OESX-2013.12.31-10Q
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 December 31, 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 21,411,695 shares of the Registrant’s common stock outstanding on February 4, 2014.


Table of Contents


Orion Energy Systems, Inc.
Quarterly Report On Form 10-Q
For The Quarter Ended December 31, 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 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
 
December 31, 2013
Assets
 
 
 
Cash and cash equivalents
$
14,376

 
$
18,339

Short-term investments
1,021

 
1,025

Accounts receivable, net of allowances of $900 and $413
18,397

 
20,328

Inventories, net
15,230

 
13,517

Deferred contract costs
2,118

 
669

Prepaid expenses and other current assets
2,465

 
4,795

Total current assets
53,607

 
58,673

Property and equipment, net
27,947

 
25,254

Long-term inventory
11,491

 
9,544

Goodwill

 
4,676

Other intangible assets, net
1,709

 
7,705

Deferred tax assets

 
145

Long-term accounts receivable
5,069

 
2,841

Other long-term assets
2,274

 
2,246

Total assets
$
102,097

 
$
111,084

Liabilities and Shareholders’ Equity
 
 
 
Accounts payable
$
7,773

 
$
11,197

Accrued expenses and other
5,457

 
4,717

Deferred revenue, current
2,946

 
1,182

Current maturities of long-term debt
2,597

 
3,677

Total current liabilities
18,773

 
20,773

Long-term debt, less current maturities
4,109

 
3,762

Deferred revenue, long-term
1,258

 
1,336

Other long-term liabilities
188

 
874

Total liabilities
24,328

 
26,745

Commitments and contingencies (See Note G)

 

Shareholders’ equity:
 
 
 
Common stock, no par value: Shares authorized: 200,000,000 at March 31, 2013 and December 31, 2013; shares issued: 30,498,900 and 30,796,592 at March 31, 2013 and December 31, 2013; shares outstanding: 20,162,397 and 21,298,930 at March 31, 2013 and December 31, 2013

 

Additional paid-in capital
128,104

 
129,797

Treasury stock: 10,336,503 and 9,497,662 common shares at March 31, 2013 and December 31, 2013
(38,378
)
 
(36,354
)
Shareholder notes receivable
(265
)
 
(52
)
Retained deficit
(11,692
)
 
(9,052
)
Total shareholders’ equity
77,769

 
84,339

Total liabilities and shareholders’ equity
$
102,097

 
$
111,084

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


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ORION ENERGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
 
 
Three Months Ended December 31, 2013
 
Nine Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
Product revenue
$
22,660

 
$
22,380

 
$
53,171

 
$
61,084

Service revenue
6,427

 
5,312

 
10,634

 
14,955

Total revenue
29,087

 
27,692

 
63,805

 
76,039

Cost of product revenue
15,708

 
15,742

 
37,172

 
44,264

Cost of service revenue
4,798

 
3,800

 
7,874

 
10,073

Total cost of revenue
20,506

 
19,542

 
45,046

 
54,337

Gross profit
8,581

 
8,150

 
18,759

 
21,702

Operating expenses:
 
 
 
 
 
 
 
General and administrative
2,848

 
3,277

 
10,788

 
9,134

Acquisition and integration related

 
88

 

 
519

Sales and marketing
4,730

 
3,397

 
13,243

 
10,344

Research and development
427

 
478

 
1,834

 
1,416

Total operating expenses
8,005

 
7,240

 
25,865

 
21,413

Income (loss) from operations
576

 
910

 
(7,106
)
 
289

Other income (expense):
 
 
 
 
 
 
 
Interest expense
(138
)
 
(123
)
 
(441
)
 
(378
)
Interest income
213

 
132

 
656

 
459

Total other income
75

 
9

 
215

 
81

Income (loss) before income tax
651

 
919

 
(6,891
)
 
370

Income tax (benefit) expense

 
(99
)
 
4,057

 
(2,270
)
Net income (loss)
$
651

 
$
1,018

 
$
(10,948
)
 
$
2,640

Basic net income (loss) per share attributable to common shareholders
$
0.03

 
$
0.05

 
$
(0.51
)
 
$
0.13

Weighted-average common shares outstanding
20,191,547

 
21,219,946

 
21,271,465

 
20,830,247

Diluted net income (loss) per share
$
0.03

 
$
0.05

 
$
(0.51
)
 
$
0.12

Weighted-average common shares and share equivalents outstanding
20,245,194

 
22,328,766

 
21,271,465

 
21,562,526

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 CASH FLOWS
(in thousands)
 
Nine Months Ended December 31,
 
2012
 
2013
Operating activities
 
 
 
Net (loss) income
$
(10,948
)
 
$
2,640

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating
 
 
 
activities:
 
 
 
Depreciation
3,258

 
2,987

Amortization of long-term assets
156

 
355

Stock-based compensation expense
914

 
973

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

 
11

Deferred income tax expense (benefit)
3,945

 
(2,335
)
Loss on sale of property and equipment
38

 
112

Provision for bad debts
712

 
87

Other
44

 
101

Changes in operating assets and liabilities, net of effects of acquisition:
 
 
 
Accounts receivable, current and long-term
(330
)
 
2,384

Inventories, current and long-term
823

 
5,293

Deferred contract costs
466

 
1,449

Prepaid expenses and other assets
(805
)
 
(2,225
)
Accounts payable
(941
)
 
1,905

Accrued expenses
3,737

 
(1,202
)
Deferred revenue
(1,130
)
 
(1,686
)
Net cash (used in) provided by operating activities
(61
)
 
10,849

Investing activities
 
 
 
Cash paid for acquisition, net of cash acquired

 
(4,992
)
Purchase of property and equipment
(1,848
)
 
(357
)
Purchase of short-term investments
(4
)
 
(4
)
Additions to patents and licenses
(97
)
 
(23
)
Proceeds from sales of property, plant and equipment
30

 
68

Net cash used in investing activities
(1,919
)
 
(5,308
)
Financing activities
 
 
 
Payment of long-term debt
(2,194
)
 
(2,391
)
Proceeds from long-term debt
156

 

Proceeds from repayment of shareholder notes
7

 
213

Repurchase of common stock into treasury
(6,007
)
 

Excess tax benefits from stock-based compensation
21

 
19

Deferred financing costs

 
(19
)
Proceeds from issuance of common stock
60

 
600

Net cash used in financing activities
(7,957
)
 
(1,578
)
Net (decrease) increase in cash and cash equivalents
(9,937
)
 
3,963

Cash and cash equivalents at beginning of period
23,011

 
14,376

Cash and cash equivalents at end of period
$
13,074

 
$
18,339

Supplemental cash flow information:
 
 
 
Cash paid for interest
$
408

 
$
328

Cash paid for income taxes
$
98

 
$
22

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Shares issued from treasury for shareholder note receivable
$
82

 
$
213

Shares returned to treasury in satisfaction of receivable
$

 
$
48

Acquisition related contingent consideration liability
$

 
$
612

Acquisition financed through debt
$

 
$
3,124

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 office space in Green Cove Springs, Florida. The Company leases office space for sales offices located in 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 December 31, 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

 
December 31, 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
1,025

 

 

 
1,025

 

 
1,025

Total
$
1,513

 
$

 
$

 
$
1,513

 
$
488

 
$
1,025

As of March 31, 2013 and December 31, 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 December 31, 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
$
2,473

 
$
50

 
$
176

 
$
226

 
$
2,699

Lease balances included in consolidated accounts receivable—long-term
2,107

 

 

 

 
2,107

Total gross sales-type leases
4,580

 
50

 
176

 
226

 
4,806

Allowance
(8
)
 
(2
)
 
(93
)
 
(95
)
 
(103
)
Total net sales-type leases
$
4,572

 
$
48

 
$
83

 
$
131

 
$
4,703

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 nine months ended December 31, 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 9 to 24 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 December 31, 2013, the Company had inventory obsolescence reserves of $2.3 million and $1.2 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
 
December 31, 2013
Raw materials and components
$
8,207

 
$
6,994

Work in process
846

 
854

Finished goods
6,177

 
5,669

 
$
15,230

 
$
13,517

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 $0.7 million as of March 31, 2013 and December 31, 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
 
December 31, 2013
Land and land improvements
$
1,562

 
$
1,562

Buildings
15,918

 
15,889

Furniture, fixtures and office equipment
11,995

 
12,146

Leasehold improvements
58

 
58

Equipment leased to customers under Power Purchase Agreements
4,997

 
4,997

Plant equipment
10,620

 
10,323

Construction in progress
91

 
117

 
45,241

 
45,092

Less: accumulated depreciation and amortization
(17,294
)
 
(19,838
)
Net property and equipment
$
27,947

 
$
25,254

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
Equipment leased to customers under Power Purchase Agreements
20 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 agreements
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 nine months ended December 31, 2013 was as follows (in thousands):
Balance at March 31, 2013
$

Acquisition of Harris
4,676

Balance at December 31, 2013
$
4,676

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

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March 31, 2013
 
December 31, 2013
 
Gross Carrying Amount
 
Accumulated Amortization
 
Gross Carrying Amount
 
Accumulated Amortization
Patents
$
2,358

 
$
(649
)
 
$
2,338

 
$
(750
)
Licenses
58

 
(58
)
 
58

 
(58
)
Trade name and trademarks

 

 
1,945

 

Customer relationships

 

 
3,400

 
(217
)
Developed technology

 

 
900

 
(1
)
Non-competition agreements

 

 
100

 
(10
)
Total
$
2,416

 
$
(707
)
 
$
8,741

 
$
(1,036
)
As of December 31, 2013, the weighted average useful life of intangible assets was 7.6 years. The estimated amortization expense for each of the next five years is shown below (in thousands):
For the remaining 3 months of fiscal 2014
$
325

Fiscal 2015
1,288

Fiscal 2016
1,168

Fiscal 2017
844

Fiscal 2018
584

Fiscal 2019
417

Thereafter
1,134

Total
$
5,760

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 December 31, 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 financed receivable
1,889

Less: amount above to be collected during the next 12 months
(1,003
)
Less: amount representing interest
(152
)
Net long-term receivable
$
734

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 $39,000 of deferred financing costs as of March 31, 2013 and December 31, 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).

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Accrued Expenses
Accrued expenses include warranty accruals, accrued wages and benefits, accrued vacation, accrued legal costs, accrued commissions, accrued acquisition liabilities, 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 December 31, 2013, respectively, and $0.7 million and $1.6 million of accrued project costs as of March 31, 2013 and December 31, 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 December 31,
 
Nine Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
Beginning of period
$
87

 
$
189

 
$
84

 
$
284

Provision (benefit) to product cost of revenue
82

 
93

 
223

 
168

Charges
(28
)
 
(88
)
 
(166
)
 
(258
)
End of period
$
141

 
$
194

 
$
141

 
$
194

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

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comprehensive site assessment, site field verification, utility incentive and government subsidy management, engineering 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 December 31, 2013, the Company had a valuation allowance of $4.7 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 nine months ended December 31, 2012 and 2013, realized tax benefits from the exercise of stock options were $21,000 and $19,000, respectively.

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Stock Option Plans
The Company did not issue any stock options during the three months ended December 31, 2013. The fair value of each option grant during the three and nine months ended December 31, 2012 and 2013 was determined using the assumptions in the following table:
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
Weighted average expected term
4.4 years

 
N/A
 
5.4 years

 
4.1 years

Risk-free interest rate
0.6
%
 
N/A
 
0.8
%
 
0.8
%
Expected volatility
72.7
%
 
N/A
 
74.0
%
 
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 and restricted shares vested. 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. The effect of net income (loss) per common share is calculated based upon the following shares (in thousands except share amounts):
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
Numerator:
 
 
 
 
 
 
 
Net income (loss) (in thousands)
$
651

 
$
1,018

 
$
(10,948
)
 
$
2,640

Denominator:
 
 
 
 
 
 
 
Weighted-average common shares outstanding
20,191,547

 
21,219,946

 
21,271,465

 
20,830,247

Weighted-average effect of assumed conversion of stock options, warrants and restricted shares
53,647

 
1,108,820

 

 
732,279

Weighted-average common shares and common share equivalents outstanding
20,245,194

 
22,328,766

 
21,271,465

 
21,562,526

Net income (loss) per common share:
 
 
 
 
 
 
 
Basic
$
0.03

 
$
0.05

 
$
(0.51
)
 
$
0.13

Diluted
$
0.03

 
$
0.05

 
$
(0.51
)
 
$
0.12

The following table indicates the number of potentially dilutive securities outstanding as of the end of each period: 
 
December 31, 2012
 
December 31, 2013
Common stock options
3,280,818

 
2,965,931

Restricted shares
105,000

 
462,262

Common stock warrants
38,980

 
38,980

Total
3,424,798

 
3,467,173

Concentration of Credit Risk and Other Risks and Uncertainties
For the three months ended December 31, 2012, two customers accounted for 16% and 15% of revenue, respectively. For the nine months ended December 31, 2012, one customer accounted for 10% of revenue. For the three and nine months ended December 31, 2013, one customer accounted for 23% and 26% of revenue, respectively.
As of March 31, 2013 and December 31, 2013, no customer accounted for more than 10% of accounts receivable.
Recent Accounting Pronouncements

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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 was a Florida-based lighting company which engineered, designed, sourced and manufactured energy efficient lighting systems, including fluorescent and LED lighting solutions, and day-lighting products.
The acquisition of Harris expanded the Company's product lines, including a patent pending LED lighting product designed for commercial office buildings, increased its sales force and provided growth opportunities into markets where the Company had 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, $3.1 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.
On October 21, 2013, the Company executed a letter agreement amending the Purchase Agreement. 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 2, 2014, the Company issued $0.6 million, or 83,943 shares, of the Company's unregistered 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 2, 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.
Total revenues and pre-tax income (loss) from Harris since the date of acquisition included in the accompanying consolidated statements of income for the three months ended December 31, 2013 were $2.7 million and $(0.6) million, respectively. Total revenues and pre-tax income (loss) from Harris since the date of acquisition included in the accompanying consolidated statements of income for the nine months ended December 31, 2013 were $6.9 million and $(0.5) million, respectively. The Company incurred $0.5 million in acquisition and integration related costs for Harris during the nine months ended December 31, 2013, which included contingent consideration, legal, accounting and other integration related expenses.
The Purchase Agreement contained customary representations and warranties, as well as indemnification obligations, and limitations thereon, by the Company and the Harris Shareholders to each other.

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The following table summarizes the consideration paid to the Harris Shareholders and the preliminary fair value allocation of the purchase price (in thousands):
Consideration paid to Harris Shareholders:
 
Cash
$
5,000

Seller provided debt
3,124

Shares of Company common stock
2,065

Contingent consideration arrangement
612

Total consideration paid
$
10,801

 
 
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
3,400

Non-competition agreement
100

Developed technology
900

Trade name and trademarks
1,900

Accounts payable
(1,519
)
Deferred tax liabilities
(2,330
)
Accrued and other liabilities
(526
)
Total identifiable net assets
6,125

Goodwill
4,676

 
$
10,801

Prior to the amendment discussed above, 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 have been required to make under the contingent consideration arrangement was between $0 and $1.0 million. The Company recorded $0.6 million for the non-employee Harris Shareholder portion of the contingent consideration liability on the acquisition date. Total contingent consideration of $0.5 million for employee Harris Shareholders will be recorded as compensation expense through the end of calendar 2014. During the three and nine months ended December 31, 2013, the Company expensed $0.2 million and $0.3 million in compensation expense, respectively.
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 agreements
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

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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.
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 $4.7 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 nine months ended December 31, 2012 and 2013, respectively, are based on the historical financial statements of the Company 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 $2.3 million recorded during the nine months ended December 31, 2013 was eliminated and the tax benefit was recorded during the nine months ended December 31, 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
 
Nine Months Ended December 31,
(dollars in thousands)
2012
 
2013
Revenue
75,893

 
80,284

Net loss (income) available to common shareholders
(8,486
)
 
123

(Loss) income per share:
 
 
 
Basic
(0.39
)
 
0.01

Diluted
(0.39
)
 
0.01

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 nine months ended December 31, 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 nine months ended December 31, 2012 and 2013, the Company had no related party transactions.
NOTE E — LONG-TERM DEBT
Long-term debt as of March 31, 2013 and December 31, 2013 consisted of the following (in thousands):
 
March 31, 2013
 
December 31, 2013
Term note
$
263

 
$
49

Harris seller's note

 
2,875

Customer equipment finance notes payable
4,408

 
2,771

First mortgage note payable
694

 
630

Debenture payable
721

 
686

Other long-term debt
620

 
428

Total long-term debt
6,706

 
7,439

Less current maturities
(2,597
)
 
(3,677
)
Long-term debt, less current maturities
$
4,109

 
$
3,762


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New Debt Arrangement
On July 1, 2013, the Company issued an unsecured and subordinated promissory note in the principal amount of $3.1 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 December 31, 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 December 31, 2013. In August 2013, the Company completed an additional amendment to extend the maturity date of the Credit Agreement to August 30, 2014, and made certain changes to the financial covenants, which are described below.
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, (iii) a debt service coverage ratio of greater than 1.25 to 1.00 as of the last day of any fiscal quarter and (iv) a funded debt to EBITDA ratio of less than 2.5 to 1.0 as of the last day of any 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 December 31, 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 met as of December 31, 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 December 31, 2013, the Company had $1.1 million outstanding under the credit agreement. The loan amount is collateralized by the OTA-related equipment and the expected future monthly payments under the supporting 37 individual OTA customer contracts. The current loan amount under the credit agreement bears interest at LIBOR plus 4% and matures in December 2016. In August 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, (ii) a debt service coverage ratio of greater than 1.25 to 1.00 as of the last day of any fiscal quarter and (iii) a funded debt to EBITDA ratio of less than 2.5 to 1.0 as of the last day of any fiscal quarter. The Company was in compliance with all covenants, as amended, in the credit agreement as of December 31, 2013.
NOTE F — INCOME TAXES
The income tax provision for the nine months ended December 31, 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 December 31, 2013, the Company recorded a decrease in its valuation allowance of $2.3

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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 adjustment considers the projected combined results and available taxable differences resulting from the Harris acquisition. As of December 31, 2013, the Company had recorded a valuation allowance of $4.7 million 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 recent positive evidence with a return to profitability, 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:
 
Nine Months Ended December 31,
 
2012
 
2013
Statutory federal tax rate
34.0
 %
 
34.0
 %
State taxes, net
2.5
 %
 
6.0
 %
Federal tax credit
2.2
 %
 
(19.4
)%
State tax credit
(0.4
)%
 
(8.0
)%
Change in valuation reserve
(98.4
)%
 
(649.4
)%
Permanent items
(1.1
)%
 
2.7
 %
Change in tax contingency reserve
0.1
 %
 
5.9
 %
Prior year permanent differences
2.4
 %
 
15.8
 %
Other, net
(0.2
)%
 
(1.1
)%
Effective income tax rate
(58.9
)%
 
(613.5
)%
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 $19,000 were recorded for the nine months ended December 31, 2013.
As of December 31, 2013, the Company had federal net operating loss carryforwards of approximately $12.8 million, of which $3.2 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 $14.5 million, of which $4.3 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 December 31, 2013, the Company has recorded a valuation allowance of $4.7 million 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 December 31, 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.

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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 nine months ended December 31, 2012 and 2013, the Company had the following unrecognized tax benefit activity (in thousands):
 
Nine Months Ended December 31,
 
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 December 31, 2012 and 2013, respectively; and $1.3 million and $1.0 million for the nine months ended December 31, 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 December 31, 2013, the Company had entered into $8.0 million of purchase commitments related to fiscal 2014, including $1.1 million for operating lease commitments and $2.9 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 nine months ended December 31, 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

Quarter Ended December 31, 2013
319

 
$6.80
 

 
$

 
$
94,300

Total as of December 31, 2013
152,419

 
$1.66 - 6.80
 
128,143

 
$
361,550

 
$
309,873

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 December 31, 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 December 31, 2013, an aggregate of 54,350 of restricted shares were granted valued at a price per share between $3.88 and $5.92, which was the closing market price as of each grant date. For the nine months ended December 31, 2013, an aggregate of 443,221 of restricted shares were granted valued at a price per share between $2.41 and $5.92, which was the closing market price as of each grant date.
For the three and nine months ended December 31, 2012, the Company issued 6,173 and 19,720 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 $1.62 per share to $2.03 per share, the closing market price as of the issuance dates. For the three and nine months ended December 31, 2013, the Company issued 6,765 and 27,891 shares under the Plans to certain non-employee directors who elected to receive stock awards in lieu of cash compensation. The shares were issued ranging from $2.41 per share to $5.73 per share, the closing market price as of the issuance dates. Additionally, during the three and nine months ended December 31,

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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.
The following amounts of stock-based compensation were recorded (in thousands):
 
Three Months Ended December 31,
 
Nine Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
Cost of product revenue
$
21

 
$
11

 
$
78

 
$
48

General and administrative
43

 
199

 
461

 
650

Sales and marketing
78

 
83

 
357

 
266

Research and development
3

 
4

 
18

 
9

Total
$
145

 
$
297

 
$
914

 
$
973

As of December 31, 2013, compensation cost related to non-vested common stock-based compensation, excluding restricted share awards, amounted to $1.8 million over a remaining weighted average expected term of 6.4 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
(27,891
)
 

 

 
 
 
 
Restricted shares
(443,221
)
 

 

 
 
 
 
Forfeited restricted shares
62,875

 

 

 
 
 
 
Forfeited stock options
405,418

 
(405,418
)
 
3.43

 
 
 
 
Exercised

 
(246,718
)
 
2.43

 
 
 
 
Balance at December 31, 2013
1,324,415

 
2,965,931

 
$
3.40

 
6.39
 
$
10,787,480

Exercisable at December 31, 2013
 
 
1,678,954

 
$
4.01

 
5.29
 
$
5,376,418

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 $6.80 as of December 31, 2013.
A summary of the status of the Company’s outstanding non-vested stock options as of December 31, 2013 was as follows:
Non-vested at March 31, 2013
1,747,805

Granted
305,544

Vested
(360,954
)
Forfeited
(405,418
)
Non-vested at December 31, 2013
1,286,977



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During the first nine months 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
443,221

Shares vested
(23,084
)
Shares forfeited
(62,875
)
Shares outstanding at December 31, 2013
462,262

Per share price on grant date
$2.41-5.92

Compensation expense for the nine months ended December 31, 2013
$
166,624

As of December 31, 2013, the amount of deferred stock-based compensation related to grants of restricted shares, to be recognized over a remaining period of 3.7 years, was approximately $1.1 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 nine months ended December 31, 2013.
A summary of outstanding warrants at December 31, 2013 follows:
 
Number of
Shares
 
Exercise Price
 
Expiration
Balance at March 31, 2013
38,980

 
$
2.25

 
Fiscal 2015
Balance at December 31, 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.

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Revenues
 
Operating Income (Loss)
 
For the Three Months Ended December 31,
 
For the Three Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
(dollars in thousands)
 
 
 
 
 
 
 
Segments:
 
 
 
 
 
 
 
Energy Management
$
19,511

 
$
20,902

 
$
1,088

 
$
966

Engineered Systems
9,576

 
6,790

 
1,059

 
1,397

Corporate and Other

 

 
(1,571
)
 
(1,453
)
 
$
29,087

 
$
27,692

 
$
576

 
$
910

 
 
 
 
 
 
 
 
 
Revenues
 
Operating Income (Loss)
 
For the Nine Months Ended December 31,
 
For the Nine Months Ended December 31,
 
2012
 
2013
 
2012
 
2013
(dollars in thousands)
 
 
 
 
 
 
 
Segments:
 
 
 
 
 
 
 
Energy Management
$
48,763

 
$
55,203

 
$
(1,123
)
 
$
2,178

Engineered Systems
15,042

 
20,836

 
2

 
2,486

Corporate and Other

 

 
(5,985
)
 
(4,375
)
 
$
63,805

 
$
76,039

 
$
(7,106
)
 
$
289

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

 
$
65,085

 
$
564

 
$
481

Engineered Systems
9,339

 
9,368

 
3,640

 
2,037

Corporate and Other
34,131

 
36,631

 

 

 
$
102,097

 
$
111,084

 
$
4,204

 
$
2,518

The Company’s revenue and long-lived assets outside the United States are insignificant.
NOTE K — SUBSEQUENT EVENTS
On January 2, 2014, the Company issued $0.6 million, or 83,943 shares, of its unregistered common stock, to satisfy an amendment to the Purchase Agreement for the acquisition of Harris Manufacturing, Inc. and Harris LED, LLC.

On January 17, 2014, the Company filed a universal shelf registration statement with the Securities and Exchange Commission. Under its shelf registration statement, the Company has the flexibility to publicly offer and sell from time to time up to $75 million of debt and/or equity securities. The filing of the shelf registration statement will help facilitate its ability to raise public equity or debt capital to expand existing businesses, fund potential acquisitions, invest in other growth opportunities, or repay existing debt.


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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 engineered, designed, sourced and manufactured energy efficient lighting systems, including fluorescent and light emitting diode, or LED, lighting solutions, and day-lighting products. The Harris acquisition has expanded our product lines, increased our sales force and provided growth opportunities into markets where we did not have 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, $3.1 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. On January 2, 2014, we issued $0.6 million in an aggregate of 83,943 unregistered shares of common stock to the Harris shareholders. We will also settle $0.8 million on January 2, 2015 in cash. Harris had revenue of approximately $14.7 million and 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 after adjusting for non-cash amortization of intangible assets acquired and purchase accounting expenses for contingent consideration and deferred compensation.
We acquired certain 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 in which we have historically recognized 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 United States 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 fiscal 2014, we recorded a $2.3 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 high intensity fluorescent, or 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 first nine months of fiscal 2014, we have been actively expanding our in-market sales force. Our in-market sales force is responsible for the development of indirect resellers within their territory, along with a continued focus on selling directly to end customers within their territory. 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.
During fiscal 2013 and the first nine months of fiscal 2014, we have experienced a significant reduction in new solar photovoltaic, or PV, orders within our Engineered Systems segment. We attribute this to reduced cash incentives and declining pricing in the renewable energy credit markets. During this period, we have deemphasized our efforts to obtain new PV construction contracts and have focused on the completion of previously received orders within our solar backlog, which has decreased from $36.1 million at the beginning of our fiscal 2013 to $2.2 million as of December 31, 2013. We expect this trend to continue through the remainder of fiscal 2014 and into fiscal 2015. In response to this solar order decline and our de-emphasis on pursuing new PV orders, we have been redeploying personnel to focus on the tremendous opportunities within the LED retrofit market. We do not have significant capital investments or long-term assets affiliated with our Orion Engineered Systems segment.
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 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 2,700,251 of our HIF and LED lighting systems in over 10,189 facilities from December 1, 2001 through December 31, 2013. We have sold our products to 165 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 nine months of fiscal 2014 continued to be adversely affected by lengthened customer sales cycles, the government shutdown, which has delayed in process projects, 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

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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 nine months of fiscal 2014, approximately 73.3% and 93.3%, respectively, of our total completed OTA contracts were financed directly through third party 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 nine months performance compared to our fiscal 2013 first nine months performance, our investments into our in-market sales force, our intentions to continue to expand our 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, 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 nine months of fiscal 2014, wholesale revenues accounted for approximately 64% of our total revenue, not taking into consideration our renewable technologies revenue generated through our Orion Engineered Systems Division, compared to 56% for the first nine months 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 nine months of fiscal 2014, we have continued the expansion of our 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

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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.
In fiscal 2013, we recognized $6.7 million of revenue from 128 completed OTA contracts. For the three months ended December 31, 2013, we recognized $1.0 million of revenue from 19 completed contracts compared to $1.5 million from 35 completed contracts during the three months ended December 31, 2012. For the nine months ended December 31, 2013, we recognized $3.4 million of revenue from 56 completed contracts compared to $4.8 million from 87 completed contracts for the nine months ended December 31, 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 nine months of fiscal 2014, we recognized $0.4 million of revenue from completed PPAs. As of December 31, 2013, we had signed one customer to two separate PPAs representing future potential discounted revenue streams of $1.9 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 December 31, 2013 (in thousands):
Fiscal 2014
$
30

Fiscal 2015
247

Fiscal 2016
247

Fiscal 2017
247

Fiscal 2018
246

Beyond
867

Total expected future discounted revenue from PPA's
$
1,884

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

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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.
Fluctuations in our revenue are predominantly caused by changes in our unit volumes. 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 37% and 47% of our total revenue for the first nine months of fiscal 2013 and fiscal 2014, respectively. One customer accounted for 10% of our total revenue in the first nine months of fiscal 2013. One customer accounted for 26% of our total revenue in the first nine months 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.
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 programs and any new products, applications and service that we may introduce; (ii) the number and timing of large retrofit and multi-facility retrofit, or “roll-out,” projects; (iii) the rate at which we expand our in-market 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; (xi) decreasing emphasis on solar PV sales and non-recurrence of prior levels or PV revenue; (xii) the rate of government spending on our products; and (xiii) 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 December 31, 2013, we had a backlog of firm purchase orders of approximately $4.1 million, which included $2.2 million of solar PV orders, compared to $13.0 million as of September 30, 2013, which included $8.9 million of solar PV orders. We currently expect approximately $2.9 million of our December 31, 2013 backlog to be recognized as revenue in our fiscal 2014 fourth quarter 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. We purchase our solar panels from multiple suppliers for sales of our solar generating systems. For the first nine months of fiscal 2013 and fiscal 2014, no supplier accounted for more than 10% 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.

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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; (ix) our mix of revenue from Harris which has historically produced lower gross margin; and (x) our level of efficiencies from our subcontracted installation service providers.
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 in-market 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 and integration 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 have been and 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 are actively trying to sell our lease related to our corporate airplane. Based upon the level of interest received to date, such a sale transaction could result in our recognizing a significant loss, which would adversely affect our reported net income. The sale of our corporate airplane would result in a reduction of annual operating expenses of $1.5 million. These aviation expenses have been allocated to sales and marketing or general and administrative, dependent upon the business purpose.
We recognize compensation expense for the fair value of our stock option and restricted stock awards granted over their related vesting period. We recognized $0.9 million and $1.0 million of compensation expense for the first nine months of fiscal 2013 and fiscal 2014, respectively. As a result of prior option and restricted stock grants, we expect to recognize an additional $2.9 million of stock-based compensation over a weighted average period of approximately five years, including $0.3 million in the last three months 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.

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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 December 31, 2013, we had net operating loss carryforwards of approximately $12.8 million for federal tax purposes and $14.5 million for state tax purposes. Included in these loss carryforwards were $3.2 million for federal and $4.3 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 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.
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 December 31,
 
 
 
Nine Months Ended December 31,
 
 
 
2012
 
2013
 
 
 
2012
 
2013
 
 
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
%
Change
 
Amount
 
% of
Revenue
 
Amount
 
% of
Revenue
 
%
Change
Product revenue
$
22,660

 
77.9
 %
 
$
22,380

 
80.8
 %
 
(1.2
)%
 
$
53,171

 
83.3
 %
 
$
61,084

 
80.3
 %
 
14.9
 %
Service revenue
6,427

 
22.1
 %
 
5,312

 
19.2
 %
 
(17.3
)%
 
10,634

 
16.7
 %
 
14,955

 
19.7
 %
 
40.6
 %
Total revenue
29,087

 
100.0
 %
 
27,692

 
100.0
 %
 
(4.8
)%
 
63,805

 
100.0
 %
 
76,039

 
100.0
 %
 
19.2
 %
Cost of product revenue
15,708

 
54.0
 %
 
15,742

 
56.9
 %
 
0.2
 %
 
37,172

 
58.3
 %
 
44,264

 
58.2
 %
 
19.1
 %
Cost of service revenue
4,798

 
16.5
 %
 
3,800

 
13.7
 %
 
(20.8
)%
 
7,874

 
12.3
 %
 
10,073

 
13.3
 %
 
27.9
 %
Total cost of revenue
20,506

 
70.5
 %
 
19,542

 
70.6
 %
 
(4.7
)%
 
45,046

 
70.6
 %
 
54,337

 
71.5
 %
 
20.6
 %
Gross profit
8,581

 
29.5
 %
 
8,150

 
29.4
 %
 
(5.0
)%
 
18,759

 
29.4
 %
 
21,702

 
28.5
 %
 
15.7
 %
General and administrative expenses
2,848

 
9.8
 %
 
3,277

 
11.8
 %
 
15.1
 %
 
10,788

 
16.9
 %
 
9,134

 
12.0
 %
 
(15.3
)%
Acquisition and integration related expenses

 
 %
 
88

 
0.3
 %
 
N/A

 

 
 %
 
519

 
0.7
 %
 
N/A

Sales and marketing expenses
4,730

 
16.3
 %
 
3,397

 
12.3
 %
 
(28.2
)%
 
13,243

 
20.7
 %
 
10,344

 
13.6
 %
 
(21.9
)%
Research and development expenses
427

 
1.4
 %
 
478

 
1.7
 %
 
11.9
 %
 
1,834

 
2.9
 %
 
1,416

 
1.8
 %
 
(22.8
)%
Income (loss) from operations
576

 
2.0
 %
 
910

 
3.3
 %
 
58.0
 %
 
(7,106
)
 
(11.1
)%
 
289

 
0.4
 %
 
(104.1
)%
Interest expense
(138
)
 
(0.5
)%
 
(123
)
 
(0.5
)%
 
(10.9
)%
 
(441
)
 
(0.7
)%
 
(378
)
 
(0.5
)%
 
(14.3
)%
Interest income
213

 
0.7
 %
 
132

 
0.5
 %
 
(38.0
)%
 
656

 
1.0
 %
 
459

 
0.6
 %
 
(30.0
)%
Income (loss) before income tax
651

 
2.2
 %
 
919

 
3.3
 %
 
41.2
 %
 
(6,891
)
 
(10.8
)%
 
370

 
0.5
 %
 
(105.4
)%
Income tax (benefit) expense

 
 %
 
(99
)
 
(0.4
)%
 
N/A

 
4,057

 
6.4
 %
 
(2,270
)
 
(3.0
)%
 
(156.0
)%
Net income (loss)
$
651

 
2.2
 %
 
$
1,018

 
3.7
 %
 
56.4
 %
 
$
(10,948
)
 
(17.2
)%
 
$
2,640

 
3.5
 %
 
(124.1
)%
Revenue. Product revenue decreased from $22.7 million for the fiscal 2013 third quarter to $22.4 million for the fiscal 2014 third quarter, a decrease of $0.3 million, or 1%. The decrease in product revenue was a result of decreased sales of solar PV systems of $1.0 million versus the fiscal 2013 third quarter. Offsetting a portion of this decline, sales of energy efficient lighting systems during the fiscal 2014 third quarter increased due to our acquisition of Harris Manufacturing, Inc. and Harris LED on July 1, 2013. Product revenue for the fiscal 2014 third quarter was negatively impacted by the government shutdown which has delayed projects by several months. Service revenue decreased from $6.4 million for the fiscal 2013 third quarter to $5.3 million for the fiscal 2014 third quarter, a decrease of $1.1 million, or 17%. The decrease in service revenue was a result of a decrease in the number of solar projects currently under construction. Total revenue from renewable energy systems was

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$6.8 million for the fiscal 2014 third quarter compared to $9.6 million for the fiscal 2013 third quarter. The decrease in revenue from renewable energy systems was due to fewer solar projects under construction as compared to several projects under construction during fiscal 2013. We expect this trend of decreasing solar PV systems revenue to continue through the remainder of fiscal 2014 and into fiscal 2015 as we continue to deemphasize our focus on pursuing new solar projects. Product revenue increased from $53.2 million for the first nine months of fiscal 2013 to $61.1 million for the first nine months of fiscal 2014, an increase of $7.9 million, or 15%. Service revenue increased from $10.6 million for the first nine months of fiscal 2013 to $15.0 million for the first nine months of fiscal 2014, an increase of $4.4 million, or 41%. Total revenue from renewable energy systems was $20.8 million for the first nine months of fiscal 2014 compared to $15.0 million for the first nine months of fiscal 2013, an increase of $5.8 million, or 39%.
Cost of Revenue and Gross Margin. Our cost of product revenue was relatively unchanged at $15.7 million for both the fiscal 2013 and fiscal 2014 third quarters. Our cost of service revenue decreased from $4.8 million for the fiscal 2013 third quarter to $3.8 million for the fiscal 2014 third quarter, a decrease of $1.0 million, or 21%. Total gross margin decreased from 29.5% for the fiscal 2013 third quarter to 29.4% for the fiscal 2014 third quarter. Our gross margin on renewable revenue was 34.6% during the fiscal 2014 third quarter compared to 23.7% during the fiscal 2013 third quarter. Our gross margins from renewable solar PV projects were positively impacted by favorable product costs on our solar landfill project and by the completion of higher margin service projects. Gross margin from sales of our integrated lighting systems for the fiscal 2014 third quarter was 27.8% compared to 32.3% for the fiscal 2013 third quarter. Our gross margin was unfavorably impacted by severance expenses related to the reduction of Harris' workforce as we transitioned Harris' production to our Manitowoc operations and the addition of Harris, which has historically produced gross margins in the mid-20 percent range. Our cost of product revenue increased from $37.2 million for the first nine months of fiscal 2013 to $44.3 million for the first nine months of fiscal 2014, an increase of $7.1 million, or 19%. Our cost of service revenue increased from $7.9 million for the first nine months of fiscal 2013 to $10.1 million for the first nine months of fiscal 2014, an increase of $2.2 million, or 28%. Total gross margin decreased from 29.4% for the first nine months of fiscal 2013 to 28.5% for the first nine months of fiscal 2014. For the fiscal 2014 first nine months, 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 26.4% during the fiscal 2013 first nine months compared to 25.8% during the fiscal 2014 first nine months. Gross margin from our HIF and LED integrated systems revenue for the fiscal 2013 first nine months was 30.3% compared to 29.6% during the fiscal 2014 first nine months.
General and Administrative. Our general and administrative expenses increased from $2.8 million for the fiscal 2013 third quarter to $3.3 million for the fiscal 2014 third quarter, an increase of $0.5 million, or 15%. The increase was due to the acquisition of Harris and incremental expenses of $0.2 million, which included compensation expense related to the initial earn-out attributed to Harris shareholders who became Orion employees, intangible amortization expense of $0.1 million as a result of the acquisition of Harris and $0.2 million in increased stock compensation expenses. These increases were partially offset by decreased legal expenses and other discretionary spending reductions during the quarter. Our general and administrative expenses decreased from $10.8 million for the first nine months of fiscal 2013 to $9.1 million for the first nine months of fiscal 2014, a decrease of $1.7 million, or 15%. The decrease for the first nine months was due to prior year expenses of $1.2 million resulting from our reorganization, $0.5 million in reduced compensation and benefit expenses resulting from headcount reductions, $0.2 million in reduced legal expenses and $0.2 million in other reductions in discretionary spending. These increases were partially offset by increased insurance expenses of $0.2 million and $0.2 million for the amortization of intangible assets resulting from the acquisition of Harris.
Acquisition and Integration Related. Our Harris acquisition and integration related expenses were $0.1 million for the fiscal 2014 third quarter and $0.5 million for the first nine months of fiscal 2014. We incurred no acquisition and integration expenses in the first nine months 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 mark-to-market purchase accounting expenses related to the contingent consideration earn-out for the acquisition of Harris and $0.2 million for legal, accounting and integration related costs.
Sales and Marketing. Our sales and marketing expenses decreased from $4.7 million for the fiscal 2013 third quarter to $3.4 million for the fiscal 2014 third quarter, a decrease of $1.3 million, or 28%. The decrease was due to a $0.6 million reduction in bad debt expense on uncollectable receivables, reduced compensation and benefit expense of $0.4 million resulting from our headcount reductions and discretionary spending reductions of $0.7 million, offset by $0.4 million in incremental expenses resulting from the acquisition of Harris. Our sales and marketing expenses decreased from $13.2 million for the first nine months of fiscal 2013 to $10.3 million for the first nine months of fiscal 2014, a decrease of $2.9 million, or 22%. The decrease was due to reduced compensation and benefit expense of $1.4 million resulting from headcount reductions, reduced bad debt expense of $0.6 million, reorganization expenses incurred in fiscal 2013 of $0.3 million and discretionary spending reductions of $1.5 million, offset by an increase in our sales commission expense of $0.1 million resulting from the revenue increase and incremental expenses of $0.8 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 96 and 87 at December 31, 2012 and 2013, respectively.

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Research and Development. Our research and development expenses, or R&D, increased from $0.4 million for the fiscal 2013 third quarter to $0.5 million for the fiscal 2014 third quarter, an increase of $0.1 million, or 12%. Our R&D expenses decreased from $1.8 million for the first nine months of fiscal 2013 to $1.4 million for the first nine months of fiscal 2014, a decrease of $0.4 million, or 23%. Our R&D expenses decreased during the first nine months 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 decreased from $138,000 for the fiscal 2013 third quarter to $123,000 for the fiscal 2014 third quarter, a decrease of $15,000, or 11%. Our interest expense decreased from $441,000 for the first nine months of fiscal 2013 to $378,000 for the first nine months of fiscal 2014, a decrease of $63,000, or 14%. The decrease in interest expense was due to the reduction in financed contract debt compared to the prior year first nine months.
Interest Income. Our interest income decreased from $213,000 for the fiscal 2013 third quarter to $132,000 for the fiscal 2014 third quarter, a decrease of $81,000, or 38%. Our interest income decreased from $656,000 for the first nine months of fiscal 2013 to $459,000 for the first nine months of fiscal 2014, a decrease of $197,000, or 30%. 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 benefit increased from income tax expense of $0.0 million for the fiscal 2013 third quarter to an income tax benefit of $0.1 million for the fiscal 2014 third quarter. Our income tax expense decreased from income tax expense of $4.1 million for the first nine months of fiscal 2013 to an income tax benefit of $2.3 million for the first nine months of fiscal 2014, a decrease of $6.4 million, or 156%. During our fiscal 2013 first nine months, 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 nine months, we reversed $2.3 million of our valuation reserve to offset deferred tax liabilities resulting from our acquisition of Harris. Our effective income tax rate for the first nine months of fiscal 2013 was 58.9%, compared to a benefit rate of 613.5% for the first nine months 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 December 31,
 
For the Nine Months Ended December 31,
(dollars in thousands)
2012
 
2013
 
2012
 
2013
Revenues
$
19,511

 
$
20,902

 
$
48,763

 
$
55,203

Operating income (loss)
$
1,088

 
$