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XWES > SEC Filings for XWES > Form 10-Q on 14-May-2013All 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.


14-May-2013

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. Our 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 our financial condition and results of operations should be read in light of those factors and in conjunction with our accompanying condensed 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 a competitive price for energy, b) engage in energy efficiency projects to minimize quantity used and c) pursue available rebate and incentive programs. We made our mark on the industry with an innovative approach to procurement via our online auction platform, the World Energy Exchangeฎ, engaging new customers while also pursuing more cross-selling opportunities for our procurement services. We are also taking our suite of solutions to the rapidly growing small- and medium-sized customer markets.

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 ท 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 we believe 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 assumed certain obligations of Northeast Energy Partners, LLC ("NEP") pursuant to an Asset Purchase Agreement (the "Asset Purchase Agreement") between us, NEP, and its members. NEP is a Connecticut based energy management and procurement company. The purchase price was approximately $7.9 million in cash and a $2.0 million Promissory Note with NEP (the "NEP Note"). The NEP Note bears interest at 4% with $1.5 million of principal plus interest due on October 1, 2013 and the remaining $500,000 of principal plus interest due April 1, 2014. NEP may also earn up to an additional $3.2 million in cash and shares, with up to $2.5 million in cash, and 153,153 in shares based on achieving certain 12-month revenue and earnings before interest, taxes, depreciation and amortization ("EBITDA") targets, as defined. The NEP Note is unsecured and subordinated to financing with Silicon Valley Bank ("SVB"). We financed this acquisition through the use of long-term debt. We borrowed $4.0 million in the form of a 42-month term loan from SVB and $4.0 million in the form of a 8-year subordinated note from Massachusetts Capital Resource Company ("MCRC").

Our business model is heavily dependent on our people. We have significantly grown our employee base from 20 at the time of our initial public offering in November 2006 to a current high of 127 at March 31, 2013. This planned investment in staffing 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 commence to generate incremental revenue the operating leverage within our business model results in positive cash flow and profitability although there can be no assurances of this. To date we have funded our acquisitions and strategic investments primarily with cash on-hand, notes payable, cash from operations and, most recently, long-term notes payable. We have also deferred portions of the purchase


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prices through the use of earn-outs that are tied to ongoing performance of the acquired entity. Through the utilization of seller notes and earn-outs, we have been able to finance a portion of the cost of the acquisitions over time with the targets' ongoing cash flow generation. These activities 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

We earn a monthly commission on energy sales from each energy supplier based on the energy usage transacted between the energy supplier and energy consumer. The commissions are not based on the retail price for electricity but rather on the amount of energy consumed. Commissions are calculated based on the energy usage transacted between the energy supplier and energy consumer multiplied by our contractual commission rate. Revenue from commissions is recognized as earned over the life of each contract as energy is consumed, provided there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the fee is reasonably assured, and customer acceptance criteria, if any, has been successfully demonstrated. We generally recognize revenue on these transactions when we have received verification from the electricity supplier of the end-users power usage and electricity supplier's subsequent collection of the fees billed to the end user. The verification is generally accompanied with payment of the agreed upon fee to us, at which time the revenue is recognized. Commissions paid in advance are recorded as customer advances and are recognized monthly as commission revenue based on the energy exchanged that month. To the extent we do not receive verification of actual energy usage or we cannot reliably estimate what actual energy usage was for a given period, revenue is deferred until usage and collection data is received from the energy supplier.

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.

Wholesale and Environmental Commodity 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 transaction fees are accounted for utilizing two primary methods. For regulated allowance programs like RGGI, fees are paid by the lister and are recognized quarterly as revenue as auctions are completed and approved. For most 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 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), we utilize the completed-contract method. We also assess multiple contracts entered into by the same customer in close proximity to determine if the contracts should be combined for revenue recognition purposes. 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; and

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


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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, insurance 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 bank term loans, note payable and contingent consideration.

Income tax expense

Income tax expense reflects the release of our deferred tax assets to apply to projected annualized taxable income, federal alternative minimum tax liability and state income taxes.

Results of Operations

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



                                             For the Three  Months
                                                Ended March 31,
                                             2013               2012
              Revenue                            100 %            100 %
              Cost of revenue                     26               27

              Gross profit                        74               73
              Operating expenses:
              Sales and marketing                 57               56
              General and administrative          24               28

              Operating loss                      (7 )            (11 )
              Interest expense, net               (2 )             (1 )
              Other income                        -                 1
              Income tax expense                  (2 )             (1 )

              Net loss                           (11 )%           (12 )%


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Comparison of the Three Months Ended March 31, 2013 and 2012

Revenue



                                   For the Three Months Ended
                                            March 31,
                                      2013              2012               Increase
    Energy procurement           $    7,421,159      $ 6,006,263     $ 1,414,896       24 %
    Energy efficiency services        1,236,323          787,144         449,179       57

    Total revenue                $    8,657,482      $ 6,793,407     $ 1,864,075       27 %

Revenue increased 27% for the three months ended March 31, 2013 as compared to the same period in 2012 due to revenue from our NEP acquisition completed in the fourth quarter of 2012, increased auction activity in our retail and wholesale product lines and increased revenue from our Energy efficiency services segment. Our Energy procurement segment increased 24% due to the acquisition of NEP, and, to a lesser extent, increased transaction activity due to new customers. These increases were partially offset by a decrease in gas transaction activity. Revenue from our Energy efficiency services segment increased 57% as compared to the prior year as we completed projects covered by the four utility efficiency program designations that we were awarded in 2012, and from cross-sell opportunities.

Cost of revenue

                                               For the Three Months Ended March 31,
                                              2013                                2012
                                      $            % of Revenue            $          % of Revenue            Increase
Energy procurement              $   1,248,503                 17 %    $ 1,246,353                21 %    $   2,150       -  %
Energy efficiency services            984,648                 80 %        577,060                73        407,588       71

Total cost of revenue $ 2,233,151 26 % $ 1,823,413 27 % $ 409,738 22 %

Cost of revenue increased 22% for the three months ended March 31, 2013 as compared to the same period in 2012 primarily due to increases in equipment, material and labor costs associated with projects completed by our Energy efficiency services segment and the addition of NEP. Cost of revenue for our Energy procurement segment was approximately the same as 2012 as increased payroll costs associated with NEP and our retail product group were substantially offset by a decrease in amortization expense. Cost of revenue associated with our Energy procurement segment as a percent of revenue decreased by 4% due to the 24% increase in revenue with no corresponding increase in costs. Cost of revenue associated with our Energy efficiency services segment increased 71% primarily due to increased payroll costs due to the hiring of additional project managers during 2012 and a 61% increase in project material costs directly related to the 57% revenue increase due to the mix of projects completed. Cost of revenue associated with our Energy efficiency services segment as a percent of revenue increased by 7% as the cost increases were only partially offset by the revenue increase.

Operating expenses

                                                 For the Three Months Ended March 31,
                                                2013                                2012
                                        $            % of Revenue            $          % of Revenue             Increase
Sales and marketing               $   4,978,081                 57 %    $ 3,814,183                56 %    $ 1,163,898       31 %
General and administrative            2,061,673                 24        1,875,037                28          186,636       10

Total operating expenses          $   7,039,754                 81 %    $ 5,689,220                84 %    $ 1,350,534       24 %

Sales and marketing expenses increased 31% for the three months ended March 31, 2013 as compared to the same period in 2012 primarily due to increases in payroll, internal commissions and amortization of intangible assets. Payroll and internal commissions increased due to an increase of sixteen sales and marketing employees versus the same period in 2012 primarily due to our acquisition of NEP and hires in our Energy efficiency services segment. Amortization expense related to intangible assets increased in 2013 due to our 2012 acquisition of NEP. Sales and marketing expense as a percentage of revenue increased 1% due to the increase in costs described above, which was substantially offset by the 27% increase in revenue.

The 10% increase in general and administrative expenses for the three months ended March 31, 2013 as compared to the same period in 2012 was primarily due to increases in payroll and amortization expense. These increased costs were primarily due to additions in our back office operations to support our growth and our 2012 acquisition of NEP. General and administrative expenses as a percent of revenue decreased 4% as the 27% increase in revenue offset the above noted costs.


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Interest and other income (expense), net

Interest expense, net was approximately $203,000 for the three months ended March 31, 2013 compared to interest expense, net of approximately $89,000 for the three months ended March 31, 2012. The increase in interest expense, net in 2013 was primarily due to interest charged on our long-term debt. Other income in the first quarter of 2012 primarily consisted of $53,000 that was recognized from the sale of our investment in Retroficiency, Inc.

Income tax expense

We recorded income tax expense of approximately $131,000 for the three months ended March 31, 2013 compared to income tax expense of approximately $28,000 for the three months ended March 31, 2012. In the first quarter of 2013 income tax expense reflects a deferred tax provision, federal alternative minimum tax liability and state income taxes. In 2012 income tax expense reflected a federal alternative minimum tax liability and state income taxes.

Net loss

We reported a net loss of approximately $1.0 million for the three months ended March 31, 2013 and a net loss of approximately $0.8 million for the three months ended March 31, 2012, as the $0.1 million decrease in operating loss was offset by increases in interest expense and income tax expense.

Liquidity and Capital Resources

At March 31, 2013 we had no commitments for material capital expenditures. We have identified and executed against a number of strategic initiatives that we believe are key components of our future growth, including: making strategic acquisitions; entering into other energy-related markets including wholesale transactions with utilities, energy efficiency, and demand response; expanding our community of listers, bidders and channel partners on our exchanges; strengthening and extending our long-term relationships with government agencies; and growing our direct and inside sales force. As of March 31, 2013 our workforce numbered 127, an increase of one employee from the number that we employed at December 31, 2012. At March 31, 2013, we had 60 professionals in our sales and marketing and account management groups, 44 in our supply desk group and 23 in our general and administrative group.

We funded our acquisitions in 2011 with cash on hand, cash flow from ongoing operations as well cash flow generated by the acquisitions. We paid $10.4 million to acquire three businesses in 2011. During 2012, we paid $3.0 million in required installments against seller notes and an additional $2.3 million for earn-outs related to these acquisitions. In early 2012 we expanded our credit facility with SVB to include a 4-year, $2.5 million term loan. With our acquisition of NEP in October 2012, we borrowed an additional $10.0 million, including $4.0 million in long-term notes from both SVB and MCRC. In addition, we entered into a $2.0 million seller note with NEP and NEP can earn an additional $3.2 million in the form of earn-outs if certain performance criteria are met post-acquisition. We currently have $6.0 million outstanding with SVB, with $2.0 million classified as short-term, and $4.0 million outstanding with MCRC classified as long-term. In addition, we also have outstanding the $2.0 million seller note related to the NEP acquisition and a maximum of $3.5 million in potential cash earn-out obligations. While the expansion/addition of these debt instruments significantly increased our commitments, we believe we have the resources to meet both our short- and long-term obligations under these arrangements based on cash on-hand, operating cash flows from our base business and cash expected to be generated from all of our acquired businesses. During the first quarter of 2013 we generated cash flow from operations of $0.7 million and ended the quarter with $2.1 million in cash and cash equivalents.

Comparison of March 31, 2013 to December 31, 2012



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