EnerNOC, Inc.
ENERNOC INC (Form: 10-Q, Received: 11/06/2012 06:03:56)
Table of Contents

 

 

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, 2012

or

 

¨ 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.)

 

101 Federal Street

Suite 1100

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   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

There were 28,916,427 shares of the registrant’s common stock, $0.001 par value per share, outstanding as of October 30, 2012.

 

 

 


Table of Contents

EnerNOC, Inc.

Index to Form 10-Q

 

          Page  
Part I - Financial Information   
Item 1.    Financial Statements   
   Unaudited Condensed Consolidated Balance Sheets at September 30, 2012 and December 31, 2011      3   
  

Unaudited Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2012 and 2011

     4   
  

Unaudited Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and 2011

     5   
  

Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011

     6   
   Notes to Unaudited Condensed Consolidated Financial Statements      7   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      23   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      43   
Item 4.    Controls and Procedures      44   
Part II - Other Information   
Item 1.    Legal Proceedings      44   
Item 1A    Risk Factors      44   
Item 6.    Exhibits      46   
   Signatures      47   
   Exhibit Index      40   

 

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EnerNOC, Inc.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)

 

     September 30,
2012
    December 31,
2011
 

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 93,168     $ 87,297  

Restricted cash

     100       158  

Trade accounts receivable, net of allowance for doubtful accounts of $318 and $192 at September 30, 2012 and December 31, 2011, respectively

     53,796       23,977  

Unbilled revenue

     76,023       64,448  

Capitalized incremental direct customer contract costs

     5,239       5,416  

Deposits

     2,449       14,050  

Prepaid expenses and other current assets

     5,897       7,257  
  

 

 

   

 

 

 

Total current assets

     236,672       202,603  

Property and equipment, net of accumulated depreciation of $63,577 and $51,400 at September 30, 2012 and December 31, 2011, respectively

     34,700       36,636  

Goodwill

     79,481       79,213  

Customer relationship intangible assets, net

     23,129       26,993  

Other definite-lived intangible assets, net

     4,312       5,524  

Capitalized incremental direct customer contract costs, long-term

     4,442       3,056  

Deposits and other assets

     8,108       1,235  
  

 

 

   

 

 

 

Total assets

   $ 390,844     $ 355,260  
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities

    

Accounts payable

   $ 2,672     $ 3,799  

Accrued capacity payments

     69,548       58,332  

Accrued payroll and related expenses

     11,184       11,937  

Accrued expenses and other current liabilities

     9,288       6,107  

Accrued performance adjustments

     719       6,045  

Deferred revenue

     18,584       10,544  
  

 

 

   

 

 

 

Total current liabilities

     111,995       96,764  

Long-term liabilities

    

Deferred acquisition consideration

     525       500  

Accrued acquisition contingent consideration

     409       336  

Deferred tax liability

     2,647       2,646  

Deferred revenue

     12,053       6,810  

Other liabilities

     1,151       464  
  

 

 

   

 

 

 

Total long-term liabilities

     16,785       10,756  

Commitments and contingencies (Notes 7 and 8)

     —          —     

Stockholders’ equity

    

Undesignated preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued

     —          —     

Common stock, $0.001 par value; 50,000,000 shares authorized, 28,919,110 and 27,306,548 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively

     29       27  

Additional paid-in capital

     340,326       329,817  

Accumulated other comprehensive loss

     (641     (955

Accumulated deficit

     (77,650     (81,149
  

 

 

   

 

 

 

Total stockholders’ equity

     262,064       247,740  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 390,844     $ 355,260  
  

 

 

   

 

 

 

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

 

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EnerNOC, Inc.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except share and per share data)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Revenues

        

DemandSMART

   $ 169,658     $ 161,874     $ 213,586     $ 240,268  

EfficiencySMART, SupplySMART, CarbonSMART and other

     8,289       7,309       22,084       19,581  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     177,947       169,183       235,670       259,849  

Cost of revenues

     82,947       84,351       126,437       142,079  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     95,000       84,832       109,233       117,770  

Operating expenses:

        

Selling and marketing

     13,424       14,591       41,342       39,798  

General and administrative

     18,351       15,960       52,880       48,172  

Research and development

     3,914       3,310       11,536       9,892  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     35,689       33,861       105,758       97,862  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     59,311       50,971       3,475       19,908  

Other income (expense), net

     619       (2,471     1,316       (2,485

Interest expense

     (300     (397     (1,197     (798
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax

     59,630       48,103       3,594       16,625  

Benefit from (provision for) income tax

     718       (1,225     (95     (1,992
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 60,348     $ 46,878     $ 3,499     $ 14,633  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per common share

        

Basic

   $ 2.26     $ 1.83     $ 0.13     $ 0.57  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 2.21     $ 1.77     $ 0.13     $ 0.55  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding

        

Basic

     26,653,252       25,683,177       26,470,634       25,491,362  

Diluted

     27,325,949       26,538,278       27,069,569       26,498,620  

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

 

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EnerNOC, Inc.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012      2011     2012      2011  

Net income

   $ 60,348      $ 46,878     $ 3,499      $ 14,633  

Foreign currency translation adjustments

     172        (1,532     314        (1,503
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income

   $ 60,520      $ 45,346     $ 3,813      $ 13,130  
  

 

 

    

 

 

   

 

 

    

 

 

 

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

 

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EnerNOC, Inc.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Nine Months Ended
September 30,
 
     2012     2011  

Cash flows from operating activities

    

Net income

   $ 3,499     $ 14,633  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     13,414       11,976  

Amortization of acquired intangible assets

     5,438       4,533  

Impairment of acquired intangible assets

     —          241  

Stock based compensation expense

     10,018       10,488  

Impairment of equipment

     441       508  

Unrealized foreign exchange transaction (gain) loss

     (781     2,717  

Deferred taxes

     —          998  

Non-cash interest expense

     306       126  

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

     98       316  

Other, net

     142       235  

Changes in operating assets and liabilities, net of effects of acquisitions:

    

Accounts receivable, trade

     (29,801     (20,319

Unbilled revenue

     (11,574     (30,137

Prepaid expenses and other current assets

     1,583       2,921  

Capitalized incremental direct customer contract costs

     (1,209     (3,973

Other assets

     189       (2,790

Other noncurrent liabilities

     625       (159

Deferred revenue

     13,122       3,412  

Accrued capacity payments

     11,092       23,273  

Accrued payroll and related expenses

     (434     1,576  

Accounts payable, accrued performance adjustments and accrued expenses and other current liabilities

     (3,302     (3,809
  

 

 

   

 

 

 

Net cash provided by operating activities

     12,866       16,766  

Cash flows from investing activities

    

Payments made for acquisitions of businesses, net of cash acquired

     —          (67,492

Payments made for contingent consideration related to acquisitions

     —          (1,500

Purchases of property and equipment

     (11,752     (15,172

Change in restricted cash and deposits

     4,716       (9,394

Change in long-term assets

     (111     (530
  

 

 

   

 

 

 

Net cash used in investing activities

     (7,147     (94,088

Cash flows from financing activities

    

Proceeds from exercises of stock options

     141       1,891  

Repayment of borrowings and payments under capital leases

     —          (30
  

 

 

   

 

 

 

Net cash provided by financing activities

     141       1,861  

Effects of exchange rate changes on cash and cash equivalents

     11       (535
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     5,871       (75,996

Cash and cash equivalents at beginning of period

     87,297       153,416  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 93,168     $ 77,420  
  

 

 

   

 

 

 

Non-cash financing and investing activities

    

Issuance of common stock in connection with acquisitions, including earn out payments

   $ —        $ 16,498  
  

 

 

   

 

 

 

Issuance of common stock in satisfaction of bonuses

   $ 350     $ 440  
  

 

 

   

 

 

 

Deferred acquisition consideration

   $ —        $ 3,925  
  

 

 

   

 

 

 

Deferred acquisition contingent consideration

   $ —        $ 309  
  

 

 

   

 

 

 

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

 

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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 energy management applications, services and products for the smart grid, which include comprehensive demand response, data-driven energy efficiency, energy price and risk management, and enterprise carbon management applications, services and products. The Company’s energy management applications, services and products enable cost effective energy management strategies for its commercial, institutional and industrial end-users of energy (C&I customers) and its electric power grid operator and utility customers by reducing real-time demand for electricity, increasing energy efficiency, improving energy supply transparency, and mitigating carbon emissions. The Company uses its Network Operations Center (NOC) and comprehensive demand response application, DemandSMART, to remotely manage and reduce electricity consumption across a growing network of C&I customer sites, making demand response capacity available to electric power grid operators and utilities on demand while helping C&I customers achieve energy savings, improved financial results and environmental benefits. To date, the Company has received substantially all of its revenues from electric power grid operators and utilities who make recurring payments to the Company for managing demand response capacity. The Company shares these recurring payments with its C&I customers in exchange for those C&I customers reducing their power consumption when called upon.

The Company builds on its position as a leading demand response services provider by using its NOC and energy management application platform to deliver a portfolio of additional energy management applications and services to new and existing C&I, electric power grid operator and utility customers. These additional energy management applications and services include its EfficiencySMART, SupplySMART and CarbonSMART applications and services, and certain other products. EfficiencySMART is its data-driven energy efficiency suite that includes commissioning and retro-commissioning authority services, energy consulting and engineering services, a persistent commissioning application and an enterprise energy management application for managing energy across a portfolio of sites. SupplySMART is its energy price and risk management application that provides its C&I customers located in restructured or deregulated markets throughout the United States with the ability to more effectively manage the energy supplier selection process, including energy supply product procurement and implementation, budget forecasting, and utility bill information management. CarbonSMART is its enterprise carbon management application that supports and manages the measurement, tracking, analysis, reporting and management of greenhouse gas emissions. The Company’s products include its wireless technology solutions for energy management and demand response related to its leading energy management applications including an agriculture specific wireless technology solution acquired in connection with the acquisition of M2M Communications Corporation (M2M) in January 2011.

Reclassifications

The Company has reclassified certain amounts in its condensed consolidated balance sheet as of December 31, 2011 resulting in a decrease to both accounts receivable and deferred revenues of $2,012 to properly account for outstanding accounts receivable where the fees had been deferred because they were not fixed or determinable.

The Company has reclassified certain amounts in its condensed consolidated balance sheet as of December 31, 2011 resulting in an increase to both accounts receivable and accounts payable of $1,464 to properly account for receivables and payables under a contractual arrangement on a gross basis.

The Company reclassified a portion of its amortization expense related to acquired intangible assets in its condensed consolidated statements of income for the six months ended June 30, 2012 totaling $1,582 that had been classified within general and administrative expense during such period to selling and marketing expense to conform with current period presentation. Based on the nature of the acquired intangible assets to which this amortization expense relates, which are primarily customer relationship intangible assets, the Company believes that the classification within selling and marketing expense is a preferable classification. This reclassification had no impact on the condensed consolidated statements of income for the three or nine months ended September 30, 2011.

 

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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.

Subsequent Events Consideration

The Company considers events or transactions that occur after the balance sheet date but prior to the issuance of the financial statements to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated as required.

There were no material recognizable subsequent events recorded or requiring disclosure in the September 30, 2012 unaudited condensed consolidated financial statements.

Use of Estimates in Preparation of Financial Statements

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations. In the opinion of the Company’s management, the unaudited condensed consolidated financial statements and notes have been prepared on the same basis as the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011, and include all adjustments (consisting of normal, recurring adjustments) necessary for the fair presentation of the Company’s financial position at September 30, 2012 and statements of income, statements of comprehensive income and statements of cash flows for the three and nine months ended September 30, 2012 and 2011. Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results to be expected for any other interim period or the entire fiscal year ending December 31, 2012 (fiscal 2012).

The preparation of these unaudited condensed consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, allowance for doubtful accounts, valuations and purchase price allocations related to business combinations, fair value of deferred acquisition consideration, fair value of accrued acquisition contingent consideration, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of intangible assets and goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, fair value of asset retirement obligations, tax reserves and recoverability of the Company’s net deferred tax assets and related valuation allowance.

Although the Company regularly assesses these estimates, actual results could differ materially. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ from management’s estimates if these results differ from historical experience or other assumptions prove not to be substantially accurate, even if such assumptions are reasonable when made.

The Company is subject to a number of risks similar to those of other companies of similar and different sizes both inside and outside of its industry, including, but not limited to, rapid technological changes, competition from similar energy management applications, services and products provided by larger companies, customer concentration, government regulations, market or program rule changes, protection of proprietary rights and dependence on key individuals.

Foreign Currency Translation

Foreign currency translation adjustments are recorded as a component of other comprehensive income or loss and included in accumulated other comprehensive loss within stockholders’ equity. Gains (losses) arising from transactions denominated in foreign currencies and the re-measurement of certain intercompany receivables and payables are included in other income (expense), net in the unaudited condensed consolidated statements of income and were $580 and ($2,648) for the three months ended September 30, 2012 and 2011, respectively, and $1,168 and $(2,848) for the nine months ended September 30, 2012 and 2011, respectively. Foreign

 

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currency exchange gains (losses) resulted primarily from foreign denominated intercompany receivables held by the Company from one of its Australian subsidiaries which mainly resulted from funding provided to complete the acquisition of Energy Response Holdings Pty Ltd (Energy Response) and fluctuations in the Australian dollar exchange rate. During the three months ended March 31, 2012, $17,468 ($16,400 Australian) of the intercompany receivable from the Company’s Australian subsidiary was settled resulting in a realized gain of $494. During the three months ended September 30, 2012 and during the three and nine months ended September 30 2011, there were no material realized gains or losses incurred related to transactions denominated in foreign currencies. As of September 30, 2012, the Company had an intercompany receivable from its Australian subsidiary that is denominated in Australian dollars and not deemed to be of a “long-term investment” nature totaling $20,608 ($19,853 Australian).

In addition, a portion of the funding provided by the Company to one of its Australian subsidiaries to complete the acquisition of Energy Response was deemed to be of a “long-term investment nature” and therefore, the resulting translation adjustments are being recorded as a component of stockholders’ equity within accumulated other comprehensive loss. As of September 30, 2012, the intercompany funding that is denominated in Australian dollars and deemed to be of a “long-term investment” nature totaled $18,725 ($18,039 Australian).

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period resulting from transactions and other events and circumstances from non-owner sources. As of September 30, 2012 and December 31, 2011, accumulated other comprehensive loss was comprised solely of cumulative foreign currency translation adjustments. The Company presents its components of other comprehensive loss, net of related tax effects, which have not been material to date.

Software Development Costs

Software development costs of $1,203 and $805 for the three months ended September 30, 2012 and 2011, respectively, and $3,497 and $2,944 for the nine months ended September 30, 2012 and 2011, respectively, have been capitalized in accordance with Accounting Standard Codification (ASC) 350-40,  Internal-Use Software (ASC 350-40) The capitalized amount was included as software in property and equipment at September 30, 2012 and December 31, 2011. Amortization of capitalized internal use software costs was $1,185 and $1,160 for the three months ended September 30, 2012 and 2011, respectively, and $3,364 and $3,028 for the nine months ended September 30, 2012 and 2011, respectively. Accumulated amortization of capitalized internal use software costs was $14,511 and $11,147 as of September 30, 2012 and December 31, 2011, respectively. The Company anticipates that the amount of software development costs that are capitalized in accordance with ASC 350-40 will continue to increase for the foreseeable future as the Company continues its development and significant enhancement of its DemandSMART, EfficiencySMART, SupplySMART and CarbonSMART applications.

Impairment of Property and Equipment

During the three and nine months ended September 30, 2012, the Company identified impairment indicators related to certain demand response equipment as a result of the removal of such equipment from service during the three and nine months ended September 30, 2012. As a result of these impairment indicators, the Company performed impairment tests during the three and nine months ended September 30, 2012 and recognized impairment charges of $98 and $441 during the three and nine months ended September 30, 2012, respectively, representing the difference between the carrying value and fair market value of the demand response equipment, which is included in cost of revenues in the accompanying unaudited condensed consolidated statements of income. The fair market value was determined utilizing Level 3 inputs, as defined by ASC 820,  Fair Value Measurements and Disclosures  (ASC 820), based on the projected future cash flows discounted using the estimated market participant rate of return for this type of asset.

As of September 30, 2012, approximately $1,327 of the Company’s generation equipment is utilized in open market demand response programs. The recoverability of the carrying value of this generation equipment is largely dependent on the rates at which the Company is compensated for its committed capacity within these programs. These rates represent market rates and can fluctuate based on the supply and demand of capacity. Although these market rates are established up to three years in advance of the service delivery, these market rates have not yet been established for the entire remaining useful life of this generation equipment. In performing its impairment analysis, the Company estimates the expected future market rates based on current existing market rates and trends. A decline in the expected future market rates of 10% by itself would not result in an impairment charge related to this generation equipment. During the three and nine months ended September 30, 2012, there were no indicators of impairment that required an impairment test to be performed.

 

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Industry Segment Information

The Company operates in the following major geographic areas as noted in the below chart. The “All other” designation includes Canada, New Zealand and the United Kingdom. Revenues are based upon customer location and internationally totaled $21,899 and $7,543 for the three months ended September 30, 2012 and 2011, respectively, and $28,250 and $14,565 for the nine months ended September 30, 2012 and 2011, respectively.

Revenues by geography as a percentage of total revenues are as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

United States

     88     96     88     94

Australia

     10       1       7       1  

All other

     2       3       5       5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

As of September 30, 2012 and December 31, 2011, the long-lived assets related to the Company’s international subsidiaries were not material to the accompanying unaudited condensed consolidated financial statements taken as a whole.

2. Unaudited Pro Forma Information

The Company concluded that the acquisition of Energy Response on July 1, 2011 represented a material business combination under the provisions of ASC 805, Business Combinations (ASC 805), and therefore, pro forma financial information has been provided herein. Subsequent to the acquisition date, the Company’s results of operations include the results of operations of Energy Response. The following unaudited pro forma financial information presents the consolidated results of operations of the Company and Energy Response as if the acquisition had occurred on January 1, 2010 with pro forma adjustments to give effect to amortization of intangible assets, a decrease in interest expense as all of Energy Response’s debt arrangements were settled in connection with the acquisition, an increase in weighted average number of common shares outstanding based on the shares issued in connection with the acquisition and certain other adjustments:

 

     Nine
Months Ended
 
     September 30,  
     2011  

Net revenue

   $ 263,044  

Net income

   $ 11,695  

Net income per common share:

  

Basic

   $ 0.46  
  

 

 

 

Diluted

   $ 0.44  
  

 

 

 

Acquisition fees and expenses of approximately $500 were a direct result of the transaction and are excluded from the unaudited pro forma information above for the nine months ended September 30, 2011.

 

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3. Intangible Assets and Goodwill

Definite-Lived Intangible Assets

The following table provides the gross carrying amount and related accumulated amortization of intangible assets as of September 30, 2012 and December 31, 2011:

            As of September 30, 2012     As of December 31, 2011  
     Weighted Average
Amortization
Period (in years)
     Gross
Carrying
Amount
     Accumulated
Amortization
    Gross
Carrying
Amount
     Accumulated
Amortization
 

Customer relationships

     4.35      $ 32,681      $ (9,552   $ 32,279      $ (5,286
     

 

 

    

 

 

   

 

 

    

 

 

 

Total customer relationship intangible assets

        32,681        (9,552     32,279        (5,286

Customer contracts

     4.50        4,217        (2,317     4,217        (2,007

Employment agreements and non-compete agreements

     1.49        1,728        (1,015     1,726        (707

Software

     —           120        (120     120        (103

Developed technology

     2.07        2,300        (1,000     2,297        (517

Trade name

     1.40        575        (311     575        (225

Patents

     7.42        180        (45     180        (32
     

 

 

    

 

 

   

 

 

    

 

 

 

Total other definite-lived intangible assets

      $ 9,120      $ (4,808   $ 9,115      $ (3,591
     

 

 

    

 

 

   

 

 

    

 

 

 

Total

      $ 41,801      $ (14,360   $ 41,394      $ (8,877
     

 

 

    

 

 

   

 

 

    

 

 

 

The change in intangible assets from December 31, 2011 to September 30, 2012 was due to foreign currency translation adjustments that resulted from a weaker U.S. dollar. Amortization expense related to intangible assets amounted to $1,808 and $2,008 for the three months ended September 30, 2012 and 2011, respectively, and $5,438 and $4,533 for the nine months ended September 30, 2012 and 2011, respectively. Amortization expense for developed technology, which was $161 and $247 for the three months ended September 30, 2012 and 2011, respectively, and $483 and $577 for the nine months ended September 30, 2012 and 2011, respectively, is included in cost of revenues in the accompanying unaudited condensed consolidated statements of income. Amortization expense for all other intangible assets is included as a component of operating expenses in the accompanying unaudited condensed consolidated statements of income. The intangible asset lives range from one to ten years and the weighted average remaining life was 4.08 years at September 30, 2012. Estimated amortization is expected to be $2,037, $7,202, $6,500, $4,679, $4,098 and $2,925 for the three months ending December 31, 2012, and years ending 2013, 2014, 2015, 2016 and thereafter, respectively.

Goodwill

In accordance with ASC 350, Intangibles—Goodwill and Other (ASC 350), the Company tests goodwill at the reporting unit level for impairment on an annual basis and between annual tests if events and circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying value. The Company has determined that it has two reporting units: (1) the consolidated Australian operations, which represent the Company’s Australia and New Zealand operations, and (2) all other operations. During the three months ended September 30, 2012, there were no potential impairment indicators identified that required an interim impairment test of goodwill. The Company’s market capitalization as of September 30, 2012 exceeded the book value of its consolidated net assets by more than 40%. In addition, as of September 30, 2012, the fair value of both the Company’s consolidated Australia reporting unit and the Company’s all other operations reporting unit exceeded each of their respective carrying values by more than 50%. The Company will complete its annual impairment test of goodwill as of November 30 th .

The following table shows the change in the carrying amount of goodwill from December 31, 2011 to September 30, 2012:

 

Balance at December 31, 2011

   $ 79,213  

Purchase price adjustment related to Energy Response (1)

     34  

Foreign currency translation impact

     234  
  

 

 

 

Balance at September 30, 2012

   $ 79,481  
  

 

 

 

 

(1) Based on new information gathered during the three months ended March 31, 2012 about facts and circumstances that existed as of the acquisition date related to a pre-acquisition liability of Energy Response, the Company reflected this additional liability as part of its purchase accounting, resulting in a decrease of net tangible assets acquired and a corresponding increase to goodwill.

 

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4. Net Income Per Share

A reconciliation of basic and diluted share amounts for the three and nine months ended September 30, 2012 and 2011 are as follows (shares in thousands):

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2012      2011      2012      2011  

Basic weighted average common shares outstanding

     26,653        25,683        26,471        25,491  

Weighted average common stock equivalents

     673        855        599        1,008  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted weighted average common shares outstanding

     27,326        26,538        27,070        26,499  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average anti-dilutive shares related to:

           

Stock options

     —           1,775        1        1,170  

Nonvested restricted stock

     354        239        632        213  

Restricted stock units

     154        194        225        107  

In reporting periods in which the Company reports net income, anti-dilutive shares consist of those common stock equivalents that have either an exercise price above the average stock price for the period or the common stock equivalents’ related average unrecognized stock compensation expense is sufficient to “buy back” the entire amount of shares. In those reporting periods in which the Company has a net loss, anti-dilutive shares consist of the impact of those number of shares that would have been dilutive had the Company had net income plus the number of common stock equivalents that would have been anti-dilutive had the Company had net income.

The Company excludes the shares issued in connection with restricted stock awards from the calculation of basic weighted average common shares outstanding until such time as those shares vest. In addition, with respect to restricted stock awards that vest based on achievement of performance conditions, because performance conditions are considered contingencies under ASC 260, Earnings per Share, the criteria for contingent shares must first be applied before determining the dilutive effect of these types of share-based payments. Prior to the end of the contingency period (i.e., before the performance conditions have been satisfied), the number of contingently issuable common shares to be included in diluted weighted average common shares outstanding should be based on the number of common shares, if any, that would be issuable under the terms of the arrangement if the end of the reporting period were the end of the contingency period (e.g., the number of shares that would be issuable based on current performance criteria) assuming the result would be dilutive. For the three and nine months ended September 30, 2012, 322,097 and 86,540 weighted average common shares, respectively, related to restricted shares subject to performance-based vesting conditions that were probable of being achieved and would have otherwise been dilutive were excluded from the diluted weighted average common shares outstanding due to the fact that the performance vesting conditions had not been satisfied as of September 30, 2012. For the three and nine months ended September 30, 2011, no restricted shares subject to performance-based vesting conditions that were probable of being achieved and would have otherwise been dilutive were excluded from the dilutive weighted average common shares outstanding for those periods.

In connection with certain of the Company’s business combinations, the Company issued common shares that were held in escrow upon closing of the applicable business combination. The Company excludes shares held in escrow from the calculation of basic weighted average common shares outstanding where the release of such shares is contingent upon an event and not solely subject to the passage of time. The 254,654 shares related to a component of the deferred purchase price consideration from the acquisition of M2M, which are not subject to adjustment as the issuance of such shares is not subject to any contingency, are included in both the basic and diluted weighted average common shares outstanding amounts.

In July 2012, the Company released 51,921 and 46,509 shares of common stock held in escrow related to the Global Energy Partners, Inc. (Global Energy) and Energy Response acquisitions, respectively, in accordance with the provisions within their respective escrow agreements.

5. Disclosure of Fair Value of Financial Instruments

The Company’s financial instruments mainly consist of cash and cash equivalents, restricted cash, accounts receivable, accounts payable and debt obligations. The carrying amounts of the Company’s cash equivalents, restricted cash, accounts receivable and accounts payable approximate their fair value due to the short-term nature of these instruments. At September 30, 2012 and at December 31, 2011, the Company had no outstanding debt obligations.

 

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6. Fair Value Measurements

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis at September 30, 2012:

 

     Fair Value Measurement at September 30, 2012  Using  
     Totals      Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant
Other
Observable
Inputs (Level 2)
     Unobservable
Inputs (Level 3)
 

Assets:

           

Money market funds (1)

   $ 15,377      $ 15,377      $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Deferred acquisition consideration (2)

     525        —           —           525  

Accrued acquisition contingent consideration (2)

     409        —           —           409  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 934      $ —         $ —         $ 934  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in cash and cash equivalents in the accompanying unaudited condensed consolidated balance sheets. Decrease in investments in money market funds from December 31, 2011 was a result of transfer of funds to the Company’s operating account to be utilized for new contractual financial assurance requirements.
(2) Deferred acquisition consideration and accrued acquisition contingent consideration, which are liabilities, that were the result of the Company’s acquisition of M2M Communications, Inc. (M2M) and Energy Response, respectively, represent the only assets or liabilities that the Company measures and records at fair value on a recurring basis using significant unobservable inputs (Level 3). The aggregate increase in fair value of liabillities for the nine months ended September 30, 2012 of $98 was due to the increase in the liabilities as a result of the amortization of the applicable discounts related to the time value of money of $60 and changes in exchange rates. There have been no changes with respect to the probability or timing of payment subsequent to December 31, 2011.

With respect to assets measured at fair value on a non-recurring basis, which would be impaired long-lived assets, refer to Note 1 for discussion of the determination of fair value of these assets.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis at December 31, 2011:

 

     Fair Value Measurement at December 31, 2011 Using  
     Totals      Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant
Other
Observable
Inputs (Level 2)
     Unobservable
Inputs (Level 3)
 

Assets:

           

Money market funds (1)

   $ 51,841      $ 51,841      $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Deferred acquisition consideration (2)

     500        —           —           500  

Accrued acquisition contingent consideration (2)

     336        —           —           336  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 836      $ —         $ —         $ 836  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Included in cash and cash equivalents in the accompanying unaudited condensed consolidated balance sheets.

 

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(2) Deferred acquisition consideration and accrued acquisition contingent consideration, which are liabilities, that were the result of the Company’s acquisition of M2M and Energy Response, respectively, represent the only assets or liabilities that the Company measures and records at fair value on a recurring basis using significant unobservable inputs (Level 3).

7. Financing Arrangements

In April 2011, the Company and one of its subsidiaries entered into a $75,000 senior secured revolving credit facility pursuant to a credit agreement, which was subsequently amended in June 2011, November 2011 and December 2011 (the 2011 credit facility), with SVB and one other financial institution. In March 2012, the Company and one of its subsidiaries entered into a new credit facility with SVB, which was subsequently amended in June 2012 (the 2012 credit facility), under which SVB became the sole lender, the Company’s borrowing limit was decreased from $75,000 to $50,000 and certain of its financial covenant compliance requirements were modified or eliminated. The material changes in the 2012 credit facility to the Company’s monthly and quarterly financial covenants included:

 

   

a decrease in the Company’s quarterly financial covenant related to minimum earnings levels and a change in the calculation, which is now based on earnings before depreciation and amortization expense, interest expense, provision for income taxes, stock-based compensation expense, rent expense, certain impairment charges and certain other non-cash charges over a trailing twelve month period;

 

   

amendment to the Company’s monthly financial covenant related to maintenance of a minimum specified ratio of current assets to current liabilities reducing the Company’s required minimum of unrestricted cash from $50,000 to $30,000 for certain periods; and

 

   

elimination of the quarterly financial covenant related to maintenance of a minimum specified fixed charge coverage ratio.

The 2012 credit facility also decreased the letter of credit fee charged to the Company in connection with the issuance or renewal of letters of credit from 2.125 % to 2.0%.

Subject to continued compliance with the covenants contained in the 2012 credit facility, the full amount of the 2012 credit facility may be available for issuances of letters of credit and up to $5,000 of the 2012 credit facility may be available for swing line loans. The interest on revolving loans under the 2012 credit facility will accrue, at the Company’s election, at either (i) the Eurodollar Rate with respect to the relevant interest period plus 2.00% or (ii) the ABR (defined as the highest of (x) the “prime rate” as quoted in the  Wall Street Journal , (y) the Federal Funds Effective Rate plus 0.50% and (z) the Eurodollar Rate for a one-month interest period plus 1.00%) plus 1.00%. The Company expenses the interest and letter of credit fees under the 2012 credit facility, as applicable, in the period incurred. The obligations under the 2012 credit facility are secured by all domestic assets of the Company and several of its subsidiaries, excluding the Company’s foreign subsidiaries. The 2012 credit facility terminates and all amounts outstanding thereunder are due and payable in full on April 15, 2013. The Company incurred financing costs of $543 in connection with the 2011 credit facility, which were deferred and were being amortized to interest expense over the term of the 2011 credit facility, or through April 15, 2013. In connection with the 2012 credit facility, the Company incurred financing costs of $111 which were deferred and are being amortized to interest expense over the term of the 2012 credit facility, or through April 15, 2013. As a result of the 2012 credit facility, during the three months ended March 31, 2012, in addition to the amortization of deferred financing costs, the Company expensed $98, or 33%, of the remaining initial deferred financing costs related to the 33% reduction in the available borrowing limit.

The 2012 credit facility contains customary terms and conditions for credit facilities of this type, including, among other things, restrictions on the ability of the Company and its subsidiaries to incur additional indebtedness, create liens, enter into transactions with affiliates, transfer assets, make certain acquisitions, pay dividends or make distributions on, or repurchase, the Company’s common stock, consolidate or merge with other entities, or undergo a change in control. In addition, the Company is required to meet certain monthly and quarterly financial covenants customary with this type of credit facility.

The 2012 credit facility contains customary events of default, including for payment defaults, breaches of representations, breaches of affirmative or negative covenants, cross defaults to other material indebtedness, bankruptcy and failure to discharge certain judgments. If a default occurs and is not cured within any applicable cure period or is not waived, SVB may accelerate the Company’s obligations under the 2012 credit facility. If the Company is determined to be in default then any amounts outstanding under the 2012 credit facility would become immediately due and payable and the Company would be required to collateralize with cash any outstanding letters of credit up to 105% of the amounts outstanding.

In May 2012, the Company was required to provide financial assurance in connection with its capacity bid in a certain open market bidding program. The Company provided this financial assurance utilizing approximately $45,000 of its available cash on hand and a $7,000 letter of credit issued under the 2012 credit facility. At the end of May 2012, based on the capacity that the Company cleared in this open market bidding program and the required post-auction financial assurance requirements, the Company recovered $30,000 of the $45,000 of its available cash that it had provided as financial assurance prior to the auction and the $7,000 letter of credit was cancelled.

 

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As of September 30, 2012, the Company was in compliance with all of its covenants under the 2012 credit facility. The Company believes that it is reasonably assured that it will comply with the covenants under the 2012 credit facility for the foreseeable future.

In July 2012, the Company entered into a lease for its new principal executive offices located at One Marina Park Drive, Floors 4-6, Boston, Massachusetts (the New Lease). Under the terms of the New Lease, the Company was required to provide a security deposit in the form of an unconditional and irrevocable letter of credit of approximately $1,845, subject to reduction commencing August 1, 2015.

As of September 30, 2012, the Company had no borrowings, but had outstanding letters of credit totaling $44,335 under the 2012 credit facility. The increase from the amount of outstanding letters of credit as of December 31, 2011 totaling $31,631 is due to additional financial assurance requirements resulting from new customer arrangements and increases in delivery obligations under certain open market bidding programs. As of September 30, 2012, the Company had $5,665 available under the 2012 credit facility for future borrowings or issuances of additional letters of credit.

8. Commitments and Contingencies

In June 2012, the Company exercised its termination option under the current lease for its principal executive offices at 75-101 Federal Street, Boston, Massachusetts (the Current Lease) and provided notice of its election to terminate the Current Lease effective as of June 30, 2013. As a result of its election to terminate the Current Lease, the Company is required to make a lease termination payment of $1,146 of which $573 was paid upon exercise of the election to terminate and the remaining $573 is due and payable on or before July 1, 2013. In accordance with ASC 420, Exit or Disposal Cost Obligations, the Company recorded the fair value of this lease termination expense of $1,146 within general and administrative expenses in the unaudited condensed consolidated statements of operations during the three months ended June 30, 2012. The Company determined the fair value of the lease termination obligation based on the $573 paid upon the election to terminate the lease plus the $573 that will be paid on or before July 1, 2013. Pursuant to the terms of the Current Lease, in addition to the lease termination payment, the Company is required to continue to pay its contractual lease payments through the lease termination date of June 30, 2013. The Company will record the remaining contractual lease payments ratably through the lease termination date since the Company currently intends to utilize the leased space through the lease termination date. As a result of its election to terminate the Current Lease, the Company re-evaluated the estimated useful life of the leasehold improvements and furniture and fixtures related to this leased space and concluded that a change in the estimated useful life is required. As a result, commencing in June 2012, the Company revised the estimated useful life of these associated assets totaling $937 to fully depreciate the remaining net book value of these assets over the shorter of their remaining useful life or the revised lease termination date.

In July 2012, the Company entered into the New Lease. The New Lease term is through July 2020 and contains both a rent holiday period and escalating rental payments over the New Lease term. The New Lease requires payments for additional expenses such as taxes, maintenance, and utilities and contains a fair value renewal option. The Company is currently making certain improvements to the leased space and intends to occupy the space during the first half of the fiscal year ending December 31, 2013. In accordance with the New Lease, the landlord is providing certain lease incentives with respect to the leasehold improvements. In accordance with ASC 840, Leases, the Company will record the incentives as deferred rent and expense these amounts as reductions of lease expense over the lease term. Although lease payments under the New Lease do not commence until August 2013, as the Company has the right to use and controls physical access to the space, the Company has determined that the lease term commenced in July 2012 and as a result is recording rent expense on the New Lease on a straight-line basis. The New Lease also contains certain provisions requiring the Company to restore certain aspects of the leased space to its initial condition. The Company has determined that these provisions represent asset retirement obligations and will record the estimated fair value of these obligations as the related leasehold improvements are incurred. There have been no leasehold improvements which would represent asset retirement obligations as of September 30, 2012. The Company will accrete the liability to fair value over the life of the New Lease as a component of operating expenses.

As of September 30, 2012 and December 31, 2011, the Company had a deferred rent liability representing rent expense recorded on a straight-line basis in excess of contractual lease payments of $1,049 and $432, respectively, which is included in other liabilities in the accompanying condensed consolidated balance sheets.

 

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Future minimum lease payments for operating leases with non-cancelable terms of more than one year were as follows:

 

     Operating Leases  

Remainder of 2012

   $ 1,304   

2013

     4,914  

2014

     4,957  

2015

     3,967  

2016

     3,851  

Thereafter

     14,236  
  

 

 

 

Total minimum lease payments (not reduced by sublease rentals of $280)

   $ 33,229   
  

 

 

 

As of September 30, 2012, the Company was contingently liable under outstanding letters of credit for $44,335. As of September 30, 2012 and December 31, 2011, the Company had restricted cash balances of $100 and $158, respectively, all of which related to collateral to secure certain insurance commitments.

The Company is subject to performance guarantee requirements under certain utility and electric power grid operator customer contracts and open market bidding program participation rules, which may be secured by cash or letters of credit. Performance guarantees as of September 30, 2012 were $53,828 and included deposits held by certain customers of $9,493 at September 30, 2012. These amounts primarily represent up-front payments required by utility and electric power grid operator customers as a condition of participation in certain demand response programs and to ensure that the Company will deliver its committed capacity amounts in those programs. If the Company fails to meet its minimum committed capacity requirements, a portion or all of the deposits may be forfeited. The Company assessed the probability of default under these customer contracts and open market bidding programs and has determined the likelihood of default and loss of deposits to be remote. In addition, under certain utility and electric power grid operator customer contracts, if the Company does not achieve the required performance guarantee requirements, the customer can terminate the arrangement and the Company would potentially be subject to termination penalties. Under these arrangements, the Company defers all fees received up to the amount of the potential termination penalty until the Company has concluded that it can reliably determine that the potential termination penalty will not be incurred or the termination penalty lapses. As of September 30, 2012, the Company had no remaining deferred fees that were included in deferred revenue. As of September 30, 2012, the maximum termination penalty that the Company was subject to under these arrangements, which the Company has not deemed probable of incurring, was approximately $7,517.

As of September 30, 2012 and December 31, 2011, the Company has accrued in the accompanying unaudited condensed consolidated balance sheets $719 and $6,045, respectively, of performance adjustments related to fees received for its participation in a demand response program. The decrease in the accrual from December 31, 2011 was a result of the Company repaying $6,293 to the electric power grid operator during the three months ended September 30, 2012 since the Company did not deliver all of its MW obligations under this demand response program offset by an increase in additional performance adjustments. The Company believes that it is probable that the remaining balance will need to be re-paid to the electric power grid operator within the next twelve months.

The Company is currently involved in an ongoing regulatory matter related to a review of certain fees received under a contractual arrangement. Based on discussions related to this matter that occurred during the three months ended June 30, 2012, the Company believed that it was probable that a loss had been incurred and had accrued the low end of the range as required under ASC 450, Contingencies , which was not material Based on additional discussions during the three months ended September 30, 2012 and subsequent to September 30, 2012, the Company has determined that the low-end of the range of the probable loss has increased and as a result, has recorded an additional charge during the three months ended September 30, 2012 to accrue the low-end of the range as of September 30, 2012. The amount accrued is not material to the Company’s consolidated results of operations for the three or nine months ended September 30, 2012. Although this matter has not yet been resolved and the potential magnitude of the loss could exceed the amount currently accrued by more than an insignificant amount, the Company is unable to estimate the potential magnitude of the range of loss.

The Company typically grants customers a limited warranty that guarantees that its hardware will substantially conform to current specifications for one year from the delivery date. Based on the Company’s operating history, the liability associated with product warranties has been determined to be nominal.

 

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9. Stock-Based Compensation

During the nine months ended September 30, 2012 and 2011, the Company issued 44,871 shares and 18,211 shares of its common stock, respectively, to a certain executive to satisfy a portion of the Company’s bonus obligation to that individual. The Company’s Amended and Restated 2007 Employee, Director and Consultant Stock Plan (the 2007 Plan) provides for an annual increase to the shares issuable under the 2007 Plan by an amount equal to the lesser of 520,000 shares or an amount determined by the Company’s board of directors. As of September 30, 2012, 829,252 shares were available for future grant under the 2007 Plan.

Stock Options

The fair value of options granted was estimated at the date of grant using the following weighted average assumptions:

 

     Nine Months Ended
September 30,
 
     2012     2011  

Risk-free interest rate

     1.8     3.2

Vesting term, in years

     2.22       2.22  

Expected annual volatility

     78     79

Expected dividend yield

     —       —  

Exit rate pre-vesting

     8.0     7.5

Exit rate post-vesting

     14.06     14.06

Volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company calculates volatility using a component of implied volatility and historical volatility to determine the value of share-based payments. The risk-free interest rate is the rate available as of the option date on zero-coupon United States government issues with a term equal to the expected life of the option. The Company has not paid dividends on its common stock in the past and does not plan to pay any dividends in the foreseeable future. In addition, the terms of the 2012 credit facility preclude the Company from paying dividends. During the three months ended September 30, 2012, the Company updated its estimated exit rate pre-vesting and post-vesting applied to options, restricted stock and restricted stock units based on an evaluation of demographics of its employee groups and historical forfeitures for these groups in order to determine its option valuations as well as its stock-based compensation expense. The changes in estimates of the volatility, exit rate pre-vesting and exit rate post-vesting did not have a material impact on the Company’s stock-based compensation expense recorded in the accompanying unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2012.

The components of stock-based compensation expense are disclosed below:

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2012      2011      2012      2011  

Stock options

   $ 471      $ 1,107      $ 1,584      $ 4,252  

Restricted stock and restricted stock units

     2,870        2,114        8,434        6,236  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,341      $ 3,221      $ 10,018      $ 10,488  
  

 

 

    

 

 

    

 

 

    

 

 

 

Stock-based compensation is recorded in the accompanying unaudited condensed consolidated statements of income, as follows:

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2012      2011      2012      2011  

Selling and marketing expenses

   $ 1,182      $ 964      $ 3,428      $ 3,262  

General and administrative expenses

     1,908        1,975        5,712        6,355  

Research and development expenses

     251        282        878        871  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,341      $ 3,221      $ 10,018      $ 10,488  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The stock-based compensation expense related to share-based payments to non-employees was not material for the three and nine months ended September 30, 2012 and 2011. The Company recognized no material income tax benefit from share-based compensation arrangements during the three and nine months ended September 30, 2012 and 2011. In addition, no material compensation cost was capitalized during the three and nine months ended September 30, 2012 and 2011.

The following is a summary of the Company’s stock option activity during the nine months ended September 30, 2012:

 

     Nine Months Ended September 30, 2012  
     Number of
Shares
Underlying
Options
    Exercise Price
Per Share
     Weighted-
Average
Exercise
Price Per
Share
     Aggregate
Intrinsic
Value
 

Outstanding at December 31, 2011

     1,611,391     $ 0.17 -  $48.06       $ 15.35      $ 4,195 (2) 

Granted

     10,550          8.90     

Exercised

     (148,852        0.94      $ 1,139 (3) 

Cancelled

     (146,075        23.99     
  

 

 

         

Outstanding at September 30, 2012

     1,327,014     $ 0.17 -  $48.06         15.96      $ 4,075 (4) 
  

 

 

   

 

 

    

 

 

    

 

 

 

Weighted average remaining contractual life in years: 4.1

          

Exercisable at end of period

     1,150,149     $ 0.17 -  $48.06       $ 14.63      $ 3,994 (4) 
  

 

 

   

 

 

    

 

 

    

 

 

 

Weighted average remaining contractual life in years: 3.8

          

Vested or expected to vest at September 30, 2012 (1)

     1,316,441     $ 0.17 -  $48.06       $ 15.90      $ 4,068 (4) 
  

 

 

   

 

 

    

 

 

    

 

 

 

 

(1) Represents the number of vested options as of September 30, 2012 plus the number of unvested options expected to vest as of September 30, 2012 based on the unvested options outstanding at September 30, 2012, adjusted for the estimated forfeiture rate of 8.0%.
(2) The aggregate intrinsic value was calculated based on the positive difference between the estimated fair value of the Company’s common stock on December 31, 2011 of $10.87 and the exercise price of the underlying options.
(3) The aggregate intrinsic value was calculated based on the positive difference between the fair value of the Company’s common stock on the applicable exercise dates and the exercise price of the underlying options.
(4) 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, 2012 of $12.98 and the exercise price of the underlying options.

Additional Information About Stock Options

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2012      2011      2012      2011  
     In thousands, except share
and per share amounts
     In thousands, except share and
per share amounts
 

Total number of options granted during the period

     5,100        2,550        10,550        42,500  

Weighted-average fair value per share of options granted

   $ 6.15      $ 5.77      $ 5.37      $ 11.59  

Total intrinsic value of options exercised (1)

   $ 209      $ 661      $ 1,139      $ 3,450  

 

(1) Represents the difference between the market price at exercise and the price paid to exercise the options.

 

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Of the stock options outstanding as of September 30, 2012, 1,315,521 options were held by employees and directors of the Company and 11,493 options were held by non-employees. For outstanding unvested stock options related to employees as of September 30, 2012, the Company had $2,154 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 1.5 years. There were no material unvested non-employee options as of September 30, 2012.

Restricted Stock and Restricted Stock Units

For non-vested restricted stock and restricted stock units subject to service-based vesting conditions outstanding as of September 30, 2012, the Company had $9,101 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 2.5 years. For non-vested restricted stock subject to performance-based vesting conditions outstanding that were probable of vesting as of September 30, 2012, the Company had $5,308 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 1.4 years. For non-vested restricted stock subject to outstanding performance-based vesting conditions that were not probable of vesting as of September 30, 2012, the Company had $1,140 of unrecognized stock-based compensation expense. If and when any additional portion of the awards is deemed probable to vest, the Company will reflect the effect of the change in estimate in the period of change by recording a cumulative catch-up adjustment to retroactively apply the new estimate.

Restricted Stock

The following table summarizes the Company’s restricted stock activity during the nine months ended September 30, 2012:

 

     Number of
Shares
    Weighted Average
Grant Date Fair
Value Per Share
 

Nonvested at December 31, 2011

     1,141,643     $ 15.31  

Granted

     1,513,828       7.87  

Vested

     (244,513     15.73  

Cancelled

     (180,301     12.20  
  

 

 

   

Nonvested at September 30, 2012

     2,230,657     $ 10.48  
  

 

 

   

All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest. Restricted stock typically vests ratably over a four-year period from the date of issuance, with certain exceptions. Included in the above table are 20,700 shares of restricted stock granted to certain non-executive employees and 43,793 shares of restricted stock granted to certain members of the Company’s board of directors during the nine months ended September 30, 2012 that were immediately vested.

The fair value of restricted stock where vesting is solely service-based is expensed ratably over the vesting period. With respect to restricted stock where vesting contains certain performance-based vesting conditions, the fair value is expensed based on the accelerated attribution method as prescribed by ASC 718,  Stock Compensation (ASC 718) over the vesting period. During the nine months ended September 30, 2012, the Company granted 1,023,010 shares of nonvested restricted stock to certain executives and non-executive employees that contain performance-based vesting conditions and these awards will vest in equal installments in 2013 and 2014 if the performance conditions are achieved. 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.

In November 2011, the Company’s board of directors approved a plan to include performance-based stock awards as part of the annual non-executive bonus plan. In December 2011, 283,334 shares were issued under the 2007 Plan with a fair value of $2,700 and these awards will vest in equal installments in 2013 and 2014 if the performance conditions are achieved. Through December 31, 2011, the Company determined that no awards were probable of vesting and as a result, no stock-based compensation expense related to these awards was recorded through December 31, 2011. In March 2012, the performance conditions were modified and the Company determined that the modified performance conditions were probable of being achieved. As the performance-based stock awards were improbable of vesting prior to the modification of the performance conditions, the original grant date fair value is no longer used to measure compensation cost for the awards. The fair value of these awards was re-measured as of the modification date resulting in a new grant-date fair value of $2,132 after accounting for cancelled grants due to employee terminations. As these awards

 

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were probable of vesting as of March 31, 2012 and a portion of the service period had lapsed, the Company recorded a cumulative catch-up adjustment of stock-based compensation expense during the three months ended March 31, 2012 as required by ASC 718. During the three and nine months ended September 30, 2012, there were no changes to probabilities of vesting of performance-based stock awards which had a material impact on stock-based compensation expense or amounts expected to be recognized.

Additional Information about Restricted Stock

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  
     in thousands, except share and per  
     share amounts  

Total number of shares of restricted stock granted during the period

     212,950        76,850        1,513,828        531,231  

Weighted average fair value per share of restricted stock granted

   $ 10.72      $ 13.44      $ 7.87      $ 18.78  

Total number of shares of restricted stock vested during the period

     50,174        13,977        244,513        60,099  

Total fair value of shares of restricted stock vested during the period

   $ 423      $ 191      $ 2,103      $ 1,077  

Restricted Stock Units

The following table summarizes the Company’s restricted stock unit activity during the nine months ended September 30, 2012:

 

     Number of
Shares
    Weighted Average
Grant Date Fair
Value Per Share
 

Nonvested at December 31, 2011

     229,020     $ 26.75  

Granted

     —          —     

Vested

     (85,312     25.33  

Cancelled

     (30,500     29.75  
  

 

 

   

Nonvested at September 30, 2012

     113,208     $ 27.01  
  

 

 

   

Additional Information about Restricted Stock Units

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2012      2011      2012      2011  
     in thousands, except share amounts  

Total number of shares of restricted stock vested during the period

     6,728        6,728        85,312        88,437  

Total fair value of shares of restricted stock vested during the period

   $ 61      $ 71      $ 792      $ 1,537  

10. Income Taxes

The Company accounts for income taxes in accordance with ASC 740,  Income Taxes  (ASC 740), which is the asset and liability method for accounting and reporting income taxes. Under ASC 740, deferred tax assets and liabilities are recognized based on temporary differences between the financial reporting and income tax bases of assets and liabilities using statutory rates. In addition, ASC 740 requires a valuation allowance against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

 

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The Company reviews all available evidence to evaluate the recovery of deferred tax assets, including the recent history of accumulated losses in all tax jurisdictions over the last three years, as well as its ability to generate income in future periods. As of September 30, 2012, due to the uncertainty related to the ultimate use of the Company’s deferred income tax assets, the Company provided a full valuation allowance on all of its U.S. and Australian deferred tax assets.

ASC 740 also provides criteria for the recognition, measurement, presentation and disclosures of uncertain tax positions. A tax benefit from an uncertain tax position may be recognized if it is “more likely than not” that the position is sustainable based solely on its technical merits. As of September 30, 2012 and December 31, 2011, the Company had no material unrecognized tax benefits.

In accordance with ASC 740, each interim period is considered an integral part of the annual period and tax expense is measured using an estimated annual effective tax rate. An enterprise is required, at the end of each interim reporting period, to make its best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. Generally, if an enterprise has a year-to-date ordinary loss at the end of an interim period and anticipates an ordinary loss for the full fiscal year, the enterprise will record an interim period tax provision based on applying the estimated annual effective tax rate to the ordinary loss. However, if an enterprise is unable to make a reliable estimate of its annual effective tax rate then the actual effective tax rate for the year-to-date period may be the best estimate of the annual effective tax rate. For the six months ended June 30, 2012, the Company had determined that it was unable to make a reliable estimate of its annual effective tax rate due to unusual sensitivity to the rate as it relates to its forecasted fiscal 2012 U.S. loss. As a result, the Company recorded a tax provision during the six months ended June 30, 2012 based on its actual effective tax rate for the six months ended June 30, 2012.

For the nine months ended September 30, 2012, the Company determined that it is able to make a reliable estimate of its annual effective tax rate due to the resolution of certain matters that previously resulted in significant volatility in both the Company’s forecasted fiscal 2012 U.S. ordinary income and its U.S. effective tax rate, and applied this estimated annual effective tax rate to its year-to-date income. For the nine months ended September 30, 2012, the Company recorded a provision for income taxes of $95, which represents an effective tax rate of 2.6%. For the three months ended September 30, 2012, the Company recorded a benefit for income taxes of $718 related to the reversal of the previously recorded tax provision on U.S. tax deductible goodwill. The Company did not record an income tax benefit on the expected losses in the U.S. and Australia for the period because the Company maintains a valuation allowance against the deferred tax assets in these jurisdictions as the deferred tax assets are not more likely than not to be realizable.

For fiscal 2012, the Company expects a provision for income taxes of approximately $1,500 to $2,000 for the tax deductible goodwill and foreign taxes resulting from guaranteed profits, which will result in a provision for income taxes during the three months ending December 31, 2012 of approximately these same amounts. In addition, for fiscal 2012, the Company expects a nominal amount of cash paid for income taxes, primarily related to foreign jurisdictions.

The Company continues to maintain its permanent reinvestment assertion with regards to the unremitted earnings of its foreign subsidiaries. As such, it does not accrue U.S. tax for the potential future repatriation of these unremitted foreign earnings. As of September 30, 2012, the amounts of foreign earnings in Canada and the United Kingdom that are expected to remain invested outside the U.S. indefinitely, and for which no U.S. tax expense has been provided, were not material. The Company’s Australian subsidiary has not generated earnings to date. The amount of cash held by the Company’s foreign subsidiaries as of September 30, 2012 was not material and was not required to fund the Company’s U.S. operations. If the Company were to repatriate its foreign earnings, it expects to utilize existing tax attributes (U.S. net operating loss carryforwards) and expects any taxes paid to repatriate these earnings to be minimal.

11. Concentrations of Credit Risk

The following table presents the Company’s significant customers. PJM Interconnection (PJM) and ISO-New England, Inc. (ISO-NE), are regional electric power grid operator customers in the mid-Atlantic and New England regions that are comprised of multiple utilities and were formed to control the operation of the regional power system, coordinate the supply of electricity, and establish fair and efficient markets. No other customers comprised more than 10% of consolidated revenues during either the three or nine months ended September 30, 2012.

 

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     Three Months Ended September 30,  
     2012     2011  
     Revenues      % of Total
Revenues
    Revenues      % of Total
Revenues
 

PJM

   $ 108,294        61   $ 120,160        71

ISO-NE

     *         *        *         *   
     Nine Months Ended September 30,  
     2012     2011  
     Revenues      % of Total
Revenues
    Revenues      % of Total
Revenues
 

PJM

   $ 109,657        47   $ 151,533        58

ISO-NE

     *         *        29,724        11  

 

* Represents less than 10% of total revenues.

Accounts receivable from PJM was approximately 11% and 21% of the accounts receivable balance at September 30, 2012 and December 31, 2011, respectively. Pacific Gas and Electric (PG&E) was the only other customer that comprised 10% or more of the accounts receivable balance at September 30, 2012, which represented 13% of such accounts receivable balance. Other than PJM, Tennessee Valley Authority was the only additional customer that comprised 10% or more of the accounts receivable balance at December 31, 2011 at 13%.

Unbilled revenue related to PJM was $75,998 and $64,099 at September 30, 2012 and December 31, 2011, respectively. There was no significant unbilled revenue for any other customers at September 30, 2012 and December 31, 2011.

Deposits and restricted cash consist of funds to secure performance under certain contracts and open market bidding programs with electric power grid operator and utility customers. Deposits held by these customers were $9,493 and $14,281 at September 30, 2012 and December 31, 2011, respectively. Restricted cash to secure insurance commitments was $100 and $158 at September 30, 2012 and December 31, 2011, respectively.

12. Recent Accounting Pronouncements

Disclosures about Offsetting Assets and Liabilities

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities  (ASU No. 2011-11). ASU No. 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. An entity is required to apply ASU No. 2011-11 for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by ASU No. 2011-11 retrospectively for all comparative periods presented. The Company does not expect that the adoption of ASU No. 2011-11 will have a significant, if any, impact on its consolidated financial statements.

 

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

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, as filed with the Securities and Exchange Commission, or the SEC, on March 15, 2012 and as amended on April 17, 2012, or our 2011 Form 10-K. 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, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Without limiting the foregoing, the words “may,” “will,” “should,” “could,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” “target” and variations of those 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, operating 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, as well as in our 2011 Form 10-K. 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 provider of energy management applications, services and products for the smart grid, which include comprehensive demand response, data-driven energy efficiency, energy price and risk management and enterprise carbon management applications, services and products. Our energy management applications, services and products enable cost effective energy management strategies for commercial, institutional and industrial end-users of energy, which we refer to as our C&I customers, and our electric power grid operator and utility customers by reducing real-time demand for electricity, increasing energy efficiency, improving energy supply transparency, and mitigating carbon emissions.

We believe that we are the largest demand response service provider to C&I customers. As of September 30, 2012, we managed approximately 8,500 megawatts, or MW, of demand response capacity across a C&I customer base of approximately 5,800 accounts and approximately 13,500 sites throughout multiple electric power grids. Demand response is an alternative to traditional power generation and transmission infrastructure projects that enables electric power grid operators and utilities to reduce the likelihood of service disruptions, such as brownouts and blackouts, during periods of peak electricity demand and otherwise manage the electric power grid during short-term imbalances of supply and demand or during periods when energy prices are high. We use our Network Operations Center, or NOC, and comprehensive demand response application, DemandSMART, to remotely manage and reduce electricity consumption across a growing network of C&I customer sites, making demand response capacity available to electric power grid operators and utilities on demand while helping C&I customers achieve energy savings, improved financial results and environmental benefits. To date, we have received substantially all of our revenues from electric power grid operators and utilities who make recurring payments to us for managing demand response capacity. We share these recurring payments with our C&I customers in exchange for those C&I customers reducing their power consumption when called upon.

In providing our demand response services, we match obligation, in the form of MW that we agree to deliver to our utility and grid operator customers, with supply, in the form of MW that we are able to curtail from the electric power grid through our arrangements with C&I customers. We increase our ability to curtail demand from the electric power grid by deploying a sales team to contract with our C&I customers and by installing our equipment at these customers’ sites to connect them to our network. When we are called upon by our utility or grid operator customers to deliver MW, we use our DemandSMART application to dispatch this network to meet the demands of these utility and grid operator customers. We occasionally reallocate and re-align our capacity supply and obligation through open market bidding programs, supplemental demand response programs, auctions or other similar capacity arrangements and bilateral contracts to account for changes in supply and demand forecasts, as well as changes in programs and market rules in order to achieve more favorable pricing opportunities. We refer to the above activities as managing our portfolio of demand response capacity.

 

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We build on our position as a leading demand response services provider by using our NOC and energy management application platform to deliver a portfolio of additional energy management applications, services and products to new and existing C&I, electric power grid operator and utility customers. These additional energy management applications, services and products include our EfficiencySMART, SupplySMART, and CarbonSMART applications and services, and certain wireless energy management products. EfficiencySMART is our data-driven energy efficiency suite that includes commissioning and retro-commissioning authority services, energy consulting and engineering services, a persistent commissioning application and an enterprise energy management application for managing energy across a portfolio of sites. SupplySMART is our energy price and risk management application that provides our C&I customers located in restructured or deregulated markets throughout the United States with the ability to more effectively manage the energy supplier selection process, including energy supply product procurement and implementation, budget forecasting, and utility bill management. CarbonSMART is our enterprise carbon management application that supports and manages the measurement, tracking, analysis, reporting and management of greenhouse gas emissions. Our wireless energy management products are designed to ensure that our C&I customers can connect their equipment remotely and access meter data securely, and include both cellular modems and an agricultural specific wireless technology solution acquired as part of our acquisition of M2M Communications Corporation, or M2M, in January 2011.

Since inception, our business has grown substantially. We began by providing demand response services in one state in 2003 and have expanded to providing our portfolio of energy management applications, services and products in several regions throughout the United States, as well as internationally in Australia, Canada, New Zealand and the United Kingdom.

Revenues and Expense Components

Revenues

We derive recurring revenues from the sale of our energy management applications, services and products. We do not recognize any revenues until persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and we deem collection to be reasonably assured.

Our revenues from our demand response services primarily consist of capacity and energy payments, including ancillary services payments. We derive revenues from demand response capacity that we make available in open market programs and pursuant to contracts that we enter into with electric power grid operators and utilities. In certain markets, we enter into contracts with electric power grid operators and utilities, generally ranging from three to ten years in duration, to deploy our demand response services. We refer to these contracts as utility contracts.

Where we operate in open market programs, our revenues from demand response capacity payments may vary month-to-month based upon our enrolled capacity and the market payment rate. Where we have a utility contract, we receive periodic capacity payments, which may vary monthly or seasonally, based upon enrolled capacity and predetermined payment rates. Under both open market programs and utility contracts, we receive capacity payments regardless of whether we are called upon to reduce demand for electricity from the electric power grid, and we recognize revenue over the applicable delivery period, even where payments are made over a different period. We generally 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 measurement and verification test establishes a new demonstrated capacity amount. In most cases, we also receive an additional payment for the amount of energy usage that we actually curtail from the grid during a demand response event. We refer to this as an energy payment.

As program rules may differ for each open market program in which we participate and for each utility contract, we assess whether or not we have met the specific service requirements under the program rules and recognize or defer revenues as necessary. We recognize demand response capacity revenues when we have provided verification to the electric power grid operator or utility of our ability to deliver the committed capacity under the open market program or utility contract. 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 or determinable and are recognized monthly over the performance period until the next demand response event or measurement and verification test. In subsequent demand response events or measurement and verification tests, if our verified capacity is below the previously verified amount, the electric power grid operator or utility customer will reduce future payments based on the adjusted verified capacity amounts. Under certain utility contracts and open market program participation rules, our performance and related fees are measured and determined over a period of time. If we can reliably estimate our performance for the applicable performance period, we will reserve the entire amount of estimated penalties that will be incurred, if any, as a result of estimated underperformance prior to the commencement of revenue recognition. If we are

 

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unable to reliably estimate the performance and any related penalties, we defer the recognition of revenues until the fee is fixed or determinable. Any changes to our original estimates of net revenues are recognized as a change in accounting estimate in the earliest reporting period that such a change is determined.

We defer incremental direct costs incurred related to the acquisition or origination of a utility contract or open market program in a transaction that results in the deferral or delay of revenue recognition. As of September 30, 2012 and December 31, 2011, there were no deferred incremental direct contract acquisition costs. In addition, we defer incremental direct costs incurred related to customer contracts where the associated revenues have been deferred as long as the deferred incremental direct costs are deemed realizable. During the three months ended September 30, 2012 and 2011, we deferred $0.7 million and $1.1 million, respectively, of incremental direct costs. During the nine months ended September 30, 2012 and 2011, we deferred $11.5 million and $5.2 million, respectively, of incremental direct costs. The increase in the deferral of incremental direct costs during the nine months ended September 30, 2012 compared to the same period in 2011 was primarily related to the deferral of the costs associated with the payment obligations to our C&I customers in connection with our participation in the PJM Interconnection, or PJM, open market demand response program due to the change in our revenue recognition methodology in the fiscal year ending December 31, 2012, or fiscal 2012. In addition, the increase in the deferral of incremental costs during the nine months ended September 30, 2012 as compared to the same period in 2011 was also due to our participation in the Western Australia demand response program, an open market program that we did not participate in until the third quarter of the fiscal year ending December 31, 2011, or fiscal 2011, pursuant to which the associated fees have been deferred because they are not fixed or determinable until the end of the applicable program period on September 30 th of each year. During the nine months ended September 30, 2012 and 2011, we expensed $8.9 million and $0.9 million, respectively, of deferred incremental direct costs to cost of revenues. As of September 30, 2012 there have been no material realizability issues related to deferred incremental direct costs. During the three months ended September 30, 2012 and 2011, we capitalized $0.9 million and $1.9 million, respectively, of production and generation equipment costs. During the nine months ended September 30, 2012 and 2011, we capitalized $6.1 million and $8.5 million, respectively, of production and generation equipment costs. We believe that the above accounting treatments appropriately match expenses with the associated revenue.

As of September 30, 2012, we had approximately 8,500 MW under management in our demand response network, meaning that we had entered into definitive contracts with our C&I customers representing approximately 8,500 MW of demand response capacity. In determining our MW under management in the seasonal demand response programs in which we participate, we typically count the maximum determinable amount of curtailable load for a C&I customer site over a trailing twelve-month period as the MW under management for that C&I customer site. However, the trailing period could be longer in certain programs under which significant rule changes have occurred or under which we do not have enough obligation to enroll all of our MW in a given program period, but have enough obligation in a future program period to enroll those MW again. We generally begin earning revenues from our MW under management within approximately one to three months from the date on which we enable the MW, or the date on which we can reduce the MW from the electricity grid if called upon to do so. The most significant exception is the PJM forward capacity market, which is a market from which we derive a substantial portion of our revenues. Because PJM operates on a June to May program-year basis, a MW that we enable after June of each year may not begin earning revenue until June of the following year. This results in a longer average revenue recognition lag time in our C&I customer portfolio from the point in time when we consider a MW to be under management to when we actually earn revenues from that MW. Certain other markets in which we currently participate, such as the Western Australia market and ISO New England, Inc., or ISO-NE, market, or may choose to participate in the future, operate or may operate in a manner that could create a delay in recognizing revenue from the MW that we enable in those markets. Additionally, not all of our MW under management may be enrolled in a demand response program or may earn revenue in a given program period or year based on the way that we manage our portfolio of demand response capacity.

In the PJM open market program in which we participate, the program year operates on a June to May basis and performance is measured based on the aggregate performance during the months of June through September. As a result, fees received for the month of June could potentially be subject to adjustment or refund based on performance during the months of July through September. Based on recent changes to certain PJM program rules, we have concluded that we no longer have the ability to reliably estimate the amount of fees potentially subject to adjustment or refund until the performance period ends on September 30 th of each year. Therefore, commencing in fiscal 2012, all demand response capacity revenues related to our participation in the PJM open market program are being recognized at the end of the performance period, or during the three months ended September 30 th of each year. As a result of the fact that the period during which we are required to perform (June through September) is shorter than the period over which we receive payments under the program (June through May), a portion of the revenues that have been earned will be recorded and accrued as unbilled revenue. Revenues related to the current PJM open market program year were recognized during the three months ended September 30, 2012, and therefore we had $76.0 million in unbilled revenues from PJM at September 30, 2012.

 

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In February 2012, the Federal Energy Regulatory Commission, or FERC, issued an order substantially accepting a proposal by PJM regarding certain market rule changes with respect to capacity compliance measurement and verification of demand response resources in the PJM capacity market, which we refer to as the PJM proposal. The FERC order resulted in the immediate implementation of the PJM proposal. As a result, our future PJM revenues and profit margins may be reduced and our future results of operations and financial condition may be negatively impacted. These impacts may be offset by the effective management of our portfolio of demand response capacity, including our future growth in MW under management, the adjustment of our zonal capacity obligations through our participation in PJM incremental auctions and bilateral contracts in the PJM market.

Our revenues have historically been higher in the second and third fiscal quarters of our fiscal year due to seasonality related to the demand response market. As a result of the change in our ability to estimate performance in the PJM open market program, all PJM revenues related to the current PJM program year, which commenced on June 1, 2012, were recognized during the third quarter of fiscal 2012 and represented 61% of our total revenues for the three months ended September 30, 2012 as compared to 71% of our total revenues for the three months ended September 30, 2011. No other individual electric power grid operator or utility customer accounted for more than 10% of our total revenues for either the three or nine months ended September 30, 2012.

Revenues generated from open market sales to ISO-NE accounted for 7% and 11% of our total revenues for the three months ended September 30, 2011. Other than PJM and ISO-NE, no individual electric power grid operators or utility customers accounted for more than 10% of our total revenues for either the three or nine months ended September 30, 2011.

In addition to demand response revenues, we generally receive either a subscription-based fee, consulting fee or a percentage savings fee for arrangements under which we provide our other energy management applications and services, specifically our EfficiencySMART, SupplySMART and CarbonSMART applications and services, and certain other wireless energy management products. Revenues derived from these applications and services were $8.3 million and $7.3 million for the three months ended September 30, 2012 and 2011, respectively, and $22.1 million and $19.6 million for the nine months ended September 30, 2012 and 2011, respectively.

Cost of Revenues

Cost of revenues for our demand response services primarily consist of amounts owed to our C&I customers for their participation in our demand response network and are generally recognized over the same performance period as the corresponding revenue. We enter into contracts with our C&I 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 energy payment when a C&I customer reduces consumption of energy from the electric power grid during a demand response event. The equipment and installation costs for our devices located at our C&I customer sites, which monitor energy usage, communicate with C&I customer sites and, in certain instances, remotely control energy usage to achieve committed capacity are capitalized and depreciated over the lesser of the remaining estimated customer relationship period or the estimated useful life of the equipment, and this depreciation is reflected in cost of revenues. We also include in cost of revenues our amortization of acquired developed technology, amortization of capitalized internal-use software costs related to our DemandSMART application, the monthly telecommunications and data costs we incur as a result of being connected to C&I customer sites, and our internal payroll and related costs allocated to a C&I customer site. Certain costs, such as equipment depreciation and telecommunications and data costs, are fixed and do not vary based on revenues recognized. These fixed costs could impact our gross margin trends during interim periods. Cost of revenues for our EfficiencySMART, SupplySMART and CarbonSMART applications and services and certain other wireless energy management products include our amortization of capitalized internal-use software costs related to those applications, services and products, third party services, equipment costs, equipment depreciation, and the wages and associated benefits that we pay to our project managers for the performance of their services.

Gross Profit and Gross Margin

Gross profit consists of our total revenues less our cost of revenues. Our gross profit has been, and will be, affected by many factors, including (a) the demand for our energy management applications, services and products, (b) the selling price of our energy management applications, services and products, (c) our cost of revenues, (d) the way in which we manage, or are permitted to manage by the relevant electric power grid operator or utility, our portfolio of demand response capacity, (e) the introduction of new energy management applications, services and products, (f) our demand response event performance and (g) our ability to open and enter new markets and regions and expand deeper into markets we already serve. The effective management of our portfolio of demand response capacity, including our outcomes in negotiating favorable contracts with

 

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our C&I customers, as well as with our electric power grid operator and utility customers, our participation in capacity auctions and bilateral contracts, and our demand response event performance, is the primary determinant of our gross profit and gross margin.

Operating Expenses

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 587 full-time employees at September 30, 2011 to 660 full-time employees at September 30, 2012 primarily as a result of our overall growth and expansions into new markets during this period. We expect to continue to hire employees to support our growth for the foreseeable future. In addition, we incur significant up-front costs associated with the expansion of the number of MW under our management, which we expect to continue for the foreseeable future. We expect our overall operating expenses to increase in absolute dollar terms for the foreseeable future as we grow our MW under management, further increase our headcount and expand the development of our energy management applications, services and products. In addition, amortization expense from intangible assets acquired in possible future acquisitions could potentially increase our operating expenses in future periods.

Selling and Marketing

Selling and marketing expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards, related to our sales and marketing organization, (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 an increase 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.

General and Administrative

General and administrative expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards and bonuses, related to our executive, finance, human resource, information technology and operations organizations, (b) facilities expenses, (c) accounting and legal professional fees, (d) depreciation and amortization and (e) 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 our continued growth.

Research and Development

Research and development expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards, related to our research and development organization, (b) payments to suppliers for design and consulting services, (c) costs relating to the design and development of new energy management applications, services and products, and enhancement of existing energy management applications, services and products, (d) quality assurance and testing and (e) other related overhead. During the three and nine months ended September 30, 2012, we capitalized software development costs of $1.2 million and $3.5 million, respectively, and the amount is included as software in property and equipment at September 30, 2012. During the three and nine months ended September 30, 2011, we capitalized software development costs of $0.8 million and $2.9 million, respectively, and the amount is included as software in property and equipment at September 30, 2011. We expect research and development expenses to increase in absolute dollar terms for the foreseeable future as we develop new technologies and enhance our existing technologies.

Stock-Based Compensation

We account for stock-based compensation in accordance with Accounting Standards Codification, or ASC, 718, Stock Compensation . As such, all share-based payments to employees, including grants of stock options, restricted stock and restricted stock units, are recognized in the statements of income based on their fair values as of the date of grant. During the nine months ended September 30, 2012, in lieu of a portion of cash bonuses related to our 2012 and 2013 bonus plans, we granted 1,023,010 shares of nonvested restricted stock to certain executives and non-executive employees that contain performance-based vesting conditions. These awards will vest in equal installments in 2013 and 2014 if the performance conditions are achieved. If the employee who received the restricted stock leaves the company for any reason prior to the vesting date, the shares of restricted stock will be forfeited and returned to us. We did not make any additional grants with performance-based vesting conditions during the three months ended September 30, 2012. In addition, in December 2011, we granted 283,334 shares of nonvested restricted stock to certain non-executive

 

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employees that contained performance-based vesting conditions in lieu of a portion of cash bonuses related to our 2012 and 2013 bonus plan. The performance conditions associated with the December 2011 grants were modified during the three months ended March 31, 2012. As a result of these grants of nonvested restricted stock, we anticipate that, on a per employee basis, stock-based compensation expense will increase with a corresponding decrease in cash compensation expense.

For the three months ended September 30, 2012 and 2011, we recorded expenses of approximately $3.3 million and $3.2 million, respectively, in connection with share-based payment awards to employees and non-employees. For the nine months ended September 30, 2012 and 2011, we recorded expenses of approximately $10.0 million and $10.5 million, respectively, in connection with share-based payment awards to employees and non-employees. With respect to option grants through September 30, 2012, a future expense of non-vested options of approximately $2.2 million is expected to be recognized over a weighted average period of 1.5 years. For non-vested restricted stock and restricted stock units subject to service-based vesting conditions outstanding as of September 30, 2012, we had $9.1 million of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 2.5 years. For non-vested restricted stock subject to performance-based vesting conditions outstanding and that were probable of vesting as of September 30, 2012, we had $5.3 million of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 1.4 years. For non-vested restricted stock subject to outstanding performance-based vesting conditions that were not probable of vesting as of September 30, 2012, we had $1.1 million of unrecognized stock-based compensation expense. If and when any additional portion of our outstanding equity awards is deemed probable to vest, we will reflect the effect of the change in estimate in the period of change by recording a cumulative catch-up adjustment to retroactively apply the new estimate.

Although the number of share-based awards has increased significantly during the nine months ended September 30, 2012 as compared to the same period in 2011 due to stock-based compensation being issued in lieu of cash compensation, the overall amount of our stock-based compensation expense has decreased as a result of the lower fair value of these awards compared to awards granted in prior periods due to our lower stock price compared to the same period in 2011. Accordingly, the weighted average grant date fair value of share-based payments issued during the nine months ended September 30, 2012 was $7.85 per share as compared to $18.25 per share for the same period in 2011.

Other Income and Expense, Net

Other income and expense consist primarily of gains or losses on transactions designated in currencies other than our or our subsidiaries’ functional currency, interest income earned on cash balances, and other non-operating income and expense. We historically have invested our cash in money market funds, treasury funds, commercial paper, and municipal bonds.

Interest Expense

Interest expense primarily consists of fees associated with our $50.0 million senior secured revolving credit facility pursuant to an amended and restated credit agreement with Silicon Valley Bank, or SVB, which we refer to as the 2012 credit facility. Interest expense also consists of fees associated with issuing letters of credit and other financial assurances.

Consolidated Results of Operations

Three and Nine Months Ended September 30, 2012 Compared to the Three and Nine Months Ended September 30, 2011

Revenues

The following table summarizes our revenues for the three and nine months ended September 30, 2012 and 2011 (dollars in thousands):

 

     Three Months Ended September 30,      Dollar      Percentage  
     2012      2011      Change      Change  

Revenues:

           

DemandSMART

   $ 169,658      $ 161,874      $ 7,784        4.8

EfficiencySMART, SupplySMART, CarbonSMART and Other

     8,289        7,309        980        13.4  
  

 

 

    

 

 

    

 

 

    

Total

   $ 177,947      $ 169,183      $ 8,764        5.2
  

 

 

    

 

 

    

 

 

    

 

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     Nine Months Ended September 30,      Dollar     Percentage  
     2012      2011      Change     Change  

Revenues:

          

DemandSMART

   $ 213,586      $ 240,268      $ (26,682     (11.1 )% 

EfficiencySMART, SupplySMART, CarbonSMART and Other

     22,084        19,581        2,503       12.8  
  

 

 

    

 

 

    

 

 

   

Total

   $ 235,670      $ 259,849      $ (24,179     (9.3 )% 
  

 

 

    

 

 

    

 

 

   

For the three months ended September 30, 2012, our DemandSMART revenues increased by $7.8 million, or 5%, as compared to the three months ended September 30, 2011. For the nine months ended September 30, 2012, our DemandSMART revenues decreased by $26.7 million, or 11%, as compared to the nine months ended September 30, 2011. The increase (decrease) in our DemandSMART revenues was primarily attributable to changes in the following operating areas (dollars in thousands):

 

     Revenue Increase (Decrease):     Revenue (Decrease) Increase:  
     Three Months Ended
September 30, 2011 to
September 30, 2012
    Nine Months Ended
September 30, 2011 to
September 30, 2012
 

Australia

   $ 15,063     $ 16,651  

Act 129

   $ 3,188     $ 4,250  

California

   $ 2,438     $ 3,371  

ERCOT

   $ 1,890     $ 3,208  

CenterPoint

   $ 1,783     $ 1,638  

ONCOR

   $ 940     $ 895  

PJM

   $ (11,865   $ (41,875

ISO-NE

   $ (4,927   $ (12,176

OPA

   $ (1,738   $ (4,109

Other (1)

   $ 1,012     $ 1,465  
  

 

 

   

 

 

 

Total increased (decreased) DemandSMART revenues

   $ 7,784     $ (26,682
  

 

 

   

 

 

 

 

(1) The amounts included in this category relate to net increases in various demand response programs, none of which are individually material.

The increase in DemandSMART revenues during the three months ended September 30, 2012 as compared to the same period in 2011 was primarily due to the increase in revenues from our Western Australia program driven by increases in both enrolled MW and pricing. All revenues from this program are recognized at the end of the program period, or September 30 th of each year. The increase in DemandSMART revenues during the three months ended September 30, 2012 as compared to the same period in 2011 was also due to revenue we earned from the Pennsylvania Act 129, or Act 129, programs and certain other demand response programs in which we participate, which did not exist in 2011. Additionally, the increase in DemandSMART revenues during the three months ended September 30, 2012 as compared to the same periods in 2011 was due to an increase in enrolled MW and improved performance in our California programs and an increase in enrolled MW and pricing in certain of our Texas programs, including ERCOT, CenterPoint and ONCOR. The increase in DemandSMART revenues was partially offset by a decrease in our MW delivery obligation and less favorable pricing in the PJM program and ISO-NE program. As a result of recent changes to certain PJM program rules, we no longer have the ability to estimate performance in the PJM program, which has resulted in all revenue related to our participation in the PJM program in fiscal 2012 being recognized during the three months ended September 30, 2012 compared to the four months ended September 30, 2011. However, the decrease in our MW delivery obligation and less favorable pricing in this program more than offset the change in timing of revenue recognition. The increase in DemandSMART revenues during the three months ended September 30, 2012 as compared to the same period in 2011 was also offset by the termination of an ISO-NE program in the three months ended June 30, 2012, from which we derived revenues throughout the fiscal year ended December 31, 2011, or fiscal 201, and for the six months ended June 30, 2012.

 

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The decrease in DemandSMART revenues during the nine months ended September 30, 2012 as compared to the same period in 2011 was due to less favorable pricing and a decrease in our MW delivery obligations in the PJM and ISO-NE programs as well as decreased energy revenues as a result of fewer demand response events that yielded energy payments and a change in the mix of energy rates. The decrease in DemandSMART revenues during the nine months ended September 30, 2012 as compared to the same period in 2011 was also attributable to the termination of an ISO-NE program in the three months ended June 30, 2012, from which we derived revenues throughout fiscal 2011 and for the six months ended June 30, 2012. In addition, the decrease in DemandSMART revenues during the nine months ended September 30, 2012 as compared to the same period in 2011 was attributable to the recognition of previously deferred revenues during the nine months ended September 30, 2011 as a result of an amendment to our utility contract with Ontario Power Authority, or the OPA contract. There was no similar recognition of deferred revenues under the OPA contract during the nine months ended September 30, 2012. The decrease in DemandSMART revenues during the nine months ended September 30, 2012 as compared to the same period in 2011 was partially offset by revenue from an increase in enrolled MW and pricing in our Western Australia program and certain of our Texas programs, an increase in revenues in the Act129 programs, an increase in enrolled MW and improved performance in our California programs.

For the three and nine months ended September 30, 2012, our EfficiencySMART, SupplySMART and CarbonSMART applications and services and other revenues increased by $1.0 million and $2.5 million, respectively, as compared to the same periods in 2011 due to continued growth in customers and contracts, building on our customer relationships that resulted from our acquisitions of Global Energy Partners, Inc., or Global Energy, and M2M in 2011, as well as an increase in our EfficiencySMART customers. In addition, the increase in our EfficiencySMART, SupplySMART and CarbonSMART applications and services and other revenues for the nine months ended September 30, 2012 was attributable to the recognition of a full nine months of revenues during fiscal 2012 as compared to the nine months ended September 30, 2011, during which we acquired both Global Energy and M2M, each in early 2011.

We currently expect our total revenues to decrease for the full year 2012 as compared to the full year 2011, primarily due to a decrease in revenues derived from the PJM market. This decrease is due to a decline in enrolled MW in the PJM market, a decline in MW obligation in a particular zone within the PJM market, a decline in PJM prices during fiscal 2012 as compared to fiscal 2011, and the implementation of PJM’s market rule changes regarding capacity compliance measurement and verification. Although we expect our revenues derived from the PJM market to increase in the fiscal year ending December 31, 2013, or fiscal 2013, as PJM prices return to more historic levels, we expect our revenues derived from the PJM market to decrease as a percentage of our total annual revenue as we further increase our MW under management in our other operating regions, enroll new C&I customers in our demand response programs, expand the sales of our EfficiencySMART, SupplySMART and CarbonSMART applications and services and other services and products to our new and existing C&I customers, and pursue more favorable pricing opportunities with our C&I customers.

In addition, the discontinuance of PJM’s Interruptible Load for Reliability program in June 2012 reduced our flexibility to manage our portfolio of demand response capacity in the PJM market and negatively impacted our revenues for the three and nine months ended September 30, 2012 and will continue to negatively impact our future revenues in the PJM market.

Gross Profit and Gross Margin

The following table summarizes our gross profit and gross margin percentages for our energy management applications, services and products for the three and nine months ended September 30, 2012 and 2011 (dollars in thousands):

 

Three Months Ended September 30,

2012

  

2011

Gross Profit

  

Gross Margin

  

Gross Profit

  

Gross Margin

$                   95,000

   53.4%    $                  84,832    50.1%

 

     

 

  

Nine Months Ended September 30,

2012

  

2011

Gross Profit

  

Gross Margin

  

Gross Profit

  

Gross Margin

$                 109,233

   46.3%    $                117,770    45.3%

 

     

 

  

 

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The increase in gross profit during the three months ended September 30, 2012 as compared to the same period in 2011 was primarily due to improved management of our portfolio of demand response capacity, including the adjustment of our zonal capacity obligations through our participation in PJM incremental auctions, an increase in revenues related to our Australia programs and lower costs associated with our C&I contracts. The decrease in gross profit during the nine months ended September 30, 2012 as compared to the same period in 2011 was primarily due to less favorable pricing and a decrease in enrolled MW in our PJM and ISO-NE programs, as well as the termination of an ISO-NE program during the three months ended June 30, 2012 from which we derived revenues throughout fiscal 2011. This decrease was partially offset by improved management of our portfolio of demand response capacity and an overall reduction in the percentage of revenues paid to our C&I customers.

Our gross margin during the three months and nine months ended September 30, 2012 increased as compared to the same periods in 2011 due to improved management of our portfolio of demand response capacity, including the adjustment of our zonal capacity obligations through our participation in PJM incremental auctions and lower costs associated with our C&I contracts. These increases were offset by a decrease in gross margins under our OPA contract due to the recognition of revenues during the three months ended March 31, 2011 in connection with the amendment to the OPA contract, for which we recognized the cost of such revenues in previous periods. The increase in our gross margin during the nine months ended September 30, 2012 as compared to the same period in 2011 was also offset by a decrease in gross margins due to the recognition of revenues during the three months ended March 31, 2011 in connection with a California demand response program in which we participate for which we recognized the cost of such revenues in previous periods.

We currently expect that our gross margin for the full year 2012 will be similar to our gross margin for the full year 2011 due to the improved management of our portfolio of demand response capacity, including the adjustment of our zonal capacity obligations through our participation in PJM incremental auctions, which we expect will offset a decrease in MW enrolled in the PJM market, a decrease in PJM prices in fiscal 2012 as compared to fiscal 2011, which will not be entirely offset by lower payments to our C&I customers, and the implementation of PJM’s market rule changes regarding capacity compliance measurement and verification. We also expect that our gross margin for the three months ended September 30, 2012 will be the highest gross margin among our four quarterly reporting periods in fiscal 2012 due to the seasonality of the demand response industry, which is consistent with our gross margin pattern in fiscal 2011 and prior years.

Operating Expenses

The following table summarizes our operating expenses for the three and nine months ended September 30, 2012 and 2011 (dollars in thousands):

 

     Three Months Ended September 30,      Percentage
Change
 
     2012      2011     

Operating Expenses:

        

Selling and marketing

   $ 13,424      $ 14,591        (8.0 )% 

General and administrative

     18,351        15,960        15.0

Research and development

     3,914        3,310        18.2
  

 

 

    

 

 

    

Total

   $ 35,689      $ 33,861        5.4
  

 

 

    

 

 

    
     Nine Months Ended September 30,      Percentage
Change
 
     2012      2011     

Operating Expenses:

        

Selling and marketing

   $ 41,342      $ 39,798        3.9

General and administrative

     52,880        48,172        9.8

Research and development

     11,536        9,892        16.6
  

 

 

    

 

 

    

Total

   $ 105,758      $ 97,862        8.1
  

 

 

    

 

 

    

In certain forward capacity markets in which we choose to participate, such as PJM, we may enable our C&I customers, meaning we may install our equipment at a C&I customer site to allow for the curtailment of MW from the electric power grid, up to twelve months in advance of enrolling the C&I customer in a particular program. This market feature creates a longer average revenue recognition lag time across our C&I customer portfolio from the point in time when we consider a MW to be under management to when we actually earn revenues from that MW. As a result, there has been a trend of incurring operating expenses associated with enabling our C&I customers in advance of recognizing the corresponding revenues because we incur operational expenses, including salaries and related personnel costs, at the time of enablement.

 

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We saw an increase in payroll and related costs within our operating expenses during the three and nine months ended September 30, 2012 as compared to the same periods in 2011 primarily driven by an increase in headcount, from 587 full-time employees at September 30, 2011 to 660 full-time employees at September 30, 2012, due to overall growth of the business as well as our acquisition of Energy Response Holdings Pty Ltd, or Energy Response, in July 2011. This increase was partially offset by a decrease in expected cash bonuses for fiscal 2012 as we granted certain restricted stock awards in lieu of a portion of cash bonuses, which awards will vest only if certain performance conditions are achieved, certain of which are not deemed probable as of September 30, 2012. The expense related to these restricted stock awards is recorded as a component of stock-based compensation expense.

Selling and Marketing Expenses

 

     Three Months Ended September 30,      Percentage
Change
 
     2012      2011     

Payroll and related costs

   $ 8,513      $ 9,296        (8.4 )% 

Stock-based compensation

     1,182        964        22.6

Other

     3,729        4,331        (13.9 )% 
  

 

 

    

 

 

    

Total

   $ 13,424      $ 14,591        (8.0 )% 
  

 

 

    

 

 

    
     Nine Months Ended September 30,      Percentage
Change
 
     2012      2011     

Payroll and related costs

   $ 26,639      $ 26,362        1.1

Stock-based compensation

     3,428        3,262        5.1

Other

     11,275        10,174        10.8
  

 

 

    

 

 

    

Total

   $ 41,342      $ 39,798        3.9
  

 

 

    

 

 

    

The decrease in selling and marketing expenses for the three months ended September 30, 2012 compared to the same period in 2011 was primarily driven by compensation related expenses. The decrease in payroll and related costs for the for the three months ended September 30, 2012 compared to the same period in 2011 was due to a decrease in expected cash bonuses for fiscal 2012 as a portion of those bonuses will be settled in shares of our common stock and therefore is recorded in stock-based compensation expense. Additionally, the decrease in payroll and related costs for the three months ended September 30, 2012 compared to the same period in 2011 was the result of a decrease in the average commission percentage payable to employees in our sales organization and a decrease in MW sold in PJM due to a decline in our enrolled MW in the PJM market for fiscal 2012. The increase in payroll and related costs for the nine months ended September 30, 2012 compared to the same period of 2011 was primarily due to an increase in salary rates per full-time employee which was partially offset by lower commissions and a decrease in expected cash bonuses for fiscal 2012 as a portion of those bonuses will be settled in shares of our common stock and therefore is recorded in stock-based compensation expense. In addition, we incurred higher travel related costs of $0.3 million.

The increase in stock-based compensation for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was primarily due to a portion of the expected bonuses for fiscal 2012 that will be settled in shares of our common stock rather than cash and is, therefore, recorded as a component of stock-based compensation expense. This increase was offset by a lower grant date fair value of stock-based awards granted during the nine months ended September 30, 2012, which was lower than the grant date fair value of stock-based awards that became fully vested during the nine months ended September 30, 2011, as well as a reversal of stock-based compensation due to forfeitures of a greater number of stock-based awards during the nine months ended September 30, 2012.

The decrease in other selling and marketing expenses for the three months ended September 30, 2012 compared to the same period in 2011 was due to a $0.2 million decrease in marketing costs, a $0.1 million decrease in facilities costs, and a $0.2 million decrease in financial costs due to the trade name impairment expense recorded in the three months ended September 30, 2011. The increase in other selling and marketing expenses for the nine months ended September 30, 2012 compared to the same period of 2011 was due to a $1.0 million increase in amortization related to acquired intangible assets as a result of our acquisition of Energy Response in July 2011.

 

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General and Administrative Expenses

 

     Three Months Ended September 30,      Percentage
Change
 
     2012      2011     

Payroll and related costs

   $ 9,622      $ 8,621        11.6

Stock-based compensation

     1,908        1,975        (3.4 )% 

Other

     6,821        5,364        27.2
  

 

 

    

 

 

    

Total

   $ 18,351      $ 15,960        15.0
  

 

 

    

 

 

    
     Nine Months Ended September 30,      Percentage
Change
 
     2012      2011     

Payroll and related costs

   $ 27,640      $ 26,678        3.6

Stock-based compensation

     5,712        6,355        (10.1 )% 

Other

     19,528        15,139        29.0
  

 

 

    

 

 

    

Total

   $ 52,880      $ 48,172        9.8
  

 

 

    

 

 

    

The increase in payroll and related costs for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was primarily attributable to an increase in the number of general and administrative full-time employees from 313 at September 30, 2011 to 367 at September 30, 2012. This increase was partially offset by a portion of the expected bonuses for fiscal 2012 that will be settled in shares of our common stock rather than cash and is, therefore, recorded as a component of stock-based compensation expense.

The decrease in stock-based compensation for the three months ended September 30, 2012 compared to the same period in 2011 was primarily due to significant stock-based awards granted in 2007 that became fully expensed prior to the three months ended September 30, 2012. This decrease was offset by an increase in stock-based compensation related to a portion of the expected bonuses for fiscal 2012 that will be settled in shares of our common stock rather than cash, which is recorded as a component of stock-based compensation expense. The decrease in stock-based compensation for the nine months ended September 30, 2012 compared to the same period in 2011 was primarily due to the reversal of stock-based compensation expense related to the forfeiture of stock-based awards that were granted to our former chief financial officer, as well as fully-vested stock awards that were granted to our board of directors at a lower grant-date fair value in the nine months ended September 30, 2012 than the fair value of stock-based awards granted to them during the nine months ended September 30, 2011. These decreases were offset by an increase in stock-based compensation related to a portion of the expected bonuses for fiscal 2012 that will be settled in shares of our common stock rather than cash, which is recorded as a component of stock-based compensation expense.

The increase in other general and administrative expenses for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was attributable to an increase of $0.8 million and $1.1 million, respectively, in facilities expenses due to higher rent and insurance costs in addition to higher depreciation expense that resulted from a change in useful life of the leasehold improvements under our current lease, in addition to an increase of $1.0 million and $2.1 million, respectively, in higher fees mainly associated with our regulatory compliance. The increase in other general and administrative expenses for the nine months ended September 30, 2012 compared to the same period in 2011 was also attributable to a lease termination charge of $1.1 million that resulted from our election to terminate the operating lease for our current corporate headquarters effective June 30, 2013 in addition to higher travel related costs of $0.3 million. The increase in other general and administrative expenses for the three months ended September 30, 2012 compared to the same period in 2011 was offset by a $0.3 million decrease in technology and communication costs. The increase in other general and administrative expenses for the nine months ended September 30, 2012 compared to the same period in 2011 was offset by a decrease of $0.3 million in finance charges related to an arrangement that was terminated in late 2011.

 

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Research and Development Expenses

 

     Three Months Ended September 30,      Percentage
Change
 
     2012      2011     

Payroll and related costs

   $ 2,077      $ 1,869        11.1

Stock-based compensation

     251        282        (11.0 )% 

Other

     1,586        1,159        36.8
  

 

 

    

 

 

    

Total

   $ 3,914      $ 3,310        18.2
  

 

 

    

 

 

    
     Nine Months Ended September 30,      Percentage
Change
 
     2012      2011     

Payroll and related costs

   $ 6,490      $ 5,541        17.1

Stock-based compensation

     878        871        0.8

Other

     4,168        3,480        19.8
  

 

 

    

 

 

    

Total

   $ 11,536      $ 9,892        16.6
  

 

 

    

 

 

    

The increase in research and development expenses for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was primarily driven by payroll and related costs associated with an increase in the number of research and development full-time employees from 72 at September 30, 2011 to 86 at September 30, 2012, as well as an increase in salary rates per full-time employee. This increase for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was partially offset by an increase in capitalized application development costs primarily related to our DemandSMART application.

The decrease in stock-based compensation expense for the three months ended September 30, 2012 compared to the same period in 2011 was primarily attributable to significant stock-based awards granted in 2007 that became fully expensed prior to the period ended September 30, 2012. This decrease was offset by an increase in stock-based compensation for the three and nine months ended September 30, 2012 related to a portion of the expected bonuses for fiscal 2012 that will be settled in shares of our common stock rather than cash and is, therefore, recorded as a component of stock-based compensation expense.

The increase in other research and development expenses for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was primarily due to an increase of $0.2 million and $0.5 million, respectively, in the allocation of company-wide overhead costs which are allocated based on headcount. The increase in other research and development expenses for the three and nine months ended September 30, 2012 compared to the same periods in 2011 was also due to an increase of $0.2 million and $.04 million, respectively, related to increased license fees.

Other Income (Expense), Net

Other income, net for the three and nine months ended September 30, 2012 was $0.6 million and $1.3 million, respectively compared to other (expense), net of ($2.5) million for both the three and nine months ended September 30, 2011. Other income (expense), net was primarily comprised of foreign currency gains (losses) and a nominal amount of interest income. We have approximately $20.6 million ($19.9 million Australian) in intercompany receivables denominated in Australian dollars that arose from the acquisition of Energy Response in July 2011. Substantially all of the foreign currency gains (losses) represent unrealized gains (losses) and, therefore, are non-cash in nature. We currently do not hedge any of our foreign currency transactions.

Income Taxes

In accordance with ASC 740, Income Taxes, or ASC 740, each interim period is considered an integral part of the annual period and tax expense is measured using an estimated annual effective tax rate. An enterprise is required, at the end of each interim reporting period, to make its best estimate of the annual effective tax rate for the full fiscal year and use that rate to provide for income taxes on a current year-to-date basis. Generally, if an enterprise has a year-to-date ordinary loss at the end of an interim period and anticipates an ordinary loss for the full fiscal year, the enterprise will record an interim period tax provision based on applying the estimated annual effective tax rate to the ordinary loss. However, if an enterprise is unable to make a reliable estimate of its annual

 

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effective tax rate, then the actual effective tax rate for the year-to-date period may be the best estimate of the annual effective tax rate. For the six months ended June 30, 2012, we had determined that we were unable to make a reliable estimate of our annual effective tax rate due to unusual sensitivity to the rate as it relates to the forecasted 2012 U.S. loss. As a result, we recorded a tax provision during the six months ended June 30, 2012 based on our actual effective tax rate for the six months ended June 30, 2012. For the nine months ended September 30, 2012, we have determined that we are able to make a reliable estimate of our annual effective tax rate due to the resolution of certain matters that previously resulted in significant volatility in both the forecasted fiscal 2012 U.S. ordinary income and our U.S. effective tax rate, and applied this estimated annual effective tax rate to our year-to-date income.

Since we determined the estimate of our annual effective tax rate to be reliable, we recorded a benefit from income taxes of $0.7 million and income tax expense of $0.1 million for the three and nine months ended September 30, 2012, respectively. The application of the estimated annual tax rate on year-to-date income resulted in a benefit from income taxes for the three months ended September 30, 2012 primarily due to the reversal of the amortization of the U.S. tax deductible goodwill previously recorded during the six months ended June 30, 2012. The provision for income taxes for the nine months ended September 30, 2012 represents the estimated foreign taxes resulting from guaranteed profit allocable to our foreign subsidiaries, which were determined to be limited-risk service providers acting on behalf of the U.S. parent for tax purposes and for which there were no tax net operating loss carryforwards. For fiscal 2012, we expect a provision for income taxes of approximately $1.5 million to $2.0 million for the estimated foreign taxes and tax on deductible goodwill, for which the amortization creates a deferred tax liability that could not be offset by net operating losses or other deferred tax assets since its reversal is considered indefinite in nature. This will result in a tax provision for the three months ending December 31, 2012 of approximately these same amounts. We do not to pay expect any significant amount of cash income taxes for the year ending December 31, 2012.

We reviewed all available evidence to evaluate the recovery of deferred tax assets, including the recent history of accumulated losses in all tax jurisdictions over the last three years, as well as our ability to generate income in future periods. As of September 30, 2012, due to the uncertainty related to the ultimate use of our deferred income tax assets, we have provided a full valuation allowance on all of our U.S. deferred tax assets.

Liquidity and Capital Resources

Overview

We have generated significant cumulative losses since inception. As of September 30, 2012, we had an accumulated deficit of $77.7 million. As of September 30, 2012, our principal sources of liquidity were cash and cash equivalents totaling $93.2 million, an increase of $5.9 million from the December 31, 2011 balance of $87.3 million, and amounts available under the 2012 credit facility. At September 30, 2012 and December 31, 2011, our excess cash was primarily invested in money market funds.

We believe our existing cash and cash equivalents at September 30, 2012, amounts available under the 2012 credit facility and our anticipated net cash flows from operating activities will be sufficient to meet our anticipated cash needs, including investing activities, for at least the next 12 months. Our future working capital requirements will depend on many factors, including, without limitation, the rate at which we sell our energy management applications, services and products to customers and the increasing rate at which letters of credit or security deposits are required by electric power grid operators and utilities, the introduction and market acceptance of new energy management applications, services and products, the expansion of our sales and marketing and research and development activities, and the geographic expansion of our business operations. To the extent that our cash and cash equivalents, amounts available under the 2012 credit facility and our anticipated cash flows from operating activities are insufficient to fund our future activities or planned future acquisitions, we may be required to raise additional funds through bank credit arrangements or public or private equity or debt financings. We also may raise additional funds in the event we determine in the future to effect one or more acquisitions of businesses, technologies or products. In addition, we may elect to raise additional funds even before we need them if the conditions for raising capital are favorable. Any equity or equity-linked financing could be dilutive to existing stockholders. In the event we require additional cash resources we may not be able to obtain bank credit arrangements or complete any equity or debt financing on terms acceptable to us or at all.

 

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Cash Flows

The following table summarizes our cash flows for the nine months ended September 30, 2012 and 2011 (dollars in thousands):

 

     Nine Months Ended
September 30,
 
     2012     2011  

Cash flows provided by operating activities

   $ 12,866     $ 16,766  

Cash flows used in investing activities

     (7,147     (94,088

Cash flows provided by financing activities

     141       1,861  

Effects of exchange rate changes on cash

     11       (535
  

 

 

   

 

 

 

Net change in cash and cash equivalents

   $ 5,871     $ (75,996
  

 

 

   

 

 

 

Cash Flows Provided by Operating Activities

Cash provided by operating activities primarily consists of net income 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 provided by operating activities for the nine months ended September 30, 2012 was $12.9 million and consisted of net income of $3.5 million and $29.1 million of noncash items, primarily consisting of depreciation and amortization, stock-based compensation charges, impairment charges of property and equipment, unrealized foreign exchange transaction gains, and non-cash interest expense, offset by $19.7 million of net cash used in working capital and other activities. Cash used in working capital and other activities consisted of an increase of $29.8 million in accounts receivable due to the timing of cash receipts under the demand response programs in which we participate, an increase of $11.6 million in unbilled revenues relating to the PJM demand response market, a decrease of $3.3 million in accounts payable, accrued performance adjustments and accrued expenses primarily due to the repayment of certain accrued performance adjustments, an increase in capitalized incremental direct customer contract costs of $1.2 million, and a decrease of $0.4 million in accrued payroll and related expenses. These amounts were offset by cash provided by working capital and other activities consisting of an increase of $13.1 million in deferred revenue, an increase in accrued capacity payments of $11.1 million, the majority of which was related to the PJM demand response market, an increase in other noncurrent liabilities of $0.6 million, and a decrease in prepaid expenses and other assets of $1.6 million.

Cash provided by operating activities for the nine months ended September 30, 2011 was approximately $16.8 million and consisted of net income of $14.6 million and $32.1 million of non-cash items, primarily consisting of depreciation and amortization, deferred taxes, stock-based compensation charges, impairment charges of property and equipment, and unrealized foreign exchange losses, offset by $30.0 million of net cash used in working capital and other activities. Cash provided by working capital and other activities consisted of an increase in accrued capacity payments of $23.3 million relating primarily to the PJM demand response market, an increase of $3.4 million in deferred revenue, an increase of $1.6 million in accrued payroll and related expenses, and a decrease of $2.9 million in prepaid expenses and other current assets. These amounts were offset by cash used in working capital and other activities consisting of an increase of $30.1 million in unbilled revenues relating to the PJM demand response market, an increase of $20.3 million in accounts receivable due to the timing of cash receipts under the demand response programs in which we participate, a decrease of $3.8 million in accounts payable and accrued expenses and other current liabilities due to the timing of payments, an increase in capitalized incremental direct customer contract costs of $4.0 million, an increase in other assets of $2.8 million and a decrease in other noncurrent liabilities of 0.2 million.

Cash Flows Used in Investing Activities

Cash used in investing activities was $7.1 million for the nine months ended September 30, 2012. During the nine months ended September 30, 2012, we incurred $11.8 million in capital expenditures primarily related to the purchase of office equipment, capitalized internal use software costs and demand response equipment and other miscellaneous capital expenditures. In addition, during the nine months ended September 30, 2012, our restricted cash and deposits decreased by $4.7 million due to a decrease in deposits principally related to the financial assurance requirements for demand response programs in which we participate, as these deposits were replaced with letters of credit.

Cash used in investing activities was $94.1 million for the nine months ended September 30, 2011. During the nine months ended September 30, 2011, we acquired Global Energy for a purchase price of $26.7 million, of which $19.9 million was paid in cash, M2M for a purchase price of $28.6 million, of which $17.5 million was paid in cash, DMT Energy Pty Ltd, or DMT, for a purchase price of $5.2 million, of which $3.9 million was paid in cash, and Energy Response for a purchase price of $30.1 million, of which $27.3 million was paid in cash. The net cash acquired from these acquisitions was $1.1 million. Additionally, our cash investments included the cash portion of the acquisition contingent consideration for Cogent Energy, Inc., or Cogent, of $1.5 million. Our other principal cash investments during the nine months ended September 30, 2011 related to capitalized internal use software costs used to build out and expand our energy management applications and services and purchases of property and equipment. During the nine

 

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months ended September 30, 2011, we also incurred $15.2 million in capital expenditures primarily related to the purchase of office equipment and demand response equipment and other miscellaneous expenditures. In addition, during the nine months ended September 30, 2011, our deposits increased by $9.4 million primarily due to financial assurance requirements related to demand response programs in Australia.

Cash Flows Provided by Financing Activities

Cash provided by financing activities was $0.1 million and $1.9 million for the nine months ended September 30, 2012 and 2011, respectively, and consisted primarily of proceeds that we received from exercises of options to purchase shares of our common stock.

Credit Facility Borrowings

In April 2011, we and one of our subsidiaries entered into a $75,000 senior secured revolving credit facility pursuant to a credit agreement, which was subsequently amended in June 2011, November 2011 and December 2011, with SVB and one other financial institution, which we refer to as the 2011 credit facility. In March 2012, we and one of our subsidiaries entered into the 2012 credit facility, which replaced the 2011 credit facility. The 2012 credit facility was subsequently amended in June 2012 to reduce minimum earnings levels for the quarterly financial covenant for the period ended June 30, 2012, under which SVB became the sole lender, our borrowing limit was decreased from $75.0 million to $50.0 million and certain of our financial covenant compliance requirements were modified or eliminated. The material changes to our monthly and quarterly financial covenants in the 2012 credit facility included:

 

   

a decrease in our quarterly financial covenant related to minimum earnings levels and a change in the calculation, which is now based on earnings before depreciation and amortization expense, interest expense, provision for income taxes, stock-based compensation expense, rent expense, certain impairment charges and certain other non-cash charges over a trailing twelve month period;

 

   

amendment to our monthly financial covenant related to maintenance of a minimum specified ratio of current assets to current liabilities reducing our required minimum of unrestricted cash from $50.0 million to $30.0 million for certain periods; and

 

   

elimination of the quarterly financial covenant related to maintenance of a minimum specified fixed charge coverage ratio.

The 2012 credit facility also decreased the letter of credit fee charged to us in connection with the issuance or renewal of letters of credit from 2.125 % to 2.0%.

Subject to continued compliance with the covenants contained in the 2012 credit facility, the full amount of the 2012 credit facility may be available for issuances of letters of credit and up to $5.0 million of the 2012 credit facility may be available for swing line loans. The interest on revolving loans under the 2012 credit facility will accrue, at our election, at either (i) the Eurodollar Rate with respect to the relevant interest period plus 2.00% or (ii) the ABR (defined as the highest of (x) the “prime rate” as quoted in the  Wall Street Journal , (y) the Federal Funds Effective Rate plus 0.50% and (z) the Eurodollar Rate for a one-month interest period plus 1.00%) plus 1.00%. We expense the interest and letter of credit fees under the 2012 credit facility, as applicable, in the period incurred. The obligations under the 2012 credit facility are secured by all of our domestic assets and the assets of several of our subsidiaries, excluding our foreign subsidiaries. The 2012 credit facility terminates and all amounts outstanding thereunder are due and payable in full on April 15, 2013. We incurred financing costs of $0.5 million in connection with the 2012 credit facility, which were deferred and were being amortized to interest expense over the term of the 2012 credit facility, or through April 15, 2013. In connection with the 2012 credit facility, we incurred financing costs of $0.1 million which were deferred and are being amortized to interest expense over the term of the 2012 credit facility. As a result of the 2012 credit facility, during the six months ended June 30, 2012, in addition to the amortization of deferred financing costs, we expensed $0.1 million, or 33%, of the remaining initial deferred financing costs related to the 33% reduction in the available borrowing limit.

The 2012 credit facility contains customary terms and conditions for credit facilities of this type, including, among other things, restrictions on our ability to incur additional indebtedness, create liens, enter into transactions with affiliates, transfer assets, make certain acquisitions, pay dividends or make distributions on, or repurchase, our common stock, consolidate or merge with other entities, or undergo a change in control. In addition, we are required to meet certain monthly and quarterly financial covenants customary with this type of credit facility.

The 2012 credit facility contains customary events of default, including for payment defaults, breaches of representations, breaches of affirmative or negative covenants, cross defaults to other material indebtedness, bankruptcy and failure to discharge certain judgments. If a default occurs and is not cured within any applicable cure period or is not waived, SVB may accelerate our

 

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obligations under the 2012 credit facility. If we are determined to be in default then any amounts outstanding under the 2012 credit facility would become immediately due and payable and we would be required to collateralize with cash any outstanding letters of credit up to 105% of the amounts outstanding.

In May 2012, we were required to provide financial assurance in connection with our capacity bid in a certain open market bidding program. We provided this financial assurance utilizing approximately $45.0 million of our available cash on hand and a $7.0 million letter of credit issued under the 2012 credit facility. At the end of May 2012, based on the capacity that we cleared in the above open market bidding program and the required post-auction financial assurance requirements, we recovered $30.0 million of the $45.0 million of our available cash that we had provided as financial assurance prior to the auction and the $7.0 million letter of credit was cancelled.

As of September 30, 2012, we were in compliance with all of our covenants under the 2012 credit facility. We believe that it is reasonably assured that we will comply with the financial covenants under the 2012 credit facility for the foreseeable future. The 2012 credit facility will expire in April 2013. If we are unable to renew the 2012 credit facility under favorable terms or enter into a new credit facility, we may be required to collateralize with cash any outstanding letters of credit.

As of September 30, 2012, we had no borrowings, but had outstanding letters of credit totaling $44.3 million under the 2012 credit facility. The increase from the amount of outstanding letters of credit as of December 31, 2011 totaling $31.6 million is due to additional financial assurance requirements resulting from new customer arrangements and increases in delivery obligations under certain open market bidding programs. As of September 30, 2012, we had $5.7 million available under the 2012 credit facility for future borrowings or issuances of additional letters of credit.

Capital Spending

We have made capital expenditures primarily for general corporate purposes to support our growth and for equipment installation related to our business. Our capital expenditures totaled $11.8 million and $15.2 million during the nine months ended September 30, 2012 and 2011, respectively. As we continue to grow, we expect our capital expenditures for fiscal 2012 to increase as compared to fiscal 2011. Furthermore, we expect our capital expenditures for fiscal 2013 to continue to increase partially due to the capital expenditures related to our new lease for our new principal executive offices.

Contractual Obligations

As of September 30, 2012, the contractual obligations disclosure contained in our 2011 Form 10-K has not materially changed, except as disclosed herein:

In June 2012, we exercised our termination option under our current lease and provided notice of our election to terminate our current lease for our principal executive offices. The termination will be effective as of June 30, 2013. As a result of our election to terminate our current lease, we are required to make a lease termination payment of $1.1 million, of which $573,000 was paid upon exercise of the election to terminate and the remaining $573,000 is due and payable on or before July 1, 2013. In accordance with ASC 420, Exit or Disposal Cost Obligations, we recorded the fair value of this lease termination expense of $1.1 million within general and administrative expenses in the unaudited condensed consolidated statements of income during the three months ended June 30, 2012. Pursuant to the terms of our current lease, in addition to the lease termination payments, we are required to continue to pay our contractual lease payments through the lease termination date of June 30, 2013. We will record the remaining contractual lease payments ratably through the lease termination date since we currently intend to utilize the leased space through the lease termination date. As a result of our election to terminate our current lease, we have re-evaluated the estimated useful life of the leasehold improvements and furniture and fixtures related to this leased space and have concluded that a change in the estimated useful life is required. As a result, commencing in June 2012, we revised the estimated useful life of these associated assets totaling $0.9 million to fully depreciate the remaining net book value of these assets over the shorter of their remaining useful life or the revised lease termination date.

In July 2012, we entered into a new lease for our new principal executive offices. The new lease term is through July 2020 and the new lease contains both a rent holiday period and escalating rental payments over the lease term. The new lease also requires payments for additional expenses such as taxes, maintenance, and utilities and contains a fair value renewal option. The new lease also contains representations and warranties customary for this type of lease agreement. We are currently making certain improvements to the leased space and intend to occupy the space during the first half of fiscal 2013. In accordance with the new lease, the landlord is providing certain lease incentives with respect to the leasehold improvements. In accordance with ASC 840, Leases, we will record the incentives as deferred rent and expense these amounts as reductions of lease expense over the lease term. Although lease payments

 

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under the new lease do not commence until August 2013, as we have the right to use and control physical access to the space, we have determined that the lease term commenced in July 2012 and as a result are recording rent expense on this lease arrangement on a straight-line basis. The new lease also contains certain provisions requiring us to restore certain aspects of the leased space to its initial condition. We have determined that these provisions represent asset retirement obligations and will record the estimated fair value of these obligations as the related leasehold improvements are incurred. There have been no leasehold improvements which would represent asset retirement obligations as of September 30, 2012. We will accrete the liability to fair value over the life of the lease as a component of operating expenses.

Information regarding our significant contractual obligations of the types described below is set forth in the following table and includes the new lease and the change in the expected payments under our Current Lease described above. Payments due by period have been presented based on payments due subsequent to September 30, 2012. For example, the payments due in less than one year represent contractual obligations that will be settled by September 30, 2013.

 

     Payments Due By Period (in thousands)  

Contractual Obligations

   Total      Less than
1 Year
     1 - 3 Years      3 - 5 Years      More than
5 Years
 

Operating lease obligations (not reduced by sublease rentals of $280)

   $ 33,229      $ 4,822      $ 9,328      $ 7,697      $ 11,382  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 33,229      $ 4,822      $ 9,328      $ 7,697      $ 11,382  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Our operating lease obligations relate primarily to the lease of our corporate headquarters in Boston, Massachusetts and our offices in Walnut Creek, San Francisco, Irvine and Concord, California; Baltimore, Maryland; Boise, Idaho; Dallas, Texas; Melbourne, Australia; and London, United Kingdom as well as certain property and equipment. There have been no other material changes in our operating lease obligations during the three months ended September 30, 2012.

Off-Balance Sheet Arrangements

As of September 30, 2012, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. We have issued letters of credit in the ordinary course of our business in order to participate in certain demand response programs. As of September 30, 2012, we had outstanding letters of credit totaling $44.3 million under the 2012 credit facility. For information on these commitments and contingent obligations, see “Liquidity and Capital Resources — Credit Facility Borrowings” above and Note 8 to our unaudited condensed consolidated financial statements contained herein.

Critical Accounting Policies and Use of Estimates

The discussion and analysis of our financial condition and results of operations are based upon our interim unaudited condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition for multiple element arrangements, allowance for doubtful accounts, valuations and purchase price allocations related to business combinations, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of intangible assets and goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, tax reserves and recoverability of our net deferred tax assets and related valuation allowance. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates if past experience or other assumptions do not turn out to be substantially accurate. Any differences may have a material impact on our financial condition and results of operations.

The critical accounting estimates used in the preparation of our financial statements that we believe affect our more significant judgments and estimates used in the preparation of our interim unaudited condensed consolidated financial statements presented in this Quarterly Report on Form 10-Q are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the notes to the consolidated financial statements included in our 2011 Form 10-K. There have been no material changes to our critical accounting policies or estimates during the three and nine months ended September 30, 2012.

 

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Recent Accounting Pronouncements

Disclosures about Offsetting Assets and Liabilities

In December 2011, the Financial Accounting Standards Board, or FASB, issued ASU No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities,” or ASU 2011-11. ASU 2011-11 requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. An entity is required to apply ASU 2011-11 for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by ASU 2011-11 retrospectively for all comparative periods presented. We do not expect that the adoption of ASU 2011-11 will have a significant, if any, impact on our consolidated financial statements.

Additional Information

Non-GAAP Financial Measures

To supplement our consolidated financial statements presented on a GAAP basis, we disclose certain non-GAAP measures that exclude certain amounts, including non-GAAP net income, non-GAAP net income per share, adjusted EBITDA and free cash flow. These non-GAAP measures are not in accordance with, or an alternative for, generally accepted accounting principles in the United States.

The GAAP measure most comparable to non-GAAP net income is GAAP net income; the GAAP measure most comparable to non-GAAP net income per share is GAAP net income per share; the GAAP measure most comparable to adjusted EBITDA is GAAP net income; and the GAAP measure most comparable to free cash flow is cash flows from operating activities. Reconciliations of each of these non-GAAP financial measures to the corresponding GAAP measure are included below.

Use and Economic Substance of Non-GAAP Financial Measures

Management uses these non-GAAP measures when evaluating our operating performance and for internal planning and forecasting purposes. Management believes that such measures help indicate underlying trends in our business, are important in comparing current results with prior period results, and are useful to investors and financial analysts in assessing our operating performance. For example, management considers non-GAAP net income to be an important indicator of the overall performance because it eliminates the effects of events that are either not part of our core operations or are non-cash compensation expenses. In addition, management considers adjusted EBITDA to be an important indicator of our operational strength and performance of our business and a good measure of our historical operating trend. Moreover, management considers free cash flow to be an indicator of our operating trend and performance of our business.

The following is an explanation of the non-GAAP measures that we utilize, including the adjustments that management excluded as part of the non-GAAP measures for the three and nine months ended September 30, 2012 and 2011, respectively, as well as reasons for excluding these individual items:

 

   

Management defines non-GAAP net income as net income before expenses related to stock-based compensation and amortization expenses related to acquisition-related intangible assets, net of related tax effects.

 

   

Management defines adjusted EBITDA as net income, excluding depreciation, amortization, stock-based compensation, interest, income taxes and other income (expense). Adjusted EBITDA eliminates items that are either not part of our core operations or do not require a cash outlay, such as stock-based compensation. Adjusted EBITDA also excludes depreciation and amortization expense, which is based on our estimate of the useful life of tangible and intangible assets. These estimates could vary from actual performance of the asset, are based on historic cost incurred to build out our deployed network and may not be indicative of current or future capital expenditures.

 

   

Management defines free cash flow as net cash provided by operating activities less capital expenditures. Management defines capital expenditures as purchases of property and equipment, which includes capitalization of internal-use software development costs.

 

40


Table of Contents

Material Limitations Associated with the Use of Non-GAAP Financial Measures

Non-GAAP net income, non-GAAP net income per share, adjusted EBITDA and free cash flow may have limitations as analytical tools. The non-GAAP financial information presented here should be considered in conjunction with, and not as a substitute for or superior to, the financial information presented in accordance with GAAP and should not be considered measures of our liquidity. There are significant limitations associated with the use of non-GAAP financial measures. Further, these measures may differ from the non-GAAP information, even where similarly titled, used by other companies and therefore should not be used to compare our performance to that of other companies.

Non-GAAP Net Income and Non-GAAP Net Income per Share

Net income for the three months ended September 30, 2012 was $60.3 million, or $2.26 per basic share and $2.21 per diluted share, compared to net income of $46.9 million, or $1.83 per basic share and $1.77 per diluted share, for the three months ended September 30, 2011. Net income for the nine months ended September 30, 2012 was $3.5 million, or $0.13 per basic and diluted share, compared to net income of $14.6 million, or $0.57 per basic and $0.55 per diluted share, for the nine months ended September 30, 2011. Excluding stock-based compensation charges and amortization of expenses related to acquisition-related assets, net of tax effects, non-GAAP net income for the three months ended September 30, 2012 was $65.5 million, or $2.46 per basic share and $2.40 per diluted share compared to non-GAAP net income of $52.1 million, or $2.03 per basic share and $1.96 per diluted share, for the three months ended September 30, 2011. Excluding stock-based compensation charges and amortization of expenses related to acquisition-related assets, net of tax effects, non-GAAP net income for the nine months ended September 30, 2012 was $19.0 million, or $0.72 per basic share and $0.70 per diluted share, compared to non-GAAP net income of $29.7 million, or $1.16 per basic share and $1.12 per diluted share, for the nine months ended September 30, 2011. The reconciliation of GAAP net income to non-GAAP net income is set forth below:

 

     Three Months Ended
September 30,
 
     2012      2011  
     (In thousands, except share
and per share data)
 

GAAP net income

   $ 60,348      $ 46,878  

ADD: Stock-based compensation

     3,341        3,221  

ADD: Amortization expense of acquired intangible assets

     1,808        2,008  

LESS: Income tax effect on Non-GAAP adjustments (1)

     —           —     
  

 

 

    

 

 

 

Non-GAAP net income

   $ 65,497      $ 52,107  
  

 

 

    

 

 

 

GAAP net income per basic share

   $ 2.26      $ 1.83  

ADD: Stock-based compensation

     0.13        0.12  

ADD: Amortization expense of acquired intangible assets

     0.07        0.08  

LESS: Income tax effect on Non-GAAP adjustments (1)

     —           —     
  

 

 

    

 

 

 

Non-GAAP net income per basic share

   $ 2.46      $ 2.03  
  

 

 

    

 

 

 

GAAP net income per diluted share

   $ 2.21      $ 1.77  

ADD: Stock-based compensation

     0.12        0.12  

ADD: Amortization expense of acquired intangible assets

     0.07        0.07  

LESS: Income tax effect on Non-GAAP adjustments (1)

     —           —     
  

 

 

    

 

 

 

Non-GAAP net income per diluted share

   $ 2.40      $ 1.96  
  

 

 

    

 

 

 

Weighted average number of common shares outstanding

     

Basic

     26,653,252        26,683,177  

Diluted

     27,325,949        26,538,278  

 

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Table of Contents
     Nine Months Ended
September 30,
 
     2012      2011  
    

(In thousands, except share

and per share data)

 

GAAP net income

   $ 3,499      $ 14,633  

ADD: Stock-based compensation

     10,018        10,488  

ADD: Amortization expense of acquired intangible assets

     5,438        4,533  

LESS: Income tax effect on Non-GAAP adjustments (1)

     —           —     
  

 

 

    

 

 

 

Non-GAAP net income

   $ 18,955      $ 29,654  
  

 

 

    

 

 

 

GAAP net income per basic share

   $ 0.13      $ 0.57  

ADD: Stock-based compensation

     0.38        0.41  

ADD: Amortization expense of acquired intangible assets

     0.21        0.18  

LESS: Income tax effect on Non-GAAP adjustments (1)

     —           —     
  

 

 

    

 

 

 

Non-GAAP net income per basic share

   $ 0.72      $ 1.16  
  

 

 

    

 

 

 

GAAP net income per diluted share

   $ 0.13      $ 0.55  

ADD: Stock-based compensation

     0.37        0.40  

ADD: Amortization expense of acquired intangible assets

     0.20        0.17  

LESS: Income tax effect on Non-GAAP adjustments (1)

     —           —     
  

 

 

    

 

 

 

Non-GAAP net income per diluted share

   $ 0.70      $ 1.12  
  

 

 

    

 

 

 

Weighted average number of common shares outstanding

     

Basic

     26,470,634        25,491,362  

Diluted

     27,069,569        26,498,620  

 

(1) The non-GAAP adjustments would have no impact on the provision for income taxes recorded for the three or nine months ended September 30, 2012 or 2011, respectively.

Adjusted EBITDA

Adjusted EBITDA was $69.1 million and $60.7 million for the three months ended September 30, 2012 and 2011, respectively. Adjusted EBITDA was $32.3 million and $46.9 million for the nine months ended September 30, 2012 and 2011, respectively.

The reconciliation of net income to adjusted EBITDA is set forth below:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012     2011      2012     2011  

Net income

   $ 60,348     $ 46,878      $ 3,499     $ 14,633  

Add back:

         

Depreciation and amortization

     6,428       6,545        18,852       16,509  

Stock-based compensation expense

     3,341       3,221        10,018       10,488  

Other (income) expense

     (619     2,471        (1,316     2,485  

Interest expense

     300       397        1,197       798  

(Benefit from) provision for income tax

     (718     1,225        95       1,992  
  

 

 

   

 

 

    

 

 

   

 

 

 

Adjusted EBITDA

   $ 69,080     $ 60,737      $ 32,345     $ 46,905  
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Free Cash Flow

Cash flows provided by operating activities were $8.6 million and $12.9 million for the three and nine months ended September 30, 2012, respectively. Cash flows provided by operating activities were $8.7 million and $16.8 million for the three and nine months ended September 30, 2011, respectively. We had positive free cash flows of $6.0 million and $5.7 million for the three months ended September 30, 2012 and 2011, respectively. We had positive free cash flows of $1.1 million and $1.6 million for the nine months ended September 30, 2012 and 2011, respectively. The reconciliation of cash flow from operating activities to free cash flow is set forth below:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Net cash provided by operating activities

   $ 8,625     $ 8,714     $ 12,866     $ 16,766  

Subtract:

        

Purchases of property and equipment

     (2,618     (3,028     (11,752     (15,172
  

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

   $ 6,007     $ 5,686     $ 1,114     $ 1,594  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Except as disclosed herein, there have been no material changes in the interest rate risk information and foreign exchange risk information disclosed in the “Quantitative and Qualitative Disclosures About Market Risk” subsection of the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2011 Form 10-K during the three months ended September 30, 2012.

Foreign Currency Exchange Risk

Our international business is subject to risks, including, but not limited to unique economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.

A substantial majority of our foreign expense and sales activities are transacted in local currencies, including Australian dollars, British pounds, Canadian dollars and New Zealand dollars. In addition, our foreign sales are denominated in local currencies. Fluctuations in the foreign currency rates could affect our sales, cost of revenues and profit margins and could result in exchange losses. In addition, currency devaluations can result in a loss if we maintain deposits in a foreign currency. During the three and nine months ended September 30, 2012, approximately 12% of our consolidated sales in each period were generated outside the United States, and we anticipate that sales generated outside the United States will continue to represent greater than 10% of our consolidated sales for fiscal 2012 and will continue to grow in subsequent fiscal years.

We believe that the operating expenses of our international subsidiaries that are incurred in local currencies will not have a material adverse effect on our business, results of operations or financial condition for fiscal 2012. Our operating results and certain assets and liabilities that are denominated in foreign currencies are affected by changes in the relative strength of the U.S. dollar against the applicable foreign currency. Our expenses denominated in foreign currencies are positively affected when the U.S. dollar strengthens against the applicable foreign currency and adversely affected when the U.S. dollar weakens.

During the three months ended September 30, 2012 and 2011, we incurred foreign exchange gains totalling $0.6 million and foreign exchange losses totalling $2.6 million, respectively. During the nine months ended September 30, 2012 and 2011, we incurred foreign exchange gains totalling $1.2 million and foreign exchange losses totalling $2.8 million, respectively. The significant increase in (losses) gains arising from transactions denominated in foreign currencies for the three and nine months ended September 30, 2012 as compared to the same periods in 2011 was due to the significant increase of foreign denominated intercompany receivables held by us from one of our Australian subsidiaries primarily as a result of the funding provided to complete the acquisition of Energy Response and the exchange rate fluctuations of the U.S. dollar to the Australian dollar during the three months and nine months ended September 30, 2012. During the nine months ended September 30, 2012, we realized gains of $0.5 million related to transactions denominated in foreign currencies. During the three months ended September 30, 2012 and the three and nine months ended September 30, 2011, there were no material realized gains or losses related to transactions denominated in foreign currencies. As of September 30, 2012, we had an intercompany receivable from our Australian subsidiary that is denominated in Australian dollars and not deemed to be of a “long-term investment nature” totaling $20.6 million, or $19.9 million Australian.

 

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Table of Contents

A hypothetical 10% increase or decrease in foreign currencies in which we transact would not have a material adverse effect on our financial condition or results of operations other than the impact on the unrealized gain (loss) on the intercompany receivable held by us from our Australian subsidiary that is denominated in Australian dollars, and for which a hypothetical 10% increase or decrease in the foreign currency would result in an incremental $2.0 million gain or loss.

We currently do not have a program in place that is designed to mitigate our exposure to changes in foreign currency exchange rates. We are evaluating certain potential programs, including the use of derivative financial instruments, to reduce our exposure to foreign exchange gains and losses, and the volatility of future cash flows caused by changes in currency exchange rates. The utilization of forward foreign currency contracts would reduce, but would not eliminate, the impact of currency exchange rate movements.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures.

Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

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, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. We do not expect the ultimate costs to resolve these matters to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.

 

Item 1A. Risk Factors

We operate in a rapidly changing environment that involves a number of risks that could materially affect our business, financial condition or future results, some of which are beyond our control. In addition to the other information set forth in this Quarterly Report on Form 10-Q, the risks and uncertainties that we believe are most important for you to consider are discussed in Part I — Item 1A under the heading “Risk Factors” in our 2011 Form 10-K. During the three months ended September 30, 2012, there were no material changes to the risk factors that were disclosed in Part I — Item 1A under the heading “Risk Factors” in our 2011 Form 10-K.

The following risk factors replace and supersede the corresponding risk factors set forth in our 2011 Form 10-K:

Unfavorable regulatory decisions, changes to the market rules applicable to the programs in which we currently participate or may participate in the future, and varying regulatory structures in certain regional electric power markets could negatively affect our business and results of operations.

Unfavorable regulatory decisions in markets where we currently operate or choose to operate in the future could also significantly and negatively affect our business. For example, in February 2012 FERC issued an order substantially accepting the PJM

 

44


Table of Contents

proposal, which resulted in the immediate implementation of PJM’s proposed market rule changes regarding capacity compliance measurement and verification. As a result, our future revenues and profit margins with respect to the PJM region may be reduced and our future results of operations and financial condition may be negatively impacted, although these impacts may be offset by our future growth in MWs in the PJM market. In addition, to the extent that PJM or any other grid operator or utility customer is successful at modifying any program or market rules in the future in a manner adverse to our business, our future revenues and profit margins may be significantly reduced and our future results of operations and financial condition could be further negatively impacted. Market rules could also be modified to change the design of a particular demand response program, which may adversely affect our participation in that program, or a demand response program in which we currently participate could be eliminated in its entirety and replaced with a new program that is more expensive for us to operate. For example, the commencement of ISO-NE’s forward capacity market in June 2010, included new program rules that changed measurement and verification methodologies and lowered prices for certain demand response resource types as compared to the ISO-NE program in effect prior to June 2010. This rule change resulted in reduced participation by demand response resources and negatively impacted our revenues, profits and profit margins in the ISO-NE market. Any elimination or change in the design of a demand response program, including any supplemental program, could adversely impact our ability to successfully manage our portfolio of demand response capacity in that program and especially in the PJM, ISO-NE and Western Australian markets where we have substantial operations, could have a material adverse effect on our results of operations and financial condition.

Regulators could also modify market rules in certain areas to further limit the use of back-up generators in demand response markets or could implement bidding floors or caps that could lower our revenue opportunities. For example, the Environmental Protection Agency, or the EPA, has proposed a rule in the National Environmental Standards for Hazardous Air Pollutants for Reciprocating Internal Combustion Engines that would allow emergency generators to participate in emergency demand response programs for up to 100 hours per year. In the event the EPA adopts a final rule that decreases the proposed 100 hour per year limit for participation by emergency generators in emergency demand response programs or eliminates any participation by emergency generators in emergency demand response programs, some of the demand response capacity reductions that we aggregate from C&I customers willing to reduce consumption from the electric power grid by activating their own back-up generators during demand response events would not qualify as capacity without the addition of certain emissions reduction equipment, and we would have to find alternative sources of capacity to meet our capacity obligations to our electric power grid operator and utility customers. 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 energy management applications, services and products in those regions. For instance, in some markets, regulated quantity or payment levels for demand response capacity or energy make it more difficult for us to cost-effectively enroll and manage many C&I customers in demand response programs. Further, some markets 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, unfavorable regulatory structures could limit the number of regional electricity markets available to us for expansion.

We may be subject to governmental or regulatory investigations or audits and may incur significant penalties and fines if found to be in non-compliance with any applicable State or Federal regulation.

While the electric power markets in which we operate are regulated, most of our business is not directly subject to the regulatory framework applicable to the generation and transmission of electricity. However, regulations by FERC related to market design, market rules, tariffs, and bidding rules impact how we can interact with our electric power grid operator and utility customers. In addition, we may be subject to governmental or regulatory investigations or audits from time to time in connection with our participation in certain demand response programs. For example, we are currently the subject of two investigations by FERC, the first of which addresses unintentional meter data errors associated with a small number of our demand response sites in the ISO-NE market and the second of which addresses the failure by Celerity to make two FERC filings in a timely manner in 2010. Although we do not currently expect that the investigations by FERC will have a material adverse effect on our business, financial condition or results of operations, any similar investigation could result in a material adjustment to our historical financial statements and may have a material adverse effect on our results of operations and financial condition. As part of any regulatory investigation or audit, FERC or any other governmental or regulatory entity may review our performance under our utility contracts and open market bidding programs, cost structures, and compliance with applicable laws, regulations and standards. If an investigation or audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, in addition to any negative publicity associated with any such penalties or sanctions, which could have a material adverse effect on our results of operations and financial condition.

In addition, our subsidiary Celerity exports power to the electric power grid and is thus subject to direct regulation by FERC and its regulations related to the sale of wholesale power at market based rates. In addition, to the extent our demand response resources are used to provide ancillary services that involve a sale of electric energy or capacity for resale, or the export of power onto the electric power grid, such activities are also subject to direct regulation by FERC. Despite our efforts to manage compliance with such regulations, we may be found to be in non-compliance with such regulations and therefore subject to penalties or fines, which could have a material adverse effect on our business, financial condition and results of operations.

 

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Table of Contents

Item 6. Exhibits.

 

10.1*#   Lease Agreement by and between EnerNOC, Inc. and Fallon Cornerstone ONEMPDLLC, dated as of July 5, 2012.
31.1*   Certification of Chief Executive Officer of EnerNOC, Inc. pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
31.2*   Certification of Chief Accounting Officer of EnerNOC, Inc. pursuant to Rule 13a-14(a) or Rule 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
32.1*   Certification of the Chief Executive Officer and Chief Accounting Officer of EnerNOC, Inc. pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101@   The following materials from EnerNOC, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Unaudited Condensed Consolidated Balance Sheets, (ii) the Unaudited Condensed Consolidated Statements of Income, (iii) the Unaudited Condensed Consolidated Statements of Comprehensive Income, (iv) the Unaudited Condensed Consolidated Statements of Cash Flows, and (v) Notes to Unaudited Condensed Consolidated Financial Statements.

 

* Filed herewith.
# Portions of this Exhibit have been omitted and filed separately with the Securities and Exchange Commission as part of an application for confidential treatment pursuant to the Securities Act of 1933, as amended.
@ Users of the XBRL data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

46


Table of Contents

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, 2012   By:  

/s/ Timothy G. Healy

    Timothy G. Healy
    Chief Executive Officer
Date: November 5, 2012   By:  

/s/ Kevin Bligh

    Kevin Bligh
    Chief Accounting Officer

 

47

Exhibit 10.1

FINAL

ONE MARINA PARK DRIVE

OFFICE LEASE

THIS LEASE (this “Lease”), made as of July 5, 2012 by and between FALLON CORNERSTONE ONE MPD LLC, a Delaware limited liability company (“Landlord”), and ENERNOC, INC., a Delaware corporation (“Tenant”).

INDEX

 

Article    Title

1.

   Basic Provisions

2.

   Premises, Term and Commencement Date

3.

   Rent

4.

   Taxes and Operating Expenses

5.

   Delivery of Premises, Tenant’s Work, Alterations and Additions

6.

   Tenant’s Use, Restrictions and Compliance with Laws

7.

   Services

8.

   Insurance

9.

   Indemnification

10.

   Casualty Damage

11.

   Condemnation

12.

   Repair and Maintenance

13.

   Inspection of Premises

14.

   Surrender of Premises

15.

   Holding Over

16.

   Subletting and Assignment

17.

   Subordination, Non-Disturbance, Attornment and Mortgagee Protection; Lease Subject to Project Documents

18.

   Estoppel Certificate

19.

   Defaults

20.

   Remedies

21.

   Quiet Enjoyment

22.

   Accord and Satisfaction

23.

   Security Deposit

24.

   Brokerage Commission

25.

   Force Majeure

26.

   Parking

27.

   Hazardous Materials

28.

   Additional Rights Reserved by Landlord

29.

   Defined Terms

30.

   Miscellaneous Provisions

31.

   Generator

32.

   Right of First Offer

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


EXHIBITS

 

Exhibit A    Plan Showing Premises
Exhibit B    Tenant’s Work Exhibit
Exhibit B-1    Base Building Condition
Exhibit C    Form of Sublease Consent
Exhibit D    Building’s Rules and Regulations; Janitorial Specifications
Exhibit E    Intentionally Deleted
Exhibit F    Option to Extend Term
Exhibit G    Intentionally Deleted
Exhibit H    Pro Forma Budget of FPOC Expenses
Exhibit I    Form of Escalation Statement
Exhibit J    OTIS Standards
Exhibit K    Intentionally Deleted
Exhibit L    Plan Showing Building Common Areas as of Commencement Date
Exhibit M    Current Cricket Schedule of Service

 

2

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


ARTICLE 1.

BASIC PROVISIONS

 

A. Tenant’s Trade Name:

   EnerNOC, Inc.

B. Tenant’s Address:

  

Prior to Tenant’s occupancy of the Premises:

 

101 Federal Street, Suite 1100

Boston, Massachusetts 02110

Attention: Mr. Timothy Healy

 

With a copy to:

 

101 Federal Street, Suite 1100

Boston, Massachusetts 02110

Attention: David Samuels

 

And to:

 

101 Federal Street, Suite 1100

Boston, Massachusetts 02110

Attention: Julia Regan

 

And to:

 

Nutter, McClennen & Fish, LLP

Seaport West

155 Seaport Boulevard

Boston, Massachusetts 02210

Attention: Michael F. Burke, Esq.

 

On and after Tenant’s occupancy of the Premises:

 

One Marina Park Drive, Floors 4-6

Boston, Massachusetts 02210

Attention: Mr. Timothy Healy

 

With a copy to:

 

One Marina Park Drive, Floors 4-6

Boston, Massachusetts 02210

Attention: David Samuels

 

And to:

 

One Marina Park Drive, Floors 4-6

Boston, Massachusetts 02210

Attention: Julia Regan

 

3

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


  

And to:

 

Nutter, McClennen & Fish, LLP

Seaport West

155 Seaport Boulevard

Boston, Massachusetts 02210

Attention: Michael F. Burke, Esq.

C. Building Name and Address:

  

One Marina Park Drive

Boston, Massachusetts 02210

D. Premises:

   81,986 rentable square feet of space in the Building in the aggregate, comprised of the following suites: Suite 400, comprising the entire fourth (4 th ) floor of the Building and measuring approximately 27,147 rentable square feet, Suite 500, comprising the entire fifth (5 th ) floor of the Building and measuring approximately 27,147 rentable square feet, and Suite 600, comprising the entire sixth (6 th ) floor of the Building and measuring approximately 27,692 rentable square feet, all as shown on the space plans attached hereto as Exhibit A.

E. Landlord:

   Fallon Cornerstone One MPD LLC

F. Landlord’s Address:

  

c/o Cornerstone Real Estate Advisers LLC

180 Glastonbury Boulevard, Suite 200

Glastonbury, Connecticut 06033

Attention: Linda C. Houston, Vice President

G. Building Manager Name and Address:

  

CB Richard Ellis – N.E. Partners LP

One Marina Park Drive

Boston, Massachusetts 02210

H. Commencement Date:

   Upon the date of full execution of this Lease, which date is set forth on the first page hereof.

I. Rent Commencement Date:

   August 1, 2013

J. Expiration Date:

   July 31, 2020, unless sooner terminated or further extended as provided in this Lease.

K. Security Deposit:

   $1,844,685.00, which shall be in the form of a Letter of Credit (as hereinafter defined), subject to reduction as provided in Article 23 of this Lease.

K. Security Deposit:

   $1,844,685.00, which shall be in the form of a Letter of Credit (as hereinafter defined), subject to reduction as provided in Article 23 of this Lease.

 

4

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


L. Monthly Base Rent:   

Time Period

   Monthly Base
Rent
     Annual
Rental
Rate PSF
 
  

August 1, 2013 through July 31, 2017

   $ 307,447.50       $ 45.00   
  

August 1, 2017 through July 31, 2020

   $ 334,776.17       $ 49.00   

M. Tenant’s Pro Rata Share:

   17.41%.   

N. Normal Business Hours of Building:

  

Monday through Friday: 8:00 a.m. to 6:00 p.m.

 

Saturday: 8:00 a.m. to 1:00 p.m.

 

Sunday: None

 

(Excepting national holidays)

  

  

  

  

O. Permitted Use:

   General and executive office use only (which may include, for purposes of this Lease, the operation of a network operations center, energy management research and development activities and all other office uses reasonably related to the business of Tenant as a provider of energy management applications, services and products), and for no other purpose.          

P. Broker(s):

   CB Richard Ellis – N.E. Partners LP, representing Landlord, and T3 Advisors, LLC, representing Tenant.     

Q. Parking Rights:

   Tenant shall have the right to lease monthly parking spaces in the Parking Garage (as hereinafter defined) at a ratio of up to [***] per [***] square feet of the Premises at the monthly rate then in effect for such Parking Garage, which rate may change from time to time, and in compliance with the Parking        

 

5

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


   Garage rules and regulations. Landlord shall have no right to adjust the foregoing parking ratio. Prior to [***], the rate for monthly parking in the Parking Garage shall not exceed [***] at the [***] parking garages. Tenant’s parking rights hereunder shall be further subject to the terms and conditions of Article 26 below.

R. Base Year:

   Calendar year 2013 for Operating Expenses (as hereinafter defined), and fiscal year 2014 for Taxes (as hereinafter defined).

S. TI Allowance:

   An amount equal to the product of (i) the area of the Premises in rentable square feet and (ii) [***].

The foregoing provisions shall be interpreted and applied in accordance with the other provisions of this Lease set forth below. The capitalized terms, and the terms defined in Article 29, shall have the meanings set forth herein or therein (unless otherwise modified in the Lease) when used as capitalized terms in other provisions of the Lease.

Landlord and Tenant hereby agree that the Premises contain the number of rentable square feet specified in Article 1 above.

ARTICLE 2.

PREMISES, TERM AND COMMENCEMENT DATE

Subject to the terms and conditions set forth herein, Landlord hereby leases and demises to Tenant and Tenant hereby takes and leases from Landlord the Premises for a term (“Term”) commencing on the Commencement Date and ending on the Expiration Date set forth in Article 1, unless sooner terminated as provided herein. As of the Commencement Date, Tenant shall have the exclusive right to use and control physical access to the Premises, subject to the rights and obligations of Landlord as set forth in this Lease. Tenant shall be permitted to extend the original Term hereof in accordance with the provisions of Exhibit F attached hereto.

ARTICLE 3.

RENT

A. Monthly Base Rent . Commencing on the Rent Commencement Date, Tenant shall pay Monthly Base Rent in advance on or before the first (1 st ) day of each month of the Term without demand, setoff or deduction except as otherwise expressly set forth in this Lease. If the Term shall commence or end on a day other than the first (1 st ) day of a month, the Monthly Base Rent for the first (1 st ) or last partial month of the Term shall be prorated on a per diem basis.

 

6

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


B. Additional Rent . All costs and expenses, other than Monthly Base Rent, which Tenant assumes or agrees to pay and any other sum payable by Tenant pursuant to this Lease, including, without limitation, the Escalation Increase (as hereinafter defined), shall be deemed Additional Rent.

C. Rent . Monthly Base Rent, Additional Rent, and any other amounts of every nature which Tenant is or becomes obligated to pay Landlord under this Lease are herein referred to collectively as “Rent,” and all remedies applicable to the nonpayment of Rent shall be applicable thereto. Landlord may apply payments received from Tenant to any obligations of Tenant then accrued, without regard to such obligations as may be designated by Tenant.

D. Place of Payment, Late Charge, Default Interest . Rent and other charges required to be paid under this Lease, no matter how described, shall be paid by Tenant to Landlord without offset, deduction, credit or the like, except as otherwise expressly set forth in this Lease, at the Building Manager’s address listed in Article 1, or to such other person and/or address as Landlord may designate in writing. In the event Tenant fails to pay Rent due under this Lease within ten (10) business days following the due date thereof, Tenant shall pay to Landlord a late charge equal to [***] of the overdue amount. Any Rent not paid when due shall also bear interest at the Default Rate (as hereinafter defined).

ARTICLE 4.

TAXES AND OPERATING EXPENSES

A. Payment of Taxes and Operating Expenses . Commencing upon the expiration of the Base Year and for each year, or portion thereof, thereafter during the Term (hereinafter each referred to as a “Comparison Year”), Tenant shall pay Landlord an amount equal to Tenant’s Pro Rata Share of increases in Operating Expenses and Taxes over the Operating Expenses and Taxes for the Base Year for Operating Expenses and the Base Year for Taxes, respectively (collectively, the “Escalation Increase”). Landlord shall have the right to change the Comparison Year from a calendar year to a fiscal year from time to time (or vice versa), provided that equitable adjustment is made so that Tenant shall not be charged more than once for the same period and such adjustment does not result in an increase in the Escalation Increase (other than an increase related solely to Operating Expenses being greater during the new time period than they were during the previous time period). As soon as practicable following the end of the Base Year for Operating Expenses and the Base Year for Taxes, respectively, but in any event within one hundred twenty (120) days after the last day of such Base Year, Landlord shall provide a statement setting forth the actual Operating Expenses or Taxes, as the case may be, for the respective Base Year (each, a “Base Year Statement”). Commencing with the first (1 st ) month of the first (1 st ) Comparison Year and on the first (1 st ) day of each month thereafter during the original Term or any extension thereof, Tenant shall pay Escalation Increases to Landlord, as Additional Rent due concurrently with Monthly Base Rent, in installments equal to one-twelfth (1/12) of Landlord’s estimate (as determined by

 

7

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


Landlord in its reasonable discretion) of any projected Escalation Increase for the particular Comparison Year (the “Estimated Escalation Increase”). In computing the Estimated Escalation Increase for any particular Comparison Year, Landlord shall take into account any prior increases in Tenant’s Pro Rata Share of Operating Expenses and Taxes. If any Estimated Escalation Increase is less than the Estimated Escalation Increase for the immediately preceding Comparison Year, the payments to be paid by Tenant for the new Comparison Year attributable to said Estimated Escalation Increase shall be decreased accordingly; provided, however, in no event will the Rent paid by Tenant hereunder ever be less than the Monthly Base Rent.

B. Escalation Reconciliation . As soon as practicable following the end of each Comparison Year but in any event within one hundred twenty (120) days after the last day of such Comparison Year, Landlord shall submit to Tenant a statement setting forth the actual Escalation Increase for the Comparison Year which was just completed and the Estimated Escalation Increase for the current Comparison Year (the “Escalation Statement”), which Escalation Statement shall be substantially in the form attached hereto as Exhibit I. To the extent that the actual Escalation Increase exceeds the Estimated Escalation Increase paid by Tenant for the Comparison Year just completed, Tenant shall pay Landlord the difference, in cash within thirty (30) days following receipt by Tenant from Landlord of the Escalation Statement. If the actual Escalation Increase for the Comparison Year just completed is less than the Estimated Escalation Increase paid by Tenant for such year, then Tenant shall receive a credit on future Rent owing under this Lease (or cash within thirty (30) days of delivery of the Escalation Statement to Tenant, if there is no future Rent owing hereunder). Until Tenant receives the Escalation Statement, Tenant’s Estimated Escalation Increases for the new Comparison Year shall continue to be paid at the rate being paid for the particular Comparison Year just completed. Tenant shall commence payment to Landlord of the Estimated Escalation Increase for the then current Comparison Year, beginning on the first (1 st ) day of the month following the month in which Tenant receives the applicable Escalation Statement.

C. Changes in Escalations During the Lease Year . In addition to the above, if, during any particular Comparison Year, there is a change in the information upon which the then current Estimated Escalation Increase is based, Landlord shall be permitted (but in no event more than one (1) time in any calendar year) to revise such Estimated Escalation Increase by notifying Tenant, and such adjustment shall be made in the payment of Estimated Escalation Increases, commencing on the first (1 st ) day of the month following the delivery of such notice to Tenant. When the Escalation Statement for the Comparison Year in which this Lease terminates is delivered to Tenant, Tenant shall pay to Landlord, within thirty (30) days after Landlord’s delivery of such Escalation Statement, any additional amounts due as calculated pursuant to this Article 4. Landlord’s and Tenant’s responsibilities with respect to Escalation Increases shall survive the expiration or early termination of this Lease.

If the Building is less than ninety-five percent (95%) occupied during the Base Year or any particular Comparison Year, Landlord shall adjust those Operating Expenses which are affected by Building occupancy for both the Base Year and the particular Comparison Year, or portion thereof, as the case may be, to reflect an occupancy of not less than ninety-five percent (95%) of all such rentable area of the Building. If the Building is not fully built-out for occupancy by tenants or is otherwise not leased at full

 

8

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


market value during the Base Year for Taxes or during any particular Comparison Year, then the Taxes for the Base Year or the particular Comparison Year will be adjusted to reflect the undiscounted fair market value of the Building as shown on the City of Boston Tax Assessor’s field card for the Building as of the Commencement Date. In addition, if in any Comparison Year, any new or materially improved component of Operating Expenses which was not included in Operating Expenses in the Base Year is included in Operating Expenses, there shall be added to the Operating Expenses in the Base Year the cost that would have been paid for such component in the first (1 st ) calendar year of the inclusion of such component. If in any Comparison Year, any component of Operating Expenses which was included in Operating Expenses in the Base Year is excluded from Operating Expenses for such Comparison Year, there shall be excluded from the Operating Expenses in the Base Year the cost that would not have been paid for such component in the first (1 st ) calendar year of the exclusion of such component.

D. Disputes Over Taxes or Operating Expenses . If Tenant disputes the amount of an Estimated Escalation Increase or an actual Escalation Increase, Tenant shall give Landlord written notice of such dispute within one hundred fifty (150) days after Landlord delivers the applicable Escalation Statement. Tenant’s failure to give such notice shall waive its right to audit the amounts so determined, except with respect to the amounts contained in the Base Year Statement, which Tenant may dispute during the first (1 st ) two (2) years following the issuance to Tenant of the first such Escalation Statement which indicates an Estimated Escalation Increase or an actual Escalation Increase, after which two (2)-year period Tenant shall have no such right to dispute a Base Year Statement. Tenant shall not be entitled to audit the foregoing amounts if Tenant is then in default (as defined in Article 19). Said audit will be conducted at Tenant’s expense by a certified public accountant paid on an hourly basis unrelated to actual savings identified. Tenant shall only be permitted to conduct such a review during regular business hours at Landlord’s office in Boston or Connecticut, after Tenant gives Landlord twenty (20) business days’ prior written notice. Landlord shall make available its books and records for only the Comparison Year (or, if applicable, the Base Year, as provided above) under review, and no more than once during any twelve (12) month period during the Term following commencement of Tenant’s payment obligations under this Article 4. If such review discloses that the charges actually incurred by Landlord are less than those used by Landlord in calculating Escalation Increases, then Landlord shall reimburse Tenant for the amount Tenant paid in excess of Tenant’s actual Escalation Increases within thirty (30) days of notice thereof from Tenant. If any such review discloses that the Escalations Increases exceed the amount which should have been charged as Escalations Increases by five percent (5%) or more of the Actual Expenses for such Comparison Year, then Landlord shall pay the reasonable costs of such review. If Tenant does not review Landlord’s records within two hundred ten (210) days after receipt of the Escalation Statement, Tenant shall have no further right to review Landlord’s records for the applicable period. No subtenant shall have the right to conduct such audit and no assignee (other than an assignee pursuant to a Permitted Transfer, as defined in Article 16.B. of this Lease) shall conduct an audit for any period during which such assignee was not in possession of the Premises.

In the event Tenant elects to exercise its audit rights hereunder, Tenant shall nevertheless timely pay Landlord the amount of the prior year’s Escalation Reconciliation and continue to pay Estimated Escalation Increases as set forth in the then applicable

 

9

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


Escalation Statement until the parties have agreed as to the appropriate adjustment. Landlord’s delay in submitting any Escalation Statement for any Comparison Year shall not affect the provisions of this Article 4, nor constitute a waiver of Landlord’s rights as set forth herein for said Comparison Year or any subsequent Comparison Year during the Term or any extension thereof, provided, however, that Landlord’s failure to submit any Escalation Statement within three (3) years following the end of the applicable Comparison Year shall constitute such a waiver, and Tenant shall have no further payment obligations with respect to the Escalation Statement for such Comparison Year.

E. Tenant acknowledges that the Building is part of the Project. As a result thereof, any Operating Expenses and Taxes attributable in part to the Building and in part to other portions of the Project, including, without limitation, the Building Common Areas (as hereinafter defined), shall be allocated to the Building and said other portions of the Project pursuant to the Declaration or any other applicable reciprocal easement agreement and otherwise on an equitable basis. In addition, any Operating Expenses and Taxes attributable in part to the Office Component and in part to the Retail Component shall be allocated to the Office Component or the Retail Component, as the case may be, on an equitable basis.

F. Tenant shall pay, prior to delinquency, all taxes assessed against or levied upon trade fixtures, furnishings, equipment and all other personal property of Tenant located in the Premises and any excise, sales or use taxes related to Tenant’s business. In the event any or all of Tenant’s trade fixtures, furnishings, equipment and other personal property shall be assessed and taxed with property of Landlord, Tenant shall pay to Landlord its share of such taxes within thirty (30) days after delivery to Tenant by Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant’s property. Tenant shall pay directly to the party or entity entitled thereto all business license fees, gross receipts taxes and similar taxes and impositions which may from time to time be assessed against or levied upon Tenant, as and when the same become due and before delinquency. Notwithstanding anything to the contrary contained herein, any sums payable by Tenant under this Article 4 shall not be included in the computation of “Taxes.”

G. Appropriate credit against Taxes shall be given for any refund obtained by reason of a reduction in any Taxes by the City of Boston assessor or the administrative, judicial or other governmental agency responsible therefor, net of reasonable fees incurred to prosecute the abatement application and/or negotiate the re-assessment (such as, by way of example and not limitation, appraisal fees, stenographer fees, if any, and legal fees). The original computations, as well as reimbursement or payments of additional charges, if any, or allowances, if any, under the provisions of this section shall be based on the undiscounted fair market value of the Building as shown on the City of Boston Tax Assessor’s field card for the Building as of the Commencement Date, with adjustments to be made at a later date when the tax refund, if any, shall be paid to Landlord by the taxing authorities.

 

10

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


ARTICLE 5.

DELIVERY OF PREMISES, TENANT’S WORK, ALTERATIONS AND ADDITIONS

A. Delivery of Premises . On the Commencement Date, Landlord shall deliver the Premises to Tenant in the condition described in Exhibit B-1 attached hereto (the “Base Building Condition”). Landlord represents and warrants to and covenants with Tenant that as of the Commencement Date (i) the Common Areas of the Building and the Base Building Condition of the Premises comply with all applicable Laws, including, without limitation, the ADA (as hereinafter defined) and all other applicable laws and rules governing access to and use of facilities by people with disabilities, including the Massachusetts Architectural Access Board regulations and (ii) to the best of Landlord’s information, knowledge and belief, there are no conditions in the Building or the Premises that would prevent Tenant from receiving a certificate of occupancy or certificate of completion upon completion of Tenant’s Work, and Landlord will cooperate (at no cost to Landlord, except to the extent that Landlord is obligated to modify the Base Building Condition in accordance with Section 6 of Exhibit B attached hereto, which shall be at Landlord’s cost) with Tenant’s efforts to obtain a certificate of occupancy or certificate of completion.

B. Tenant’s Work . On and after the Commencement Date, Tenant, at its sole cost and expense (subject to the TI Allowance), shall be responsible for constructing initial improvements in and to the Premises in accordance with the work exhibit attached hereto as Exhibit B (collectively, “Tenant’s Work”). In addition, during this time period, Tenant shall have the exclusive right to use and control physical access to the Premises (subject to Landlord’s rights and obligations under this Lease), including but not limited to, the right to install its furniture, furnishings and equipment in the Premises, generally prepare the Premises for occupancy and actually occupy the Premises for the conduct of business, without any of the foregoing causing an acceleration of the Rent Commencement Date. Tenant shall complete all of Tenant’s Work in good and workmanlike manner in accordance with the plans and specifications approved by Landlord and Tenant as provided in Exhibit B, as the same may be amended from time to time (subject to written approval by Landlord and Tenant), and shall use reasonable efforts to complete Tenant’s Work on or before the Rent Commencement Date, provided, however, that any failure by Tenant to complete Tenant’s Work before the stated Rent Commencement Date shall not postpone or delay such date, unless such failure is caused by Landlord or Landlord’s employees, agents or contractors, in which case the Rent Commencement Date shall be delayed two (2) days for every day of delay in the completion of Tenant’s Work caused by Landlord or Landlord’s employees, agents or contractors, provided, however, that any such delay of the Rent Commencement Date shall be expressly conditioned on Tenant’s diligent submission of plans and specifications for Tenant’s Work for Landlord review and approval in accordance with the terms and conditions of Exhibit B attached hereto and Tenant’s diligent and continuous prosecution of Tenant’s Work following Landlord’s approval of such plans and specifications. If any aspect of Tenant’s Work would affect any Building Systems (as hereinafter defined), Landlord shall have the right to reasonably require Tenant to utilize Landlord’s pre-approved vendors and/or contractors in connection with such work. All Tenant Improvements, as defined in Exhibit B, shall remain the property of Tenant during the Term.

 

11

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


C. Alterations . Other than as provided in Article 5.B. above and herein, Tenant shall make no alterations or additions to the Premises (“Alterations”) without the prior written consent of Landlord, which consent may be withheld in Landlord’s sole discretion as to alterations which adversely affect or impair the structural integrity of, or the proper operation of the operating systems of, the Building, and which consent shall not be unreasonably withheld, conditioned or delayed as to all other alterations and only by contractors or mechanics approved by Landlord in writing (which approval shall not be unreasonably withheld, conditioned or delayed) and upon the approval by Landlord in writing of fully detailed and dimensioned plans and specifications pertaining to the Alterations in question, to be prepared and submitted by Tenant, at its sole cost and expense, which approval shall not be unreasonably withheld, conditioned or delayed. Tenant shall, at its sole cost and expense, obtain all necessary approvals and permits pertaining to any Alterations approved by Landlord. Notwithstanding the foregoing, Landlord’s consent shall not be required, and Tenant shall not be required to submit plans to Landlord, for alterations which are (i) non-structural aesthetic alterations (including, without limitation, painting and carpeting) or (ii) will not affect any Building Systems or structure and will cost less than [***] on a per project basis. If Alterations are made, they shall be made at Tenant’s sole cost and expense and shall remain the property of Tenant during the Term. Notwithstanding anything contained herein to the contrary, Landlord may, by written notice to Tenant given at the time of Landlord’s approval of the Alterations in question, require Tenant, at Tenant’s expense, upon the expiration or earlier termination of the Lease Term, to remove such Alterations installed by Tenant, and to repair any damage caused by such removal. Any and all costs attributable to or related to the applicable building codes of the City of Boston (or any other authority having jurisdiction over the Building) arising from Tenant’s plans, specifications, improvements, alterations or otherwise shall be paid by Tenant at its sole cost and expense. With regard to repairs, Alterations or any other work arising from or related to this Article 5 and which require Landlord’s consent pursuant to this Article 5 (but excluding Tenant’s Work), Landlord shall be entitled to receive an administrative/supervision fee (which fee shall vary depending upon whether or not Tenant orders the work directly from Landlord but which shall not exceed three percent (3%) of hard costs).

D. Liens . Tenant will not cause or permit any mechanic’s, materialman’s or similar liens or encumbrances to be filed or exist against the Premises or the Building or Tenant’s interest in this Lease in connection with work done under this Article 5 or in connection with any other work, and Tenant agrees to defend, indemnify and hold harmless Landlord from and against any such lien or claim or action thereon, together with costs of suit and reasonable attorneys’ fees incurred by Landlord in connection with any such claim or action. Tenant shall remove any such lien or encumbrance, by bond or otherwise within twenty (20) days from the date of filing of the applicable Statement of Account (the parties acknowledging and agreeing that the mere filing of a Notice of Contract shall not trigger the foregoing obligation). If Tenant fails to do so, Landlord may, without being responsible to investigate the validity or lawfulness of the lien, pay the amount or take such other action as Landlord deems necessary to remove any such lien or encumbrance unless Tenant deposits with Landlord in cash and lawful money of the United States, one hundred ten percent (110%) of the amount of such claim, which sum may be retained by Landlord until such claim shall have been removed of record or until judgment shall have been rendered on such claim and such judgment shall have

 

12

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


become final, at which time Landlord shall have the right to apply such deposit in discharge of the judgment on said claim and any costs, including reasonable attorneys’ fees incurred by Landlord, and shall remit the balance thereof to Tenant. The amounts so paid and costs incurred by Landlord shall be deemed Additional Rent under this Lease and payable in full within thirty (30) days of demand therefor.

E. Compliance with ADA . Landlord and Tenant agree that responsibility for compliance with the Americans With Disabilities Act of 1990, as amended (the “ADA”) shall be allocated as follows: (i) Landlord shall be responsible for compliance with the provisions of Title III of the ADA for all Building Common Areas, including exterior and interior areas of the Building not included within the Premises or the premises of other tenants; (ii) Landlord shall be responsible for compliance with the provisions of Title III of the ADA for the Base Building Condition of the Premises and for any construction, renovations, alterations and repairs made within the Premises if such construction, renovations, alterations or repairs are made by Landlord for the purpose of improving the Building generally; and (iii) Tenant shall be responsible for compliance with the provisions of Title III of the ADA for any construction, renovations, alterations and repairs made within the Premises if such construction, renovations, alterations and repairs are made by Tenant, its employees, agents or contractors, at the direction of Tenant or done pursuant to plans and specifications prepared or provided by Tenant or Tenant’s architect or space planner.

F. Labor Covenant . As a condition precedent to any proposed construction work or Alteration, Tenant shall deliver to Landlord evidence satisfactory to Landlord that Tenant shall cause such construction, alteration or service contract work to be performed solely by contractors whose employees are represented by unions and such employment will conform to the traditional craft jurisdictions in the area (the “Labor Covenant”), provided, however, that the Labor Covenant shall not apply to (i) the services for installation, operation, maintenance and repair of personal property owned exclusively by Tenant (e.g., computer systems, telephones and furniture other than modular furniture) or for any of Tenant’s specialized equipment, (ii) a specific item or instance of maintenance, repair or replacement to the extent union labor is not available in the market to perform such specific item or instance of maintenance, repair or replacement, and/or (iii) maintenance, repairs and replacements that may be and are self-performed by the existing staff of Tenant with the retention, engagement or hiring of any third party or additional employee. Subject to the foregoing exceptions, Tenant shall include the Labor Covenant in each of its contracts for such construction or alteration work and in each of its service contracts for any maintenance, repair and services relating to, or to be performed for the benefit of, the Premises. Subject to the foregoing exceptions, Tenant shall also provide such evidence as Landlord may reasonably require, from time to time during the course of such construction or alteration work or the performance of such services, that the Labor Covenant is being fully and faithfully observed and Tenant shall include the obligation to provide such evidence in each contract entered into by Tenant for such construction or alteration work or service being provided to the Premises. Tenant further agrees that it shall incorporate the foregoing requirements in any sublease of the Premises. Tenant improvement or Alteration work requiring specialized skills that are not available through unionized contractors may be exempted from the Labor Covenant, subject to prior approval by Landlord, which shall not be unreasonably withheld, conditioned or delayed.

 

13

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


G. Building Sustainability Strategies . Landlord has received [***]. Landlord shall take all [***] within its control (which shall not include incorporation or enforcement of any specific requirements in tenant leases) [***]. In addition, Landlord shall take all [***] within its control (which shall not include incorporation or enforcement of any specific requirements in tenant leases) to [***]. Landlord shall [***].

ARTICLE 6.

TENANT’S USE, RESTRICTIONS AND COMPLIANCE WITH LAWS

A. Tenant’s Use . Tenant shall use the Premises for the Permitted Use, and for no other purpose whatsoever, subject to and in compliance with all other provisions of this Lease, including without limitation the Rules and Regulations (as hereinafter defined). Tenant and its invitees shall also have the non-exclusive right, along with other tenants of the Building, Landlord and others having the right to the use thereof pursuant to the Project Documents, to use the Building Common Areas and the “Common Areas and Facilities” (as defined in the Project Documents) subject to the Project Documents and the Rules and Regulations. Landlord represents, to the best of its information, knowledge and belief, that the Premises are permitted by Law to be used for the Permitted Use. Tenant shall have the non-exclusive right to use the Building’s fire stairs as communicating stairs between the floors (whether full or partial) making up the Premises (the “Fire Stairs”). As part of such use, Tenant shall have the right to (i) choose and install, at Tenant’s sole cost and expense, design finishes in the Fire Stairs and (ii) install card key access from the Fire Stairs to the Premises; provided, however, any such installations shall (a) be subject to Landlord’s prior written approval, which approval shall not be unreasonably withheld, conditioned or delayed, (b) be tied to the Building’s life safety systems and otherwise in accordance with all Laws, including, but not limited to, those of the City of Boston Fire Department, (c) not increase Landlord’s insurance premiums or rate of insurance (unless Tenant pays for any such increase), or decrease the coverage provided under Landlord’s insurance policies, and (d) be maintained by Tenant at Tenant’s sole cost, except with respect to the janitorial service to be provided by Landlord under Section 7.C. Notwithstanding the foregoing, Landlord shall be permitted to override Tenant’s access system if Landlord needs to access the Premises via the Fire Stairs in the event of an emergency or as otherwise deemed necessary in Landlord’s reasonable discretion upon reasonable advance notice to Tenant.

B. Tenant’s Restrictions . Tenant shall not, without Landlord’s consent, at any time use or occupy, or suffer or permit anyone to use or occupy, the Premises or do or permit anything to be done in the Premises which: (a) causes injury to persons, to the Building or its equipment, facilities or systems; (b) impairs the appearance of the Building as a first class office building; (c) impairs the proper and economic maintenance, operation and repair of the Building or its equipment, facilities or systems; or (d) would invalidate or increase the cost of any fire and extended coverage insurance policy covering the Building and/or the property located therein. Tenant shall comply with all rules, orders, regulations and requirements of any organization which sets out standards, requirements or recommendations commonly referred to by major fire insurance underwriters to the extent that the same are required in writing by Landlord’s insurers, provided that the same are applied to all tenants of the Building in a non-discriminatory

 

14

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


manner. Tenant shall, within thirty (30) days of demand, reimburse Landlord for any additional premium charges for any such insurance policy assessed or increased by reason of Tenant’s failure to comply with the provisions of this Article 6.

C. Tenant’s Compliance with Laws . Tenant shall, at Tenant’s sole cost and expense, keep and maintain the Premises to the extent set forth in Section 12.A, its use thereof (subject to Landlord’s representation in Section 6.A above) and its business at the Premises in compliance with all Laws now in force, or which may hereafter be in force or effect, to the extent applicable to the Premises. Tenant shall comply with all Laws relating to the Premises and Tenant’s use or occupancy thereof, including without limitation Laws in connection with the health, safety and building codes, and any permit or license requirements.

D. [***]. So long as (i) this Lease is in full force and effect, (ii) Tenant is not in default hereunder beyond any and all applicable notice and cure periods, and (iii) Tenant has not assigned this Lease or sublet all or any portion of the Premises other than (a) pursuant to a Permitted Transfer or (b) a sublease or subleases of any portion of the Premises comprising more than one (1) floor of the Building, [***].

ARTICLE 7.

SERVICES

A. Climate Control . Landlord shall furnish heat and air conditioning to the Premises during Normal Business Hours of the Building as set forth in Article 1, in accordance with the standards and specifications set forth in OTIS (as hereinafter defined). If Tenant requires heat or air conditioning at any other time (“After Hours Services”), Landlord shall use reasonable efforts to furnish such After Hours Services upon at least four (4) hours advance telephonic notice by Tenant, and Tenant shall pay Landlord, as Additional Rent, the then current rate for such After Hours Services. The current estimated rate for After Hours Services is [***], which rate is subject to change from time to time in Landlord’s sole, but reasonable discretion, in accordance with changes to the actual cost to Landlord of providing such services.

The performance by Landlord of its obligations under this Article is subject to Tenant’s satisfying its obligations under this Lease in a manner which complies with all standards, capacities and limitations set forth in the One Marina Park Drive Office Tenant Interior Standards dated December 31, 2009 (“OTIS”), a copy of which is attached hereto as Exhibit J. Tenant shall not use the Premises or any part thereof in a manner in conflict with the specifications set forth in OTIS.

Notwithstanding the foregoing, Tenant shall have the right to install supplemental HVAC equipment in the Premises with Landlord’s prior written consent, not to be unreasonably withheld, conditioned or delayed, and any such equipment shall remain the property of Tenant.

B. Elevator Service . Landlord, during Normal Business Hours of the Building, shall furnish elevator service to Tenant to be used in common with others. At least one (1) elevator servicing the Premises shall remain in service during all other hours. Landlord may designate a specific elevator for use as a service elevator, which shall be available twenty-four (24) hours per day, seven (7) days per week.

 

15

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


C. Janitorial Services . Landlord shall provide janitorial and cleaning services to the Premises and the Fire Stairs, substantially as described in Exhibit D attached hereto and shall provide janitorial and cleaning services to the Building Common Areas. The cost of all such services shall be included in Operating Expenses except that Tenant shall pay to Landlord within thirty (30) days of demand the reasonable costs incurred by Landlord for (i) any cleaning of the Premises in excess of the specifications in Exhibit D because of (A) misuse or neglect on the part of Tenant or Tenant’s agents, contractors, invitees, employees and customers, (B) the use of portions of the Premises for special purposes requiring greater or more difficult cleaning work than office areas other than typical coffee stations, sinks, and the like, (C) interior glass partitions or unusual quantities of interior glass surfaces, and (D) non-Building standard materials or finishes installed by Tenant or at its request but only to the extent that the same cost more to clean (in the manner required by Exhibit D) than Building-standard materials or finishes; and (ii) removal from the Premises of any refuse and rubbish of Tenant in excess of that ordinarily accumulated in general office occupancy. Notwithstanding the foregoing, except in case of an emergency, Landlord shall use commercially reasonable efforts to provide notice to Tenant prior to performing any janitorial services which will result in such additional cost.

D. Water and Electricity . Landlord shall make available domestic water in reasonable quantities to the Building Common Areas and the Premises and cause electric service sufficient for lighting the Building Common Areas and the Premises in accordance with the standards and specifications set forth in OTIS. Landlord shall have the exclusive right to make any replacement of lamps, fluorescent tubes and lamp ballasts in the Premises (provided, however, that replacements of specialty lighting shall be at Tenant’s sole cost and expense and that the cost of replacements of specialty lighting for any tenant in the Building shall not be included in Operating Expenses). Landlord may adopt a system of relamping and ballast replacement periodically on a group basis in accordance with good management practice, provided that Landlord will replace non-operational lamps, fluorescent tubes and lamp ballasts as needed. Tenant’s use of electric energy or water in the Premises shall not at any time exceed the capacity of any of the risers, piping, electrical conductors and other equipment in or serving the Premises as set forth on Exhibit B-1 or OTIS, as applicable. In order to insure that such capacity is not exceeded and to avert any possible adverse effect upon the Building’s electric system, Tenant shall not, without Landlord’s prior written consent in each instance, not to be unreasonably withheld, conditioned or delayed, connect appliances or heavy duty equipment, other than equipment contemplated by OTIS, to the Building’s electric system or make any alteration or addition to the Building’s electric system. Should Tenant request, and Landlord grant its consent in writing, which consent shall not to be unreasonably withheld, conditioned or delayed, to additional risers, piping and electrical conductors or other equipment not included in the Base Building Condition, the same shall be provided by Landlord and the cost thereof shall be paid by Tenant within thirty (30) days after the later of (i) installation of such equipment and (ii) Landlord’s demand therefor.

 

16

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


E. Separate Meters . As part of Tenant’s Work, Tenant shall cause the Premises to be separately metered for electricity, on a permanent basis, and, following such separate metering, Tenant shall pay monthly electricity charges directly to the applicable electricity provider based upon Tenant’s separately metered consumption of electricity. From and after the later to occur of (i) the Commencement Date or (ii) the date on which Tenant actually takes sole and exclusive possession and control of the Premises from Landlord (the parties hereby acknowledging that Tenant shall have the exclusive right to use and control physical access to the Premises, subject to the rights and obligations of Landlord as set forth in this Lease, as of the Commencement Date), and continuing until such time as the Premises are separately metered for electricity as provided above, Tenant shall be responsible for the costs of all electricity consumed in the Premises, which costs shall constitute Additional Rent hereunder and shall be billed to Tenant on a regular basis by Landlord (or, if applicable, by the applicable electricity provider). Landlord also reserves the right to install separate meters for the Premises to register the usage of all or any one of such other utilities, and, in such event, Tenant shall pay for the cost of utility usage as metered to the Premises and which is in excess of the usage contemplated by OTIS. The cost of installing, maintaining and repairs the separate meters contemplated hereby shall be borne by Landlord, unless Tenant actual usage exceeds the usage contemplated by OTIS by more than ten percent (10%).

Notwithstanding anything contained herein to the contrary, Tenant, at its sole cost and expense, shall be permitted to meter, monitor and control all utilities, facilities and systems serving the Premises beyond Landlord’s base Building equipment, facilities and connections. Specifically excluded from this right of metering, monitoring and control shall be the restroom facilities (including, without limitation, the related plumbing facilities serving same) located on the floors of the Premises. In addition to the foregoing, Tenant, at its sole cost and expense, shall be permitted to monitor total Building electrical and [***] water usage via check meters installed at the Building’s service entry points, subject to Landlord’s approval of the specifications and locations of such check meters (which approval shall not be unreasonably withheld, conditioned or delayed). Any meters, monitors or controls under this Article 7.E. shall be installed and maintained at Tenant’s sole risk, and Landlord does not warrant the validity or accuracy of the information conveyed by such meters, monitors and controls.

F. Interruptions . Landlord does not represent or warrant that any of the services referred to above, or any other services which Landlord may supply, will be free from interruption and Tenant acknowledges that any one or more of such services may be suspended by reason of accident, repairs, inspections, alterations or improvements necessary to be made, or by Force Majeure. Any interruption, reduction or discontinuance of service shall not be deemed an eviction or disturbance of Tenant’s use and possession of the Premises, or any part thereof, nor render Landlord liable to Tenant for damages (unless such damages are caused by Landlord’s negligence or willful misconduct), nor relieve Tenant from performance of Tenant’s obligations under this Lease. Landlord shall however, exercise reasonable diligence to minimize any such interruptions (for example, by keeping at least one elevator serving the Premises in operation if possible) and to restore any service so interrupted.

 

17

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


Notwithstanding the foregoing, if any services to be supplied by Landlord under this Lease are interrupted, [***] and Tenant [***] of such [***],[***] to an [***] of the [***] following the date on which [***].

G. Additional Utilities Provided by Tenant .

(a) Additional Utilities . Tenant shall make application in Tenant’s own name for all utilities desired by Tenant and not provided herein by Landlord and shall: (i) comply with all utility company regulations for such utilities, including requirements for the installation of meters, and (ii) obtain such utilities directly from, and pay for the same when due directly to, the applicable utility companies. The term “utilities” for purposes hereof shall include but not be limited to telephone and other communication and alarm services, and all taxes or other charges thereon. Tenant shall install and connect all equipment and lines required to supply such additional utilities to the extent not already available at or serving the Premises. Tenant shall maintain, repair and replace all such items, operate the same, and keep the same in good working order and condition. Tenant shall not install any equipment or fixtures, or use the same, so as to exceed the safe and lawful capacity of any utility equipment or lines serving the same. The installation, alteration, replacement or connection of any utility equipment and lines shall be subject to the requirements for Alterations of the Premises set forth in Article 5. Tenant shall ensure that all of Tenant’s HVAC equipment is installed and operated at all times in a manner to prevent roof leaks (if any of Tenant’s equipment is installed on the roof), damage, or noise due to vibrations or improper installation, maintenance or operation.

(b) Communications Equipment . Tenant shall have the right to install one (1) satellite transmission and receiving dish and related equipment, cabling and wiring, or one (1) antenna and related equipment, cabling and wiring (in either case, “Tenant’s Roof Equipment”) on the so-called “low” roof of the Building in an area designated by Landlord, as well as other equipment and cabling reasonably necessary or reasonably desirable in order to connect the same to the Premises, provided that: (i) Tenant complies with all local, state and federal laws pertaining to the installation, maintenance, operation, removal and replacement of any of Tenant’s Roof Equipment; (ii) Tenant does not do any act which would invalidate any roof warranty or guaranty which now or hereafter relates to the roof of the Building; (iii) Tenant obtains Landlord’s prior written consent as to the amount of area required, size, appearance and the location of Tenant’s Roof Equipment; (iv) Tenant obtains all required operating permits and approvals from any governmental entity with jurisdiction over such activities, (v) Tenant, at its sole cost and expense, shall maintain the Tenant’s Roof Equipment and adequate insurance thereon; (vi) in the event of any damage caused to the Building (including, without limitation, the roof or any exterior portions thereof), by reason of the installation, maintenance, operation, removal or replacement of any of Tenant’s Roof Equipment, Tenant shall, at Landlord’s option (x) promptly repair such damage or (y) promptly reimburse Landlord for costs and expenses incurred by Landlord in repairing such damage; (vii) in the event of interference with the equipment of any other tenant or licensee of the Building which is installed either prior to Tenant’s Roof Equipment (“the Pre-Existing Equipment”) or after Tenant’s Roof Equipment expressly pursuant to any lease, license agreement or occupancy agreement executed prior to the date of this Lease if such lease or agreement does not include a prohibition on interference with

 

18

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


previously installed equipment (the “Future Permitted Equipment”), by reason of the installation, maintenance, operation, removal or replacement of any of Tenant’s Roof Equipment, Tenant shall (x) immediately cease the use of Tenant’s Roof Equipment, (y) relocate Tenant’s Roof Equipment to another location reasonably designated by Landlord, at Tenant’s sole cost and expense, and (z) pay all reasonable costs or damages incurred by Landlord or such other tenant or licensee in connection with the Tenant’s interference with such Pre-Existing Equipment or Future Permitted Equipment, as applicable (but only if Tenant does not immediately cease the use thereof within one (1) business day after written notice thereof is given to Tenant), provided, however, that Tenant shall have no such obligation with respect to non-Pre-Existing Equipment, non-Future Permitted Equipment, and any equipment of a telecom provider which does not primarily serve the space tenants of the Building whether or not existing at the Building prior to the Tenant’s Roof Equipment; (viii) Tenant shall use such contractors and observe such reasonable requirements as reasonably required by Landlord in connection with the installation, maintenance, servicing, repair, replacement and removal of Tenant’s Roof Equipment; and (ix) Tenant shall remove Tenant’s Roof Equipment and repair any damage caused by the removal of the same, upon the expiration or sooner termination of the term of this Lease. Tenant acknowledges that, due to the fact that interference with Pre-Existing Equipment or Future Permitted Equipment, as applicable, caused by Tenant’s Roof Equipment may cause irreparable injury to Landlord, its tenants, and the owners and users of such other roof equipment, Landlord shall have the right, in addition to any other remedy at law or in equity, to enjoin such interference. The provisions of this subsection (b) shall survive the expiration or sooner termination of this Lease. The rights of Tenant set forth in this subsection (b) are subject to any rights of other tenants or licensees of the Building, but only to the extent set forth above, and further subject to the right of Landlord to enter into extensions or renewals of leases or licenses in effect with any tenant or licensee then leasing or licensing such space following the expiration of its lease (whether or not an express renewal option is afforded to such tenant under the terms of its lease or license), subject to the obligation of such parties not to interfere with Tenant’s Roof Equipment or the operation thereof. Landlord makes no representations or warranties as to the suitability or effectiveness of any such Tenant’s Roof Equipment, or as to the governmental requirements applicable thereto. The permission granted in this subsection (b) for Tenant to install and operate the Tenant’s Roof Equipment shall not be deemed to make the roof of the Building and/or the Building Systems part of the Premises for any purpose under this Lease. The permission granted herein is non-exclusive. Landlord reserves the right from time to time to permit other tenants of the Building or others to install, operate and maintain equipment on the roof(s) of the Building or elsewhere, so long as such operation does not interfere unreasonably or materially with Tenant’s operation of Tenant’s Roof Equipment. Tenant shall be responsible for the entire cost of supplying electricity to the Tenant’s Roof Equipment. Electric usage shall be measured by meters installed by Landlord at Tenant’s cost, and the cost of such electric usage shall be billed to Tenant and shall constitute Additional Rent hereunder.

H. Additional Installations . If any lights, machines or equipment (including but not limited to computers) are used by Tenant in the Premises which materially affect the temperature otherwise maintained by the air conditioning system, or generate substantially more heat in the Premises than would be generated by the lighting and equipment contemplated by OTIS, then, at Landlord’s option, Landlord shall have the right to either (i) require Tenant to install a supplemental HVAC system, at Tenant’s sole

 

19

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


cost and expense, subject to Landlord’s review and approval of the plans and specifications therefor (which approval shall not be unreasonably withheld, conditioned or delayed), or (ii) install or cause to be installed any machinery and equipment which Landlord reasonably deems necessary to restore temperature balance, including but not limited to modifications to the standard air conditioning equipment, and the cost thereof, including the cost of installation and any additional cost of operation and maintenance occasioned thereby, shall be paid by Tenant to Landlord within thirty (30) days of demand by Landlord. Landlord shall not be liable under any circumstances for loss of or injury to property, however occurring, through or in connection with or incidental to failure to furnish such installation or modification. Prior to performing any installation or modification pursuant to this Section H, Landlord shall notify Tenant of the same and provide Tenant with a reasonable opportunity to (i) modify or remove any of Tenant’s lights, machines or equipment in order to restore the temperature balance or (ii) install or modify, at Tenant’s sole cost, equipment or machinery in order to restore the temperature balance, subject to Landlord’s review and approval of the plans and specifications therefor (which approval shall not be unreasonably withheld, conditioned or delayed).

I. Access to Building Common Areas . Tenant shall have access to the Building Common Areas twenty-four (24) hours per day, seven (7) days per week, three hundred sixty-five (365) days per year. Upon initial occupancy, Tenant will be entitled to one (1) access card or other access device per employee for use at the Building turnstiles and elevators, and to one (1) such access card for each new employee hired thereafter. Additional access cards or devices for employees who have already been provided with an access card or device may be obtained at the rate of [***] per additional card or device, which rate is subject to change from time to time in Landlord’s sole but reasonable discretion, provided, however, that [***].

J. Shuttle Service . During the Lease Term, Landlord shall provide, or shall cause FPOC (as hereinafter defined) to provide, vehicular shuttle/limousine service for Tenant’s use (which use shall be reasonably related to Tenant’s Permitted Use). Such shuttle service shall be offered both on-demand (by written or telephonic notice) and on a scheduled basis, provided, however, that on-demand service shall only be available during Normal Business Hours, except as such hours may be expanded as set forth below. Notwithstanding anything contained herein to the contrary, the costs of providing such vehicular shuttle/limousine service shall be included as part of Operating Expenses hereunder; there shall be no additional charge or cost whatsoever to Tenant or Tenant’s employees for the use of such vehicular shuttle/limousine service. As demand for use of such vehicular shuttle/limousine service increases during the Term, Landlord shall increase the number and/or size of vehicles and/or expand the operating hours and/or frequency of scheduled service to accommodate such increased demand. Notwithstanding anything contained herein to the contrary, the cost of the purchasing or leasing of any vehicles required in connection with the aforesaid shuttle service shall be included in Operating Expenses as FPOC Expenses. Exhibit M attached hereto for informational purposes only reflects the current scheduled shuttle service. Notwithstanding the foregoing, neither Landlord nor FPOC shall be obligated to provide shuttle service to Boston’s South Station; provided, however, that [***], during Normal Business Hours Tenant may [***].

 

20

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


K. [***]. By April 1, 2013, Landlord shall [***] in the Building with [***], provided, however, that the costs of operating and maintaining [***]. There shall be no additional charge or cost whatsoever to Tenant [***]. As of the date hereof, Landlord contemplates [***], in Landlord’s discretion, and, following the [***], in Landlord’s sole discretion. [***].

L. Supplemental HVAC System . Notwithstanding anything contained herein to the contrary, Tenant shall be permitted to install, at its sole cost and expense, supplemental HVAC equipment and, in connection therewith, to utilize, on a seven (7) days per week, twenty-four (24) hours per day basis during the Term, the capped tie-in for supplemental HVAC facilities located on each floor of the Premises in accordance with the procedures and specifications set forth in OTIS. In connection therewith, Tenant shall be responsible for the cost of condenser water serving such supplemental HVAC equipment, Tenant’s consumption of which shall be measured by a water meter installed on the condenser water line by Tenant, at Tenant’s sole cost and expense.

ARTICLE 8.

INSURANCE

A. Required Insurance . Tenant shall, at all times during the Term of this Lease, and at its own cost and expense, maintain insurance policies, with responsible companies licensed to do business in the Commonwealth of Massachusetts naming Landlord, the Building Manager, Cornerstone Real Estate Advisers LLC, Tenant and any Mortgagee of Landlord, as their respective interests may appear, including: (i) a policy of standard fire, extended coverage and special extended coverage property insurance which shall be primary on Tenant’s personal property and the Premises Improvements (as hereinafter defined), including Tenant’s goods, equipment and inventory, in an amount adequate to cover their replacement cost, including a vandalism and malicious mischief endorsement, and sprinkler leakage coverage; (ii) business interruption insurance, loss of income and extra expense insurance covering the failure of Tenant’s telecommunications equipment and all other perils, failures or interruptions; (iii) commercial general liability insurance on an occurrence basis with limits of liability in an amount not less than Two Million Dollars ($2,000,000) combined single limit for each occurrence, and Three Million Dollars ($3,000,000) in the annual aggregate; and (iv) Worker’s Compensation Coverage as required by law. The commercial general liability policy shall include contractual liability which includes the provisions of Article 9 herein.

Prior to entry into the Premises to commence Tenant’s Work, Tenant shall furnish to Landlord and the Building Manager, certificates of insurance evidencing the liability insurance coverage set forth above, including naming Landlord, Cornerstone Real Estate Advisers LLC and the Building Manager as additional insureds. Tenant shall also furnish evidence of the property insurance coverage required to be maintained by Tenant as provided in the preceding paragraph. Renewal certificates must be furnished to Landlord at least thirty (30) days prior to the expiration date of such insurance policies showing the above coverage to be in full force and effect.

The foregoing policy sets forth minimum limits of liability and Tenant’s procurement and maintenance thereof shall in no event limit the liability of Tenant under

 

21

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


this Lease. All such insurance policies carried by Tenant shall be with companies having a rating of not less than A-VIII in Best’s Insurance Guide. All such policies shall be endorsed to agree that Tenant’s policy is primary and that any insurance covered by Landlord is excess and not contributing with any Tenant insurance requirement hereunder. Tenant agrees that if Tenant does not take out and maintain such insurance or furnish Landlord with certificates of insurance as required herein, Landlord may (but shall not be required to) procure said insurance on Tenant’s behalf and charge Tenant the cost thereof, which amount shall be payable by Tenant within thirty (30) days of written demand. All such insurance shall provide that it cannot be canceled except upon thirty (30) days prior written notice to Landlord. Tenant shall comply with all rules and directives of any insurance board, company or agency determining rates of hazard coverage for the Premises, including but not limited to the installation of any equipment in or exclusively serving the Premises, and/or the correction of any condition for which Tenant would otherwise be responsible pursuant to this Lease necessary to prevent any increase in such rates.

B. Landlord’s Insurance . During the Term of this Lease, Landlord shall maintain All Risk property and commercial general liability insurance covering the Building, including, on a secondary basis only, the Premises Improvements. The All Risk property insurance policy shall cover all structures and improvements for full replacement value, with replacement cost endorsement, above foundation walls. The commercial general liability insurance shall be in an amount of at least Five Million Dollars ($5,000,000.00) and shall insure against claims for bodily injury and property damage occurring in or about the Building or the Project. Such insurance may be included in blanket policies carried by Landlord so long as such blanket policies do not reduce the amount of insurance available to pay any such claim. The commercial general liability policy shall include contractual liability which includes the provisions of Article 9 herein.

C. Waiver of Subrogation . Landlord and Tenant each agree that neither Landlord nor Tenant will have any claim against the other for any loss, damage or injury which is covered by insurance carried by or required to be carried by either party, notwithstanding the negligence of either party in causing the loss, and each agree to have their respective insurers issuing the insurance described in this Article 8 waive any rights of subrogation that such companies may have against the other party. This release shall be valid only if the insurance policy in question permits waiver of subrogation or if the insurer agrees in writing that such waiver of subrogation will not affect coverage under said policy. Each party agrees to use commercially reasonable efforts to obtain such an agreement from its insurer if the policy does not expressly permit a waiver of subrogation.

D. Waiver of Claims . Except for claims arising from Landlord’s willful misconduct or gross negligence that are not covered by Tenant’s insurance required hereunder, Tenant waives all claims against Landlord for damage to property or to any other interest of Tenant sustained by Tenant or any party claiming, through Tenant resulting from: (i) any occurrence in or upon the Premises; (ii) leaking of roofs, bursting, stoppage or leaking of water, gas, sewer or steam pipes or equipment, including sprinklers; (iii) wind, rain, snow, ice, flooding, freezing, fire, explosion, earthquake, excessive heat or cold, or other casualty; (iv) the Building, Premises, or the operating and

 

22

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


mechanical systems or equipment of the Building, being defective, or failing; and (v) vandalism, malicious mischief, theft or other acts or omissions of any other parties including, without limitation, other tenants, contractors and invitees at the Building. Tenant agrees that Tenant’s property loss risks shall be borne by its insurance, and Tenant agrees to look solely to and seek recovery only from its insurance carriers in the event of such losses. For purposes hereof, any deductible amount shall be treated as though it were recoverable under such policies. In no event will Landlord or Tenant be responsible for any indirect, special, consequential or punitive damages incurred by the other party, including but not limited to, lost profits or interruption of business, as a result of any alleged default by Landlord or Tenant hereunder, except as otherwise provided in Article 15 below.

ARTICLE 9.

INDEMNIFICATION

A. Tenant Indemnity of Landlord . Except to the extent caused by Landlord’s negligence or willful misconduct, Tenant shall defend, indemnify and hold harmless Landlord from and against any and all injury, loss, costs, expenses, liabilities, claims or damage (including attorneys’ fees and disbursements) to any person or property (i) arising from, related to, or in connection with any use or occupancy of the Premises by Tenant or (ii) arising from, related to, or in connection with any act or omission (including, without limitation, construction and repair of the Premises arising out of any Alterations) of Tenant, its agents, contractors, employees, customers, and invitees, which indemnity extends to any and all claims arising from any default (as defined in Article 19) in the performance of any obligation on Tenant’s part to be performed under the terms of this Lease. This indemnification shall survive the expiration or termination of the Lease Term.

B. Landlord Indemnity of Tenant . Landlord shall defend, indemnify and hold Tenant harmless from and against all claims, causes of action, liabilities, losses, costs and expense arising from or in connection with any injury or other damage (including attorneys’ fees and disbursements) to any person or property (i) resulting from any act or omission of Landlord, (ii) occurring outside of the Premises, unless caused by Tenant’s negligence or willful misconduct, or (iii) resulting from a default by Landlord under this Lease.

C. Indemnity Limitations . The indemnity obligations set forth in Sections A. and B. above shall not apply (i) to any costs or expenses not reasonably incurred by the indemnitee, or (ii) to any claims, causes of action, liabilities, losses, costs and expenses resulting from a default by the indemnitee hereunder. In addition, the indemnifying party will pay reasonable legal fees as incurred and such damages or costs as are finally awarded against the indemnified party or agreed to in settlement for such claim provided that the indemnified party gives the indemnifying party (a) prompt written notice of any such claim or threatened claim; (b) sole control of the defense, negotiations and settlement of such claim (subject to Section 9.D. below); and (c) reasonable cooperation in any defense or settlement of the claim.

 

23

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


D. Acceptable Attorneys . In any instance where this Lease requires either party to defend the other, such defense shall involve an attorney or attorneys reasonably acceptable to the indemnitee.

E. Limitation on Liability . Landlord shall not be liable to Tenant for any damage by or from any act or negligence of any other tenant or other occupant of the Building, or by any owner or occupants of adjoining or contiguous property [***]; provided, however, that upon being provided with written notice of the same, Landlord shall [***]. Neither Landlord nor Tenant shall be liable for any injury or damage to persons or property resulting in whole or in part from the criminal activities or willful misconduct of third parties not falling within the definition of “Tenant” or “Landlord” set forth in Article 29, as applicable. Nothing contained herein shall be construed to relieve either party from liability for any personal injury resulting from such party’s gross negligence, fraud or willful misconduct.

F. Security . Tenant acknowledges that Landlord’s election to provide mechanical surveillance or to post security personnel in the Building is subject to Landlord’s sole discretion. Landlord shall have no liability in connection with the presence or non-presence of mechanical surveillance or security personnel in the Building, and Tenant hereby waives all claims based thereon, except claims due to Landlord’s gross negligence, fraud or willful misconduct as set forth in Subsection E. above.

Notwithstanding anything contained herein to the contrary, during the Lease Term, the lobby of the Building shall be manned by on-site security personnel twenty-four (24) hours per day, seven (7) days per week.

ARTICLE 10.

CASUALTY DAMAGE

Tenant shall promptly notify Landlord or the Building Manager of any fire or other casualty to the Premises, or, to the extent that Tenant knows of the same, to the Building. Landlord shall promptly notify Tenant of any fire or other casualty or damage to the Building. In the event the Premises or any substantial part of the Building is wholly or partially damaged or destroyed by fire or other casualty which is required to be covered by Landlord’s insurance as provided herein, Landlord will proceed to restore the same (excluding the Premises Improvements, unless Tenant makes available to Landlord the insurance proceeds related to same) to substantially the same condition existing immediately prior to such damage or destruction unless Landlord notifies Tenant (the “Casualty Notice”) that (i) such damage or destruction is incapable of repair or restoration within one hundred eighty (180) days from the date of such fire or other casualty as reasonably determined by Landlord’s architect; or (ii) the insurance proceeds recovered by reason of the damage or destruction are, in Landlord’s reasonable judgment, inadequate (after adding the deductible amount thereto) to complete the restoration of the Building; in either of which events Landlord or Tenant may, by written notice given to the other party within twenty (20) days of Tenant’s receipt of the Casualty Notice, declare this Lease terminated as of the happening of such damage or destruction, except that Landlord shall not have the right to so terminate if such funds are inadequate

 

24

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


due to Landlord allowing the coverage required under this Lease to lapse. To the extent after fire or other casualty that Tenant shall be deprived of the use and occupancy of the Premises or any portion thereof as a result of any such damage, destruction or the repair thereof, then Tenant shall be relieved of the same ratable portion of the Monthly Base Rent due under this Lease as the amount of damaged or useless space in the Premises bears to the rentable square footage of the Premises until such time as the entire Premises shall be restored and a certificate of occupancy is issued therefor (provided that Tenant diligently commences its required restoration activities hereunder and thereafter diligently and continuously prosecutes same to completion), the parties acknowledging and agreeing that, in connection with any such casualty not resulting in termination of this Lease, Landlord shall only be responsible for restoring the Premises to Base Building Condition, and Tenant shall be responsible for restoring the Tenant Improvements so long as same are damaged or destroyed by fire or other casualty which is required to be covered by Tenant’s insurance as provided herein. Landlord shall reasonably determine the amount of damaged or useless space and the square footage of the Premises referenced in the prior sentence. Notwithstanding anything to the contrary contained herein, in the event of a casualty which materially impairs Tenant’s use of the Premises or access thereto during the last eighteen (18) months of the Term of this Lease, Tenant may, by written notice to Landlord within sixty (60) days [***] after the date of the applicable casualty, declare this Lease terminated as of the occurrence of such damage or destruction.

ARTICLE 11.

CONDEMNATION

In the event of a condemnation or taking of the entire Premises by a public or quasi-public authority, this Lease shall terminate as of the date title vests in the public or quasi-public authority. In the event of (i) a taking or condemnation of fifteen percent (15%) or more (but less than the whole) of the Building, including at least twenty percent (20%) of the Premises; (ii) a taking or condemnation which results in Landlord electing not to restore the Building; or (iii) a taking or condemnation which results in Landlord electing to change the use of the land upon which the Building is located, Landlord may elect to terminate this Lease by giving notice to Tenant within sixty (60) days of Landlord receiving notice of such condemnation. In the event of a partial taking as described in this Article 11, or a sale, transfer or conveyance in lieu thereof, which does not result in the termination of this Lease, Rent shall be apportioned according to the ratio that the part of the Premises remaining usable by Tenant bears to the total area of the Premises. Notwithstanding the foregoing, in the event of a taking of at least twenty percent (20%) of the Premises, Tenant may elect to terminate this Lease by giving notice to Landlord within sixty (60) days of Tenant receiving notice of such condemnation. All compensation awarded for any condemnation shall be the property of Landlord, whether such damages shall be awarded as a compensation for diminution in the value of the leasehold or to the fee of the Premises, and Tenant hereby assigns to Landlord all of Tenant’s right, title and interest in and to any and all such compensation. Provided, however that in the event this Lease is terminated, Tenant shall be entitled to make a separate claim for the taking of Tenant’s personal property (including fixtures paid for by Tenant), and for costs of moving.

 

25

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


ARTICLE 12.

REPAIR AND MAINTENANCE

A. Tenant’s Obligations . Except to the extent of Landlord’s obligations pursuant to Sections 7.C and 12.B, Tenant shall keep the Premises in good working order, repair (and in compliance with all Laws now or hereafter adopted) and condition (which condition shall be neat, clean and sanitary), reasonable wear and tear and damage due to casualty or condemnation excepted, and shall make all necessary non-structural repairs thereto and any repairs to non-Building standard mechanical, HVAC, electrical and plumbing systems or components installed by or at the request or direction of Tenant in or serving the Premises. Tenant’s obligations hereunder shall include, but not be limited to, Tenant’s trade fixtures and equipment, security systems, signs, interior decorations, floor-coverings, wall-coverings, entry and interior doors, interior glass, light fixtures, keys and locks, and alterations to the Premises installed by Tenant, but shall specifically exclude those items which are the responsibility of Landlord to maintain pursuant to Section 12.B. Landlord may make any repairs which are not made by Tenant after Tenant’s receipt of written notice and the reasonable opportunity of Tenant to make said repair (but in no event less than ten (10) days following Tenant’s receipt of notice), and charge Tenant for the reasonable actual cost thereof, which cost shall be paid by Tenant within ten (10) days following invoice from Landlord.

B. Landlord’s Obligations . Landlord shall maintain (i) the foundations, roof, perimeter walls and exterior windows and all exterior elements of the Building and all structural aspects of the Building and (ii) all nonstructural aspects of the Building which relate to the Building Common Areas or to more than one tenant’s premises, or which no tenant of the Building is required to maintain and repair, including all systems and facilities necessary for the operation of the Building and the provision of services and utilities as required herein (except to the extent that any of the foregoing items are installed by or on behalf of and for the sole use of, or are the property of, Tenant). Landlord shall also make all necessary structural repairs to the Building and any necessary repairs to the Building standard mechanical, HVAC, electrical, and plumbing systems in or servicing the Premises (the cost of which shall be included in Operating Expenses to the extent permitted under Article 4). Landlord shall have no responsibility to make any repairs unless and until Landlord receives written notice of the need for such repair or otherwise becomes aware. Landlord shall not be liable for any failure to make repairs or to perform any maintenance unless such failure shall persist for ten (10) days after written notice of the need for such repairs or maintenance is received by Landlord from Tenant or after Landlord otherwise becomes aware, unless such repair or maintenance cannot reasonably be effected within such ten (10) day period, in which case Landlord shall have such additional time as required provided that Landlord commences such repair or maintenance within such ten (10) day period and thereafter diligently prosecutes the same to completion. Landlord shall make every reasonable effort to perform all such repairs or maintenance in such a manner (in its reasonable judgment) so as to cause minimum interference with Tenant and the Premises but Landlord shall not be liable to Tenant for any interruption or loss of business pertaining to such activities, except pursuant to Section 7.F. Landlord shall have the right to require that any damage caused by the willful misconduct of Tenant or any of Tenant’s agents, contractors, employees, invitees or customers, be paid for and performed by the Tenant (without limiting Landlord’s other remedies herein).

 

26

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


C. General Obligations . Alterations to the Premises required from time to time to comply with applicable Laws, requirements of any board of property insurance underwriters or similar entity, or reasonable requirements of Landlord’s or Tenant’s insurers shall be made by the party to this Lease responsible for maintaining and repairing the applicable aspect of the Premises hereunder. Landlord warrants to Tenant that, as of the Commencement Date, all aspects of the Premises comprising the Base Building Condition, if any, shall comply with all applicable Laws, with the requirements of Landlord’s insurers, and with the requirements of all boards of property insurance underwriters and similar entities.

D. Signs and Obstructions . Tenant shall not obstruct or permit the obstruction of lights, halls, Building Common Areas, roofs, parapets, stairways or entrances to the Building or the Premises and will not affix, paint, erect or inscribe any sign, projection, awning, signal or advertisement of any kind to any part of the Building or the Premises, including the inside or outside of the windows or doors, without the written consent of Landlord, which consent shall not be unreasonably withheld, conditioned or delayed. If such work is done by Tenant through any person, firm or corporation not approved by Landlord, or without the express written consent of Landlord, Landlord shall have the right to remove such signs, projections, awnings, signals or advertisements without being liable to the Tenant by reason thereof and to charge the cost of such removal to Tenant as Additional Rent, payable within thirty (30) days of Landlord’s demand therefor. Tenant shall be entitled to Building directory signage, at no additional cost.

During the Lease Term, Landlord and Tenant shall [***]. Such opportunities may include, by way of example and not limitation, [***]. All of such signage or electronic media (including, without limitation, the [***], if any) shall be [***]. Tenant shall be solely responsible for the [***], all at Tenant’s sole cost and expense.

The parties shall also discuss and [***].

Notwithstanding anything contained herein to the contrary, Landlord agrees that it [***].

E. Outside Services . Tenant shall not permit, except by Landlord or a person or company reasonably satisfactory to and approved by Landlord, (i) the servicing of Tenant’s supplemental heating, ventilating and air conditioning equipment in the Premises, and (ii) window cleaning, janitorial services or similar work in or about the Premises.

F. Condition of Premises . Except as otherwise provided herein to the contrary, (i) Tenant hereby agrees that the Premises shall be taken “as is,” “with all faults,” and “without any representations or warranties,” so long as the Building and the Premises are in Base Building Condition when the Premises is delivered to Tenant, and (ii) Tenant hereby acknowledges and agrees that it has investigated and inspected the condition of the Premises and the suitability of same for Tenant’s Permitted Use, and, except as otherwise provided herein, Tenant does hereby waive and disclaim any

 

27

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


objection to, cause of action based upon, or claim that its obligations hereunder should be reduced or limited because of the condition of the Premises or the Building or the suitability of same for Tenant’s Permitted Use. Tenant acknowledges that, except as specifically set forth in this Lease, neither Landlord nor any agent nor any employee of Landlord has made any representation or warranty with respect to the Premises or the Building or with respect to the suitability of either for the conduct of Tenant’s Permitted Use, and Tenant expressly represents and warrants that Tenant has relied solely on its own investigation and inspection of the Premises and the Building in Tenant’s decision to enter into this Lease and let the Premises in “as is” condition. The Tenant Improvements to be constructed in the Premises pursuant to the terms and conditions of Exhibit B attached hereto, together with any subsequent Alterations during the Term of this Lease, may be collectively referred to herein as the “Premises Improvements.” Notwithstanding the foregoing, Landlord shall, at Landlord’s sole cost and expense, cure all latent defects in the Base Building Condition within thirty (30) days following Landlord’s receipt of written notice of the same, or such longer period as may be reasonably necessary under the circumstances, provided that Landlord commences such cure within said thirty (30) day period and thereafter diligently and continuously prosecutes such cure to completion.

Landlord reserves the right from time to time: (i) to install, use, maintain, repair, replace and relocate for service to the Premises (but above the Premises ceiling or behind Premises walls if commercially practicable under the circumstances, and provided that such activity does not reduce the useable space in the Premises [collectively, the “Limitation”]) and/or other parts of the Building, facilities, pipes, ducts, conduits, wires, appurtenant fixtures, and mechanical systems, wherever located in the Premises (subject to the Limitation) or Building, and provided that the foregoing shall be subject to payment and/or reimbursement from Tenant only to the extent otherwise provided in this Lease, (ii) to alter, close or relocate any facility in the Premises or the Building Common Areas or otherwise conduct any of the above activities for the purpose of complying with a general plan for fire/life safety for the Building or otherwise (subject to the Limitation) and (iii) to comply with any Law with respect thereto or the regulation thereof not currently in effect. Landlord shall attempt to perform any such work with the least inconvenience to Tenant as possible, but, except as otherwise expressly provided herein, in no event shall Tenant be permitted to withhold or reduce Rent or other charges due hereunder as a result of same or otherwise make claim against Landlord for interruption or interference with Tenant’s business and/or operations.

ARTICLE 13.

INSPECTION OF PREMISES

Upon at least forty-eight (48) hours prior written notice, except in case of an emergency (for which no such written notice shall be required), Tenant shall permit the Landlord, the Building Manager and its authorized representatives to enter the Premises during the Normal Business Hours of the Building and at other reasonable times to inspect the Premises, to clean the Premises, to serve or post notices as provided by law or which Landlord deems necessary for the protection of Landlord or Landlord’s property, and to make such repairs, improvements, alterations or additions in the Premises or in the Building of which they are a part as Landlord may deem necessary or appropriate and at

 

28

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


any time in the event of an emergency. Landlord shall have the right to enter the Premises at any time during an emergency. Subject to Landlord’s obligation to provide notice contained in this Article 13, if Tenant shall not be personally present to open and permit an entry into the Premises at any time when such an entry is necessary or permitted hereunder, Landlord may enter by means of a master key or may enter forcibly, only in the case of an emergency, without liability to Tenant and without affecting this Lease. Notwithstanding the foregoing, Tenant shall have the right to reasonably designate certain areas which contain confidential information or trade secrets of Tenant, and to require that a Tenant representative accompany Landlord, the Building Manager or Landlord’s authorized representatives during any access to such designated areas.

ARTICLE 14.

SURRENDER OF PREMISES

Upon the expiration of the Term, or sooner termination of the Lease, Tenant shall quit and surrender to Landlord the Premises, broom clean, in good order and condition, normal wear and tear and damage by fire and other casualty excepted. All Premises Improvements and other fixtures, such as light fixtures and HVAC equipment, wall coverings, carpeting and drapes, and Tenant’s furniture, fixtures and equipment, in or serving the Premises, whether installed by Tenant or Landlord, shall be Tenant’s property during the Term. Upon the expiration or earlier termination of this Lease, such items shall become the property of Landlord and shall remain, all without compensation, allowance or credit to Tenant; provided that Tenant shall, at its expense, remove any Alterations required to be so removed by Landlord in any notice given at the time of approval of such Alterations in accordance with Article 5.C., and repair any damages to the Premises caused by such removal; and provided further that Tenant shall have the option to remove any specialty equipment, trade fixtures, and furniture, fixtures and equipment, and shall repair any damages to the Premises caused by such removal. Notwithstanding the foregoing, Tenant shall [***], except for any [***] by Tenant, and any [***] in the Premises for [***]. Notwithstanding the foregoing, Any property not removed shall be deemed to have been abandoned by Tenant and may be retained or disposed of by Landlord at Tenant’s expense free of any and all claims of Tenant, as Landlord shall desire. All property not removed from the Premises by Tenant may be handled or stored by Landlord at Tenant’s expense and Landlord shall not be liable for the value, preservation or safekeeping thereof. At Landlord’s option all or part of such property may be conclusively deemed to have been conveyed by Tenant to Landlord as if by bill of sale without payment by Landlord.

ARTICLE 15.

HOLDING OVER

Should Tenant, without Landlord’s written consent, hold over after termination of this Lease, Tenant shall become a tenant at sufferance and any such holding over shall not constitute an extension of this Lease. Tenant shall pay Landlord, monthly and in advance, [***] of the annual Rent that was payable immediately preceding the hold-over period, prorated on a per diem basis (the “Holdover Rent”), for each day Tenant shall retain

 

29

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


possession of the Premises or any part thereof after expiration or earlier termination of this Lease, [***], then, effective as of the [***] and (ii) Tenant shall also be responsible for all damages sustained by Landlord on account of such holding over by Tenant. The foregoing provisions shall not serve as permission for Tenant to hold-over, nor serve to extend the Term (although Tenant shall remain bound to comply with all provisions of this Lease until Tenant vacates the Premises) and Landlord shall have the right at any time thereafter to enter and possess the Premises and remove all property and persons therefrom or to require Tenant to surrender possession of the Premises as provided in this Lease upon the expiration or earlier termination of the Term, so long as such actions are taken in compliance with applicable Laws. If Tenant fails to surrender the Premises upon the expiration or earlier termination of this Lease, then, effective as of the [***], Tenant agrees to indemnify, defend and hold harmless Landlord from all costs, loss, expense or liability, including, without limitation, claims made by any succeeding tenant and real estate brokers’ claims and reasonable attorneys’ fees. No acceptance by Landlord of any Rent during or for any period following the expiration or termination of the Lease shall operate or be construed as an extension or renewal of the Lease.

ARTICLE 16.

SUBLETTING AND ASSIGNMENT

A. Landlord’s Consent . Tenant shall not assign its interests hereunder or sublease all or any portion of the Premises (for purposes of this Lease, a license shall be deemed to be a sublease) without the prior written consent of Landlord, which shall not be unreasonably withheld, conditioned or delayed, except that Landlord shall not, under any circumstances, be obligated to consent to any assignment or subletting by Tenant to any other tenant of the Building (unless Landlord has no space in the Building available to lease to such other tenant or unless Landlord has offered, and such other tenant has rejected, available space in the Building). Without limiting the generality of the foregoing, it shall be reasonable for Landlord to deny consent if:

(1) The financial strength of the proposed assignee or subtenant, both in terms of net worth and in terms of reasonably anticipated cash flow over the Lease term, is materially less than Tenant’s financial strength at the time this Lease was signed.

(2) The proposed assignee or subtenant will burden the Premises and/or Building Common Areas to an extent substantially disproportionate to typical tenants of the Building, whether through disproportionate demand for landlord services or utilities, disproportionate bearing weights on floor areas, deterioration of floors or other elements of the Building, or otherwise.

(3) The proposed assignee’s or subtenant’s use of the Premises is not a use expressly permitted under applicable law for the Building and will not, in Landlord’s sole judgment, be compatible with the uses of the other tenants in the Building or will not be appropriate for a Class A office building.

(4) The use to be made of the Premises by the proposed assignee or subtenant is (A) not generally consistent with the character and nature of all other tenancies in the Office Component, or (B) a use which conflicts with any so-called

 

30

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


“exclusive” then in favor of, or for any use which is the same as that stated in any percentage rent lease to, another tenant of the Building, or (C) is a use which would be prohibited by any other portion of this Lease (including, but not limited to, any Rules and Regulations then in effect).

(5) The proposed assignee or subtenant is either a governmental agency or instrumentality thereof.

(6) Either the proposed assignee or subtenant or any person or entity which directly or indirectly controls, is controlled by or is under common control with the proposed assignee or subtenant (A) occupies space in the Building at the time of the request for consent, or (B) (i) is negotiating with Landlord for lease of space in the Building or (ii) has received a written proposal from Landlord to lease space in the Building during the six (6) month period immediately preceding the date of the proposed transfer (as used herein, to lease space in the Building; notwithstanding the foregoing, this restriction shall not apply if Landlord does not then have space available in the Building for lease.

(7) The proposed assignee or subtenant has an anticipated use of the Premises involving the generation, storage, use, treatment, or disposal of Hazardous Material, other than Hazardous Materials permitted to be used at the Premises pursuant to this Lease.

With respect to any proposed assignment or subleasing requiring Landlord’s consent, Tenant shall submit to Landlord in writing, at least fourteen (14) business days prior to the effective date of the assignment or sublease, (a) a notice of application to assign or sublease, setting forth the proposed effective date; (b) the name of the proposed assignee or subtenant; (c) the nature of the proposed assignee’s or subtenant’s business to be carried on in the Premises; (d) the terms of the proposed sublease or assignment; and (e) then-available financial information for the proposed assignee or subtenant. Tenant shall not submit any such application to Landlord until Tenant has received a bona fide offer from the proposed assignee or subtenant. Any transfer (or sequence of transfers resulting, in the aggregate, in the transfer) of fifty percent (50%) of more of the beneficial ownership of Tenant shall constitute an assignment for purposes of this Article 16; provided, however, transfers of shares of stock occurring while Tenant is a publicly-traded company shall not constitute an assignment hereunder.

B. Transfers Not Requiring Consent . Notwithstanding the foregoing, Landlord’s consent shall not be required with respect to any assignment or sublease (each a “Permitted Transfer”) to any of the following parties (each, a “Permitted Transferee”): (1) an entity which wholly owns Tenant or which wholly owns the entity which wholly owns Tenant (in either case, a “Parent”); or (2) an entity which is wholly owned by Tenant or a Parent; or (3) an entity which is wholly owned by an entity which is wholly owned by Tenant or a Parent; or (4) an entity which purchases all or substantially all of Tenant’s stock or assets; or (5) an entity which is a successor by merger to Tenant. With respect to any assignment or subletting to which Landlord’s consent is not required, the following provisions shall apply:

 

31

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


(a) Tenant shall give Landlord written notice of the assignment or subletting no less than ten (10) business days after the effective date thereof, which notice shall set forth the identity of the assignee or subtenant, the reason(s) why Landlord’s consent was not required, and the nature of the assignee’s or subtenant’s business to be carried on in the Premises.

(b) Tenant shall furnish Landlord no less than ten (10) business days after the effective date of the assignment or subletting, with then-available financial information for the assignee or subtenant reasonably acceptable to Landlord.

C. Procedure . Except for assignments or subleases under Article 16.B. above, Landlord shall notify Tenant within fourteen (14) business days from the submission of the aforesaid information as to Landlord’s choice, at Landlord’s sole discretion, of the following options:

(1) That Landlord consents to a subleasing of the Premises or assignment of the Lease to such replacement tenant provided that Tenant shall remain fully liable for all of its obligations and liabilities under this Lease and provided further that Landlord shall be entitled to [***] of the Net Revenue (“Net Revenue” being defined as one hundred percent (100%) of any profit obtained by Tenant from such subletting or assignment after deducting Tenant’s costs of transfer including brokerage, legal and tenant improvement costs); or

(2) That Landlord declines to consent to such sublease or assignment due to insufficient or unsatisfactory documentation furnished to Landlord to establish Tenant’s financial strength and proposed use of and operations upon Premises.

D. Net Revenues . In the event that Net Revenue is derived from an assignment or sublease requiring Landlord’s consent, [***] of such Net Revenue received by Tenant for any month shall be paid to Landlord within thirty (30) days after receipt thereof by Tenant.

E. Continuing Liability; Voidable Transfers . No assignment of this Lease, and no subletting of all or any portion of the Premises, shall release Tenant with respect to any post-transfer obligations, unless Landlord agrees otherwise in writing in its absolute discretion and any such assignment or sublease shall, at Landlord’s option, be void in the event that Tenant does not expressly acknowledge and affirm its continuing liability in form and substance reasonably satisfactory to Landlord. The continuing liability of the assigning Tenant shall be primary, and Landlord shall be entitled to exercise its rights and remedies against any such assignor with respect to any Tenant default (as defined in Article 19) without exhausting its rights and remedies against any successor of such assignor. In the event that it is ever held, notwithstanding the contrary intention of the parties hereto, that any such assignor’s continuing liability is that of a guarantor (rather than primary), Tenant hereby waives any and all suretyship rights and defenses to which it would otherwise be entitled in connection with such continuing liability.

 

32

 

Portions of this Exhibit, indicated by the mark “[***],” were omitted and have been filed separately with the

Securities and Exchange Commission pursuant to the Registrant’s application requesting confidential

treatment pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.


Notwithstanding the foregoing, in the event that, following any assignment, Landlord and such assignee modify this Lease in such a way as to increase Tenant’s obligations hereunder, neither the assigning Tenant nor any guarantor whose guaranty pre-dated such assignment shall be liable for the incremental portion of Tenant’s total obligations corresponding to such increase. The acceptance of any assignment by an assignee shall automatically constitute the assumption by such assignee of all obligations of Tenant with respect to the assigned premises that accrue following the assignment; provided, however, that any assignment of this Lease shall, at Landlord’s option, be void in the event that the assignee does not expressly acknowledge and affirm the effectiveness of the foregoing assumption in form and substance reasonably satisfactory to Landlord. Any assignment or subletting by Tenant to which Landlord’s consent is required but not obtained shall, at Landlord’s option, be void.

F. Other Provisions Applicable to Transfers . No assignment or subletting shall be deemed to modify any provision of this Lease, with respect to permitted or restricted uses of the Premises or otherwise, unless Landlord then agrees otherwise in writing in its absolute discretion. Tenant shall promptly furnish Landlord with a copy of each executed assignment or sublease, and with copies of any supplements or modifications thereto which may be executed from time to time.

G. Assignment of Sublease Revenues . Tenant hereby assigns to Landlord all of Tenant’s right, title and interest in and to all revenues from each sublease of all or any portion of the Premises; provided, however, that Landlord hereby grants Tenant a license, which shall remain in effect so long as no Tenant default, as defined in Article 19, remains uncured, to collect all such revenues (subject to Tenant’s obligation to deliver certain of such revenues to Landlord under this Article 16). Upon the occurrence of any monetary Tenant default (as defined in Article 19), Landlord may revoke such license by written notice to Tenant and may, by written notice to any subtenant of Tenant, demand that such subtenant pay all such revenues directly to Landlord. In such event, Tenant hereby irrevocably authorizes and directs any such subtenant to pay such revenues to Landlord, and further agrees (a) that any such subtenant shall be obligated and entitled to pay such revenues to Landlord notwithstanding any contrary contentions or instructions later received from Tenant and (b) that no such subtenant shall have any liability to Tenant for any such revenues paid to Landlord in accordance with the foregoing. Landlord shall not be entitled to use or enjoy any such revenues except for the purpose of applying such revenues against unfulfilled obligations of Tenant hereunder with respect to which the applicable cure periods have expired, or to reimburse Landlord for costs reasonably incurred as a result of any Tenant default (as defined in Article 19), or to compensate Landlord for other losses suffered by Landlord as a result of any Tenant default (as defined in Article 19). Any such revenues remaining in Landlord’s possession following the cure of all Tenant defaults (as defined in Article 19) and the reimbursement of all such costs and losses shall be delivered to Tenant upon demand. No such notice to any subtenant or receipt of revenues from any subtenant shall be deemed to constitute either (i) Landlord’s consent to such sublease or (ii) the assumption by Landlord of any obligation of Tenant under such sublease, nor shall any such notice or receipt create privity of contract between Landlord and the app