Orion Energy Systems Inc (OESX) 2009 Q3 法說會逐字稿

Good afternoon, everyone, and welcome to the Orion Energy Systems' third quarter 2009 earnings conference call. Your line has been placed in a listen-only mode until the question and answer segment of today's call. This call is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the call over Erik Birkerts, Chief Operating Officer. Erik, you may begin.

Thank you, Jamie. And thank you for joining us for Orion Energy Systems' fiscal 2009 third quarter conference call.

With me on the call today are Neal Verfuerth, President and CEO, and Scott Jensen, CFO.

Before we begin, I'll read the Safe Harbor Statement. Our remarks that follow, including answers to your questions, includes statements that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are generally identified as such because of the context of such statements, and will include words such as "believes, anticipate, expect," or words of similar import. Similarly statements that describe future plans, objectives, or goals are also forward-looking statements.

These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in our press release issued this afternoon and furnished to the Securities and Exchange Commission on Form 8-K and Form 10-K filed with the SEC on June 27th, 2008, and other filings we have made with the SEC.

Except as described in these filings we disclaim any obligation to update these forward-looking statements which may not be updated until our next quarterly conference call, if at all.

Now, I'd like to turn the call over to Neal.

Thanks, Erik. I'd also like to welcome everyone to the Orion Energy Systems' fiscal 2009 third quarter conference call. After I make a few opening comments, I'll ask Erik to provide some highlights from the quarter, as well as describe progress within our business. Scott will then provide financial detail on the third quarter, and I will conclude with comments on the Orion strategic direction and long-term vision.

We're pleased with the results our business delivered in the third quarter, despite navigating through the worst global recession seen in decades. These results demonstrate the strong fundamentals of our business, the value of our technology that we deliver to our customers and, most importantly, the hard work and commitment of our people. Additionally, our results during the quarter nearly reached a record level that we achieved in last year's third quarter, a time when the economy was healthier and business confidence was high.

For the third quarter of fiscal 2009 we reported revenues of $22.4 million, net income of $1.2 million, and earnings per share of $0.04. During the third quarter we installed our high performance energy efficient lighting, known as Phase I, in over 344 facilities, an increase of over 300 facilities that we completed in the second quarter. Our installed base of our customers' facilities in total now numbers 4,387 facilities and represents over 725 million square feet of space retrofitted.

Our projects have a positive impact on grid capacity, and since late 2001 we've delivered permanent base load reduction of over 422 megawatts of base load. Furthermore, we've made significant progress in delivering new and innovative solutions to our customers with strong shipments and installations of our products, which include an addition or a Phase I offering of specialty freezer fixture, a [web rated] fixture, and we continue to gain traction on our Phase II and Phase III deployment of the Apollo solar light pipe and wireless intelite control systems.

Despite the economic headwinds, we continue to win new customers and roll-out our solutions across our existing customer base. Even in the tough times the economic savings and improved working conditions delivered by our technology are major contributors to our customers' cost cutting and lean initiatives.

However, this overall uncertainty in the market continues to present challenge to the Orion sales engine. We now have to invest more time into developing new deals and resetting existing deals due to plant closures and key contacts and decison makers losing their jobs. We are also investing time thawing Orion proposals from frozen CapEx budgets.

We continue to be encouraged that our strong value proposition is shining through, but at this point we are still maintaining a conservative outlook for the remainder of fiscal '09. With that being said, we are reaffirming our guidance in the range of 0% to 9% with an earnings per share of $0.06 to $0.11.

We're committed to ensuring that the Company remains profitable, without compromising our long-term enterprise value. We will continue to invest in our business with a long-term view that will allow us to capture the sizable opportunities that lie before us.

I want to emphasize our financial strength and flexibility which will allow us to continue to be aggressive in the market. We're profitable and cash flow positive on an operating basis. We have $49 million in cash and short-term investments and nominal debt in our balance sheet as of December 31. We maintain a bank revolving line of credit with approximately $20 million in availability.

We're confident that we have the resources necessary to execute on our strategy. We also have about $7.5 million remaining on our $30 million share repurchase and authorization from the Board, and we have the ability to continue repurchasing shares in the market as opportunities present themselves.

While our current strategy remains unchanged, which is attacking the significant opportunities that exist within the $9 billion retrofit market, we are continually focused on providing our customers with a path to substantial energy savings in the future.

The successes we have witnessed with our innovative new technologies have only begun to scratch the surface of the opportunity, and we're encouraged by Orion's progress to date. And I will conclude the call with further comments on our long-term vision and strategy.

With that, let me turn the call over to Erik to take you through the progress we've made in our business. Erik?

Thanks, Neal.

Before jumping into some details around our sales organization, I'd like to take a quick moment to update on our new venture, the Orion Virtual Power Plant. We have seen positive traction since officially launching the Orion Virtual Power Plant in October of 2008. It has allowed our salespeople to capture deals that would not otherwise have occurred due to capital constraints.

To remind everybody, the Orion Virtual Plant is an energy supply contract in which Orion commits to deliver a set amount of megawatts, essentially energy savings, at a fixed late lower than the customers' rate to acquire power from the utility. As the Orion Virtual Power Plant is structured to qualify as an operating expense, customers benefit from cost savings, incremental cash flows, and Orion's technology without having to make upfront investments or capital outlays.

As of December 31st, 2008 we have 12 contracts to deliver over 27.5 million megawatts, and we expect to continue to build further momentum with the Orion Virtual Power Plant in the future. As we discussed in our last call, we have the option of selling the recurring megawatt payments to a third party and recognizing the value of the deal upfront. The current present value of the 27.5 million megawatts we have under contract is roughly $750,000.

Alternatively, we may also elect to hold these contracts and recognize the recurring revenue on a monthly basis as we deliver across the megawatt delivery period. From an accounting and reporting standpoint this option may lessen near-term revenues but may lead to more stable and predictable revenue streams over time.

Moving to our sales force, we finished Q3 with 62 people in our sales organization. We have resumed our recruitment efforts, and we are now looking to selectively hire the good talent that is increasingly available, and we expect to finish our fiscal year with about 70 people in our sales organization. As Neal mentioned, our sales team is performing well under difficult circumstances, and we are making progress on our core strategy of capturing the $9 billion plus retrofit opportunity.

Regarding new customers acquired during the quarter, we worked with 18 new national account customers, retrofitting 20 locations in 11 states and one Canadian province. This compares favorably to the 11 new national account customers in 18 locations we retrofitted in the second quarter.

We also secured a significant new customer rollout agreement. This agreement encompasses 15 facilities for a publicly traded multinational plastics manufacturer. At this point, our project management team is working with counterparts at this company to define the rollout schedule, the majority of which will take place in fiscal year '10, or 2010, excuse me.

As we discussed on earlier calls, our third and fourth quarters historically have represented our most active months for national account projects. This year is no exception as we completed projects at 99 facilities for national account customers already doing business with Orion. These new locations cover 48 national account customers in 30 states and two Canadian provinces.

The customers for whom we are most active completing multiple projects in the third quarter included Anheuser-Busch, Coca-Cola, U.S. Food Service, Kraft, [Americo Logistics], and Sysco Foods.

I'd also like to provide some more detail on the success of our product development initiatives, which provide valuable differentiated solutions for our customers. In the third quarter we shipped over 8,000 units of our specialty freezer fixture, designed to operate at high performance at ambient temperatures as low as negative 20 degrees Fahrenheit. This product is a great application for the food service and cold storage industries.

We also shipped over 3,500 units of our wet rated fixture, we launched in April. This specialty fixture is designed to operate optimally in wet and full wash-down operating environments prevalent in the food and beverage sectors.

We deployed our Phase II proprietary wireless in flight control systems at seven customer facilities in the third quarter, bringing to 25 the number of facilities with Orion wireless in flight controls installed. Although our wireless control systems have yet to contribute meaningful revenues, we believe this technology will be a game changer by virtue of adding intelligent store fixtures, and we expect that it'll soon be deployed in most new projects we undertake.

We are also beginning dialogue with existing customers about wireless control upgrades and, as Neal will discuss a bit later, our wireless controls allow Orion to provide impactful demand response solutions.

Finally, our Phase III Apollo solar light pipes also continue to gain market acceptance. In the third quarter we shipped 284 units and across the first nine months of fiscal 2009 we have shipped over 1,100 units.

Let's move on to our wholesale business. As we have discussed, we are making a strong push to strengthen our wholesale network of partners, as this network will provide us with the geographic reach and market coverage necessary to capture the wealth of opportunities that exist at small and midsized customers across the United States.

The top performers across this network will also serve as valuable installation and project management partners to help us deploy projects for our direct customers. Within the quarter, our wholesale business contributed about 37% of revenues, whereas our direct sales efforts contribute about 63%.

For the nine months ended December 31st, our wholesale business contributed about 43% of revenues. For this fiscal year we expect the contribution of our wholesale business to be about 40% of revenues as the strength of our national account business in Q3 and Q4 outpaces our wholesale business on a relative basis.

In terms of growth, our VAR sales are up 47% versus prior year for the nine month period ended December 31st. We saw exceptional performance and growth from the VARs in the second quarter, whereas this quarter, while still strong, their sales were on a par with what we witnessed last year in Q3. This served to pull-down the year-to-date growth rate from the 83% we cited in our previous earnings call to the current 47%.

We also continue to expand our contractor network, adding 51 new contractor partners in the third quarter. The network of contractors that have done business with Orion on a recurring basis now numbers over 370 companies as of December 31st, 2008.

In terms of sales, our contractor network is performing well. Sales to contractor partners for the nine months ended December 31st exceeded prior year's sales for the same period by 75%.

Let me conclude by quickly reviewing what we expect to see in the fourth quarter. As Neal stated above, we forecast annual revenues this year in the range between $81 million and $88 million, although we will be closer to the lower end than the top end of this range.

In the fourth quarter we currently expect that a little more than 40% of this target will come from national account rollouts that are scheduled for Q4. We currently expected a little less than 40% to come from well qualified deals that are in the late stages of their sales cycles.

Our VAR partners are currently estimated to contribute about 20% of revenues in the fourth quarter. We also witnessed some quick hit and unexpected deals surface with frequency, deals on which we have no visibility but we are not including these in our forecast.

Again, at this juncture we remain confident in our expectations for the remainder of our fiscal year, but we are cautious and proactively addressing any additional risks that may come from the uncertain times we now find ourselves in, which may include unanticipated plant closures or organizational upheavals at customers.

I'll now turn the call over to Scott to take you through the financial results in more detail. Scott can also describe some of the discretionary spending reductions and efficiencies we pursued in the quarter. Scott?

Thank you, Erik.

Our reported revenues for the third quarter were $22.4 million compared to revenues of $23.3 million in the same period of fiscal 2008. $20.7 million or approximately 92% of the quarter revenue was driven by product sales, while service revenue accounted for the remaining 8%.

As Erik mentioned, our partner sales continued to remain strong, which impacts our overall level of service revenue. We also had several projects still in process at yearend, for which we did not record the related service revenues.

Our gross margin for the quarter was 33.2% versus 35.4% in the comparable prior year. Gross profit dollars for the quarter were $7.4 million compared to $8.3 million in fiscal 2008.

Product margins were negatively impacted by incremental manufacturing costs incurred as a result of increasing volumes of our enclosure, freezer, and recently launched wet rated fixtures. These product lines are more complicated to manufacture and require more production time for both fabrication and assembly.

Due to customer project timelines we incurred an additional $300,000 in added personnel costs, overtime costs, and inefficiencies resulting in an overall margin impact of 1.3% for the quarter. Over the past several weeks we've reengineered our assembly process for enclosure fixtures, eliminated the additional staffing, and reduced material handling costs. We believe that we are now better positioned to improve our gross margin on these important product lines.

G&A expenses for our third quarter were $2.4 million or 10.9% of revenue versus the prior year of $3.3 million or 14.1% of revenues. Additionally, this was a $455,000 decrease versus our most recent quarter.

For the quarter we scaled back or eliminated areas of discretionary spending and implemented a corporate cost reduction program. For example, we eliminated our yearend employee and management bonuses. We also reduced travel, supply, consulting expenses as appropriate.

For the quarter we incurred $400,000 of public company costs that were not incurred during our prior year third quarter. These expenses are attributable to our Sarbanes-Oxley 404 compliance efforts and increased costs for legal, audit, insurance, and investor relations activities. Also, it is important to note that in our prior year third quarter we incurred $750,000 in IPO bonus cost that did not recur.

Sales and marketing expenses for the quarter ended December 31st, 2008 were $2.7 million or 12.3% of revenues, compared to $2.3 million or 9.7% of revenues in the prior year. During the quarter we did introduce some cost reduction initiatives along with some discretionary spending reductions in our sales and marketing areas. The increase in cost year-over-year was due to total higher sales headcounts and direct mail campaigns targeting customer and channels, although we did scale back our marketing efforts from our most recent prior quarters.

R&D expenses for the third quarter were $347,000 or 1.6% of revenues, down from $454,000 or 1.9% of revenues in Q3 of fiscal 2008. R&D expenses have declined due to a decrease in material testing costs, as our wireless technology moves into the production and go to market stages. We also witnessed a decrease in our product development consulting costs. We consider this reduction in R&D expenses to be temporary, as our wireless technology moves into the market and as we initiate product development around new initiatives. Moving forward we expect roughly $400,000 per quarter spending in R&D.

Income from operations for the third quarter was $1.9 million versus $2.3 million in the prior third quarter. Net interest expense for the quarter was $33,000 versus $648,000 in the same period of fiscal 2008. The decrease in interest expense was due to $500,000 of convertible debt interest costs that were recognized at the time of last year's IPO.

Net income for the third quarter was $1.2 million or $0.04 per share on weighted average, fully diluted shares outstanding of 26.4 million compared to net income of $1.2 million or $0.05 per share for the same period in the prior year based on 22.8 million weighted average fully diluted shares outstanding.

Moving to our year-to-date numbers, our reported revenues for the nine months ended in December were $57.2 million compared to revenues of $58.4 million in the same period of fiscal 2008. The decrease can be primarily attributable to the softer sales that we experienced in the first half of this fiscal year and the difficult economic conditions in the marketplace.

Our gross margin for the first nine months of fiscal 2009 was 33.1% versus 34.5% in the comparable prior year. Our gross profit for the nine months was $19 million compared to $20.2 million in fiscal 2008. Gross margins were negatively impacted by under absorbed factory cost, resulting from new processes for manufacturing and coating introduced during the end of our prior fiscal year.

G&A expenses for the first nine months were $7.9 million or 13.9% of revenue versus the prior year of $6.8 million or 11.6% of revenues. As I've previously stated we believe in our most recent quarter we made some strides in addressing our cost structure and reducing discretionary spending. Year-over-year our costs have increased approximately $1.5 million due to the costs that we attribute as a public company operating cost, including the defense costs for the class action litigation.

Sales and marketing expenses for the nine months ended December 31st, 2008 were $8.2 million or 14.3% of revenues compared to $6.3 million or 10.8% of revenues in the prior year. Our sales and marketing expense increased by $1.4 million for additional compensation costs due to increased headcount and $500,000 for increased marketing efforts. We believe the marketing channel spending was a good investment based upon the success we've experienced in our wholesale channel this year.

R&D expenses for the first nine months were $1.1 million or 2% of revenues, down from $1.3 million or 2.3% of revenues in fiscal 2008. Our operating income for the first nine months was $1.7 million versus income from operations of $5.8 million in the same period in the prior year.

Net interest expense for the first nine months was $141,000 versus $1.3 million in the same period in fiscal 2008.

Net income for the first nine months was $1.7 million or $0.06 per share on weighted average fully diluted shares outstanding of 28.7 million compared to net income of $3 million or $0.14 per share for the same period in the prior year based on 20.8 million weighted average fully diluted shares outstanding.

Turning to the balance sheet, as of December 31 we had a total of $24.2 million in cash and equivalents on hand compared to $78.3 million at the end of our fiscal year ended March 31, 2008.

As a reminder, a significant portion of this decrease is due to a different classification for our $24.7 million invested in short-term government agency bonds, which carry improved yield versus our cash and money market investments.

All of our agency bonds have continued to mature at par value. None of our cash is invested beyond one year, and 70% of our cash and investment portfolio is highly liquid with maturity dates of 120 days or less.

The remaining balance and our changing cash from our prior fiscal yearend is due to the $22.4 million in Treasury share repurchases and the $10.6 million in capital spending, invested in our technology center, ERP system, and operational cost reduction and integration measures.

In December we did experience an increase in our accounts receivable. Nearly 20% of our yearend balance was paid within the first seven business days of January. We're cognizant of the current liquidity and credit challenges in the economic environment and the high level of underwriting due diligence required as we review new customer opportunities. Overall our receivables portfolio continues to be sound, primarily consisting of our national account customers and our wholesale partners.

We decreased our inventory levels by $300,000 from the prior quarter, as we continued to focus on improving inventory turns. Additionally, we are carrying inventory of our wireless components which have longer production lead-times than our traditional fixture inventory components. Our wireless component inventory also reflects our belief in the market's success of our wireless technology and Phase II initiatives.

In the third quarter we repurchased over 3.8 million shares of common stock at a cost of $14.3 million. For the year-to-date we've generated $4.2 million in positive cash flow from operations before accounting for changes on the balance sheet.

With that, let me turn the call over to Neal to discuss Orion's longer term strategy. Neal?

Thank you, Scott.

Although we're realistic about the challenges we face in the coming year, we're optimistic about our value proposition and competitive advantage in the market. In fact, we believe our strong financial position coupled with the power of the Orion Virtual Power Plant to get deals over the tough times will allow us to aggressively pursue the $9 billion retrofit opportunity at a time when many other companies may be retrenching, particularly those who have franchises built around the new construction market.

Keep in mind that we have a greater than 10-year track record of successful execution in the retrofit market. Most recent evidence of our experience and success is the prestigious Facility Supplier of the Year Award we received from Sysco Corporation, a global leader in the food service industry. This is the second straight year we've received this award, and we were chosen by the popular vote of the Sysco broad line distribution companies in the U.S. and Canada. We've retrofitted over 60 facilities, many several years ago, and the fact that we still receive the popular vote goes to show that the benefits of energy efficiency keep giving over time.

I would also like to highlight that we believe Orion's integrative energy management system is a preeminent solution in the marketplace. In December Orion received the coveted Platts Global Energy Award for Sustainable Technology Innovation of the Year. According to Platts the award is given to the company that has made the single most innovative technology advance in the area of green technology.

At the end of the day, however, what really matters are results. To this end, let me highlight what Coca-Cola Enterprises has achieved in California. Orion has retrofitted more than 4,000 lights with our Phase I solution at 24 Coca-Cola Enterprises' facilities throughout California with our HIF technology.

This retrofit initiative will decrease CCE's energy consumption by over 5.6 million kilowatt hours each year which is enough electricity to power 530 homes annually. Over the 20-year life of the system, energy consumption will be reduced by 113 million kilowatt hours. From an environmental standpoint CCE will prevent over 3,700 tons of carbon from entering the atmosphere each year. We think that is impressive, and we commend Coca-Cola Enterprises on their commitment to sustainable business practices.

Although we remain focused on the $9 billion retrofit market, I would like to highlight several initiatives that we believe will enhance Orion's future growth. We're very excited about the launch of our outdoor lighting product that will target parking lot and street lighting applications. By simply extending our existing technology with some minimal incremental R&D efforts we have designed a product offering that outperforms high [purchase sodium] and LED alternatives. Given that the U.S. Department of Energy research indicates that there are more than 20 million parking lots in the United States, not to mention millions upon millions of streetlights, we see a tremendous opportunity to go after. Moreover, we can envision the day when the load reduced in the evenings and the nighttime can be redeployed to power the electric vehicles of the future. We also see tremendous opportunity working with utilities to reduce base load capacity constraints.

In our first foray we received approval in December from the New Jersey Board of Public Utilities to deploy Orion's integrated lighting system as a capacity solution in the Port Region of New Jersey. The integrated solution will include all three phases of the Orion technology. Under the program, which is a partnership between Orion, PSE&G, and General Electric, PSE&G and GE will provide financial incentive to reduce a simple payback period for Orion to integrate its systems, which includes all three phases, to two years. We're excited about this program, and we are using it as a model we can deploy with other utilities in the future.

Our wireless intelite controls also position Orion to address peak load capacity issues. Not only do our wireless controls allow Orion to offer demand response solutions on the utility side of the meter, but they also offer demand control solutions to our customers on the customer side of the meter, as well. It is important to realize that in a warehouse and in industrial settings, lighting load often exceeds HVAC and other loads in the facility. Our wireless controls hit this sweet spot. Moreover, our wireless controls are easily extended to control compressors, chillers, HVAC, and other load sources.

We also realize that our installed base of over 4,300 facilities is a tremendous asset. As such, we are exploring additional partnership opportunities and acquisitions of other technologies that complement our existing suite of energy efficiency solutions. From a partnership standpoint, we are speaking with numerous solar players to create a [PB] offering for our customers.

In conclusion, we recognize that President Obama's Administration may bring unprecedented opportunities to companies such as Orion, which will provide workable solutions to the energy and sustainability challenges facing this country. It is still unclear how the President's financial stimulus plan and broader energy and climate policies will ultimately take shape. However, the fact that energy is top agenda item for our President, bodes well for Orion as a pure play energy efficiency company.

Some things we are watching closely include funds targeted towards energy efficiency and weatherization upgrades for government and public buildings. This chunk of money when deployed may present immediate opportunities for Orion in school gymnasiums, government warehouse spaces, military facilities, and such.

It also appears that significant funds may be sent to individual states to manage and disperse. Our people in Washington at the state level advise us that these funds will likely be directed into existing energy efficiency programs. And those such programs deploy funds through rebate incentives for energy efficiency projects, clearly a benefit to Orion.

We are closely monitoring how funds targeting these smart grid initiatives will be deployed as we see opportunities with our wireless intelite control systems and associated demand response solutions.

Beyond the fiscal stimulus plan, President Obama appears committed to new legislation around climate change. Whether this legislation takes the form of a [cap in rate] or a carbon taxation remains to be seen. Orion stands to benefit under either scenario as our technology provides permanent base load capacity reductions that translate into CO2 reductions.

Let me leave you with a few facts to keep in mind as you think about Obama's fiscal stimulus plan, climate change legislation, and energy policies. Orion's solution offers customers a 50-50 value proposition. Our technology will reduce our customers' lighting related expenses, many times as much as 50% of overall load, by 50% or more, while providing our customers 50% more high quality light. We call it energy savings without compromise.

As it relates to the overall load on a macro level, every 4,200 fixtures Orion permanently displaces one 400-watt legacy [HID] will result in one megawatt of base load capacity, and the potential to expand an additional 40% of peak load from the grid going forward. And from a carbon reduction each one of these measures, each six-lamp Orion fixture will displace one ton of carbon annually.

Operator, at this time, we'd like to open up the call for questions.

Thank you, sir. (OPERATOR INSTRUCTIONS.)

And we'll take our first question from Eric Glover with Canaccord Adams.

Hi, congratulations on a good quarter.

Thank you.

Thank you, Eric.

First question, I was wondering if you could provide a little more detail about what you're currently seeing out in the market now? If you could compare and contrast what your customers are doing or potential customers are doing, thinking now as compared to a year earlier?

Eric, this is Neal. I think that the thinking and the desire is still there. They're dealing with the same uncertainties we're all dealing with about what just to expect in the overall economy. What we're seeing is essentially a lengthening of the sales cycle, and that could consist of having to revisit the same deal as it's going through the process, additional times, we're seeing several locations where we're actually having to go back and talk to a new group of individuals that have responsibility for the project, whether our initial sponsors were downsized out of the organization or even the case where our sponsors have additional workload because other of their team members were displaced.

And then, lastly, of course, when we get through all of that gauntlet, we have to get the capital freed up. If they don't want to participate with our Virtual Power Plant, they want to pay cash, many times it takes even CEO intervention to go in and pull the Orion deal out of the frozen CapEx budget, because the fact of the matter is even when times are slow the lights stay on and our value proposition is still compelling, even more compelling now than in the past.

Eric, this is Erik Birkerts. As we've talked about on earlier calls, about a year ago what we were seeing is we were able to really affect some quick hit deals, where we would go in and just based on the payback period we were able to get decisions from customers very quickly. And as we've talked about before, at the time we were seeing as much as 40% of deals closing within 60 days.

That quick hit opportunity is not out there right now, that doesn't mean that we don't get the deals, it's just taken a lot longer. And when we are looking at our data, now we're seeing maybe only 10% of the deals closing within 60 days. So things are just taking more time than they were in the past.

Okay. Thanks, that's very helpful. And a quick housekeeping question, what was the depreciation and amortization in the quarter?

Eric, in the quarter depreciation and amortization was $480,000.

Okay. Thanks a lot.

We'll take our next question from Eric Stine with Northland Security.

Hey, guys, how is it going?

Fine, thanks. How are you Eric?

Hi, Eric.

Not too bad. Just a few housekeeping questions of mine, before I continue, I was wondering if you could break-down the gross margin between product and service?

Sure. On the product side gross margins were 34%, and as I mentioned there was costs in the quarter that impacted that margin around some of our fixture lines that we feel we've addressed and very optimistic about our opportunities to grow gross margin on those product lines.

Our service margins for the quarter were 23%, Eric, and a big reason for that decrease was we had some legacy project costs recorded in this quarter, based on some estimating issues, so that's not something that I expect to recur. I view that more as an aberration.

Okay, so we should think about the service gross margin returning to somewhat of a more normal level?

Correct.

Okay. One other thing I was hoping you could -- you guys did a good job of this, last quarter when you talked about the remainder of the year and guidance, could you break-out this quarter, what the revenue was between the national account base, the VAR channel, and also your pipeline?

You mean for Q3?

Yes.

Yes, national accounts were a little over $9 million. VARs were right around $4 million. And then kind of pipeline conversion was $8.5 million.

Okay. Let's see, I was just wondering, to switch gears if you could, just talk a little bit -- I know Neal did some, just on the competitive environment? I know over the last few weeks, and this has been going on for quarters that a number of your larger competitors have talked about weakness in the commercial construction market, and for that reason they're going after the retrofit market. Have you seen any difference in how they have acted or are there any pricing pressures as a result?

This is Neal. As I see it, really nothing has changed. We continue to go head-to-head with the normal cast of characters out there, you know, the large, multibillion dollar, you know, the [cuities] and then the Hubbell's, et cetera, and we continue to win business. And if anything we're seeing some of the less established competitors out there being more challenged than they were in the past just due to what's going on today in the marketplace and their access to capital and technology. So I think you'll probably see a shaking out of some of the smaller ones on a go-forward basis.

Lastly, I just want to comment that we're seeing as relates to comparing HIF technology to LED, we're seeing a lot of change in overall sentiment in LED compared to what, looking at lumens per watt and just overall performance. The HIF technology is proving itself to be far superior to the LED in so many ways.

Okay. The LED is being shown to be more niche applications?

Well, what's interesting is you're seeing a lot of press out there in industry magazines and the whitepapers done, that are talking about a drastic reduction in the overall longevity of the LED, and I saw them probably as recent as 18 months ago at 150,000 hours, then down to 100, and now they're saying 50,000 hours. Conversely, the fluorescent, the linear fluorescent guys are now north of 40,000 in life.

And just on a lumens per watt basis you can't beat the high frequency balance and [tri phosphor lamps] on lumens per watt, they meet or exceed the LED. So the LED, you know, part of their story was historically longevity, now they're getting down very close to what the fluorescent guys are at. So, but, the difference being there even if you assumed all things are equal, they're five times the cost.

Yes, and as a footnote, Eric, they have an issue with lumen maintenance, so even across those five, you know, 50,000 hours they may not burn out per se, but they start -- there's lumen depreciation such that -- and what we're talking about are white LEDs, not colored LEDs. And white LEDs are the technology that would be most suitable to general illumination.

Okay. Thanks a lot. That's very helpful. And then just one more question and I will jump back into line. Just on the cost side. If I recall correctly, you had your aluminum hedged through the end of '08. Should we expect to start seeing some benefit from that now that prices have come down and you're unhedged?

Yes, Eric. We did lock-up new pricing for this year at a nice benefit, so our anticipation is that will flow through our gross margin line.

Okay. Thanks a lot. I appreciate it.

Thank you.

And we'll go next to Glenn Wortman with Sidoti.

Good evening, guys.

Hi, how are you?

I'm doing pretty good. Just on -- for the G&A expense do you expect that lower level of about $2.5 million to repeat in the fourth quarter or should we expect that to move-up a little bit?

Good question, Glenn. I'd anticipate that that will move-up a little bit in the fourth quarter. Some of our discretionary spending had to do with holiday functions, yearend bonuses. Obviously, that won't recur to the same level. Having said that, though, we have implemented a corporate cost reduction program, and we're very cognizant of our spending right now in driving profitability to the bottom line.

Okay. And then with respect to the sales and marketing, I know you said you were adding, looking to add eight new salespeople, so I guess we should pick that up a little bit, as well, right?

Correct.

Okay. Actually, as far as like talking about the Federal stimulus, do you know if any of your products are currently going into government facilities?

We have done projects with some military bases in the past, but by and large we're focused on commercial and industrial in the private sector.

Finally, just on the tax rate, that looked like that jumped to about 47% or just what we should be modeling there going forward?

Yes, Glenn, it's just a little over 46% right now. I would anticipate that that's where that rate is going to end up at yearend. We continue to be challenged with the nondeductible ISO stock option expense, and we do get a benefit when somebody might exercise and sell those on the same day but it's very difficult to forecast that.

So we had some higher exercise activity coming out of the lockup period around those, and in the most recent quarter based on the share price there was very minimal option, exercise activity. So from a modeling standpoint what you see is what you're going to get right now for the balance of this year.

All right. Thank you for your time, guys.

Thank you.

And we'll go next to [Tom Spiro] with [Spiro Capital Management].

Good afternoon.

Good afternoon.

You mentioned in your commentary that the sales cycle has lengthened, and you had attributed that largely to the economic weakness the country is suffering these days. I was curious whether you think that another factor might be moderation in the price of electricity? In fact, perhaps it's even going down in certain places?

I haven't heard of any place, you know, natural gas of course going down, but I see a $7 onetime credit or something for homeowners for electricity, but on a C&I side, I haven't seen any significant movement downward on the price of kilowatt hour, especially the daytime.

And the -- on the utility side, are they now looking at reserve capacity that appears to be much more adequate than it appeared say a year ago?

Oh, absolutely. When we're perusing less goods the overall demand is going to go down on a somewhat linear basis. But having said that the base load requirements of the utilities are still something that they are short on, they need to shore-up so, our solutions offer a significant base load reduction, so they will continue to have value in utilities, and if anything we gain more traction in every passing month as utilities recognize that we have a least cost alternative, we're clean and we free-up any issues that are plaguing their distribution infrastructure locally, because we go right to the load center. It's almost like distributed generation in many ways, but it's a load reduction.

Thanks much.

You're welcome.

We'll take our next question from Jeff Osborne with Thomas Weisel Partners.

I was wondering if you could just discuss kind of what your outlook is over the next couple quarters, not just next quarter or this current quarter, but the mix shift that you're seeing in terms of the VAR channel versus the direct channel? How you're realigning that?

Well, Jeff, this is Erik. Yes, I am hesitant to kind of front run kind of our discussions on what fiscal year '10 will look like, but in terms of the mix we just, we are investing in our partner network, and I think you're just going to continually just see that number in terms of percentage of revenue contributed form wholesale move upward. And that really reflects the fact that we realize that our partners give us that geographic reach, cost effective geographic reach to start penetrating into those smaller and midsized customers that we just can't cost effectively target and service with a direct sales force.

Got you. And then I understand you don't want to comment about the upcoming fiscal year, but just generically speaking can you talk about what the margin impact is with that kind of secular shift in terms of gross margins? I understand OpEx would be a little bit lower as you referenced, more cost effective, but just is it a lower gross margin business but perhaps a higher operating margin business versus your historical direct model? Can you just comment on that?

Historically, our gross margins with our wholesale business have actually been higher than our direct business.

Okay. And then what about the -- on an operating basis, any type of commentary there?

Very, very similar. Generally, on an operating basis you don't have the direct costs either, Jeff, so.

Got you. And then the last question, I was wondering if you could just talk about I understand that the megawatts rollout and the strategy there, but can you just talk about more of the classic financing need that you're seeing from your customer, either existing installed base or new customers and their ability to get financing and move through with purchases?

It's a question regarding, you know, whether they make a cash/CapEx purchase versus an Orion Virtual Power Plant purchase?

Well, I think at the time of the IPO you folks had partnered with a relatively small Minnesota bank for financing, and I was just curious if you have any new type of financing partners that you can detail?

Well, we're still working with that bank that you reference. We also recognize that at this point in the grand scheme of things the Orion Virtual Power Plant represents a small portion of our business, but looking forward we realize it's going to become a larger percentage of our business, so we're currently talking to other partners that will provide both capital and credit writing expertise so that we can offload some of that from our shoulders.

Very good. Thanks much.

Thanks, Jeff.

And that does conclude our question and answer session. At this time, I'd like to turn the call back over to Mr. Neal Verfuerth for closing remarks.

Thank you. I think that's it. I think we're through, and we thank everybody for joining us on this call, and have a good evening.

That does conclude today's conference. Thank you for your participation. You may disconnect.