OESX-2013.09.30-10Q
Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________ 
FORM 10-Q
_____________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2013
OR
 ¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-33887
______________________________
Orion Energy Systems, Inc.
(Exact name of Registrant as specified in its charter)
______________________________ 
Wisconsin
 
39-1847269
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification number)
2210 Woodland Drive, Manitowoc, Wisconsin
 
54220
(Address of principal executive offices)
 
(Zip code)
Registrant’s telephone number, including area code: (920) 892-9340
_______________________________ 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).    Yes  x   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
  
Accelerated filer  ¨
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company  x
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

There were 21,161,029 shares of the Registrant’s common stock outstanding on November 6, 2013.


Table of Contents


Orion Energy Systems, Inc.
Quarterly Report On Form 10-Q
For The Quarter Ended September 30, 2013
Table Of Contents
 
 
 
Page(s)
ITEM 1.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 5.
ITEM 6.
Exhibit 2.1
 
Exhibit 3.2
 
Exhibit 31.1
 
Exhibit 31.2
 
Exhibit 32.1
 
Exhibit 32.2
 
EX-101 INSTANCE DOCUMENT
 
EX-101 SCHEMA DOCUMENT
 
EX-101 CALCULATION LINKBASE DOCUMENT
 
EX-101 LABELS LINKBASE DOCUMENT
 
EX-101 PRESENTATION LINKBASE DOCUMENT
 


2

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PART I – FINANCIAL INFORMATION
Item 1: Financial Statements
ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
 
 
March 31, 2013
 
September 30, 2013
Assets
 
 
 
Cash and cash equivalents
$
14,376

 
$
17,563

Short-term investments
1,021

 
1,024

Accounts receivable, net of allowances of $900 and $652
18,397

 
17,254

Inventories, net
15,230

 
15,207

Deferred contract costs
2,118

 
2,453

Prepaid expenses and other current assets
2,465

 
2,483

Total current assets
53,607

 
55,984

Property and equipment, net
27,947

 
26,127

Long-term inventory
11,491

 
9,878

Goodwill

 
4,899

Other intangible assets, net
1,709

 
7,568

Deferred tax assets

 
134

Long-term accounts receivable
5,069

 
3,460

Other long-term assets
2,274

 
2,285

Total assets
$
102,097

 
$
110,335

Liabilities and Shareholders’ Equity
 
 
 
Accounts payable
$
7,773

 
$
11,925

Accrued expenses and other
5,457

 
4,427

Deferred revenue, current
2,946

 
822

Current maturities of long-term debt
2,597

 
3,326

Total current liabilities
18,773

 
20,500

Long-term debt, less current maturities
4,109

 
5,041

Deferred revenue, long-term
1,258

 
1,355

Other long-term liabilities
188

 
944

Total liabilities
24,328

 
27,840

Commitments and contingencies (See Note F)

 

Shareholders’ equity:
 
 
 
Common stock, no par value: Shares authorized: 200,000,000 at March 31, 2013 and September 30, 2013; shares issued: 30,498,900 and 30,641,710 at March 31, 2013 and September 30, 2013; shares outstanding: 20,162,397 and 21,143,729 at March 31, 2013 and September 30, 2013

 

Additional paid-in capital
128,104

 
129,067

Treasury stock: 10,336,503 and 9,497,981 common shares at March 31, 2013 and September 30, 2013
(38,378
)
 
(36,356
)
Shareholder notes receivable
(265
)
 
(146
)
Retained deficit
(11,692
)
 
(10,070
)
Total shareholders’ equity
77,769

 
82,495

Total liabilities and shareholders’ equity
$
102,097

 
$
110,335

The accompanying notes are an integral part of these condensed consolidated statements.


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Table of Contents


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
 
 
Three Months Ended September 30, 2013
 
Six Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
Product revenue
$
16,931

 
$
21,181

 
$
30,511

 
$
38,704

Service revenue
2,477

 
6,314

 
4,207

 
9,643

Total revenue
19,408

 
27,495

 
34,718

 
48,347

Cost of product revenue
11,867

 
15,638

 
21,464

 
28,522

Cost of service revenue
1,736

 
4,028

 
3,076

 
6,273

Total cost of revenue
13,603

 
19,666

 
24,540

 
34,795

Gross profit
5,805

 
7,829

 
10,178

 
13,552

Operating expenses:
 
 
 
 
 
 
 
General and administrative
4,638

 
3,173

 
7,940

 
5,857

Acquisition related

 
356

 

 
431

Sales and marketing
4,561

 
3,644

 
8,513

 
6,947

Research and development
710

 
448

 
1,407

 
938

Total operating expenses
9,909

 
7,621

 
17,860

 
14,173

(Loss) income from operations
(4,104
)
 
208

 
(7,682
)
 
(621
)
Other income (expense):
 
 
 
 
 
 
 
Interest expense
(142
)
 
(142
)
 
(303
)
 
(255
)
Interest income
218

 
153

 
443

 
327

Total other income
76

 
11

 
140

 
72

(Loss) income before income tax
(4,028
)
 
219

 
(7,542
)
 
(549
)
Income tax expense (benefit)
5,631

 
(2,184
)
 
4,057

 
(2,171
)
Net (loss) income
$
(9,659
)
 
$
2,403

 
$
(11,599
)
 
$
1,622

Basic net income (loss) per share attributable to common shareholders
$
(0.46
)
 
$
0.11

 
$
(0.53
)
 
$
0.08

Weighted-average common shares outstanding
21,075,624

 
21,089,917

 
21,814,321

 
20,634,333

Diluted net income (loss) per share
$
(0.46
)
 
$
0.11

 
$
(0.53
)
 
$
0.08

Weighted-average common shares and share equivalents outstanding
21,075,624

 
21,541,942

 
21,814,321

 
21,102,849

The accompanying notes are an integral part of these condensed consolidated statements.


4

Table of Contents


ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Six Months Ended September 30,
 
2012
 
2013
Operating activities
 
 
 
Net (loss) income
$
(11,599
)
 
$
1,622

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating
 
 
 
activities:
 
 
 
Depreciation
2,122

 
2,024

Amortization of long-term assets
108

 
172

Stock-based compensation expense
770

 
676

Accretion of fair value of deferred and contingent purchase price consideration related to acquisition

 
425

Deferred income tax expense (benefit)
3,945

 
(2,212
)
Loss on sale of property and equipment
30

 
96

Provision for bad debts
100

 
75

Other
34

 
62

Changes in operating assets and liabilities, net of effects of acquisition:
 
 
 
Accounts receivable, current and long-term
440

 
4,849

Inventories, current and long-term
(224
)
 
3,269

Deferred contract costs
(2,571
)
 
(335
)
Prepaid expenses and other assets
445

 
58

Accounts payable
866

 
2,633

Accrued expenses
1,985

 
(1,837
)
Deferred revenue
1,222

 
(2,027
)
Net cash (used in) provided by operating activities
(2,327
)
 
9,550

Investing activities
 
 
 
Cash paid for acquisition, net of cash acquired

 
(4,992
)
Purchase of property and equipment
(1,715
)
 
(222
)
Purchase of short-term investments
(3
)
 
(3
)
Additions to patents and licenses
(75
)
 
(14
)
Proceeds from sales of property, plant and equipment
19

 
39

Net cash used in investing activities
(1,774
)
 
(5,192
)
Financing activities
 
 
 
Payment of long-term debt
(1,415
)
 
(1,497
)
Proceeds from long-term debt
156

 

Proceeds from repayment of shareholder notes
6

 
119

Repurchase of common stock into treasury
(4,523
)
 

Excess tax benefits from stock-based compensation
21

 

Deferred financing costs

 
(18
)
Proceeds from issuance of common stock
59

 
225

Net cash used in financing activities
(5,696
)
 
(1,171
)
Net (decrease) increase in cash and cash equivalents
(9,797
)
 
3,187

Cash and cash equivalents at beginning of period
23,011

 
14,376

Cash and cash equivalents at end of period
$
13,214

 
$
17,563

Supplemental cash flow information:
 
 
 
Cash paid for interest
$
279

 
$
97

Cash paid for income taxes
$
37

 
$
18

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Shares issued from treasury for shareholder note receivable
$
68

 
$
119

Shares returned to treasury in satisfaction of receivable
$

 
$
48

Acquisition related contingent consideration liability
$

 
$
612

Acquisition financed through debt
$

 
$
3,158

Common stock issued for acquisition
$

 
$
2,065

The accompanying notes are an integral part of these condensed consolidated statements.

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ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A — DESCRIPTION OF BUSINESS
Organization
The Company includes Orion Energy Systems, Inc., a Wisconsin corporation, and all consolidated subsidiaries. The Company is a developer, manufacturer and seller of lighting and energy management systems and a seller and integrator of renewable energy technologies to commercial and industrial businesses, predominantly in North America.

See Note I “Segment Reporting” of these financial statements for further discussion of the Company's reportable segments.

The Company’s corporate offices and primary manufacturing operations are located in Manitowoc, Wisconsin and an operations facility is located in Plymouth, Wisconsin. The Company leases manufacturing and office space in Green Cove Springs, Florida. The Company leases office space for sales offices located in New Jersey, Chicago and Texas.
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The condensed consolidated financial statements include the accounts of Orion Energy Systems, Inc. and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Reclassifications
Where appropriate, certain reclassifications have been made to prior years’ financial statements to conform to the current year presentation.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results that may be expected for the year ending March 31, 2014 or other interim periods.
The condensed consolidated balance sheet at March 31, 2013 has been derived from the audited and adjusted consolidated financial statements at that date but does not include all of the information required by GAAP for complete financial statements.
The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2013 filed with the Securities and Exchange Commission on June 14, 2013.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during that reporting period. Areas that require the use of significant management estimates include revenue recognition, inventory obsolescence and bad debt reserves, accruals for warranty expenses, income taxes and certain equity transactions. Accordingly, actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid, short-term investments with original maturities of three months or less to be cash equivalents.

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Short-Term Investments
The amortized cost and fair value of short-term investments, with gross unrealized gains and losses, as of March 31, 2013 and September 30, 2013 were as follows (in thousands):
March 31, 2013
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
Cash and Cash
Equivalents
 
Short-term
Investments
Money market funds
$
487

 
$

 
$

 
$
487

 
$
487

 
$

Bank certificate of deposit
1,021

 

 

 
1,021

 

 
1,021

Total
$
1,508

 
$

 
$

 
$
1,508

 
$
487

 
$
1,021

 
September 30, 2013
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair Value
 
Cash and Cash
Equivalents
 
Short-term
Investments
Money market funds
$
488

 
$

 
$

 
$
488

 
$
488

 
$

Bank certificate of deposit
1,024

 

 

 
1,024

 

 
1,024

Total
$
1,512

 
$

 
$

 
$
1,512

 
$
488

 
$
1,024

As of March 31, 2013 and September 30, 2013, the Company’s financial assets described in the table above were measured at cost which approximates fair value due to the short-term nature of the investment (level 1 inputs).
Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued expenses and other and long-term debt. The carrying amounts of the Company’s financial instruments approximate their respective fair values due to the relatively short-term nature of these instruments, or in the case of long-term, because of the interest rates currently available to the Company for similar obligations. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. GAAP describes a fair value hierarchy based on the following three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:
Level 1 — Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2 — Valuations are based on quoted prices for similar assets or liabilities in active markets, or quoted prices in markets that are not active for which significant inputs are observable, either directly or indirectly.
Level 3 — Valuations are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Inputs reflect management's best estimate of what market participants would use in valuing the asset or liability at the measurement date.
Accounts Receivable
The majority of the Company’s accounts receivable are due from companies in the commercial, industrial and agricultural industries, as well as wholesalers. Credit is extended based on an evaluation of a customer’s financial condition. Generally, collateral is not required for end users; however, the payment of certain trade accounts receivable from wholesalers is secured by irrevocable standby letters of credit and/or guarantees. Accounts receivable are generally due within 30-60 days. Accounts receivable are stated at the amount the Company expects to collect from outstanding balances. The Company provides for probable uncollectible amounts through a charge to earnings and a credit to an allowance for doubtful accounts based on its assessment of the current status of individual accounts. Balances that are still outstanding after the Company has used reasonable collection efforts are written off through a charge to the allowance for doubtful accounts and a credit to accounts receivable.
Financing Receivables
The Company considers its lease balances included in consolidated current and long-term accounts receivable from its Orion Throughput Agreement, or OTA, sales-type leases to be financing receivables. Additional disclosures on the credit quality of the Company’s financing receivables are as follows:

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Aging Analysis as of September 30, 2013 (in thousands):
 
Not Past Due
 
1-90 days
past due
 
Greater than 90
days past due
 
Total past due
 
Total sales-type
leases
Lease balances included in consolidated accounts receivable—current
$
2,667

 
$
97

 
$
187

 
$
284

 
$
2,951

Lease balances included in consolidated accounts receivable—long-term
2,618

 

 

 

 
2,618

Total gross sales-type leases
5,285

 
97

 
187

 
284

 
5,569

Allowance

 

 
(84
)
 
(84
)
 
(84
)
Total net sales-type leases
$
5,285

 
$
97

 
$
103

 
$
200

 
$
5,485

Allowance for Credit Losses on Financing Receivables
The Company’s allowance for credit losses is based on management’s assessment of the collectability of customer accounts. A considerable amount of judgment is required in order to make this assessment, including a detailed analysis of the aging of the lease receivables and the current credit worthiness of the Company’s customers and an analysis of historical bad debts and other adjustments. If there is a deterioration of a major customer’s credit worthiness or if actual defaults are higher than historical experience, the estimate of the recoverability of amounts due could be adversely affected. The Company reviews in detail the allowance for doubtful accounts on a quarterly basis and adjusts the allowance estimate to reflect actual portfolio performance and any changes in future portfolio performance expectations. The Company believes that there is currently no impairment of the receivables for the sales-type leases. The Company incurred no write-offs or credit losses against its OTA sales-type lease receivable balances in fiscal 2013 and for the six months ended September 30, 2013.
Inventories
Inventories consist of raw materials and components, such as ballasts, metal sheet and coil stock and molded parts; work in process inventories, such as frames and reflectors; and finished goods, including completed fixtures and systems, and wireless energy management systems and accessories, such as lamps, meters and power supplies. All inventories are stated at the lower of cost or market value with cost determined using the first-in, first-out (FIFO) method. The Company reduces the carrying value of its inventories for differences between the cost and estimated net realizable value, taking into consideration usage in the preceding 12 months, expected demand, and other information indicating obsolescence. The Company records as a charge to cost of product revenue the amount required to reduce the carrying value of inventory to net realizable value. As of March 31, 2013 and September 30, 2013, the Company had inventory obsolescence reserves of $2.3 million and $1.1 million, respectively.
Costs associated with the procurement and warehousing of inventories, such as inbound freight charges and purchasing and receiving costs, are also included in cost of product revenue.
Inventories were comprised of the following (in thousands):
 
March 31, 2013
 
September 30, 2013
Raw materials and components
$
8,207

 
$
7,406

Work in process
846

 
753

Finished goods
6,177

 
7,048

 
$
15,230

 
$
15,207

Deferred Contract Costs
Deferred contract costs consist primarily of the costs of products delivered, and services performed, that are subject to additional performance obligations or customer acceptance. These deferred contract costs are expensed at the time the related revenue is recognized. Current deferred costs amounted to $2.1 million and $2.5 million as of March 31, 2013 and September 30, 2013, respectively.
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist primarily of prepaid insurance premiums, prepaid license fees, purchase deposits, advance payments to contractors, unbilled revenue, prepaid taxes and miscellaneous receivables.

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Property and Equipment
Property and equipment were comprised of the following (in thousands):
 
March 31, 2013
 
September 30, 2013
Land and land improvements
$
1,562

 
$
1,562

Buildings
15,918

 
15,889

Furniture, fixtures and office equipment
11,995

 
12,130

Leasehold improvements
58

 
58

Equipment leased to customers under Power Purchase Agreements
4,997

 
4,997

Plant equipment
10,620

 
10,333

Construction in progress
91

 
100

 
45,241

 
45,069

Less: accumulated depreciation and amortization
(17,294
)
 
(18,942
)
Net property and equipment
$
27,947

 
$
26,127

Depreciation is provided over the estimated useful lives of the respective assets, using the straight-line method. Depreciable lives by asset category are as follows:
Land improvements
10-15 years
Buildings and building improvements
3-39 years
Leasehold improvements
Shorter of asset life or life of lease
Furniture, fixtures and office equipment
2-10 years
Plant equipment
3-10 years
Goodwill and Other Intangible Assets
The costs of specifically identifiable intangible assets that do not have an indefinite life are amortized over their estimated useful lives. Goodwill and intangible assets with indefinite lives are not amortized. Goodwill and intangible assets with indefinite lives are reviewed for impairment annually, as of January 1, or more frequently if impairment indicators arise. Amortizable intangible assets are amortized over their estimated economic useful life to reflect the pattern of economic benefits consumed based upon the following lives and methods:
Patents
10-17 years
Straight-line
Licenses
7-13 years
Straight-line
Customer relationships
5-8 years
Accelerated based upon the pattern of economic benefits consumed
Developed technology
8 years
Accelerated based upon the pattern of economic benefits consumed
Non-competition agreement
5 years
Straight-line
Indefinite lived intangible assets are evaluated for potential impairment whenever events or circumstances indicate that the carrying value may not be recoverable based primarily upon whether expected future undiscounted cash flows are sufficient to support the asset recovery. If the actual useful life of the asset is shorter than the estimated life estimated by us, the asset may be deemed to be impaired and accordingly a write-down of the value of the asset determined by a discounted cash flow analysis or shorter amortization period may be required.
The change in the carrying value of goodwill for the six months ended September 30, 2013 was as follows (in thousands):
Balance at March 31, 2013
$

Acquisition of Harris
4,899

Balance at September 30, 2013
$
4,899

The components of, and changes in, the carrying amount of other intangible assets as of September 30, 2013 were as follows (in thousands):

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Gross Carrying Amount
 
Accumulated Amortization
Patents
$
2,335

 
$
(716
)
Licenses
58

 
(58
)
Trade name and trademarks
1,939

 

Customer relationships
3,100

 
(84
)
Developed technology
900

 
(5
)
Non-competition agreement
100

 
(1
)
Total
$
8,432

 
$
(864
)
As of September 30, 2013, the weighted average useful life of intangible assets was 7.8 years. The estimated amortization expense for each of the next five years is shown below (in thousands):
For the remaining 6 months of fiscal 2014
$
433

Fiscal 2015
1,217

Fiscal 2016
1,118

Fiscal 2017
808

Fiscal 2018
558

Fiscal 2019
397

Thereafter
1,098

Total
$
5,629

Long-Term Receivables
The Company records a long-term receivable for the non-current portion of its sales-type capital lease OTA contracts. The receivable is recorded at the net present value of the future cash flows from scheduled customer payments. The Company uses the implied cost of capital from each individual contract as the discount rate.
Also included in other long-term receivables are amounts due from a third party finance company to which the Company has sold, without recourse, the future cash flows from OTAs entered into with customers. Such receivables are recorded at the present value of the future cash flows discounted between 8.8% and 11%. As of September 30, 2013, the following amounts were due from the third party finance company in future periods (in thousands):
Fiscal 2014
$
616

Fiscal 2015
955

Fiscal 2016
309

Fiscal 2017
9

Total gross long-term receivable
1,889

Less: amount representing interest
(194
)
Net long-term receivable
$
1,695

Long-Term Inventories
The Company records long-term inventory for the non-current portion of its wireless controls finished goods inventory. The inventories are stated at the lower of cost or market value with cost determined using the FIFO method.
Other Long-Term Assets
Other long-term assets include long-term security deposits, prepaid licensing costs, a note receivable, deferred costs for a long-term contract, and deferred financing costs. Other long-term assets include $58,000 and $45,000 of deferred financing costs as of March 31, 2013 and September 30, 2013, respectively. Deferred financing costs related to debt issuances are amortized to interest expense over the life of the related debt issue (1 to 10 years).
Accrued Expenses

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Accrued expenses include warranty accruals, accrued wages and benefits, accrued vacation, accrued legal costs, accrued commissions, accrued acquisition earn-out liability, accrued project costs, sales tax payable and other various unpaid expenses. Accrued expenses include $1,300,000 and $0 of accrued reorganization and settlement costs as of March 31, 2013 and September 30, 2013, respectively, and $0.7 million and $1.4 million of accrued project costs as of March 31, 2013 and September 30, 2013, respectively.
The Company generally offers a limited warranty of one year on its lighting products in addition to those standard warranties offered by major original equipment component manufacturers. The manufacturers’ warranties cover lamps and ballasts, which are significant components in the Company’s lighting products. Included in other long-term liabilities is $0.1 million for warranty reserves related to solar operating systems.
Changes in the Company’s warranty accrual were as follows (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
Beginning of period
$
90

 
$
287

 
$
84

 
$
284

Provision (benefit) to product cost of revenue
126

 
(74
)
 
141

 
75

Charges
(129
)
 
(24
)
 
(138
)
 
(170
)
End of period
$
87

 
$
189

 
$
87

 
$
189

Revenue Recognition
Revenue is recognized on the sales of our lighting and related energy efficiency systems and products when the following four criteria are met:
persuasive evidence of an arrangement exists;
delivery has occurred and title has passed to the customer;
the sales price is fixed and determinable and no further obligation exists; and
collectability is reasonably assured.
These four criteria are met for the Company’s product-only revenue upon delivery of the product and title passing to the customer. At that time, the Company provides for estimated costs that may be incurred for product warranties and sales returns. Revenues are presented net of sales tax and other sales related taxes.
For sales of the Company’s lighting and energy management technologies, consisting of multiple elements of revenue, such as a combination of product sales and services, the Company determines revenue by allocating the total contract revenue to each element based on their relative selling prices in accordance with ASC 605-25, Revenue Recognition - Multiple Element Arrangements. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (1) vendor-specific objective evidence (VSOE) of fair value, if available, (2) third-party evidence (TPE) of selling price if VSOE is not available, and (3) best estimate of the selling price if neither VSOE nor TPE is available (a description as to how the Company determined estimated selling price is provided below).
The nature of the Company’s multiple element arrangements for the sale of its lighting and energy management technologies is similar to a construction project, with materials being delivered and contracting and project management activities occurring according to an installation schedule. The significant deliverables include the shipment of products and related transfer of title and the installation.
To determine the selling price in multiple-element arrangements, the Company established the selling price for its HIF lighting and energy management system products using management's best estimate of the selling price, as VSOE or TPE does not exist. Product revenue is recognized when products are shipped. For product revenue, management's best estimate of selling price is determined using a cost plus gross profit margin method. In addition, the Company records in service revenue the selling price for its installation and recycling services using management’s best estimate of selling price, as VSOE or TPE does not exist. Service revenue is recognized when services are completed and customer acceptance has been received. Recycling services provided in connection with installation entail the disposal of the customer’s legacy lighting fixtures. The Company’s service revenues, other than for installation and recycling that are completed prior to delivery of the product, are included in product revenue using management’s best estimate of selling price, as VSOE or TPE does not exist. These services include comprehensive site assessment, site field verification, utility incentive and government subsidy management, engineering

11

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design, and project management. For these services, along with the Company's installation and recycling services, under a multiple-element arrangement, management’s best estimate of selling price is determined by considering several external and internal factors including, but not limited to, economic conditions and trends, customer demand, pricing practices, margin objectives, competition, geographies in which the Company offers its products and services and internal costs. The determination of estimated selling price is made through consultation with and approval by management, taking into account all of the preceding factors.
For sales of solar photovoltaic systems, which are governed by customer contracts that require the Company to deliver functioning solar power systems and are generally completed within three to 15 months from the start of construction, the Company recognizes revenue from fixed price construction contracts using the percentage-of-completion method in accordance with ASC 605-35, Construction-Type and Production-Type Contracts. Under this method, revenue arising from fixed price construction contracts is recognized  as work is performed based upon the percentage of incurred costs to estimated total forecasted costs. The Company has determined that the appropriate method of measuring progress on these sales is measured by the percentage of costs incurred to date of the total estimated costs for each contract as materials are installed. The percentage-of-completion method requires revenue recognition from the delivery of products to be deferred and the cost of such products to be capitalized as a deferred cost and asset on the balance sheet. The Company performs periodic evaluations of the progress of the installation of the solar photovoltaic systems using actual costs incurred over total estimated costs to complete a project. Provisions for estimated losses on uncompleted contracts, if any, are recognized in the period in which the loss first becomes probable and reasonably estimable.
The Company offers a financing program, called an OTA, for a customer’s lease of the Company’s energy management systems. The OTA is structured as a sales-type lease and upon successful installation of the system and customer acknowledgment that the system is operating as specified, revenue is recognized at the Company’s net investment in the lease, which typically is the net present value of the future cash flows.
The Company offers a financing program, called a power purchase agreement, or PPA, for the Company’s renewable energy product offerings. A PPA is a supply side agreement for the generation of electricity and subsequent sale to the end user. Upon the customer’s acknowledgment that the system is operating as specified, product revenue is recognized on a monthly basis over the life of the PPA contract, which is typically in excess of 10 years.
Deferred revenue relates to advance customer billings, investment tax grants received related to PPAs and a separate obligation to provide maintenance on OTAs and is classified as a liability on the Consolidated Balance Sheet. The fair value of the maintenance is readily determinable based upon pricing from third-party vendors. Deferred revenue related to maintenance services is recognized when the services are delivered, which occurs in excess of a year after the original OTA contract is executed.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between financial reporting and income tax basis of assets and liabilities, measured using the enacted tax rates and laws expected to be in effect when the temporary differences reverse. Deferred income taxes also arise from the future tax benefits of operating loss and tax credit carryforwards. A valuation allowance is established when management determines that it is more likely than not that all or a portion of a deferred tax asset will not be realized. As of September 30, 2013, the Company had a valuation allowance of $5.2 million against its deferred tax assets.
ASC 740, Income Taxes, also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination. The Company has classified the amounts recorded for uncertain tax benefits in the balance sheet as other liabilities (non-current) to the extent that payment is not anticipated within one year. The Company recognizes penalties and interest related to uncertain tax liabilities in income tax expense. Penalties and interest are immaterial and are included in the unrecognized tax benefits.
Deferred tax benefits have not been recognized for income tax effects resulting from the exercise of non-qualified stock options. These benefits will be recognized in the period in which the benefits are realized as a reduction in taxes payable and an increase in additional paid-in capital. For the six months ended September 30, 2012 and 2013, realized tax benefits from the exercise of stock options were $21,000 and $0, respectively.
Stock Option Plans

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The Company did not issue any stock options during the three months ended September 30, 2013. The fair value of each option grant during the three and six months ended September 30, 2012 and 2013 was determined using the assumptions in the following table:
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
Weighted average expected term
6.0 years

 
N/A
 
5.6 years

 
4.1 years

Risk-free interest rate
0.9
%
 
N/A
 
0.8
%
 
0.8
%
Expected volatility
73.0
%
 
N/A
 
74.2
%
 
73.3
%
Expected forfeiture rate
15.1
%
 
N/A
 
15.1
%
 
21.4
%
Net Income (Loss) per Common Share
Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common shareholders by the weighted-average number of common shares outstanding for the period and does not consider common stock equivalents.
Diluted net income (loss) per common share reflects the dilution that would occur if warrants and stock options were exercised. In the computation of diluted net income (loss) per common share, the Company uses the “treasury stock” method for outstanding options, warrants and restricted shares. Diluted net loss per common share was the same as basic net loss per common share for the three and six months ended September 30, 2012, because the effects of potentially dilutive securities were anti-dilutive. The effect of net income (loss) per common share is calculated based upon the following shares (in thousands except share amounts):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
Numerator:
 
 
 
 
 
 
 
Net income (loss) (in thousands)
$
(9,659
)
 
$
2,403

 
$
(11,599
)
 
$
1,622

Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
21,075,624

 
21,089,917

 
21,814,321

 
20,634,333

Weighted-average effect of assumed conversion of stock options and warrants

 
452,025

 

 
468,516

Weighted-average common shares and common share equivalents outstanding
21,075,624

 
21,541,942

 
21,814,321

 
21,102,849

Net income (loss) per common share:
 
 
 
 
 
 
 
Basic
$
(0.46
)
 
$
0.11

 
$
(0.53
)
 
$
0.08

Diluted
$
(0.46
)
 
$
0.11

 
$
(0.53
)
 
$
0.08

The following table indicates the number of potentially dilutive securities outstanding as of the end of each period: 
 
September 30, 2012
 
September 30, 2013
Common stock options
4,321,571

 
3,195,917

Restricted shares
163,750

 
462,537

Common stock warrants
38,980

 
38,980

Total
4,524,301

 
3,697,434

Concentration of Credit Risk and Other Risks and Uncertainties
The Company previously depended on one supplier for a number of components necessary for its lighting products, including ballasts and lamps. Currently, the Company has been able to obtain these components from multiple suppliers. For the three months ended September 30, 2012, purchases from two suppliers accounted for 11% and 12% of total cost of revenue. For the six months ended September 30, 2012, no supplier accounted for more than 10% of total cost of revenue. For the three and six months ended September 30, 2013, no supplier accounted for more than 10% of total cost of revenue.
The Company previously purchased a majority of its solar panels from one supplier for its sales of solar generating systems through its Orion Engineered Systems Division. Currently, the Company has been able to obtain panels from multiple suppliers. For the three and six months ended September 30, 2012, panel purchases from one supplier accounted for 11% and

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6% of total cost of revenue, respectively. For the three and six months ended September 30, 2013, panel purchases from one supplier accounted for 11% and 12% of total cost of revenue, respectively.
For the three and six months ended September 30, 2012, no customers accounted for more than 10% of revenue. For the three and six months ended September 30, 2013, one customer accounted for 33% and 28% of revenue, respectively.
As of March 31, 2013 and September 30, 2013, no customer accounted for more than 10% of accounts receivable.
Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2013-11 ("ASU 2013-11"), “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to the deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The provisions of ASU 2013-11 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company is currently evaluating the impact of ASU 2013-11.
NOTE C — ACQUISITION
On July 1, 2013, the Company acquired all of the equity interests of Harris Manufacturing, Inc. and Harris LED, LLC (collectively, Harris). Harris is a Florida-based lighting company which engineers, designs, sources and manufactures energy efficient lighting systems, including fluorescent and LED lighting solutions, and day-lighting products.
The acquisition of Harris expands the Company's product lines, including a patent pending LED lighting product designed for commercial office buildings, increases its sales force and provides growth opportunities into markets where the Company has previously not had a strong presence, specifically, new construction, retail store fronts, commercial office and government.
The acquisition was consummated pursuant to a Stock and Unit Purchase Agreement, dated as of May 22, 2013 (Purchase Agreement), by and among Harris, the shareholders and members of Harris (Harris Shareholders), and the Company. The acquisition consideration paid to the Harris Shareholders was valued under the Purchase Agreement at an aggregate of $10.0 million, plus an adjustment of approximately $0.2 million to reflect the Company's acquisition of net working capital in excess of a targeted amount, plus an additional $0.6 million for the contingent consideration earn-out value assigned to non-employee Harris shareholders. The aggregate acquisition consideration was paid through a combination of $5.0 million in cash, $3.2 million in a three-year unsecured subordinated promissory note and the issuance of 856,997 shares of unregistered Company common stock. For purposes of the acquisition and the acquisition consideration, the shares of common stock issued in the acquisition of Harris were valued at $2.33 per share, which was the average closing share price as reported on the NYSE MKT for the 45 trading days preceding and the 22 trading days following the execution of the Purchase Agreement. For purposes of applying the purchase accounting provisions of ASC 805, Business Combinations, the shares of common stock issued in the acquisition were valued at $2.41 per share, which was the closing sale price of the Company's common stock as reported on the NYSE MKT on the July 1, 2013, date of acquisition.
Total revenues and pre-tax income from the Harris business since the date of acquisition included in the accompanying consolidated statements of income for the three months ended September 30, 2013 were $4.2 million and $0.1 million, respectively. The Company incurred $0.4 million in acquisition related costs for Harris during the six months ended September 30, 2013, which included contingent consideration, legal, accounting and other integration related expenses.
The Purchase Agreement contains customary representations and warranties as well as indemnification obligations, and limitations thereon, by the Company and the Harris Shareholders to each other.
The following table summarizes the consideration paid to the Harris Shareholders and the preliminary fair value allocation of the purchase price (in thousands):

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Consideration paid to Harris Shareholders:
 
Cash
$
5,000

Seller provided debt
3,158

Shares of Company common stock
2,065

Contingent consideration arrangement
612

Total consideration paid
$
10,835

 
 
Cash and cash equivalents
$
8

Accounts receivable, net
2,215

Inventories
1,633

Other current assets
86

Property, plant and equipment
117

Deferred tax asset
141

Identifiable intangible assets:
 
Customer relationships
3,100

Non-competition agreement
100

Developed technology
900

Trade name and trademarks
1,900

Accounts payable
(1,519
)
Deferred tax liabilities
(2,219
)
Accrued and other liabilities
(526
)
Total identifiable net assets
5,936

Goodwill
4,899

 
$
10,835


Prior to the amendment discussed in Note K, the contingent consideration arrangement required the Company to pay the Harris Shareholders up to $1.0 million in unregistered shares of the Company's common stock upon Harris' achievement of certain revenue milestones in calendar year 2013 and/or 2014, and, in the case of certain Harris Shareholders who became employees of the Company, their continued employment by the Company. The potential undiscounted amount of all future payments that the Company could be required to make under the contingent consideration arrangement is between $0 and $1.0 million. The Company recorded $0.6 million for the non-employee Harris Shareholder portion of the contingent consideration liability. Contingent consideration of $0.6 million for employee Harris Shareholders will be recorded as compensation expense through the end of calendar 2014. During the three and six months ended September 30, 2013, the Company expensed $0.2 million in compensation expense.
As part of the preliminary purchase price allocation, the Company determined that the separately identifiable intangible assets acquired consisted of customer relationships, developed technology, trademarks and trade names, and non-competition agreements. The fair value of the acquired identifiable intangible assets and the goodwill in the table above are provisional pending completion of the final valuations for those assets. All of the intangible asset value was assigned to the Company's Energy Management segment.
The separately identifiable intangible assets acquired that do not have an indefinite life are amortized over their estimated economic useful life to reflect the pattern of economic benefits consumed based upon the following lives and methods:
Customer relationships
5-8 years
Accelerated based upon the pattern of economic benefits consumed
Developed technology
8 years
Accelerated based upon the pattern of economic benefits consumed
Non-competition agreement
5 years
Straight-line
Trade name and trademarks
N/A
Indefinite life
The Company used the income approach to value the customer relationships, developed technology and non-competition agreements. This approach calculates the fair value by discounting the forecasted after-tax cash flows for each intangible asset back to a present value at an appropriate risk-adjusted rate of return. The data for these analyses was the cash flow estimates used to price the transaction. Fair value estimates are based on a complex series of judgments about future events and uncertainties and rely heavily on estimates and assumptions.

15

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In estimating the useful lives of the acquired assets, the Company considered ASC 350-30-35, General Intangibles Other Than Goodwill, and reviewed the following factors: the expected use by the combined company of the assets acquired, the expected useful life of another asset (or group of assets) related to the acquired assets, legal, regulatory or other contractual provisions that may limit the useful life of an acquired asset, the effects of obsolescence, demand, competition and other economic factors, and the level of maintenance expenditures required to obtain the expected future cash flows from the assets. The Company will amortize these intangible assets over their estimated economic useful lives.
The goodwill of $4.9 million arising from the Harris acquisition consists largely of the synergies and economies of scale expected from combining operations, and, to a lesser extent, the assembled workforce of Harris. All of the goodwill was assigned to the Company's Energy Management segment. None of the acquired goodwill is expected to be deductible for tax purposes.
The following unaudited pro forma condensed combined results of operations for the six months ended September 30, 2012 and 2013, respectively, are based on the historical financial statements of Orion and Harris giving effect to the business combination as if it had occurred at the beginning of the period presented. Therefore, this pro forma data has been adjusted to include amortization of purchased intangible assets and interest on the promissory note delivered as part of the purchase price during the entire applicable periods. Additionally, the tax benefit of $2.2 million recorded during the six months ended September 30, 2013 was eliminated and the tax benefit was recorded during the six month period ended September 30, 2012. This data is not necessarily indicative of the results of operations that would have been generated if the transaction had occurred at the beginning of the respective periods. Moreover, this data is not intended to be indicative of future results of operations.
 
Acquisition of Harris Pro Forma Results of Operations
 
Six Months Ended September 30,
(In Thousands):
2012
 
2013
Revenue
41,976

 
52,592

Net loss available to common shareholders
(9,118
)
 
(622
)
Loss per share:
 
 
 
Basic
(0.41
)
 
(0.03
)
Diluted
(0.41
)
 
(0.03
)
The supplemental pro forma results above exclude any benefits that may result from the acquisition due to synergies that are expected to be derived from the elimination of any duplicative costs. In addition, the pro forma results for the six months ended September 30, 2013 were adjusted to exclude non-recurring aggregate acquisition-related costs of $0.2 million that were incurred in 2013.
NOTE D — RELATED PARTY TRANSACTIONS
During the six months ended September 30, 2012 and 2013, the Company had no related party transactions.
NOTE E — LONG-TERM DEBT
Long-term debt as of March 31, 2013 and September 30, 2013 consisted of the following (in thousands):
 
March 31, 2013
 
September 30, 2013
Term note
$
263

 
$
122

Harris seller's note

 
3,158

Customer equipment finance notes payable
4,408

 
3,245

First mortgage note payable
694

 
651

Debenture payable
721

 
698

Other long-term debt
620

 
493

Total long-term debt
6,706

 
8,367

Less current maturities
(2,597
)
 
(3,326
)
Long-term debt, less current maturities
$
4,109

 
$
5,041

New Debt Arrangement

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On July 1, 2013, the Company issued an unsecured and subordinated promissory note agreement in the principal amount of $3.2 million to partially fund the acquisition of Harris. The note is included in the table above as Harris seller's note. The note bears interest at the rate of 4% per annum. Principal and interest are payable quarterly and the note matures in July 2016.
Revolving Credit Agreement
The Company has an amended credit agreement (Credit Agreement) with JP Morgan Chase Bank, N.A. (JP Morgan). The Credit Agreement provides for a revolving credit facility (Credit Facility) that matures on August 30, 2014. Borrowings under the Credit Facility are limited to $15.0 million, subject to a borrowing base requirement when the outstanding principal balance of loans under the Credit Facility is greater than $5.0 million. Such commitment includes a $2.0 million sublimit for the issuance of letters of credit. As of September 30, 2013, the Company had outstanding letters of credit totaling $1.7 million, primarily for securing collateral requirements under equipment operating leases. There were no borrowings outstanding under the Credit Agreement as of March 31, 2013 or September 30, 2013. In February 2013, the Company completed an amendment to the Credit Agreement making certain changes to the financial covenants, which are described below. In August 2013, the Company completed an additional amendment to extend the maturity date of the Credit Agreement to August 30, 2014.
The Credit Agreement requires the Company to maintain (i) a ratio of total liabilities to tangible net worth not to exceed 0.50 to 1.00 as of the last day of any fiscal quarter, (ii) average daily unencumbered liquidity of at least $20.0 million during each period of three consecutive business days and (iii) EBITDA of at least $1.0 million during each fiscal quarter. The Credit Agreement also contains certain restrictions on the ability of the Company to make capital or lease expenditures over prescribed limits, incur additional indebtedness, consolidate or merge, guarantee obligations of third parties, make loans or advances, declare or pay any dividend or distribution on its stock, redeem or repurchase shares of its stock or pledge assets. The Company was in compliance with all covenants in the Credit Agreement as of September 30, 2013.
The Credit Agreement is secured by a first priority security interest in the Company’s accounts receivable, inventory and general intangibles, and a second priority security interest in the Company’s equipment and fixtures. All OTAs, PPAs, leases, supply agreements and/or similar agreements relating to solar PV and wind turbine systems or facilities, as well as all accounts receivable and assets of the Company related to the foregoing, are excluded from these liens, except to the extent the Company elects to finance any such assets with JP Morgan.
Borrowings under the Credit Agreement bear interest based on LIBOR plus an applicable margin (Applicable Margin), which ranges from 2.0% to 3.0% per annum based on the Company's debt service coverage ratio from time to time. The Company must pay a fee ranging between 0.25% and 0.50% per annum on the average daily unused amount of the Credit Facility (with the amount of such fee based on the Company's debt service coverage ratio from time to time) and a fee in the amount of the Applicable Margin on the daily average face amount of undrawn issued letters of credit. The fee on unused amounts is waived if the Company or its affiliates maintain funds on deposit with JP Morgan or its affiliates above a specified amount. The deposit threshold requirement was not met as of September 30, 2013.
OTA Credit Agreement
The Company has a credit agreement with JP Morgan that provided up to $5.0 million that was immediately available to fund completed customer contracts under its OTA finance program. The Company had one year from the date of the commitment to borrow under the credit agreement, which expired on September 30, 2012 for new borrowings. As of September 30, 2013, the Company had $2.2 million outstanding under the credit agreement. There were no new borrowings during fiscal 2013. The loan amount is collateralized by the OTA-related equipment and the expected future monthly payments under the supporting 39 individual OTA customer contracts. The current loan amount under the credit agreement bears interest at LIBOR plus 4% and matures in December 2016. In February 2013, the Company completed an amendment to the credit agreement making certain changes to the financial covenants requiring the Company to maintain (i) average daily unencumbered liquidity of at least $20.0 million during each period of three consecutive business days and (ii) EBITDA of at least $1.0 million during each fiscal quarter. The Company was in compliance with all covenants, as amended, in the credit agreement as of September 30, 2013.
NOTE F — INCOME TAXES
The income tax provision for the six months ended September 30, 2013 was determined by applying an estimated annual effective tax rate. The estimated annual tax rate is modified to exclude the effect of losses from jurisdictions where the tax benefits cannot be recognized. Items discreet to a specific quarter are reflected in the tax expense for that period. The estimated effective income tax rate was determined by applying statutory tax rates to pretax loss adjusted for certain permanent book to tax differences and tax credits. As of September 30, 2013, the Company recorded a decrease in its valuation allowance of $2.2 million as a result of the Harris acquisition. ASC 805, Business Combinations, requires the release of all or part of an acquirer's valuation allowance as a result of a business combination to be recorded at the acquisition date. The valuation allowance

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adjustment considers the projected combined results and available taxable differences resulting from the Harris acquisition. As of September 30, 2013, the Company had recorded a valuation allowance of $5.2 million, equaling the net deferred tax asset due to the uncertainty of its realization value in the future. ASC 740, Income Taxes, requires that a deferred tax asset be reduced by a valuation allowance if there is less than a 50% chance that it will be realized. The determination of the realization of deferred tax assets requires considerable judgment. ASC 740 prescribes the consideration of both positive and negative evidence in evaluating the need for a valuation allowance. Negative evidence for the Company includes a cumulative three year operating loss and limited visibility into future earnings. While the Company has positive evidence with a strong backlog of orders, the Company has determined that the current negative evidence outweighs the current positive evidence and has concluded to record a valuation allowance. The estimated effective income tax rate was determined by applying statutory tax rates to pretax income (loss) adjusted for certain permanent book to tax differences and tax credits.
Below is a reconciliation of the statutory federal income tax rate and the effective income tax rate:
 
Six Months Ended September 30,
 
2012
 
2013
Statutory federal tax rate
(34.0
)%
 
34.0
 %
State taxes, net
(2.4
)%
 
0.3
 %
Federal tax credit
(2.0
)%
 
17.1
 %
State tax credit
0.4
 %
 
5.8
 %
Change in valuation reserve
92.7
 %
 
345.8
 %
Permanent items
1.2
 %
 
(1.0
)%
Change in tax contingency reserve
(0.1
)%
 
(4.0
)%
Other, net
(2.0
)%
 
(2.5
)%
Effective income tax rate
53.8
 %
 
395.5
 %
The Company is eligible for tax benefits associated with the excess of the tax deduction available for exercises of non-qualified stock options, or NQSOs, over the amount recorded at grant. The amount of the benefit is based on the ultimate deduction reflected in the applicable income tax return. Benefits of $0.1 million were recorded in fiscal 2013 as a reduction in taxes payable and a credit to additional paid in capital based on the amount that was utilized during the year. Benefits of $0 were recorded for the six months ended September 30, 2013.
As of September 30, 2013, the Company had federal net operating loss carryforwards of approximately $15.1 million, of which $3.0 million are associated with the exercise of NQSOs that have not yet been recognized by the Company. The Company also has state net operating loss carryforwards of approximately $15.5 million, of which $4.1 million are associated with the exercise of NQSOs. The Company also has federal tax credit carryforwards of approximately $1.5 million and state tax credits of $0.5 million. As of September 30, 2013, the Company has recorded a valuation allowance of $5.2 million, equaling the net deferred tax asset due to the uncertainty of its realization value in the future. The Company considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. In the event that the Company determines that the deferred tax assets are able to be realized, an adjustment to the deferred tax asset would increase income in the period such determination is made.
Uncertain Tax Positions
As of September 30, 2013, the balance of gross unrecognized tax benefits was approximately $0.2 million, all of which would reduce the Company’s effective tax rate if recognized. The Company does not expect this amount to change during fiscal 2014 as none of the issues are currently under examination, the statutes of limitations do not expire within the period, and the Company is not aware of any pending litigation. Due to the existence of net operating loss and credit carryforwards, all years since 2002 are open to examination by tax authorities.
The Company has classified the amounts recorded for uncertain tax benefits in the balance sheet as other liabilities (non-current) to the extent that payment is not anticipated within one year. The Company recognizes penalties and interest related to uncertain tax liabilities in income tax expense. Penalties and interest are immaterial as of the date of adoption and are included in the unrecognized tax benefits. For the six months ended September 30, 2012 and 2013, the Company had the following unrecognized tax benefit activity (in thousands):

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Six Months Ended September 30,
 
2012
 
2013
Unrecognized tax benefits as of beginning of period
$
401

 
$
188

Additions based on tax positions related to the current period positions

 
22

Unrecognized tax benefits as of end of period
$
401

 
$
210

NOTE G — COMMITMENTS AND CONTINGENCIES
Operating Leases and Purchase Commitments
The Company leases vehicles, equipment and facility space under operating leases expiring at various dates through 2021. Rent expense under operating leases was $0.4 million and $0.3 million for the three months ended September 30, 2012 and 2013, respectively; and $0.9 million and $0.6 million for the six months ended September 30, 2012 and 2013, respectively. The Company enters into non-cancellable purchase commitments for certain inventory items in order to secure better pricing and ensure materials are on hand to meet anticipated order volume and customer expectations, as well as for capital expenditures. As of September 30, 2013, the Company had entered into $8.0 million of purchase commitments related to fiscal 2014, including $1.0 million for operating lease commitments and $3.4 million for inventory purchase commitments.
NOTE H — SHAREHOLDERS’ EQUITY
Shareholder Rights Plan
On January 7, 2009, the Company’s Board of Directors adopted a shareholder rights plan and declared a dividend distribution of one common share purchase right (Right) for each outstanding share of the Company’s common stock. The issuance date for the distribution of the Rights was February 15, 2009 to shareholders of record on February 1, 2009. Each Right entitles the registered holder to purchase from the Company one share of the Company’s common stock at a price of $30.00 per share, subject to adjustment (Purchase Price).
The Rights will not be exercisable (and will be transferable only with the Company’s common stock) until a “Distribution Date” occurs (or the Rights are earlier redeemed or expire). A Distribution Date generally will occur on the earlier of a public announcement that a person or group of affiliated or associated persons (Acquiring Person) has acquired beneficial ownership of 20% or more of the Company’s outstanding common stock (Shares Acquisition Date) or 10 business days after the commencement of, or the announcement of an intention to make, a tender offer or exchange offer that would result in any such person or group of persons acquiring such beneficial ownership.
If a person becomes an Acquiring Person, holders of Rights (except as otherwise provided in the shareholder rights plan) will have the right to receive that number of shares of the Company’s common stock having a market value of two times the then-current Purchase Price, and all Rights beneficially owned by an Acquiring Person, or by certain related parties or transferees, will be null and void. If, after a Shares Acquisition Date, the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold, proper provision will be made so that each holder of a Right (except as otherwise provided in the shareholder rights plan) will thereafter have the right to receive that number of shares of the acquiring company’s common stock which at the time of such transaction will have a market value of two times the then-current Purchase Price.
Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company. At any time prior to a person becoming an Acquiring Person, the Board of Directors of the Company may redeem the Rights in whole, but not in part, at a price of $0.001 per Right. Unless they are extended or earlier redeemed or exchanged, the Rights will expire on January 7, 2019.
Employee Stock Purchase Plan
In August 2010, the Company’s Board of Directors approved a non-compensatory employee stock purchase plan, or ESPP. The ESPP authorizes 2,500,000 shares to be issued from treasury or authorized shares to satisfy employee share purchases under the ESPP. All full-time employees of the Company are eligible to be granted a non-transferable purchase right each calendar quarter to purchase directly from the Company up to $20,000 of the Company’s common stock at a purchase price equal to 100% of the closing sale price of the Company’s common stock on the NYSE MKT exchange on the last trading day of each quarter. The ESPP allows for employee loans from the Company, except for Section 16 officers, limited to 20% of an individual’s annual income and no more than $250,000 outstanding at any one time. Interest on the loans is charged at the 10-year loan IRS rate and is payable at the end of each calendar year or upon loan maturity. The loans are secured by a pledge of any and all the Company’s shares purchased by the participant under the ESPP and the Company has full recourse against the employee, including offset against compensation payable. As of March 31, 2013, the Company had halted the loan

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program. The Company had the following shares issued from treasury as of March 31, 2013 and for the six months ended September 30, 2013:
 
Shares Issued Under ESPP
Plan
 
Closing Market
Price
 
Shares Issued Under Loan
Program
 
Dollar Value of
Loans Issued
 
Repayment of
Loans
Cumulative through March 31, 2013
150,408

 
$1.66-4.04
 
128,143

 
$
361,550

 
$
96,441

Quarter Ended June 30, 2013
990

 
$2.48
 

 

 
823

Quarter Ended September 30, 2013
702

 
$3.76
 

 

 
118,309

Total as of September 30, 2013
152,100

 
$1.66 - 4.04
 
128,143

 
$
361,550

 
$
215,573

Loans issued to employees are reflected on the Company’s balance sheet as a contra-equity account.
Share Repurchase Program
In October 2011, the Company’s Board of Directors approved a share repurchase program authorizing the Company to repurchase in aggregate up to a maximum of $1.0 million of the Company’s outstanding common stock. In November 2011, the Company’s Board of Directors approved an increase to the share repurchase program authorizing the Company to repurchase in aggregate up to a maximum of $2.5 million of the Company’s outstanding common stock. In April 2012, the Company’s Board approved another increase to the share repurchase program authorizing the Company to repurchase in aggregate up to a maximum of $7.5 million of the Company’s outstanding common stock. As of September 30, 2013, the Company had repurchased a total of 3.0 million shares of common stock at a cost of $6.8 million under the program. The Company does not intend to repurchase any additional common stock under this program in the near-term.
NOTE I — STOCK OPTIONS, RESTRICTED SHARES AND WARRANTS
The Company grants stock options and restricted stock awards under its 2003 Stock Option and 2004 Stock and Incentive Awards Plans (Plans). Under the terms of the Plans, the Company has reserved 13,500,000 shares for issuance to key employees, consultants and directors. The options generally vest and become exercisable ratably between 1 month and 5 years although longer and shorter vesting periods have been used in certain circumstances. Exercisability of the options granted to employees are generally contingent on the employees’ continued employment and non-vested options are subject to forfeiture if employment terminates for any reason. Options under the Plans have a maximum life of 10 years. In the past, the Company has granted both ISOs and NQSOs, although in July 2008, the Company adopted a policy of thereafter only granting NQSOs. Certain non-employee directors have elected to receive stock awards in lieu of cash compensation pursuant to elections made under the Company’s non-employee director compensation program. The Plans also provide to certain employees accelerated vesting in the event of certain changes of control of the Company as well as under other special circumstances.
In fiscal 2011, the Company converted all of its existing ISO awards to NQSO awards. No consideration was given to the employees for their voluntary conversion of ISO awards.
In June 2012, the Compensation Committee of the Board of Directors approved the issuance of restricted shares under the Plans to key employees to provide an opportunity for such employees to earn long-term equity incentive awards. In May 2013, the Compensation Committee of the Board of Directors changed the Company's long-term equity incentive grant policy so that only restricted shares are issued to all employees under the Plans. The restricted shares are settled in Company stock when the restriction period ends. Compensation cost for restricted shares granted to employees is recognized ratably over the vesting term, which is between three to five years. Settlement of the shares is contingent on the employees’ continued employment and non-vested shares are subject to forfeiture if employment terminates for any reason. For the three months ended September 30, 2013, an aggregate of 202,083 of restricted shares were granted valued at a price per share between $2.41 and $3.88, which was the closing market price as of each grant date. For the six months ended September 30, 2013, an aggregate of 388,871 of restricted shares were granted valued at a price per share between $2.41 and $3.88, which was the closing market price as of each grant date.
For the three and six months ended September 30, 2012, the Company issued zero and 13,547 shares under the Plans to certain non-employee directors who elected to receive stock awards in lieu of cash compensation. The shares were valued at $2.03, the closing market price as of the issuance date. For the three and six months ended September 30, 2013, the Company issued 7,412 and 21,126 shares under the Plans to certain non-employee directors who elected to receive stock awards in lieu of cash compensation. The shares were valued ranging from $2.41 per share to $3.88 per share, the closing market price as of the issuance dates. Additionally, during the three and six months ended September 30, 2012, the Company issued zero and 3,000 shares to a consultant as part of a consulting compensation agreement. The shares were valued at $2.03 per share, the closing market price as of the issuance date.

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The following amounts of stock-based compensation were recorded (in thousands):
 
Three Months Ended September 30,
 
Six Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
Cost of product revenue
$
26

 
$
17

 
$
57

 
$
37

General and administrative
269

 
230

 
419

 
451

Sales and marketing
102

 
57

 
279

 
183

Research and development
7

 
2

 
15

 
5

Total
$
404

 
$
306

 
$
770

 
$
676

As of September 30, 2013, compensation cost related to non-vested common stock-based compensation, excluding restricted share awards, amounted to $2.2 million over a remaining weighted average expected term of 6.5 years.
The following table summarizes information with respect to the Plans:
 
Options Outstanding
 
Shares
Available for
Grant
 
Number
of Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term (in years)
 
Aggregate
Intrinsic
Value
Balance at March 31, 2013
1,632,778

 
3,312,523

 
$
3.42

 
6.54
 
 
Granted stock options
(305,544
)
 
305,544

 
2.41

 
 
 
 
Granted shares
(21,126
)
 

 

 
 
 
 
Restricted shares
(388,871
)
 

 

 
 
 
 
Forfeited restricted shares
8,250

 

 

 
 
 
 
Forfeited stock options
323,550

 
(323,550
)
 
3.43

 
 
 
 
Exercised

 
(98,600
)
 
2.28

 
 
 
 
Balance at September 30, 2013
1,249,037

 
3,195,917

 
$
3.36

 
6.60
 
$
3,093,399

Exercisable at September 30, 2013
 
 
1,647,530

 
$
4.08

 
5.15
 
$
1,142,506

The aggregate intrinsic value represents the total pre-tax intrinsic value, which is calculated as the difference between the exercise price of the underlying stock options and the fair value of the Company’s closing common stock price of $3.76 as of September 30, 2013.
A summary of the status of the Company’s outstanding non-vested stock options as of September 30, 2013 was as follows:
Non-vested at March 31, 2013
1,747,805

Granted
305,544

Vested
(181,412
)
Forfeited
(323,550
)
Non-vested at September 30, 2013
1,548,387


During the first half of fiscal 2014, the Company granted restricted shares as follows (which are included in the above stock plan activity tables):
Balance at March 31, 2013
105,000

Shares issued
388,871

Shares vested
(23,084
)
Shares forfeited
(8,250
)
Shares outstanding at September 30, 2013
462,537

Per share price on grant date
$2.41-3.88

Compensation expense for six months ended September 30, 2013
$
95,121


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As of September 30, 2013, the amount of deferred stock-based compensation related to grants of restricted shares, to be recognized over a remaining period of 3.8 years, was approximately $1.0 million.
The Company has previously issued warrants in connection with various private placement stock offerings and services rendered. The warrants granted the holder the option to purchase common stock at specified prices for a specified period of time. No warrants were issued in fiscal 2013 or during the six months ended September 30, 2013.
A summary of outstanding warrants at September 30, 2013 follows:
 
Number of
Shares
 
Exercise Price
 
Expiration
Balance at March 31, 2013
38,980

 
$
2.25

 
Fiscal 2015
Balance at September 30, 2013
38,980

 
$
2.25

 
Fiscal 2015
NOTE J — SEGMENTS
The descriptions of the Company’s segments and their summary financial information are presented below.
Energy Management
The Energy Management Division develops, manufactures, integrates and sells commercial HIF and other lighting systems and energy management systems.
Engineered Systems
The Engineered Systems Division sells and integrates alternative renewable energy systems, such as solar and wind systems.
Corporate and Other
Corporate and Other is comprised of operating expenses not directly allocated to the Company’s segments and adjustments to reconcile to consolidated results, which primarily include intercompany eliminations.
 
Revenues
 
Operating Income (Loss)
 
For the Three Months Ended September 30,
 
For the Three Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
(dollars in thousands)
 
 
 
 
 
 
 
Segments:
 
 
 
 
 
 
 
Energy Management
$
16,652

 
$
18,410

 
$
(453
)
 
$
1,123

Engineered Systems
2,756

 
9,085

 
(661
)
 
911

Corporate and Other

 

 
(2,990
)
 
(1,826
)
 
$
19,408

 
$
27,495

 
$
(4,104
)
 
$
208

 
 
 
 
 
 
 
 
 
Revenues
 
Operating Income (Loss)
 
For the Six Months Ended September 30,
 
For the Six Months Ended September 30,
 
2012
 
2013
 
2012
 
2013
(dollars in thousands)
 
 
 
 
 
 
 
Segments:
 
 
 
 
 
 
 
Energy Management
$
29,252

 
$
34,300

 
$
(2,211
)
 
$
1,271

Engineered Systems
5,466

 
14,047

 
(1,057
)
 
1,114

Corporate and Other

 

 
(4,414
)
 
(3,006
)
 
$
34,718

 
$
48,347

 
$
(7,682
)
 
$
(621
)

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Total Assets
 
Deferred Revenue
 
March 31, 2013
 
September 30, 2013
 
March 31, 2013
 
September 30, 2013
(dollars in thousands)
 
 
 
 
 
 
 
Segments:
 
 
 
 
 
 
 
Energy Management
$
58,627

 
$
64,789

 
$
564

 
$
420

Engineered Systems
9,339

 
9,180

 
3,640

 
1,757

Corporate and Other
34,131

 
36,366

 

 

 
$
102,097

 
$
110,335

 
$
4,204

 
$
2,177

The Company’s revenue and long-lived assets outside the United States are insignificant.
NOTE K — SUBSEQUENT EVENTS
On October 21, 2013, the Company executed a letter agreement amending the Purchase Agreement for the Harris acquisition. The letter agreement established a fixed future consideration of $1.4 million for the previously existing earn-out component of the Purchase Agreement and eliminated the requirement that certain revenue targets must be achieved. Under the letter agreement, on January 1, 2014, the Company will issue $0.6 million in unregistered shares of the Company's common stock. The fixed consideration was determined based upon the existing share calculation at a fair value of $3.80 per common share. On January 1, 2015, the Company will pay $0.8 million in cash to settle all outstanding obligations related to the earn-out component of the Purchase Agreement.

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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and related notes included in this Form 10-Q, as well as our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2013.
Cautionary Note Regarding Forward-Looking Statements
Any statements in this Quarterly Report on Form 10-Q about our expectations, beliefs, plans, objectives, prospects, financial condition, assumptions or future events or performance are not historical facts and are “forward-looking statements” as that term is defined under the federal securities laws. These statements are often, but not always, made through the use of words or phrases such as “believe”, “anticipate”, “should”, “intend”, “plan”, “will”, “expects”, “estimates”, “projects”, “positioned”, “strategy”, “outlook” and similar words. You should read the statements that contain these types of words carefully. Such forward-looking statements are subject to a number of risks, uncertainties and other factors that could cause actual results to differ materially from what is expressed or implied in such forward-looking statements. There may be events in the future that we are not able to predict accurately or over which we have no control. Potential risks and uncertainties include, but are not limited to, those discussed in “Part I, Item 1A. Risk Factors” in our fiscal 2013 Annual Report filed on Form 10-K for the fiscal year ended March 31, 2013 and elsewhere in this Quarterly Report. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or uncertainties after the date hereof or to reflect the occurrence of unanticipated events.

Recent Developments
On July 1, 2013, we completed the acquisition of the equity interests of Harris Manufacturing, Inc. and Harris LED, LLC, or collectively, Harris. Harris engineers, designs, sources and manufactures energy efficient lighting systems, including fluorescent and LED lighting solutions, and day-lighting products. We expect the Harris acquisition to expand our product lines, increase our sales force and provide growth opportunities into markets where we have not had a strong presence, specifically, new construction, retail store fronts, commercial office and government. The initial purchase price for the transaction was $10.8 million, after an adjustment of $0.2 million for excess net working capital over a targeted amount. The purchase price was paid in a combination of $5.0 million of cash, $3.2 million in a three-year unsecured subordinated note bearing interest at the rate of 4% per annum, and the issuance of 856,997 shares of unregistered common stock, representing a fair value on the date of issuance of $2.1 million. We also agreed to issue up to $1.0 million in shares of our unregistered common stock if Harris met certain revenue targets through calendar year 2014, and, in the case of certain Harris shareholders who became employees of the Company, their continued employment by us. In October 2013, we amended the earn-out provisions of the Harris purchase agreement to fix the future consideration for the earn-out at $1.4 million and eliminate the future revenue targets, although the employee retention provisions still apply to Harris shareholders who became our employees. We believe that the contingent Harris revenue targets were more likely than not to be achieved. We agreed to settle $0.6 million of the earn-out payment on January 1, 2014 in an equivalent value of unregistered shares of our common stock and $0.8 million on January 1, 2015 in cash. Harris had audited revenue of approximately $14.7 million and audited net income of approximately $0.9 million during the year ended December 31, 2012. We expect the transaction to be accretive to our future earnings during fiscal 2014.
We acquired certain light emitting diode, or LED, technologies through the acquisition of Harris which complement our existing portfolio of LED lighting products. In particular, Harris' LED door retrofit, or LDR, product is designed to retrofit commercial office space, a market where we have historically had little revenue contribution. Since the acquisition of Harris, our engineering and design teams have worked to expand the LDR product line to include architectural, industrial and contractor product categories. According to a May 2013 US Department of Energy report, we estimate the potential North American LED retrofit market within our key product categories to be approximately 1.1 billion lighting fixtures. We continue to research LED technologies and expect that as component performance attributes increase and product costs decrease, LED technologies will become an increasingly larger component of our future revenue.
During fiscal 2013, we recorded operating expenses related to reorganization costs of $2.1 million, which included $1.9 million to general and administrative expenses and $0.2 million to sales and marketing expenses. Additionally, we recorded a $4.1 million non-cash income tax expense to establish a valuation allowance against our deferred tax assets. During the fiscal 2014 second quarter, we recorded a $2.2 million benefit against this valuation allowance to offset deferred tax liabilities acquired from Harris.

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During the fiscal 2013 second half, we implemented $5.2 million in annualized cost reduction initiatives, including a reduction in headcount of approximately 18%, the termination of consulting agreements, material and component cost savings in our HIF lighting products, and discretionary spending reductions. We have also identified an additional $2.0 million of annualized cost containment initiatives which we are working towards implementing in the future. These new initiatives will require some time to implement due to contractual obligations, engineering review, production planning and other analysis related to ensuring minimal business interruption and risk. There is no guarantee that we will be able to implement these cost containment opportunities and recognize any of these additional cost savings.
During the fiscal 2014 first half, we have been actively expanding our direct sales force. We expect to continue to increase our sales headcount during the remainder of our fiscal 2014 year. We expect that these additional costs will increase our overall sales and marketing expense in fiscal 2014 by approximately $2.3 million and that the net benefit of these additions and our implemented cost containment initiatives will result in reduced annual expense of approximately $2.9 million.
Overview
We design, manufacture, market and implement energy management systems consisting primarily of high-performance, energy efficient lighting systems, controls and related services and market and implement renewable energy systems consisting primarily of solar generating photovoltaic, or PV, systems and wind turbines. We operate in two business segments, which we refer to as our Energy Management Division and our Engineered Systems Division.
We typically generate the majority of our revenue from sales of high intensity fluorescent, or HIF, lighting systems and related services to commercial and industrial customers. We typically sell our HIF lighting systems in replacement of our customers’ existing high intensity discharge, or HID, fixtures. We call this replacement process a “retrofit.” We frequently engage our customer’s existing electrical contractor to provide installation and project management services. We also sell our HIF lighting systems on a wholesale basis, principally to electrical contractors and value-added resellers to sell to their own customer bases.
We have more recently introduced new products of our LED lighting and energy management systems. We believe that we have taken a responsible approach to this emerging technology. Based upon recent improvements, including drastic reduction of chip prices, availability of name-brand drivers and the integration with our InteLite controls offerings, we believe that LED will become a larger part of our overall interior and exterior lighting strategy in the future. We believe that our new LED product offerings also present new opportunities in the hospitality, health care, education, commercial office and general retail markets, in addition to strengthening our position as an energy management leader in the commercial, industrial and food service markets.
We have sold and installed more than 2,634,000 of our HIF and LED lighting systems in over 9,735 facilities from December 1, 2001 through September 30, 2013. We have sold our products to 162 Fortune 500 companies, many of which have installed our HIF lighting systems in multiple facilities. Our top direct customers by revenue in fiscal 2013 included Coca-Cola Enterprises, Inc., PepsiCo Inc., U.S. Foodservice, SYSCO Corp., Quad Graphics, Inc. and Wakefern Food Corporation.
Our fiscal year ends on March 31. We refer to our prior fiscal year which ended on March 31, 2013, as “fiscal 2013”, and our current fiscal year, which will end on March 31, 2014, as “fiscal 2014.” Our fiscal first quarter of each fiscal year ends on June 30, our fiscal second quarter ends on September 30, our fiscal third quarter ends on December 31 and our fiscal fourth quarter ends on March 31.
Due to a difficult economic environment, especially as it has impacted capital equipment manufacturers, our results for fiscal 2013 and the first half of fiscal 2014 continued to be adversely affected by lengthened customer sales cycles and sluggish customer capital spending. To address these difficult economic conditions, we implemented several cost reduction initiatives during the fiscal 2013 second half as described above. During fiscal 2014, we are aggressively focused on additional cost containment initiatives related to material product costs, service margin expansion and implementing lean manufacturing methodologies to reduce production costs in our manufacturing facility. We currently anticipate approximately $1.0 million in annualized synergies from our Harris acquisition related to headcount reductions and facility operating cost decreases. We do not expect full synergies to be achieved until the end of calendar year 2014.
In response to the constraints on our customers’ capital spending budgets, we have been promoting the advantages to our customers of purchasing our energy management systems through our Orion Throughput Agreement, or OTA, financing program. Our OTA financing program provides for our customer’s purchase of our energy management systems without an up-front capital outlay. During fiscal 2012, we entered into an arrangement with a national equipment finance company to provide immediate non-recourse funding of pre-credit approved OTA finance contracts upon project completion and customer acceptance. The majority of these sales occur on a non-recourse basis. During fiscal 2013 and the first half of fiscal 2014, approximately 73.3% and 90.5%, respectively, of our total completed OTA contracts were financed directly through third party

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equipment finance companies. In the future, we intend to continue to utilize third party finance companies to fund the majority of our OTA contracts. In future periods, the number of customers who choose to purchase our systems by using our OTA financing program will be dependent upon our relationships with third party equipment finance companies, the extent to which customers' choose to use their own capital budgets and the extent to which customers' choose to enter into finance contracts. Additionally, we have provided a financing program to our alternative renewable energy system customers called a solar Power Purchase Agreement, or PPA, as an alternative to purchasing our systems for cash. The PPA is a supply side agreement for the generation of electricity and subsequent sale to the end user. We do not intend to use our own cash balances to fund future PPA opportunities and have been able to secure several external sources of funding for PPA’s on behalf of our customers.
Despite these recent economic challenges, we remain optimistic about our near-term and long-term financial performance. Our near-term optimism is based upon our return to profitability during our fiscal 2013 second half, the significant improvement in our fiscal 2014 first half performance compared to our fiscal 2013 first half performance, our investments into our retail sales force and our intentions to continue to expand our retail sales force during the remainder of fiscal 2014, our cost containment initiatives and opportunities, the increasing volume of unit sales of our new products, specifically our exterior HIF and LED fixtures, and the completion of our acquisition of Harris and the increased sales market opportunities and cost synergies that Harris provides. Our long-term optimism is based upon the considerable size of the existing market opportunity for lighting retrofits, including the new market opportunities in commercial office, government and retail that Harris provides, the continued development of our new products and product enhancements, including our new LED product offerings, the opportunity for additional revenue from sales of third party technologies through our Orion Engineered Systems Division, our refocused management efforts which has resulted in our cost reduction initiatives, and the opportunity to increase gross margins through the leverage of our under-utilized manufacturing capacity.
Our annual report on Form 10-K for the fiscal year ended March 31, 2013 provides additional information about our business and operations.
Revenue and Expense Components
Revenue. We sell our energy management products and services directly to commercial and industrial customers, and indirectly to end users through wholesale sales to electrical contractors and value-added resellers. We currently generate the majority of our revenue from sales of HIF lighting systems and related services to commercial and industrial customers. While our services include comprehensive site assessment, site field verification, utility incentive and government subsidy management, engineering design, project management, installation and recycling in connection with our retrofit installations, we separately recognize service revenue only for our installation and recycling services. Our installation and recycling service revenues are recognized when services are complete and customer acceptance has been received. Our wholesale channels, which includes our value-added resellers and electrical contractors, accounted for approximately 59% of our total revenue in fiscal 2013, not taking into consideration our renewable technologies revenue generated through our Orion Engineered Systems Division. During the first half of fiscal 2014, wholesale revenues accounted for approximately 66% of our total revenue, not taking into consideration our renewable technologies revenue generated through our Orion Engineered Systems Division, compared to 58% for the first half of fiscal 2013. In fiscal 2012, we focused our expansion efforts on our direct retail sales channel through the creation of a telemarketing call center for the purpose of customer lead generation, the establishment of a sales office and personnel in Houston, Texas and headcount additions to our retail sales force and our Engineered Systems Division. During the fiscal 2013 second half, we re-engineered our telemarketing call center for the purpose of improving the quality of leads and increasing sales closing ratios. During the first half of fiscal 2014, we have continued the expansion of our direct in-market sales force and intend to continue increasing the number of direct sales personnel during the remainder of fiscal 2014.
Additionally, we offer our OTA sales-type financing program under which we finance the customer’s purchase of our energy management systems. The OTA program was established to assist customers who are interested in purchasing our energy management systems but who have capital expenditure budget limitations. Our OTA contracts are capital leases under GAAP and we record revenue at the present value of the future payments at the time customer acceptance of the installed and operating system is complete. Our OTA contracts under this sales-type financing are either structured with a fixed term, typically 60 months, and a bargain purchase option at the end of term, or are one year in duration and, at the completion of the initial one-year term, provide for (i) one to four automatic one-year renewals at agreed upon pricing; (ii) an early buyout for cash; or (iii) the return of the equipment at the customer’s expense. The revenue that we are entitled to receive from the sale of our lighting fixtures under our OTA financing program is fixed and is based on the cost of the lighting fixtures and applicable profit margin. Our revenue from agreements entered into under this program is not dependent upon our customers’ actual energy savings. We recognize revenue from OTA contracts at the net present value of the future cash flows at the completion date of the installation of the energy management systems and the customer’s acknowledgment that the system is operating as specified. Upon completion of the installation, we may choose to sell the future cash flows and residual rights to the equipment on a non-recourse basis to third party finance companies in exchange for cash and future payments.

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In fiscal 2013, we recognized $6.7 million of revenue from 128 completed OTA contracts. For the three months ended September 30, 2013, we recognized $0.7 million of revenue from 13 completed contracts compared to $1.6 million from 33 completed contracts during the three months ended September 30, 2012. For the six months ended September 30, 2013, we recognized $2.4 million of revenue from 37 completed contracts compared to $3.4 million from 52 completed contracts for the six months ended September 30, 2012.
Our PPA financing program provides for our customer’s purchase of electricity from our renewable energy generating assets without an upfront capital outlay. Our PPA is a longer-term contract, typically in excess of 10 years, in which we receive monthly payments over the life of the contract. This program creates an ongoing recurring revenue stream, but reduces near-term revenue as the payments are recognized as revenue on a monthly basis over the life of the contract versus upfront upon product shipment or project completion. In fiscal 2013, we recognized $0.7 million of revenue from completed PPAs. In the first half of fiscal 2014, we recognized $0.4 million of revenue from completed PPAs. As of September 30, 2013, we had signed one customer to two separate PPAs representing future potential discounted revenue streams of $2.0 million. We discount the future revenue from PPAs due to the long-term nature of the contracts, typically in excess of 10 years. The timing of expected future discounted GAAP revenue recognition and the resulting operating cash inflows from PPAs, assuming the systems perform as designed, was as follows as of September 30, 2013 (in thousands):
Fiscal 2014
$
98

Fiscal 2015
247

Fiscal 2016
247

Fiscal 2017
247

Fiscal 2018
246

Beyond
867

Total expected future discounted revenue from PPA's
$
1,952

For sales of our solar PV systems, which are governed by customer contracts that require us to deliver functioning solar power systems and are generally completed within three to 15 months from the start of project construction, we recognize revenue from fixed price construction contracts using the percentage-of-completion method. Under this method, revenue arising from fixed price construction contracts is recognized as work is performed based upon the percentage of incurred costs to estimated total forecasted costs. We have determined that the appropriate method of measuring progress on these sales is measured by the percentage of costs incurred to date of the total estimated costs for each contract as materials are installed. The percentage-of-completion method requires revenue recognition from the delivery of products to be deferred and the cost of such products to be capitalized as a deferred cost and current asset on the balance sheet. We perform periodic evaluations of the progress of the installation of the solar PV systems using actual costs incurred over total estimated costs to complete a project. Provisions for estimated losses on uncompleted contracts, if any, are recognized in the period in which the loss first becomes probable and reasonably estimable.
We recognize revenue on product only sales of our lighting and energy management systems at the time of shipment. For lighting and energy management systems projects consisting of multiple elements of revenue, such as a combination of product sales and services, we recognize revenue by allocating the total contract revenue to each element based on their relative selling prices. We determine the selling price of each element based upon management's best estimate giving consideration to pricing practices, margin objectives, competition, scope and size of individual projects, geographies in which we offer our products and services and internal costs. We recognize revenue at the time of product shipment on product sales and on services completed prior to product shipment. We recognize revenue associated with services provided after product shipment, based on their relative selling price, when the services are completed and customer acceptance has been received. When other significant obligations or acceptance terms remain after products are delivered, revenue is recognized only after such obligations are fulfilled or acceptance by the customer has occurred.
Our dependence on individual key customers can vary from period to period as a result of the significant size of some of our solar PV projects and multi-facility roll-out projects. Our top 10 customers accounted for approximately 30% and 49% of our total revenue for the first half of fiscal 2013 and fiscal 2014, respectively. No customer accounted for more than 10% of our total revenue in the first half of fiscal 2013. One customer accounted for 28% of our total revenue in the first half of fiscal 2014. To the extent that large solar PV projects and multi-facility roll-out projects become a greater component of our total revenue, we may experience more customer concentration in given periods. The loss of, or substantial reduction in sales volume to, any of our significant customers could have a material adverse effect on our total revenue in any given period and may result in significant annual and quarterly revenue variations.

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Our level of total revenue for any given period is dependent upon a number of factors, including (i) the demand for our products and systems, including our OTA and PPA programs and any new products, applications and service that we may introduce through our Orion Engineered Systems Division; (ii) the number and timing of large retrofit and multi-facility retrofit, or “roll-out,” projects; (iii) the rate at which we expand our direct sales force; (iv) our ability to realize revenue from our services; (v) market conditions; (vi) the level of our wholesale sales; (vii) our execution of our sales process; (viii) our ability to compete in a highly competitive market and our ability to respond successfully to market competition; (ix) the selling price of our products and services; (x) changes in capital investment levels by our customers and prospects; (xi) the rate of performance improvement and cost decreases of LED product offerings; and (xi) customer sales and budget cycles. As a result, our total revenue may be subject to quarterly variations and our total revenue for any particular fiscal quarter may not be indicative of future results.
Backlog. We define backlog as the total contractual value of all firm orders and OTA contracts received for our lighting and solar products and services where delivery of product or completion of services has not yet occurred as of the end of any particular reporting period. Such orders must be evidenced by a signed proposal acceptance or purchase order from the customer. Our backlog does not include PPAs or national contracts that have been negotiated, but under which we have not yet received a purchase order for the specific location. As of September 30, 2013, we had a backlog of firm purchase orders of approximately $13.0 million, which included $8.9 million of solar PV orders, compared to $18.6 million as of June 30, 2013, which included $16.5 million of solar PV orders. We currently expect approximately $11.1 million of our September 30, 2013 backlog to be recognized as revenue in our fiscal 2014 second half and the remainder in future years. We generally expect this level of firm purchase order backlog related to HIF lighting systems to be recognized as revenue within the following quarter. We generally expect our firm purchase order backlog related to solar PV systems to be recognized within the following three to 15 months from the time construction of the system begins, although during fiscal 2012, we received a $20.2 million single order for which the solar PV system construction began during our fiscal 2014 first quarter. As a result of the decreased volume of our solar PV orders, the continued lengthening of our customer’s purchasing decisions because of current recessed economic conditions and related factors, the continued shortening of our installation cycles and the number of projects sold through OTAs, a comparison of backlog from period to period is not necessarily meaningful and may not be indicative of actual revenue recognized in future periods.
Cost of Revenue. Our total cost of revenue consists of costs for: (i) raw materials, including sheet, coiled and specialty reflective aluminum; (ii) electrical components, including ballasts, power supplies and lamps; (iii) materials for sales of solar PV systems through our Engineered Systems Division, including solar panels, inverters and wiring; (iv) wages and related personnel expenses, including stock-based compensation charges, for our fabricating, coating, assembly, logistics and project installation service organizations; (v) manufacturing facilities, including depreciation on our manufacturing facilities and equipment, taxes, insurance and utilities; (vi) warranty expenses; (vii) installation and integration; and (viii) shipping and handling. Our cost of aluminum can be subject to commodity price fluctuations, which we attempt to mitigate through the recycling of old scrap fixtures through our facility which contain similar content of aluminum when compared to new fixtures. We also purchase many of our electrical components through forward purchase contracts. We buy most of our specialty reflective aluminum from a single supplier. We purchase our ballast and lamp components from multiple suppliers. For the first half of fiscal 2013 and fiscal 2014, no supplier accounted for more than 10% of total cost of revenue. We purchase our solar panels from multiple suppliers for sales of our solar generating systems. For the first half of fiscal 2013, purchases from one supplier accounted for 6% of total cost of revenue. For the first half of fiscal 2014, purchases from one supplier accounted for 12% of total cost of revenue. Our cost of revenue from OTA projects is recorded upon customer acceptance and acknowledgment that the system is operating as specified. Our production labor force is non-union and, as a result, our production labor costs have been relatively stable. We have been expanding our network of qualified third-party installers to realize efficiencies in the installation process. During fiscal 2013, we reduced indirect headcount as part of our cost containment initiative. During fiscal 2014, we are aggressively focused on cost containment initiatives related to material product costs, service margin expansion and the implementation of lean manufacturing methodologies to reduce production costs in our manufacturing facility.
Gross Margin. Our gross profit has been, and will continue to be, affected by the relative levels of our total revenue and our total cost of revenue, and as a result, our gross profit may be subject to quarterly variation. Our gross profit as a percentage of total revenue, or gross margin, is affected by a number of factors, including: (i) our level of solar PV sales which have greater margin volatility due to recent decreases in product costs versus our traditional energy management systems; (ii) our mix of large retrofit and multi-facility roll-out projects with national accounts; (iii) the level of our wholesale and partner sales (which generally have historically resulted in lower relative gross margins, but higher relative net margins, than our sales to direct customers); (iv) our realization rate on our billable services; (v) our project pricing; (vi) our level of warranty claims; (vii) our level of utilization of our manufacturing facilities and production equipment and related absorption of our manufacturing overhead costs; (viii) our level of efficiencies in our manufacturing operations; and (ix) our level of efficiencies from our subcontracted installation service providers.

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Operating Expenses. Our operating expenses consist of: (i) general and administrative expenses; (ii) acquisition related expenses; (iii) sales and marketing expenses; and (iv) research and development expenses. Personnel related costs are our largest operating expense. In fiscal 2013, we decreased headcount as part of our cost containment initiatives. In fiscal 2014, we expect to increase headcount in our sales areas for direct sales employees.
Our general and administrative expenses consist primarily of costs for: (i) salaries and related personnel expenses, including stock-based compensation charges related to our executive, finance, human resource, information technology and operations organizations; (ii) public company costs, including investor relations, external audit and internal audit; (iii) occupancy expenses; (iv) professional services fees; (v) technology related costs and amortization; (vi) asset impairment charges; and (vii) corporate-related travel.
Our acquisition related expenses consist primarily of costs for: (i) variable purchase accounting expenses for contingent consideration; (ii) legal and accounting costs; and (iii) integration expenses.
Our sales and marketing expenses consist primarily of costs for: (i) salaries and related personnel expenses, including stock-based compensation charges related to our sales and marketing organization; (ii) internal and external sales commissions and bonuses; (iii) travel, lodging and other out-of-pocket expenses associated with our selling efforts; (iv) marketing programs; (v) pre-sales costs; (vi) bad debt; and (vii) other related overhead.
Our research and development expenses consist primarily of costs for: (i) salaries and related personnel expenses, including stock-based compensation charges, related to our engineering organization; (ii) payments to consultants; (iii) the design and development of new energy management products and enhancements to our existing energy management system; (iv) quality assurance and testing; and (v) other related overhead. We expense research and development costs as incurred.
During the back half of fiscal 2013, we initiated cost containment efforts that reduced expenses related to compensation, consulting and other discretionary spending. We expense all pre-sale costs incurred in connection with our sales process prior to obtaining a purchase order. These pre-sale costs may reduce our net income in a given period prior to recognizing any corresponding revenue. We intend to continue to invest in the expansion of our in-market direct sales force during fiscal 2014. We also intend to continue investing in our research and development of new and enhanced energy management products and services.
We recognize compensation expense for the fair value of our stock option and restricted stock awards granted over their related vesting period. We recognized $0.8 million and $0.7 million of compensation expense for the first half of fiscal 2013 and fiscal 2014, respectively. As a result of prior option and restricted stock grants, we expect to recognize an additional $3.2 million of stock-based compensation over a weighted average period of approximately six years, including $0.6 million in the last half of fiscal 2014. These charges have been, and will continue to be, allocated to cost of product revenue, general and administrative expenses, sales and marketing expenses and research and development expenses based on the departments in which the personnel receiving such awards have primary responsibility. A substantial majority of these charges have been, and likely will continue to be, allocated to general and administrative expenses and sales and marketing expenses.
Interest Expense. Our interest expense is comprised primarily of interest expense on outstanding borrowings under long-term debt obligations, including the amortization of previously incurred financing costs. We amortize deferred financing costs to interest expense over the life of the related debt instrument, ranging from one to ten years.
Interest Income. We report interest income earned from our financed OTA contracts and on our cash and cash equivalents and short term investments.
Income Taxes. As of September 30, 2013, we had net operating loss carryforwards of approximately $15.1 million for federal tax purposes and $15.5 million for state tax purposes. Included in these loss carryforwards were $3.0 million for federal and $4.1 million for state tax purposes of compensation expenses that were associated with the exercise of nonqualified stock options. The benefit from our net operating losses created from these compensation expenses has not yet been recognized in our financial statements and will be accounted for in our shareholders’ equity as a credit to additional paid-in capital as the deduction reduces our income taxes payable. We also had federal tax credit carryforwards of approximately $1.5 million and state credit carryforwards of approximately $0.5 million. A valuation allowance has been set up to fully reserve for our net operating losses and our tax credits. It is possible that we may not be able to utilize the full benefit of our state tax credits due to our state apportioned income and the potential expiration of the state tax credits due to the carry forward period. These federal and state net operating losses and credit carryforwards are available, subject to the discussion in the following paragraph, to offset future taxable income and, if not utilized, will begin to expire in varying amounts between 2020 and 2033. Our valuation allowance for deferred tax assets is based upon our cumulative three year operating losses.

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Generally, a change of more than 50% in the ownership of a company’s stock, by value, over a three year period constitutes an ownership change for federal income tax purposes. An ownership change may limit a company’s ability to use its net operating loss carryforwards attributable to the period prior to such change. There was no limitation that occurred for fiscal 2012 or fiscal 2013.
Results of Operations
The following table sets forth the line items of our consolidated statements of operations on an absolute dollar basis and as a relative percentage of our total revenue for each applicable period, together with the relative percentage change in such line item between applicable comparable periods set forth below (dollars in thousands):
 
Three Months Ended September 30,
 
 
 
Six Months Ended September 30,
 
 
 
2012
 
2013
 
 
 
2012
 
2013
 
 
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
%
Change
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
%
Change
Product revenue
$
16,931

 
87.2
 %
 
$
21,181

 
77.0
 %
 
25.1
 %
 
$
30,511

 
87.9
 %
 
$
38,704

 
80.1
 %
 
26.9
 %
Service revenue
2,477

 
12.8
 %
 
6,314

 
23.0
 %
 
154.9
 %
 
4,207

 
12.1
 %
 
9,643

 
19.9
 %
 
129.2
 %
Total revenue
19,408

 
100.0
 %
 
27,495

 
100.0
 %
 
41.7
 %
 
34,718

 
100.0
 %
 
48,347

 
100.0
 %
 
39.3
 %
Cost of product revenue
11,867

 
61.2
 %
 
15,638

 
56.9
 %
 
31.8
 %
 
21,464

 
61.8
 %
 
28,522

 
59.0
 %
 
32.9
 %
Cost of service revenue
1,736

 
8.9
 %
 
4,028

 
14.6
 %
 
132.0
 %
 
3,076

 
8.9
 %
 
6,273

 
13.0
 %
 
103.9
 %
Total cost of revenue
13,603

 
70.1
 %
 
19,666

 
71.5
 %
 
44.6
 %
 
24,540

 
70.7
 %
 
34,795

 
72.0
 %
 
41.8
 %
Gross profit
5,805

 
29.9
 %
 
7,829

 
28.5
 %
 
34.9
 %
 
10,178

 
29.3
 %
 
13,552

 
28.0
 %
 
33.1
 %
General and administrative expenses
4,638

 
23.9
 %
 
3,173

 
11.5
 %
 
(31.6
)%
 
7,940

 
22.9
 %
 
5,857

 
12.1
 %
 
(26.2
)%
Acquisition related expenses

 
 %
 
356

 
1.3
 %
 
N/A

 

 
 %
 
431

 
0.9
 %
 
N/A

Sales and marketing expenses
4,561

 
23.5
 %
 
3,644

 
13.3
 %
 
(20.1
)%
 
8,513

 
24.4
 %
 
6,947

 
14.4
 %
 
(18.4
)%
Research and development expenses
710

 
3.6
 %
 
448

 
1.6
 %
 
(36.9
)%
 
1,407

 
4.1
 %
 
938

 
1.9
 %
 
(33.3
)%
(Loss) income from operations
(4,104
)
 
(21.1
)%
 
208

 
0.8
 %
 
(105.1
)%
 
(7,682
)
 
(22.1
)%
 
(621
)
 
(1.3
)%
 
(91.9
)%
Interest expense
(142
)
 
(0.8
)%
 
(142
)
 
(0.6
)%
 
 %
 
(303
)
 
(0.9
)%
 
(255
)
 
(0.5
)%
 
(15.8
)%
Interest income
218

 
1.1
 %
 
153

 
0.6
 %
 
(29.8
)%
 
443

 
1.3
 %
 
327

 
0.7
 %
 
(26.2
)%
(Loss) income before income tax
(4,028
)
 
(20.8
)%
 
219

 
0.8
 %
 
(105.4
)%
 
(7,542
)
 
(21.7
)%
 
(549
)
 
(1.1
)%
 
(92.7
)%
Income tax expense (benefit)
5,631

 
29.0
 %
 
(2,184
)
 
(7.9
)%
 
(138.8
)%
 
4,057

 
11.7
 %
 
(2,171
)
 
(4.5
)%
 
(153.5
)%
Net (loss) income
$
(9,659
)
 
(49.8
)%
 
$
2,403

 
8.7
 %
 
(124.9
)%
 
$
(11,599
)
 
(33.4
)%
 
$
1,622

 
3.4
 %
 
(114.0
)%
Revenue. Product revenue increased from $16.9 million for the fiscal 2013 second quarter to $21.2 million for the fiscal 2014 second quarter, an increase of $4.3 million, or 25%. The increase in product revenue was a result of increased sales of solar PV systems, $2.6 million of revenue resulting from our acquisition of Harris and increased sales of our LED fixtures. Service revenue increased from $2.5 million for the fiscal 2013 second quarter to $6.3 million for the fiscal 2014 second quarter, an increase of $3.8 million, or 155%. The increase in service revenue was a result of the installation of solar projects under construction and $1.6 million in service revenue resulting from our acquisition of Harris. Total revenue from renewable energy systems was $9.1 million for the fiscal 2014 second quarter compared to $2.8 million for the fiscal 2013 second quarter. The percentage increase in revenue from renewable energy systems was due to an increase in the system size of our projects under construction compared to smaller projects under construction during fiscal 2013. Product revenue increased from $30.5 million for the first half of fiscal 2013 to $38.7 million for the first half of fiscal 2014, an increase of $8.2 million, or 27%. Service revenue increased from $4.2 million for the first half of fiscal 2013 to $9.6 million for the first half of fiscal 2014, an increase of $5.4 million, or 129%. Total revenue from renewable energy systems was $14.0 million for the first half of fiscal 2014 compared to $5.5 million for the first half of fiscal 2013, an increase of $8.5 million, or 155%.
Cost of Revenue and Gross Margin. Our cost of product revenue increased from $11.9 million for the fiscal 2013 second quarter to $15.6 million for the fiscal 2014 second quarter, an increase of $3.7 million, or 32%. Our cost of service revenue increased from $1.7 million for the fiscal 2013 second quarter to $4.0 million for the fiscal 2014 second quarter, an increase of $2.3 million, or 132%. Gross margin decreased from 29.9% for the fiscal 2013 second quarter to 28.5% for the fiscal 2014 second quarter. Our gross margins were unfavorably impacted by an increased mix of lower margin solar projects during the fiscal 2014 second quarter compared to the prior year second quarter. Our gross margin on renewable revenue was 21.2% during the fiscal 2014 second quarter compared to 27.1% during the fiscal 2013 second quarter. We expect that our total margins from sales of renewable solar systems will continue to remain in the 20.0% range during the remainder of fiscal 2014. Gross margin from sales of our integrated lighting systems for the fiscal 2014 second quarter was 32.1% compared to 30.4% for the fiscal 2013 second quarter. The increase in our lighting gross margin percentage was due to the cost containment

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initiatives within our manufacturing facility. Our cost of product revenue increased from $21.5 million for the first half of fiscal 2013 to $28.5 million for the first half of fiscal 2014, an increase of $7.0 million, or 33%. Our cost of service revenue increased from $3.1 million for the first half of fiscal 2013 to $6.3 million for the first half of fiscal 2014, an increase of $3.2 million, or 104%. Total gross margin decreased from 29.3% for the first half of fiscal 2013 to 28.0% for the first half of fiscal 2014. For the fiscal 2014 first half, our gross margin percentage declined due to the increased mix of lower margin solar projects compared to the prior year. Our gross margin on renewable revenues was 31.0% during the fiscal 2013 first half compared to 21.5% during the fiscal 2014 first half. Gross margin from our HIF integrated systems revenue for the fiscal 2013 first half was 29.0% compared to 30.7% during the fiscal 2014 first half.
General and Administrative. Our general and administrative expenses decreased from $4.6 million for the fiscal 2013 second quarter to $3.2 million for the fiscal 2014 second quarter, a decrease of $1.4 million, or 32%. The decrease was due to reorganization expenses of $1.3 million incurred in the prior year as a result of our management change, and reduced compensation and benefit expenses of $0.3 million resulting from our headcount reductions. These reductions were partially offset by increased insurance expenses and $0.1 million of intangible asset amortization resulting from the acquisition of Harris in July 2013. Our general and administrative expenses decreased from $7.9 million for the first half of fiscal 2013 to $5.9 million for the first half of fiscal 2014, a decrease of $2.0 million, or 26%. The decrease for the first half was due to prior year expenses of $1.3 million resulting from our reorganization, $0.7 million in reduced compensation and benefit expenses resulting from headcount reductions and other reductions in discretionary spending. These increases were partially offset by increased insurance expenses of $0.1 million and $0.1 million for the amortization of intangible assets resulting from the acquisition of Harris.
Acquisition Related. We incurred acquisition related expenses of $0.4 million for the fiscal 2014 second quarter and the fiscal 2014 first half related to the Harris acquisition. We incurred no acquisition expenses in the first half of fiscal 2013. The expenses were due to the acquisition of Harris during the fiscal 2014 second quarter and included $0.3 million for variable purchasing accounting expenses for mark-to-market expenses related to the contingent consideration earn-out for the acquisition of Harris and other expenses for legal, accounting and integration related costs.
Sales and Marketing. Our sales and marketing expenses decreased from $4.6 million for the fiscal 2013 second quarter to $3.6 million for the fiscal 2014 second quarter, a decrease of $1.0 million, or 20%. The decrease was due to reduced compensation and benefit expense of $0.4 million resulting from our headcount reductions, reorganization expenses incurred in fiscal 2013 of $0.4 million and discretionary spending reductions of $0.7 million, offset by an increase in our sales commission expense of $0.2 million and incremental expenses of $0.3 million resulting from the acquisition of Harris. Our sales and marketing expenses decreased from $8.5 million for the first half of fiscal 2013 to $6.9 million for the first half of fiscal 2014, a decrease of $1.6 million, or 18%. The decrease was due to reduced compensation and benefit expense of $1.0 million resulting from headcount reductions, reorganization expenses incurred in fiscal 2013 of $0.4 million and discretionary spending reductions of $0.9 million, offset by an increase in our sales commission expense of $0.4 million and incremental expenses of $0.3 million resulting from the acquisition of Harris. We have recently been increasing, and intend to continue to increase, our in-market direct sales force. Total sales and marketing headcount was 115 and 87 at September 30, 2012 and 2013, respectively.
Research and Development. Our research and development expenses decreased from $0.7 million for the fiscal 2013 second quarter to $0.4 million for the fiscal 2014 second quarter, a decrease of $0.3 million, or 37%. Our research and development expenses decreased from $1.4 million for the first half of fiscal 2013 to $0.9 million for the first half of fiscal 2014, a decrease of $0.5 million, or 33%. Our R&D expenses decreased during the second quarter and first half of fiscal 2014 due to a reduction in compensation expenses, consulting expenses and product testing costs related to our energy management controls initiatives.
Interest Expense. Our interest expense was unchanged from $142,000 for the fiscal 2013 second quarter to $142,000 for the fiscal 2014 second quarter. Our interest expense decreased from $303,000 for the first half of fiscal 2013 to $255,000 for the first half of fiscal 2014, a decrease of $48,000, or 16%. The decrease in interest expense was due to the reduction in financed contract debt compared to the prior year first half. In the future, we expect an increase in interest expense due to the $3.2 million promissory note issued as part of the Harris acquisition.
Interest Income. Interest income decreased from $218,000 for the fiscal 2013 second quarter to $153,000 for the fiscal 2014 second quarter, a decrease of $65,000, or 30%. Interest income decreased from $443,000 for the first half of fiscal 2013 to $327,000 for the first half of fiscal 2014, an a decrease of $116,000, or 26%. Our interest income decreased as we increased the utilization of third party finance providers for a majority of our financed projects. In the future, we expect our interest income to decrease as we continue to utilize third party finance providers for our Orion Throughput Agreements, or OTA, projects.
Income Taxes. Our income tax expense decreased from income tax expense of $5.6 million for the fiscal 2013 second quarter to an income tax benefit of $2.2 million for the fiscal 2014 second quarter, a decrease of $7.8 million, or 139%. Our

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income tax expense decreased from income tax expense of $4.1 million for the first half of fiscal 2013 to an income tax benefit of $2.2 million for the first half of fiscal 2014, a decrease of $6.3 million, or 154%. During our fiscal 2013 first half, we recorded a valuation reserve against our deferred tax assets in the amount of $4.1 million due to uncertainty over the realization value of these assets in the future. During our fiscal 2014 first half, we reversed $2.2 million of our valuation reserve to offset deferred tax liabilities resulting from our acquisition of Harris. Our effective income tax rate for the first half of fiscal 2013 was 53.8%, compared to a benefit rate of 395.5% for the first half of fiscal 2014. The change in effective rate was due primarily to the changes in the valuation reserve and expected minimum state tax liabilities.
Energy Management Segment
The following table summarizes our Energy Management segment operating results:
 
For the Three Months Ended September 30,
 
For the Six Months Ended September 30,
(dollars in thousands)
2012
 
2013
 
2012
 
2013
Revenues
$
16,652

 
$
18,410

 
$
29,252

 
$
34,300

Operating (loss) income
$
(453
)
 
$
1,123

 
$
(2,211
)
 
$
1,271

Operating margin
(2.7
)%
 
6.1
%
 
(7.6
)%
 
3.7
%
Energy Management segment revenue increased $1.7 million, or 11%, from $16.7 million for the fiscal 2013 second quarter to $18.4 million for the fiscal 2014 second quarter. The increase in revenue for the fiscal 2014 second quarter was primarily due to the acquisition of Harris. Energy Management segment revenue increased $5.0 million, or 17%, from $29.3 million for the first half of fiscal 2013 to $34.3 million for the first half of fiscal 2014. The increase in revenue for the fiscal 2014 first half was due to the acquisition of Harris and increased sales of our LED lighting systems.
Energy Management segment operating income increased $1.6 million, or 348%, from operating loss of $0.5 million for the fiscal 2013 second quarter to operating income of $1.1 million for the fiscal 2014 second quarter. Energy Management segment operating income increased $3.5 million, or 157%, from operating loss of $2.2 million for the first half of fiscal 2013 to operating income of $1.3 million for the first half of fiscal 2014. The increase in operating income for both the fiscal 2013 second quarter and year-to-date periods was a result of the increased gross margin contribution from the revenue increase and cost decreases due to our cost containment initiatives resulting in reduced material costs and reduced operating expenses.
Engineered Systems Segment
The following table summarizes our Engineered Systems segment operating results:
 
For the Three Months Ended September 30,
 
For the Six Months Ended September 30,
(dollars in thousands)
2012
 
2013
 
2012
 
2013
Revenues
$
2,756

 
$
9,085

 
$
5,466

 
$
14,047

Operating income (loss)
$