracts.

Given that there has been some confusion in the past around the term bookings, I wanted to spend a few minutes redefining the term going forward as contracted revenues. To be clear, these are deals that are under contract. The design and engineering work has been completed. The product has been built and are purchased and are typically producing megawatts and/or kilowatts to our customers and recurring revenue to Orion within 90 to 180 days.

Given the execution of our strategy to increase the adoption of our supply agreements, the OTA and PPA, we truly believe that contracted revenues are a key performance metric that more accurately reflects the traction we continue to make with our customers.

During the quarter we recorded a GAAP loss of $0.05. Scott will go into more detail on that momentarily but again, given the increasing number of deals being completed through our financing solutions we believe that providing a non-GAAP reconciliation for EPS more properly reflects the financial impact of these contracts, particularly as it relates to the cost associated with the customer acquisitions.

Thus in combination with reported of our bookings or contracted revenues going forward, we will also provide you a non-GAAP EPS number which should give you a more meaningful accurate way of evaluating our current and future business performance.

As such during the quarter we reported a non-GAAP loss per share of $0.02. However, on an annual basis, given our solid performance during the quarter as well as the increased activity we are experiencing in various stages of our pipeline, including some sizable deals, we're confident that Orion's technology will continue to excel in the marketplace, outperforming competitors time and time again, in spite of the continued uncertainty in the general macroeconomic environment.

As such we are reaffirming our fiscal 2011 guidance of contracted revenues of a 100 to $110 million, GAAP revenues in the range of 78 to 85 million, GAAP EPS in the range of $0.02 to $0.10 and non-GAAP EPS in the range of $0.25 to $0.33 per share.

Our suite of products deliver permanent distributed load reduction and renewable generation allowing our customers to take themselves off the grid by reducing the waste of the facilities during peak time hours and then supplementing that with renewable generating assets positioning Orion as a leading power technology enterprise.

Our priority going forward is to build up on the success we have seen to-date and expanding our partner channel and giving more feed on the street that are trade and selling and servicing our technology the Orion way.

We continue to believe that this channel will be key to our long-term success as it allows us to scale our business more economically and effectively on an end market basis. Our growing product or operating which has of second quarter now includes and LED lighting platform of demand response solution and a new metering application with our InteLite wireless controls all compliments our existing products.

The integrated lighting solution, external lighting product and affordable Tyack and finally the continued adoption of our innovative finance solution. Before I go into detail around these key growth initiatives let me highlight a few drivers of this quarter's performance. In the first quarter we retrofitted nearly 37 million square feet, 250 facility bringing our total coverage to 923 million square feet across 5870 facilities throughout North America.

To-date we have delivered on our promise sending our customers a total of $935 million in energy cost while reducing their consumption by 12.1 billion kilowatt-hours as well as reducing their carbon dioxide emission by 8.1 million tons since 2001.

Top line performance in the quarter was driven by increasing order volume as we ramped up our wholesale and partner driven side of the business. In the first quarter our partner network contributed 53% of our revenues. We continue to dedicate resource to building our wholesale network providing our partners with the tools that are necessary to drive growth within their businesses.

On the national account side we continue to make significant strides completing sizable projects for new and existing customers. During the first quarter we had more than seven new national accounts from companies that maintained leading market positions across a wide range of industries which represent a significant opportunity for future business.

The new customer wins and continued traction with existing customers in the first quarter continued to demonstrate our market leadership as an energy expert and further validates the compelling value proposition of the Orion solutions by saving customers significant dollars and energy cost and helping them achieve their sustainability goals.

Moving to growth initiatives let me first touch on our expanding partner channel and we are aligning the business to take advantage of a significant opportunity head for Orion. As you can see on slide six we made significant progress in building our geographic footprint, as of today we have elite partners strategically aligned and located across the country.

Each partners adding people within their networks that are trained in selling and servicing our technology the Orion way. In fact, our partners have doubled the feet on the street in just the last 12 months.

This channel will continue to bring significant value and enable us to build and scale more economically and efficiently going forward. In addition, margins from this channel are inline with our retail channel if not more favorable. We fully expect the total number of new partners to continue to grow over time and our focus on enhancing the effectiveness of them through training programs at Orion University in teaching them to sell and integrate the technology the Orion way.

Second, with regard to growing our product portfolio, we continue to capitalize on the opportunity for exterior lighting product to expand in the businesses that traditionally would not deploy our Hi-Bay technology indoors but have substantial savings opportunities in their parking lot areas.

Moreover we nearly doubled the number of installed outdoor fixtures in the first quarter. Our outdoor lighting solution, while still a small part of our overall revenues, represents an immense opportunity for Orion with an estimated 20 million outdated HID parking lot lights in North America.

As an example of our superior technology in this space, one of our large existing national accounts recently conducted a bake-off in the exterior product category which included LED competitors and induction lighting. Not only did they praise our products but recommended them for future implementation to facility managers throughout their footprint.

In addition to the exterior lighting technology market, we have the potential to capitalize on enormous opportunities as we build our renewable product offering, which includes our affordable Tyack or PV technology and our partnership with Solyndra.

We saw three substantial new products get underway during the quarter. Our 1:37 (inaudible) technology offering is a logical extension of our core business, positioning us a complete energy management company and enables us to meet the demands of our customers.

I want to quickly highlight a few of our newest offerings that deliver permanent distributed low reductions under Orion's suite of services and products. Recently we announced a deal with PJM Interconnection, a regional transmission organization that coordinates the movement of wholesale to deliver this natural demand response into the PJM system which includes the mid west and the eastern United States.

While this will only be small portion of our overall business in the near term, our long term plan has always been to enter in demand response business over time. Our primary competitor advantage that we take to the market with this offering is the fact that we do not have the significant customer acquisition cost as many of our competitors do, given our existing large installed base and our penetration in the more 5,800 facilities, commercial industrial facilities across North America uniquely positions us as a trusted resource to supply the revenue and energy savings and deploying DR can delver to our customers.

We've also been utilizing our InteLite controls to enable customers to better monitor their energy usage throughout the manufacturing process, creating better management tools and profiles under energy consumption during peak and off peak hours down to each individual piece of equipment. As an example, we've had discussions with large industrial conglomerates in which energy spend was one of their top three expenses.

While they may not want to reduce that spend, they not only want to reduce that spend, excuse me; they're also looking to meter this because you can't manage what you can't measure. So giving the ability to actually measure the amount of energy used kilowatt\hour specifically and put that across to the overall finished goods is a powerful tool given the amount of money these companies are spending on energy. As a market leading technology, our advanced wireless metering allows our customers to effectively and efficiently track and monitor their total energy usage down to the final product.

And finally, we launched our LED lighting platform designed to reduce energy consumption and cost in freezer applications. There has been an increasing interest in LED and after two years of R&D with collaboration or in collaboration with many of our LED components suppliers, our LED platform addresses the thermal and optical considerations that have challenged the wide spread adoption of LED light sources.

In fact Orion's modular LED technology significantly outperformed best of breed industry peers at facilities using existing HID lighting. Orion's LED lighting delivered more light while using less energy than the competitors LED and the HID lighting legacy product that was in the customer's facility. Ultimately, operating at a higher rate of efficiency and the result for our customers is better lightning and significantly reduced energy spent.

Lastly let me touch on the momentum we see building for our innovative finance solution. More, more of our new and exciting customers opt into our order and the PPA supply agreement and to-date they have supported these agreements with the cash on our balance sheet recognizing that our financing solution is becoming the adoption, the option of choice for our customers and will be a critical element in our business going forward. We have been pursuing several financing alternatives to provide funding of up to a $100 million specifically to support our financing activities in the OTA and PPA contracts.

In addition, I think it is prudent to give a general overview and update of Orion asset management which will begin to play a larger role in our financing products. Our wholly owned subsidiary of Orion Energy Systems, Orion Asset Management works with utilities, grid operators, commercial industrial companies to leverage financial energy and environmental mechanisms.

Orion Asset Management provides program development consultation, ample market research for a capacity sizing and load potential, educational programs for end users, customer acquisition strategies and measure and verification.

Orion Asset Management will continue to create effective customer financing products as recently started to experience strong momentum to raise project financing. Ultimately asset management will have responsibility over financial products which includes OTA and PPA and emissions monetization whatever form that may take.

A compelling aspect for this is that unlike other people at this space the emissions piece is a bioproduct of what Orion technology already delivers. Orion's future remains bright; our current pipeline is strong and robust. We have confidence in the significant opportunities that lay ahead through for us.

As I mentioned earlier we have seen a strong uptick in the overall activity within our pipeline from initial cost to customers to delivery of the ROI proposals and ultimately closing the sale. This increased activity is a reflection of our strategy to increase the number of feet on the street as well as a more refined approach to managing the sales process across our channels with our new CRM tool.

We are excited for the opportunities that we lay ahead for Orion, going forward we'll continue to execute on our growth initiatives throughout fiscal 2011 allowing the company to maintain and extent our market position while also providing the noteworthy returns for our shareholders.

With that I'm going to turn over the call to Scott Jensen. Scott?

Scott Jensen

Thank you Neal. Our reported revenues for the first quarter of fiscal 2011 were $14.7 million compared to $12.6 million for the first quarter of fiscal 2010, representing an increase of 17%. This increase was driven by increased order volume in our partner and retail channels on a slightly improving purchasing environment within the market.

Our customers are reengaging in discussions around energy savings opportunities as they continue to shift their focus from evaluating the need for a facility to managing operating costs within those facilities.

As Neal mentioned partner revenues for the quarter were 53% of our total revenue up from 27% of total revenues in our most recent fourth quarter. The increase in contribution from our partner channel was driven by increased momentum gained in our partner expansion efforts, increased partner deal closings and improved market conditions.

Contracted revenues or bookings for the quarter were $18.8 million, including 2.2 million for Orion throughput agreements and 1.9 million for solar purchased power agreements. That compares to the 15.4 million in the prior first year quarter, which included $2.3 million for OTA contracts.

As a reminder on how we define contracted revenues, let me briefly review. Our reported contracted revenues have three components. First our cash component is based upon customer purchase orders received in hand.

Second, our Orion throughput agreements are based upon the gross future revenue streams over the expected life of the agreement. We consider an OTA as contracted revenue upon the customer's execution of the contract agreement. In most cases we expect that our OTA contracts will be generating monthly revenue within 90 days from the contract signing.

With regard to our solar power purchase agreements which are generally in excess of 10 years, we have defined PPA contracted revenues as the discounted value of revenues from energy generation over the life of the agreement along with the discounted value of revenues anticipated for renewable energy credits for as long as the programs are currently defined to be in existence with the governing body.

Again our PPA contracts are contracts in hand and our expectation is that they generally will begin to generate monthly revenue within 180 days from the contract signing. During the first quarter of fiscal 2011 we secured 26 new Orion throughput agreement megawatt supply contracts representing gross income streams of $2.2 million. Revenue for these customer projects, once completed will be recognized across the 24 to 60 month term of the agreements.

Service revenues accounted for 8.3% of our total revenues for the first quarter. We will continue to expect to see a decline in the ratio of service revenues to total revenues as the percentage of our partnered product only sales increase.

Our blended gross margin for the first quarter was 35.7%, up from 27.7% in the comparable prior year period. Our gross profit dollars increased to $5.2 million for the first quarter of fiscal 2011, compared to 3.5 million in the first quarter of fiscal 2010. Our margin improvement was a result of the cost reduction initiatives implemented last year which included headcount reductions and efficiency gains based upon the redesign of our production assembly processes.

G&A expenses for the first quarter were 2.9 million or 20% of revenue, versus 3.2 million in the first quarter of fiscal 2010 or 25% of revenues. Year-over-year decreases in G&A costs were a result of reduced compensation expenses, due to headcount reductions and other discretionary spending decreases.

Sales and marketing expenses for the first quarter of fiscal 2011 were $3.6 million or 24.4% of revenues compared to 3.2 million or 25% of revenues in the prior year period. As we've discussed on prior calls, we've continued to invest in revenue generating opportunities.

The increase in expenses from the prior year was due to compensation costs resulting from headcount additions and technical resources to support our controls and exterior product offerings along with an increase in customer and channel marketing expenses which included collateral materials for our expanding partner network and participation in industry and customer trade events. Our R&D expenses for the first quarter were $610,000 or 4.2% of revenues up from 419,000 or 3.3% of revenues in the first quarter of fiscal 2010.

This increase in spending was due to head count additions in our product development and engineering group and our continued investment in the development and refinements of new lightning product renewable technologies.

Our loss from operations for the first quarter of fiscal 2011 was 1.9 million decreasing from loss from operations at 3.2 million in the prior year period. Our income tax benefit for the first quarter of fiscal 2011 was $904,000 versus an income tax benefit of $393,000 in the prior year first quarter.

Our annualized effective tax rate is estimated to be 46.2% based up on our current year projections for taxable income, the impact of permanent and temporary differences for tax purchases which includes the impact of non-deductible stock option expense.

Our fully diluted loss per share for the first quarter of fiscal 2011 was $0.05 on weighted average shares outstanding 22.5 million shares. The compares to fully diluted loss per share for the first quarter of fiscal 2010 of $0.13 and a weighted average shares outstanding of 21.6 million shares.

As Neal highlighted we believe that providing an non-GAAP reconciliation for earnings per share properly reflects the financial impact of Orion's OTA and PPA contracts and the expectation for increase in finance contract volumes in future periods.

Orion expenses all SG&A cost as incurred related to the customer sale and administrative cost of a financed contract while deferring the revenue recognition from these contracts over the full life of the contract term including annual renewals.

These up front costs reduce near term profitability as revenue in gross profit are recorded on a monthly basis under GAAP in future periods.

Non-GAAP earnings per share as presented restates the financial statement impact in the accretive earnings impact of discounting future operating contribution margin dollars from these financed contracts into the fiscal period where the contract was executed.

We believe that providing investors with a non-GAAP earnings per share pro forma calculation in addition to our contracted revenue number will give the most meaningful way of evaluating our current and future business performance.

As indicated on slide 12 of the presentation we have presented the pro forma impact of the discounted OTA and PPA contracted revenues from our first quarter of fiscal 2011.

On a non-GAAP basis these contracts would have provided an additional accretive $0.03 of earnings per share and reduced our loss per share from $0.05 to $0.02 per share during the quarter. Looking at the full year for fiscal 2011 and incorporating the mid-point of our annual guidance range and our expectation for 20 to 25% of our contracted revenues to come from financed contracts on a non-GAAP basis the pro forma impact of the discounted earnings from these financed contracts provides an accretive $0.23 per share for fiscal 2011 and provides a non-GAAP earnings range per share of $25 to $0.33 per share.

As of June 30, we had 22.6 million common shares outstanding; in addition we have warrants and options totaling 3.8 million shares outstanding. Turning to the balance sheet, we finished the quarter with 17.2 million in cash and equivalents in short term investments on hand, compared to 24.4 million at March 31st 2010.

We continue to maintain our investments in short term highly liquid vehicles to provide for maximum liquidity. In June we completed a new $15 million credit facility with JPMorgan Chase bank which provides additional liquidity as the borrowing base collateral is secured by working capital assets, namely accounts receivable and inventory.

Related to our cash flows, cash used for operating activities was 4.6 million during the quarter, driven primarily by our net loss and our investment in inventory. Our inventories grew as we neared the completion of our initial build out of our wireless product offering. These electronic components which are manufactured overseas have delivery lead times in excess of 18 months.

Additionally we were able to benefit from a pricing opportunity on a $1.5 million solar inventory purchase with the expectation that the customer orders will be received in our fiscal 2011 second quarter. We remain committed to continuing to invest in the growth of our financed equipment programs and in the first quarter used $1.7 million of cash to produce an install our energy management technologies and renewable technologies within our customer base.

Turning to our outlook for the full year fiscal 2011, we are reaffirming our previously stated fiscal 2011 guidance. As a reminder, our reason for moving to annual guidance was driven by two primary factors. First, as we have always noted, we view our business from a long term perspective and annual guidance is more reflective of that perspective. Second, with the improving economic environment, we believe that visibility has improved somewhat, giving us more confidence to provide any annual outlook.

Additionally, given the increase in contribution that we have witnessed from our OTA and PPA supply agreements we believe that contracted revenue bookings are more reflective of how we view our performance.

For fiscal year 2011, we continue to anticipate total contracted revenues to be between 100 and 110 million and for the year we anticipate our finance deals to contribute to total contracted revenues in the range of 20 to 25%. As a result, we expect revenues for fiscal year 2011 to be in the range of 78 to 84 million.

As we have stated in the past, given that our customer base has historically been focused on the commercial and industrial sector, our results tend to mimic CapEx budgeting which leads to an increase in committed projects towards the end of the calendar year. As a result, as we move through fiscal year 2011, we expect to see the greatest contribution to our bookings coming in our fiscal second and third quarters.

Earnings per share for fiscal 2011 are estimated to be between two and $0.10 per diluted share with the achievability of this range being highly dependent upon the percentage of revenue realized from OTA and PPA supply agreements. On a non-GAAP basis, earnings per share for fiscal 2011 are estimated to be between 25 and $0.33 per diluted share.

With that, I would like to turn the call over to the operator for questions.

Question-and-Answer Session


(Operator Instructions). Our first question comes from Glenn Wortman. You may proceed.

Glenn Wortman - Sidoti & Company

Yeah, good evening everyone.

Scott Jensen

Hey Glenn.

Neal Verfuerth

Hey Glenn.

Glenn Wortman - Sidoti & Company

Okay, a couple of questions. First on the cash position, I say that decreased $7 million. Where do you see that cash balance going as you move that to fiscal year.

Scott Jensen

That's good question Glenn, it certainly will be highly dependent upon the continued expected increase in our financed solutions and offerings to our customers and as Neal mentioned a key driver for our desire to go out and raise some debt capital to support that program. Our spend on inventory has stabilized as we near the completion of our initial purchases around our wireless product offering and the very lengthening lead times right now for any electronic components coming out of Asia.

So, we are feeling more optimistic on our operating cash flow changes and paying very close attention to being able to support our growth within the financed product sales.

Glenn Wortman - Sidoti & Company

Okay and just looking at the gross margin, it seems to jump around a lot; it showed a significant sequential improvement this quarter on lower sales. Can you just help us understand that results and how should we think about that?

Scott Jensen

Yeah I think as you recall on a quarterly basis if you look back to mid-last year second and third quarters as a result of the cost reduction projects and opportunities that we put into place to really help reduce headcounts and stabilize some of the premium costs that we have referred to in the past which, when you have a short lead time delivery really can impact your business to get products to the customer up on your promise.

We are encouraged Glenn by the results again on lower revenue product volumes that we were in access of 36% product margin and we believe that we have got the staffing levels and the process efficiency improvements in place to support that level of gross margin and improve up on it as revenue volumes increase.

Glenn Wortman - Sidoti & Company

Okay and then just I don't know, what is your difference in your OVPP and the OTA agreements?

Neal Verfuerth

It's really, this is Neal, it's a branding issue. Just as we have had this program in place for many years we are drilling down, what's the best way to package it and it's started all that way actually as a customer kind of stated early contracts this is kind of like a power plant and it just seem to add clarity and just simplify it and allow for customers to get their arms around the concept more readily by going to the throughput agreement.

And there is actually little more tie end with the PPA.

Glenn Wortman - Sidoti & Company

Okay and just kind of focusing on the OTA and OVPP agreements, do you think either sales that you otherwise will not get; you think they are cannibalizing otherwise more conventional sales?

Neal Verfuerth

Absolutely not. I think its allowing customers; again they are the same thing. It's allowing customers to forego the typical CapEx budgeting requirement and get the technology deployed and just take advantage of the cash flow that they provide and the other thing that we like about it is I think it helps us retain the margins that we are looking for here because the customers are not buying anything and even inclined to try to get you down in price because again they are not buying anything. The key here is getting the system installed as quickly as possible so realizing the cash flow.

Glenn Wortman - Sidoti & Company

Okay. Thank you for your time.

Neal Verfuerth

Thank you.

Scott Jensen

Thank you Glenn.


Thank you. Our next question comes from Brian Kremer. You may proceed.

Brian Kremer - Roth Capital Partners

Can you hear me?

Neal Verfuerth

Hello Brian.

Scott Jensen

Hey Brian.

Brian Kremer - Roth Capital Partners

Hi. You're continue on the OTA I guess and the PPA. In previous calls you would normally comment on if we hadn't sold these through those financing mechanism, this is how much revenue we would have recognized. I'm assuming that number is slightly different than the number that shows up now and bookings, contracted revenues versus, the bookings versus the contracted revenues with OVPP and PPA, is that or?

Scott Jensen

Yeah Brian, let me answer that question. It is slightly different; call it on the revenue side. What we've tried to really accommodate now is be consistent with the bookings or contracted revenues, definition and account for that in terms of deal contract volume but think about the impact of the OVPP and the OTA on a non-GAAP basis. Again that too, all of the costs related to sell that product, administer the contract are going through our P&L and our operating lines as incurred but the revenue being deferred over a longer time, we felt that the real benefit of a non-GAAP exercise to that or the way to look at it was to discount the revenue opportunities of the contribution margin backwards.

Brian Kremer - Roth Capital Partners

Okay, and now towards the end of the call you talked about 26 new throughput representing 2.6 million in revenue over the next 24 to 62 months. Is the 4.1 million that you provide in the non-GAAP versus the 2.6, is that existing throughput contracts?

Scott Jensen

Its all new contracts. So its $2.2 million. So throughput contracts closed or contracts signed within the quarter and 1.9 million of our purchase agreements signed within the quarter and we've taken those revenues and discounted them back. Again if you think about it, almost treating them as if they were a cash sale on a discounted basis.

Brian Kremer - Roth Capital Partners

Got it. Okay. And what, you're forecast 20 to 25% of sales or of the contracted revenues from the financing part of our business. If we look back for us and then investors trying to compare apples to apples and I think it would be, I think the reason you're moving this direction obviously is because a larger percentage is moving into financing which could skew potentially the top line a little bit. Year-over-year, where do you think that number has moved up from? If we look at last year, fiscal year 2010, on a percentage basis when we look at the 20 to 25% this year graded is on a larger top line as well.

Neal Verfuerth

Correct, so if you just look at the first quarter Brian with the 41 on the 18.8, that's almost 22%. Last year on an annualized basis related to our contracted revenues or bookings number we were a little below 15% I believe.

I don't have that right in front of me but its continuing to grow and we expect that based upon the behaviors we're seeing and the customers very strong interest in that as a solution for them and in lieu of no capital budget existing for some of our customers that's a great way to get our product technologies adopted into an initial facility and set the stage for rollouts and expansion of new technologies.

Brian Kremer - Roth Capital Partners

And then obviously you have talked in the past about still trying to inside internally strategically how you deal with these. You have sold some already and I assume that might be part of the strategy going forward. Could you talk a little bit about that as well as what happens at the end of the life of this contract.

I forgot now, does the ownership is it transferred?

Scott Jensen

So I will start, so your second question Brian the asset ownership transfers to the customer, but we are encouraged by the opportunities that once maybe, once they have adopted the lightning technologies through a retrofit and we reach the end of that first OTA contract. We now the opportunity to go back and introduce wireless or outdoor or continue to almost extend that contract with new technologies and extend the term of the recurring revenue opportunity and then your first question really from I think a strategic standpoint what are we thinking about in terms of near term and long-term.

As Neal mentioned we have engaged a party to go out and raise some money to help support these. Along the lines of really equipment finance we would have that capital available to us and we would deploy it on a project basis and we think that has a better earnings potential than selling these often at a significant discounted rate. So, that would be our first choice and our primary strategy right now as we look at the opportunity.

We still reserve the right to bundle these if we think it makes sense and the financial makes sense.

Brian Kremer - Roth Capital Partners

And maybe the last one on this is you obviously have a small number of these out right now but as you go out over the next year or two the number of pieces of equipment out there that you guys own under these programs and you will get to the end of life I guess actually it will be a few more years out. Still I am just curious where you then seem as with other companies doing something similar, will you take deprecation at that point. How does the depreciation work?

Scott Jensen

We are depreciating these assets over the life of the contract.

Brian Kremer - Roth Capital Partners


Scott Jensen

Equally, we have capitalized the asset on our books since we own it and we are depreciating it over whatever the term of the contract is, so if it's a 24 month contract the depreciation is 24 months.

Brian Kremer - Roth Capital Partners

Okay and then real quick just from the operating expenses. I know you have said, you have made some investments here. The G&A it has bounced up, it bounced up last quarter and now it has back down. I mean are these specific cuts, is it just one time items, how do we look at that going forward?

Scott Jensen

Yeah the fourth quarter as a point of reference we had some significant one time type charges in there related to the legal settlement and the accrual that we set aside for that along with some severance costs. It has we did it in the first quarter had some staffing changes and some head count reductions and related to that there was a small component of severance about a half a penny of severance cost in the quarter. I'm expecting Brian that that's going to settle and come down a little bit from the first quarter results.

Brian Kremer - Roth Capital Partners

Okay. And then R&D, obviously it looks like that's not one where -- you can that kind of maintaining these levels. I don't expect you guys to keep bringing that in too much from the sound of things.

Neal Verfuerth

No we actually went out and increased our staffing around R&D product -- both the product development group and the engineering group as a function of all of the new product offerings that we've got in place right now and the technology offerings that we have as it's expanded outside of energy efficiency and management solutions to renewable.

Brian Kremer - Roth Capital Partners

All right, great. Appreciate it.

Scott Jensen

Thanks Brian.


Our next question comes from Jeff Osborne. You may proceed with your question.

Jeff Osborne - Thomas Weisel Partners

Great, good evening. Most of my questions have been answered. Just two quick ones. How should we be thinking about what type of interest rate you guys would be exposed to with the partners that you've hired on that side?

Scott Jensen

We're still; we're targeting Jeff, less than double digits.

Jeff Osborne - Thomas Weisel Partners

Okay. I think for your GAAP accounting you had a 7.5% cost of capital. I wasn't sure if that would be kind of consistent with what you're seeing or not.

Scott Jensen

Yeah, it's in that range. It's in that range. We just want to make sure we know what our cost of capital embedded in the deal and we want to protect profitability and make the best use of capital that would be coming in to help fund these.

Jeff Osborne - Thomas Weisel Partners

Understand. And sort of on the same lines, its just at the board level, is there any type of limit in terms of exposure that the company or the sales force is allowed to have to OVPP and PPA, that delta on contract revenue versus recording revenue and how much capital you want to tie up. I guess what I'm asking, is there a bit of a pause or a maximum limit that is in place until this financing is secured?

Neal Verfuerth

We have really the right reviews on one off basis any deal for a wide variety of reasons. Obviously the first almost the credit approval but also just to see that it makes sense and we're very proactive on the front end, just business we're really soliciting that would fit into the profile for this. We've got a lot of lines in the water Jeff right now as it relates to raising capital and we do still have the old traditional options in selling these deals out as we've done in the past but it's just the cost of selling these things out, given today's credit environment it's expensive. So, that's always our fall back position.

Jeff Osborne - Thomas Weisel Partners

Understand. Thanks so much.

Scott Jensen

Thank you Jeff.


Thank you. I'm showing no further questions at this time.

Neal Verfuerth

Okay, thanks operator.


You're welcome. Ladies and gentlemen, we thank you for participating in today's conference. This concludes the call. You may now disconnect. Have a good day.

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