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RGS Energy, Inc. (NASDAQ:RGSE)

Q2 2014 Earnings Conference Call

August 19, 2014 4:30 PM ET

Executives

Dennis Lacey – Chief Executive Officer

Tony DiPaolo – Chief Financial Officer

Analysts

Philip Shen – ROTH Capital Partners

Joshua Baribeau – Canaccord Genuity Inc.

Jeffrey Osborne – Cowen and Company

Evan Richert – Sidoti & Company

Operator

Good afternoon and thank you for joining us today to discuss RGS Energy’s Second Quarter Ended June 30, 2014. With us today are Dennis Lacey, the company's Chief Executive Officer; and Anthony DiPaolo, its Chief Financial Officer.

Following their remarks, we will open up the call for your questions. Then before the conclusion of today's call, I'll provide necessary cautions regarding forward-looking statements made by management during this call.

We would like to remind everyone that this call is available for replay through August 26, 2014, starting later this evening. A webcast replay will also be available via the link provided in today's press release, as well as available on the company's website at rgsenergy.com.

Now I would like to turn the call over to Chief Executive Officer of RGS Energy, Mr. Dennis Lacey. Sir, please go ahead.

Dennis Lacey

Thank you. Good afternoon, everyone. I am very glad to talk to you today as the new CEO of RGS Energy. I am thrilled about the opportunity because I believe in the future of RGS. I have had the good fortune during my career of being part of multiple successful business turnarounds, something I believe we can accomplish here. In brief I’ve been instrumental with three turnarounds of public companies and different industries. Equipment leasing, QSR restaurants and call centers. In each of these situations the companies were stabilized and returned to profitable operations and their stock prices increased very nicely.

In fact two of those situations have a direct correlation to our future plans. One being to use call centers to reduce customer acquisition costs. And another being adding leasing to our product set as a new source of income. There are certain common themes to all business turnarounds. And there are eventual pathways to financial health. Usually these involve a focus on the basics, blocking and tackling well if you will. In our case we are not going to be pursing the acquisitions of other EPC companies; we are going to focus on pricing discipline and efforts to streamline costs and improve operational efficiency. Our plan is to take the appropriate steps to return the company to profitable operations at a point they’re in 2015.

We are already taking steps in this direction. We closed three offices and location where the circumstances are such we cannot operate at a profit. These type of the cost saving actions will improve our go forward results. In addition I am glad to say we are making progress in leasing, we have built up the internal infrastructure to handle this and just started the beta test in one of our West Coast offices and already have signed contracts with customers. I have served as the President of our Residential Division since April and have had the good fortunate of visiting each of our residential offices and meeting our employees.

I was very impressed by our employee’s dedication and the numerous ideas and suggestions they brought to my attention to improve our business. Many other ideas will be incorporated into our go forward plans. As you can tell from the segment disclosure included in our second quarter report the gross margins in our residential business are much higher than our commercial business. The commercial marketplace has been undergoing pricing pressure from financiers and developers moving into the EPC space, forcing down pricing. As such on a go forward basis I expect us to devote significantly more of our resources to residential than commercial.

Turning to the quarters results themselves, obviously these results are simply unacceptable to us. As I mentioned we will be sticking to our knitting and be laser focused on improving our core business, in particular our residential business as that appears to have the greatest potential for future profitable growth. Specifically, we will be adding to our sales organization on the West and expanding our East Coast operational capacity. We’ll be integrating our recent acquisition of Sunetric in Hawaii, for instance we will be introducing leasing in that location. We will be evaluating all aspects of our business to reduce costs while continuing to provide a positive customer experience and in fact a better one.

We’re in the midst of team building and strategic planning and are optimistic that the outcome of those activities will galvanize our organization to improve financial performance. Our Board of Directors is solidly behind the company, its management and our strategy. While we certainly have a lot of work to do I’m extremely excited about this opportunity and the future for RGS. My optimism, I based in part on the good progress we’ve been making in the residential segment as I pointed out in the press release there are improved close rates, higher ASP, increased backlog et cetera.

Tony will review with you now the numbers and we both will be available to answer your questions following that. Thank you. Tony?

Tony DiPaolo

Thank you, Dennis and good afternoon everyone. As Dennis said our results for the quarter are not acceptable to us. The financial tables in our press release provide a concise and complete summary of the quarter’s financial results. So I’ll keep my comments brief. Of course the full disclosure in our report on Form 10-Q presents more information and we encourage everyone to read that report. I would like to start with a review of our reportable segments. We have three primary segments: Residential, Commercial and Sunetric.

Let me start with residential segment. Our main focus going forward is going to be residential including our in-house lease financing option. Our residential revenue increased nearly 50% from the same period last year making this segment the most promising one for the future of our company.

Now turning to the commercial segment it recently has come under more pricing pressure which has reduced our margins significantly. This pricing pressure is coming from developers and financiers who’ve established greater control over projects in the downstream EPC market, which has resulted in fierce competition for EPC work and consequently significant declines in gross margin percentages.

In addition, sales in the construction backlog have been disappointing we sold $10 million for the first half of 2014 in contracts resulting in a declining backlog through June 30. As disclosed in our press release, we recorded an impairment charge of $18.8 million this quarter to reflect the declining value of our commercial business arising from the factors I just discussed.

Now, on to Sunetric. Sunetric was acquired May 14, and that segment is included in our results from that acquisition date. Our results include amortization of acquired intangible assets associated with the Sunetric acquisition of approximately $400,000.

I’ll turn now to the warrant accounting, which is complex and essentially reflects the mark-to-market of the carrying value of our warrants to their respective fair values. The fair value of the warrants is driven by the stock price of the company primarily that does include other valuation model inputs.

The impact of those inputs is that generally and the stock market price for our shares increases, we’ve reported change in the non-cash expense of an increase in income, when our stock price decreases, we report the change as a non-cash increase to income. Our stock price decreased over the course of the second quarter and consequently we recorded a $6.1 million credit to earnings for this quarter for that change in fair value.

Moving to the balance sheet, our working capital increased $1.1 million since the same time last year. On July 9, 2014 we raised an additional $6.4 million of proceeds through the sale of shares in a private placement financing transaction. Going forward we will be managing our business to operate in a positive cash flow manner and we feel through collection of receivables, conversion of inventory and other elements of our business that we can influence. We will have enough cash flow to operate our business going forward.

At this point I would like to turn the conversation back to Dennis.

Dennis Lacey

Thank you, Tony. Admittedly, we have placed ourselves in a position where we really have to get very tactical and focus on running our business well and profitably. Fortunately, we have an outstanding brand name, internal know-how, and employees with the ability and desire to build a profitable company. We also have in our favor the fact that solar is still in its early days. Customers are delighted by the benefits of solar both financially for them and for the good of the planet.

We also have our legacy; we’re the pioneer in this space and have been around longer than the warranty of many of the solar installations we have completed. Our longevity and the fact we wrote the book on solar, resonates very well with our customers. And it all starts with our sales reps serving our customers wealth. As part of our go forward plan, we will develop resources both current and new resources we free up from cost saving initiatives to ensure we deliver on the promise to our customers by growing our sales force construction capability and training and supporting them well.

Without being redundant I have been fortunate with my past turnarounds and see no reason why we’ll not be successful here. As I’ve said, I’ve met most of our employees in person, and I know they are supportive of the cause as is our Board of Directors. I look forward to updating you on our progress in upcoming quarters. Now operator we will take questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) And we will take our first question from Philip Shen of Roth Capital. Please go ahead sir.

Philip Shen – ROTH Capital Partners

Hi, guys. Dennis congrats on your new role and thanks for taking my questions.

Dennis Lacey

Thank you.

Philip Shen – ROTH Capital Partners

I like start off with guidance, I think back in July you guys issued updated guidance of 55 megawatts to 65 megawatts in 2014. Given the change in leadership what is your latest thinking on the guidance and volumes for the year?

Dennis Lacey

Yes, Phil. Well, being new to the role, and in the process of adjusting our operations for future profitable operations on a go forward basis this is not the time to be providing guidance. But however I can say we certainly plan to operate our company – operate on a profit in the future, but we’re not going to be giving guidance at this time.

Philip Shen – ROTH Capital Partners

Okay. And I know you guys talked about targeting EBITDA breakeven by Q4 as well, so is it fair to say that’s off the table as well?

Dennis Lacey

Phil as I said, so we’re not going to be giving guidance at this time. The question of when one gets to breakeven is a factor of sales and your cost structures, our cost structures to breakeven number changes. So, like I said we’re in the process of putting together our plans so that for next year, we are going to operate with the plan and the intention to operate at a profit, but we are not going to give any discrete date that we get to breakeven.

Philip Shen – ROTH Capital Partners

Okay. Perhaps you can speak loosely about the mix of residential versus commercial business, I know with the focus on residential now, what do you expect our mix to be and are we thinking about maybe 20 mix something or what are your thoughts there?

Dennis Lacey

Well, I suspect going forward it’ll be more residential than commercial. As I said we’d like to develop more of our resources to that business, which has a much higher gross margin.

Philip Shen – ROTH Capital Partners

Okay. In terms of your operating expenses this might be one for Tony, how do you expect OpEx to change hopefully start thinking about models as, I think you closed three offices you have further plans to close additional offices and ultimately what should we model in for OpEx in Q3, Q4?

Dennis Lacey

Yes, so let me handle the tail end of your question, we have no current plans to close any other offices, but closing those three will have an impact on both OpEx and COGS because some of those employees were in operations. And as I mentioned in my scripted comments, we’re going to be looking at areas [inaudible] as where we can improve on our cost structure. Tony, do you want to add to that.

Anthony M. DiPaolo

No, I think that’s a complete answer.

Philip Shen – ROTH Capital Partners

Okay, great. I’ll jump back in queue. Thanks.

Dennis Lacey

Thank you.

Operator

And we will move on to Josh Baribeau of Canaccord.

Joshua Baribeau – Canaccord Genuity Inc.

Hi, thanks. Could you talk a little bit about what that - what your customer acquisition cost is now and then maybe where your goals are going forward?

Dennis Lacey

Sure, the company we really never had a history of disclosing the precise amount of our customer acquisition cost, and to my experience and history so far I’m not sure everybody calculates at the same, I mean do they have, which elements go into that calculations. So I’m not really sure how long we’ll go about that, but clearly that is one of the areas we’re very much focused upon. We are going focus on the margin line and we have plans to do that, but equally important is reducing our cost of acquisition that’s why I mentioned in my scripted comments about our focus on the call center, I think it’s the lowest cost way to deliver results. So, we’re very focused on that; we’re exploring a variety of marketing ways to go about getting a low cost of acquisition per close exploring several avenues along that line; it is clearly one of our top focuses in the company at this time.

Joshua Baribeau – Canaccord Genuity Inc.

Okay, maybe switching gears a little bit then, talk about the residential lease program, I know that you had been working with partners before with the residential leases, could you tell me a little bit or can tell all of us a little bit about how that’s new program might differ if you are financing things internally or if you’re just using different partners or maybe what some of the structure could look like?

Dennis Lacey

Sure, we intend as we are in the crawl, walk, run stage, I would say right now for leasing. We’re starting off on a beta test basis. We’ll expand some more markets as we go forward, but while we’re still doing that we’re going to be continuing to use the partners we use today to place transactions in fact, since our intention is to continue to grow our sales force that means there should be ample business from our existing financing partners plus those that we will keep on our own balance sheet.

Joshua Baribeau – Canaccord Genuity Inc.

Okay. And then maybe…

Dennis Lacey

I’m sorry.

Joshua Baribeau – Canaccord Genuity Inc.

I didn’t want to interrupt you is that.

Dennis Lacey

No, no, go ahead it was a false start.

Joshua Baribeau – Canaccord Genuity Inc.

Okay. And then, yes, so lastly for me I’ll change gears once again, any impacts from the ongoing trade war between the U.S. and China, maybe talk a little bit about some of the contracts you have in place that protect you from some of the potential price increases?

Dennis Lacey

Well, we announced I guess a month or two ago about our partnership with Solar World, and we think that puts us in a pretty good position strategically, [tech] [ph] price, we think that their price is competitive. And by the way we think it kind of resonates well with lot of our customers [indiscernible] product.

Joshua Baribeau – Canaccord Genuity Inc

Okay, great. Thank you all. I will pass it on.

Operator

And Jeff Osborne of Cowen and Company has our next question.

Jeffrey Osborne – Cowen and Company

Great. Good afternoon. I look forward to working with you Dennis, just a couple of questions on my end I was wondering if you can talk about the regional trends and if you could name the three offices that you closed, and particularly with the backlog growth, is there any one geography that’s driving that or is it more widespread?

Dennis Lacey

We have focused on the meeting in California and the East Coast we’re doing very well. So, it was in the Colorado and Missouri where those offices were closed.

Jeffrey Osborne – Cowen and Company

Okay. And then is there any regional mixes that you’re seeing with that backlog growth in terms of the legacy Mercury acquisitions versus Sunetric versus your West Coast presence. And I guess what’s trending maybe above expectation versus behind on the residential side in particular?

Dennis Lacey

Well, on the residential side, I think, I made reference it is on the press release, we’re delighted by our East Coast sales team, I think they might have so more than our current ability to install this quarter exist. So as a present problem that have. So we’ve been doing very well on the East Coast. Hawaii is new to us one of the couple of months encouraged about that like a team. We would like the market and literally small, but we like the economics there. So, we forget about those particular locations.

Jeffrey Osborne – Cowen and Company

Excellent, is there buyer start leasing from a geographic perspective or is that West Coast versus East Coast for solar or that’s just kind of slowly, but really gaining market share in terms of installations in each of those regions and sub 10 kilowatt systems?

Dennis Lacey

Yes, it’s going to be that crawl, walk, run approach that you’re referring to and we’re going to start in California and Hawaii and the Missouri go from there.

Jeffrey Osborne – Cowen and Company

Okay. Any sense of perspective and when you will be running is that 12 months to 18 months process or 6 months process or do you just happen….

Dennis Lacey

It will stretch into 2015.

Jeffrey Osborne – Cowen and Company

Okay, perfect. And then maybe a question for Tony or yourself, but could you give us a – you highlighted the backlog growth is fantastic, could you give us a sense of perspective of past year or two entering a quarter how much of the reported revenue is typically covered with the backlog?

Tony DiPaolo

Yes, so our lead time on the residential side or typically in the 75 day to 90 day range. So what I would mean is that the backlog that we exit the June quarter with, we’re typically be fully built in the next quarter we’ll convert to revenue in other words.

Jeffrey Osborne – Cowen and Company

Gotcha. Perfect, I think that’s going to do it for me I appreciate the answers.

Tony DiPaolo

Thank you.

Operator

And now we’ll go to Evan Richert of Sidoti.

Evan Richert – Sidoti & Company

Good afternoon, guys. First, if you could just talk about, I guess first Dennis your thoughts on the call center would you be targeting certain geographies and matters that just going to initialize?

Dennis Lacey

What are the other natural resources if you will we have at the companies are large installed base. And so that’s a natural group to call into for referrals et cetera and since we had a lot of installations in California on a legacy basis, we clearly have the call center focused on California.

Evan Richert – Sidoti & Company

Okay.

Dennis Lacey

We also certainly East Coast too, but I’m just saying as a leg up in California for us.

Evan Richert – Sidoti & Company

Sure, sure. And then can you talk about your thoughts on using third-party installers?

Dennis Lacey

Yes, we do use third-party installers and we would continue to do so. If we want to maximize our gross margin percentage we need to find the light blend of in-house crews and third-party integrators. So that we minimize our downtime with own staff, so we can sort of flex up and flex down using third-parties. But we have a rather robust integrator program where they do some qualifications and testing, because after all reflects on our reputation. And we have a whole [indiscernible] around third-party integrators to the short, we serve our customers well and protect our reputation.

Evan Richert – Sidoti & Company

Sure, I guess what I’m just getting out there. Do you see that the coming of bigger role going forward, or I am just staying in line with what you’ve done recent – for using third-parties?

Dennis Lacey

Yes, I think that might vary by individual office. I’m not sure the overall trend made change as much we have circumstances like we had recently with a large growth in areas, we will certainly use more third-party integrators at that point. I think results will vary by offices and by quarter.

Evan Richert – Sidoti & Company

Okay, fair enough. And then on the residential side for the customers that you do quotes for if you could just touch on what are they most sensitive to and other words if you’re losing add on an install is that typically because those installation price or that financing, how do you see that competition?

Dennis Lacey

Sure, well I think we’re competitive and customers do shop the deals, I don’t think we get many salesforce deals. Although on a fall situations, it is interesting. My reaction would be I think price is always important and I think we’re price competitive, we also have to have the product they want some, it varies by location. But some people are wealthy and they could pay cash, some can only do the lease, some are okay with the loan it varies. So, we have a wide pallet, if you will of options that we can offer to people. But I think it seems to me like it somewhat neck-and-neck between price and confidence in the provider, people will check around and look for references and that carries a lot of weight. So, I think those are the two biggest factors and forcing with track record, and play out well on those scenarios.

Evan Richert – Sidoti & Company

Okay. And then last question for me and then I’ll hop back in the queue. You talked about your background and previous roles as far as turnarounds go. Can you talk a little more detail about how long each of those lasted and how long you see yourself in this role at RGS?

Dennis Lacey

Well, I’ll take that last one first, I see myself on the solar long time.

Evan Richert – Sidoti & Company

Okay.

Dennis Lacey

I like the [indiscernible] I think solar is good, I like the message, I like doing – green is good, I like the people. And I see myself doing this for a long, long time. In terms of how long these take, they always take some period of time. At least a year I think before you really see something. Because there is a certain degree of realignment you have to do within a company and other changes you have to make. And it’s kind of like the old outage of changing the tires in the car, while the car is still moving. So, it takes sometime to engineer properly within years normally a timeframe that look to.

Evan Richert – Sidoti & Company

Okay, guys, thanks I’ll hop back in the queue.

Dennis Lacey

Okay.

Operator

And at this time this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Lacey. Sir, please proceed.

Dennis Lacey

Thank you. Thank you for joining us today and we look forward to updating you on our progress in the future. Thank you.

Operator

And before we end today’s presentation, I would like to take a moment to read the company’s Safe Harbor statement that provides important cautions regarding forward-looking statements.

This communication includes forward-looking statements relating to matters that are not historical facts. Forward-looking statements may be identified by the use of words such as expect, intend, believe, will, should or comparable terminology or by discussions of strategy. While RGS Energy believes its assumptions and expectations underlying forward-looking statements are reasonable, there can be no assurance that actual results will not be materially different.

Risks and uncertainties that could launch materially different results include, among others, failure to successfully launched residential leasing platform, the possibility of negative impact from weather conditions, ability to attract and retain an adequate sales forces, contract disputes, introduction of new products and services, completion and integration of acquisitions, the possibility of negative economic conditions and other risks and uncertainties included in RGS Energy’s filings with the Securities and Exchange Commission. RGS Energy assumes no duty to update any forward-looking statements.

I would like to remind everyone that this call will be available for replay through August 26, 2014 starting and about two hours. Please refer to today’s press release for dial-in replay instructions. A webcast replay will also be available via the company’s website at rgsenergy.com. Thank you for joining us today for our presentation. This concludes today’s call. You may now disconnect.

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