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EnerNOC Inc. (NASDAQ:ENOC)

Q1 2008 Earnings Call

May 7, 2008 5:00 pm ET

Executives

Will Lyons - Investor Relations Manager

Tim Healy - Chairman and CEO

David Brewster - President

Neal Isaacson - CFO

Analysts

John Quealy - Canaccord Adams

Ben - Stanford Group

Michael Carboy - Signal Hill

Paul Clegg - Jefferies

Richard Baxter- Ardour Capital

Elaine Kwee - Piper Jaffray

Nick Allen - Morgan Stanley

Colin Rusch - Broadpoint Capital

Operator

Good day, and welcome to the EnerNOC First Quarter 2008 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to the Investor Relations Manager, Mr. Will Lyons. Please go ahead, sir.

Will Lyons

Thank you, Tamika. Good afternoon and thank you for joining EnerNOC's first quarter 2008 investor conference call. Speaking today will be Tim Healy, EnerNOC's Chairman and Chief Executive Officer; David Brewster, EnerNOC's President; and Neal Isaacson, EnerNOC's Chief Financial Officer.

I'd like to remind everyone that today's presentation contains estimates and other statements relating to future financial performance and the future growth of the company's demand response and energy management solutions, including the company's ability to capture market share and grow its business in terms of megawatts under management, revenues, and gross margins that may constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions that are subject to both risks and uncertainties, and involve a number of factors that may cause actual results to differ materially from those indicated by these forward-looking statements.

Additional information concerning these factors can be found under risk factors in EnerNOC's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 28th, 2008. Please refer to our SEC filings, as well as our earnings release for a more detailed description of these risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

Though we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and, therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

With that, I'm going to turn the call over to Tim Healy.

Tim Healy

Thanks, Will. Good afternoon, everyone, and thank you for participating in EnerNOC's first quarter 2008 earnings conference call. EnerNOC appreciates this opportunity to discuss with its stakeholders our recent business progress and financial results, as well as the opportunities and challenges associated with being a first mover in our rapidly evolving industry.

Our strong start in 2008 and continued momentum demonstrates that we are effectively executing our strategy to become the energy management market leader. On this call, I will touch on two main discussion points. First, I'll discuss a number of positively trending financial and operating metrics that demonstrate attractive growth and scale in our business on our past profitability.

Second, I will discuss how energy has risen to become a C-level priority for many commercial, industrial, and institutional customers, and how EnerNOC is strategically positioning itself as a long-term preferred energy efficiency partner of these end users. We believe that these two discussion points illustrate how we are positioned to continue to drive disciplined growth in our business, capture market share, and capitalize on new large and profitable market opportunities as they develop.

Let's hit on some items with regard to our first theme by reviewing some key developments that reflect our financial discipline and continued track record of delivering strong results to our shareholders. Our first quarter performance, along with continued moment in our core business and growing receptivity to our new business initiatives, gives us confidence to reiterate the financial guidance that we recently issued in March.

As a reminder, that guidance was the following. We expect revenues to be $99 million to $105 million in 2008. We expect operating expenses to be $74 million to $79 million in 2008, and our gross margin to exceed our 2007 results. Finally, we expect to generate positive cash flow from operations in the second half of fiscal year 2009, and in 2010 will be our first full year of profitability. We believe that the first quarter of 2008 represents the latest in what we anticipate will be a series of building blocks towards reaching that milestone.

As it relates to the financial performance metrics, let's start with revenue. As Neal described more fully later in this call, we achieved first quarter revenue of $18.6 million, an 87% increase over our revenue in the first quarter of 2007. This year-over-year revenue growth is indicative of the fact that we continue to execute upon the plan to unlock multiple revenue streams by enrolling our CNI megawatts in capacity, energy, and ancillary services markets.

Our gross margin for Q1 was 34.8% compared to 29.1% for the same period in 2007. We're particularly pleased that we have achieved double-digit top line revenue growth year-over-year without sacrificing margin or diluting service levels to our customers. In fact, we're experiencing the opposite effect. In the midst of many companies, both small and large, announcing that they are entering the demand response industry, we're experiencing margin expansion, not compression, while continuing to grow rapidly.

We believe that this is evidence that our demand response offerings are differentiated in the market as a result of having highly trained expert personnel with extensive knowledge of various industry verticals, as well as patented technology and a full-service offering that sets us apart from new and existing competitors.

The favorable gross margin trends we've experienced over the past several quarters makes us comfortable also reiterating our gross margin guidance again today. Specifically, we expect to see greater than 36% gross margins for the full year 2008, which would be the second year in a row in which we've exceeded our previous year's gross margin.

Another key metric is our megawatts under management. At the end of March, we had 1,502 high-value megawatts under management, up from 1,112 megawatts at the end of 2007, an increase of 390 megawatts during the quarter. This represents the best quarterly performance in our company's history, beating our previous best quarter of megawatt under management growth by 70%.

To put this into perspective, EnerNOC added to our network the capacity equivalent of nearly four average-sized peaking power plants in just 90 days. We believe this performance is due in part to our decision in 2007, to increase our direct C&I sales force and operational enablement teams to their current levels.

We believe we are now better positioned than ever to cost effectively add valuable megawatts to our network in the regions where we operate and in regions where we are seeking to expand. We intend to have more than 2 gigawatts of reliable demand response capacity under management in our network by year end, and we are turning extremely well toward that goal. We believe we are positioned to drive rapid and meaningful system benefits for our customers and have an unparalleled track record for doing so.

Overall, factoring in seasonality, certain contractual elements and our typical deployment cycles, we estimate that we will have approximately 90% of the 1,502 megawatts that were under management as of March 31st, earning revenue for us by June 1, 2008.

As of the end of the quarter, we had just under 400 megawatts in PJM that were enabled and under management in our network, but are waiting to become billable starting on June 1 of this year, in accordance with PJM's market structure. We believe that this positions us to achieve very strong revenue results in the second half of 2008, keeping us on plan and on track to achieve the revenue guidance we have provided.

By adding all of the new capacity that we described, we simultaneously expanded our demand response customer base to 1,062 C&I customers across 2,864 participating sites. Figures which are up 34% and 31% respectively from December 31st, 2007. This means that we have made a significant number of new relationships with diverse energy decision makers at these sites, while further solidifying the relationships we have with our existing energy user customer base.

Our operating expenses were $18.2 million for the first quarter. A key metric to track, that we believe is indicative of our operating efficiencies and shows the leverage inherent to our recurring revenue model, is our megawatts under management relative to our total employee headcount.

As stated, we had 1,502 megawatts as of March 31st, under management, and we had a total employee headcount of 286 at that time. That equates to 5.3 megawatts under management per full-time employee. This metric was 4.4 as of December 31st, meaning it is taking us fewer employees to manage a growing base of megawatts under management. Out stated goal is to drive this metric to higher than 6 at the end of 2008.

We lost $0.57 per basic and diluted share during the first quarter, which is in line with our internal projections, given that we are in the midst of investing in our business to support its growth. Our people, business processes, and technologies are our three most important assets. Collectively, we believe they are the reason that we are able to be first to market with innovative demand response and energy management solutions and to quickly expand into new markets such as those in New Mexico and Florida last year and Texas and Ontario so far in 2008.

Overall, as I just described, the first quarter was another in a succession of quarters in which we continue to see the key financial and operating metrics of our business trend comfortably in line with our internal plan for the business.

The second discussion point that I want to touch on is how energy has risen to become a C-level priority for many commercial, industrial, and institutional customers. We believe that this is a market dynamic that favors EnerNOC's prospects for sustained growth. As I noted in the Chairman's letter that accompanied this year's annual report, I believe that energy is one of every company's five basic inputs along with land, labor, raw materials and tools. But in most cases, energy is the only one of these five items that is not actively managed. In fact, US corporations spend an estimated $194 billion per year on electricity, yet less than 1% of these companies make a significant investment in advanced technology to manage this expensive input.

We believe that all of the regulations, performance, and technology requirements and metering and verification needs inherent to the energy markets dictate that when companies want to actively participate in these complex markets, they will look to outsource these activities to a trusted third party. And to become an energy management market leader requires not only in-depth understanding of energy markets, but also an intimate understanding of the needs of energy users and energy providers.

So let's start with energy users. Our energy user customer base is operating in a more challenging economic climate than existed just six months ago. I mention this primarily because, we believe that this is something that actually helps our business. Let me explain.

In good economic times, businesses are more inclined to spend money on capital-intensive projects such as new energy efficiency equipment or major infrastructure upgrades. But in an economic downturn, budgetary restrictions have typically stifled investments in many areas, including energy efficiency and energy management.

However, this is where EnerNOC's value proposition really stands out. Partnering with EnerNOC to participate in demand response and drive energy efficiency savings does not necessitate any material out-of-pocket spending by our customers. We believe that the fact that our services do not create a new budgetary item and in the case of demand response actually generate a new source of cash flow, makes our services even more attractive for customers during an economic downturn.

To bring this point to light, let me spend a minute talking about a couple of customers in our own network. Cabot Creamery, makers of the world's best cheddar, as they say, has been actively enrolled in EnerNOC's demand response network since early 2007. With increases in both input and operational costs, Cabot evaluated a number of innovative strategies for preserving margins.

For Cabot demand response represented an opportunity to earn incremental cash flow, better control energy costs, and reduce its environmental impact while contributing to help solve today's global energy challenges. Earlier this year, Cabot was recognized for its efforts with a 2007 Demand Response Achievement Award from ISO New England.

Another example is that of Western Connecticut State University, which has been an EnerNOC demand response customer since 2004. WCSU signed up for EnerNOC's monitoring-based, continuous commissioning offering, enabling EnerNOC to integrate our PowerTrak software with WCSU's existing building management system to realize significant energy efficiency results. EnerNOC's PowerTrak technology platform continuously monitors and analyzes WCSU's energy consumption in detail and provides near real-time automated recommendations to WCSU on how to maximize operational and energy efficiencies.

WCSU and EnerNOC have identified 44 individual energy efficiency measures, 14 of which have been cost effectively implemented to date with little or no capital outlays. From these measures, WCSU has reduced electricity and natural gas cost by over $90,000. In total, the implementation of all the identified measures could cut WCSU's energy consumption by 14% and save approximately $250,000 per year in their energy costs. Recently WCSU was granted a prestigious Energy Project Award from the Association of Energy Engineers. This is the first monitoring base commissioning and demand response project to win this type of award for innovation.

So in good economic times or bad, demand response and energy management solutions can help businesses and institutions meet their objectives, to improve their financial condition, and enhance their business continuity planning. And ultimately, demand response provides us an opportunity to quickly and cost effectively establish a trusted business relationship with our customers who are seeking more energy efficiency solutions and an additional energy expense management advice from us, their energy technology solutions partner.

And what about energy providers. Well, demand response and energy efficiency is a C-level priority for these entities as well. Utilities and grid operators continue to plan in longer 5 to 10 year planning cycles, and now have to do so with the uncertainty of potential carbon legislation. Grid stability and electricity availability remain paramount regardless of the economic climate, and we believe that demand side management is becoming an increasingly important factor in preserving that balance.

Demand response with EnerNOC provides greater system reliability and reduces system cost, which benefits all rate payers. As such, we expect the momentum around demand response and energy efficiency to continue to grow. We like where we are positioning ourselves, as an energy management market leader, with more than just demand response to offer a customer base eager to find innovative ways to achieve their energy efficiency goals.

We further believe that our comprehensive presence from energy procurement to demand response and energy efficiency, as well as our award-winning technology and our exemplary performance track record will continue to differentiate EnerNOC from our competitors.

In summary, I just want to reiterate all that I've just described. We believe that our award-winning technology-enabled full-solution approach and our C&I focus market leadership continue to differentiate us in the marketplace even as that market becomes more competitive, and this is evidenced by our continued strong, organic, disciplined growth.

In addition, our advanced demand response management notification and control technologies have enabled our company to effectively administer this growth and drive increases in our operational efficiency. We are optimistic that our investments along our strategic roadmap, including our recently announced acquisition of South River, which David and Neal will describe in more detail, as well as other developments in our energy efficiency offerings are paying off and will position us to emerge as the market leader in demand response and energy management.

I will now turn the call over to our President, David Brewster, who's going to elaborate on some recent business and regulatory updates.

David Brewster

Thanks, Tim. Let me pick up where Tim left off by providing some additional details about the results we achieved in the energy management solutions part of our business. After that, I'll touch on some important industry trends.

We were excited to announce on May 5th, that we augmented our energy management solutions platform by completing the purchase of Baltimore, Maryland-based South River Consulting. South River is an energy procurement services and risk management advisory firm that we believe is an excellent fit with EnerNOC, both culturally and strategically.

This acquisition, which is the fifth in our company's history, is aligned with our strategic roadmap. More specifically, it's consistent with our vision to simplify the process of purchasing energy in restructured markets. The success in strengthening our high-margin energy procurement services offering through the acquisition of MD Energy last fall, gave us the confidence that it was the right strategic move to bring South River into the fold.

We believe that this acquisition will significantly strengthen our presence in the PJM interconnection region and will further enhance our already-strong energy procurement services offering and it will provide us with more opportunities to cross sell our demand response solutions to South River's existing base of over 200 commercial, industrial, and institutional customers. The addition of risk management advisory services is also an attractive component of this deal, as it further diversifies our portfolio of service offerings to our customers.

In a separate development, we further validated our position as a demand response market leader, by securing our second patent from the U.S. Patent and Trademark Office. This patent focuses on the complex aspects associated with the remote management and control of distributed energy resources, including monitoring, alarming, aggregation, cost allocation, data management, and reporting. We're very excited about this patent and the competitive advantages that it provides.

So why is our technology platform so important? We believe that it is because it enables us to manage the highest value megawatts by unlocking numerous revenue streams from each megawatt in our network. More specifically, the megawatts that we have under management earn revenue not only through participation and capacity markets, but also through the energy and ancillary services that they can provide.

We anticipate the emergence of more opportunities like PJM synchronized reserve market, which is a distinct example of how our technology advantage enabled us to be the first demand response aggregator to participate in a highly valuable ancillary services market. We are poised with the people, field-proven technology, and the know-how to capitalize on these opportunities to enhance shareholder value.

Our technology also enables us to be a first mover when new attractive market opportunities emerge. Recently we continued to diversify our company by commencing operations in two new important regions in North America. The ERCOT market in Texas and the Ontario Power Authority Region in Canada. These two regions represent relatively untapped opportunities for demand response and have stringent technology requirements and corresponding pricing that we think is attractive, particularly in Ontario where capacity prices are over $100,000 per megawatt per year because of performance, metering and verification requirements.

Shifting gears, I want to touch on some important regulatory matters. The highly regulated energy industry provides the same challenges today as it did when we founded this company back in 2001. Individual regulatory obstacles are and always will be par for the course in this industry. What's important is that we believe the overall regulatory landscape and broader market conditions continue to be very healthy and favorable for demand response. Although somewhat counterintuitive, we believe that the regulatory speed bumps that demand response has recently hit in New England and California, are a positive indication that the demand response industry has begun to come of age.

Of course, it is important to recognize and to work through the temporary speed bumps that we experience along the way. Specifically, we are working to find more agreeable outcomes for our PUC-denied contracts in Connecticut and California. We are also working diligently with ISO New England and the Federal Energy Regulatory Commission to try to find more beneficial course of action after the FERC upheld the market rule change to ISO New England's Day Ahead Load Response Program.

We are encouraged by some recent incrementally positive developments and public comments and maintain very positive relationships with the regulators who are shaping our industry.

On a macro level, we're encouraged by the overall trends regarding demand response and energy efficiency. Examples of some positive developments in the marketplace include the Federal Energy Regulatory Commission's Notice of Proposed Rule Making, or NOPR as it's called, which illustrates what a strong demand response advocate the FERC has become. The NOPR calls for the removal of certain barriers that prevent comparable treatment of demand response with supply side resources.

Removing barriers to demand response's participation in certain markets will create a fair, more robust playing field and will also provide EnerNOC more opportunities to extract additional revenue streams through participation and capacity, energy, and ancillary services markets. The real value of the NOPR from our perspective is the frequent and clear statements of policy that are extremely favorable to the demand response industry.

Another recent example of the positive regulatory trend happened in Colorado, where a local utility was recently granted permission to build a fossil fuel power plant subject to one important condition. And that is that it issue an RFP by this summer to retain one or more third-party demand response aggregators to manage demand response resources in its service territory. The Colorado Commission insisted that the utility put forth great effort to spur demand side resource growth. We believe that this type of conditional acceptance of new supply side resources is indicative of broader market trends of regulators wanting first and foremost to see utilities make more progress on demand response and energy efficiency.

Finally, and perhaps most significantly, Texas recently experienced what we believe will become an increasing challenge for grid operators and a growing opportunities for demand response resources as more renewable energy resources are developed.

In late February, a weather front caused a sudden and significant drop in wind speeds in Texas, depleting wind generating capacity and forcing the grid operator, ERCOT, to utilize emergency demand response resources to stabilize the system. Texas has approximately 4,000 megawatts of wind capacity online today and is expecting to double that capacity to roughly 8,000 megawatts by year end. We believe that the market expansion of these highly attractive intermittent renewable resources has the potential to increase the role of demand response as a critical supplemental resource to help grid operators and utility balance the supply and demand of electricity.

These examples are the latest developments that substantiate our claim that demand response not only works, but that customers and regulators alike are looking for ways to employ more of it.

In summary, we believe that the positive macro trends that we see provide a good indication of where the business is headed. We've invested in our people, our processes, and our technology. Our goal is to stay at the forefront of this evolving marketplace, and we intend to continue to lead the pack in terms of innovative demand side management practices. We believe this will position us to continue to deliver world-class energy management solutions to our customers well into the future.

I'll now turn the call over to our Chief Financial Officer, Neal Isaacson, who will provide details on our first quarter financial results.

Neal Isaacson

Thanks, David. We started 2008 on a positive note and are extremely pleased with our first quarter financial performance and continued fiscal discipline. During the quarter, we continued to organically increase our megawatts under management, which helped drive both demand response revenues as well as our energy management solutions revenues.

For the quarter ended March 31, 2008, we recognized revenues of $18.6 million compared to $10 million for the quarter ended March 31, 2007, an increase of $8.6. million or 87%. Sales of our energy management solutions for the quarter ended March 31, 2008, were $1 million compared to $300,000 for the quarter ended March 31, 2007, an increase of $700,000. This revenue contribution was primarily driven by our energy procurement services offering.

Specifically, we are now beginning to see the results of successful cross selling as evidenced by our 125% increase in quarter-over-quarter cross sell agreements signed from Q4 '07 to Q1 '08. This success is just one of a number of drivers that led to our decision to acquire South River Consulting.

Cost of revenues for the quarter ended March 31, 2008 were $12.1 million compared to $7.1 million for the quarter ended March 31, 2007, an increase of $5.1 million. Our cost of revenues continue to be driven predominantly by the capacity and energy payments that we share with our C&I customers, but also include communications cost and depreciation.

Our gross profit for the quarter was $6.5 million compared to $2.9 million for the quarter ended March 31, 2007, an increase of $3.6 million. Gross margin for the quarter ended March 31, 2008 was 34.8% compared to 29.1% for the quarter ended March 31, 2007.

In 2008, we plan to further enhance our margins by continuing to leverage our differentiation to keep a high percentage of the revenue we receive for aggregating our demand response resources. We also anticipate that increased traction of our energy management solutions platform will continue to contribute to our positive gross margin trend.

We continue to grow our business in this investment year and are simultaneously driving operating efficiencies. Evidence of this fact is our megawatts under management per full-time employee metric was 4.4 at the end of 2007, and 5.3 at the end of the first quarter 2008. We anticipate that this metric will trend north of 6 at the end of 2008.

We believe that our investments and technology and scalable systems will continue to pay dividends for our customers and shareholders, and will enable us to creatively serve evolving markets.

As of March 31, 2008, we had 286 employees, of which approximately 60 were C&I sales people and is right in line with the sales force number that we indicated a year ago we wanted to have at this time.

We have also nearly doubled the number of engineering resources we had at the time of our IPO, also in line with our strategic growth plan. This group not only continues to refine our technology to scale our network more efficiently, but also is building innovative energy efficiency technologies for our growing C&I customer base.

Furthermore, we have already experienced the benefits of this team's capabilities to create better, faster demand response capabilities as David alluded to in his example in which he described that we were the first third-party demand response aggregator to participate in the PJM synchronized reserves market. We are working diligently to continue to set the pace in terms of demand response and energy efficiency, market leadership and development.

Employee-related charges, including non-cash, stock-based compensation continued to represent the majority of our operating expenses. Our total operating expenses for the quarter ended March 31, 2008 was $18.2 million compared to $6.9 million for the quarter ended March 31, 2007, an increase of $11.3 million. Specifically, of these operating expenses, employee-related charges accounted for $11.1 million and stock-based compensation accounted for $2.2 million, totaling $13.3 million or approximately 73% of the operating expenses for the quarter.

Net loss for the quarter ended March 31, 2008 was $11 million or $0.57 per share basic and diluted, compared to a loss of $3.8 million or $0.91 per share basic and diluted for the quarter ended March 31, 2007. Let me a gain mention that our net loss includes non-cash, stock-based compensation charges of $2.2 million, representing $0.11 per share or 20% of the total losses for the period. These results are in line with our internal projections, given that we are in the midst of investing in our business to support our growth.

As David mentioned, on May 1st, 2008, we acquired South River Consulting for approximately $4.8 million, which included $3 million in cash and 120,000 shares of EnerNOC common stock valued at approximately $1.8 million, and other considerations.

We currently have 19.6 million shares issued and outstanding, and as of March 31st, 2008, there were approximately 19.2 million weighted average basic and diluted shares outstanding.

Our cash, cash equivalents, and marketable securities at March 31st, 2008, totaled $62.4 million, as compared to $85.7 million at December 31, 2007, which again is in line with our plan. Our strong balance sheet enables us to post the financial assurances required by our grid operators and utility customers with respect to upcoming capacity obligations. As of March 31st, 2008, these assurances totaled $27.4 million compared to $17.5 million at December 31, 2007.

As we enroll capacity in certain programs and contracts, a portion or all of these deposits will be released. So when you look at our cash position, it's important to understand not only the current cash balance, but also the amount of financial assurance deposits expected to be released in the near term. For example, we expect in excess of $15 million to be released in PJM during the second quarter of 2008, in accordance with program rules and contractual terms. As we have in the past, we intend to seek the most cost-effective means for financing these assurances moving forward.

We reiterate our 2008 financial guidance that we previously provided, including $99 million to $105 million in revenues, $74 million to $79 million in operating expenses, and better than 36% gross margin. We believe that we are on plan to generate positive cash flow from operations in the second half of 2009, and achieve our first full year of profitability in 2010.

In closing, during the first quarter, our team has again demonstrated that we have the ability to rapidly expand our business and cost effectively execute our plans along our path towards profitability. We are pleased with the increased efficiencies we are seeing from our investments in headcount and technology. We were able to organically increase our megawatts under management, reflect positive competitive advantages through expanded gross margins, and complete our company's fifth acquisition with the purchase of South River Consulting. We believe that we remain firmly on track on our path to profitability.

With that, I'll now turn the call back over to the operator, who will take your questions.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). We'll go first to John Quealy with Canaccord Adams.

John Quealy - Canaccord Adams

Good afternoon, folks. A couple of questions on the margin mix, if you could, in the quarter. You talked about three sources of revenue, capacity, energy, and ancillary services. Can you give us a characterization of where the margin uplift was in what would be a seasonally weak quarter, especially given the power markets? And perhaps also if you can give us an indication of geographic strength.

Tim Healy

Sure, John. Thanks. This is Tim. First and foremost, it's a combination of factors that are driving our margin expansion. And as we've mentioned in the past, what we're trying to do is enable high-value megawatts, bring those megawatts into the market with multiple revenue streams and combine that with adding additional value to our customers through some of the energy management solutions activities.

What we're seeing is that we are commanding a higher percentage revenue split as we continue to differentiate ourselves in the market. Part of that is due to the fact that when we go in and bring our expertise as well as our technology to bear in any sort of competitive situations, we find ourselves unlocking more megawatts for our customers and competing on overall value rather than on other metrics for our customers, such that the overall revenue split that we can achieve in those commercial and industrial relationships tends to favor a higher gross margin and continued expansion of our gross margins.

You combine that with some of the value-added activities in our energy management solutions business that continues to grow that has higher gross margin activities, and then you also combine that with some of the operational efficiencies because a portion of our gross margin activity is actually -- has to do with the enablement activity, cost of communication, etcetera. All of those things combined are what are driving our gross margin increases.

John Quealy - Canaccord Adams

And just in terms of geography, Tim, obviously you're New England centric in many ways right now. But most of the up-selling New England-based or are you getting some traction aside from the acquisition in the PJM side?

Tim Healy

Well, as you mentioned, we've added 390 megawatts in the PJM market. We continue to diversify. Diversification has been a key goal for us this year, and I think we're very pleased to see new markets open up in Texas and Ontario. We continue to expand and we're executing on our contracts in places like New Mexico and Florida. So we're seeing growth in New England, we're seeing continued growth in the regions that we're operating, and the activity that is happening in PJM gives us an awful lot of confidence that our solutions are applicable not just in New England where, as many people know we got our start several years ago with a very small contract, but is actually something that we're seeing across the country and now across North America.

John Quealy - Canaccord Adams

And just a second question. On productivity gains, if we can drill down on the C&I sales force, can you comment on what sort of productivity you're seeing, the weighted average of that sales force versus the older members who traditionally have done a lot of business and maybe the new members. How are those new members coming up to speed on megawatt generation and booking?

Tim Healy

Yes. Well, I mean, I think when we talk about some of the efficiencies, the operational efficiencies that we're seeing and the productivity that we're seeing, it's really overall. It's not just sales force productivities. It's modest efficiencies in the cost to acquire, the cost to enable, and the cost to maintain a megawatt. Our overall operating efficiencies has to do with expanding a larger and larger revenue base by growing our megawatts under management a lot faster than we're having to grow the headcount to manage that set of megawatts under management.

You asked a very specific question about the productivity of the sales team, the new folks as well as the experienced folks. I think what we're seeing is that the experienced folks continue to lead the pack, they continue to be very successful at training the new folks that are coming onboard. And I think we mentioned in our last call, and we'll reiterate it here, being a public company, achieving the amount of success that we've achieved, being as widespread as we are now, we're continuing to attract more and more and increasingly talented new folks to the team, but we still see that the training takes place over those first six months or so before our salespeople are fully productive.

But we like what we're seeing in terms of the overall trends, and that's really what we focus on.

John Quealy - Canaccord Adams

And just a last one, if I could, perhaps for David. In your conversations with public utility commissions, can you comment on what their time frames seem to be for adding demand response capacity? Clearly, in Connecticut they felt reserve margins were adequate for the near term. Can you comment on how focused utility commissions are on the near term versus the longer term reserve margin issues they have currently?

David Brewster

Sure. John, it's hard to give you a flat answer for that because the electric power industry is very regional. We don't deal with a single public utility commission. As you know, we deal with 50 different public utility commissions. So it's very much regionally driven by needs and by desires in those regions to really promote clean and new sources of capacity.

So it's hard to give you a set answer on that. But what we want to leave you with is something that's important is just that the overall trend of what we see is increasing attention to demand response, increasing support for demand response, and one really pertinent example of that that I talked about is the NOPR, the Notice of Proposed Rule Making by FERC. And there is overwhelming support in the NOPR that really I think influences public utility commissions and it really calls repeatedly to have demand response treated as a comparable resource to supply side resources for removing barriers so that DR can really participate effectively in all the different types of markets in the energy industry.

And so we like where it's going. Certainly some regions we see great uptake and others are becoming more and more educated and informed about the resource and overall we like the trend very much.

Tim Healy

John, I'd add, this is Tim. I'd add that what we are seeing is increased attention over the last several months as David pointed out on the earnings call, to the impact and the planning that needs to take place or the impact of renewable resources amidst very aggressive renewable portfolio standards. And we've heard from a number of officials that they continue to be excited about demand response's opportunity to very quickly become involved in these markets as more and more renewable intermittent resources that are non-dispatchable become a bigger and bigger part of their overall resource mix. And that is a trend that is, I would say a more recent development in terms of the way the mindset of public utility commissions as well as the system operators, and they've been reaching out to us to talk through those issues.

Operator

I'll take our next question from Michael Horwitz with Stanford Group.

Ben - Stanford Group

Thank you for taking my question. This is actually Ben with Stanford. Michael had to step away. I was wondering if you guys could update on the CPUC's guidelines that they recently released and how that would affect your program (inaudible).

Tim Healy

Sure. This is Tim. And before I give that over to David who can talk about the specifics and some details about the CPUC, I think one of the things to keep in mind that I hope we made clear on the call, but we'll reiterate is just, this is still a new industry that's coming of age. And I think the way we've got to think about this is that, demand response is becoming more and more important to system operators and utilities and grid operators and the public utility commissions. And they're basically starting to make some of the rules at the same time that these resources are actually playing a role in their market, simultaneously.

And so what we are seeing is us emerging, hopefully, as a thought leader, as we've seen, and being called into these discussions to help shape these cost-effectiveness methodologies and other things that are shaping the way folks like the CPUC are looking at, the value of demand response in their market and methodologies to essentially evaluate that value.

And in terms of specifically with CPUC, let me just turn it over to David who's been managing some of that activity specifically there.

David Brewster

Yes, and I'll pick up right where Tim left off in the sense that since the time of the CPUC's decisions in February, I think some good progress has been made in terms of the cost effectiveness model that's going to be used in California. I think it better -- now better values our type of technology-enabled demand response resources, which is a good thing.

It's also really important to recognize that we have an existing 40 megawatt contract with Southern California Edison, that's complete unaffected by the ruling in the CPUC in February. So we're still up and running and marching towards fulfilling that contract. So we continue to have great relationships with both SCE and the CPUC. We're renegotiating and going to re-file with the Commission for their consideration a new contract. We intend to do so this June. And we feel very good, both for our own contract and, just more generally, about the CPUC's support for demand response in California.

You probably saw Commissioner Chong and President Peevey who actually chimed in and provided some additional comments in that decision that really came out and outright said that California absolutely supports demand response. It's the second highest priority in their loading order behind energy efficiency. And Commissioner Chong in particular said that they absolutely advocated for more third-party developers to participate in the DR market in California. So we feel very good about it.

Ben - Stanford Group

Okay. Great. And then you talked about Ontario in your prepared remarks some. Are there other international markets, maybe even in other places in Canada that you're looking at where there are some capacity constraints?

Tim Healy

I mean, there are other international markets that as we continue to grow and people hear more and more about what we're doing here domestically and in North America, there are places like South Africa and ESCOM where you've seen highly publicized challenges that they're having with their electricity system and where they've essentially had interruptions to their electricity grid due to not having enough capacity resources and other challenges in that market.

For us, it's about our domestic growth right here at home, because the market opportunities that we see in front of us are, you know, they're big, they continue to grow, and we're incredibly well-positioned now with our sales force and enablement teams here domestically in North America to continue to take advantage of a growing market opportunity. And that's where right now we think we should be focusing the majority of our attention.

Operator

(Operator Instructions) We do ask that you limit yourself to two questions. We'll go next to Michael Carboy with Signal Hill.

Michael Carboy - Signal Hill

Good afternoon, ladies and gentlemen.

Tim Healy

Good afternoon.

Michael Carboy - Signal Hill

For Tim, I'd like you to elaborate a little bit on this sort of the legalistic way in which the FERC and NOPR actually influences the state behavior. To me, the FERC is more of a wholesale transmission -- has [throw weight] in the wholesale transmission market, not so much down at the distribution level. I'm wondering if you could elaborate on how the initiatives and the energy bill and now seeing in the FERC and NOPR, actually work their way down into the various public utility commissions. And --

Tim Healy

I'm --

Michael Carboy - Signal Hill

If you think there's a distinction between the way the PUC's operate and what the FERC's looking for, do you believe the FERC will ultimately leave it in the state's hands?

Tim Healy

I think that David Brewster wants to chime in here. But before he does, I guess one of the most interesting things for me in the last 6 or -- 6 or 10 weeks was when I was sitting on a panel with an official from the PJM Interconnection who was asked a fairly similar question, and he answered it basically saying, "We as the PJM Interconnection, are essentially -- we follow the mandate of FERC. And simply put, FERC is who guides us in terms of the way we are supposed to shape our markets." And I think that that is a theme that is shared. We've seen -- you asked another specific question. We've seen that after the EPACT of 2005, we saw a dramatic uptick in the number of public utility commissions that invited us in to describe to them some of the things that we were doing with innovative demand response technologies and solutions, to help them react to what that Energy Policy Act was demanding. And then I think we've seen the same thing in 2007.

But let me turn it over to David for some more specific comments to that effect.

David Brewster

So as Tim mentioned, regional transmission operators and independent system operators like PJM, New York ISO, ISO New England, in those deregulated or restructured market environments, FERC has direct authority. So the FERC is literally the regulator of those RTOs and ISOs. So there's direct oversight there. And policy statements and rulings from FERC are going to trickle directly down to those ISOs to market rule implementations and stakeholder processes.

It's a little bit more abstract in terms of state PUCs in traditionally regulated markets. But I think what FERC does is FERC sets the atmosphere. It sets the policy sort of environment in the atmosphere. It's a relatively small community of state public utility commissioners who frequently get together, and there is, from our experience, direct -- indirect movements that happen from FERC where the people really understand from FERC where the market's going and really then start to implement it. So it's more of a policy direction setting an atmospheric change than it is a direct oversight.

Michael Carboy - Signal Hill

Okay. And then --

David Brewster

It's interesting that FERC has recently sort of taken on and federal entities recently have taken on more sort of teeth in terms of some things like transmission planning and reliability, so. So we see sort of increased role as the federal government, in terms of maintaining the critical infrastructure of our national electric power grid.

Michael Carboy - Signal Hill

And for my follow-up question here, with regard to South River, are any of their customers currently enrolled with other demand response service providers?

Tim Healy

I don't believe so, but before I validate that, I'd like to go back and double check. We know that a number of their customers, because we mentioned that they've been working with us for quite some time, a number of their customers are enrolled with us already, which was part of the partnership process that we've had in place for a number of months, gives us some great optimism moving forward that those cross selling opportunities are going to continue to materialize. They have approximately 200-plus commercial and industrial customers. They're the types of customers that fit squarely in line with the type that we see adding to our demand response network, and we're pretty encouraged by the early results.

Michael Carboy - Signal Hill

Okay. And if I can just inch in one more here. You mentioned the $15 million of assurances that would likely flow back to you once [systems] turn on after June 1. Could you elaborate a little bit about on how those assurances work?

Neal Isaacson

Sure. This is Neal Isaacson. When we make a bid to put into an auction, a future auction, in order to make a bid, you have to post a financial assurance depending upon the size of your bid. Once we enroll that capacity, it would be released based upon various program rules. So we know what we're about to enroll in the PJM markets because we know what we sold. Therefore, we know how much of the financial assurance, and, in fact, in this case, the majority of the financial assurances will come back to us.

We've got a demonstrated track record of bidding capacity, achieving our bid, and receiving our money back. We get the benefit of being a public company because we have such a strong balance sheet. Our track record goes back to 2004.

Operator

We'll take our next question from Paul Clegg with Jefferies.

Paul Clegg - Jefferies

Hi. Hi, guys. Thanks for the call. Last quarter you gave us a little glimpse into the current quarter in terms of megawatts under management at the time of the call and of course, this is a subset of that, the megawatts likely to start generating revenues. Any chance we could get you to talk about that again, how it looks currently?

Tim Healy

We appreciate the question very much and understand that that's something that we provided last quarter, a little glimpse into what was occurring in the first quarter, just to give people a sense of what some of our goals and objectives were for the year.

What we've done since then is tried to help by providing financial guidance for the year, because really as we look at the business, it's much more helpful to look at the business on an annual basis. A lot of things can impact the quarterly timing of revenues. And so what we've tried to do is shy away from giving confusing numbers. 90% of the 1,502 megawatts that we have under management are going to be earning revenue on 6/1. There are megawatts on the sideline.

And in our case, we've been having a phenomenal first sales quarter. We believe it puts us squarely on track for an excellent second half of the year revenue-wise and again puts us right on our path to profitability as we've mentioned on the phone call.

Paul Clegg - Jefferies

Okay. Could I actually get you to talk a little bit more about pricing and how much visibility you have into pricing trends for the remainder of the year relative to this quarter?

Tim Healy

Sure. First and foremost, when we talk about pricing, we really talk about the value of a megawatt and the -- the value of our high-value megawatts in our network is something that we're seeing continuing to go up. And I want to talk a little bit about that. It's going up because of the fact that we're seeing us increase our capabilities to unlock multiple revenue streams from these high-value megawatts. We talked a little bit about it on the call, but let's just touch on a few things.

I'm talking about not just capacity value of our megawatts. If you get stuck on capacity value, you're missing some of the other parts of the value streams or the revenue streams that are coming in from us managing our megawatts in our network. There are ancillary services market opportunities for these megawatts. There are energy payments that we get, pay-ahead load response programs, system benefit fees that we're getting for our megawatts. So there are multiple revenue streams that we're unlocking.

And what we like is that things like the FERC coming out and indicating that we want to see demand response megawatts operating in more, broader, expansive parts of the market, give us great confidence that that's a trend that we're seeing moving forward.

And then the other trend that we're seeing at the same time is that the substitute resources or competing resources, the cost of new plants, new peaking power plants, natural gas costs increasing, the substitute resources and competitive resources give us a sense that overall we're seeing very positive revenue trends for our megawatts under management.

Operator

We'll take our next question from Richard Baxter with Ardour Capital.

Richard Baxter- Ardour Capital

Good evening. Good questions so far. Can you explain a little bit more about I guess customer retention for anybody that's come up on a contract this first quarter?

Tim Healy

Yes. Historically we've had and we've made a point to discuss that we've had a very enviable track record as it relates to our customer retention rates. We've had a relatively small sample size associated with that retention rate, but we continue to be pleased with what we're seeing again this year, as customers are coming up for renewal on various contracts across the country.

As we look at it and try to attribute what that's all about, we think that some of our energy management solutions activity is very appealing to customers that want to get involved with that as a next step with us. The information management activity that we're doing with them, the fact that we have all of that data, and the fact that we are in so many markets and continue to be in that market, plus another trend that gives us an advantage simply because of the business that we're in is that this really isn't a budgetary line item for them. It's not something that's getting flagged as they go back to put their budgets together as a cost item for them where they want to try to go out and bid it with multiple providers, they seem to be more inclined to stick with their current existing provider, provided we can continue to give them the high service.

Richard Baxter- Ardour Capital

Great. Thanks.

Operator

We'll take our next question from [Elaine Kwee] with Piper Jaffray.

Elaine Kwee - Piper Jaffray

Hi, there. I was wondering with regard to the cost effectiveness framework and load-impact protocols being developing by the California PUC, whether you guys are seeing similar sorts of double elements in other state PUCs, if there's any type of convergence that you're seeing in the regulatory world.

David Brewster

We are definitely seeing other states to try and better understand the value, the high-value attributes of demand response and really try and incorporate all of the transmission and distribution benefits, the environmental benefits. And we have not seen a lot of convergence in that. It's a very early industry. It's a young industry. I think states are grappling with that on a more independent basis. I think there's some sharing of best practices and transfer of methodologies. But we haven't yet seen a clear emergence of a standard cost effectiveness methodology. We've always been a thought leader in this area. We've always worked very collaboratively with state public utility commissions. We will continue to do that.

I think as one of the leading C&I demand response companies, you can be confident that we have a seat at the table when regulators are trying to really understand and develop these methodologies, but we're not there yet. When you look at the energy efficiency industry, there's very open and established cost effectiveness methodologies and we're not quite there yet from a demand response industry. But we are working very hard with the various public utility commissions and are making progress in terms of better capturing the full range of value and attributes of demand response resources.

Tim Healy

This is Tim. I think it's also important to understand, not every single one of our bilateral contracts that are in our pipeline necessarily will need approval post us executing those contracts, and we'll make it pretty clear which ones will be going through some sort of regulatory approval, which ones don't. Some get pre-approval ahead of time. So there's, as David just mentioned, there is no standard quite yet. It's an industry that's taking shape and it's exciting for us to have a seat at the table helping have that industry take shape, because we are a credible, trusted thought leader in the industry.

Elaine Kwee - Piper Jaffray

Okay. Great. And I was wondering if you could just comment a little bit on the opportunity that you see potentially for the California ISO market redesign and technology upgrade program, and whether that's going to be similar to the PJM opportunities that you have now.

David Brewster

Well, we hope so. I mean, we've been very actively involved in that proceeding and other proceedings in California. So we're working -- we have a regulatory affairs team that's well off the curb and involved in that proceeding. Hopefully the Cal ISO or the California ISO has an increasing role. Hopefully there's a vibrant ancillary services market that develops in California. We will continue to work that as aggressively as we can and continue to try and add value to California rate payers.

I don't think that there's going to be any immediate development from that proceeding. But it will be interesting to see how exactly the markets evolve in California, because California is sort of an interesting hybrid between a deregulated market and a traditionally regulated markets with the IOU and the Cal ISO.

Operator

We'll go next to [Nick Allen] from Morgan Stanley.

Nick Allen - Morgan Stanley

Good afternoon. Could you guys give a little color on the number of sales people you had? I think you talked about total headcount. But you guys have been bringing sales people on pretty rapidly, and I'm wondering how many you're up to and what number of those you would consider fully productive.

Tim Healy

So we did -- we did cover it. We only covered it once in our earnings call, so it may have -- may have just been pretty quick in and out of it.

We have approximately 60 at the end of the first quarter, which is right in line with the plan that we had put in place and articulated about a year ago. In terms of productive sales people, the number that we had at the end of the year was -- let me just get that number at the end of the year to give you a sense. I think it was -- I think it was 55, but I want to double check that and confirm that for you.

Nick Allen - Morgan Stanley

But was that fully productive, meaning that's every --

Tim Healy

No. No. And a number of those, again, you got to look quarter-by-quarter at the numbers that we've released. And generally we think it takes about six months for our sales team to get fully productive. And while I'm just gathering the data from our last couple of calls right here, we had 32 productive sales people Q4 and 36 productive in the end of Q1.

Nick Allen - Morgan Stanley

Okay. Good.

Operator

We'll go next to Colin Rusch with Broadpoint Capital.

Colin Rusch - Broadpoint Capital

Good afternoon and congratulations on excellent execution this quarter. Regarding your comments on the synergy of intermittent generation assets with demand response, are you working with any wind or solar project developers in prospecting business in any sort of joint marketing relationship?

Tim Healy

We are continuing to be involved in the stakeholder processes and talk to a number of players in the industry. We're not currently involved in any active projects, though.

Colin Rusch - Broadpoint Capital

Excellent.

Tim Healy

Let us correct an incorrect number that we just gave to you guys. The 36 and 32 numbers were another metric that we mistakenly gave. I apologize for that. The number of salespeople that we had on December 31st of this year was 55. And again, at the end of the first quarter, we had approximately 60. So we've added five additional folks. As you might imagine, those five folks are not going to be productive until the second half of the year.

Colin Rusch - Broadpoint Capital

Those other two numbers were --

Tim Healy

Were not numbers to use in any of the metrics that we've used in the past.

Operator

(Operator Instructions) We'll take a follow-up from Elaine Kwee with Piper Jaffray.

Elaine Kwee - Piper Jaffray

Hi. Just a quick follow-up on the sales force. It looks like with the impressive number of megawatts that you guys added this quarter, that the per-person productivity did experienced a bump. I was wondering if that was a sort of a one-time thing or if that's going to be an increase in the rate going forward.

Tim Healy

It's a good question. The productivity of a salesperson that I know a lot of people have written about and analyzed and discussed, has always been on an annual basis. And there are times of the year where, certain periods of the year where we have certain opportunities for one reason or another, contractual opportunities, overall opportunities in the market, the timing of the summer months being upon us in a short period of time, where we might see a quarterly up-tick in the productivity, but it doesn't necessarily indicate or suggest that the overall trend is going to be some sort of a quarterly run rate for those sales people.

We've, again, by giving annual revenue guidance, letting people know what we think this year is going to be overall in terms of our megawatts, in terms of in excess of two gigawatts under management, the revenues that we're achieving, we really tried to take some of the complexity out of modeling salesperson productivity and the timing of bringing sales people onboard and instead have tried to focus people on, these are how many megawatts we think we'll have in our network by year end, this is how much revenue we think we'll be achieving by year end, and then continue to update people as we go as to what that portends for the future.

Elaine Kwee - Piper Jaffray

Okay. Great.

Operator

We'll take a follow-up from [Nick Allen] with Morgan Stanley.

Nick Allen - Morgan Stanley

That's okay. My question was answered. Thank you.

Operator

There are no further questions at this time. I'll turn the conference back over to Mr. Tim Healy for any closing remarks.

Tim Healy

Thank you very much. In closing, we feel we're off to a great start in 2008. We brought in a record number of new megawatts this quarter, which is going to have a positive impact on the second half of the year. We view our customers' successes like those we talked about with Cabot and Western Connecticut State University, as a great reflection of the value we bring to our C&I customer base. Most importantly, we're executing against our overall plan to become the market leading provider of energy management solutions, and that the macroeconomic and regulator trends all favor our position in the market.

We really appreciate everybody's time today and the thoughtful questions, and look forward to continued updates in the future. Have a great afternoon.

Operator

And that does conclude today's conference. We thank you all for your participation and you may now disconnect.

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