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AMERESCO, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2013 included in our Annual Report on Form 10-K for the year ended December 31, 2013 filed on March 17, 2014 with the U.S. Securities and Exchange Commission ("SEC"). This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All statements, other than statements of historical fact, including statements that refer to projections regarding our future financial performance, our anticipated growth and trends in our businesses, our future capital needs and capital expenditures; our future market position and competitive changes in the marketplace for our services; our ability to integrate new technologies into our services; our ability to access credit or capital markets; our reliance on subcontractors; potential acquisitions or divestitures; the continued availability of key personnel; and other characterizations of future events or circumstances are forward-looking statements. These statements are often, but not exclusively, identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," "target," "project," "predict" or "continue," and similar expressions or variations. These forward-looking statements are based on current expectations and assumptions that are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially and adversely from future results expressed or implied by such forward-looking statements. Risks, uncertainties and factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled "Risk Factors," set forth in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013 and elsewhere in this Report. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. Subsequent events and developments may cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we undertake no obligation to do so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q. Overview Ameresco is a leading provider of energy efficiency solutions for facilities throughout North America. We provide solutions that enable customers to reduce their energy consumption, lower their operating and maintenance costs and realize environmental benefits. Our comprehensive set of services includes upgrades to a facility's energy infrastructure and the construction and operation of small-scale renewable energy plants. In addition to organic growth, strategic acquisitions of complementary businesses and assets have been an important part of our historical development. Since inception, we have completed numerous acquisitions, which have enabled us to broaden our service offerings and expand our geographical reach. Our acquisition of the energy services business of Duke Energy in 2002 expanded our geographical reach into Canada and the southeastern United States and enabled us to penetrate the Federal Government market for energy efficiency projects. The acquisition of the energy services business of Exelon in 2004 expanded our geographical reach into the Midwest. Our acquisition of the energy services business of Northeast Utilities in 2006 substantially grew our capability to provide services for the Federal market and in Europe. Our acquisition of Southwestern Photovoltaic in 2007 significantly expanded our offering of solar energy products and services. Our acquisition of energy services company Quantum in 2010 expanded our geographical reach into the northwest U.S. We made three acquisitions in 2011. Our acquisition of energy efficiency and demand side management consulting services provider Applied Energy Group, Inc. ("AEG"), expanded our service offering to utility customers. Our acquisition of APS Energy Services Company, Inc., which we renamed Ameresco Southwest, a company that provides a full range of integrated energy efficiency and renewable energy solutions, strengthened our geographical position in the southwest U.S. Our acquisition of the xChangePoint® and energy projects businesses from Energy and Power Solutions, Inc. ("EPS"), which we operate as Ameresco Intelligent Systems ("AIS"), expanded our service offerings to private sector commercial and industrial customers. AIS offers energy efficiency solutions to customers across North America encompassing the food and beverage, meat, dairy, paper, aerospace, oil and gas and REIT industries. Our acquisition of infrastructure asset management solutions provider FAME Facility Software Solutions Inc. ("FAME") in 2012 expanded our asset planning consulting and software services offerings and our geographical position in western Canada. 24-------------------------------------------------------------------------------- Table of Contents Our acquisition of the business of Ennovate Corporation in the first quarter of 2013 increased our footprint and penetration in the Rocky Mountain area. Our acquisition of energy management consulting companies The Energy Services Partnership Limited (now known as Ameresco Limited) and ESP Response Limited (together "ESP") in the second quarter of 2013 added a local presence in the United Kingdom ("UK"), expertise and seasoned energy industry professionals to support multi-national customers of our enterprise energy management service offerings. Our acquisition of the energy consultancy and energy project management business of Energyexcel LLP in the third quarter of 2014 added to our local presence in the UK and to our commercial and industrial customer base. Effects of Seasonality We are subject to seasonal fluctuations and construction cycles, particularly in climates that experience colder weather during the winter months, such as the northern United States and Canada, or at educational institutions, where large projects are typically carried out during summer months when their facilities are unoccupied. In addition, Government customers, many of which have fiscal years that do not coincide with ours, typically follow annual procurement cycles and appropriate funds on a fiscal-year basis even though contract performance may take more than one year. Further, Government contracting cycles can be affected by the timing of, and delays in, the legislative process related to Government programs and incentives that help drive demand for energy efficiency and renewable energy projects. As a result, our revenue and operating income in the third quarter are typically higher, and our revenue and operating income in the first quarter are typically lower, than in other quarters of the year. As a result of such fluctuations, we may occasionally experience declines in revenue or earnings as compared to the immediately preceding quarter, and comparisons of our operating results on a period-to-period basis may not be meaningful. Our annual and quarterly financial results are also subject to significant fluctuations as a result of other factors, many of which are outside our control. See "Our business is affected by seasonal trends and construction cycles, and these trends and cycles could have an adverse effect on our operating results" in Item 1A, Risk Factors in our Annual Report on Form 10-K. Backlog and Awarded Projects Total construction backlog represents projects that are active within our ESPC sales cycle. Our sales cycle begins with the initial contact with the customer and ends, when successful, with a signed contract, also referred to as fully-contracted backlog. Our sales cycle recently has been averaging 18 to 42 months. Awarded backlog is created when a potential customer awards a project to Ameresco following a request for proposal. Once a project is awarded but not yet contracted, we typically conduct a detailed energy audit to determine the scope of the project as well as identify the savings that may be expected to be generated from upgrading the customer's energy infrastructure. At this point, we also determine the sub-contractor, what equipment will be used, and assist in arranging for third party financing, as applicable. Recently, awarded projects have been taking 12 to 18 months to result in a signed contract and thus convert to fully-contracted backlog. It may take longer, however, depending upon the size and complexity of the project. Historically, approximately 90% of our awarded projects ultimately have resulted in a signed contract. After the customer and Ameresco agree to the terms of the contract and the contract becomes executed, the project moves to fully-contracted backlog. The contracts reflected in our fully-contracted backlog typically have a construction period of 12 to 24 months and we typically expect to recognize revenues for such contracts over the same period. Fully-contracted backlog begins converting into revenues generated from backlog on a percentage-of-completion basis once construction has commenced. See "We may not recognize all revenues from our backlog or receive all payments anticipated under awarded projects and customer contracts" and "In order to secure contracts for new projects, we typically face a long and variable selling cycle that requires significant resource commitments and requires a long lead time before we realize revenues" in Item 1A, Risk Factors in our Annual Report on Form 10-K. As of September 30, 2014, we had backlog of approximately $400.6 million in expected future revenues under signed customer contracts for the installation or construction of projects, which we sometimes refer to as fully-contracted backlog; and we also had been awarded projects for which we do not yet have signed customer contracts with estimated total future revenues of an additional $1,037.1 million. As of September 30, 2013, we had fully-contracted backlog of approximately $366.0 million in expected future revenues under signed customer contracts for the installation or construction of projects; and we also had been awarded projects for which we had not yet signed customer contracts with estimated total future revenues of an additional $1,041.7 million. Critical Accounting Policies and Estimates This discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of these condensed consolidated financial statements requires management to make 25-------------------------------------------------------------------------------- Table of Contents estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense and related disclosures. The most significant estimates with regard to these condensed consolidated financial statements relate to estimates of final contract profit in accordance with long-term contracts, project development costs, project assets, impairment of goodwill, impairment of long-lived assets, fair value of derivative financial instruments, income taxes and stock-based compensation expense. Such estimates and assumptions are based on historical experience and on various other factors that management believes to be reasonable under the circumstances. Estimates and assumptions are made on an ongoing basis, and accordingly, the actual results may differ from these estimates. The following, in no particular order, are certain critical accounting policies that among others, affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements: • Revenue Recognition; • Project Assets; • Derivative Financial Instruments; and • Variable Interest Entities. Further details regarding our critical accounting policies and estimates can be found in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K. In addition, please refer to Note 2, "Summary of Significant Accounting Policies," of our Notes to Condensed Consolidated Financial Statements included under Part I, Item 1 of this Quarterly Report on Form 10-Q. Management has determined that no material changes concerning our critical accounting policies have occurred since December 31, 2013. Non-GAAP Financial Measures We use the non-GAAP financial measures defined and discussed below to provide investors and others with useful supplemental information to our financial results prepared in accordance with GAAP. These non-GAAP financial measures should not be considered as an alternative to any measure of financial performance calculated and presented in accordance with GAAP. The tables below provide a reconciliation of these non-GAAP measures to the most directly comparable financial measures prepared in accordance with GAAP. We understand that, although measures similar to these non-GAAP financial measures are frequently used by investors and securities analysts in their evaluation of companies, they have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for the most directly comparable GAAP financial measures or an analysis of our results of operations as reported under GAAP. To properly and prudently evaluate our business, we encourage investors to review our GAAP financial statements included above, and not to rely on any single financial measure to evaluate our business. Adjusted EBITDA We define adjusted EBITDA as operating income (loss) before depreciation, amortization of intangible assets, impairment of goodwill and stock-based compensation expense. We believe adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons: adjusted EBITDA and similar non-GAAP measures are widely used by investors to measure a company's operating performance without regard to items that can vary substantially from company to company depending upon financing and accounting methods, book values of assets, capital structures and the methods by which assets were acquired; securities analysts often use adjusted EBITDA and similar non-GAAP measures as supplemental measures to evaluate the overall operating performance of companies; and by comparing our adjusted EBITDA in different historical periods, investors can evaluate our operating results without the additional variations of depreciation and amortization expense, goodwill impairment and stock-based compensation expense. Our management uses adjusted EBITDA: as a measure of operating performance, because it does not include the impact of items that we do not consider indicative of our core operating performance; for planning purposes, including the preparation of our annual operating budget; to allocate resources to enhance the financial performance of the business; to evaluate the effectiveness of our business strategies; and in communications with the board of directors and investors concerning our financial performance. 26-------------------------------------------------------------------------------- Table of Contents Adjusted Free Cash Flow We define adjusted free cash flow as cash flows from operating activities, less purchases of property and equipment, plus proceeds from Federal ESPC projects. Cash received in payment of Federal ESPC projects is treated as a financing cash flow under GAAP due to the unusual financing structure for these projects. These cash flows, however, correspond to the revenues generated by these projects. Thus we believe that adjusting operating cash flow to include the cash generated by our Federal ESPC projects and to give effect for purchases of property and equipment provides investors with a useful measure for evaluating the cash generating ability of our core operating business. Our management uses adjusted free cash flow as a measure of liquidity because it captures all sources of cash associated with our revenues generated by operations. Reconciliations The following table presents a reconciliation of adjusted EBITDA to operating income, the most comparable GAAP measure (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 Operating income $ 9,224 $ 7,581 $ 6,221 $ 3,590 Depreciation and amortization of intangible assets 5,938 5,227 16,923 15,505 Stock-based compensation 683 789 2,108 2,125 Adjusted EBITDA $ 15,845 $ 13,597 $ 25,252 $ 21,220 The following table presents a reconciliation of adjusted free cash flow to cash flows from operating activities, the most comparable GAAP measure (in thousands): Nine Months Ended September 30, 2014 2013 (Revised)Cash flows from operating activities $ (12,093 ) $ (45,313 ) Less: purchases of property and equipment (1,553 ) (2,331 ) Plus: proceeds from Federal ESPC projects 32,886 21,383 Adjusted free cash flow $ 19,240 $ (26,261 ) Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606). The guidance in this ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance in this ASU supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. Additionally, this ASU supersedes some cost guidance included in ASC 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer are amended to be consistent with the guidance on recognition and measurement in this ASU. For a public entity, the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Retrospective application of the amendments in this ASU are required. The new guidance must be adopted using either a full retrospective approach for all periods presented in the period of adoption (with some limited relief provided) or a modified retrospective approach. Early application is not permitted under GAAP. We are currently assessing the impact of this ASU on our consolidated financial statements. In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40) ("ASU 2014-15"). ASU 2014-15 requires management to assess an entity's ability to continue as a going concern by incorporating and expanding upon certain principles of current U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term 'substantial doubt", (2) require an evaluation every reporting period, including interim periods, (3) provide principles for considering the mitigating effect of management's plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management's plans, (5) require an express statement and other disclosures when substantial doubt is still present, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). ASU 2014-15 is effective for annual reporting periods ending after 27-------------------------------------------------------------------------------- Table of Contents December 15, 2016 and interim periods thereafter. We do not believe that this pronouncement will have an impact on our consolidated financial statements. Results of Operations The following tables set forth certain financial data from the consolidated statements of income (loss) expressed as a percentage of revenues for the periods presented (in thousands): Three Months Ended September 30, 2014 2013 Dollar % of Dollar % of Amount Revenues Amount Revenues Revenues $ 168,891 100.0 % $ 161,648 100.0 % Cost of revenues 133,867 79.3 % 131,585 81.4 % Gross profit 35,024 20.7 % 30,063 18.6 % Selling, general and administrative expenses 25,800 15.3 % 22,482 13.9 % Operating income 9,224 5.5 % 7,581 4.7 % Other expenses, net 2,465 1.5 % 1,588 1.0 % Income before (benefit) provision for income taxes 6,759 4.0 % 5,993 3.7 % Income tax (benefit) provision (532 ) (0.3 )% 1,448 0.9 % Net income $ 7,291 4.3 % $ 4,545 2.8 % Nine Months Ended September 30, 2014 2013 Dollar % of Dollar % of Amount Revenues Amount Revenues Revenues $ 412,180 100.0 % $ 398,037 100.0 % Cost of revenues 331,666 80.5 % 323,072 81.2 % Gross profit 80,514 19.5 % 74,965 18.8 % Selling, general and administrative expenses 74,293 18.0 % 71,375 17.9 % Operating income 6,221 1.5 % 3,590 0.9 % Other expenses, net 4,993 1.2 % 2,502 0.6 % Income before (benefit) provision for income taxes 1,228 0.3 % 1,088 0.3 % Income tax (benefit) provision (501 ) (0.1 )% 248 0.1 % Net income $ 1,729 0.4 % $ 840 0.2 % RevenuesThe following tables set forth a comparison of our revenues for the periods presented (in thousands): Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 168,891 $ 161,648 $ 7,243 4.5 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 412,180 $ 398,037 $ 14,143 3.6 % Revenues increased $7.2 million, or 4.5%, for the three months ended September 30, 2014 compared to the same period of 2013 due to a $7.1 million increase in revenues from our Federal segment, a $1.9 million increase in revenues from our Canada segment, a $4.2 million increase in revenues from our Small-Scale Infrastructure segment and $4.7 million in revenues as a result of our current year acquisitions. These increases were partially offset by a $10.8 million decrease in revenues from our U.S. Regions segment. 28-------------------------------------------------------------------------------- Table of Contents Revenues increased $14.1 million, or 3.6%, for the nine months ended September 30, 2014 compared to the same period of 2013 due to a $17.5 million increase in revenues from our Federal segment, an $8.2 million increase in revenues from our Canada segment, a $9.0 million increase in revenues from our Small-Scale Infrastructure segment, a $5.2 million increase in revenues from enterprise energy management services and integrated-PV sales and $5.0 million as a result of our current year acquisitions. These increases were partially offset by a $29.8 million decrease in revenues from our U.S. Regions segment. We derive a majority of our revenue from energy efficiency products and services, which accounted for approximately 72.2% and 66.3% of revenues for the nine months ended September 30, 2014 and 2013, respectively. Cost of Revenues and Gross Profit The following tables set forth a comparison of our cost of revenues and gross profit for the periods presented (in thousands): Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Cost of revenues $ 133,867 $ 131,585 $ 2,282 1.7 % Gross margin % 20.7 % 18.6 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Cost of revenues $ 331,666 $ 323,072 $ 8,594 2.7 % Gross margin % 19.5 % 18.8 % Cost of revenues increased $2.3 million, or 1.7%, for the three months ended September 30, 2014 compared to the same period of 2013 primarily due to the increase in revenues described above, partially offset by a favorable mix of higher margin projects. Cost of revenues increased $8.6 million, or 2.7%, for the nine months ended September 30, 2014 compared to the same period of 2013 primarily due to the increase in revenues described above as well as higher fuel and operating costs, at our Savannah River Site ("SRS"), due to weather related issues during the first quarter of 2014, partially offset by a $1.0 million recovery during the second quarter of 2014 related to a customer warranty issue and a favorable mix of higher margin projects. The majority of our cost of revenues are incurred in connection with energy efficiency projects for which expenditures represented approximately 81.3% and 81.0% of corresponding revenue for the nine months ended September 30, 2014 and 2013, respectively. As a result of certain acquisitions, we have intangible assets related to customer contracts; these are amortized over a period of approximately one to five years from the respective date of acquisition. This amortization is recorded as a cost of revenues in the consolidated statements of income (loss). For the three months ended September 30, 2014 and 2013, we recorded amortization expense of $0.5 million and $0.5 million, respectively, related to customer contracts. For the nine months ended September 30, 2014 and 2013, we recorded amortization expense of $1.1 million and $1.0 million, respectively, related to customer contracts. Selling, General and Administrative Expenses The following tables set forth a comparison of our selling, general and administrative expenses for the periods presented (in thousands): Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Selling, general and administrative expenses $ 25,800 $ 22,482 $ 3,318 14.8 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Selling, general and administrative expenses $ 74,293 $ 71,375 $ 2,918 4.1 % Selling, general and administrative expenses increased $3.3 million, or 14.8%, for the three months ended September 30, 2014 compared to the same period of 2013 primarily due to increases in project development costs and an increase in expenses, including salaries and benefits, as a result of acquisitions. The three months ended September 30, 2013 also included a gain on a project termination, which reduced selling, general and administrative expenses for the period. Selling, general and 29-------------------------------------------------------------------------------- Table of Contents administrative expenses increased $2.9 million, or 4.1%, for the nine months ended September 30, 2014 compared to the same period of 2013 primarily due to the third quarter changes described above as well as severance charges recognized during the first quarter of 2014, partially offset by decreases in marketing, travel and professional fees as well as a decrease in salary and benefits, excluding acquisitions. Amortization expense of intangible assets related to customer relationships, non-compete agreements, technology and trade names is included in selling, general and administrative expenses in the consolidated statements of income (loss). For the three months ended September 30, 2014 and 2013, we recorded amortization expense, related to these intangible assets, of $0.9 million and $1.0 million, respectively. For the nine months ended September 30, 2014 and 2013, we recorded amortization expense, related to these intangible assets, of $2.1 million and $2.3 million, respectively. Other Expenses, Net Other expenses, net includes gains and losses from derivatives, interest income and expenses, amortization of deferred financing costs, net and foreign currency transaction gains and losses. Other expenses, net, increased $0.9 million for the three months ended September 30, 2014 compared to the same period of 2013 primarily due to foreign currency exchange losses. Other expenses, net, increased $2.5 million for the nine months ended September 30, 2014 compared to the same period of 2013 primarily due to foreign currency exchange losses and a $1.2 million increase in interest expense, net of interest income. The increase in interest expense for the nine months ended September 30, 2014 was primarily due to a $0.9 million decrease in interest capitalized relating to construction financing and an increase in interest related to the conversion to term loans on our construction-to-term loan credit facility during the second half of 2013 and first half of 2014. Income (Loss) Before Taxes Income before taxes increased $0.8 million, or 12.8%, to $6.8 million for the three months ended September 30, 2014 from $6.0 million for the three months ended September 30, 2013 due to the reasons described above. Income before taxes increased $0.1 million, or 12.9%, to $1.2 million for the nine months ended September 30, 2014 from $1.1 million for the nine months ended September 30, 2013 due to the reasons described above. Provision (Benefit) from Income Taxes The benefit for income taxes was $0.5 million for the three months ended September 30, 2014, compared to a provision of $1.4 million for the three months ended September 30, 2013. The benefit for income taxes was $0.5 million for the the nine months ended September 30, 2014, compared to a provision of $0.2 million for the nine months ended September 30, 2013. The estimated annual effective tax rate applied for the three months ended September 30, 2014 was (7.9)% compared to 24.1% for the three months ended September 30, 2013 and was (40.8)% for the nine months ended September 30, 2014 compared to 22.8% for the nine months ended September 30, 2013, respectively. The decrease in the rate compared to the same periods in the prior year was due to investment tax credits on energy efficiency projects placed or expected to be placed in service in 2014 as compared to deductions allowed under Section 179D of the Internal Revenue Code in 2013. The principal reason for the difference between the statutory rate and the estimated annual effective rate for 2014 were the effects of investment tax credits and production tax credits to which we are entitled from plants we own. The principal reasons for the difference between the statutory rate and the estimated annual effective rate for 2013 were the effects of deductions permitted under Section 179D in 2013, which relate to the installation of certain energy efficiency equipment in Federal, state, provincial and local government-owned buildings, as well as tax credits to which we are entitled from plants we own. Net Income (Loss) and Earnings (Loss) Per Share Net income increased $2.7 million, or 60.4%, for the three months ended September 30, 2014 to $7.3 million from $4.5 million for the three months ended September 30, 2013 due to the reasons described above. Net income increased $0.9 million, or 105.8%, for the nine months ended September 30, 2014 to $1.7 million from $0.8 million for the nine months ended September 30, 2013 due to the reasons described above. Basic and diluted earnings per share for the three months ended September 30, 2014 were $0.16 per share, an increase of $0.06 per share, or 60.0%, compared to the same period of 2013. Basic and diluted earnings per share for the nine months ended September 30, 2014 were $0.04 per share, an increase of $0.02 per share, or 100.0%, compared to the same period of 2013. 30-------------------------------------------------------------------------------- Table of Contents Business Segment Analysis (in thousands) Our reportable segments are U.S. Regions, U.S. Federal, Canada and Small-Scale Infrastructure. Our U.S. Regions, U.S. Federal and Canada segments offer energy efficiency products and services, which include the design, engineering and installation of equipment and other measures to improve the efficiency and control the operation of a facility's energy infrastructure; renewable energy products and services, which include the construction of small-scale plants for customers that produce electricity, gas, heat or cooling from renewable sources of energy; and O&M services. Our Small-Scale Infrastructure segment sells electricity, processed LFG, heat or cooling produced from renewable sources of energy from small-scale plants that we own. The "All Other" category offers enterprise energy management services, consulting services and the sale and installation of solar PV energy products and systems. These segments do not include results of other activities, such as corporate operating expenses not specifically allocated to the segments. U.S. Regions Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 80,503 $ 91,334 $ (10,831 ) (11.9 )% Income before taxes $ 8,199 $ 10,079 $ (1,880 ) (18.7 )% Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 184,294 $ 214,132 $ (29,838 ) (13.9 )% Income before taxes $ 14,801 $ 16,870 $ (2,069 ) (12.3 )% Revenues for the U.S. Regions segment decreased for the three months ended September 30, 2014 compared to the same period of 2013 by $10.8 million, or 11.9%, to $80.5 million and decreased for the nine months ended September 30, 2014 compared to the same period of 2013 by $29.8 million, or 13.9%, to $184.3 million primarily due to a decrease in revenues from the construction of small-scale renewable energy plants for customers and the timing of revenue recognized as a result of the phase of active projects. Income before taxes for the U.S. Regions segment decreased for the three months ended September 30, 2014 compared to the same period of 2013 by $1.9 million, or 18.7%, to $8.2 million. The decrease was primarily due to the decrease in revenues described above, partially offset by a favorable mix of higher margin projects. Income before taxes for the U.S. Regions segment decreased for the nine months ended September 30, 2014 compared to the same period of 2013 by $2.1 million, or 12.3%, to $14.8 million. The decrease was primarily due to the decrease in revenues, partially offset by the recovery on a customer warranty issue described above. U.S. Federal Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 26,233 $ 19,118 $ 7,115 37.2 % Income before taxes $ 4,222 $ 1,971 $ 2,251 114.2 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 62,374 $ 44,826 $ 17,548 39.1 % Income before taxes $ 6,487 $ 1,851 $ 4,636 250.5 % Revenues for the U.S. Federal segment increased for the three months ended September 30, 2014 compared to the same period of 2013 by $7.1 million, or 37.2%, to $26.2 million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $17.5 million, or 39.1%, to $62.4 million due to two large new energy efficiency projects for which revenue began to be recognized during the second quarter of 2014. Income before taxes for the U.S. Federal segment increased for the three months ended September 30, 2014 compared to the same period of 2013 by $2.3 million to $4.2 million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $4.6 million to $6.5 million. The increases were primarily due to the increase in revenues described above. 31-------------------------------------------------------------------------------- Table of Contents Canada Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 21,976 $ 20,060 $ 1,916 9.6 % Loss before taxes $ (318 ) $ (127 ) $ (191 ) 150.4 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 58,043 $ 49,845 $ 8,198 16.4 % Loss before taxes $ (3,387 ) $ (2,061 ) $ (1,326 ) 64.3 % Revenues for the Canada segment increased for the three months ended September 30, 2014 compared to the same period of 2013 by $1.9 million, or 9.6%, to $22.0 million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $8.2 million, or 16.4%, to $58.0 million, primarily due to the timing of revenue recognized as a result of the phase of active projects, including several new projects. Loss before taxes for the Canada segment increased for the three months ended September 30, 2014 compared to the same period of 2013 by $0.2 million to a loss of $0.3 million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $1.3 million, or 64.3%, to a loss of $3.4 million. The increase in the losses was primarily due to an unfavorable mix of lower margin projects. Small-Scale Infrastructure Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 13,954 $ 9,750 $ 4,204 43.1 % Income before taxes $ 1,372 $ 78 $ 1,294 1,659.0 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 39,309 $ 30,324 $ 8,985 29.6 % Income before taxes $ 5,187 $ 2,705 $ 2,482 91.8 % Revenues for the Small-Scale Infrastructure segment increased for the three months ended September 30, 2014 compared to the same period of 2013 by $4.2 million, or 43.1%, to $14.0 million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $9.0 million, or 29.6%, to $39.3 million primarily due to an increase in the number of plants fully operational during the nine months ended September 30, 2014, as compared to the same period of 2013. Income before taxes for the Small-Scale Infrastructure segment increased for the three months ended September 30, 2014 compared to the same period of 2013 by $1.3 million to $1.4 million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $2.5 million, or 91.8%, to $5.2 million. The increases were primarily due to the increase in revenues described above. 32-------------------------------------------------------------------------------- Table of Contents All Other & Unallocated Corporate Activity Three Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 26,225 $ 21,386 $ 4,839 22.6 % Income (loss) before taxes $ 128 $ (497 ) $ 625 125.8 % Unallocated corporate activity $ (6,844 ) $ (5,511 ) $ (1,333 ) 24.2 % Nine Months Ended September 30, Dollar Percentage 2014 2013 Change Change Revenues $ 68,160 $ 58,910 $ 9,250 15.7 % Loss before taxes $ (13 ) $ (141 ) $ 128 90.8 %Unallocated corporate activity $ (21,847 ) $ (18,136 ) $ (3,711 ) 20.5 % Revenues not allocated to segments and presented as all other increased for the three months ended September 30, 2014 compared to the same period of 2013 by $4.8 million, or 22.6%, to $26.2 million primarily due to our current year acquisitions. Revenues not allocated to segments and presented as all other increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $9.3 million, or 15.7%, to $68.2 million primarily due to increases in integrated-PV sales and acquisitions. Income before taxes not allocated to segments and presented as all other increased by $0.6 million to $0.1 million for the three months ended September 30, 2014 compared to the same period of 2013 primarily due to the increase in revenues described above, partially offset by increased acquisition related costs, including contingent consideration recognized as compensation for post-combination services and amortization of acquired intangible assets. Loss before taxes not allocated to segments and presented as all other decreased for the nine months ended September 30, 2014 compared to the same period of 2013 by $0.1 million to a loss of $0.0 million primarily due an increase in acquisition related selling, general and administrative expenses, depreciation expense and amortization of acquired intangible assets, partially offset by, the increase in revenues described above. Unallocated corporate activity includes all corporate level selling, general and administrative expenses and other expenses not allocated to the segments. We do not allocate any indirect expenses to the segments. Unallocated corporate activity increased for the three months ended September 30, 2014 compared to the same period of 2013 by $1.3 million, or 24.2%, to $(6.8) million and increased for the nine months ended September 30, 2014 compared to the same period of 2013 by $3.7 million, or 20.5%, to $(21.8) million primarily due to an increase in acquisition related professional fees, a decrease in interest capitalized during the construction of project assets and an increase in salary and benefits expense, including severance charges realized during the first quarter of 2014. Liquidity and Capital Resources Sources of liquidity. Since inception, we have funded operations primarily through cash flow from operations, advances from Federal ESPC projects and various forms of debt. We believe that available cash and cash equivalents and availability under our revolving senior secured credit facility, combined with our access to credit markets, will be sufficient to fund our operations through 2014 and thereafter. Proceeds from our Federal ESPC projects are generally received through agreements to sell the ESPC receivables related to certain ESPC contracts to third-party investors. We use the advances from the investors under these agreements to finance the projects. Until recourse to us ceases for the ESPC receivables transferred to the investor, upon final acceptance of the work by the Government customer, we are the primary obligor for financing received. The transfers of receivables under these agreements do not qualify for sales accounting until final customer acceptance of the work, so the advances from the investors are not classified as operating cash flows. Cash draws that we receive under these ESPC agreements are recorded as financing cash inflows. The use of the cash received under these arrangements to pay project costs is classified as operating cash flows. Due to the manner in which the ESPC contracts with the third-party investors are structured, our reported operating cash flows are materially impacted by the fact that operating cash flows only reflect the ESPC contract expenditure outflows and do not reflect any inflows from the corresponding contract revenues. Upon acceptance of the project by the Federal customer the ESPC receivable and corresponding ESPC liability are removed from our consolidated balance sheet as a non-cash settlement. 33-------------------------------------------------------------------------------- Table of Contents See Note 2 to our Notes to Condensed Consolidated Financial Statements under Part I, Item 1 of this Quarterly Report on Form 10-Q. As a result of the structure of the Federal ESPC project arrangements management uses adjusted free cash flows, as previously defined, as a measure of liquidity because it captures all sources of cash associated with our revenues generated by operations. Adjusted free cash flows for the nine months ended September 30, 2014 and 2013 were $19.2 million and $(26.3) million, respectively. Our service offering also includes the development, construction and operation of small-scale renewable energy plants. Small-scale renewable energy projects, or project assets, can either be developed for the portfolio of assets that we own and operate or designed and built for customers. Expenditures related to projects that we own are recorded as cash outflows from investing activities. Expenditures related to projects that we build for customers are recorded as cash outflows from operating activities as cost of revenues. The amount of interest capitalized relating to construction financing during the period of construction for the nine months ended September 30, 2014 and 2013 was $0.4 million and $1.3 million, respectively. Cash flows from operating activities. Operating activities used $12.1 million of net cash during the nine months ended September 30, 2014. During that period, we had net income of 1.7 million, which is net of non-cash compensation, depreciation, amortization, deferred income taxes and other non-cash items totaling $21.2 million. Decreases in inventory, costs and estimated earnings in excess of billings and billings in excess of costs and estimated earnings, net and prepaid expenses and other current assets, as well as increases in accounts payable and accrued expenses provided $17.9 million. These were offset by increases in restricted cash, accounts receivable, including retainage, project development costs and other assets and decreases in other liabilities and income taxes payable, which used $19.5 million in cash. An increase in Federal ESPC receivables used an additional $33.4 million. As described above, Federal ESPC operating cash flows only reflect the ESPC expenditure outflows and do not reflect any inflows from the corresponding contract revenues, which are recorded as cash inflows from financing activities due to the timing of the receipt of cash related to the assignment of the ESPC receivables to the third-party investors. Operating activities used $45.3 million of net cash during the nine months ended September 30, 2013. During that period, we had net income of $0.8 million, which is net of non-cash compensation, depreciation, amortization, deferred income taxes and other non-cash items totaling $13.0 million. Decreases in accounts receivable, including retainage, and inventory and increases in other liabilities provided $6.3 million. These were offset by increases in restricted cash, costs and estimated earnings in excess of billings and billings in excess of costs and estimated earnings, net, prepaid expenses and other current assets, project development costs and other assets and decreases in accounts payable and accrued expenses and income taxes payable, which used $41.1 million in cash. An increase in Federal ESPC receivables used an additional $24.3 million. Cash flows from investing activities. Cash flows from investing activities during the nine months ended September 30, 2014 used $28.3 million. Development of our renewable energy plants used $16.5 million. We now expect to invest $20.0 million to $25.0 million on capital expenditures, principally for renewable energy plants, in 2014. In addition, we invested $1.6 million in purchases of other property and equipment and $13.9 million was used for acquisitions. Partially offsetting these amounts were $3.7 million related to Section 1603 grants received during the period. Cash flows from investing activities during the nine months ended September 30, 2013 used $42.9 million. Development of our renewable energy plants used $35.8 million. In addition, we invested $2.3 million in purchases of other property and equipment and $9.9 million was used for acquisitions. These were partially offset by $1.6 million relating to grant awards received on project assets and $3.5 million in proceeds from the sale of assets. Cash flows from financing activities. Cash flows from financing activities during the nine months ended September 30, 2014 provided $45.3 million. This was primarily due to $20.0 million in net draws on our revolving credit facility, a decrease in our investment in restricted cash of $2.8 million and proceeds from exercises of options of $1.4 million. These were partially offset by payments on long-term debt of $13.9 million and payments of financing fees of $0.4 million. Proceeds from Federal ESPC projects provided $32.9 million. Cash flows from financing activities during the nine months ended September 30, 2013 provided $43.3 million. This was primarily due to draws on our revolving credit facility of $18.0 million, proceeds from long-term debt financing of $9.4 million, proceeds from the exercise of stock options of $1.7 million and a decrease in our investment in restricted cash of $1.3 34-------------------------------------------------------------------------------- Table of Contents million, partially offset by payments of long-term debt of $8.4 million. Proceeds from Federal ESPC projects provided $21.4 million. Senior Secured Credit Facility - Revolver and Term Loan We have a credit and security agreement with two banks. The credit facility consists of a $60.0 million revolving credit facility and an initial $40.0 million term loan. At September 30, 2014, $20.0 million was outstanding under the revolving credit facility and $21.4 million was outstanding under the term loan. The term loan requires quarterly principal payments of $1.4 million, with the balance due at maturity. Ameresco, Inc. is the sole borrower under the credit facility. The credit facility is secured by a lien on all of our assets other than renewable energy projects that we own and for which financing from others remains outstanding, and limits our ability to enter into other financing arrangements. Availability under the revolving credit facility is based on two times our EBITDA for the preceding four quarters, and we are required to maintain a minimum EBITDA amount on a rolling four-quarter basis. EBITDA for purposes of the facility excludes the results of renewable energy projects that we own and for which financing from others remains outstanding. The credit facility matures on June 30, 2016, when all amounts will be due and payable in full. During the first quarter of 2014, we amended the senior credit facility to: • increase the margins over the applicable benchmark rate in determining the interest rate by 25 basis points; • waive compliance with the minimum EBITDA covenant for the four consecutive fiscal quarters ended December 31, 2013; • reduce the required minimum EBITDA amount to $16.5 million for the four consecutive fiscal quarters ended March 31, 2014, $22.0 million for the four consecutive fiscal quarters ended June 30, 2014, $24.0 million for the four consecutive fiscal quarters ended September 30, 2014, and $27.0 million for the four consecutive fiscal quarters ended December 31, 2014 and thereafter; • increase the maximum ratio of total funded debt to EBITDA as of the end of each fiscal quarter to 2.5 to 1.0 for March 31, 2014 and 2.25 to 1.0 for June 30, 2014, returning to 2.0 to 1.0 for September 30, 2014 and thereafter; and • reduce the minimum ratio of cash flow to debt service to 1.25 to 1.0 for the four fiscal quarters ended March 31, 2014, returning to 1.5 to 1.0 for the four fiscal quarters ended June 30, 2014 and thereafter. As of September 30, 2014, we were in compliance with all of the financial and operational covenants in the senior credit facility. In addition, we do not consider it likely that we will fail to comply with these covenants for the next twelve months. Project Financing Construction and Term Loans. We have entered into a number of construction and term loan agreements for the purpose of constructing and owning certain renewable energy plants. The physical assets and the operating agreements related to the renewable energy plants are owned by wholly owned, single member special purpose subsidiaries. These construction and term loans are structured as project financings made directly to a subsidiary, and upon acceptance of a project, the related construction loan converts into a term loan. While we are required under generally accepted accounting principles to reflect these loans as liabilities on our consolidated balance sheet, they are generally nonrecourse and not direct obligations of Ameresco, Inc. As of September 30, 2014, we had outstanding $80.6 million in aggregate principal amount under these loans, bearing interest at rates ranging from 3.2% to 7.3% and maturing at various dates from 2017 to 2028. One loan with an outstanding balance as of September 30, 2014 totaling $3.9 million, does require Ameresco, Inc. to provide assurance to the lender of the project performance. A second loan, entered into during 2012, with an outstanding balance as of September 30, 2014 of $43.2 million requires Ameresco, Inc. to provide assurance to the lender of reimbursement upon any recapture of certain renewable energy Government cash grants upon the occurrence of events that cause the recapture of such grants. As of December 31, 2013, we had outstanding $90.5 million in aggregate principal amount under these loans, bearing interest at rates ranging from 6.1% to 8.7% and maturing at various dates from 2015 to 2028. These construction and term loan agreements require us to comply with a variety of financial and operational covenants. As of September 30, 2014 we were in compliance with all of these financial and operational covenants. In addition, we do not consider it likely that we will fail to comply with these covenants during the term of these agreements. Federal ESPC Liabilities. We have arrangements with certain lenders to provide advances to us during the construction or installation of projects for certain customers, typically Federal Governmental entities, in exchange for our assignment to the 35-------------------------------------------------------------------------------- Table of Contents lenders of our rights to the long-term receivables arising from the ESPCs related to such projects. These financings totaled $64.8 million and $44.3 million in principal amounts at September 30, 2014 and December 31, 2013, respectively. Under the terms of these financing arrangements, we are required to complete the construction or installation of the project in accordance with the contract with our customer, and the debt remains on our consolidated balance sheet until the completed project is accepted by the customer. Contractual Obligations The following table summarizes our significant contractual obligations and commitments as of September 30, 2014 (in thousands): Payments due by Period Less than One to Three to More than Total One Year Three Years Five Years Five Years Senior Secured Credit Facility: Revolver $ 20,000 $ - $ 20,000 $ - $ - Term Loan 21,428 5,714 15,714 - - Project Financing: Construction and term loans 80,644 7,909 12,862 12,776 47,097 Federal ESPC liabilities(1) 64,833 - 64,833 - - Interest obligations(2) 32,897 4,700 7,815 6,077 14,305 Operating leases 11,255 3,394 5,328 2,130 403 Total $ 231,057 $ 21,717 $ 126,552 $ 20,983 $ 61,805 (1 ) Federal ESPC arrangements relate to the installation and construction of projects for certain customers, typically Federal Governmental entities, where we assign to the third-party lenders our right to customer receivables. We are relieved of the liability when the project is completed and accepted by the customer. We typically expect to be relieved of the liability between one and three years from the date of project construction commencement. The table does not include, for our Federal ESPC liability arrangements, the difference between the aggregate amount of the long-term customer receivables sold by us to the lender and the amount received by us from the lender for such sale. (2 ) For both the revolver and term loan portion of our senior secured credit facility, the table above assumes that the variable interest rate in effect at September 30, 2014 remains constant for the term of the facility. Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under SEC rules, such as relationships with unconsolidated entities or financial partnerships, which are often referred to as structured finance or special purpose entities, established for the purpose of facilitating financing transactions that are not required to be reflected on our balance sheet. Item 3. Quantitative and Qualitative Disclosures About Market Risk As of September 30, 2014, there have been no significant changes in market risk exposures that materially affected the quantitative and qualitative disclosures as described in Item 7A to our Annual Report on Form 10-K for the year ended December 31, 2013. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this quarterly report, or the evaluation date. Disclosure controls and procedures are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our management, after evaluating the effectiveness of our disclosure 36-------------------------------------------------------------------------------- Table of Contents controls and procedures as of the evaluation date, concluded that as of the evaluation date, our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weakness in our internal control over financial reporting disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 17, 2014, and discussed below. Changes in Internal Control over Financial Reporting There were no changes in our internal control over financial reporting, other than those stated below, during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Material Weakness Discussion and Remediation As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 17, 2014, we identified a material weakness in our internal control over financial reporting. Specifically, we did not have adequate processes to ensure timely preparation and reviews necessary to provide reasonable assurance that financial statements and related disclosures could be prepared in accordance with generally accepted accounting principles and recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. During the three months ended September 30, 2014, we have undertaken the following actions, which had a material affect on our internal controls over financial reporting, to remediate the material weakness identified: • we continued to act upon the enhancements to our internal controls that we implemented in 2013 as described in our Annual Report on Form 10-K for the year ended December 31, 2013; and • we continued improving the quality and timing of our accounting close process and financial reporting to allow for an increase in time for review. Further work, however, is required to develop appropriate controls in some aspects of our financial statement preparation and review process to provide reasonable assurance that controls are designed in the most effective and efficient manner possible. Therefore, while we believe these changes reduce the risk of financial statement misstatement, there continues to be additional work required for us to conclude that reasonable assurance has been obtained that all controls are operating effectively and in a timely manner. We expect to continue to undertake these actions as appropriate throughout the remainder of 2014. The Audit Committee is monitoring management's continuing development and implementation of its plan for undertaking the foregoing remedial measures. In addition, under the direction of the Audit Committee, management will continue to review and make necessary changes to the overall design of our internal control environment, as well as policies and procedures to improve the overall effectiveness of internal control over financial reporting. Management is committed to continuous improvement of our internal control processes and will continue to diligently review our reporting controls and procedures. As management continues to evaluate and work to improve internal control over financial reporting, we may determine to take additional measures to address control deficiencies or determine to modify, or in appropriate circumstances not to complete, certain of the remediation measures described above. We expect that our remediation efforts will continue throughout 2014. For the near-term future, the matter identified above will continue to constitute a material weakness in our internal control over financial reporting that could result in material misstatements in our financial statements not being prevented or detected. 37-------------------------------------------------------------------------------- Table of Contents |