EnerNOC, Inc.
ENERNOC INC (Form: 10-Q, Received: 11/05/2007 16:31:26)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

 

 

 

 

 

x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended September 30, 2007

 

 

 

or

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to

 

Commission File Number: 001-33471

 

EnerNOC, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

87-0698303

(State or Other Jurisdiction of
Incorporation or Organization)

 

(IRS Employer
Identification No.)

 

 

 

75 Federal Street
Suite 300
Boston, Massachusetts

 

02110

(Address of Principal Executive Offices)

 

(Zip Code)

 

(617) 224-9900

(Registrant’s Telephone Number, Including Area Code)

 

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  o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer   o     Accelerated Filer   o     Non-Accelerated Filer   x

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes  o  No  x

 

There were 18,612,047 shares of the Registrant’s common stock, $.001 par value per share, outstanding as of October 30, 2007.

 

 



 

Table of Contents

 

EnerNOC, Inc.

Index to Form 10-Q

 

 

 

 

Page

Part I  - Financial Information

 

 

 

 

 

 

Item 1.

Unaudited Condensed Consolidated Financial Statements

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at September 30, 2007 (unaudited) and December 31, 2006

 

3

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006

 

4

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006

 

5

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

6

 

 

 

 

Item 2 .

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

14

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

21

 

 

 

 

Item 4T.

Controls and Procedures

 

21

 

 

 

 

Part II - Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

22

 

 

 

 

Item 1A.

Risk Factors

 

22

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

34

 

 

 

 

Item 5.

Other Information

 

35

 

 

 

 

Item 6.

Exhibits

 

35

 

Signatures

 

36

 

Exhibit Index

 

37

 

2



 

PART I — FINANCIAL INFORMATION

 

Item 1.  Financial Statements .

 

EnerNOC, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

 

 

September 30,
2007

 

December 31,
2006

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

73,790

 

$

9,184

 

Restricted cash

 

2,543

 

510

 

Marketable securities

 

12,600

 

 

Accounts receivable, net allowance for doubtful accounts of $317 at September 30, 2007 and $7 at December 31, 2006

 

12,023

 

4,447

 

Deferred costs of sales

 

1,700

 

410

 

Prepaid expenses and other current assets

 

878

 

328

 

Total current assets

 

103,534

 

14,879

 

Property and equipment, net

 

20,320

 

6,547

 

Goodwill and other intangible assets, net

 

13,644

 

7,132

 

Deferred financing costs

 

537

 

668

 

Other assets

 

1,946

 

724

 

Total assets

 

$

139,981

 

$

29,950

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity (Deficit)

 

 

 

 

 

Current liabilities

 

 

 

 

 

Accounts payable

 

$

2,646

 

$

1,660

 

Accrued capacity payments

 

9,753

 

5,210

 

Current portion of deferred related-party acquisition payments

 

853

 

1,989

 

Accrued payroll and related expenses

 

2,613

 

1,275

 

Accrued expenses and other current liabilities

 

1,727

 

1,215

 

Deferred revenue

 

3,113

 

971

 

Current portion of long-term debt

 

2,380

 

1,128

 

Total current liabilities

 

23,085

 

13,448

 

 

 

 

 

 

 

Long-term liabilities

 

 

 

 

 

Long-term debt, net of current portion

 

4,279

 

4,072

 

Deferred related-party acquisition payments, net of current portion

 

 

400

 

Contingent consideration provision

 

2,247

 

2,247

 

Deferred revenue

 

114

 

420

 

Redeemable convertible preferred stock warrant liability

 

 

606

 

Other liabilities

 

144

 

149

 

 

 

 

 

 

 

Total long-term liabilities

 

6,784

 

7,894

 

 

 

 

 

 

 

Redeemable convertible preferred stock

 

 

 

 

 

Series A Redeemable Convertible Preferred Stock, $0.001 par value; 713,118 shares authorized, issued, and outstanding at December 31, 2006, at redemption value

 

 

828

 

Series A-1 Redeemable Convertible Preferred Stock, $0.001 par value; 916,212 shares authorized, issued, and outstanding at December 31, 2006, at redemption value

 

 

1,739

 

Series B Redeemable Convertible Preferred Stock, $0.001 par value; 1,177,097 shares authorized, issued and outstanding at December 31, 2006, at redemption value

 

 

7,685

 

Series B-1 Redeemable Convertible Preferred Stock, $0.001 par value; 296,632 shares authorized, 277,778 shares issued and outstanding at December 31, 2006, at redemption value

 

 

2,691

 

Series C Redeemable Convertible Preferred Stock, $0.001 par value; 271,346 shares authorized, 104,921 shares issued and outstanding at December 31, 2006, at redemption value

 

 

5,749

 

Stockholders’ equity (deficit)

 

 

 

 

 

Common stock, $0.001 par value; 50,000,000 shares authorized, 18,564,556 and 4,245,324 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively

 

18

 

4

 

Additional paid-in capital

 

134,908

 

771

 

Redeemable convertible preferred stock subscription receivable

 

 

(800

)

Accumulated deficit

 

(24,814

)

(10,059

)

 

 

 

 

 

 

Total stockholders’ equity (deficit)

 

110,112

 

(10,084

)

Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)

 

$

139,981

 

$

29,950

 

 

See accompanying notes.

 

3



 

EnerNOC, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

19,139

 

$

10,978

 

$

41,126

 

$

20,192

 

Cost of revenues

 

11,258

 

5,212

 

26,232

 

12,295

 

Gross profit

 

7,881

 

5,766

 

14,894

 

7,897

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing expenses

 

4,362

 

1,745

 

11,840

 

3,832

 

General and administrative expenses

 

6,699

 

1,945

 

18,036

 

4,990

 

Research and development expenses

 

985

 

189

 

1,824

 

682

 

Total operating expenses

 

12,046

 

3,879

 

31,700

 

9,504

 

(Loss) income from operations

 

(4,165

)

1,887

 

(16,806

)

(1,607

)

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

1,709

 

18

 

2,537

 

109

 

Interest expense

 

(69

)

(13

)

(276

)

(158

)

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(2,525

)

$

1,892

 

$

(14,545

)

$

(1,656

)

 

 

 

 

 

 

 

 

 

 

Net (loss) income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.14

)

$

0.52

 

$

(1.30

)

$

(0.47

)

Weighted average number of shares used in computation

 

18,153

 

3,649

 

11,215

 

3,533

 

Net (loss) income per share:

 

 

 

 

 

 

 

 

 

Diluted

 

$

(0.14

)

$

0.13

 

$

(1.30

)

$

(0.47

)

Weighted average number of shares used in computation

 

18,153

 

14,096

 

11,215

 

3,533

 

 

See accompanying notes.

 

4



 

EnerNOC, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Nine Months Ended
September 30,

 

 

 

2007

 

2006

 

Cash flows from operating activities

 

 

 

 

 

Net loss

 

$

(14,545

)

$

(1,656

)

Adjustments to reconcile net loss to net cash used in operating activities

 

 

 

 

 

Depreciation

 

1,880

 

561

 

Amortization of intangibles

 

1,658

 

1,683

 

Stock-based compensation expense

 

5,759

 

67

 

Non-cash interest expense

 

131

 

 

Increase (decrease) in cash from changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(7,576

)

(6,729

)

Deferred revenue

 

1,722

 

177

 

Prepaid expenses and other current assets

 

(530

)

(204

)

Deferred cost of sales

 

(1,290

)

(24

)

Other noncurrent assets

 

(1,174

)

(19

)

Accrued capacity payments

 

4,543

 

3,366

 

Other noncurrent liabilities

 

(5

)

(71

)

Accounts payable and accrued expenses

 

2,836

 

579

 

Net cash used in operating activities

 

(6,591

)

(2,270

)

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Purchase of marketable securities

 

(15,000

)

 

Sale and maturity of marketable securities

 

2,400

 

 

Purchase of Mdenergy, LLC

 

(3,362

)

 

Deferred related party acquisition payment for Pinpoint Power DR LLC

 

(1,470

)

(1,380

)

Purchase of eBidenergy, Inc.

 

 

(27

)

Purchase of Celerity Energy Partners

 

 

(3,057

)

Purchases of property and equipment

 

(15,656

)

(2,092

)

Net cash used in investing activities

 

(33,088

)

(6,556

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Proceeds from the issuance of common stock, net of issuance costs

 

95,159

 

 

Proceeds from exercises of stock options

 

105

 

1

 

Proceeds from borrowing

 

2,500

 

 

Repayment of borrowings

 

(1,041

)

(604

)

Increase in restricted cash

 

(2,033

)

(111

)

Proceeds from the issuance of preferred stock, net of issuance costs

 

9,990

 

2,630

 

Repurchase of treasury stock

 

(395

)

 

Net cash provided by financing activities

 

104,285

 

1,916

 

Net change in cash and cash equivalents

 

64,606

 

(6,910

)

Cash and cash equivalents at beginning of period

 

9,184

 

9,719

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

73,790

 

$

2,809

 

 

 

 

 

 

 

Non-cash financing and investing activities

 

 

 

 

 

Purchase of fixed assets through a capital lease obligation

 

$

 

$

3

 

Deferred related party stock issuance for Pinpoint Power DR LLC

 

$

66

 

$

92

 

Conversion and net exercise into common stock of preferred stock warrant

 

$

606

 

$

 

Purchase of eBidenergy, Inc. through the issuance of common stock

 

$

 

$

35

 

Issuance of common stock to related party

 

$

395

 

$

 

Accretion of preferred stock issuance costs

 

$

216

 

$

21

 

Purchase of Mdenergy, LLC through the issuance of common stock

 

$

4,752

 

$

 

 

See accompanying notes.

 

5



 

EnerNOC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share data)

 

1. Description of Business and Basis of Presentation

 

Description of Business

 

EnerNOC, Inc. (the Company) is a service company that was incorporated in Delaware on June 5, 2003. The Company operates in a single segment providing full-service demand response and energy management solutions. The Company enables energy users, energy suppliers, system operators, and utilities to reduce demand for electricity during periods of peak demand or supply shortfalls by proactively shedding noncritical loads, dispatching backup generators, and analyzing real-time data to optimize energy consumption. The Company’s demand response and energy management solutions deliver immediate bottom-line benefits to end-use customers and energy suppliers while helping to create a more reliable and efficient electricity grid for system operators and utilities.

 

Basis of Consolidation

 

The unaudited condensed consolidated financial statements of the Company include the accounts of its wholly-owned subsidiaries and have been prepared in conformity with accounting principles generally accepted in the United States (GAAP). Intercompany transactions and balances are eliminated upon consolidation. In the opinion of the Company’s management, the unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of operations for this period.

 

The results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the results expected for the full fiscal year ending December 31, 2007 or for any other fiscal period. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2006 and the footnotes thereto included in the Company’s registration statement on Form S-1, as filed with the Securities and Exchange Commission (SEC) on October 29, 2007.

 

Reclassifications

 

Certain amounts in prior periods have been reclassified to conform to the 2007 presentation.  These reclassifications have no impact on previously reported results of operations or stockholders’ equity (deficit).

 

Liquidity

 

In May 2007, the Company completed its initial public offering (IPO) of 4,312,500 shares of common stock at a price of $26.00 per share, which includes the exercise of the underwriters’ over-allotment option to purchase 562,500 shares and the sale of 225,000 shares by certain of the Company’s stockholders. Net proceeds to the Company from the IPO were approximately $95,200 (net of underwriting discounts and commissions and offering expenses). Prior to its IPO, the Company had primarily funded its operations through the issuance of an aggregate of $27,900 in preferred stock and $7,500 in borrowings under its loan and security agreement described below. The Company used these proceeds to fund its operations, to develop its technology for its demand response programs, to open new markets and to make acquisitions.

 

The Company had $73,790 in cash and cash equivalents as of September 30, 2007, compared to $9,184 at December 31, 2006. The Company believes that its existing cash and cash equivalents, including the proceeds from its IPO and borrowings under its loan and security agreement, will be sufficient to meet its anticipated cash needs for at least the next 24 months.

 

Allowance for Doubtful Accounts

 

The Company reduces gross trade accounts receivable by an allowance for doubtful accounts. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the Company's existing accounts receivable. The Company reviews its allowance for doubtful accounts on a regular basis and all past due balances are reviewed individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Provisions for allowance for doubtful accounts are recorded in general and administrative expenses.

 

Below is a summary of the changes in the Company's allowance for doubtful accounts for the nine months ended September 30, 2007.

 

 

 

Balance at  Beginning of Period

 

Additions Charged to Expense

 

Deductions - Write-offs, Payments and Other Adjustments

 

Balance at End of Period

 

Nine Months ended September 30, 2007
(unaudited)

 

$

7

 

$

310

 

$

 

$

317

 

 

 

2. Acquisition

 

On September 13, 2007, the Company acquired all of the outstanding membership interests of Mdenergy, LLC (MDE), an energy procurement service provider, pursuant to the terms of a merger agreement. The total purchase price paid by the Company at closing was approximately $7.9 million, of which approximately $3.16 million was paid in cash and the remainder of which was paid by the issuance of 139,056 shares of the Company’s common stock. Of the total shares of the Company’s common stock issued in the transaction, 35,114 shares worth approximately $1.2 million at the closing were deposited into an escrow fund to secure certain indemnification obligations of the former holders of MDE membership interests.

 

In addition to the amounts paid at closing, the Company is obligated to pay to the former holders of MDE membership interests an earnout amount equal to two times the revenues of MDE’s business during the period from July 1, 2007 through December 31, 2007, such earnout to be payable in cash during the first quarter of 2008. The contingent consideration related to the earnout will be recorded as additional purchase price when the contingency is resolved.

 

Pursuant to the merger agreement, the Company is also obligated to pay to certain employees of MDE a cash bonus payment of up to $300,000 in the first quarter of 2008 and up to $600,000 in the first quarter of 2009 upon the achievement of certain revenue-based milestones during 2007 and 2008, respectively. These payments are considered bonuses for post combination services and will be expensed over the service period.

 

6



 

                The MDE acquisition has been accounted for under SFAS No. 141, Business Combinations . The closing of the MDE acquisition was on September 13, 2007, and as such, the Company’s consolidated financial statements reflect MDE’s results of operations from that date forward.

 

The aggregate purchase price of $8,113 consists of the following:

 

Common stock, $0.001 par value

 

$

4,752

 

Cash

 

3,168

 

Acquisition related expenses

 

193

 

Total purchase price

 

$

8,113

 

 

The aggregate purchase price has been allocated to the acquired assets based on their fair values as determined by the Company as follows:

 

Total purchase price

 

$

8,113

 

Prepaid expenses and other current assets

 

 

20

 

Computer equipment

 

12

 

Customer contracts

 

2,400

 

Employment agreements

 

90

 

Accrued Expenses

 

(66

Net assets acquired

 

$

2,456

 

Excess purchase price over the fair value of assets acquired

 

$

5,657

 

 

                The financial information above reflects a preliminary allocation of the purchase price. The estimated fair values of the assets acquired and liabilities assumed are not yet complete and are subject to future adjustments. In addition to the amounts paid at closing, the Company is obligated to pay the former holders of MDE membership interests an earnout payment, as described above. These amounts will be assessed if additional purchase price is deemed probable.

 

Supplemental Information

 

The following unaudited pro forma combined financial information is presented for comparative purposes for the three and nine months ended September 30, 2007 and 2006 and gives effect to certain adjustments, including amortization of the definite life intangible assets as if the acquisition occurred on January 1, 2006. The information below is not necessarily indicative of the results of operations that would have actually been reported had the purchase occurred at the beginning of the periods presented, nor is it necessarily indicative of future financial position or results of operations (dollars in thousands, except per share data):

 

 

 

Three months
ended

 

Nine months
ended

 

 

 

September
30, 2007

 

September
30, 2006

 

September
30, 2007

 

September
30, 2006

 

Revenues

 

$

19,836

 

$

11,242

 

$

43,002

 

$

20,921

 

Net (Loss) Income

 

(3,149

)

1,846

 

(14,756

)

(1,636

)

Pro forma net (loss) income per share – basic

 

$

(0.17

)

$

0.49

 

$

(1.30

)

$

(0.45

)

Pro forma net (loss) income per share - diluted

 

$

(0.17

)

$

0.13

 

$

(1.30

)

$

(0.45

)

 

7



 

3.  Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS No. 157). This statement defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in GAAP and expands disclosure related to the use of fair value measures in financial statements. SFAS No. 157 does not expand the use of fair value measures in financial statements, but standardizes its definition and guidance in GAAP. The standard emphasizes that fair value is a market-based measurement and not an entity-specific measurement based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price). SFAS No. 157 establishes a fair value hierarchy from observable market data as the highest level to fair value based on an entity’s own fair value assumptions as the lowest level. SFAS No. 157 is to be effective for the Company’s financial statements issued in 2008, however, earlier application is encouraged. The Company does not expect the pronouncement to have a material impact on its consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS No. 159 provides an entity with the option, at specified election dates, to measure certain financial assets and liabilities and other items at fair value, with changes in fair value recognized in earnings as those changes occur. SFAS No. 159 also establishes presentation and disclosure requirements that include displaying the fair value of those assets on the face of the balance sheet and providing management’s reasons for electing the fair value option for each eligible item. The provisions of SFAS No. 159 will become effective beginning January 1, 2008. Early adoption is permitted provided that an election is also made to apply the provisions of SFAS No. 157. The Company is currently evaluating the impact that SFAS No. 159 may have on its results of operations and financial condition.

 

4. Net Loss Per Share

 

Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed using the weighted average number of common shares outstanding and, when dilutive, potential common shares from options and warrants using the treasury stock method, and from convertible securities using the as-converted method. The calculation of dilutive weighted average shares outstanding is as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September
30, 2007

 

September
30, 2006

 

September
30, 2007

 

September
30, 2006

 

Basic weighted average shares outstanding

 

18,153,456

 

3,648,846

 

11,214,656

 

3,532,837

 

Dilutive effect of:

 

 

 

 

 

 

 

 

 

Series A Redeemable Convertible Preferred Stock

 

 

2,018,837

 

1,002,023

 

2,018,837

 

Series A-1 Redeemable Convertible Preferred Stock

 

 

2,593,796

 

1,287,397

 

2,593,796

 

 

 

 

 

 

 

 

 

 

 

Series B Redeemable Convertible Preferred Stock

 

 

3,332,362

 

1,653,975

 

3,332,362

 

Series B-1 Redeemable Convertible Preferred Stock

 

 

786,390

 

390,314

 

786,390

 

 

 

 

 

 

 

 

 

 

 

Series C Redeemable Convertible Preferred Stock

 

 

 

354,522

 

 

Outstanding options and warrants

 

2,179,211

 

1,716,076

 

2,380,476

 

1,528,576

 

Shares held in escrow

 

5,725

 

 

1,929

 

 

Dilutive weighted average shares outstanding

 

20,338,392

 

14,096,307

 

18,285,292

 

13,792,798

 

 

Because the Company reported a net loss for the three and nine months ended September 30, 2007 and the nine months ended September 30, 2006, all potential common shares have been excluded from the computation of dilutive net loss per share since the effect would have been antidilutive.

 

Included in the calculation of the weighted average number of common shares outstanding at September 30, 2007 and September 30, 2006 are 44,260 and 110,211 contingently issuable shares of common stock, respectively. These shares were issuable in connection with the Company’s acquisition of Pinpoint Power DR LLC (PPDR) in 2005. These shares have been included in the calculation as there are no restrictions for issuance except for the passage of time.

 

The weighted average common shares outstanding at September 30, 2007 does not include 35,114 shares issued in the MDE acquisition that are held in escrow. These shares are included in the calculation of diluted shares outstanding as if the contingency period ended on September 30, 2007.

 

5. Marketable Securities

 

Cash equivalents consist principally of money market funds and corporate bonds with original maturities of three months or less at the date of purchase. Marketable securities consist primarily of municipal auction rate securities. Marketable securities at September 30, 2007 are classified as “available-for-sale.” Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in a separate component of accumulated other comprehensive income (loss) in stockholders’ equity (deficit). The cost of debt securities that are deemed available-for-sale securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest and other income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities and other investments are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest and other income.

 

The following is a summary of our available-for-sale marketable securities (dollars in thousands):

 

8



 

 

 

Gross unrealized

 

As of September 30, 2007

 

Cost

 

Gains

 

Losses

 

Fair value

 

Municipal auction rate securities

 

$

12,600

 

$

 

$

 

$

12,600

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

 12,600

 

$

 —

 

$

 —

 

$

 12,600

 

 

The following is a summary of the cost and fair value of current available-for-sale marketable securities at September 30, 2007, by contractual maturity (dollars in thousands):

 

 

Cost

 

Fair value

 

Due in one year or less

 

$

 

$

 

Due after one year through three years

 

 

 

Due after three years

 

12,600

 

12,600

 

 

 

$

12,600

 

$

12,600

 

 

6. Property and Equipment

 

Property and equipment as of September 30, 2007 and December 31, 2006 consisted of the following:

 

 

 

Estimated Useful
Life (Years)

 

September 30,
2007

 

December 31,
2006

 

Computers and office equipment

 

3

 

$

3,204

 

$

745

 

Software

 

3

 

2,278

 

117

 

Demand response equipment

 

3-5

 

3,182

 

1,767

 

Back-up generators

 

5

 

7,430

 

885

 

Furniture and fixtures

 

5

 

624

 

37

 

Leasehold improvements

 

Lesser of the
useful life
or lease
term

 

819

 

14

 

Assets under capital lease

 

Lesser of the useful life or lease term

 

201

 

200

 

Construction-in-progress, including capitalized interest

 

 

 

5,629

 

3,949

 

 

 

 

 

23,367

 

7,714

 

Accumulated depreciation

 

 

 

(3,047

)

(1,167

Property and equipment, net

 

 

 

$

20,320

 

$

6,547

 

 

Depreciation expense was $962 and $218 for the three months ended September 30, 2007 and September 30, 2006, respectively. For the nine months ended September 30, 2007 and September 30, 2006, depreciation expense was $1,880 and $561, respectively.  For the three months ended September 30, 2007 and September 30, 2006, $468 and $156 were included in cost of revenues, and $494 and $62 were included in general and administrative expenses, respectively. For the nine months ended September 30, 2007 and September 30, 2006, $978 and $398 were included in cost of revenues and $902 and $163 were included in general and administrative expenses, respectively.

 

Software development costs of $0 and $677 for the three and nine months ended September 30, 2007 have been capitalized in accordance with Statement of Position No. 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use . No amounts were capitalized during the three or nine months ended September 30, 2006. The Company ceased capitalizing software development costs as of May 31, 2007 when the system became operational. These expenses are currently recorded in research and development costs. The capitalized amount is included as software in property and equipment at September 30, 2007.

 

Construction-in-progress consists principally of demand response equipment and back-up generators that have not been placed in service. Construction-in-progress at September 30, 2007 and December 31, 2006 consisted of the following:

 

9



 

 

 

September 30,
2007

 

December 31,
2006

 

Software

 

$

 

$

786

 

Demand response equipment

 

595

 

 

Back-up generators

 

4,623

 

3,036

 

Capitalized interest

 

411

 

127

 

 

 

$

5,629

 

$

3,949

 

 

7. Letters of Credit

 

The Company is contingently liable under unused letters of credit. Included in the September 30, 2007 and December 31, 2006 restricted cash balances are unused letters of credit in the amount of $2,543 and $510, respectively.

 

8. Financing Arrangements

 

In November 2006, the Company entered into a loan and security agreement with a debt lender, which loan and security agreement provides for borrowings of up to $19,500 pursuant to a term loan facility of up to $7,500 and an equipment term loan facility of up to $12,000. The term loan portion of the facility allowed the Company to borrow $7,500 on or before March 31, 2007. Borrowings under the term loan facility will mature on a 36 month amortization schedule. Under the equipment term loan portion of the facility, the Company was eligible to borrow up to $8,000 on or before June 30, 2007 and up to an additional $4,000 on or before December 31, 2007, in each case, if the Company is not in default under the terms of the loan and security agreement at the time of the borrowing. Borrowings made under the equipment term loan facility will require repayment over a 36 to 84 month period, depending on the type of equipment financed. Borrowings under the loan and security agreement currently bear interest at (a) the greater of 5.22% or the yield on three-year U.S. Treasury Notes on the date of the loan plus (b) in the case of the term loans, 655 basis points per annum, and in the case of the equipment loans, 695 basis points per annum. Provisions in the loan and security agreement impose restrictions on the Company’s ability to, among other things (i) incur more debt; (ii) pay dividends and make distributions; (iii) redeem or repurchase capital stock; (iv) create liens; (v) enter into transactions with affiliates; and (vi) merge or consolidate. The loan and security agreement contains other customary covenants but does not impose financial ratio maintenance requirements. The loan and security agreement permits the lender to declare an event of default under various circumstances, including if any event occurs that has a material adverse effect on the Company. The borrowings under the term loan facility are collateralized by all assets of the Company and the equipment term loan facilities are collateralized by the underwritten equipment. In connection with the loan and security agreement, the Company has deferred costs of $74 to execute the agreement, which are amortized over the loan term.

 

During 2006, the Company borrowed $5,000 under the term loan facility, which amount matures on February 1, 2010. In connection with this amount, on January 1, 2007, the Company began making monthly interest-only payments and commencing April 1, 2007, the Company began making monthly principal and interest payments of $168. During March 2007, the Company borrowed $2,500 under the term loan facility which matures on April 1, 2010. In connection with this amount, on April 1, 2007, the Company began making monthly interest-only payments and commencing on May 1, 2007, the Company began making monthly principal and interest payments of $83. As of September 30, 2007, there was $6,487 outstanding under the term loan facility. As of September 30, 2007, no borrowings were outstanding under the equipment loan facility and $12,000 was available for future borrowing.

 

In connection with the term loan financing, the Company issued warrants to purchase up to $700 of its Series B-1 redeemable convertible preferred stock. Prior to the IPO, these warrants automatically converted into warrants to purchase 53,372 shares of common stock. The warrants were exercised using the net exercise method which resulted in the issuance by the Company of 26,447 shares of common stock. There were no proceeds received by the Company related to this transaction.

 

9. Stockholders’ Equity

 

Stock Split

 

On May 1, 2007, the Company effected a 2.831 for one split of its common stock. All financial information in the financial statements presented reflects the impact of this split.

 

Initial Public Offering

 

On May 18, 2007, the Company successfully completed its IPO. The IPO consisted of the sale of 4,312,500 shares of common stock at a price of $26.00 per share. Of these 4,312,500 shares, 4,087,500 shares were sold in the IPO by the Company, including 562,500 shares sold pursuant to the exercise by the underwriters of their over-allotment option, which exercise occurred in May 2007, and 225,000 shares were sold by certain stockholders of the Company. Net proceeds to the Company from the IPO after deducting underwriters’ discounts and commissions and offering expenses were approximately $95,200. Upon closing of the IPO, all of the Company’s outstanding shares of convertible preferred stock converted into an aggregate of 9,499,556 shares of common stock. Also in connection with the IPO, outstanding

 

10



 

warrants to purchase Series B-1 redeemable convertible preferred stock were automatically converted into warrants to purchase 26,447 shares of the Company’s common stock.

 

Subsequent to the IPO, a significant amount of stock options were exercised. A total of 146,282 shares were issued as a result of option exercises from May 18, 2007 through September 30, 2007.

 

10. Stock-Based Compensation

 

For the three months ended September 30, 2007 and 2006, the Company recorded total stock-based compensation expense of $1,439 and $35, respectively.  For the nine months ended September 30, 2007 and 2006, the Company recorded total stock-based compensation expense of $5,759 and $67, respectively.  The components of stock-based compensation expense are disclosed below.

 

Stock Grants

 

On April 25, 2007, the Company granted certain of its executives 104,393 shares of common stock that were held in treasury at March 31, 2007. The $2,300 fair value of these shares at the date of grant was recognized in full as compensation expense in the second quarter of 2007. The shares of common stock were issued at no cost to the recipients.

 

Stock Options

 

Under the Company’s Amended and Restated 2003 Stock Option and Incentive Plan (the 2003 Plan), options may be granted to persons who are, at the time of grant, employees, officers, or directors of, or consultants or advisors to, the Company. The 2003 Plan provides for the granting of nonstatutory stock options, incentive stock options, stock bonuses, and rights to acquire restricted stock. The provisions of the 2003 Plan limit the exercise of incentive stock options, but in no case may the exercise period extend beyond ten years from the date of grant. Prior to the IPO, the option price at the date of grant was determined by the Board of Directors of the Company (the Board) and was supported by a contemporaneous valuation by a third party valuation specialist. The 2003 Plan expired upon the IPO in May 2007.

 

The Company’s 2007 Employee, Director and Consultant Stock Plan (the 2007 Plan and together with the 2003 Plan, the Plans) was adopted by the Board in April 2007 and by its stockholders in May 2007 and became effective on May 17, 2007. The 2007 Plan provides for the grant of incentive stock options, nonqualified stock options, restricted and unrestricted stock awards and other stock-based awards to eligible employees, directors and consultants of the Company for up to an aggregate maximum of 2,600,000 shares of the Company’s common stock. Options granted under the 2007 Plan are exercisable for a period determined by the Company, but in no event longer than ten years from the date of the grant. Options generally vest ratably over four years. Under the 2007 Plan, the Company offers performance based stock awards to certain members of its sales team for meeting their annual objectives.

 

On January 1, 2006, the Company adopted SFAS No. 123(R), Share Based Payment (SFAS No. 123 (R)). The Company has elected to use the Black-Scholes option pricing model to determine the weighted average fair value of stock options granted under the Plans. In accordance with SFAS No. 123(R), the Company recognizes the compensation cost of stock-based awards on a straight-line basis over the vesting period of the award. Stock-based compensation for stock options issued to employees for the three and nine months ended September 30, 2007 was $1,213 and $2,999, respectively. For the three and nine months ended September 30, 2006, the stock-based compensation to employees was $31 and $55, respectively.

 

In order to estimate the fair value of options granted in 2007, the Company utilized the Black-Scholes option pricing model, utilizing the following assumptions (weighted averages based on grants during the period):

 

Risk-free interest rate

 

4.1-5.0

%

Expected term of options, in years

 

6.25

 

Expected annual volatility

 

87

%

Expected dividend yield

 

0

%

 

Volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company determines volatility based on an analysis of comparable public companies. The risk-free interest rate is the rate available as of the option date on zero-coupon U.S. government issues with a remaining term equal to the expected life of the option. Because the Company does not have a sufficient history to estimate the expected term, the Company uses the simplified method for estimating expected term described in Staff Accounting Bulletin (SAB) No. 107, Share Based Payment . The simplified method is based on vesting-tranches and the contractual life of each grant. The Company has not paid dividends in the past and does not plan to pay any dividends in the foreseeable future.

 

The Company accounts for transactions in which services are received from non-employees in exchange for equity instruments based on the fair value of such services received or of the equity instruments issued, whichever is more reliably measured, in accordance with SFAS No. 123, Accounting for Stock-Based Compensation and Emerging Issue Task Force (EITF) No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services . The stock-based

 

11



 

compensation expense related to stock option grants to non-employees for the three and nine months ended September 30, 2007 was approximately $116 and $243, respectively. For the three and nine months ended September 30, 2006, the stock-based compensation expense related to stock option grants to non-employees was $4 and $12, respectively.

 

The following is a summary of the Company’s stock option activity as of September 30, 2007 and the stock option activity for all stock option plans during the nine months ended September 30, 2007:

 

 

 

Nine Months Ended September 30, 2007

 

 

 

 

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

Average

 

 

 

 

 

Number of
Options

 

Exercise
Price
Per Share

 

Exercise
Price
Per Share

 

Aggregate
Intrinsic
Value (2)

 

 

 

(in Shares)

 

 

 

 

 

 

 

Outstanding at beginning of year

 

2,416,706

 

 

 

$

0.44

 

 

 

Granted

 

1,039,747

 

 

 

 

 

 

 

Exercised

 

(324,484

)

 

 

 

 

 

 

Cancelled

 

(242,079

)

 

 

 

 

 

 

Outstanding at end of period

 

2,889,890

 

$ 0.11-$40.79

 

$

7.37

 

$

89,074

 

Exercisable at end of period

 

319,648

 

$ 0.11-$16.60

 

$

1.42

 

$

11,751

 

Vested or expected to vest at September 30, 2007(1)

 

2,632,866

 

$ 0.11-$40.79

 

$

7.30

 

$

81,300

 

 


(1)   This represents the number of vested options as of September 30, 2007 plus the number of unvested options expected to vest as of September 30, 2007 based on the unvested options outstanding at September 30, 2007, adjusted for the estimated forfeiture rate of 10%.

 

(2)   The aggregate intrinsic value was calculated based on the positive difference between the estimated fair value of the Company’s common stock on September 30, 2007 of $38.18 and the exercise price of the underlying options.

 

Of the stock options outstanding as of September 30, 2007, 2,815,166 options were held by employees and 74,724 options were held by non-employees. The grant-date fair value of the 1,039,747 options granted during the nine months ended September 30, 2007 was $20,610, after the Company reassessed the fair value of its common stock in connection with its IPO considerations. Subsequent to the $3,242 of stock-based compensation expense recognized in the nine months ended September 30, 2007, the amount of stock-based compensation expense that may be recognized for outstanding, unvested options as of September 30, 2007 was $19,833 which is to be recognized over a weighted average period of 3.4 years. The amount that may be recognized into expense over the next four years is as follows:

 

Remainder of 2007

 

$

1,459

 

2008

 

5,788

 

2009

 

5,664

 

2010

 

5,427

 

2011

 

1,495

 

 

 

$

19,833

 

 

12



 

Restricted Stock

 

The following table summarizes the Company’s grants of restricted stock during the nine months ended September 30, 2007:

 

 

 

Number of
Shares

 

Weighted
Average
Grant Date
Fair Value
Per Share

 

Nonvested at December 31, 2006

 

152,460

 

$

1.53

 

Granted

 

42,000

 

$

38.13

 

Vested

 

(2,000

)

$

38.13

 

Nonvested at September 30, 2007

 

192,460

 

$

9.14

 

 

All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest. The shares vest annually over a four year period from the date of issuance, with the exception of 2,000 shares issued in 2007 that vested immediately. The fair value of the restricted stock is expensed ratably over the vesting period. The shares of restricted stock have been issued at no cost to the recipients, except for the 152,460 shares of restricted stock granted in 2006 that were purchased for $0.51 per share. The Company records the proceeds received for unvested shares in accrued expenses. The amount will be amortized into additional paid-in capital as the shares vest. Subject to limited exceptions, if the employee who received the restricted stock leaves the Company prior to the vesting date for any reason, the shares of restricted stock will be forfeited and returned to the Company. The stock-based compensation expense related to restricted stock awards for the three and nine months ended September 30, 2007 was $110 and $217, respectively. There were no restricted awards granted or outstanding during the nine months ended September 30, 2006. For restricted stock at September 30, 2007, the Company had $1,608 of stock-based compensation expense which is expected to be recognized over a weighted-average period of 3.4 years.

 

11. Income Taxes

 

The Company provides for income taxes as set forth in SFAS No. 109, Accounting for Income Taxes (SFAS No. 109). Under SFAS No. 109, the liability method is used in accounting for income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to reflect the uncertainty associated with their ultimate realization.

 

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes–An Interpretation of Statement 109 (FIN 48), as of January 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s consolidated financial statements.

 

12. Related Party Transactions

 

Deferred Acquisition Payments

 

On June 1, 2005, the Company acquired all of the outstanding membership interests in PPDR from the sole member of PPDR (the Sole Member) in a purchase business combination pursuant to a purchase agreement (the Purchase Agreement). Under the Purchase Agreement, the Company is required to (i) make fixed payments of $5,925 and (ii) issue 303,001 shares of the Company’s common stock to the Sole Member. As of September 30, 2007, 44,260 shares remain to be issued through May 31, 2008. As part of the Purchase Agreement, the Company acquired a contract that contains a one-year option to extend, as of May 31, 2008, at the sole discretion of a certain customer. If exercised, the Company is obligated to make an additional payment of $2,366 and issue an additional 28,287 shares of the Company’s common stock in connection with the Purchase Agreement.

 

As of September 30, 2007 and December 31, 2006, deferred payments to the Sole Member and the fair value of the common stock to be issued to the Sole Member are as follows:

 

At September 30, 2007

 

Gross
Payment

 

Discount
Payment

 

Common
Stock

 

Total

 

Current liability

 

$

895

 

$

809

 

$

44

 

$

853

 

Long-term liability

 

 

 

 

 

Total

 

$

895

 

$

809

 

$

44

 

$

853

 

 

13



 

At December 31, 2006

 

Gross
Payment

 

Discount
Payment

 

Common
Stock

 

Total

 

Current liability

 

$

2,023

 

$

1,923

 

$

66

 

$

1,989

 

Long-term liability

 

440

 

356

 

44

 

400

 

Total

 

$

2,463

 

$

2,279

 

$

110

 

$

2,389

 

 

Contingent Consideration

 

As of September 30, 2007 and December 31, 2006, the Company recorded $2,247 in contingent consideration provisions to the Sole Member as a noncurrent liability.

 

13. Industry Segment Information

 

Based on qualitative and quantitative criteria established by SFAS No. 131 Disclosures about Segments of an Enterprise and Related Information , the Company operates within one reportable segment.

 

During the three and nine months ended September 30, 2007 and 2006, the Company had certain customers whose revenue individually represented 10% or more of the Company’s total revenues as follows:

 

 

 

Three Months Ended September 30,

 

 

 

2007

 

2006

 

 

 

Revenues

 

% of Total
Revenues

 

Revenues

 

% of Total
Revenues

 

Customer 1

 

$

12,717

 

66.4

%

$

7,074

 

64.4

%

Customer 2

 

$

2,980

 

15.6

%

$

1,602

 

14.6

%

Customer 3

 

*

 

*

 

$

1,356

 

12.4

%

Total

 

$

15,697

 

82.0

%

$

10,032

 

91.4

%

 

 

 

Nine Months Ended September 30,

 

 

 

2007

 

2006

 

 

 

Revenues

 

% of Total
Revenues

 

Revenues

 

% of Total
Revenues

 

Customer 1

 

$

24,906

 

60.6

%

$

14,329

 

71.0

%

Customer 2

 

$

9,879

 

24.0

%

$

2,471

 

12.2

%

Customer 3

 

*

 

*

 

*

 

*

 

Total

 

$

34,785

 

84.6

%

$

16,800

 

83.2

%

 


* Less than 10% of total revenue.

 

14. Subsequent Events

 

In October 2007, the Company paid a total of $10.9 million in deposit as collateral in connection with certain open market bidding commitments.

 

On October 29, 2007, the Company filed a registration statement on Form S-1 relating to a proposed offering of 4,000,000 shares of its common stock. The registration statement, which has not been declared effective as of November 2, 2007, specifies that it is expected that 800,000 of the shares will be offered by the Company and 3,200,000 shares will be offered by certain stockholders. The Company and the selling stockholders expect to grant the underwriters an over-allotment option to purchase up to 200,000 and 400,000 additional shares, respectively.

 


 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should be read with our unaudited financial statements and notes included in Item 1 of this Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2007 and 2006, as well as the audited financial statements and notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2006, included in our Registration Statement on Form S-1, as filed with the Securities and Exchange Commission, or the SEC, on October 29, 2007. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Without limiting the foregoing, the words “may,” “will,” “should,” “could,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” “target” and

 

14



 

variations of these terms or the negatives of those terms and similar expressions are intended to identify forward-looking statements. All forward-looking statements included in this Quarterly Report on Form 10-Q are based on current expectations, estimates, forecasts and projections and the beliefs and assumptions of our management including, without limitation, our expectations regarding our results of operations, selling and marketing expenses, general and administrative expenses, research and development expenses, and the sufficiency of our cash for future operations. We assume no obligation to revise or update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain important factors, including those set forth below under this Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1A — “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. You should carefully review those factors and also carefully review the risks outlined in other documents that we file from time to time with the SEC.

 

Overview

 

We are a leading developer and provider of clean and intelligent energy solutions. We use our Network Operations Center, or NOC, to remotely manage and reduce electricity consumption across a network of commercial, institutional and industrial customer sites to enable a more information-based and responsive, or intelligent, electric power grid. Our customers are electric power grid operators and utilities, as well as commercial, institutional and industrial end-users of electricity. Our demand response and energy management solutions help optimize the balance of electric supply and demand and create a lower risk and more environmentally sound alternative to building additional power plants and transmission lines. Grid operators and utilities pay us a stream of recurring cash flows for managing demand response capacity that we share with participating end-use customers. We receive most of our revenues from grid operators and utilities and we make payments to end-users of electricity for both contracting to reduce electricity usage and actually doing so when called upon. In doing so, we establish a base of installed users for an expanding portfolio of technology-enabled energy management solutions.

 

Our customer base has grown from 19 commercial, institutional and industrial customers with 70 sites in our network at the end of 2004 to approximately 691 end-use customers for our demand response solutions with approximately 2,034 sites in our demand response network as of September 30, 2007. The demand response capacity we manage through our network has grown from 10 megawatts, or MW, at the end of 2004 to approximately 918 MW as of September 30, 2007. In addition, in the third quarter of 2007, we entered into two new utility contracts which, in aggregate, would enable us to enroll up to an additional 145 MW of demand response capacity; of these, 120 MW are pursuant to a contract that is still subject to regulatory approval.

 

We continue to devote substantially all of our efforts toward the sale of our demand response and energy management solutions. We have incurred cumulative net losses of $24.8 million from inception to September 30, 2007. Our net losses were $5.8 million for the year ended December 31, 2006 and $14.5 million for the nine months ended September 30, 2007.

 

On September 13, 2007, we acquired all of the outstanding membership interests of Mdenergy, LLC, or MDE, an energy procurement service provider, for a total purchase price of approximately $7.9 million, of which approximately $3.16 million was paid in cash and the remainder of which was paid by the issuance of 139,056 shares of our common stock. The acquisition of MDE enables us to apply leading energy market intelligence as well as an online reverse auction technology platform, now called EnerNOC Exchange TM , to help commercial, institutional, and industrial customers make more informed commodity purchasing decisions. The MDE acquisition included the addition of over 400 new commercial, institutional and industrial customers to whom we now provide energy management solutions. We intend to pursue opportunities to provide demand response solutions to a substantial numbers of these new customers.

 

On May 18, 2007, we completed our initial public offering, or IPO, of 4,312,500 shares of common stock at a price of $26.00 per share, which includes the exercise of the underwriters’ over-allotment option to purchase 562,500 shares and the sale of 225,000 by certain of our stockholders. Net proceeds to us from the offering were approximately $95.2 million (net of underwriting discounts and commissions and offering expenses.)

 

We made three other acquisitions through September 30, 2007. In June 2005, we acquired Pinpoint Power DR, the demand response business of Pinpoint Power LLC. This acquisition increased our base of end-use customers and capacity under management in the New England region. To further strengthen our technology platform, we acquired certain assets and obligations of eBidenergy, Inc. from Trillium Capital Partners LLC in February 2006. In May 2006, we acquired substantially all of the assets of Celerity Energy Partners LLC, a demand response provider for grid operators and utilities, including all of the membership interests in Celerity Energy Partners San Diego LLC. This acquisition increased our base of end-use customers and capacity under management in California.

 

15



 

Revenues

 

We derive recurring revenues from the sale of our demand response and energy management solutions. Our revenues from our demand response solutions consist primarily of capacity and energy payments. In certain markets we enter into long-term capacity contracts with grid operators and utilities, generally ranging from three to 10 years in duration, to deploy our demand response solutions. In addition, we derive revenues from demand response capacity we make available in open market programs, which are open market bidding opportunities established by grid operators or utilities. In these open market programs, grid operators and utilities generally seek bids from companies such as ours to provide demand response capacity based on prices offered in competitive bidding. These opportunities are generally characterized by flexible capacity commitments and prices that vary by month.

 

Where we have a long-term contract, we receive periodic capacity payments, which may vary monthly or seasonally, based upon enrolled capacity and predetermined payment rates. Where we operate in open markets, our revenues from demand response capacity payments generally vary month-to-month based upon our enrolled capacity and the market payment rate. Under both long-term contracts and open market programs, we receive capacity payments regardless of whether we are called upon to reduce demand for electricity from the electric power grid. At least once per year we demonstrate our capacity either through a demand response event or a measurement and verification test. This demonstrated capacity is typically used to calculate the continuing periodic capacity payments to be made to us until the next demand response event or test establishes a new demonstrated capacity amount. In most cases, we also receive a second type of payment for the amount of energy usage we actually curtail from the grid; we call this an energy payment. The energy payment is based upon the amount of energy usage we actually reduce from the electricity grid in kilowatt hours during the demand response event.

 

In accordance with SAB No. 101, Revenue Recognition in Financial Statements, as amended by SAB No. 104, Revenue Recognition (SAB No. 104), in all of our arrangements, we do not recognize any revenues until we can determine that persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and we deem collection to be probable. As the program rules may differ for each contract and/or region where we operate, we assess whether or not we have met the specific delivery requirements and defer revenues as necessary. In accordance with SAB No. 104, we recognize demand response revenues when we have provided verification to the grid operator or utility of our ability to deliver the committed capacity under the agreement. Committed capacity is verified through the results of an actual demand response event or a measurement and verification test. Once the capacity amount has been verified, the revenues are recognized and future revenues become fixed and determinable and are recognized monthly until the next verification event. In subsequent verification events, if our verified capacity is below the previously verified amount, the grid operator or utility will reduce future payments based on the adjusted verified capacity amounts. The payments received from the customer can be decreased or increased, up to the committed capacity amounts under the agreement, in connection with subsequent verification events. Revenues recognized between demand response events or tests are not subject to penalty or customer refund.

 

Our energy management solutions include demand response audits where we evaluate end-use customers’ energy utilization and operating flexibility to determine potential savings opportunities from implementing demand response, conserving energy and limiting peak demand. We receive a fee from our electric grid operator and utility customers for each audit typically based upon a rate times the amount of kilowatts, or kW, that we identify that can be reduced from the electric power grid. We also use our PowerTrak TM platform to deliver energy analytics and control, energy procurement services and emissions tracking and trading support. We generally receive either a subscription-based fee or a percentage savings fee for these energy management solutions. We have yet to earn substantial revenues from these energy management solutions.

 

Cost of Revenues

 

Cost of revenues for our demand response solutions consists of payments we make to our commercial, institutional and industrial customers for their participation in our demand response network. We generally enter into one to five year contracts with our end-use customers under which we deliver recurring cash payments to them for the capacity they commit to make available on demand. We also generally make an additional payment when a customer reduces consumption of energy from the electric power grid. The equipment and installation costs for our devices at our commercial, institutional and industrial customer sites are capitalized and depreciated over the lesser of the remaining term of the contract or the estimated useful life of the equipment and this depreciation is also reflected in cost of revenues. When services have been provided, but the revenue associated with the agreement have been deferred as a result of not meeting the revenue recognition criteria required by SAB No. 104, we also defer the related direct costs of revenues for the service.

 

Stock-Based Compensation

 

Effective as of January 1, 2006, we adopted the requirements of Statement of Financial Accounting Standards (SFAS) No. 123(R), Share Based Payment (SFAS No. 123(R)). SFAS No. 123(R) addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS No. 123(R) requires us to expense share-based payment awards with compensation cost for share-based payment transactions measured at fair value. We continue to evaluate the effect that the adoption of SFAS No. 123(R) will have on our financial position and results of operations. For the three and nine months ended September 30, 2007, we recorded stock-based compensation expenses of approximately $1.4 million and $5.8 million, respectively, in connection with share-based payment

 

16



 

awards to employees and non-employees. Included within the amount for the nine months ended is $2.3 million in compensation expense associated with a grant that we made to our chief executive officer and our president in April 2007. With respect to grants through September 30, 2007, a future expense of non-vested options of approximately $19.8 million is expected to be recognized over a weighted-average period of 3.4 years. For restricted stock at September 30, 2007, we had $1.6 million of stock-based compensation expense which is expected to be recognized over a weighted-average period of 3.4 years. See Footnote 10, “Stock-Based Compensation,” to the Unaudited Condensed Consolidated Financial Statements for further discussion regarding stock options.

 

Consolidated Results of Operations

 

Three and Nine Months Ended September 30, 2007 Compared to the Three and Nine Months Ended September 30, 2006

 

Revenues

 

The following table summarizes our revenues for the three and nine months ended September 30, 2007 and 2006 (dollars in thousands):

 

 

 

Three Months
Ended

 

 

 

 

 

September 30,
 2007

 

September
30, 2006

 

Percentage
Change

 

Revenues:

 

 

 

 

 

 

 

Demand response solutions

 

$

18,871

 

$

10,833

 

74.2

%

Energy management solutions

 

268

 

145

 

84.8

%

Total revenues

 

$

19,139

 

$

10,978

 

74.3

%

 

 

 

Nine Months
Ended
September 30,
2007

 

Nine Months
Ended
September 30,
2006

 

Percentage
Change

 

Revenues:

 

 

 

 

 

 

 

Demand response solutions

 

$

40,502

 

$

20,000

 

102.5

%

Energy management solutions

 

624

 

192

 

225.0

%

Total revenues

 

$

41,126

 

$

20,192

 

103.7

%

 

During the three and nine months ended September 30, 2007, the increase in our demand response solutions revenues was primarily due to an increase in our capacity under management in all operating regions and the enrollment of new end-use customers in our demand response programs. Also contributing to the increase in our demand response solutions revenues was an increase in the number of our commercial, institutional and industrial customers utilizing our price-based demand response solutions to reduce their electrical consumption from the electric power grid during times of high wholesale market prices. As of September 30, 2007, we had approximately 918 MW of electric capacity under management compared to 294 MW of electric capacity under management as of September 30, 2006.

 

For the three and nine months ended September 30, 2007, the increase in our energy management solutions was primarily due to the initiation of our energy efficiency solutions and our acquisition of MDE, an energy procurement service provider that we acquired to augment our energy management solutions.

 

Gross Profit and Gross Margin

 

The following tables summarize our gross profit and gross margin percentages for our demand response and energy management solutions for the three and nine months ended September 30, 2007 and 2006 (dollars in thousands):

 

Three Months Ended September 30,

 

2007

 

2006

 

Gross
Profit

 

Gross
Margin

 

Gross
Profit

 

Gross
Margin

 

$

7,881

 

41.2

%

$

5,766

 

52.5

%

 

Nine Months Ended September 30,

 

2007

 

2006

 

Gross
Profit

 

Gross
Margin

 

Gross
Profit

 

Gross
Margin

 

$

14,894

 

36.2

%

$

7,897

 

39.1

%

 

17



 

Our gross profit has been, and will be, affected by many factors, including (a) the demand for our demand response and energy management solutions, (b) the selling price of our solutions, (c) our cost of revenues, (d) the introduction of new clean and intelligent energy solutions and (e) our ability to open and enter new markets/regions and expand deeper into markets we already serve.

 

The decrease in the gross margin percentage for the three and nine months ended September 30, 2007 was primarily due to the fact that our continued growth and a change in the mix of demand response programs in which we participate has lessened the impact of our higher summer margins associated with our Pinpoint Power DR contract. We also shared a higher percentage of the payments we received from utilities and grid operators with our commercial, institutional and industrial customers that curtailed usage in times of high wholesale market prices.

 

Operating Expenses

 

The following tables summarize our operating expenses for the three and nine months ended September 30, 2007 and 2006 (dollars in thousands):

 

 

 

Three Months Ended September 30,

 

Percentage

 

 

 

2007

 

2006

 

Change

 

Operating Expenses:

 

 

 

 

 

 

 

Selling and marketing expenses

 

$

4,362

 

$

1,745

 

150.0

%

General and administrative expenses

 

6,699

 

1,945

 

244.4

%

Research and development expenses

 

985

 

189

 

421.2

%

Total

 

$

12,046

 

$

3,879

 

210.5

%

 

 

 

Nine Months Ended September 30,

 

Percentage

 

 

 

2007

 

2006

 

Change

 

Operating Expenses:

 

 

 

 

 

 

 

Selling and marketing expenses

 

$

11,840

 

$

3,832

 

209.0

%

General and administrative expenses

 

18,036

 

4,990

 

261.4

%

Research and development expenses

 

1,824

 

682

 

167.4

%

Total

 

$

31,700

 

$

9,504

 

233.5

%

 

Operating expenses consist of selling and marketing, general and administrative, and research and development expenses. Personnel-related costs are the most significant component of each of these expense categories. We grew from 75 employees at September 30, 2006 to 207 employees at September 30, 2007. We expect to continue to hire employees to support our growth for the foreseeable future.

 

Selling and Marketing Expenses

 

Selling and marketing expenses consist primarily of (a) salaries and related personnel costs, (b) commissions, (c) travel, lodging and other out-of-pocket expenses, (d) marketing programs such as trade shows, and (e) other related overhead. Commissions are recorded as an expense when earned by the employee. We expect increases in selling and marketing expenses in absolute dollar terms for the foreseeable future as we further increase the number of sales professionals and, to a lesser extent, increase our marketing activities.

 

The increases in selling and marketing expenses were primarily driven by the costs associated with an increase in the number of selling and marketing employees from 26 at September 30, 2006 to 70 at September 30, 2007. Stock-based compensation expense related to selling and marketing employees for the three and nine months ended September 30, 2007, increased $0.6 million and $1.2 million, respectively, when compared to the same periods in 2006.

 

General and Administrative Expenses

 

General and administrative expenses consist primarily of (a) salaries and related personnel costs related to our executive, finance, human resource, information technology and operations organizations, (b) facilities expenses, (c) accounting and legal professional fees, and (d) other related overhead. We expect general and administrative expenses to continue to increase in absolute dollar terms for the foreseeable future as we invest in infrastructure to support continued growth and incur additional expenses related to being a public company, including

 

18



 

increased audit and legal professional fees, costs of compliance with securities and other regulations, investor relations expenses, and higher insurance premiums.

 

The increases in general and administrative expenses were primarily due to costs associated with an increase in the number of general and administrative (including operations) employees from 35 at September 30, 2006 to 106 at September 30, 2007, as well as to greater costs associated with being a public company. Stock-based compensation expense related to general and administrative employees for the three and nine months ended September 30, 2007, increased $0.8 million and $4.3 million, respectively, when compared to the same periods in 2006. Included in the stock-based compensation during the second quarter of 2007 is $2.3 million related to stock granted to certain of our executives which was recognized in full as compensation expense.

 

Research and Development Expenses

 

Research and development expenses consist primarily of (a) salaries and related personnel costs related to our engineering organization, (b) payments to suppliers for design and consulting services, (c) costs relating to the design and development of new solutions and enhancement of existing solutions, (d) quality assurance and testing, and (e) other related overhead. During 2006 and through May 31, 2007, we have capitalized internal software and development costs of $1.5 million in accordance with Statement of Position 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use , and the amount is included as software in property and equipment at September 30, 2007. We intend to continue to invest in our research and development efforts. We expect research and development expenses to increase in absolute dollar terms for the foreseeable future.

 

The increases in research and development expenses were primarily due to costs associated with an increase in the number of research and development employees from 14 at September 30, 2006 to 31 at September 30, 2007. Stock-based compensation expense related to research and development employees for the three and nine months ended September 30, 2007 increased $0.1 million and $0.2 million, respectively, when compared to the same periods in 2006. Expense increases for the three and nine months ended September 30, 2007 were slightly offset by capitalized internal software and development costs of $0 and $0.7 million, respectively. On May 31, 2007, we ceased capitalizing internal software and development costs as the asset was put into service.

 

Interest and Other Income (Expense), Net

 

Interest and other income (expense) consists primarily of interest income earned on cash balances. We historically have invested our cash in money market funds. Interest and other income (expense) includes interest expense on our debt facilities.

 

Net interest and other income was $1.6 million for the three months ended September 30, 2007, compared to net interest and other income of $5,000 for the three months ended September 30, 2006. For the nine months ended September 30, 2007, net interest and other income was $2.3 million, compared to net interest and other expense of $49,000 for the nine months ended September 30, 2006. The increase in interest and other income in the three and nine months ended September 30, 2007 as compared to September 30, 2006 were primarily due to interest income earned on the proceeds from our IPO, partially offset by interest expense on our outstanding debt.

 

Income Taxes

 

No provision for income taxes was recorded for either the three or nine month periods ended September 30, 2007 or 2006. We provided a full valuation allowance for our deferred tax assets because the realization of any future tax benefits could not be sufficiently assured as of September 30, 2007 or 2006.

 

Liquidity and Capital Resources

 

Overview

 

In May 2007, we completed our IPO of 4,312,500 shares of common stock at a price of $26.00 per share, which includes the exercise of the underwriters’ over-allotment option to purchase 562,500 shares and the sale of 225,000 shares by certain of our stockholders. Net proceeds to us from the IPO were approximately $95.2 million (net of underwriting discounts and commissions and offering expenses). Prior to our IPO, we primarily funded our operations through the issuance of an aggregate of $27.9 million in preferred stock and $7.5 million in borrowings under our loan and security agreement. We used these proceeds to fund our operations, to develop our technology for our demand response programs, to open new markets and to make acquisitions.

 

We had approximately $73.8 million in cash and cash equivalents as of September 30, 2007, compared to $9.2 million at December 31, 2006. In October 2007, we posted cash collateral of $10.9 million in connection with certain of our open market bidding commitments. We believe that our existing cash and cash equivalents, including the net proceeds from our IPO and borrowings under our loan and security agreement, will be sufficient to meet our anticipated cash needs for at least the next 24 months.

 

19



 

Cash Flows

 

The following table summarizes our cash flows for the nine months ended September 30, 2007 and 2006 (dollars in thousands):

 

 

 

Nine Months
Ended

 

 

 

September 30,
2007

 

September 30,
2006

 

 

 

(In thousands)

 

Cash flows used in operating activities

 

$

(6,591

)

$

(2,270

)

Cash flows used in investing activities

 

(33,088

)

(6,556

)

Cash flows provided by financing activities

 

104,285

 

1,916

 

Net increase (decrease) in cash and cash equivalents

 

$

64,606

 

$

(6,910

)

 

Cash Flows Used in Operating Activities

 

Cash used in operating activities primarily consists of net income (loss) adjusted for certain non-cash items including depreciation and amortization, stock-based compensation expenses, and the effect of changes in working capital and other activities.

 

Cash used in operating activities in the nine months ended September 30, 2007 was $6.6 million and consisted of a $14.5 million net loss and approximately $1.5 million of net cash used for working capital purposes and other activities, offset by $9.4 million of non-cash items, consisting primarily of depreciation and amortization, interest expense and stock-based compensation charges. Cash used for working capital and other activities primarily reflected a $7.6 million increase in accounts receivable due to increased revenues, a $0.5 million increase in prepaid expenses and other current assets, a $1.3 million increase in deferred cost of sales, and a decrease of $1.2 million in other noncurrent assets. These amounts were partially offset by an increase of $2.8 million in accounts payable and accrued expenses, an increase in accrued capacity payments of $4.5 million and an increase in deferred revenue of $1.7 million as our operations continued to grow.

 

Cash used in operating activities in the nine months ended September 30, 2006 was $2.3 million and consisted of a $1.7 million net loss and $2.9 million of net cash used by working capital and other activities offset by $2.3 million of non-cash items, consisting primarily of depreciation and amortization and stock-based compensation charges. Cash used by working capital and other activities primarily reflected a $6.7 million increase in accounts receivable offset by a $0.6 million increase in accounts payable and accrued expenses as our operations continued to grow, a $3.4 million increase in accrued capacity payments and other noncurrent liabilities.

 

Cash Flows Used in Investing Activities

 

Cash used in investing activities was $33.1 million and $6.6 million for the nine months ended September 30, 2007 and 2006, respectively. Our principal cash investments related to installation services used to build out and expand our demand response programs, purchases of property and equipment, the cash portion of the purchase price for our acquisitions of MDE and Pinpoint Power DR, the acquisition of the assets of eBidenergy Inc, and the acquisition of substantially all of the assets of Celerity Energy Partners LLC. For the nine months ended September 30, 2007, purchases of available-for-sale securities were approximately $15.0 million and sales of available-for-sale maturities were $2.4 million.

 

Cash Flows Provided by Financing Activities

 

Cash flows provided by financing activities were $104.3 million and $1.9 million for the nine months ended September 30, 2007 and 2006, respectively. Cash flows provided by financing activities consisted of the following:

 

Equity Financing Activities

 

In May 2007, we completed our IPO of 4,312,500 shares of common stock at a price of $26.00 per share, which includes the exercise of the underwriters’ over-allotment option to purchase 562,500 shares and the sale of 225,000 shares by certain of our stockholders. Net proceeds to us from the IPO were approximately $95.2 million (net of underwriting discounts and commissions and offering expenses). In January 2007, we raised $10 million of proceeds through sales of our Series C Convertible Preferred Stock. In May 2006, we raised $2.6 million of proceeds through sales of our Series B-1 Convertible Preferred Stock. In addition, we received approximately $0.1 million and $1,000 from exercises of common stock options during the nine months ended September 30, 2007 and September 30, 2006, respectively.

 

During the nine months ended September 30, 2007, we increased our restricted cash by $2.0 million and incurred $3.6 million of costs associated with the filing of our IPO. In February 2007, we repurchased 104,393 shares of our common stock for $0.4 million.

 

20



 

Credit Facility Borrowings

 

During the nine months ended September 30, 2007, we borrowed $2.5 million under the loan and security agreement and made scheduled principal payments on our outstanding debt and capital lease obligations of $1.0 million. During the nine months ended September 30, 2006, we made $0.6 million of scheduled principal payments on our outstanding debt.

 

Capital Spending

 

We have made capital expenditures primarily for general corporate purposes to support our growth and for equipment installation related to our demand response programs. Our capital expenditures totaled $15.7 million and $2.1 million for the nine months ended September 30, 2007 and 2006, respectively. Under certain of our contracts we are required to make capital expenditures of $4.0 million to $6.0 million related to environmental control facilities. Most of those expenditures are expected to be made in 2007 and the first half of 2008, and we do not expect to make additional capital expenditures in connection with those contracts unless our capacity commitment is expanded under the contracts.

 

Contractual Obligations

 

The disclosures relating to our contractual obligations in our registration statement on Form S-1, which we filed with the SEC on October 29, 2007, have not materially changed since we filed that registration statement. As described in our registration statement, during the third quarter of 2007 and as part of our acquisition of MDE, we incurred the obligation to pay to the former members of MDE an earnout amount equal to two times the revenues of MDE’s business during the period from July 1, 2007 through December 31, 2007.  The earnout will be payable in cash during the first quarter of 2008.  Also in connection with the MDE acquisition, we are obligated to pay to certain employees of MDE a cash bonus payment of up to $300,000 in the first quarter of 2008 and up to $600,000 in the first quarter of 2009 upon the achievement of certain revenue-based milestones during 2007 and 2008, respectively, related to MDE’s services.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements other than letters of credit issued in the ordinary course of business.

 

Application of Critical Accounting Policies and Use of Estimates

 

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ significantly from these estimates under different assumptions or conditions. There have been no material changes to these estimates during the third quarter of 2007. For a detailed explanation of the judgments made in these areas, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” within our registration statement on Form S-1, which we filed with the SEC on October 29, 2007.

 

Item 3.  Quantitative and Qualitative Disclosure About Market Risk .

 

Foreign Exchange Risk

 

We face minimal exposure to adverse movements in foreign currency exchange rates.

 

Interest Rate Risk

 

As of September 30, 2007, all of our $6.7 million of outstanding debt was at fixed interest rates; therefore, there was no significant impact from changes in interest rates.

 

We manage our cash and cash equivalents portfolio considering investment opportunities and risks, tax consequences and overall financing strategies. Our investment portfolio consists primarily of cash and cash equivalents, money market funds, and municipal auction rate securities with carrying amounts approximating market value. As our investments are made with highly rated municipal auction rate securities and short-term securities, we are not anticipating any significant impact in the short term from a change in interest rates.

 

Item 4T.  Controls and Procedures .

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2007. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that 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. Disclosure controls and procedures include, without limitation, controls and procedures 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 accumulated and communicated to the company’s management, including its

 

21



 

principal executive and principal financial officers as appropriate to allow timely decisions regarding required disclosure. 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. Based on the evaluation of our disclosure controls and procedures as of September 30, 2007, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

 

Internal Control over Financial Reporting

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2007, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II — OTHER INFORMATION

 

Item 1.    Legal Proceedings .

 

In the ordinary conduct of our business we are subject to periodic lawsuits, investigations and claims.  Although we cannot predict with certainty the ultimate resolution of such lawsuits, investigations and claims against us, we do not believe that any currently pending or threatened legal proceeding or proceedings to which we are a party will have a material adverse effect on our business, results of operations, cash flows or financial condition.

 

Item 1A.  Risk Factors .

 

An investment in our common stock involves a high degree of risk. You should carefully read and consider the risks and uncertainties described below together with the other information contained in this Quarterly Report on Form 10-Q, including our financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the risks and uncertainties described under the section titled “Risk Factors” of our registration statement on Form S-1 that we filed with the SEC on October 29, 2007, before making an investment decision. If any of these risks actually occurs, our business, financial condition, results of operations, and future growth prospects may suffer. As a result, the trading price of our common stock could decline, and you may lose all or part of your investment.

 

Risks Related to Our Business

 

We have incurred net losses since our inception, and we may continue to incur net losses in the future and may never reach profitability.

 

Our net losses in 2004, 2005 and 2006 were $1.9 million, $1.7 million and $5.8 million, respectively. Our net operating loss for the three and nine months ended September 30, 2007 was $2.5 million and $14.5 million, respectively. We have not achieved profitability for any calendar year, although we have for certain quarters, and we expect to continue to incur operating losses for the foreseeable future. As of September 30, 2007, we had an accumulated deficit of $24.8 million. Initially, our operating losses were principally driven by start-up costs and the costs of developing our technology, which included research and development. More recently, our net losses have been principally driven by selling and marketing, and general and administrative expenses. As we seek to grow our revenues and customer base, we plan to continue to expand our demand response and energy management solutions, which will require increased selling and marketing, general and administrative, and research and development expenses. These increased operating costs may cause us to incur net losses for the foreseeable future, and there can be no assurance that we will be able to grow our revenues, sustain the growth rate of our revenues, expand our customer base or become profitable. Furthermore, these expenses are not the only factors that may contribute to our net losses. For example, interest expense on our currently outstanding debt and on any debt that we incur in the future could contribute to our net losses. As a result, even if we significantly increase our revenues, we may continue to incur net losses in the future. If we fail to achieve profitability, the market price of our common stock could decline substantially.

 

We have a limited operating history in an emerging market, which may make it difficult to evaluate our business and prospects, and may expose us to increased risks and uncertainties.

 

We began operating as a New Hampshire limited liability company in December 2001, and were incorporated as a Delaware corporation in June 2003. We first began generating revenues in 2003. Accordingly, we have only a limited history of generating revenues, and the future revenue potential of our business in the emerging market for clean and intelligent energy solutions is uncertain. As a result of our short operating history, we have limited financial data that can be used to evaluate our business, strategies, performance and prospects or an investment in our common stock. Any evaluation of our business and our prospects must be considered in light of our limited operating history and the risks and uncertainties encountered by companies at our stage of development. To address these risks and uncertainties, we must do the following:

 

     maintain our current relationships and develop new relationships with grid operators and utilities and the entities that regulate them;

 

     maintain and expand our current relationships and develop new relationships with commercial, institutional and industrial customers;

 

     maintain and enhance our existing demand response and energy management solutions;

 

22



 

           continue to develop clean and intelligent energy solutions that achieve significant market acceptance;

 

           continue to enhance our information processing systems;

 

           execute our business and marketing strategies successfully;

 

           respond to competitive developments;

 

           attract, integrate, retain and motivate qualified personnel; and

 

           continue to participate in shaping the regulatory environment.

 

We may be unable to accomplish one or more of these objectives, which could cause our business to suffer. In addition, accomplishing many of these goals might be very expensive, which could adversely impact our operating results and financial condition. Any predictions about our future operating results may not be as accurate as they could be if we had a longer operating history.

 

Our results of operations could be adversely affected if our operating expenses do not correspond with the timing of our revenues.

 

Most of our operating expenses, such as employee compensation and rental expense for properties, are either relatively fixed in the short-term or incurred in advance of sales. Moreover, our spending levels are based in part on our expectations regarding future revenues. As a result, if revenues for a particular quarter are below expectations, we may not be able to proportionately reduce operating expenses for that quarter. For example, if a demand response event or metering and verification test does not occur in a particular quarter, we may not be able to recognize revenues for the undemonstrated capacity in that quarter. This shortfall in revenues could adversely affect our operating results for that quarter and could cause the market price of our common stock to decline substantially.

 

We operate in highly competitive markets; if we are unable to compete successfully, we could lose market share and revenues.

 

The market for clean and intelligent energy solutions is fragmented. Some traditional providers of advanced metering solutions have added, or may add, demand response services to their existing business. We face strong competition from clean and intelligent energy solutions providers, both larger and smaller than we are. We also compete against traditional supply-side resources such as natural gas-fired peaking power plants. In addition, utilities and competitive electricity suppliers offer their own demand response solutions, which could decrease our base of potential customers along with our revenues and profitability.

 

Many of our competitors have greater financial resources than we do. Our competitors could focus their substantial financial resources to develop a competing business model or develop products or services that are more attractive to potential customers than what we offer. Some advanced metering infrastructure service providers, for example, are substantially larger and better capitalized than we are and have the ability to combine advanced metering and demand response solutions into an integrated offering to a large, existing customer base. Our competitors may offer clean and intelligent energy solutions at prices below cost or even for free in order to improve their competitive positions. Any of these competitive factors could make it more difficult for us to attract and retain customers, cause us to lower our prices in order to compete, and reduce our market share and revenues, any of which could have a material adverse effect on our financial condition and results of operations. In addition, we may also face competition based on technological developments that reduce peak demand for electricity, increase power supplies through existing infrastructure or that otherwise compete with our demand response and energy management solutions.

 

If we fail to successfully educate existing and potential grid operator and utility customers regarding the benefits of our demand response and energy management solutions or a market otherwise fails to develop for those solutions, our ability to sell our solutions and grow our business could be limited.

 

Our future success depends on commercial acceptance of our clean and intelligent energy solutions and our ability to obtain additional contracts. We anticipate that revenues related to our demand response solutions will constitute a substantial portion of our revenues for the foreseeable future. The market for clean and intelligent energy solutions in general is relatively new. If we are unable to educate our potential customers about the advantages of our solutions over competing products and services, or our existing customers no longer rely on our demand response solutions, our ability to sell our solutions will be limited. In addition, because the clean and intelligent energy solutions sector is rapidly evolving, we cannot accurately assess the size of the market, and we may have limited insight into trends that may emerge and affect our business. For example, we may have difficulty predicting customer needs and developing clean and intelligent energy solutions that address those needs. If the market for our demand response and our energy management solutions does not continue to develop, our ability to grow our business could be limited and we may not be able to achieve profitability.

 

If the actual amount of demand response capacity that we make available under our capacity contracts is materially less than required, our committed capacity could be reduced and we could be required to make refunds and pay penalty fees.

 

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We provide demand response capacity to our grid operator and utility customers either under fixed price long-term contracts, or under terms established in open bidding markets where capacity is purchased. Under the long-term contracts and open bidding market commitments, grid operators and utilities make periodic payments to us based on the amount of demand response capacity that we are obligated to make available to them during the contract period, or make monthly payments to us based on the amount of demand response capacity that we chose to make available to them during the relevant period. We refer to these payments as committed capacity payments. Committed capacity is negotiated and established by the contract or set in the open market bidding process and is subject to subsequent confirmation by measurement and verification tests or performance in a demand response event. In our open bidding markets, we offer different amounts of committed capacity to our grid operator and utility customers based on market rules on a periodic basis. We refer to measured and verified capacity as our demonstrated or proven capacity. Once demonstrated, the proven capacity amounts typically establish a baseline of capacity for each end-use customer site in our portfolio, on which committed capacity payments are calculated going forward and until the next demand response event or measurement and verification test when we are called to make capacity available.

 

The capacity level that we are able to achieve varies with the electricity demand of targeted equipment, such as heating and cooling equipment, at the time an end-use customer is called to perform. Accordingly, our ability to deliver committed capacity depends on factors beyond our control, such as temperature and humidity and the time of day that an end-use customer is called to perform. The correct operation of, and timely communication with, devices used to control equipment are also important factors that affect available capacity. Under some of our contracts, any difference between our demonstrated capacity and the committed capacity on which capacity payments were previously made will result in either a refund payment from us to our grid operator or utility customer or an additional payment to us by such customer. Any refund payable by us would reduce our deferred revenues, but would not impact our previously recognized revenues. If there is a true-up settlement due to a grid operator or utility customer, we generally make a corresponding adjustment in our payments to the end-use customer or customers who failed to make the appropriate level of capacity available, however we are sometimes unable to do so. In addition, some of our contracts with and open market programs established by our grid operator and utility customers provide for penalty payments, which can be substantial, in certain circumstances in which we do not meet our capacity commitments, either in measurement and verification tests or in demand response events. Further, because measurement and verification test results for some capacity contracts establish capacity levels on which payments will be made until the next test or demand response event, the payments to be made to us under such capacity contracts would be reduced until the level of capacity is established at the next test or demand response event. To date we have been required to make only de minimis refund and penalty payments, and we have incurred only immaterial downward adjustments in capacity payments, as a result of failures to achieve our committed capacity levels. However, we could experience significant period-to-period fluctuations in our financial results in future periods due to true-up settlements, capacity payment adjustments, replacement costs or other payments, which could be substantial. We incurred aggregate penalty payments of $54,971 and $1,971 during the nine months ended September 30, 2007 and September 30, 2006, respectively.

 

Our business may become subject to modified or new government regulation, which may negatively impact our ability to market our clean and intelligent energy solutions.

 

While the electric power markets in which we operate are regulated, we are not directly subject to the regulatory framework applicable to the generation and transmission of electricity. However, the installation of devices used in providing those solutions and electric generators sometimes installed or activated when providing demand response solutions may be subject to governmental oversight and regulation under state and local ordinances relating to building codes, public safety regulations pertaining to electrical connections and local and state licensing requirements. In the future, federal, state, provincial or local governmental entities may seek to change existing regulations or impose additional regulations. Any modified or new government regulation applicable to our current or future solutions, whether at the federal, state, provincial or local level, may negatively impact the installation, servicing and marketing of those solutions and increase our costs and the price of our solutions. In a relatively few instances, we have agreed to own and operate a back-up generator at a commercial, institutional or industrial customer location for a period of time and to activate the generator when capacity is called for dispatch so that the commercial, institutional or industrial customer can reduce its consumption of electricity from the electric power grid. These generators could become ineligible to participate in demand response programs in the future, or be compensated less for such participation, thereby reducing our revenues and adversely affecting our financial position. In addition, certain of our contracts and expansion of existing contracts with grid operators and utility customers are subject to approval by state or local regulatory agencies. There can be no assurance that such approvals will be obtained or be issued on a timely basis  For example, we received notification in October 2007 from the California Public Utilities Commission, or the CPUC, that the CPUC denied our initial 25 MW expansion request that San Diego Gas & Electric, or SDG&E, had supported for our demand reduction program, citing procedural requirements that SDG&E and we purposely omitted by seeking fast-tracked approval of our clean capacity resource. Although we are working with SDG&E and the CPUC on the procedural actions that the CPUC recommends, we cannot be certain that our expansion request will be granted.

 

A substantial majority of our revenues are generated from contracts with, and open market sales to, a small number of grid operator and utility customers, including in particular one grid operator customer, and the modification or termination of these contracts or sales relationships could materially adversely affect our business.

 

A majority of our revenues have been generated from contracts with, and open market sales to, ISO New England Inc. This customer accounted for 86%, 65% and 61% of our total revenues in

 

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2005, 2006 and the nine months ended September 30, 2007, respectively. Moreover, revenues from our three largest grid operator and utility customers represented approximately 88%, 93% and 88% of our total revenues in 2005, 2006 and the nine months ended September 30, 2007, respectively. Any modification or termination of these contracts or key customer relationships could have a material adverse effect on our business.

 

A substantial portion of our revenues historically have been derived from three fixed price contracts. In 2005 and 2006, and the nine months ended September 30, 2007, these contracts accounted for approximately 86%, 62% and 49%, respectively, of our total revenues. Although we have entered into additional long-term contracts in different geographic regions and are regularly in discussions with our customers to extend our existing contracts or enter into new contracts with these existing customers, two of the three major contracts described above expire in May 2008 and the third expires in December 2008. There can be no assurance that any of these contracts will be extended or that we will enter into new contracts on favorable terms. If these contracts are not extended or replaced, we would expect to enroll the capacity that we make available under such contracts in another demand response capacity program, although there is no assurance that we would be able to do so. In addition, other programs could provide lower capacity payments than our existing fixed price contracts. Thus, the failure to renew any of these contracts could significantly reduce our revenues.

 

Failure of third parties to manufacture quality products or provide reliable services in a timely manner could cause delays in the delivery of our solutions, which could damage our reputation, cause us to lose customers and negatively impact our growth.

 

Our success depends on our ability to provide quality, reliable demand response and energy management solutions in a timely manner, which in part requires the proper functioning of facilities and equipment owned, operated or manufactured by third parties upon which we depend. For example, our reliance on third parties includes:

 

     utilizing components that we install or have installed at commercial, institutional and industrial locations;

 

     outsourcing email notification and cellular and paging wireless communications that are used to notify our end-use customers of their need to reduce electricity consumption at a particular time and to execute instructions to devices installed at our customer locations and which are programmed to automatically reduce consumption on receipt of such communications; and

 

     outsourcing certain installation and maintenance operations to third-party providers.

 

Any delays, malfunctions, inefficiencies or interruptions in these products, services or operations could adversely affect the reliability or operation of our demand response and energy management solutions, which could cause us to experience difficulty retaining current customers and attracting new customers. Such delays could also result in our making refunds or paying penalty fees to our grid operator and utility customers. In addition, our brand, reputation and growth could be negatively impacted.

 

If we lose key personnel upon whom we are dependent, we may not be able to manage our operations and meet our strategic objectives.

 

Our continued success depends to a considerable degree upon the continued availability, contributions, vision, skills, experience and effort of our senior management, sales and marketing, engineering and operations teams. We do not maintain “key person” insurance on any of our employees. We have entered into employment agreements with certain members of our senior management team, but none of these agreements guarantees the services of the individual for a specified period of time. All of the agreements with members of our senior management team provide that employment is at-will and may be terminated by the employee at any time and without notice. Although we do not have any reason to believe that we may lose the services of any of these persons in the foreseeable future, the loss of the services of any of these persons might impede our operations or the achievement of our strategic and financial objectives. We rely on our engineering team to research, design and develop new and enhanced demand response and energy management solutions. We rely on our operations team to install, test, deliver and manage our demand response solutions. The loss or interruption of the service of members of our senior management, sales and marketing, engineering or operations teams, or our inability to attract or retain other qualified personnel or advisors could have a material adverse effect on our business, financial condition and results of operations and could significantly reduce our ability to manage our operations and implement our strategy.

 

We expect to continue to expand our sales and marketing, operations, engineering, research and development capabilities and financial and reporting systems, and as a result, we may encounter difficulties in managing our growth, which could disrupt our operations.

 

We expect to experience significant growth in the number of our employees and the scope of our operations. To manage our anticipated future growth, we must continue to implement and improve our managerial, operational, financial and reporting systems, expand our facilities, and continue to recruit and train additional qualified personnel. All of these measures will require significant expenditures and will demand the attention of management. Due to our limited resources, we may not be able to effectively manage the expansion of our operations or recruit and adequately train additional qualified personnel. The physical expansion of our operations may lead to significant costs and may divert our management and business development resources. Any inability to manage growth could delay the execution of our business plans or disrupt our operations.

 

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We are currently in the process of implementing a new software system that will integrate all of our departments and functions onto a single computer system. Any difficulties or delays in implementing this system could make it more difficult for us to grow and manage our operations, divert management attention from operations and require further expense.

 

We compete for personnel and advisors with other companies and other organizations, many of which are larger and have greater name recognition and financial and other resources than we do. If we are not able to hire, train and retain the necessary personnel, or if these managerial, operational, financial and reporting improvements are not implemented successfully, we could lose customers and revenues.

 

We allocate our operations, sales and marketing, research and development, general and administrative, and financial resources based on our business plan, which includes assumptions about current and future contracts with grid operator and utility customers and commercial, institutional and industrial customers, variable prices in open markets for demand response capacity, the development of ancillary services markets which enable demand response as a revenue generating resource and a variety of other factors relating to electricity markets, and the resulting demand for our demand response and energy management solutions. However, these factors are uncertain. If our assumptions regarding these factors prove to be incorrect or if alternatives to those offered by our solutions gain further acceptance, then actual demand for our demand response and energy management solutions could be significantly less than the demand we anticipate and we may not be able to sustain our revenue growth or achieve profitability.

 

An oversupply of electric generation capacity and varying regulatory structures in certain regional power markets could negatively affect our business and results of operations.

 

Although demand for electric capacity has been increasing throughout North America, a buildup of new electric generation facilities could result in excess electric generation capacity in certain regional power markets. In addition, the electric power industry is highly regulated. The regulatory structures in regional electricity markets are varied and some regulatory requirements make it more difficult for us to provide some or all of our demand response solutions in those regions. For instance, in some markets, such as Texas, regulated quantity or payment levels for demand response capacity or energy make it more difficult for us to cost-effectively enroll and manage many commercial, institutional and industrial customers in demand response programs. Further, some markets, such as New York, have regulatory structures that do not yet include demand response as a qualifying resource for purposes of short-term reserve requirements known as ancillary services. As part of our business strategy, we intend to expand into additional regional electricity markets. However, the combination of excess electric generation capacity and unfavorable regulatory structures could limit the number of regional electricity markets available to us for expansion. Unfavorable regulatory decisions in markets where we currently operate could also negatively affect our business. For example, regulators could modify market rules in certain areas to further limit the use of back-up generators in demand response markets or could implement bidding caps that could lower our revenue opportunities. A limit on back-up generators would mean that some of the capacity reductions we aggregate from end-use customers willing to reduce consumption from the grid by activating their own back-up generators during demand response events would not qualify as capacity, and we would have to find additional sources of capacity from end-use customers willing to reduce load by curtailing consumption rather than by generating electricity themselves.

 

We face pricing pressure relating to electric capacity made available to grid operators and utilities and in the percentage or fixed amount paid to commercial, institutional and industrial customers for making capacity available, which could adversely affect our results of operations and financial position and delay or prevent our future profitability.

 

The rapid growth of the clean and intelligent energy solutions sector is resulting in increasingly aggressive pricing, which could cause the prices for clean and intelligent energy solutions to decrease over time. Our grid operator and utility customers may switch to other clean and intelligent energy solutions providers based on price, particularly if they perceive the quality of our competitors’ products or services to be equal or superior to ours. Continued decreases in the price of capacity by our competitors could result in a loss of grid operator and utility customers or a decrease in the growth of our business, or it may require us to lower our prices for capacity to remain competitive, which would result in reduced revenues and lower profit margins and would adversely affect our results of operations and financial position and delay or prevent our future profitability. Continued increases in the percentage or fixed amount paid to commercial, institutional and industrial customers by our competitors for making capacity available could result in a loss of commercial, institutional and industrial customers or a decrease in the growth of our business. It also may require us to increase the percentage or fixed amount we pay to our commercial, institutional and industrial customers to remain competitive, which would result in increases in the cost of revenues and lower profit margins and would adversely affect our results of operations and financial position and delay or prevent our future profitability.

 

Our inability to protect our intellectual property could negatively affect our business and results of operations.

 

Our ability to compete effectively depends in part upon the maintenance and protection of the intellectual property related to our demand response solutions. We hold only one issued patent. Patent protection is unavailable for certain aspects of the technology and operational processes that are important to our business. Any patent held by us or to be issued to us, or any of our pending patent applications, could be challenged, invalidated, unenforceable or circumvented. Moreover, some of our trademarks which are not in use may become available to others. To date, we have relied principally on copyright, trademark and trade secrecy laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our intellectual property. However, we have not obtained confidentiality agreements from all of our customers and vendors and although we have entered into confidentiality agreements with all of our employees, we cannot be certain

 

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that these agreements will be honored. Some of our confidentiality agreements are not in writing, and some customers are subject to laws and regulations that require them to disclose information that we would otherwise seek to keep confidential. Policing unauthorized use of our intellectual property is difficult and expensive, as is enforcing our rights against unauthorized use. The steps that we have taken or may take may not prevent misappropriation of the intellectual property on which we rely. In addition, effective protection may be unavailable or limited if we expand to other jurisdictions outside the United States, as the intellectual property laws of foreign countries sometimes offer less protection or have onerous filing requirements. From time to time, third parties may infringe our intellectual property rights. Litigation may be necessary to enforce or protect our rights or to determine the validity and scope of the rights of others. Any litigation could be unsuccessful, cause us to incur substantial costs, divert resources away from our daily operations, and result in the impairment of our intellectual property. Failure to adequately enforce our rights could cause us to lose rights in our intellectual property and may negatively affect our business.

 

We may be subject to damaging and disruptive intellectual property litigation related to allegations that our demand response and energy management solutions infringe on intellectual property held by others, which could result in the loss of use of those solutions.

 

Third-party patent applications and patents may be applicable to our clean and intelligent energy solutions. As a result, third-parties may in the future make infringement and other allegations that could subject us to intellectual property litigation relating to our solutions, which litigation could be time-consuming and expensive, divert attention and resources away from our daily operations, impede or prevent delivery of our solutions, and require us to pay significant royalties, licensing fees and damages. In addition, parties making infringement and other claims may be able to obtain injunctive or other equitable relief that could effectively block our ability to provide our solutions and could cause us to pay substantial damages. In the event of a successful claim of infringement, we may need to obtain one or more licenses from third parties, which may not be available at a reasonable cost, or at all.

 

If our information technology systems fail to adequately gather and assess data used in providing our clean and intelligent energy solutions, or if we experience an interruption in their operation, our business, financial condition and results of operations could be adversely affected.

 

The efficient operation of our business is dependent on our information technology systems. We rely on our information technology systems to effectively control the devices which enable our demand response solutions; gather and assess data used in providing our energy management solutions; manage relationships with our customers; and maintain our research and development data. The failure of our information technology systems to perform as we anticipate could disrupt our business and product development and make us unable, or severely limit our ability, to respond to demand response events. In addition, our information technology systems are vulnerable to damage or interruption from:

 

            earthquake, fire, flood and other natural disasters;

 

            terrorist attacks and attacks by computer viruses or hackers;

 

            power loss; and

 

            computer systems, Internet, telecommunications or data network failure.

 

Although our information technology systems have fail-over redundancy where they are housed, we do not have geographic fail-over redundancy. Any interruption in the operation of our information technology systems could result in decreased revenues under our demand response contracts and energy management contracts and commitments, reduced margins on revenues where fixed payments are due to our commercial, institutional, and industrial customers, reductions in our demonstrated capacity levels going forward, customer dissatisfaction and lawsuits and could subject us to penalties, any of which could have a material adverse effect on our business, financial condition and results of operations.

 

We depend on the electric power industry for revenues and, as a result, our operating results have experienced, and may continue to experience, significant variability due to volatility in electric power industry spending and other factors affecting the electric utility industry, such as seasonality of peak demand.

 

We currently derive substantially all of our revenues from the sale of demand response solutions, directly or indirectly, to the electric power industry. Purchases of our demand response solutions by grid operators or electric utilities may be deferred or cancelled as a result of many factors, including mergers and acquisitions involving electric utilities, changing regulations, fluctuations in interest rates and increased electric utility capital spending on traditional supply-side resources. In addition, sales of capacity in open markets are particularly susceptible to variability based on changes in the spending patterns of our grid operator and utility customers and on associated fluctuating market prices for capacity. In addition, peak demand for electricity and other capacity constraints tend to be seasonal. Peak demand in the United States tends to be most extreme in warmer months. Hence, some capacity markets yield higher prices for capacity or contract for the availability of a greater amount of capacity during these warmer months. As a result, our demand response revenues can be seasonal. For example, in 2006, our demand response revenues in the third quarter were higher than our demand response revenues in the fourth quarter. Further, occasional events, such as a spike in natural gas prices, can lead grid operators and utilities to implement short-term calls for demand response capacity to respond

 

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to these events, but we cannot be sure that such calls will continue or that we will be in a position to generate revenues when they do occur. In the first quarter of 2006, we earned $3.6 million under the Demand Response Winter Supplemental Program, a temporary demand response program established by ISO New England Inc. in response to an anticipated shortage in natural gas resulting from Hurricanes Katrina and Rita. We have experienced, and may in the future experience, significant variability in our revenues, on both an annual and a quarterly basis, as a result of these and other factors. Pronounced variability or an extended period of reduction in spending by grid operators and utilities, or continued requests from grid operators and utilities to pay for demand response capacity at prices that are not equal on a monthly or quarterly basis over the course of a contract year, could negatively impact our business and make it difficult for us to accurately forecast our future sales, which could lead to increased spending by us that does not result in increases in revenues.

 

Electric power industry sales cycles can be lengthy and unpredictable and require significant employee time and financial resources with no assurances that we will realize revenues.

 

Sales cycles with grid operator and utility customers are generally long and unpredictable. The grid operators and utilities that are our potential customers generally have extended budgeting, procurement and regulatory approval processes. They also tend to be risk averse and tend to follow industry trends rather than be the first to purchase new products or services, which can extend the lead time for or prevent acceptance of new products or services such as our demand response solutions. Accordingly, our potential customers may take longer to reach a decision to purchase services. This extended sales process requires the dedication of significant time by our personnel and our use of significant financial resources, with no certainty of success or recovery of our related expenses. It is not unusual for a grid operator or utility customer to go through the entire sales process and not accept any proposal or quote.

 

An increased rate of terminations by our commercial, institutional and industrial customers, or their failure to renew contracts when they expire, would negatively impact our business by reducing our revenues and requiring us to spend more money to maintain and grow our commercial, institutional and industrial customer base.

 

Our ability to provide demand response capacity under our demand response contracts depends on the number of commercial, institutional and industrial customers who enter into agreements with us to reduce electricity consumption on demand and the levels of consumption which those customers agree to reduce. The average annual rate of terminations by our commercial, institutional and industrial customers in 2004, 2005, and 2006 was less than 1%. If this termination rate increases, or if customers do not renew their contracts as they expire, we will need to acquire additional commercial, institutional and industrial customers or expand our relationships with existing commercial, institutional and industrial customers in order to maintain our revenues and grow our business. The loss of revenues resulting from terminations could be significant, and limiting customer terminations is an important factor in our ability to achieve future profitability. If we are unsuccessful in controlling our commercial, institutional and industrial customer terminations, we may be unable to acquire a sufficient number of new customers or we may incur significant costs to replace customers, which could cause our revenues to decrease and our cost of revenues to increase, and delay or prevent our profitability.

 

The success of our businesses depends in part on our ability to develop new clean and intelligent energy solutions and increase the functionality of our current demand response and energy management solutions.

 

The market for demand response and energy management solutions is characterized by rapid technological changes, frequent new software introductions, Internet-related technology enhancements, uncertain product life cycles, changes in customer demands, and evolving industry standards and regulations. We may not be able to successfully develop and market new clean and intelligent energy solutions that comply with present or emerging industry regulations and technology standards. Also, any new regulation or technology standard could increase our cost of doing business.

 

From time to time, our customers have expressed a need for increased functionality in our solutions. In response, and as part of our strategy to enhance our clean and intelligent energy solutions and grow our business, we plan to continue to make substantial investments in the research and development of new technologies. Our future success will depend in part on our ability to continue to design new, competitive clean and intelligent energy solutions, enhance our existing demand response and energy management solutions and provide new, value-added services to our customers. Initiatives to develop new solutions will require continued investment, and we may experience unforeseen problems in the performance of our technologies and operational processes, including new technologies and operational processes that we develop and deploy, to implement our solutions. In addition, software addressing the procurement and management of energy assets is complex and can be expensive to develop, and new software and software enhancements can require long development and testing periods. If we are unable to develop new clean and intelligent energy solutions or enhancements to our existing demand response and energy management solutions on a timely basis, or if the market does not accept such solutions, we will lose opportunities to realize revenues and customers and our business and results of operations will be adversely affected.

 

Any internal or external security breaches involving our demand response and energy management solutions could harm our reputation, and even the perception of security risks of our solutions or the transmission of data over the Internet, whether or not valid, could inhibit market acceptance of our solutions and cause us to lose customers.

 

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We and our customers use our demand response and energy management solutions to compile and analyze sensitive or confidential information related to our customers. In addition, some of our demand response and energy management solutions allow us to remotely control equipment at commercial, institutional and industrial locations. Our demand response and energy management solutions rely on the secure transmission of proprietary data over the Internet for some of their functionality. Well-publicized compromises of Internet security could have the effect of substantially reducing confidence in the Internet as a medium of data transmission. The occurrence or perception of security breaches in our demand response and energy management solutions or our customers’ concerns about Internet security or the security of our solutions, whether or not they are warranted, could have a material adverse effect on our business, harm our reputation, inhibit market acceptance of our demand response and energy management solutions and cause us to lose customers, any of which could have a material adverse effect on our financial condition and results of operations.

 

We may come into contact with sensitive consumer information or data when we perform operational, installation or maintenance functions for our customers. Even the perception that we have improperly handled sensitive, confidential information could have a negative effect on our business. If, in handling this information, we fail to comply with privacy or security laws, we could incur civil liability to government agencies, customers and individuals whose privacy is compromised. In addition, third parties may attempt to breach our security or inappropriately use our demand response and energy management solutions through computer viruses, electronic break-ins and other disruptions. If a breach is successful, confidential information may be improperly obtained, and we may be subject to lawsuits and other liabilities.

 

We may require significant additional capital to pursue our growth strategy, but we may not be able to obtain additional financing on acceptable terms or at all.

 

The growth of our business will depend on substantial amounts of additional capital for marketing and product development of our demand response and energy management solutions. Our capital requirements will depend on many factors, including the rate of our revenue growth, our introduction of new solutions and enhancements to existing solutions, and our expansion of sales and marketing and product development activities. In addition, we may consider strategic acquisitions of complementary businesses or technologies to grow our business, such as our acquisition of MDE, which could require significant capital and could increase our capital expenditures related to future operation of the acquired business or technology. Because of our losses, we do not fit traditional credit lending criteria. We may not be able to obtain loans or additional capital on acceptable terms or at all. Moreover, our current loan and security agreement contains restrictions on our ability to incur additional indebtedness, which, if not waived, could prevent us from obtaining needed capital. Any future credit facilities would likely contain similar restrictions. In the event additional funding is required, we may not be able to obtain bank credit arrangements or effect an equity or debt financing on terms acceptable to us or at all. A failure to obtain additional financing when needed could adversely affect our ability to maintain and grow our business.

 

Our loan and security agreement contains financial and operating restrictions that may limit our access to credit. If we fail to comply with covenants in our loan and security agreement, we may be required to repay our indebtedness thereunder, which may have an adverse effect on our liquidity.

 

Provisions in our senior loan and security agreement with Bluecrest Capital Partners, L.P., or Bluecrest Capital, as assignee of Ritchie Capital Finance, L.L.C., impose restrictions on our ability to, among other things:

 

            incur more debt;

 

            pay dividends and make distributions;

 

            redeem or repurchase capital stock;

 

            create liens;

 

            enter into transactions with affiliates; and

 

            merge or consolidate.

 

Our loan and security agreement also contains other customary covenants. We may not be able to comply with these covenants in the future. Our failure to comply with these covenants may result in the declaration of an event of default and could cause us to be unable to borrow under our loan and security agreement with Bluecrest Capital. In addition to preventing additional borrowings under our loan and security agreement, an event of default, if not cured or waived, may result in the acceleration of the maturity of indebtedness outstanding under the agreement, which would require us to pay all amounts outstanding. If an event of default occurs, we may not be able to cure it within any applicable cure period, if at all. If the maturity of our indebtedness is accelerated, we may not have sufficient funds available for repayment or we may not have the ability to borrow or obtain sufficient funds to replace the accelerated indebtedness on terms acceptable to us, or at all.

 

Our ability to use our net operating loss carryforwards may be subject to limitation.

 

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Generally, a change of more than 50% in the ownership of a company’s stock, by value, over a three year period constitutes an ownership change for U.S. 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. The number of shares of our common stock that we issued in our IPO, together with any subsequent shares of stock we issue, may be sufficient, taking into account prior or future shifts in our ownership over a three year period, to cause us to undergo an ownership change. As a result, if we earn net taxable income, our ability to use our pre-change net operating loss carryforwards to offset U.S. federal taxable income may become subject to limitations, which could potentially result in increased future tax liability for us.

 

We may not be able to identify suitable acquisition candidates or complete acquisitions successfully, which may inhibit our rate of growth, and acquisitions that we complete may expose us to a number of unanticipated operational and financial risks.

 

In addition to organic growth, we intend to continue to pursue growth through the acquisition of companies or assets that may enable us to expand our project skill-sets and capabilities, enlarge our geographic market, add experienced management personnel and increase our service offerings. However, we may be unable to implement this growth strategy if we cannot identify suitable acquisition candidates, reach agreement on potential acquisitions on acceptable terms, successfully integrate personnel or assets that we acquire, or for other reasons. Our acquisition efforts may involve certain risks, including:

 

     we may have difficulty integrating operations and systems;

 

     key personnel and customers of the acquired company may terminate their relationships with the acquired company as a result of the acquisition;

 

     we may experience additional financial and accounting challenges and complexities in areas such as tax planning and financial reporting;

 

     we may assume or be held liable for risks and liabilities (including for environmental-related costs) as a result of our acquisitions, some of which we may not discover during our due diligence;

 

     our ongoing business may be disrupted or receive insufficient management attention; and

 

     we may not be able to realize the cost savings or other financial and operational benefits we anticipated.

 

The process of negotiating acquisitions and integrating acquired products, services, technologies, personnel, or businesses might result in operating difficulties and expenditures and might require significant management attention that would otherwise be available for ongoing development of our business, whether or not any such transaction is ever consummated. Moreover, we might never realize the anticipated benefits of any acquisition. Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities, or impairment expenses related to goodwill, and impairment or amortization expenses related to other intangible assets, which could harm our financial condition. In addition, if we are unable to integrate any acquired businesses, products or technologies effectively, our business, financial condition and results of operations may be materially adversely affected. In September 2007, we acquired MDE and there can be no assurance that we will be able to successfully integrate it or any other companies, products or technologies that we acquire.

 

Our ability to provide bid bonds, performance bonds or letters of credit is limited and could negatively affect our ability to bid on or enter into significant long-term agreements.

 

We are occasionally required to provide bid bonds or performance bonds to secure our performance under long-term contracts with our grid operator and utility customers. In addition, some of our customers also require collateral in the form of letters of credit to secure performance or to fund possible damages or true-up payments as the result of a failure to make available capacity at agreed levels or an event of default under our contracts with them. Our ability to obtain such bonds and letters of credit primarily depends upon our capitalization, working capital, past performance, management expertise and reputation and external factors beyond our control, including the overall capacity of the surety market. Surety companies consider those factors in relation to the amount of our tangible net worth and other underwriting standards that may change from time to time. Events that affect surety markets generally may result in bonding becoming more difficult to obtain in the future, or being available only at a significantly greater cost. As of September 30, 2007, we had $2.5 million of letters of credit outstanding. Our inability to obtain adequate bonding or letters of credit and, as a result, to bid or enter into significant long-term agreements, could have a material adverse effect on our future revenues and business prospects. In addition, in October 2007, we posted collateral of $10.9 million in connection with our open market bidding programs.

 

If the software we use in providing our demand response and energy management solutions produces inaccurate information or is incompatible with the systems used by our customers, it could make us unable to provide our solutions, which could lead to a loss of revenues and trigger penalty payments.

 

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Our software is complex and, accordingly, may contain undetected errors or failures when introduced or subsequently modified. Software defects or inaccurate data may cause incorrect recording, reporting or display of information about the level of demand reduction at a commercial, institutional and industrial customer location, which could cause us to fail to meet our commitments to have capacity available. Although we have not incurred penalty payments or adjusted revenue in 2005, 2006, or the first nine months of 2007 for failures to have capacity available due to inaccurate software information, any such failures could cause us to be subject to penalty payments to our grid operator and utility customers or reduce revenue in the period the adjustment is identified and result in reductions in capacity payments under contracts in subsequent periods. In addition, such defects and inaccurate data may prevent us from successfully providing our energy management solutions, which would result in lost revenues. Software defects or inaccurate data may lead to customer dissatisfaction and our customers may seek to hold us liable for any damages incurred. As a result, we could lose customers, our reputation may be harmed and our financial condition and results of operations could be materially adversely affected.

 

We currently serve a commercial, institutional and industrial customer base that uses a wide variety of constantly changing hardware, software applications and operating systems. Building control, process control and metering systems frequently reside on non-standard operating systems. Our demand response and energy management solutions need to interface with these non-standard systems in order to gather and assess data and to implement changes in electricity consumption. Our business depends on the following factors, among others:

 

      our ability to integrate our technology with new and existing hardware and software systems, including metering, building control, process control, and distributed generation systems;

 

      our ability to anticipate and support new standards, especially Internet-based standards and building control system protocol languages; and

 

      our ability to integrate additional software modules under development with our existing technology and operational processes.

 

If we are unable to adequately address any of these factors, our results of operations and prospects for growth and profitability could be materially adversely effected.

 

We may face certain product liability or warranty claims if we disrupt our customers’ networks or applications.

 

For some of our current and planned solutions, our software and hardware is integrated with our customers’ networks and software applications. The integration of our software and hardware may entail the risk of product liability or warranty claims based on disruption to these networks or applications. In addition, the failure of our software and hardware to perform to customer expectations could give rise to warranty claims against us. Any of these claims, even if without merit, could result in costly litigation or divert management’s attention and resources. Although we carry general liability insurance, our current insurance coverage could be insufficient to protect us from all liability that may be imposed under these types of claims. A material product liability claim may seriously harm our results of operations.

 

Risks Related to Our Common Stock

 

We expect our quarterly revenues and operating results to fluctuate. If we fail to meet the expectations of market analysts or investors, the market price of our common stock could decline substantially.

 

Our quarterly revenues and operating results have fluctuated in the past and may vary from quarter to quarter in the future. Accordingly, we believe that period-to-period comparisons of our results of operations may be misleading. You should not rely upon the results of one quarter as an indication of future performance. Our revenues and operating results may fall below the expectations of securities analysts or investors in some future quarter or quarters. Our failure to meet these expectations could cause the market price of our common stock to decline substantially.

 

Our quarterly revenues and operating results may vary depending on a number of factors, including:

 

      demand for and acceptance of our clean and intelligent energy solutions;

 

      delays in the implementation and delivery of our clean and intelligent energy solutions, which may impact the timing of our recognition of revenues;

 

      delays or reductions in spending for clean and intelligent energy solutions by our customers and potential customers;

 

      the long lead time associated with securing new customer contracts;

 

      the mix of our revenues during any period, particularly on a regional basis, since local payments for demand response capacity tend to vary according to the level of available capacity in given regions;

 

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      the termination of existing contracts with grid operator and utility customers;

 

      development of new relationships and maintenance and enhancement of existing relationships with customers and strategic partners;

 

      the pricing terms of some long-term capacity contracts that provide for higher payments during warmer months and lower payments during the rest of the year;

 

      temporary capacity programs that could be implemented by grid operators and utilities to address short-term capacity deficiencies, such as the 2006 Demand Response Winter Supplemental Program in New England after Hurricanes Katrina and Rita;

 

      changes in open market rules and pricing for demand response capacity; and

 

      increased expenditures for sales and marketing, software development and other corporate activities.

 

We do not intend to pay dividends on our common stock.

 

We have not declared or paid any cash dividends on our common stock to date, and we do not anticipate paying any dividends on our common stock in the foreseeable future. We currently intend to retain all available funds and any future earnings for use in the development, operation and growth of our business. In addition, our loan and security agreement prohibits us from paying dividends and future loan agreements may also prohibit the payment of dividends. Any future determination relating to our dividend policy will be at the discretion of our board of directors and will depend on our results of operations, financial condition, capital requirements, business opportunities, contractual restrictions and other factors deemed relevant. To the extent we do not pay dividends on our common stock, investors must look solely to stock appreciation for a return on their investment in our common stock.

 

Shares eligible for future sale may cause the market price for our common stock to decline even if our business is doing well.

 

Sales of substantial amounts of our common stock in the public market, or the perception that these sales may occur, could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital in the future through the sale of our equity securities. Under our certificate of incorporation, we are authorized to issue up to 50,000,000 shares of common stock, of which 18,564,556 shares of common stock were outstanding at September 30, 2007. Of these shares, the shares of common stock sold in our IPO are freely transferable without restriction or further registration under the Securities Act by persons other than “affiliates,” as that term is defined in Rule 144 under the Securities Act. In addition, substantially all of our shares of outstanding common stock will be freely tradeable immediately upon the termination of the lock-up agreements described below. Certain of our stockholders will be able to cause us to register common stock that they own under the Securities Act pursuant to registration rights that are described in “Certain Relationships and Related Transactions—Registration Rights” contained in our registration statement on Form S-1, which we filed with the SEC on October 29, 2007. We also registered all shares of common stock that we may issue under our Amended and Restated 2003 Stock Option and Incentive Plan, or 2003 Stock Plan, and our 2007 Employee, Director and Consultant Stock Plan, or 2007 Stock Plan.

 

Our executive officers and directors and most of our stockholders have entered into lock-up agreements in connection with our IPO, pursuant to which they have agreed, subject to certain exceptions and extensions, not to sell or transfer, directly or indirectly, any shares of our common stock for a period of 180 days from the date of our final prospectus dated May 17, 2007, which is on file with the SEC or to exercise registration rights during such period with respect to such shares. However, after the lock-up period expires, or if the lock-up restrictions are waived by the underwriters, such persons will be able to sell their shares and exercise registration rights to cause them to be registered. We cannot predict the size of future issuances of our common stock or the effect, if any, that future sales and issuances of shares of our common stock, or the perception of such sales or issuances, would have on the market price of our common stock.

 

Provisions of our charter, bylaws, and Delaware law and of some of our employment arrangements may make an acquisition of us or a change in our management more difficult and could discourage acquisition bids or merger proposals, which may adversely affect the market price of our common stock.

 

Certain provisions of our certificate of incorporation and bylaws could discourage, delay, or prevent a merger, acquisition, or other change of control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. These provisions also could limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. Stockholders who wish to participate in these transactions may not have the opportunity to do so. Furthermore, these provisions could prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions:

 

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      allow the authorized number of directors to be changed only by resolution of our board of directors;

 

      require that vacancies on the board of directors, including newly-created directorships, be filled only by a majority vote of directors then in office;

 

      establish a classified board of directors, providing that not all members of the board be elected at one time;

 

      authorize our board of directors to issue, without stockholder approval, blank check preferred stock that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our board of directors;

 

      require that stockholder actions must be effected at a duly called stockholder meeting and prohibit stockholder action by written consent;

 

      prohibit cumulative voting in the election of directors, which would otherwise allow holders of less than a majority of stock to elect some directors;

 

      establish advance notice requirements for stockholder nominations to our board of directors or for stockholder proposals that can be acted on at stockholder meetings;

 

      limit who may call stockholder meetings; and

 

      require the approval of the holders of 75% of the outstanding shares of our capital stock entitled to vote in order to amend certain provisions of our certificate of incorporation and bylaws.

 

Some of our employment arrangements and restricted stock and incentive stock option agreements provide for severance payments and accelerated vesting of benefits, including accelerated vesting of restricted stock and options, upon a change of control. These provisions may discourage or prevent a change of control.

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may, unless certain criteria are met, prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a proscribed period of time.

 

The requirements of being a public company, including compliance with the reporting requirements of the Securities Exchange Act of 1934 and The Nasdaq Global Market, require significant resources, increase our costs and distract our management, and we may be unable to comply with these requirements in a timely or cost-effective manner.

 

As a public company with equity securities listed on The Nasdaq Global Market, we must comply with statutes and regulations of the SEC and requirements of The Nasdaq Global Market, with which we were not required to comply prior to the completion of our initial public offering in May 2007. Complying with these statutes, regulations and requirements occupies a significant amount of the time of our board of directors and management and will significantly increases our costs and expenses.

 

In addition, as a public company we incur substantially higher costs to obtain director and officer liability insurance policies than we did as a private company. These factors could make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee.

 

Our failure to maintain adequate internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 or prevent or detect material misstatements in our annual or interim consolidated financial statements in the future could materially harm our business and cause our stock price to decline.

 

As a public company, our internal control over financial reporting is required to comply with the standards adopted by the Public Company Accounting Oversight Board in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Accordingly, we are required to document and test our internal controls and procedures to assess the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm is required to report on management’s assessment of the effectiveness of our internal control over financial reporting and the effectiveness of our internal control over financial reporting in 2008. If we are unable to maintain effective control over financial reporting, such conclusion would be disclosed in our Annual Report on Form 10-K for the year ending December 31, 2008. In the future, we may identify material weaknesses and deficiencies which we may not be able to remediate in a timely manner. If we fail to maintain effective internal control over financial reporting in accordance with Section 404, we will not be able to conclude that we have and maintain effective internal control over financial reporting or our independent registered accounting firm may not be able to issue an unqualified report on the effectiveness of our internal control over financial reporting. As a result, our ability to report our financial

 

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results on a timely and accurate basis may be adversely affected, we may be subject to sanctions or investigation by regulatory authorities, including the SEC or The Nasdaq Global Market, and investors may lose confidence in our financial information, which in turn could cause the market price of our common stock to decrease. We may also be required to restate our financial statements from prior periods. In addition, testing and maintaining internal control in accordance with Section 404 requires increased management time and resources. Any failure to maintain effective internal control over financial reporting could impair the success of our business and harm our financial results, and you could lose all or a significant portion of your investment.

 

Insiders will continue to have substantial control over us, which could delay or prevent a change of corporate control or result in the entrenchment of management and/or the board of directors.

 

As of September 30, 2007, our directors, executive officers and principal stockholders, together with their affiliates and related persons, beneficially own, in the aggregate, approximately 67% of our outstanding common stock. As a result, these stockholders, if acting together, will continue to have the ability to determine the outcome of matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation, or sale of all or substantially all of our assets. In addition, these persons, if acting together, will have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership may harm the market price of our common stock by:

 

      delaying, deferring, or preventing a change of control;

 

      entrenching our management and/or the board of directors;

 

      impeding a merger, consolidation, takeover, or other business combination involving us;

 

      discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us; or

 

      causing us to enter into transactions or agreements that are not in the best interests of all stockholders.

 

In addition, Delaware law limits the protection afforded minority stockholders, and we do not intend to enact provisions that may be beneficial to minority holders, such as cumulative voting.

 

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will continue to depend in part on the research and reports that securities or industry analysts publish about us or our business. If these analysts do not continue to provide adequate research coverage or if one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds .

 

(a)    Unregistered Sales of Equity Securities

 

We offered, issued and/or sold the following unregistered securities during the quarter ended September 30, 2007:

 

On September 13, 2007, in connection with our acquisition of MDE, we issued 139,056 shares of our common stock worth approximately $4.7 million to the holders of membership interests of MDE. Also on September 13, 2007, we issued 66,921 shares of our common stock to each of Lighthouse Capital Partners IV, L.P. and Lighthouse Capital Partners V, L.P. upon each entity’s net exercise of warrants to purchase shares of our common stock.

 

These issuances of securities were made in reliance on an exemption from the registration provisions of the Securities Act of 1933, as amended, or the Securities Act, set forth in Rule 506 of Regulation D promulgated thereunder. The recipients of securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and other instruments issued in such transactions. The sales of these securities were made without general solicitation or advertising.

 

(b)       Use of Proceeds

 

We registered shares of our common stock in connection with our IPO under the Securities Act. The registration statement on Form S-1 (File No. 333-140632) filed in connection with our IPO was declared effective by the SEC on May 17, 2007. The offering commenced on May 17, 2007 and did not terminate before any securities were sold. As of the date of this filing, the offering has terminated. Including shares sold pursuant to the exercise by the underwriters of their over-allotment option, 4,087,500 shares of our common stock were registered and sold in the IPO by us and an additional 225,000 shares of common stock were registered and sold by the selling stockholders named in the registration statement. All the shares were sold at a price to the public of $26.00 per share.

 

The managing underwriters of the offering were Credit Suisse Securities (USA) LLC and Morgan Stanley & Co. Incorporated. The net offering proceeds received by us, after deducting underwriting discounts and commissions and expenses incurred in connection with the offering, were approximately $95.2 million. These expenses consisted of direct payments of:

 

i.    $7.4 million in underwriters discounts, fees and commissions; and

 

ii.    $3.6 million in legal, accounting and printing fees and miscellaneous expenses.

 

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No payments for such expenses were directly or indirectly to (i) any of our directors, officers or their associates, (ii) any person(s) owning 10% or more of any class of our equity securities or (iii) any of our affiliates.

 

The net proceeds of approximately $95.2 million from the IPO are invested in short-term investment grade securities and money market accounts. We currently plan to use the net proceeds from the offering to fund the expansion of our business into new regions and expand our customer base, to finance research and development, to fund cash consideration for future acquisitions and for other general corporate purposes. We also may repay indebtedness. There has been no material change in the planned use of proceeds from our IPO as described in our final prospectus filed with the SEC on May 18, 2007 pursuant to Rule 424(b). Through September 30, 2007, the proceeds from our IPO have been used to fund the operations of our business and for general corporate purposes.

 

Item 5.  Other Information .

 

On November 1, 2007, we, the holders of substantially all of our shares of common stock issued upon conversion of our preferred stock in connection with our IPO, and our founders, entered into a fifth amended and restated investor rights agreement, which amended and restated our fourth amended and restated investor rights agreement, entered into on May 11, 2007.  The agreement provides, among other things, the parties thereto, as well as our executive officers, with certain registration rights and associated rights and obligations, including payment of expenses and indemnification by us in connection with the exercise of such registration rights.  The fifth amended and restated investor rights agreement has been included as an exhibit to this Quarterly Report on Form 10-Q as Exhibit 4.1.

 

Item 6.  Exhibits .

 

The following documents are filed as exhibits to this report:

 

2.1

 

Agreement and Plan of Merger, dated as of September 12, 2007, by and among EnerNOC, Inc., a Delaware corporation, Mdenergy, LLC, a Connecticut limited liability company, MDE Acquisition LLC, a Delaware limited liability company and a wholly-owned subsidiary of EnerNOC, Inc., Clifford Sirlin, in his capacity as the Mdenergy, LLC members’ representative, and Clifford Sirlin and Andrew Appelbaum, individually, filed as an Exhibit to EnerNOC, Inc.’s Current Report on Form 8-K (File No. 001-33471) filed on September 18, 2007 and incorporated herein by reference.

4.1

 

Fifth Amended and Restated Investor Rights Agreement.

10.1*

 

Demand Response Resource Purchase Agreement, by and between EnerNOC, Inc. and Southern California Edison Company, dated September 27, 2007, filed as an Exhibit to EnerNOC, Inc.’s Current Report on Form 8-K/A (File No. 001-33471) filed on October 12, 2007 and incorporated herein by reference.

31.1

 

Certification of Chief Executive Officer of EnerNOC, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

31.2

 

Certification of Chief Financial Officer of EnerNOC, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

32.1

 

Certification of Chief Executive Officer of EnerNOC, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

32.2

 

Certification of Chief Financial Officer of EnerNOC, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

 


*  Confidential portions of this Exhibit have been filed separately with the Securities and Exchange Commission pursuant to a grant of confidential treatment.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

EnerNOC, Inc.

 

 

 

Date: November 5, 2007

By:

/s/ Timothy G. Healy

 

 

 

Timothy G. Healy

 

 

Chief Executive Officer

 

 

(principal executive officer)

 

 

 

Date: November 5, 2007

By:

/s/ Neal C. Isaacson

 

 

 

Neal C. Isaacson

 

 

Chief Financial Officer

 

 

(principal financial and accounting officer)

 

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Exhibit Index

 

Number

 

Description of Exhibit

 

 

 

2.1

 

Agreement and Plan of Merger, dated as of September 12, 2007, by and among EnerNOC, Inc., a Delaware corporation, Mdenergy, LLC, a Connecticut limited liability company, MDE Acquisition LLC, a Delaware limited liability company and a wholly-owned subsidiary of EnerNOC, Inc., Clifford Sirlin, in his capacity as the Mdenergy, LLC members’ representative, and Clifford Sirlin and Andrew Appelbaum, individually, filed as an Exhibit to EnerNOC, Inc.’s Current Report on Form 8-K (File No. 001-33471) filed on September 18, 2007 and incorporated herein by reference.

4.1

 

Fifth Amended and Restated Investor Rights Agreement.

10.1*

 

Demand Response Resource Purchase Agreement, by and between EnerNOC, Inc. and Southern California Edison Company, dated September 27, 2007, filed as an Exhibit to EnerNOC, Inc.’s Current Report on Form 8-K/A (File No. 001-33471) filed on October 12, 2007 and incorporated herein by reference.

31.1

 

Certification of Chief Executive Officer of EnerNOC, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

31.2

 

Certification of Chief Financial Officer of EnerNOC, Inc. pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

32.1

 

Certification of Chief Executive Officer of EnerNOC, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

32.2

 

Certification of Chief Financial Officer of EnerNOC, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.

 


*  Confidential portions of this Exhibit have been filed separately with the Securities and Exchange Commission pursuant to a grant of confidential treatment.

 

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Exhibit 4.1

 

FIFTH AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT

 

This FIFTH AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT (this “ Agreement ”) is entered into as of  November 1, 2007 by and among (i) EnerNOC, Inc., a Delaware corporation (the “ Company ”); (ii) the individuals and entities listed under the heading “Investors” on the signature pages hereto; (iii) the Founders; and (iv) each person who shall, after the date hereof, join in and become a party to this Agreement by executing and delivering to the Company an Instrument of Accession in substantially the form set forth on Schedule I hereto (collectively, the “ Investors ”).

WHEREAS, the Company entered into that certain Investors Rights Agreement dated June 17, 2003 (the “ Original Agreement ”) with certain of the Investors listed under the heading “Investors” on the signature pages thereto (the “ Original Stockholders ”);

WHEREAS, those Investors holding shares of the Company’s Series A Convertible Preferred Stock, $.001 par value (the “ Series A Preferred Stock ”) subsequently acquired shares of the Company’s Series A-1 Convertible Preferred Stock, $.001 par value (“ Series A-1 Preferred Stock ”);

WHEREAS, the Company entered into that certain Amended and Restated Investor Rights Agreement dated January 11, 2005 with the Original Stockholders, the Investors holding shares of Series A-1 Preferred Stock and the Investors holding shares of the Company’s Series B Convertible Preferred Stock, $.001 par value (“ Series B Preferred Stock ”);

WHEREAS, the Company entered into that certain Second Amended and Restated Investor Rights Agreement dated May 16, 2006 with the Original Stockholders and the Investors holding shares of Series A-1 Preferred Stock, the Investors holding shares of Series B Preferred Stock and the Investors holding shares of the Company’s Series B-1 Convertible Preferred Stock, $.001 par value (“ Series B-1 Preferred Stock ”);

WHEREAS, the Company entered into that certain Third Amended and Restated Investor Rights Agreement dated December 29, 2006 with the Original Stockholders and the Investors holding shares of Series A-1 Preferred Stock, the Investors holding shares of Series B Preferred Stock, the Investors holding shares of Series B Preferred Stock and the Investors holding shares of the Company’s Series C Convertible Preferred Stock, $.001 par value (“ Series C Preferred Stock ”);

WHEREAS, the Company entered into that certain Fourth Amended and Restated Investor Rights Agreement dated May 11, 2007 (the “ Restated Agreement ”) with the Original Stockholders and the Investors holding shares of Series A-1 Preferred Stock, the Investors holding shares of Series B Preferred Stock, the Investors holding shares of Series B-1 Preferred Stock, the Investors holding shares of the Company’s Series C Convertible Preferred Stock, $.001 par value (“ Series C Preferred Stock ”) and the Founders;

WHEREAS, pursuant to Section 6.4 of the Restated Agreement, the Company and the requisite number of Major Investors desire to amend and restate the Restated Agreement in order to, among other things, designate stockholders who have registration rights in the Company’s Second Public Offering (as defined herein); and



WHEREAS, the Company and the Investors desire to provide for certain arrangements with respect to, among other things the registration of shares of capital stock of the Company under the Securities Act of 1933.

NOW, THEREFORE, in consideration of the mutual promises and covenants herein contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, hereby agree as follows:

ARTICLE I
DEFINITIONS

1.1           Certain Definitions .  As used in this Agreement, the following terms shall have the following meanings:

Board of Directors ” shall mean the board of directors of the Company as constituted from time to time.

Braemar ” shall mean Braemar Energy Ventures, LP.

Commission ” shall mean the Securities and Exchange Commission, or any other federal agency at the time administering the Securities Act.

Common Stock ” shall mean the Common Stock, par value $.001 per share, of the Company, as constituted as of the date of this Agreement.

Conversion Shares ” shall mean shares of Common Stock issued or issuable upon conversion of the Preferred Shares.

DFJ-NE ” shall mean Draper Fisher Jurvetson New England Fund I, L.P.

Exchange Act ” shall mean the Securities Exchange Act of 1934, as amended, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time.

Foundation Capital ” shall mean Foundation Capital IV, L.P., FC IV Active Advisors, LLC and Foundation Capital IV Principals Fund, LLC.

Founders ” shall mean David B. Brewster and Timothy G. Healy.

Initial Public Offering ” shall mean the initial public offering of the Company’s Common Stock in which (i) the market capitalization of the Company is at least $50,000,000 and (ii) the aggregate gross proceeds (before deduction of underwriting discounts and registration expenses) from such offering to the Company are at least $10,000,000 pursuant to an effective registration under the Securities Act covering the offer and sale of the Common Stock.

Major Investor ” shall mean any Investor which holds at least 500,000 shares of Preferred Stock, appropriately adjusted to reflect stock splits, stock dividends, combinations of shares and the like.

2



Material Adverse Effect (Change) ” shall mean a material adverse effect (change) in the business, operations, affairs, or condition (financial or otherwise) of the Company.

Overallotment Shares ” has the meaning specified in Section 2.14(d) hereof.

Person ” or “ Persons ” shall mean an individual, corporation, partnership, joint venture, trust, limited liability company, or unincorporated organization, or a government or any agency or political subdivision thereof.

Preferred Shares ” shall mean the shares of Series C Preferred Stock, Series B Preferred Stock, Series B-1 Preferred Stock, Series A-1 Preferred Stock and Series A Preferred Stock.

Preferred Stock ” shall mean the Company’s Preferred Stock, par value $.001 per share, and each series thereof.

Registration Expenses ” shall mean the expenses so described in Section 2.8.

Restricted Stock ” shall mean the Conversion Shares, excluding Conversion Shares which have been (a) included in a transaction registered under the Securities Act pursuant to an effective registration statement filed thereunder and disposed of in accordance with the registration statement covering them or (b) publicly sold pursuant to Rule 144 under the Securities Act; and, for purposes of Sections 2.7, 2.8 and 2.9 only, any shares of Common Stock held by the Specified Officers that are included in the Second Public Offering.

Second Public Offering ” shall mean the first fully underwritten, firm commitment public offering following the Initial Public Offering, pursuant to an effective registration under the Securities Act covering the offer and sale by the Company of its Common Stock in which (i) the market capitalization of the Company is at least $50,000,000 and (ii) the aggregate gross proceeds (before deduction of underwriting discounts and registration expenses) from such offering to the Company are at least $10,000,000.

Second Public Offering Registration Statement ” has the meaning specified in Section 2.14(a) hereof.

Securities Act ” shall mean the Securities Act of 1933 or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time.

Selling Expenses ” shall mean the expenses so described in Section 2.8.

Specified Officers ” means Timothy Healy, David Brewster, Neal Isaacson, David Samuels, Gregg Dixon and Terry Sick.

 “ Subsidiary ” or “ Subsidiaries ” shall mean any corporation or trust of which the Company and/or any of its other Subsidiaries (as herein defined) directly or indirectly owns at the time outstanding shares of every class of such corporation or trust other than directors’ qualifying shares comprising at least fifty percent (50%) of the voting power of such corporation or trust.

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ARTICLE II
RESTRICTIONS ON TRANSFER AND REGISTRATION RIGHTS

2.1           Restrictive Legend .  Each certificate representing Preferred Shares, Conversion Shares or Restricted Stock shall, except as otherwise provided in this Section 2.1 or in Section 2.2, be stamped or otherwise imprinted with a legend substantially in the following form:

“The securities represented by this certificate have not been registered under the Securities Act of 1933 or applicable state securities laws.  These securities have been acquired for investment and not with a view to distribution or resale, and may not be sold, mortgaged, pledged, hypothecated or otherwise transferred without an effective registration statement for such securities under the Securities Act of 1933 and applicable state securities laws, or the availability of an exemption from the registration provisions of the Securities Act of 1933 and applicable state securities laws.”

A certificate shall not bear such legend if in the opinion of counsel satisfactory to the Company the securities represented thereby may be publicly sold without registration under the Securities Act and any applicable state securities laws.

2.2           Notice of Proposed Transfer .  Prior to any proposed transfer of any Preferred Shares, Conversion Shares or Restricted Stock (other than under the circumstances described in Section 2.3, 2.4, 2.5 or 2.6), the holder thereof shall give written notice to the Company of its intention to effect such transfer.  Each such notice shall describe the manner of the proposed transfer and, if requested by the Company, shall be accompanied by an opinion of counsel reasonably satisfactory to the Company to the effect that the proposed transfer may be effected without registration under the Securities Act and any applicable state securities laws, whereupon the holder of such stock shall be entitled to transfer such stock in accordance with the terms of its notice; provided, however, that no such opinion of counsel shall be required for a transfer to one or more partners or members of the transferor (in the case of a transferor that is a partnership or a limited liability company, respectively) or to an affiliated corporation (in the case of a transferor that is a corporation); provided, further, however, that any transferee shall execute and deliver to the Company a representation letter in form reasonably satisfactory to the Company’s counsel to the effect that the transferee is acquiring such shares for its own account, for investment purposes and without any view to distribution thereof.  Each certificate for Preferred Shares, Conversion Shares or Restricted Stock transferred as above provided shall bear the legend set forth in Section 2.1, except that such certificate shall not bear such legend if (i) such transfer is in accordance with the provisions of Rule 144 (or any other rule permitting public sale without registration under the Securities Act) or (ii) the opinion of counsel referred to above is to the further effect that the transferee and any subsequent transferee (other than an affiliate of the Company) would be entitled to transfer such securities in a public sale without registration under the Securities Act.  The restrictions provided for in this Section 2.2 shall not apply to securities which are not required to bear the legend prescribed by Section 2.1 in accordance with the provisions of that Section.

2.3           Initial Public Offering .  If the Company at any time proposes its Initial Public Offering, it will give notice to the Founders of its intention to do so.  Upon the written request of any Founder to register any of its Restricted Stock, the Company will use its best efforts to cause

 

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the Restricted Stock as to which registration shall have been so requested to be included in the securities to be covered by the registration statement proposed to be filed by the Company, all to the extent requisite to permit the sale or other disposition by the Founder of such Restricted Stock so registered. The number of shares of Restricted Stock to be included in the Initial Public Offering may be reduced (pro rata among the requesting Founders based upon the number of shares of Restricted Stock owned by the Founders) if and to the extent that the managing underwriter shall be of the opinion that such inclusion would adversely affect the marketing of the securities to be sold by the Company therein, provided , however , that such number of shares of Restricted Stock shall not be reduced if any shares are to be included in such underwriting for the account of any person other than the Company or the Founders.  For purposes of this Section 2.3 and Sections 2.4, 2.5, 2.6, 6.1 and 6.4, the term “Restricted Stock” shall be deemed to include the number of shares of Restricted Stock which would be issuable to a holder of Preferred Shares upon conversion of all shares of Preferred Stock; provided , however , that the only securities which the Company shall be required to register pursuant hereto shall be shares of Common Stock; provided , further , however , that, in any underwritten public offering contemplated by this Section 2.3 or Sections 2.4, 2.5 and 2.6, the holders of Preferred Shares shall be entitled to sell such Preferred Shares to the underwriters for conversion and sale of the shares of Common Stock issued upon conversion or exercise and conversion, as applicable, thereof.

2.4           Required Registration .

(a)           At any time after the earlier of (i) six (6) years from the first day on which any shares of Preferred Stock are outstanding or (ii) one year after the Initial Public Offering, the holders of Restricted Stock constituting at least 20% in interest of the total shares of Restricted Stock then outstanding may request the Company to register under the Securities Act at least 20% of the shares of Restricted Stock held by such requesting holder or holders (or any lesser percentage if the anticipated gross receipts by such holders of Restricted Stock from the proposed registration exceed $2,000,000) for sale in the manner specified in such notice.  Notwithstanding anything to the contrary contained herein, no request may be made under this Section 2.4 within 180 days after the effective date of the first registration statement on Form S-1 filed by the Company.  If the offering is to be underwritten, the initiating holders shall select the underwriters and the managing underwriters (subject to the consent of the Company, which consent will not be unreasonably withheld).

(b)           Following receipt of any notice under this Section 2.4, the Company shall immediately (subject to any lock-up agreement the Company has in connection with the Second Public Offering) notify all holders of Restricted Stock and Preferred Shares from whom notice has not been received and such holders shall then be entitled within 15 days thereafter to request the Company to include in the requested registration all or any portion of their shares of Restricted Stock.  The Company shall use its best efforts to register under the Securities Act, for public sale in accordance with the method of disposition described in paragraph (a) above, the number of shares of Restricted Stock specified in such notice (and in all notices received by the Company from other holders within 15 days after the giving of such notice by the Company).  The Company shall be obligated to register Restricted Stock pursuant to this Section 2.4 on two occasions only (except for registrations on Form S-3 or any equivalent successor form); provided , however , that such obligation shall be deemed satisfied with respect to each such occasion only when a registration statement covering seventy-five percent (75%) of the shares of

 

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Restricted Stock specified in notices received as aforesaid for sale in accordance with the method of disposition specified by the requesting holders shall have become effective or if such registration statement has been withdrawn prior to the consummation of the offering at the request of the holders of Restricted Stock and Preferred Shares (other than as a result of a Material Adverse Change) and, if such method of disposition is a firm commitment underwritten public offering, all such shares shall have been sold pursuant thereto (including shares sold pursuant to the underwriters’ over-allotment option).

(c)           The Company shall be entitled to include in any registration statement referred to in this Section 2.4 shares of Common Stock to be sold by the Company for its own account, except as and to the extent that, in the opinion of the managing underwriter, such inclusion would adversely affect the marketing of the Restricted Stock to be sold.  Except for registration statements on Form S-4, S-8 or any successor thereto, the Company will not file with the Commission any other registration statement with respect to its Common Stock, whether for its own account or that of other stockholders, from the date of receipt of a notice from requesting holders requesting sale pursuant to an underwritten offering pursuant to this Section 2.4 until the completion of the period of distribution of the registration contemplated thereby.

(d)           If in the opinion of the managing underwriter the inclusion of all of the Restricted Stock requested to be registered under this Section would adversely affect the marketing of such shares, shares to be sold by the holders of Restricted Stock, if any, shall be excluded only after any shares to be sold by the Company have been excluded, in such manner that the shares to be sold shall be allocated among the selling ho lders pro rata based on their ownership of Restricted Stock.

2.5           Incidental Registration .  If the Company at any time after the Second Public Offering (other than pursuant to Sections 2.4 or 2.6) proposes to register any of its securities under the Securities Act for sale to the public, whether for its own account or for the account of other security holders or both (except with respect to registration statements on Forms S-4, S-8 or another form not available for registering the Restricted Stock for sale to the public), each such time it will give written notice to all holders of outstanding Restricted Stock of its intention so to do.  Upon the written request of any such holder, received by the Company within 15 days after the giving of any such notice by the Company, to register any of its Restricted Stock, the Company will use its best efforts to cause the Restricted Stock as to which registration shall have been so requested to be included in the securities to be covered by the registration statement proposed to be filed by the Company, all to the extent requisite to permit the sale or other disposition by the holder of such Restricted Stock so registered.  In the event that any registration pursuant to this Section 2.5 shall be, in whole or in part, an underwritten public offering of Common Stock, the number of shares of Restricted Stock to be included in such an underwriting may be reduced (pro rata among the requesting holders based upon the number of shares of Restricted Stock owned by such holders) if and to the extent that the managing underwriter shall be of the opinion that such inclusion would adversely affect the marketing of the securities to be sold by the Company therein, provided, however, that such number of shares of Restricted Stock shall not be reduced if any shares are to be included in such underwriting for the account of any person other than the Company or requesting holders of Restricted Stock, and provided, further, however, that in no event may less than twenty percent (20%) of the total number of shares of Common Stock to be included in such underwriting be made available for shares of Restricted

 

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Stock unless the underwriting is in connection with the Company’s initial public offering and the managing underwriter shall in good faith advise the holders proposing to distribute their securities through such underwriting that such level of participation would, in its opinion, materially adversely affect the offering price or its ability to complete the offering and shall specify the number of shares of Restricted Stock which, in its opinion, can be included in the registration and underwriting without such an effect.

2.6           Registration on Form S-3 .  If at any time (i) a holder or holders of Restricted Stock request that the Company file a registration statement on Form S-3 or any successor thereto for a public offering of all or any portion of the shares of Restricted Stock held by such requesting holder or holders and the reasonably anticipated aggregate price to the public of such shares of Restricted Stock equals or exceeds $500,000, and (ii) the Company is a registrant entitled to use Form S-3 or any successor thereto to register such shares, then the Company shall use its best efforts to register under the Securities Act on Form S-3 or any successor thereto, for public sale in accordance with the method of disposition specified in such notice, the number of shares of Restricted Stock specified in such notice.  Whenever the Company is required by this Section 2.6 to use its best efforts to effect the registration of Restricted Stock, each of the procedures and requirements of Section 2.4 (including but not limited to the requirement that the Company notify all holders of Restricted Stock from whom notice has not been received and provide them with the opportunity to participate in the offering) shall apply to such registration; provided, however, that there shall be no limitation on the number of registrations on Form S-3 which may be requested and obtained under this Section 2.6; and provided, further, however, that the requirements contained in the first sentence of Section 2.4(a) shall not apply to any registration on Form S-3 which may be requested and obtained under this Section  2.6.

Notwithstanding anything to the contrary in this Section 2.6, the Company shall not be required to effect more than two registrations pursuant to this Section 2.6 in any 12 month period.

2.7           Registration Procedures .  If and whenever the Company is required by the provisions of Sections 2.3, 2.4, 2.5, 2.6 or 2.14 to use its best efforts to effect the registration of any shares of Restricted Stock under the Securities Act, the Company will, as expeditiously as possible:

(a)           prepare and file with the Commission a registration statement (which, in the case of an underwritten public offering pursuant to Section 2.4, shall be on Form S-1 or other form of general applicability satisfactory to the managing underwriter selected as therein provided) with respect to such securities and use its best efforts to cause such registration statement to become and remain effective for the period of the distribution contemplated there by (determined as hereinafter provided);

(b)           prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for the period specified in paragraph (a) above and comply with the provisions of the Securities Act with respect to the disposition of all Restricted Stock covered by such registration statement in accordance with the sellers’ intended method of disposition set forth in such registration statement for such period;

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(c)           furnish to each seller of Restricted Stock and to each underwriter such number of copies of the registration statement and the prospectus included therein (including each preliminary prospectus) as such persons reasonably may request in order to facilitate the public sale or other disposition of the Restricted Stock covered by such registration statement;

(d)           use its best efforts to register or qualify the Restricted Stock covered by such registration statement under the securities or “blue sky” laws of such jurisdictions as the sellers of Restricted Stock or, in the case of an underwritten public offering, the managing underwriter reasonably shall request; provided , however , that the Company shall not for any such purpose be required to qualify generally to transact business as a foreign corporation in any jurisdiction where it is not so qualified or to consent to general service of process in any such jurisdiction;

(e)           use its best efforts to list the Restricted Stock covered by such registration statement with any securities exchange on which the Common Stock of the Company is then listed;

(f)            provide a transfer agent and registrar for all such Restricted Stock, not later than the effective date of such registration statement;

(g)           immediately notify each seller of Restricted Stock and each underwriter under such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act, of the happening of any event of which the Company has knowledge as a result of which the prospectus contained in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances then existing;

(h)           if the offering is underwritten and at the request of any seller of Restricted Stock, use its best efforts to furnish on the date that Restricted Stock is delivered to the underwriters for sale pursuant to such registration:  (i) an opinion dated such date of counsel representing the Company for the purposes of such registration, addressed to the underwriters and to such seller, to such effect as reasonably may be requested by counsel for the underwriters and (ii) a letter dated such date from the independent public accountants retained by the Company, addressed to the underwriters and to such seller, stating that they are independent public accountants within the meaning of the Securities Act and that, in the opinion of such accountants, the financial statements of the Company included in the registration statement or the prospectus, or any amendment or supplement thereof, comply as to form in all material respects with the applicable accounting requirements of the Securities Act, and such letter shall additionally cover such other financial matters (including information as to the period ending no more than five business days prior to the date of such letter) with respect to such registration as such underwriters reasonably may request;

(i)            make available for inspection by each seller of Restricted Stock, any underwriter participating in any distribution pursuant to such registration statement, and any attorney, accountant or other agent retained by such seller or underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and cause the Company’s

 

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officers, directors and employees to supply all information reasonably requested by any such seller, underwriter, attorney, accountant or agent in connection with such registration statement.  The rights granted pursuant to this subsection (i) may not be assigned or otherwise conveyed by such person or by any subsequent transferee of any such rights without the written consent of the Company, which consent shall not be unreasonably withheld; provided , however , that the Company may refuse such written consent if the proposed transferee is a competitor of the Company as determined by the Board of Directors; and provided , further , that no such written consent shall be required if the transfer is made to a party who is not a competitor of the Company and who is a parent, subsidiary, affiliate, partner or group member of such person;

(j)            advise each selling holder of Restricted Stock, promptly after it shall receive notice or obtain knowledge thereof, of the issuance of any stop order by the Commission suspending the effectiveness of such registration statement or the initiation or threatening of any proceeding for such purpose and promptly use all reasonable efforts to prevent the issuance of any stop order or to obtain its withdrawal if such stop order should be issued;

(k)           cooperate with the selling holders of Restricted Stock and the managing underwriters, if any, to facilitate the timely preparation and delivery of certificates representing Restricted Stock to be sold, such certificates to be in such denominations and registered in such names as such holders or the managing underwriters may request at least two business days prior to any sale of Restricted Stock; and

(l)            permit any holder of Restricted Stock which holder, in the sole and exclusive judgment, exercised in good faith, of such holder, might be deemed to be a controlling person of the Company, to participate in good faith in the preparation of such registration or comparable statement and to require the insertion therein of material, furnished to the Company in writing, which in the reasonable judgment of such holder and its counsel should be included, subject to review by the Company and its counsel after consultation with such holder.

For purposes of Sections 2.7(a) and 2.7(b) and of Section 2.4(c), the period of distribution of Restricted Stock in a firm commitment underwritten public offering shall be deemed to extend until each underwriter has completed the distribution of all securities purchased by it, and the period of distribution of Restricted Stock in any other registration shall be deemed to extend until the earlier of the sale of all Restricted Stock covered thereby and 120 days after the effective date thereof.

In connection with each registration hereunder, the sellers of Restricted Stock will furnish to the Company in writing such information with respect to themselves and the proposed distribution by them as reasonably shall be necessary in order to assure compliance with federal and applicable state securities laws.

In connection with each registration pursuant to Sections 2.3, 2.4, 2.5, 2.6 or 2.14 covering an underwritten public offering, the Company and each seller of securities in such offering agree to enter into a written agreement with the managing underwriter selected in the manner herein provided in such form and containing such provisions as are customary in the securities business for such an arrangement between such underwriter and companies of the Company’s size and investment stature.

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2.8           Expenses .  All expenses incurred by the Company in complying with Sections 2.3, 2.4, 2.5, 2.6 and 2.14, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel and independent public accountants for the Company, fees and expenses (including counsel fees) incurred in connection with complying with state securities or “blue sky” laws, fees of the National Association of Securities Dealers, Inc., transfer taxes, fees of transfer agents and registrars, costs of insurance, and fees and disbursements of one special counsel for the sellers of Restricted Stock, but excluding any Selling Expenses, are called “Registration Expenses.”  All underwriting discounts and selling commissions applicable to the sale of Restricted Stock are called “Selling Expenses.”

The Company will pay all Registration Expenses in connection with each registration statement under Sections 2.3, 2.4, 2.5, 2.6 or 2.14; provided , however , that if a registration statement is withdrawn at the request of the participating holders of Restricted Stock (other than as a result of a Material Adverse Change), such Registration Expenses shall be borne by the participating holders of Restricted Stock who made such withdrawal requests in proportion to the number of shares of Restricted Stock proposed to be sold by each.  All Selling Expenses in connection with each registration statement under Sections 2.3, 2.4, 2.5, 2.6 or 2.14 shall be borne by the participating sellers in proportion to the number of shares sold by each, or by such participating sellers other than the Company (except to the extent the Company shall be a seller) as they may agree.

2.9           Indemnification and Contribution .

(a)           In the event of a registration of any of the Restricted Stock under the Securities Act pursuant to Sections 2.3, 2.4, 2.5, 2.6 or 2.14, the Company will indemnify and hold harmless each seller of such Restricted Stock thereunder, each underwriter of such Restricted Stock thereunder and each other person, if any, who controls such seller or underwriter within the meaning of the Securities Act, against any losses, claims, damages or liabilities, joint or several, to which such seller, underwriter or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any registration statement under which such Restricted Stock was registered under the Securities Act pursuant to Sections  2.3, 2.4, 2.5, 2.6 or 2.14, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each such seller, each such underwriter and each such controlling person for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided , however , that the Company will not be liable in any such case if and to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission so made in conformity with information furnished by any such seller, any such underwriter or any such controlling person in writing specifically for use in such registration statement or prospectus.

(b)           In the event of a registration of any of the Restricted Stock under the Securities Act pursuant to Sections 2.3, 2.4, 2.5, 2.6 or 2.14, each seller of such Restricted Stock

 

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thereunder, severally and not jointly, will indemnify and hold harmless the Company, each person, if any, who controls the Company within the meaning of the Securities Act, each officer of the Company who signs the registration statement, each director of the Company, each underwriter and each person who controls any underwriter within the meaning of the Securities Act, against all losses, claims, damages or liabilities, joint or several, to which the Company or such officer, director, underwriter or controlling person may become subject under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the registration statement under which such Restricted Stock was registered under the Securities Act pursuant to Sections  2.3, 2.4, 2.5, 2.6 or 2.14, any preliminary prospectus or final prospectus contained therein, or any amendment or supplement thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company and each such officer, director, underwriter and controlling person for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided , however , that such seller will be liable hereunder in any such case if and only to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with information pertaining to such seller, as such, furnished in writing to the Company by such seller specifically for use in such registration statement or prospectus; and, provided , further , however , that the liability of each seller hereunder shall be limited to the proportion of any such loss, claim, damage, liability or expense which is equal to the proportion that the public offering price of the shares sold by such seller under such registration statement bears to the total public offering price of all securities sold thereunder, but not in any event to exceed the net proceeds received by such seller from the sale of Restricted Stock covered by such registration statement.

(c)           Promptly after receipt by an indemnified party hereunder of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party hereunder, notify the indemnifying party in writing thereof, but the omission so to notify the indemnifying party shall not relieve it from any liability which it may have to such indemnified party other than under this Section 2.9 and shall only relieve it from any liability which it may have to such indemnified party under this Section 2.9 if and to the extent the indemnifying party is prejudiced by such omission.  In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in and, to the extent it shall wish, to assume and undertake the defense thereof with counsel reasonably satisfactory to such indemnified party, and, after notice from the indemnifying party to such indemnified party of its election so to assume and undertake the defense thereof, the indemnifying party shall not be liable to such indemnified party under this Section 2.9 for any legal expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation and of liaison with counsel so selected; provided , however , that, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be reasonable defenses available to it which are different from or additional to those available to the indemnifying party or if the interests of the indemnified party reasonably may be

 

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deemed to conflict with the interests of the indemnifying party, the indemnified party shall have the right to select a separate counsel and to assume such legal defenses and otherwise to participate in the defense of such action, with the expenses and fees of such separate counsel and other expenses related to such participation to be reimbursed by the indemnifying party as incurred.

(d)           In order to provide for just and equitable contribution to joint liability under the Securities Act in any case in which either (i) any holder of Restricted Stock exercising rights under this Agreement, or any controlling person of any such holder, makes a claim for indemnification pursuant to this Section 2.9 but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that this Section 2.9 provides for indemnification in such case, or (ii) contribution under the Securities Act may be required on the part of any such selling holder or any such controlling person in circumstances for which indemnification is provided under this Section 2.9; then, and in each such case, the Company and such holder will contribute to the aggregate losses, claims, damages or liabilities to which they may be subject (after contribution from others) in such proportion so that such holder is responsible for the portion represented by the percentage that the public offering price of its Restricted Stock offered by the registration statement bears to the public offering price of all securities offered by such registration statement, and the Company is responsible for the remaining portion; provided , however , that, in any such case, (A) no such holder will be required to contribute any amount in excess of the public offering price of all such Restricted Stock offered by it pursuant to such registration statement; and (B) no person or entity guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) will be entitled to contribution from any person or entity who was not guilty of such fraudulent misrepresentation.

2.10         Changes in Common Stock or Preferred Stock .  If, and as often as, there is any change in the Common Stock or the Preferred Stock by way of a stock split, stock dividend, combination or reclassification, or through a merger, consolidation, reorganization or recapitalization, or by any other means, appropriate adjustment shall be made in the provisions hereof so that the rights and privileges granted hereby shall continue with respect to the Common Stock and the Preferred Stock as so changed.

2.11         Rule 144 Reporting .  With a view to making available the benefits of certain rules and regulations of the Commission which may at any time permit the sale of the Restricted Stock to the public without registration, at all times after 90 days after any registration statement covering a public offering of securities of the Company under the Securities Act shall have become effective, the Company agrees to:

(a)           make and keep public information available, as those terms are understood and def ined in Rule 144 under the Securities Act;

(b)           use its best efforts to file with the Commission in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act; and

 

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(c)           furnish to each holder of Restricted Stock forthwith upon request a written statement by the Company as to its compliance with the reporting requirements of such Rule 144 and of the Securities Act and the Exchange Act, a copy of the most recent annual or quarterly report of the Company, and such other reports and documents so filed by the Company as such holder may reasonably request in availing itself of any rule or regulation of the Commission allowing such holder to sell any Restricted Stock without registration.

2.12         Suspension of Registration Rights .  Notwithstanding the provisions of Section 2.4, the Company’s obligation to file a registration statement, or cause such registration statement to become and remain effective, shall be suspended for a period not to exceed 120 days (in the case of a registration statement on Form S-1) or 90 days (in the case of a registration statement on Form S-3) in any 12-month period if the Company shall furnish to the Investors requesting such registration a certificate signed by the President of the Company stating either (i) that in the good faith judgment of the Company it would likely be detrimental to the Company or its stockholders (whether due to a potential adverse effect on a pending transaction or otherwise) for a registration statement to be filed in the near future or (ii) that there exists at the time material non-public information relating to the Company which, in the reasonable opinion of the Company, should not be disclosed.

2.13         No More Favorable “Piggy-Back” Registration Rights .  The Company shall not grant to any third party any “piggy-back” registration rights of the type set forth in Section 2.5 that are more favorable than or inconsistent with any of those contained herein, so long as any of the registration rights under this Agreement remains in effect without the prior written consent of at least sixty-six and two-thirds percent (66 2/3%) in interest of the Preferred Stock held by Major Investors.

2.14         Second Public Offering .

(a)           If the Company at any time proposes its Second Public Offering, it will give written notice to all holders of outstanding Restricted Stock of its intention so to do.  Upon the written request of any such holder, received by the Company within 15 days after the giving of any such notice by the Company, to register any of its Restricted Stock, the Company will use, subject to the thresholds specified in Section 2.14(b) and (c) below, its best efforts to cause the Restricted Stock as to which registration shall have been so requested to be included in the securities to be covered by the registration statement proposed to be filed by the Company (the “Second Public Offering Registration Statement”), all to the extent requisite to permit the sale or other disposition by the holder of such Restricted Stock so registered; subject to the terms set forth in this Section 2.14.

(b)           The Second Public Offering Registration Statement shall cover no less than (i) 800,000 shares to be issued by the Company, (ii) 2,100,000 shares to be sold by the holders of Restricted Stock, (iii) 600,000 shares to be sold by the Specified Officers (or such lesser amount as is specified by the Company, after consultation with the lead underwriter in the underwritten offering pursuant to such registration statement), (iv) 500,000 shares to be sold by other stockholders specified by the Company (or such lesser amount as is specified by the Company, after consultation with such lead underwriter) and (v) an amount equal to 15% of the sum of the number of shares to be included in the Second Public Offering Registration Statement

 

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pursuant to clauses (i) through (iv) of this Section 2.14(b), which amount shall constitute Overallotment Shares.

(c)           The number of shares of Restricted Stock to be included for sale in an underwritten offering made pursuant to the prospectus included in the Second Public Offering Registration Statement may be reduced (pro rata among the requesting holders based upon the number of shares of Restricted Stock owned by such holders) to a minimum of 2,100,000 shares to the extent the Company specifies, after consultation with the lead underwriter in such offering.  To the extent that more than 4,000,000 shares are proposed to be offered for sale pursuant to such prospectus (without giving effect to any exercise of the underwriters’ overallotment option), the shares proposed to be offered for sale in excess of 4,000,000 shall be allocated for sale by the holders of Restricted Stock who requested to have shares of Restricted Stock included in the Registration Statement pursuant hereto (pro rata among the requesting holders based upon the number of shares of Restricted Stock owned by such holders).

(d)           The Registration Statement shall also register shares to be offered to the underwriters pursuant to an overallotment option to be granted to the underwriters (the “Overallotment Shares”).  The shares specified in Section 2.14(c) shall be deemed not to include the Overallotment Shares.  Up to 200,000 shares of common stock may be offered by the Company to the underwriters of the offering made pursuant to the Second Public Offering Registration Statement to cover the first portion any request by such underwriters for Overallotment Shares.  Any additional Overallotment Shares shall be allocated for sale to such underwriters by the holders of Restricted Stock (pro rata among the requesting holders based upon the number of shares of Restricted Stock owned by such holders).

(e)           If the Company at any time proposes its Second Public Offering, it will give notice to the Specified Officers of its intention to do so.  Upon the written request of any Specified Officer to register any of Common Stock held by such Specified Officer, the Company will use its best efforts to cause the Common Stock as to which registration shall have been so requested to be included in the securities to be covered by the registration statement proposed to be filed by the Company, up to amounts the Company specifies, after consultation with the lead underwriter in the underwritten offering pursuant to the Second Public Offering Registration Statement, in each case, subject to the terms of this Section 2.14.

ARTICLE III
[INTENTIONALLY OMITTED]

ARTICLE IV
[INTENTIONALLY OMITTED]

ARTICLE V
[INTENTIONALLY OMITTED]

ARTICLE VI
MISCELLANEOUS

6.1           Binding Effect .  All covenants and agreements contained in this Agreement by or on behalf of any of the parties hereto shall bind and inure to the benefit of the respective

 

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successors and assigns of the parties hereto (including without limitation transferees of any Preferred Shares or Restricted Stock), whether so expressed or not; provided, however, that registration rights conferred herein on the holders of Preferred Shares, Conversion Shares or Restricted Stock shall only inure to the benefit of a transferee of Preferred Shares, Conversion Shares or Restricted Stock if the Company is given written notice thereof and either: (i) there is transferred to such transferee all of the shares (but in any event at least 100,000 shares) of Restricted Stock originally issued pursuant to the Purchase Agreement to the direct or indirect transferor of such transferee or (ii) such transferee is a limited or general partner, stockholder, member, unitholder or affiliate of a party hereto or any beneficial owner of any interest in a party hereto and such transferee agrees in writing the Company to take action under this Agreement through a single representative.

6.2           Notices .  All notices, requests, consents and other communications hereunder shall be in writing and shall be delivered in person, mailed by certified or registered mail, return receipt requested or via overnight courier, or sent by telecopier or telex, addressed as follows:

if to the Company or any other party hereto, at the address of such party set forth in the Purchase Agreement;

if to any subsequent holder of Preferred Shares, Conversion Shares or Restricted Stock, to it at such address as may have been furnished to the Company in writing by such holder;

or, in any case, at such other address or addresses as shall have been furnished in writing to the Company (in the case of a holder of Preferred Shares, Conversion Shares or Restricted Stock) or to the holders of Preferred Shares, Conversion Shares or Restricted Stock (in the case of the Company) in accordance with the provisions of this paragraph.

6.3