PowerSecure International's (POWR) CEO Sidney Hinton on Q2 2014 Results - Earnings Call Transcript

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PowerSecure International, Inc (NASDAQ:POWR) Q2 2014 Earnings Conference Call August 6, 2014 8:30 AM ET


John Bluth - Senior Vice President, Investor Relations and Corporate Communications

Sidney Hinton - Chief Executive Officer

Christopher Hutter - Chief Financial Officer


Eric Stine - Craig-Hallum Capital Group

Rob Brown - Lake Street Capital Markets

Joe Nelson - Maxim Group

Ben Kallo - Robert W. Baird

Matt Koranda - ROTH Capital Partners


Good morning, ladies and gentlemen, and welcome to the second quarter 2014 PowerSecure International, Inc. earnings conference call, hosted by John Bluth, Senior Vice President of Investor Relations and Corporate Communications. My name is Benny, and I'll be your event manager this morning. (Operator Instructions) And now, I'd like to hand it to John Bluth. Please go ahead.

John Bluth

Thanks, Benny, and thank you all for joining us today for our second quarter 2014 earnings call. Joining me on the call from the PowerSecure management team are Sidney Hinton, our Chief Executive Officer; and Chris Hutter, our Chief Financial Officer.

Before we begin, I want to remind you that during the course of the discussion today, we expect to make forward-looking statements under the Safe Harbor provisions of the federal securities laws. These are all statements other than historical facts, including statements concerning the future business, financial results and outlook of the company.

Forward-looking statements are based on the current expectations and beliefs of management, but are not guarantees of future performance or events and they are subject to risks, uncertainties and other factors, including those discussed in the company's SEC filings, as well as on the call today and in the earnings release, which could cause actual results to differ materially from those projected or implied. The company assumes no duty to update any forward-looking statements.

I'd also like to point out that beginning this quarter, we are providing more detailed financial information around three discrete segments, Distributed Generation, Utility Infrastructure and Energy Efficiency. We hope you find this additional detail useful.

Now, I'd like to turn the call over to Sidney, who will provide a business overview. Then Chris will walk you through our financial results, and then we'll open the call to Q&A

Sidney Hinton

Thank you, John. Thanks to everyone for joining us today. Before I begin my remarks to the investment community, I want to say a special thank you to our customers and utility partners who are on the call. It's an honor for us to serve each and every one of you. Thanks to our world-class customers and our employees, PowerSecure has achieved exceptional progress, since we last spoke with you three months ago, especially in three critical areas.

First, we have achieved rapid and substantive positive developments in our utility services business, including our successful renegotiation of a major utility contract, the development of new business metrics designed to improve our productivity and identifying and rationalizing unproductive cost.

Second, we have completed the transition of the manufacturing of our LED lighting products. The enhanced efficiencies of the new manufacturing platform are beginning to deliver the substantially higher gross margins we had anticipated. And third, we have increased our project backlog by 55% from last quarter and by 42% on a year-over-year basis to an all-time record high of $349 million.

The progress we have made in these areas combined with the strong business environment we see in all three of our segments and a terrific pipeline of opportunities, all position us for a very strong foundation for 2015.

Importantly, our second quarter results were right in line with the guidance we've provided to you, both from a topline and bottomline perspective. Chris will walk you through our financial results for the quarter in more detail, but our team did a great job refocusing and executing throughout the quarter to drive the business forward and make solid progress from a difficult first quarter starting point.

As we look across the business today, we also feel very well positioned to achieve the guidance that we've provided for Q3 and Q4, and we believe that our record backlog and strong project pipeline set us up on a very exciting foundation for 2015 and beyond.

Even with the challenges we faced in the first quarter, we felt very strongly that they were discrete and short-term, that they were very addressable, and therefore we felt and continue to feel very good about the mid and long-term outlook for our business.

We had a goal to renegotiate a major utility customer contract. We successfully amended that agreement in June. We had a goal to develop and deploy new business metrics into our utility services business to focus on improving productivity, and the development and deployment of these new tools is well underway.

And we had a goal to convert more small and medium as well as large opportunities from our pipeline into project backlog. As you've seen in our recent press releases, we've added $165 million in new business to our backlog.

Another reason we felt so good about the business, even as we spoke to you last quarter, was that we had a strong pipeline of projects, including large and small projects, and that we felt we were well-positioned to move in to backlog in the near term to support 2015 and 2016 revenues.

And, yes, we were hunting elephants, evidenced by the fact that the $140 million in DG project wins included two of the largest individual orders in the history of the company, as we won $120 million in solar projects to develop two projects for a major investor-owned utility.

We believe these wins could be game changers for our solar business, as we beat several established competitors for the award, by demonstrating our technical competency and the ability to win the heart of the customer, both of which, the technical competencies and ability to win the heart and trust of the customer, they're hallmarks of PowerSecure. The industry is definitely taking notice.

These projects, the solar projects I'm referring to now, they do carry lower gross margins as a percentage of revenue due to their size, but we expect that they will be meaningfully accretive to our operating margins and EPS in both 2015 and 2016. And they, obviously, provide a strong revenue foundation for those years as well.

We also announced new awards in our traditional Distributed Generation business. The pipeline here remains strong. As we noted last quarter, we've rebalanced the focus we needed to rebalance, and we're working on getting that done. The focus of our sales team on the development of, what we refer to as our bread and butter, small-and-medium sized projects to support the near-term backlog and the near-term revenue needs. While also pursuing larger game changing opportunities, which have longer sales cycles, and we're making progress here.

One of the DG project win we announced recently was the first sale of a distributed generation system to an ESCO customer. This was a major strategic milestone for PowerSecure, as we've tried for years to penetrate the ESCO customer channel with our DG offering. We tried unsuccessfully to do it.

Now, with the relationships that exist with our Energy Efficiency services team, we've been able to educate the ESCO customers on the value of our distributed generation solutions that they can provide to their end-customers, and we sense a great deal of interest from these ESCO customers on using this solution with their customers as part of their overall solution. We're very encouraged by it.

Continuing to talk about Energy Efficiency, our lighting group had a very good quarter. As I mentioned, the manufacturing transition we've completed and we have driven our LED gross margins up to 36.5% as compared to 31% in the second quarter of last year. I also mentioned that our gross margins in our energy services portion of the Energy Efficiency division were strong as well.

The gross margin that we've seen the increase, the 5 points that we've seen in the LEDs, it was exactly what we were looking for, when we made our Solais acquisition. The Solais acquisition provided us a strong leadership and strong execution to be able to deliver the results by reinventing our LED manufacturing and sourcing model. We're excited about the potential to continue to enhance our LED lighting gross margins as well as the flexibility that our new cost structure gives us to developed new products in the future.

In Utility Infrastructure, we've quickly to moved to a position of strength today, where we have renegotiated a contract with a large utility customer for profitability and our position for strong growth with the customer in 2015. And we've developed new business metrics, which are providing us greater visibility into the efficiency of our cruise and the efficiency of our equipment on an account-by-account basis.

This has led us to pursue new business in a very robust utility spending market. And we were very pleased to announce last week, $25 million in new Utility Infrastructure business with both new and existing utility customers.

We're glad to be talking with you today, having successfully accomplished these important goals, but we are not confused about the need to maintain our focus on execution, as we still have work to do to achieve our 2014 expectations and to capitalize on a record backlog and a robust pipeline to build on what is already an exceptional foundation for 2015 and 2016.

Now, I'd like to turn the call over to Chris, to walk through our financial performance and record backlog in more detail.

Christopher Hutter

Great, thanks Sidney. I'm going to focus my comments in several areas. As I usually do, I'm going to discuss the highlights of the P&L, including trends in our revenue, our gross margin and our operating expenses. I'll also breakdown our backlog, as I usually do, so you can get a feel for how our revenues are likely to be realized in the upcoming quarters, and also review our key balance sheet metrics, our cash, our debt and our CapEx.

As John mentioned, we changed our reporting this quarter to show our financial results under our three segments DG, UI and Energy Efficiency, where we're now showing in the Q revenue through operating income, including gross margins, operating cost, all that detail. We hope that you guys will find that helpful in your analysis. And again, I'd just point you to the Q on that. We'll keep the high level discussion in this call, but we hope you like the enhanced detail there.

Sidney has described the significant progress we've made over the past quarter, and how this and the additional opportunities in front of us give us a very strong foundation for 2015 and 2016. The headline in our second quarter financial results is they came in right in the middle of our revenue and EPS guidance, with our gross margin showing very nice progress. That's really the headline along with the record backlog.

Specifically, our second quarter revenues were $57.1 million, which as expected was a decrease of 18.7% compared to the $70.2 million in revenue that we reported in the second quarter of last year.

Just to note here, I had some perspective over the last couple of days on that. And I'll just point out that, last year's second quarter was an 85% growth rate from the second quarter of 2012. So this year's second quarter, while down compared to last year is still nearly $20 million or basically 50% higher than the $37.9 million of revenues we reported in the second quarter of '12. So just a little bit of perspective there, that broadly, while we're down year-over-year, strategically, we feel good about where the business has been and where it's headed.

As usual, we provide a revenue chart earnings release, which breaks out revenue from each of our segments for the second quarter. So I'd point you to that for the revenue details.

Moving down to P&L. Our gross margin for the second quarter of 2014 was 25.1%. You will know that that was ahead of our expectations by about 3 percentage points and this compares to 28.3% in the second quarter of 2013.

As expected, and as we have discussed, the year-over-year gross margin decrease was driven primarily by inefficiencies in our Utility Infrastructure segment due to lower revenues and the unfavorable pricing and service arrangement we had with a major utility customer that again, we have talked about that ad nauseam.

As you can imagine, our utility services team was strongly focused on driving the operating improvements this quarter. In June, we successfully modified this service arrangement with that major utility customer to improve the terms of our ongoing service. And in addition, our team was focused on identifying unproductive cost and improving the productivity of our assets.

Because of the action we took in the second quarter, we did see a meaningful improvement in our utility services gross margins, which were 5.9% in Q1, you may recall. And they, in fact, rose to 10.3% in Q2, so really nice improvement there. And we expect to see continued gross margin improvement in our utility services unit in the second half of the year.

Of course, those gross margins I'm talking about there are really our construction and maintenance growth area gross margins in utility services. They don't count the consulting engineering gross margin, so now I'm going to transition the overall in that segment.

Our Utility Infrastructure segment gross margins, again, including the consulting and engineering business were 14.8% versus 23.9% in the prior-year period. And again, to add some perspective, this compares to an average quarterly gross margin of 19.5% for Utility Infrastructure, the entire segment for the full year 2013. So that will give you some benchmarks as to the improvements we made and the perspective against prior-year periods. Again, feel good about what we're tracking there.

As we expect and then communicated last quarter, our second quarter year-over-year declines in utility service revenue reflects that unfavorable arrangement with that major utility customer, as well as delays in work assignments from another major customer. In addition, we put a pause on pursuing new business until we completed our utility service business assessments to make sure we were pricing and managing our business for profitability.

Overall, we're seeing excellent demand from utilities for our services. And with our new business metrics that we're in process of deploying and developing, we have begun to pursue and win new work at healthy gross margins. And this is evidenced by the $25 million of new utility infrastructure business we announced last week. Some of this new work will begin in the second half of the year, but the majority will support our 2015 and 2016 revenues.

In our Energy Efficiency segment, so to move into that, we saw a 7 percentage point increase in gross margins to 31.4% from 24.4% last year, driven by favorable gross margins from our ESCO business and efficiency LED lighting manufacturing and sourcing arrangements. Sidney mentioned in our second quarter, our LED gross margins were very healthy, 36.5%. So obviously, really pleased about that. Pleased about the progress we've made over the last 12 months.

Our lighting team has done an outstanding job implementing the transition with minimal disruption to customers. And we are very pleased to see our gross margins in the mid-30s already. And we're optimistic that our LED gross margins have even more headroom as we work our way through the second half of 2014.

Overall, we believe our new LED cost structure provides a competitive platform for us to capitalize on an excellent pipeline of opportunities, with marquee names in the high-end retail space, and also continue to build on the market introductions of our area light and our other new niche lighting product, which we haven't named, but we have been shipping. And importantly, these new products continue to gain traction with customers.

The revenue decrease in segment was pretty simple. It was driven by a decline, a 54.2% year-over-year decrease in sales to our ESCO customers, and that was really due to the second quarter of last year just being a tough comp. You may recall then in the second quarter of 2013, we recognized a significant $12 million of ESCO revenue from existing customer contracts, which really came from that being the first quarter after the acquisition of our ESCO business. We expect our ESCO revenues in the second half of 2014 to grow sequentially and outpace our first half results.

In our DG, Distributed Generation segment, the modest decline in year-over-year gross margin was driven by lower revenues and year-over-year differences in the projects completed during the period. As we have discussed, the slight revenue decrease in DG was driven by a longer sales cycle surrounding newer large scale opportunities and a reduction in the number of smaller and medium size projects that generated revenue in the second quarter of '14, partially offset by new sales from hospitals, data centers, industrial and retail customers.

Our DG sales team has refocused their efforts on developing our bread and butter projects and we're optimistic that we'll see the fruits of these efforts, as we work through the second half of 2014 setting us up to return to growth in 2015.

Moving down to P&L. Our operating expenses in the second quarter of 2014 were $18.3 million. This represents an absolute year-over-year increase of $1.9 million.

That increase is primarily due to the increase in selling expenses due to additional sales investment, sales executives and commission expense, increases in G&A due to increased personnel, stock comp, insurance and professional fees to support our growing business platforms, and depreciation and amortization from our investments in our utility infrastructure equipment and company-owned DG systems, as well as some of the acquisition-related intangible amortization that we book on now on an ongoing basis from some of our recent acquisitions.

And all the way down to bottom, our earnings per share was a loss of $0.12 in the second quarter of 2014 compared to income of $0.11 in the second quarter of 2013.

Moving on, turning to revenue backlog. As of today, our backlog stands at a record $349 million. This compares to $225 million at the time of our last earnings release in May. If you strip out the new solar projects that were $120 million, obviously the math is that the remainder is $229 million, which means that we did increase our backlog sequentially from last quarter's $225 million number. So again, $349 million, $120 million that was a new solar, you take that out, we're $229 million, and obviously that's higher than we were last quarter. So I'd tell you, we kind of did the bread and butter stuff, and our backlog increased in that as well.

As we describe in the earnings release, we breakout our backlog down into three categories, near-term backlog for project-based work, which includes orders for DG, UI and Energy Efficiency projects that we expect to recognize over the course of next three quarters. Longer-term project base work that we anticipate will be recognized fairly evenly from the second quarter of 2015 through 2016 and longer-term recurring revenues that we expect to recognize over the next seven to nine years.

And if you look at that backlog number of $349 million, a $131 million of that is near-term backlog, which is really a driver for your near-term revenue and estimates, specifically we estimate that 42.5% of this near-term backlog will be recognized in the third quarter, 35% will be recognized in the fourth quarter, and 22.5% will be recognized in the first quarter of 2015. Of course, as I always say, projects can and do move in both directions, but this is our current look at it.

The next component, the longer-term backlog, which includes longer-term base work, we anticipate we will recognize fairly evenly from the second quarter of '15 through 2016. Currently stands at a $148 million, and that number is up a bunch. And again, as I'm sure everybody has figured out that those are really our solar contracts layering in there, the new solar contracts. And the last component is $70 million of long-term recurring revenues, which are recognized over the life of those contracts.

So a simple formula, now I go through this every quarter, we'll go through it again. A simple formula to use our backlog as a basis to model our revenues over the next three quarters, that near-term project base backlog, that $131 million, and spread it according to the percentages I have just described, which again, 42.5% in the third, 35% in the fourth, 22.5% in the first quarter of '15 at $6 million of revenue each of those quarters, to account for recurring and other regular revenues that we don't include in that project base backlog; and then layer in to make assumptions about additional project sales you expect we will make and complete between now and the period you're estimating to add to that base of revenue.

Obviously, the window of selling time to impact upcoming quarters increases the further out you're projecting. So you should have bigger numbers in there, the further you go out in terms of adding additional revenue.

Stepping back. Just sort of a broad based comment. Based on this approach and our overall view of the opportunities in front of us, we continue to expect to achieve the revenue and EPS guidance we previously provided you for the third and fourth quarters of this year.

I'll breakout that. I went through a lot of detail in the backlog. I didn't want to eliminate that. When everybody will have that handy, we'll continue to work through that over the coming quarters, but at the same time, we just want to make it clear that we continue to expect to achieve the revenue and EPS guidance we previously provided you for the third and fourth quarters of this year, they remain our expectations.

In addition, many of the projects we have recently added to our backlog provide a very nice revenue foundation for 2015 and 2016. We like how all those years are shaping up this for in advance, but obviously, we still have lots of work to do between now and then. All right, that's it on the P&L backlog and all that.

Balance sheet. Our cash balance at the end of the second quarter was $41.3 million. In the quarter, we invested $3.3 million in CapEx with $2.3 million of that invested to deploy systems to support our company-owned long-term recurring revenue DG projects and the remaining $1 million was primarily to purchase equipment for our Utility Infrastructure business. We continue to anticipate CapEx in the $10 million range for the full year of 2014. We've got $24.9 million in low cost term-debt in capital leases and nothing drawn on our $20 million revolver.

And a reminder then in July, our $12 million letter of credit was issued under that revolver to support the bonding for the two major solar energy projects that we just announced. Just a little clarification on that, this letter of credit gets released, once we have our contracts in place from the panel manufactures. Once we have those in place and bonded, that LOC gets released. And we are optimistic that that will happen this third quarter. So balance sheet's in great shape as they headline.

We believe that the actions that we have taken to: first of all, improve that key utility service contract; second of all, deploy new business metrics in our utility services, which has begun, but is also an ongoing process; restructure our lighting manufacturing for increased profitability and also add to our backlog overall, and of course, our DG backlog importantly. We feel like that those have progressed well and that we positioned the company very strongly to capitalize on that backlog and build towards a significant growth in 2015.

Now with that, we'd be happy to take your questions. So operator, you can go ahead and start the Q&A.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Eric Stine.

Eric Stine - Craig-Hallum Capital Group

So maybe we could just start on Utility Infrastructure. How that's progressed here over the last few months? And clearly your confidence is building, but as you've dug into that, I mean are there, just point to some specific things that give you confidence that what happened in 1Q, that that won't happen again? And then some of the things you need to work on? And then, secondly, just talk about the contracts that are out there and in place, are you confident that those are priced right?

Sidney Hinton

Let me start at the backend of the question, I'll work my way forward. Related to the contracts that are in place, we are confident that they are priced right. We're confident that the contracts that we have taken on recently are priced right. We're confident that the contract we renegotiated is priced right.

From lessons learned standpoint, have a metrics that give us better foresight, I guess would be a operative word. Let us see what's coming forward. Measuring our productivity to reach labor dollars that we're deploying is a big measure in that business, obviously, along with the equipment. We love the business. We got a great team that has built it. We agree we stumbled in the first quarter and we're focused on fixing it. And we like where we're at.

Christopher Hutter

Eric, I'd just add to that that we took a good amount of cost out of that business too in the second quarter. Our guys scrubbed hard, in particular from an equipment perspective on things that were creating inefficiencies. Now, you remember that that fourth quarter of 2013 was a blowout quarter. And we probably had some extra equipment hanging around, we shouldn't have had it hanging around.

And so kind of that refocused down on, we have to be productive. And that's where you saw that gross margin pop back up this quarter. It was almost all because of that. It really didn't have anything to do with the renegotiated contract. The renegotiated contract, that that's really what provides us the confidence in the next couple of quarters of our guidance that we'll continue to be on track to it that.

Eric Stine - Craig-Hallum Capital Group

And then just sticking with UI, I mean can you provide an update, the contract where the new utility you were awarded or notified that you were the winner late last year and you've been doing work for that. Is that something we should think about that you're just going to continue, you're in their footprint you'll continue to do work? Or do you think that that gets finalized as part of a multi-year at some point here?

Christopher Hutter

Well, for now we're assuming that we're just going to stay in their footprint and work off our work orders as we go through this year. It could very well change. And for that reason, we've in our forecast that we presented to everybody last quarter, we didn't assume anything heroic in there for 2014.

That said, all the signs that we're getting are that that business should continue to grow, particularly as we work our way into 2015. So we're very bullish on the relationship. It's just ended up to be a little lumpier and a little less consistent than we thought. But again, strategically, we love the fact that we're serving that utility. But again, we haven't asked ourselves to do anything heroic in this current forecast set.

Eric Stine - Craig-Hallum Capital Group

Maybe last one for me. Just talking about recent development, the DG sale into the ESCO channel, just curious, if you could talk about maybe the size? I know you're not talking about who the ESCO is, but maybe the size within that specific ESCO customer. And then when this could start to move the needle in a bigger way?

Sidney Hinton

Yes. In general, I would look at those customers, without speaking to that specific situation. I mean those opportunities would range from $0.50 million on the low-end to probably $4 million on the high-end. And just to bracket it for you to help you on, we have talked about hospitals and data centers how they fall.

These typically are more what you would call an institutional customer, be it college, university or some type of federal or some type of municipal or state facility or college campus, our prism that works being done in. So that $0.5 million to $4 million, probably more in the $1 million to $2 million, if you're looking for trying to find out what's the median.

Eric Stine - Craig-Hallum Capital Group

And then, I mean just in terms of would you put this in the category, maybe a little bit behind the other ones, but in terms of the large project opportunity or the growing pipeline? I assume this is part of that growing pipeline, big opportunity, with just one ESCO, let alone all of the ESCOs that are out there?

Sidney Hinton

I now would actually say we don't consider that part of the pipeline when we talk about the quality of the pipeline. We would consider that the quality of the land beyond the pipeline, that we hope to convert the pipeline and then convert the backlog, that for us pipeline are very discreet, fixed opportunities that we're working on and this more a little broader.

We're excited about it, but I wouldn't quite put it in the pipeline driving our optimism there. We just really, we love the feedback that we've got. We like what we see coming, and hopefully six to nine months from now we'll be talking about what's in the pipeline from that.


Next question comes from Rob Brown.

Rob Brown - Lake Street Capital Markets

You mentioned the Utility Infrastructure business margin improvement is happening in gross margins. What is your target margin in that segment? Is it sort of that 20% range? Is that the area that we should sort of think as a sustainable margin in that business?

Christopher Hutter

Well, we'd love to get in there. I think that we're probably faced with the reality that as that business has grown, that it's tougher and tougher to have that via sustained gross margin. I would say more something like mid-upper teens, with upper-teens being the goal, and that reality from time-to-time that if it sags into the mid-teens, we're not going to lose any sleep over that, but as we've increased in scale, it's a tougher business to have that premium gross margin approach. I don't know if you add something to that?

Sidney Hinton

The only thing I would add was distinguishing between the Utility Infrastructure segment as we reported and the utility services business that, Chris, was referring to the utility services business. And I didn't know from a modeling standpoint, if you're referring to the overall segment.

Rob Brown - Lake Street Capital Markets

Yes. I was thinking of the overall segment, sort of as reported the combined?

Sidney Hinton

I think we would be in approaching that 20 -- upper-teens, low-20s, on a combined basis.

Rob Brown - Lake Street Capital Markets

And then on your cost structure, I think broke out your corporate and other cost. Just wanted to get a sense on how you think, is this quarter's run rate sustainable going forward or is there some one-time kind of stuff in there, and may be it's lower, but what's sort of this sustainable, maybe annualized rate there, is it sort of $20 million or more mid-teens in terms of dollar.

Christopher Hutter

I mean, we did have some things that this quarter that extended that, made that run rate a little higher than I think it will be over the course of next few quarters. So I do expect it will come down. Again, we're trying to stay consistent with the way we did guidance before, which is that we gave that revenue.

Of course, we beat the gross margin, I'm sure everybody will notice that. But we don't want to come off that basic guidance. We think we've guided within a range there. Gross margins can move one way or the other a little bit. Our operating expense can move one way or the other a little bit, but from sort of the important things topline, bottomline, we think we're right now in the fair way.


Next question comes from Bill Bremer.

Joe Nelson - Maxim Group

This is Joe Nelson on for Bill Bremer this morning. I appreciate the detail in the Q this morning. I'm wondering if I could ask you a couple of questions regarding the Energy Efficiency segment, just maybe switching gears a little bit. I noticed that we had some significant improvement in the gross margins, but didn't necessarily translate to the bottomline. I'm wondering if that's a utilization issue given the lower ESCO business and do you envision that coming back on line in the near-term or maybe even a little further out?

Christopher Hutter

It's a little bit of that. It is a little bit of the -- that ESCO revenues were down really by half. And again, last year, that first quarter out after the acquisition was the second quarter, and you may recall that they had a bunch of pent-up demand for execution of their projects, that the company we bought the ESCO business from, just because they couldn't bond them.

And so once we made the acquisition, they were running hard for the next 90 days. It's not that they weren't running hard after that, but there was definitely in surge in project completion. So I'll say it was tough comps. That was biggest issue.

We have made some investment in our lighting business as well, particularly on the sales and marketing side and new product development side. So there is a little bit of that too. It's most for the ESCO revenue decrease.

Joe Nelson - Maxim Group

And then maybe just one more quick question. Earlier you mentioned that -- and this is actually switching gears again a little bit to the new DG awards. You mentioned earlier that they'll be accretive to both consolidated gross margins and EPS. I'm just curious, do you envision that for both, as far as you can see, for both '15 and '16?

Christopher Hutter

Yes. Right now, our expectation is that it'd be recognized fairly evenly over that period. We're just so far out. And we may, of course, adjust that as we move through the next six months as we start honing down on project schedules and so forth. But right now we're just going to hold that as our expectation.


Next question comes from Ben Kallo.

Ben Kallo - Robert W. Baird

I want to talk a little bit about the guidance. It seems like utility services gross margin is going to improve. Energy Efficiency was very strong in the quarter. I'm just trying to understand how, we don't see higher gross margin going forward or if this Energy Efficiency was just a one-time we're hearing in the quarter?

Christopher Hutter

We very well could have, Ben, but we're not willing to give out that rope at this point. I mean, we really like the way the quarter came in from -- from a competitor, what we were forecasting, we like the way it came in. And as everybody out there knows, there is a fair amount of variability around our gross margins, depending on what projects hit in what quarter, I mean it's lumpy in revenue, but it also can be lumpy in gross margins. And we're just not quite ready to let that rope out at this point in time.

Ben Kallo - Robert W. Baird

And you had good analysis on the backlog. Congratulations on that. The one area we didn't see anything added was on the Energy Efficiency side. Could you just comment there? And then with your commentary on the ESCO beat down year-over-year, is that business gotten tougher for your guys as you made the acquisitions and you wouldn't fulfill that pipeline to build the backup or could you just comment on them?

Sidney Hinton

Really two different answers. One of them is on the lighting. It doesn't lend itself to backlog. Those orders come in and they typically go straight through the P&L, and the customers buy the lights, we ship them. It doesn't typically carryover from quarter-to-quarter.

On the ESCO energy services portion of it, that's when we made the announcement on the DG. We like our pipeline a lot. We feel like the second half of the year -- we're confident that the second half of the year is going to be stronger than the first half of the year. There appears to be a timing issue. We look at the pipeline as compared to a year ago, when we first acquired the business, it's a much healthier pipeline relative to the individual components.

And they are all projects that we want versus when we purchased it, there were some stuff in the pipeline that we didn't really want to move forward on. It was lower margin projects that seemed a little bit out of the strike zone for us. And so we paired those back, but then we to rebuild the pipeline on stuff we would like. So we feel good about where it's at, like the outlook over the second half of the year in 2015. Chris, anything you'd add?

Christopher Hutter

No. I agree, 100%.

Ben Kallo - Robert W. Baird

And then, my final question. As far as the new structure for your sales people on the DG side, I know it's still early days, but can you just kind of talk about how that's been received by them, and anything you guys see as far with any kind of change in your pipeline?

Sidney Hinton

Yes. So I'll take that. The words, sort of new structure for our sales people, it probably isn't so much structure, it's really about focus, that as we went through the back half of last year, we were definitely focused on a lot of these, as we've termed them, elephants, big elephants. And as sort of I've described to folks, every single project we do, we're developing the project, right. It's about our sales team going out and developing that opportunity or it's not going to happen.

And it's not that it, it goes away, it just sort of sits there. And these longer, these bigger, these elephant-type projects, we're investing our time in that, and that the small or medium size projects weren't -- we didn't have the pace of conversion from pipeline to backlog that we have historically had.

It's been interesting as we work through the quarter. I mean our guys are true blue. I mean it really is just sort of, hey, look, we got to focus back on some of the bread and butter stuff. We love -- we don't want to stop chasing these elephants, but by the same token we have to just from a resource allocation allocate our time a little more smartly back to what's built the company.

And I would just say, the response has been sort of an instance response. Absolutely, we'll do that. So I really think it's less of a structure, more of just communication, and just understanding sort of the state of play and refocus. So I'd say it's all going well. We continue to be in that process.

We don't want to leave this call to, that hey, it's completely turned, we've got complete clarity. We don't have that quite yet. We like the progress we've shown. We like the new announcements we've made over the last couple of weeks. We like the way the pipeline is shaping up and the potential to convert to backlog, we like all that. And we're optimistic that as we move to the back half of the year, you'll see the fruits of that and that will set us up to have a really nice 2015. Still very much in progress, but we like the track it's taking. I don't know, Sidney, if you want to add anything to that.

Sidney Hinton

The one thing I would add is that we created in early second quarter or late first quarter, we created a new position. Something we haven't had in the history of the company, which was a President of the Distributed Generation division by itself. And it's our Controller that have been in sales and as a Controller in the business under Chris. We've put him over that business unit. The unit is a great development opportunity for him, relative to future plans of the company.

But we're already seeing the fruits of having somebody just focused, not just on the near term, not just on the operational issues, but there is somebody who is focused on that. In addition, looking out, saying, okay, what are the key segments we need to be going after, how do we enrich our portfolio or the pipeline, how do we expand the breadth of it. And we're very, very encouraged, just the leadership and insights and attention that he's brought to it combined with the great team we have out there selling.


Next question comes from [ph] Joel Ray.

Unidentified Analyst

Two questions for you. First, you had mentioned that we are enhancing our sales effort. I was wondering if you could give us a little bit of detail as far as is this addition to headcount and where are you focusing? And secondly, because I'm hearing you talking about elephants here and you've been working on this for the better part of a year. Can you go and provide us a little bit of insight into what's involved here? How long it takes, you think, for the completion of the sales cycle on something like this? Is there something that we should be thinking about for '15 or '16 or longer term?

Sidney Hinton

Well, I will say it varies. And let me answer the last part of your question, then we'll go back to the front part. What is the sales cycle in these bigger opportunities are treated is we don't know. Historically, we felt there in that nine to 15 months range, 12 to 18 months, if you're starting with a brand new account, it definitely appears just given where we're sitting today that it must be 18 months, just because we've seen some of those situations take that wrong.

We've been blessed to harvest some a little quicker than that, but we're hopeful that over the latter part, some into third quarter, but over the last half of this year that we'll see some fruit from our efforts, along with in the first quarter of next year. That's kind of the timeframe that we're anticipating, reaping some of the harvest. And it's definitely what gives us the optimism looking out into 2015 and beyond. Once we harvest one, it will tend to take care of itself after that.

Unidentified Analyst

And on the sales and marketing effort?

Sidney Hinton

Sales and marketing effort, we're looking at adding people, we have not added other than what we call rainmakers. And we have adopted a strategy a couple of years ago of going after industry leaders in sales, proven individuals. We really spent more money on one person than have a team of three or four junior people, and we continue to do that.

We're very, very aggressive in going out recruiting top-level talent. We've made some catches there. We made a catch in the last quarter candidly in what we call retail ESCO spot for our energy services. And we're chasing the stuff candidly in the Distributed Generation world right now.


Your last question comes from Philip Shen.

Matt Koranda - ROTH Capital Partners

This is Matt on for Phil. A lot of them have been answered already, but just wanted to touch on UI for a moment. You guys mentioned potentially expanded work with the major utility customer that had given you guys unfavorable pricing previously. Can you just talk about the potential nature of that work and the revenue magnitude that it could bring?

Sidney Hinton

It would be more work along the lines of what we're doing, same scope of work. They have a very large appetite. I mean the range could be, I think we're on record, saying, this is about $3 million a quarter-type customer, $12 million a year. That could push its way. It could be a little of an increase as up to $15 million a year, as much as doubling or possibly more.

I would tell you though that if we would be reluctant, we'd be reluctant to add a tremendous amount more without additional economic relief, only because of our structure relief. Only because that any time you're working on units, unit work, as you start adding, the productivity of your new crews cannot be as good as the productivity of your existing crews. And that we just don't want to dilute ourselves.

So while we're delighted to serve them and eager to serve the utility, and love to serve the utility, great utility, love to serve them, either finding a way to bridge the implementation or having some type of additional relief, we would probably have to do something like that before we really got on a call like this and said, we've agreed to double our staffing. Growing it by 20%, we're glad to do that, that's not that hard, we can feather that in. But growing by 100%, it would be a significant undertaking and we're just careful about doing that.

Matt Koranda - ROTH Capital Partners

And then, one more here on the DG segment. We've heard some recent industry commentary during the past year-and-a-half outage severity has kind of declined compared to previous normalized periods. Does this affect your DG business in attracting new customers at all? How does it affect the DG business?

Sidney Hinton

Now, first of all, I'd say that I don't disagree completely with the statement. I mean whoever made that statement must be referring to catastrophic events on the grid. The grid and the reliability is, we have the statistic for it and it remains to be -- I mean we serve utilities, they have a great system, but they do have outages. The rate of outages has not declined. In fact, the average length of time of an outage is actually going up. I don't know. Over 20%.

And then having those key statistics helps us when we're out communicating with clients, relative to how they should or should not value. We take the guess work out of it for them, or the utility does, utility will know specifically on clients and feeders, what the rate of outages is. I assume whoever made that statement was referring to a database such as Superstorm Sandy. Yes, okay, the outages have been less severe in New York after that, because you haven't had another event such as that, but nationally that wouldn't be that the statement wouldn't hold.

John Bluth

Operator, do we have any further questions at this time?


We have no questions.

Sidney Hinton

Well, hey, thanks everybody for joining in. We're pleased with the progress that we've made, but we are nowhere near satisfied. With a record backlog and exceptional opportunities in all areas of our business, we're excited about how we have positioned the company for 2015 and 2016. We'll be in several investor conferences in August, and we hope to see many of you there. Thanks for joining us this morning.


Ladies and gentlemen, that concludes your conference today. You may now disconnect.

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