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XWES > SEC Filings for XWES > Form 10-Q on 1-Nov-2012All Recent SEC Filings

Show all filings for WORLD ENERGY SOLUTIONS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for WORLD ENERGY SOLUTIONS, INC.


1-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q including this Item 2, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. Readers can identify these statements by forward-looking words such as "may," "could," "should," "would," "intend," "will," "expect," "anticipate," "believe," "estimate," "continue" or similar words. The Company's actual results and the timing of certain events may differ significantly from the results and timing discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed or referred to in this report and in the "Risk Factors" section of our Annual Report on Form 10-K and any later publicly available filing with the Securities and Exchange Commission ("SEC"). The following discussion and analysis of the Company's financial condition and results of operations should be read in light of those factors and in conjunction with the Company's accompanying consolidated financial statements and notes thereto.

Overview

World Energy offers a range of energy management solutions to commercial and industrial businesses, institutions, utilities, and governments to reduce their overall energy costs. We come to market with a holistic approach to energy management helping customers a) contract for the lowest price for energy, b) engage in energy efficiency projects to minimize quantity used and c) maximize available rebate and incentive programs. We have primarily focused on our retail and wholesale energy procurement clients via our state-of-the-art online auction platforms, the World Energy Exchange ®, the World Green Exchange® and the World DR Exchange®. With recent investments and acquisitions, we are building out our energy efficiency practice - offering technology-enabled solutions such as online audits of facilities to identify retrofit options and project management services for retrofit implementation, believing this practice will also enable more cross-selling opportunities for commodity auctions. We are also taking our suite of solutions to the rapidly growing small- and medium-sized customer marketplaces.

We provide energy management services utilizing state-of-the-art technology and the experience of a seasoned management team to bring lower energy costs to its customers. We use a simple equation:

E = P*Q-i

to help customers to understand the holistic nature of the energy management problem. Total energy cost (E) is a function of Energy Price (P) times the Quantity of Energy Consumed (Q), minus any rebates or incentives (i) the customer can earn. This approach not only makes energy management more approachable for customers, simplifying what has become an increasingly dynamic and complex problem, it also highlights the inter-related nature of the energy management challenge. We assert that point solution vendors may optimize one of the three elements, but it takes looking at the problem holistically to unlock the most savings.

Acquisitions are an important component of our business strategy. Our focus is on both our core procurement business as well as new product lines within the energy management services industry such as energy efficiency services.

On October 3, 2012, we acquired substantially all of the assets and certain obligations of Northeast Energy Partners, LLC ("NEP") pursuant to an Asset Purchase Agreement (the "Asset Purchase Agreement") between the Company, NEP, and its members. NEP is a Connecticut based energy management and procurement company.

During the third and fourth quarters of 2011 we acquired the energy procurement business of Co-eXprise, Inc. ("Co-eXprise"), Northeast Energy Solutions, LLC ("NES") and GSE Consulting, LP ("GSE"). These acquisitions expanded our capabilities in the Energy efficiency segment, enabled the Company to enter the growing small- and medium-sized customer Energy procurement marketplaces, and consolidate the large commercial, industrial and government auction space.

With the acquisition of NES, we are managing the business as two business segments: Energy procurement and Energy efficiency services.

Our business model is heavily dependent on our people. We have significantly grown our employee base from 20 at our initial public offering ("IPO") in November 2006 to a current high of 105 at September 30, 2012. This planned investment has been, and will continue to be, a key component of our strategic initiatives and revenue growth. While these infrastructure investments result in increased operating costs in the short-term, once they begin to generate incremental revenue the operating leverage within our business model results in positive cash flow and profitability. We have been able to fund our acquisitions and strategic investments primarily with cash on-hand, notes payable and cash we have generated from


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operations, and we will continue to focus on cash generating acquisitions in the future. These activities, however, will increase our operating costs both in the short and long-term and may require us to borrow against our current credit facility and/or raise funds through additional capital raises.

Operations

Revenue

Retail Electricity Transactions

We earn a monthly commission on energy sales contracted through our online auction platform from each bidder or energy supplier based on the energy usage transacted between the bidder and lister or energy consumer. Our commissions are not based on the retail price for electricity; rather on the amount of energy consumed. Commissions are calculated based on the volume of energy usage transacted between the energy supplier and energy consumer multiplied by our contractual commission rate. Our contractual commission rate is negotiated with the energy consumer on a procurement-by-procurement basis based on energy consumer specific circumstances, including the size of auction, the effort required to organize and run the respective auction and competitive factors, among others. Once the contractual commission is agreed to with the energy consumer, all energy suppliers participating in the auction agree to that rate. That commission rate remains fixed for the duration of the contractual term regardless of energy usage. Energy consumers provide us with a letter of authorization to request their usage history from the local utility. We then use this data to compile a usage profile for that energy consumer that will become the basis for the auction. This data may also be used to estimate revenue on a going forward basis, as noted below.

Historically, our revenue and operating results have varied from quarter-to-quarter and are expected to continue to fluctuate in the future. These fluctuations are primarily due to the buying patterns of our wholesale and natural gas customers, which tend to have large, seasonal purchases during the fourth and first quarters and electricity usage having higher demand in our second and third quarters. In addition, the activity levels on the World Energy Exchange® can fluctuate due to a number of factors, including market prices, weather conditions, energy consumers' credit ratings, the ability of suppliers to obtain financing in credit markets, and economic and geopolitical events. To the extent these factors affect the purchasing decisions of energy consumers our future results of operations may be affected. Contracts between energy suppliers and energy consumers are signed for a variety of term lengths, with a one to two year contract term being typical for commercial and industrial energy consumers, and government contracts typically having two to three year terms.

We do not invoice our electricity energy suppliers for monthly commissions earned and, therefore, we report a substantial portion of our receivables as "unbilled." Unbilled accounts receivable represents management's best estimate of energy provided by the energy suppliers to the energy consumers for a specific completed time period at contracted commission rates and is made up of two components. The first component represents energy usage for which we have received actual data from the supplier and/or the utility, but for which payment has not been received at the balance sheet date. The majority of our contractual relationships with energy suppliers require them to supply actual usage data to us on a monthly basis and remit payment to us based on that usage. The second component represents energy usage for which we have not received actual data, but for which we have estimated usage. Commissions paid in advance by certain bidders are recorded as deferred revenue and amortized to commission revenue on a monthly basis on the energy exchanged that month.

Retail Natural Gas Transactions

There are two primary fee components to our retail natural gas services:
transaction fees and management fees. Transaction fees are billed to and paid by the energy supplier awarded business on the platform. These fees are established prior to award and are the same for each supplier. For the majority of our natural gas transactions, we bill the supplier upon the conclusion of the transaction based on the estimated energy volume transacted for the entire award term multiplied by the transaction fee. Management fees are paid by our energy consumers and are generally billed on a monthly basis for services rendered based on terms and conditions included in contractual arrangements. While substantially all of our retail natural gas transactions are accounted for in accordance with this policy, a certain percentage is accounted for as the natural gas is consumed by the energy consumer and recognized as revenue in accordance with the retail electricity transaction revenue recognition methodology described above.


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Mid-Market Transactions

Mid-sized energy procurement transactions have components similar to both the retail electricity and natural gas transactions. Commissions are driven primarily by the energy supplier who ultimately serves the customer. The terms and conditions underlying our agreements with each energy supplier can vary from full upfront payment at execution of the energy supply contract (similar to the retail natural gas transactions described above) to monthly over the flow period (similar to our retail electricity transactions). As a result, we recognize monthly deals as energy flows from the energy suppliers to the energy consumer. On upfront transactions and/or varied payment term deals we recognize revenue as cash is received from the energy supplier. To date, revenue recognized on a monthly basis has approximated cash that has been received from energy suppliers.

Demand Response Transactions

Demand response transaction fees are recognized when we have received confirmation from the demand response provider ("DRP") that the energy consumer has performed under the applicable Regional Transmission Organization ("RTO") or Independent System Operator ("ISO") program requirements. The energy consumer is either called to perform during an actual curtailment event or is required to demonstrate its ability to perform in a test event during the performance period. For the PJM Interconnection ("PJM"), an RTO that coordinates the movement of wholesale electricity in all or parts of 13 states and the District of Columbia, the performance period is June through September in a calendar year. Test results are submitted to the PJM by the DRPs and we receive confirmation of the energy consumer's performance in the fourth quarter. DRPs typically pay us ratably on a quarterly basis throughout the demand response fiscal (June to May) year. As a result, a portion of the revenue we recognize is reflected as unbilled accounts receivable.

Wholesale Transactions

Wholesale transaction fees are invoiced upon the conclusion of the auction based on a fixed fee. These revenues are not tied to future energy usage and are recognized upon the completion of the online auction. For reverse auctions where our customers bid for a consumer's business, the fees are paid by the bidder. For forward auctions where a lister is selling energy products, the fees are typically paid by the lister. While substantially all wholesale transactions are accounted for in this fashion, a small percentage of our wholesale revenue is accounted for as electricity or gas is delivered, similar to the retail electricity transaction methodology described above.

Environmental Commodity Transactions

Environmental commodity transaction fees are accounted for utilizing two primary methods. For regulated allowance programs like the Regional Greenhouse Gas Initiative ("RGGI"), fees are paid by the lister and are recognized quarterly as revenue as auctions are completed and approved. For all other environmental commodity transactions both the lister and the bidder pay the transaction fee and revenue is recognized upon the consummation of the underlying transaction as credits are delivered by the lister and payment is made by the bidder.

Energy Efficiency Services

Our Energy efficiency services segment is primarily project driven where we identify efficiency measures that energy consumers can implement to reduce their energy usage. We present retrofit opportunities to customers, get approval from them to proceed and submit the proposal to the local utility for cost reimbursement. Once the utility approves funding for the project, we install the equipment, typically new heating, ventilation or air conditioning equipment, or replace lighting fixtures to more efficient models. We generally recognize revenue for energy efficiency services when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured. Due to the short-term nature of projects (typically two to three weeks), the Company utilizes the completed-contract method. Revenues are recognized based upon factors such as passage of title, installation, payments and customer acceptance.

Cost of revenue

Cost of revenue consists primarily of:

• salaries, employee benefits and share-based compensation associated with our auction management and efficiency services, which are directly related to the development and production of the online auction and maintenance of market-related data on our auction platform and monthly management fees (our supply desk function);

• project costs including direct labor equipment and materials directly associated with efficiency projects;


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• amortization of capitalized costs associated with our auction platform and acquired developed technology; and

• rent, depreciation and other related overhead and facility-related costs.

Sales and marketing

Sales and marketing expenses consist primarily of:

• salaries, employee benefits and share-based compensation related to sales and marketing personnel;

• third party commission expenses to our channel partners;

• travel and related expenses;

• amortization related to customer relationships and contracts;

• rent, depreciation and other related overhead and facility-related costs; and

• general marketing costs such as trade shows, marketing materials and outsourced services.

General and administrative

General and administrative expenses consist primarily of:

• salaries, employee benefits and share-based compensation related to general and administrative personnel;

• accounting, legal, investor relations, information technology and other professional fees; and

• rent, depreciation and other related overhead and facility-related costs.

Interest income (expense), net

Interest income (expense), net consists primarily of:

• interest income earned on cash held in the bank; and

• interest expense related to capital leases, bank term loan, note payable and contingent consideration.

Income tax expense

Income tax expense reflects the Company's federal alternative minimum tax liability and state income taxes.


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Results of Operations

The following table sets forth certain items as a percent of revenue for the
periods presented:



                                          For the Three Months Ended                  For the Nine Months Ended
                                                September 30,                               September 30,
                                         2012                    2011                2012                   2011
Revenue                                       100 %                   100 %               100 %                  100 %
Cost of revenue                                31                      17                  27                     19

Gross profit                                   69                      83                  73                     81
Operating expenses:
Sales and marketing                            42                      45                  45                     49
General and administrative                     21                      23                  23                     24

Operating income                                6                      15                   5                      8
Interest income (expense), net                 (1 )                    -                   (1 )                    1
Other income                                   -                       -                   -                      -
Income tax expense                              1                      -                    1                     -

Net income                                      4 %                    15 %                 3 %                    9 %

Comparison of the Three Months Ended September 30, 2012 and 2011

Revenue



                                   For the Three Months Ended
                                          September 30,
                                      2012              2011               Increase
    Energy procurement           $    6,536,634      $ 5,625,070     $   911,564       16 %
    Energy efficiency services        1,979,410               -        1,979,410       -

    Total revenue                $    8,516,044      $ 5,625,070     $ 2,890,974       51 %

Revenue increased 51% for the three months ended September 30, 2012 as compared to the same period in 2011 due to revenue from our acquisitions completed in the fourth quarter of 2011 and increased auction activity in our retail product line. Our Energy procurement segment increased 16% due to the additions of the energy procurement contracts of Co-eXprise and GSE and, to a lesser extent, increased transaction activity due to new customers. These increases were partially offset by decreases in gas and wholesale transaction activity. The energy procurement revenue for the third quarter of 2011 included a $0.7 million incremental increase representing a one-time, upfront payment from one of our suppliers related to expected future energy usage. Our Energy efficiency services segment generated approximately $2.0 million in revenue in the third quarter of 2012 due to our October 2011 acquisition of NES and projects completed by our internal energy efficiency services group.

Cost of revenue

                                               For the Three Months Ended September 30,
                                                2012                                  2011
                                       $               % of Revenue            $         % of Revenue             Increase
Energy procurement              $     1,088,393                   17 %     $ 970,846                17 %    $   117,547        12 %
Energy efficiency services            1,544,520                   78 %            -                 -         1,544,520        -

Total cost of revenue           $     2,632,913                   31 %     $ 970,846                17 %    $ 1,662,067       171 %

Cost of revenue increased 171% for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to increases in equipment, material and labor costs associated with projects completed by our Energy efficiency services segment. Cost of revenue for our Energy procurement segment increased 12% due to increases in payroll resulting from a net increase in employees including our recent acquisitions. Cost of revenue associated with our Energy procurement segment as a percent of revenue remained the same over the periods as increases in payroll costs were offset by a 16% increase in revenue. The costs of revenue associated with our Energy efficiency services segment was primarily associated with equipment, material and labor costs associated with completed projects during the quarter. Cost of revenue as a percent of our Energy efficiency services revenue was 78% as we continued to build our project management team during the quarter.

Operating expenses

                                                 For the Three Months Ended September 30,
                                                 2012                                  2011
                                        $               % of Revenue            $          % of Revenue             Increase
Sales and marketing               $    3,638,961                   42 %    $ 2,512,191                45 %    $ 1,126,770       45 %
General and administrative             1,769,718                   21        1,293,822                23          475,896       37

Total operating expenses          $    5,408,679                   63 %    $ 3,806,013                68 %    $ 1,602,666       42 %

Sales and marketing expenses increased 45% for the three months ended September 30, 2012 as compared to the same period in 2011 primarily due to increases in payroll, internal commissions and amortization of intangible assets. Payroll and internal commissions increased due to an increase of twenty-seven sales and marketing employees versus the same period last year primarily due to our acquisitions and hires in our Energy efficiency services segment and mid-market group. Amortization expense related to intangible assets increased due to our 2011 acquisitions. Sales and marketing expense as a percentage of revenue decreased 3% due to the 51% increase in revenue, which was substantially offset by the increase in costs described above.


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The 37% increase in general and administrative expenses for the three months ended September 30, 2012 as compared to the same period in 2011 was primarily due to increases in amortization expense, compliance and payroll costs. These increased costs were primarily due to our 2011 acquisitions. General and administrative expenses as a percent of revenue decreased 2% as the 51% increase in revenue offset the above noted costs.

Interest expense, net

Interest expense, net was approximately $87,000 for the three months ended September 30, 2012 compared to interest income, net of approximately $14,000 for the three months ended September 30, 2011. The increase in interest expense, net in 2012 was primarily due to interest charged on our notes payable, contingent consideration and the term loan with Silicon Valley Bank ("SVB"). The interest income in the third quarter of 2011 was primarily due to interest earned on a convertible note receivable with Retroficiency, Inc. ("Retroficiency").

Income tax expense

We recorded income tax expense of approximately $23,000 for the three months ended September 30, 2012 compared to income tax expense of approximately $7,000 for the three months ended September 30, 2011. While we have approximately $15.0 million of net operating loss carryforwards to offset taxable income, we continue to generate taxable income which is subject to federal alternative minimum tax and state income taxes.

Net income

We reported net income for the three months ended September 30, 2012 and 2011 of approximately $0.4 million and $0.9 million, respectively, as increases in revenue in the third quarter of 2012 were offset by cost increases and lower margins associated with our Energy efficiency services segment. In addition, net income for the third quarter of 2011 reflected a $0.5 million increase representing a one-time, upfront payment from one of our suppliers related to future energy usage net of internal and third party commission expense.

Comparison of the Nine Months Ended September 30, 2012 and 2011

Revenue



                                   For the Nine Months Ended
                                         September 30,
                                     2012              2011               Increase
    Energy procurement           $  20,584,036     $ 15,180,140     $ 5,403,896       36 %
    Energy efficiency services       4,103,815               -        4,103,815       -

    Total revenue                $  24,687,851     $ 15,180,140     $ 9,507,711       63 %

Revenue increased 63% for the nine months ended September 30, 2012 as compared to the same period in 2011 due to nine months of revenue from our acquisitions completed in the fourth quarter of 2011 and increased auction activity in our retail product line. Our Energy procurement segment increased 36% due to the additions of the energy procurement contracts of Co-eXprise and GSE and, to a lesser extent, increased transaction activity due to new customers. The energy procurement revenue for the nine months ended September 30, 2011 included a $0.7 million incremental increase representing a one-time, upfront payment from one of our suppliers related to expected future energy usage. Our Energy efficiency services segment generated approximately $4.1 million in revenue in the first nine months of 2012 due to our October 2011 acquisition of NES and projects completed by our internal energy efficiency services group.

Cost of revenue

                                                 For the Nine Months Ended September 30,
                                                 2012                                  2011
                                       $               % of Revenue             $          % of Revenue             Increase
Energy procurement               $    3,518,073                    17 %    $ 2,907,359                19 %    $   610,714        21 %
Energy efficiency services            3,096,738                    75 %             -                 -         3,096,738        -

Total cost of revenue            $    6,614,811                    27 %    $ 2,907,359                19 %    $ 3,707,452       128 %

Cost of revenue increased 128% for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 primarily due to increases in equipment, material and labor costs associated with projects completed by our Energy efficiency services segment. Cost of revenue for our Energy procurement . . .

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