Table ofContents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

**x****                QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarterly period ended September 30, 2010**

 

**or**

 

**o****                   TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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          |       | (IRS Employer       |
| Incorporation or Organization)           |       | 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)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  No o

 

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

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

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o  No x

 

Therewere 24,929,157 shares of the registrant’s common stock, $0.001 par value pershare, outstanding as of November 4, 2010.

 

 

 

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**EnerNOC, Inc.**

 

**Index to Form 10-Q**

 
| ** **                                 | ** **                                                                                                                        | ** ** | **Page**   |
|--------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                 | ** **                                                                                                                        | ** ** | ** ** |
| **Part I -  Financial Information**   |                                                                                                                              |       |
|                                       |                                                                                                                              |       |       |
| Item 1.                               | Financial Statements                                                                                                              |       |       |
|                                       |                                                                                                                              |       |       |
|                                       | Unaudited Condensed Consolidated Balance Sheets at  September 30, 2010 and December 31, 2009                            |       | 3          |
|                                       |                                                                                                                              |       |       |
|                                       | Unaudited  Condensed Consolidated Statements of Income for the three and nine months  ended September 30, 2010 and 2009 |       | 4          |
|                                       |                                                                                                                              |       |       |
|                                       | Unaudited Condensed Consolidated Statements of Cash  Flows for the nine months ended September 30, 2010 and 2009        |       | 5          |
|                                       |                                                                                                                              |       |       |
|                                       | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                   |       | 6          |
|                                       |                                                                                                                              |       |       |
| Item 2.                               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                       |       | 23         |
|                                       |                                                                                                                              |       |       |
| Item 3.                               | Quantitative  and Qualitative Disclosures About Market Risk                                                                       |       | 37         |
|                                       |                                                                                                                              |       |       |
| Item 4.                               | Controls and  Procedures                                                                                                          |       | 37         |
|                                       |                                                                                                                              |       |       |
| **Part II -  Other Information** |                                                                                                                              |       |
|                                       |                                                                                                                              |       |       |
| Item 1.                               | Legal Proceedings                                                                                                                 |       | 38         |
|                                       |                                                                                                                              |       |       |
| Item 1A.                              | Risk Factors                                                                                                                      |       | 38         |
|                                       |                                                                                                                              |       |       |
| Item 6.                               | Exhibits                                                                                                                          |       | 39         |
|                                       | Signatures                                                                                                                        |       | 40         |
|                                       | Exhibit Index                                                                                                                |       | 41         |

 

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**PART I — FINANCIAL INFORMATION**

 

**EnerNOC, Inc.**

 

**UNAUDITED CONDENSED CONSOLIDATEDBALANCE SHEETS**

 

**(in thousands, except par value and share data)**

** **
| ** **                                                                                                                                                                                  | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                                                                                  |       |                             |       |                            |       |
| Current assets                                                                                                                                                                              |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                                                                                                   |       | $                                | 141,321    |                            | $          | 119,739 |   |
| Trade accounts receivable, net allowance for  doubtful accounts of $114 and $57 at September 30, 2010 and  December 31, 2009, respectively                                        |       | 33,857                           |       | 17,421                          |       |
| Unbilled revenue                                                                                                                                                                            |       | 114,221                          |       | 40,388                          |       |
| Prepaid expenses, deposits and other current assets                                                                                                                                         |       | 4,356                            |       | 4,725                           |       |
| Total current assets                                                                                                                                                                        |       | 293,755                          |       | 182,273                         |       |
| Property and equipment, net of accumulated  depreciation of $32,682 and $22,420 at September 30, 2010 and  December 31, 2009, respectively                                        |       | 34,643                           |       | 31,344                          |       |
| Goodwill                                                                                                                                                                                    |       | 24,653                           |       | 22,553                          |       |
| Definite-life intangible assets, net                                                                                                                                                        |       | 6,166                            |       | 7,075                           |       |
| Indefinite-life intangible assets                                                                                                                                                           |       | 920                              |       | —                          |       |
| Deposits and other assets                                                                                                                                                                   |       | 4,528                            |       | 3,903                           |       |
| Restricted cash                                                                                                                                                                             |       | 177                              |       | 7,874                           |       |
| Total assets                                                                                                                                                                                |       | $                                | 364,842    |                            | $          | 255,022 |   |
|                                                                                                                                                                                        |       |                             |       |                            |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                              |       |                             |       |                            |       |
| Current liabilities                                                                                                                                                                         |       |                             |       |                            |       |
| Accounts payable                                                                                                                                                                            |       | $                                | 94         |                            | $          | 55 |   |
| Accrued capacity payments                                                                                                                                                                   |       | 89,186                           |       | 40,534                          |       |
| Accrued payroll and related expenses                                                                                                                                                        |       | 11,731                           |       | 9,688                           |       |
| Accrued expenses and other current liabilities                                                                                                                                              |       | 11,245                           |       | 3,706                           |       |
| Accrued acquisition contingent consideration                                                                                                                                                |       | 1,489                            |       | 1,455                           |       |
| Deferred revenue                                                                                                                                                                            |       | 2,363                            |       | 2,119                           |       |
| Current portion of long-term debt                                                                                                                                                           |       | 39                               |       | 36                              |       |
| Total current liabilities                                                                                                                                                                   |       | 116,147                          |       | 57,593                          |       |
| Long-term liabilities                                                                                                                                                                       |       |                             |       |                            |       |
| Long-term debt, net of current portion                                                                                                                                                      |       | 7                                |       | 37                              |       |
| Deferred tax liability                                                                                                                                                                      |       | 2,330                            |       | 654                             |       |
| Deferred revenue, long-term                                                                                                                                                                 |       | 3,109                            |       | 1,200                           |       |
| Other liabilities                                                                                                                                                                           |       | 538                              |       | 563                             |       |
| Total long-term liabilities                                                                                                                                                                 |       | 5,984                            |       | 2,454                           |       |
| Commitments and contingencies (Note 8 and Note 12)                                                                                                                                          |       | —                           |       | —                          |       |
| 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, 24,923,693 and 24,233,448 shares issued and outstanding at  September 30, 2010 and December 31, 2009, respectively |       | 25                               |       | 24                              |       |
| Additional paid-in capital                                                                                                                                                                  |       | 289,356                          |       | 272,350                         |       |
| Accumulated other comprehensive loss                                                                                                                                                        |       | (71                              | )          | (56                             | )          |
| Accumulated deficit                                                                                                                                                                         |       | (46,599                          | )          | (77,343                         | )          |
| Total stockholders’ equity                                                                                                                                                             |       | 242,711                          |       | 194,975                         |       |
| Total liabilities and stockholders’ equity                                                                                                                                             |       | $                                | 364,842    |                            | $          | 255,022 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EnerNOC, Inc.**

 

**UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME**

 

**(in thousands, except share and per share data)**

** **
| ** **                                           | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Revenues                                             |       | $                                                        | 162,798    |                                                    | $          | 103,117 |   | $ | 257,467 |   | $ | 163,942 |   |
| Cost of revenues                                     |       | 85,062                                                   |       | 51,440                                                  |       | 141,164 |   | 86,232 |   |
| Gross profit                                         |       | 77,736                                                   |       | 51,677                                                  |       | 116,303 |   | 77,710 |   |
| Operating expenses:                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling and marketing                                |       | 12,893                                                   |       | 11,602                                                  |       | 34,173 |   | 29,481 |   |
| General and administrative                           |       | 13,848                                                   |       | 12,155                                                  |       | 40,114 |   | 33,252 |   |
| Research and development                             |       | 3,197                                                    |       | 2,111                                                   |       | 7,748 |   | 5,524 |   |
| Total operating expenses                             |       | 29,938                                                   |       | 25,868                                                  |       | 82,035 |   | 68,257 |   |
| Income from operations                               |       | 47,798                                                   |       | 25,809                                                  |       | 34,268 |   | 9,453 |   |
| Other income (expense)                               |       | 42                                                       |       | 89                                                      |       | 31 |   | (6 | ) |
| Interest expense                                     |       | (195                                                     | )          | (47                                                     | )          | (686 | ) | (1,511 | ) |
| Income before income tax                             |       | 47,645                                                   |       | 25,851                                                  |       | 33,613 |   | 7,936 |   |
| (Provision for) benefit from income tax              |       | (3,779                                                   | )          | 786                                                     |       | (2,869 | ) | 438 |   |
| Net income                                           |       | $                                                        | 43,866     |                                                    | $          | 26,637 |   | $ | 30,744 |   | $ | 8,374 |   |
|                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Earnings per share:                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic earnings per common share                      |       | $                                                        | 1.76       |                                                    | $          | 1.21 |   | $ | 1.25 |   | $ | 0.40 |   |
| Diluted earnings per common share                    |       | $                                                        | 1.67       |                                                    | $          | 1.12 |   | $ | 1.18 |   | $ | 0.38 |   |
|                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average number of common shares outstanding |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                |       | 24,864,755                                               |       | 21,938,427                                              |       | 24,650,453 |   | 20,703,779 |   |
| Diluted                                              |       | 26,215,766                                               |       | 23,689,477                                              |       | 26,013,402 |   | 22,154,745 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EnerNOC, Inc.**

 

**UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

**(in thousands)**

 
| ** **                                                                       | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2010**                                            | ** ** | **2009** | ** ** |
| **Cash flows from operating  activities**                                        |       |                                                |       |   |   |
| Net income                                                                       |       | $                                                   | 30,744     |   | $ | 8,374 |   |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                                |       |   |   |
| Depreciation                                                                     |       | 10,684                                              |       | 8,059 |   |
| Amortization of acquired intangible assets                                       |       | 1,109                                               |       | 514 |   |
| Stock-based compensation expense                                                 |       | 11,668                                              |       | 9,996 |   |
| Impairment of property and equipment                                             |       | 1,308                                               |       | — |   |
| Unrealized foreign exchange transaction loss                                     |       | 17                                                  |       | 71 |   |
| Deferred taxes                                                                   |       | 1,250                                               |       | 265 |   |
| Non-cash interest expense                                                        |       | —                                              |       | 45 |   |
| Loss on disposal of equipment                                                    |       | —                                              |       | 19 |   |
| Other, net                                                                       |       | 118                                                 |       | 14 |   |
| Changes in operating assets and liabilities, net  of effects of acquisitions:    |       |                                                |       |   |   |
| Accounts receivable, trade                                                       |       | (16,573                                             | )          | (9,054 | ) |
| Unbilled revenue                                                                 |       | (73,831                                             | )          | (53,257 | ) |
| Prepaid expenses and other current assets                                        |       | 1,040                                               |       | (1,809 | ) |
| Other assets                                                                     |       | 3                                                   |       | (1,615 | ) |
| Other noncurrent liabilities                                                     |       | 1,879                                               |       | 217 |   |
| Deferred revenue                                                                 |       | 218                                                 |       | 1,410 |   |
| Accrued capacity payments                                                        |       | 48,641                                              |       | 35,760 |   |
| Accrued payroll and related expenses                                             |       | 2,793                                               |       | 5,655 |   |
| Accounts payable and accrued expenses                                            |       | 7,594                                               |       | (1,622 | ) |
| Net cash provided by operating activities                                        |       | 28,662                                              |       | 3,042 |   |
|                                                                             |       |                                                |       |   |   |
| **Cash flows from investing  activities**                                        |       |                                                |       |   |   |
| Sales and maturities of marketable securities                                    |       | —                                              |       | 2,000 |   |
| Payments made for acquisitions of businesses, net  of cash acquired              |       | (2,001                                              | )          | (984 | ) |
| Purchases of property and equipment                                              |       | (15,283                                             | )          | (13,236 | ) |
| Change in restricted cash and deposits                                           |       | 6,740                                               |       | (5,946 | ) |
| Net cash used in investing activities                                            |       | (10,544                                             | )          | (18,166 | ) |
|                                                                             |       |                                                |       |   |   |
| **Cash flows from financing  activities**                                        |       |                                                |       |   |   |
| Proceeds from public offering of common stock, net  of issuance costs            |       | —                                              |       | 83,485 |   |
| Proceeds from exercises of stock options                                         |       | 3,500                                               |       | 792 |   |
| Repayment of borrowings and payments under capital  leases                       |       | (27                                                 | )          | (34 | ) |
| Net cash provided by financing activities                                        |       | 3,473                                               |       | 84,243 |   |
| Effects of exchange rate changes on cash                                         |       | (9                                                  | )          | 25 |   |
| Net change in cash and cash equivalents                                          |       | 21,582                                              |       | 69,144 |   |
| Cash and cash equivalents at beginning of period                                 |       | 119,739                                             |       | 60,782 |   |
| Cash and cash equivalents at end of period                                       |       | $                                                   | 141,321    |   | $ | 129,926 |   |
|                                                                             |       |                                                |       |   |   |
| **Non-cash financing and investing  activities**                                 |       |                                                |       |   |   |
| Issuance of common stock in connection with  acquisitions                        |       | $                                                   | 1,066      |   | $ | 1,235 |   |
| Issuance of common stock in satisfaction of  bonuses                             |       | $                                                   | 775        |   | $ | 500 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

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**EnerNOC, Inc.**

 

**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**(in thousands, except share and per share data, unless otherwise noted)**

 

**1.****             ****Descriptionof Business and Basis of Presentation**

 

**Description of Business**

 

EnerNOC, Inc. (the Company) is a service company that wasincorporated in Delaware on June 5, 2003. The Company operates in a singlesegment providing clean and intelligent energy management applications andservices, which include comprehensive demand response services, data-drivenenergy efficiency services, energy price and risk management services andenterprise carbon management services. The Company uses its Network Operations Center (NOC) and comprehensivedemand response application, DemandSMART, to remotely manage and reduceelectricity consumption across a growing network of commercial, institutionaland industrial customer sites, making demand response capacity available to gridoperators and utilities on demand while helping commercial, institutional andindustrial end-users of electricity (C&I customers) achieve energy savings,environmental benefits and improved financial results.

 

The Company builds upon its position as a leading demand responseservices provider by using its NOC and energy management application platformto also deliver a portfolio of additional energy management applications to itscustomers.  These additional energymanagement applications include the Company’s SiteSMART, SupplySMART andCarbonSMART applications.  SiteSMART isthe Company’s data-driven energy efficiency application that has multiplefeatures, including monitoring-based commissioning tools, commissioning andretro-commissioning authority services, energy consulting and engineeringservices, distributed generation services, and owner-engineer services.  SupplySMART is the Company’s energy price andrisk management application that provides the Company’s C&I customerslocated in restructured or deregulated markets throughout the United Stateswith the ability to more effectively manage the energy supplier selectionprocess, including energy supply product procurement and implementation.  CarbonSMART is the Company’s enterprisecarbon management application that supports the measurement, tracking,analysis, reporting and management of greenhouse gas emissions.

 

The Company’s energy management applications and services deliverimmediate bottom-line benefits to C&I customers and energy suppliers whilehelping to create a more reliable and efficient electricity grid for systemoperators and utilities.

 

**Reclassifications**

 

Certain reclassifications have been made to the condensed consolidatedbalance sheet as of December 31, 2009 and the unaudited condensedconsolidated statement of cash flows for the nine months endedSeptember 30, 2009 to conform to the September 30, 2010 presentation.The reclassifications include certain receivables, which were previouslyincluded in trade accounts receivable, that are not trade in nature.  These certain receivables are now beingclassified as prepaid expenses, deposits and other current assets in theunaudited condensed consolidated balance sheets.  Additionally, the Company reclassified shortterm restricted cash to long term restricted cash in the unaudited condensedconsolidated balance sheets as of December 31, 2009 and September 30,2010 as this classification more appropriately describes the nature of thisrestricted cash.

 

The Company has identified and reclassified certain costs totaling $399and $457 included in selling and marketing expenses in its unaudited condensedconsolidated statements of income for the three months ended March 31,2010 and June 30, 2010, respectively, as general and administrativeexpenses for the nine months ended September 30, 2010 to moreappropriately reflect the nature of these costs.  The Company hasdetermined that the reclassification was not material to its consolidatedfinancial statements and, in future quarterly filings, will continue toreclassify these costs, resulting in an increase in general and administrativeexpenses and a corresponding decrease in selling and marketing expenses of $399and $457 for the three months ended March 31, 2010 and June 30, 2010,respectively.

 

**Basis of Consolidation**

 

The unaudited condensed consolidated financial statements of theCompany include the accounts of its wholly-owned subsidiaries and have beenprepared in conformity with accounting principles generally accepted in theUnited States (GAAP). Intercompany transactions and balances are eliminatedupon consolidation.  In the opinion ofthe Company’s management, the unaudited condensed consolidated financialstatements include all adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of the results of operations forthe periods presented.

 

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**Subsequent Events Consideration**

 

The Company considers events or transactions that occur after thebalance sheet date, but prior to the issuance of the financial statements, toprovide additional evidence relative to certain estimates or to identifymatters that require additional disclosure. Subsequent events have beenevaluated as required.  The Company considersall of its demand response event performance prior to the issuance of thefinancial statements in order to validate its estimate of fees potentiallysubject to refund.

 

There were no material disclosable or recognizable subsequent eventsrecorded in the September 30, 2010 unaudited condensed consolidatedfinancial statements.

 

**Use of Estimates in Preparation of Financial Statements**

 

The accompanying unaudited condensedconsolidated financial statements have been prepared pursuant to therules and regulations of the Securities and Exchange Commission (SEC).Certain information and footnote disclosures normally included in financialstatements prepared in accordance with GAAP have been condensed or omittedpursuant to SEC rules and regulations. In the opinion of the Company’smanagement, the unaudited condensed consolidated financial statements and noteshave been prepared on the same basis as the audited consolidated financialstatements contained in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2009, and include all adjustments(consisting of normal, recurring adjustments) necessary for the fairpresentation of the Company’s financial position at September 30, 2010,statements of income for the three and nine months ended September 30,2010 and 2009, and statements of cash flows for the nine months endedSeptember 30, 2010 and 2009. Operating results for the three and ninemonths ended September 30, 2010 are not necessarily indicative of theresults to be expected for any other interim period or the entire fiscal yearending December 31, 2010.

 

The preparation of these unaudited condensedconsolidated financial statements requires the Company to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, the Company evaluates its estimates, including those related torevenue recognition, allowance for doubtful accounts, valuations and purchaseprice allocations related to business combinations, expected future cash flowsincluding growth rates, discount rates, terminal values and other assumptionsand estimates used to evaluate the recoverability of long-lived assets andgoodwill, estimated fair values of intangible assets and goodwill, amortizationmethods and periods, certain accrued expenses and other related charges,stock-based compensation, contingent liabilities, tax reserves andrecoverability of the Company’s net deferred tax assets and related valuationallowance.

 

Although the Company regularly assesses theseestimates, actual results could differ materially. Changes in estimates arerecorded in the period in which they become known. The Company bases itsestimates on historical experience and various other assumptions that itbelieves to be reasonable under the circumstances. Actual results may differfrom management’s estimates if these results differ from historical experienceor other assumptions prove not to be substantially accurate, even if suchassumptions are reasonable when made.

 

The Company is subject to a number of riskssimilar to those of other companies of similar and different sizes both insideand outside its industry, including, but not limited to, rapid technologicalchanges, competition from substitute products and services from largercompanies, customer concentration, government regulations, market or program rule changes,protection of proprietary rights and dependence on key individuals.

 

**Comprehensive Income**

 

Comprehensive income is defined as the change in equity of a businessenterprise during a period resulting from transactions and other events andcircumstances from non-owner sources. Comprehensive income is composed of netincome and foreign currency translation adjustments.

 

Comprehensive income for the three and nine months endedSeptember 30, 2010 and 2009 was as follows:

 
| ** **                               | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                               | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net income                               |       | $                                                        | 43,866     |                                                    | $          | 26,637 |   | $ | 30,744 |   | $ | 8,374 |   |
| Foreign currency translation adjustments |       | (47                                                      | )          | (55                                                     | )          | (15 | ) | 96 |   |
| Total comprehensive income               |       | $                                                        | 43,819     |                                                    | $          | 26,582 |   | $ | 30,729 |   | $ | 8,470 |   |

 

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**InternalUse Software Costs**

 

The Company applies the provisions of Accounting Standard Codification(ASC) 350-40, *Internal Use Software*(ASC350-40)*.* ASC 350-40 requires computer softwarecosts associated with internal use software to be expensed as incurred untilcertain capitalization criteria are met, and also defines which types of costsshould be capitalized and which should be expensed. The Company capitalizes thecost of external consultants and payroll and payroll-related costs of employeeswho devote time to the development and implementation of internal use computersoftware. The Company amortizes these costs on a straight-line basis over theestimated useful life of the software, which is generally three years. TheCompany’s judgment is required in determining the point at which variousprojects enter the stages where costs may be capitalized, in assessing theongoing value and impairment of the capitalized costs, and in determining theestimated useful lives over which the costs are amortized.

 

Capitalized internal use software costs were $1,045 and $1,027 for thethree months ended September 30, 2010 and 2009, respectively, and $5,063and $2,922 for the nine months ended September 30, 2010 and 2009,respectively.  The Company capitalized$248 and $1,216 during the three and nine months ended September 30, 2010,respectively, and $387 and $953 during the three and nine months endedSeptember 30, 2009, respectively, related to a company-wide enterpriseresource planning systems implementation project.  Additionally, the increase in capitalizedsoftware for the nine months ended September 30, 2010 compared to the ninemonths ended September 30, 2009 related to the purchase of certainlicenses to support the Company’s energy management applications.  These costs have been capitalized inaccordance with ASC 350-40. The capitalized amounts are included as software inproperty and equipment at September 30, 2010 and December 31,2009.  Amortization of capitalizedinternal use software costs was $749 and $599 for the three months endedSeptember 30, 2010 and 2009, respectively, and $2,123 and $1,647 for thenine months ended September 30, 2010 and 2009, respectively.  Accumulated amortization of capitalizedinternal use software costs was $6,310 and $4,187 as of September 30, 2010and December 31, 2009, respectively.

 

**Impairmentof Property and Equipment**

 

TheCompany reviews property and equipment for impairment whenever events orchanges in circumstances indicate that the carrying amount of assets may not berecoverable. If these assets are considered to be impaired, the impairment isrecognized in earnings and equals the amount by which the carrying value of theassets exceeds their fair market value determined by either a quoted marketprice, if any, or a value determined by utilizing a discounted cash flowtechnique. If these assets are not impaired, but their useful lives havedecreased, the remaining net book value is amortized over the revised usefullife.

 

Duringthe three months ended September 30, 2010, the Company identified animpairment indicator related to certain demand response equipment as a result oflower than estimated demand response event performance in certain demandresponse programs and the removal of demand response equipment from serviceduring the three months ended September 30, 2010.  As a result ofthis impairment indicator, the Company performed an impairment test during thethree months ended September 30, 2010 and recognized an impairment chargeof $552 during the three months ended September 30, 2010, representing thedifference between the carrying value and fair market value of demand responseequipment, which is included in cost of revenues in the accompanying unauditedcondensed consolidated statements of income. The fair market value wasdetermined 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 theestimated market participant rate of return for this type of asset.

 

Duringthe three months ended June 30, 2010, the Company identified an impairmentindicator related to certain demand response and back-up generator equipment asa result of lower than estimated demand response event performance by theseassets.  The applicable long-lived assetsare measured for impairment at the lowest level for which identifiable cashflows are largely independent of the cash flows of other assets orliabilities.  The Company determined that the undiscounted cash flows tobe generated by the asset group over its remaining estimated useful life wouldnot be sufficient to recover the carrying value of the asset group. The Companydetermined the fair value of the asset group using a discounted cash flowtechnique based on Level 3 inputs, as defined by ASC 820, and a discount rateof 11%, which the Company determined to represent a market rate of return forthe assets being evaluated for impairment. The Company determined that the fair value of the asset group was $1,543compared to the carrying value of the asset group of $2,299, and as a resultrecorded an impairment charge of $756 during the three months ended June 30,2010, which is reflected in cost of revenues in the accompanying unauditedcondensed consolidated statements of income.  The impairment charge wasallocated to the individual assets within the asset group on a pro-rata basisusing the relative carrying amounts of those assets.

 

Therecoverability of this demand response and back-up generator equipments’carrying value is largely dependent on the rates that the Company is compensatedfor its committed capacity within the programs under which this equipment isbeing used. These rates represent market rates and can fluctuate based on thesupply and demand of capacity. Although these market rates are established upto three years in advance of the service delivery, these market rates have notyet been established for the entire remaining useful life of the demandresponse equipment. In performing its impairment analysis, the Companyestimates the expected

 

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futuremarket rates based on current existing market rates and trends. A decline inthe expected future market rates of greater than 10% could result in anadditional impairment charge related to this demand response equipment.

 

**IndustrySegment Information**

 

The Company is required to disclose reporting information aboutoperating segments in annual financial statements and required selectedinformation of these segments in interim financial statements. Operatingsegments are defined as components of an enterprise about which separatefinancial information is available that is evaluated regularly by the chiefoperating decision maker, or decision making group, in making decisions on howto allocate resources and assess performance. The Company’s decision makinggroup is considered to be the team comprised of the chief executive officer andthe executive management team. The Company views its operations and manages itsbusiness as one operating segment.

 

For the three and nine months ended September 30, 2010 and 2009,operations related to the Company’s international subsidiaries were notmaterial to the accompanying unaudited condensed consolidated financialstatements taken as a whole. In addition, as of September 30, 2010 andDecember 31, 2009, the long-lived assets related to the Company’sinternational subsidiaries were not material to the accompanying unauditedcondensed consolidated financial statements taken as a whole.

 

**2.****             ****Acquisitions**

 

**SmallFoot LLC and ZOX, LLC**

 

InMarch 2010, the Company acquired substantially all of the assets andcertain liabilities of SmallFoot LLC (Smallfoot) and ZOX, LLC (Zox), which werecompanies unaffiliated with the Company but were entities under commoncontrol.  Smallfoot was in the process ofdeveloping wireless systems that manage and coordinate electricity demand forsmall commercial facilities and Zox was in the process of developing hardwareand software for automated utility meter reading. The total purchase price paidby the Company at closing was approximately $1,360, of which $1,100 was paid incash and the remainder of which was paid by the issuance of 8,758 shares of theCompany’s common stock that had a fair value of approximately $260. Theseshares were measured as of the acquisition date using the closing price of theCompany’s common stock, as reported on The NASDAQ Global Market (NASDAQ) onMarch 15, 2010.  The Companybelieves that Smallfoot’s technology will reduce deployment costs andaccelerate deeper market penetration into C&I customers, specificallysmaller C&I customers.  The Companybelieves Zox’s smart grid communications and metering technology provides aplatform for transforming electric industry legacy meters into smart meters ata substantially lower cost as compared to traditional replacement methods.

 

AlthoughSmallfoot and Zox were development stage entities as of the acquisition closedate, these entities met the definition of a business as defined under ASC 805,*Business Combinations*(ASC 805)*,* as these entities had inputs and processes that have theability to provide a return to its owners. As a result, this acquisition was treated as a business combination inaccordance with ASC 805.

 

Transaction costs related to this business combination were notmaterial and have been expensed as incurred. The transaction costs are included in general and administrativeexpenses in the accompanying unaudited condensed consolidated statements of income.

 

The allocation of the purchase price is based upon preliminaryestimates of the fair value of assets acquired and liabilities assumed as ofMarch 15, 2010. The Company is in the process of gathering information tofinalize its valuation of certain assets and liabilities. The purchase priceallocation is preliminary and will be finalized once the Company has allnecessary information to complete its estimate, but generally no later than oneyear from the date of acquisition. There were no net tangible assets acquiredin connection with this acquisition. The components and initial allocation ofthe purchase price consists of the following approximate amounts:

 
| In-process research and development |   | $   | 920    |   |
|-------------------------------------|--------|-----|--------|--------|
| Patents                             |   | 200 |   |
| Goodwill                            |   | 240 |   |
| Total                               |   | $   | 1,360  |   |

 

Aspart of the preliminary purchase price allocation, the Company determined thatthe identifiable intangible assets include two in-process research anddevelopment projects and certain acquired patents.

 

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TheCompany used the cost approach to value the two acquired in-process researchand development projects that related to the development of wireless systemsthat manage and coordinate electricity demand for small commercial facilitiesand the development of hardware and software for automated utility meterreading, but had not yet reached technological feasibility and had no alternatefuture uses as of the acquisition date. The primary basis for determining the technological feasibility of theseprojects is the completion of a working model that performs all the majorfunctions planned for the product and is ready for initial customer testing,usually identified as beta testing. ASC 805 requires that purchased researchand development acquired in a business combination be recognized as anindefinite-lived intangible asset until the completion or abandonment of theassociated research and development efforts. The cost approach calculates fairvalue by calculating the reproduction cost of an exact replica of the subjectintangible asset.  The Company calculatedthe replacement cost based on actual development costs incurred through thedate of acquisition.  In determining theappropriate valuation methodology, the Company considered, among other factors:the in-process projects’ stage of completion; the complexity of the workcompleted as of the acquisition date; the costs already incurred; the projectedcosts to complete; the expected introduction date; and the estimated usefullife of the technology. Given the stage of development as of the acquisitiondate and the current lack of sufficient information regarding future expectedcash flows, the Company determined that the cost approach was the most reliablevaluation methodology to determine the fair value of the in-process researchand development projects acquired. The Company believes that the estimatedin-process research and development amounts so determined represent the fairvalue at the date of acquisition and do not exceed the amount a third partywould pay for the projects. However, if the projects are not successful orcompleted in a timely manner, the Company may not realize the financialbenefits expected for these projects or for the acquisition as a whole.

 

Theestimated cost to complete the in-process research and development projects inthe aggregate as of September 30, 2010 was approximately $840.

 

TheCompany used the income approach to value the acquired patents.  The discount rate in connection with thisvaluation was 25% and was based on the commercial and technical risks relatedto this asset and on estimated market participant discount rates for a similarasset.

 

Thefactors contributing to the recognition of goodwill were based upon severalstrategic and synergistic benefits that were expected to be realized from thecombination.

 

**Cogent Energy, Inc.**

 

In December 2009, the Company acquired all of the outstandingcapital stock of Cogent Energy, Inc. (Cogent), a company specializing incomprehensive energy consulting, engineering and building commissioningsolutions to C&I customers. The total purchase price paid by the Company atclosing was approximately $11,172, of which $6,555 was paid in cash and theremainder of which was paid by the issuance of 114,281 shares of the Company’scommon stock that had a fair value of approximately $3,162.  These shares were measured as of theacquisition date using the closing price of the Company’s common stock, asreported on NASDAQ on December 4, 2009. As a result of gathering information to update the Company’s valuationof certain acquired assets and liabilities, the purchase price was reduced by$94 during the three months ended March 31, 2010.  This reduction in purchase price was settledin April 2010 through the release back to the Company of 3,592 shares ofthe Company’s common stock that were previously held in escrow in connectionwith the Cogent acquisition.  Upon release,the Company’s board of directors approved the retirement of these shares.  Therefore, the transaction was accounted foras a treasury stock transaction and related retirement of shares during thethree months ended June 30, 2010.

 

In addition to the amounts paid at closing, the Company may beobligated to pay an earn-out amount of $1,500 to the former stockholders ofCogent. The earn-out payment will be based on the achievement of a certainminimum revenue-based milestone and a certain earnings-based milestone ofCogent for the year ending December 31, 2010 and will be paid in cash.Both of these milestones need to be achieved in order for the earn-out paymentto occur, and there will be no partial payment if the milestones are not fullyachieved. The Company believes that it is remote that the earn-out payment willnot be made. The fair value of the earn-out payment of $1,455 was recorded asadditional purchase price as of the acquisition date. As the Company believesthat it is remote that the earn-out payment will not be made, the Companydetermined the fair value of the earn-out payment based on the present value ofthe $1,500, which will be paid in December 2010. The increase in fairvalue of the contingent consideration from December 31, 2009 toSeptember 30, 2010 was not material.

 

The components and allocation of the purchase price consist of thefollowing approximate amounts:

 

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| Net tangible assets acquired as of  December 4, 2009 |   | $     | 1,331  |   |
|-----------------------------------------------------------|--------|-------|--------|--------|
| Customer relationships                                    |   | 1,400 |   |
| Non-compete agreements                                    |   | 590   |   |
| Trade name                                                |   | 200   |   |
| Goodwill                                                  |   | 7,557 |   |
| Total                                                     |   | $     | 11,078 |   |

 

Net tangible assets acquired in the acquisition of Cogent primarilyrelated to the following:

 
| Cash                      |   | $     | 336    |   |
|---------------------------|--------|-------|--------|--------|
| Accounts receivable       |   | 1,777 |   |
| Prepaids and other assets |   | 77    |   |
| Accounts payable          |   | (331  | )      |
| Accrued expenses          |   | (528  | )      |
| Total                     |   | $     | 1,331  |   |

 

**eQuilibriumSolutions Corporation**

 

InJune 2009, the Company acquired substantially all of the assets ofeQuilibrium Solutions Corporation (eQ), a software company specializing in thedevelopment of enterprise sustainability management products and services. Thetotal purchase price paid by the Company at closing was approximately $751, ofwhich $250 was paid in cash and the remainder of which was paid by the issuanceof 21,464 shares of the Company’s common stock that had a value ofapproximately $501. These shares were measured as of the acquisition date usingthe closing price of the Company’s common stock, as reported on NASDAQ onJune 11, 2009.

 

Transactioncosts related to this business combination were not material and were expensedas incurred.  The transaction costs areincluded in general and administrative expenses. The Company’s consolidatedfinancial statements reflect eQ’s results of operations from June 11, 2009forward.

 

**South River Consulting, LLC**

 

In May 2008, the Company acquired 100% of the membership interestsof South River Consulting, LLC (SRC), an energy procurement and risk managementservices provider, for a purchase price equal to $5,524, which consisted of$3,603 in cash, $174 in related expenses and the issuance of 120,000 shares ofthe Company’s common stock that had a value of approximately $1,747 as of theclosing date. In addition to the amounts paid at closing, the Company incurreda contingent obligation to pay to the former holders of SRC membershipinterests an earn-out amount equal to 50% to 60% of the revenues of SRC’sbusiness during each twelve-month period from May 1, 2008 throughApril 30, 2010, which would be recognized as additional purchase pricewhen earned. The earn-out payments were based on the achievement of certainminimum revenue-based milestones of SRC, paid in a combination of cash andshares of the Company’s common stock and recorded as additional purchase price.The additional purchase price recorded in the three months ended June 30,2009, which was related to the May 1, 2008 to April 30, 2009 earn-outperiod, totaled $1,468, of which $734 was paid in cash during the three monthsended June 30, 2009 and the remainder of which was paid by the issuance of44,776 shares of the Company’s common stock during the three months endedSeptember 30, 2009.  The additionalpurchase price recorded in the six months ended June 30, 2010, which wasrelated to the May 1, 2009 to April 30, 2010 earn-out period, totaled$1,840, of which $901 was paid in cash during the three months endedJune 30, 2010, $39 was settled through a reduction of a receivable due tothe Company from the former holders of SRC membership interests and theremainder of which was paid by the issuance of 30,879 shares of the Company’scommon stock with a fair value of $900.

 

Proforma information relating to the above acquisitions has not been providedsince the impact to the consolidated financial statements was not material.

 

**3.  Impairment of IntangibleAssets and Goodwill**

 

*Intangible Assets*

 

TheCompany amortizes its intangible assets that have finite lives using either thestraight-line method or, if reliably determinable, based on the pattern inwhich the economic benefit of the asset is expected to be consumed utilizingexpected undiscounted future cash flows. Amortization is recorded over theestimated useful lives ranging from one to ten years. The Company

 

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reviewsits intangible assets subject to amortization to determine if any adverseconditions exist or a change in circumstances has occurred that would indicateimpairment or a change in the remaining useful life. If the carrying value ofan asset exceeds its undiscounted cash flows, the Company will write-down thecarrying value of the intangible asset to its fair value in the periodidentified. In assessing recoverability, the Company must make assumptionsregarding estimated future cash flows and discount rates. If these estimates orrelated assumptions change in the future, the Company may be required to recordimpairment charges. The Company generally calculates fair value as the presentvalue of estimated future cash flows to be generated by the asset using arisk-adjusted discount rate. If the estimate of an intangible asset’s remaininguseful life is changed, the Company will amortize the remaining carrying valueof the intangible asset prospectively over the revised remaining useful life.There were no indicators of impairment identified during the three and ninemonths ended September 30, 2010 and 2009 that required an interimimpairment test.

 

The following table provides the gross carrying amount and relatedaccumulated amortization of the Company’s definite-life intangible assets as ofSeptember 30, 2010 and December 31, 2009:

 
| ** **                                       | ** ** | **Weighted Average**                     | ** ** | **As of September 30, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | **Amortization Period  (in years)** | ** ** | **Gross Carrying  Amount**                  | ** ** | **Accumulated  Amortization**                   | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Customer contracts                               |       | 6.53                                          |       | $                                                | 4,217      |                                            | $          | (1,490 | ) | $ | 4,217 |   | $ | (1,180 | ) |
| Employment agreements and non-compete agreements |       | 2.60                                          |       | 772                                              |       | (267                                            | )          | 772 |   | (118 | ) |
| Software                                         |       | 1.73                                          |       | 120                                              |       | (53                                             | )          | 120 |   | (23 | ) |
| Customer relationships                           |       | 6.33                                          |       | 3,510                                            |       | (844                                            | )          | 3,510 |   | (333 | ) |
| Trade name                                       |       | 0.10                                          |       | 115                                              |       | (104                                            | )          | 115 |   | (5 | ) |
| Patents                                          |       | 9.45                                          |       | 200                                              |       | (10                                             | )          | — |   | — |   |
| Total                                            |       |                                          |       | $                                                | 8,934      |                                            | $          | (2,768 | ) | $ | 8,734 |   | $ | (1,659 | ) |

 

The increase in patents from December 31, 2009 toSeptember 30, 2010 was due to the allocation of purchase price related tothe Smallfoot and Zox acquisition in the three months ended March 31,2010.  Amortization expense related tointangible assets amounted to $353 and $1,109, respectively, for the three andnine months ended September 30, 2010 and $182 and $514, respectively, forthe three and nine months ended September 30, 2009. These costs areincluded in general and administrative expenses in the accompanying unauditedcondensed consolidated statements of income. The definite-life intangible assetlives range from one to ten years and the weighted average remaining life was6.03 years at September 30, 2010.

 

In addition to the definite-life intangible assets described above, theCompany also has two indefinite-life intangible assets related to in-processresearch and development projects acquired in connection with the Smallfoot andZox acquisition (refer to Note 2 for further discussion).  The indefinite-life in-process research anddevelopment intangible assets totaled $920 as of September 30, 2010.  There were no indefinite-life intangibleassets as of December 31, 2009.

 

*Goodwill*

 

In accordance with ASC 350, *Intangibles—Goodwill andOther* (ASC 350), the Company tests goodwill at the reporting unitlevel for impairment on an annual basis and between annual tests if events andcircumstances indicate it is more likely than not that the fair value of areporting unit is less than its carrying value. Events that would indicate impairment and trigger an interim impairmentassessment include, but are not limited to, current economic and marketconditions, including a decline in market capitalization, a significant adversechange in legal factors, business climate or operational performance of thebusiness, and an adverse action or assessment by a regulator. The Company’sannual impairment test date is November 30.

 

In performing the test, the Company utilizes the two-step approachprescribed under ASC 350. The first step requires a comparison of the carryingvalue of the reporting units, as defined, to the fair value of these units. TheCompany considers a number of factors to determine the fair value of areporting unit, including an independent valuation to conduct this test. Thevaluation is based upon expected future discounted operating cash flows of thereporting unit as well as analysis of recent sales or offerings of similarcompanies. The Company bases the discount rate used to arrive at a presentvalue as the date of the impairment test on its weighted average cost ofcapital. If the carrying value of its reporting unit exceeds its fair value,the Company will perform the second step of the goodwill impairment test tomeasure the amount of impairment loss, if any. The second step of the goodwillimpairment test

 

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comparesthe implied fair value of a reporting unit’s goodwill to its carrying value. Todate, the Company has not been required to perform the second step of theimpairment test.

 

The fair value of the entity is determined by use of a market approachbased on the quoted market price of its common stock, the number of sharesoutstanding and a discounted cash flow analysis (DCF) under the incomeapproach. The key assumptions that drive the fair value in the DCF model arethe discount rates, i.e., weighted average cost of capital (WACC),terminal values, growth rates, and the amount and timing of expected futurecash flows. If the current worldwide financial markets and economic environmentwere to deteriorate, this would likely result in a higher WACC because marketparticipants would require a higher rate of return. In the DCF, as the WACCincreases, the fair value decreases. The other significant factor in the DCF isits projected financial information, i.e., amount and timing of expectedfuture cash flows and growth rates, and if its assumptions were to be adverselyimpacted, it could result in a reduction of the fair value of the entity. TheCompany believes that it is not at risk of failing the first step of thegoodwill impairment test.

 

The estimate of fair value requires significant judgment. Any lossresulting from an impairment test would be reflected in operating loss in theCompany’s consolidated statements of income. The annual impairment testingprocess is subjective and requires judgment at many points throughout theanalysis. If these estimates or their related assumptions change in the future,the Company may be required to record impairment charges for these assets notpreviously recorded.

 

The following table shows the change in the carrying amount of goodwillfrom December 31, 2009 to September 30, 2010:

 
| Balance at December 31, 2009            |   | $     | 22,553 |   |
|----------------------------------------------|--------|-------|--------|--------|
| Acquisition of Smallfoot and Zox             |   | 240   |   |
| Purchase price adjustments related to Cogent |   | 20    |   |
| SRC earn-out                                 |   | 1,840 |   |
| Balance at September 30, 2010           |   | $     | 24,653 |   |

 

**4. Net Income Per Share**

 

A reconciliation of basic and diluted share amounts for the three andnine months ended September 30, 2010 and 2009 are as follows (shares inthousands):

 
| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Numerator:                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                         |       | $                                                    | 43,866     |                                                | $          | 26,637 |   | $ | 30,744 |   | $ | 8,374 |   |
| Denominator:                                       |       |                                                 |       |                                                |       |   |   |   |   |
| Basic weighted average common shares outstanding   |       | 24,865                                               |       | 21,938                                              |       | 24,650 |   | 20,704 |   |
| Weighted average common stock equivalents          |       | 1,351                                                |       | 1,751                                               |       | 1,363 |   | 1,451 |   |
| Diluted weighted average common shares outstanding |       | 26,216                                               |       | 23,689                                              |       | 26,013 |   | 22,155 |   |
|                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Basic net income per common share                  |       | $                                                    | 1.76       |                                                | $          | 1.21 |   | $ | 1.25 |   | $ | 0.40 |   |
| Diluted net income per common share                |       | $                                                    | 1.67       |                                                | $          | 1.12 |   | $ | 1.18 |   | $ | 0.38 |   |
| Weighted average anti-dilutive shares related to:  |       |                                                 |       |                                                |       |   |   |   |   |
| Stock options                                      |       | 945                                                  |       | 861                                                 |       | 954 |   | 1,253 |   |
| Nonvested restricted shares                        |       | 151                                                  |       | 184                                                 |       | 170 |   | 210 |   |
| Restricted stock units                             |       | 391                                                  |       | 120                                                 |       | 333 |   | 103 |   |

 

In the reporting period in which the Company has reported net income,anti-dilutive shares comprise those common stock equivalents that have eitheran exercise price above the average stock price for the quarter or the commonstock equivalent’s related average unrecognized stock compensation expense issufficient to “buy back” the entire amount of shares.  In those reporting periods in which theCompany has a net loss, anti-dilutive shares comprise the impact of thosenumber of shares that would have been dilutive

 

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hadthe Company had net income plus the number of common stock equivalents thatwould be anti-dilutive had the Company had net income.

 

The Company excludes the shares issued in connection with restrictedstock awards from the calculation of basic weighted average common sharesoutstanding until such time as those shares vest.  In addition, in connection with certain ofthe Company’s business combinations, the Company has issued shares that were heldin escrow upon closing of the applicable business combination. The Companyexcludes shares held in escrow from the calculation of basic weighted averagecommon shares outstanding where the release of such shares is contingent uponan event and not solely subject to the passage of time.

 

**5.Disclosure of Fair Value of Financial Instruments**

 

TheCompany’s financial instruments mainly consist of cash and cash equivalents,restricted cash, accounts receivable, and accounts payable and debtobligations. The carrying amounts of the Company’s cash equivalents, restrictedcash, accounts receivable and accounts payable approximate their fair value dueto the short-term nature of these instruments. At September 30, 2010 andDecember 31, 2009, there were no amounts outstanding under the loan andsecurity agreement (the Credit Facility) entered into between the Company, oneof its subsidiaries and Silicon Valley Bank (SVB).

 

**6. Fair Value Measurements**

 

ASC 820 establishes a fair value hierarchy that requires the use ofobservable market data, when available, and prioritizes the inputs to valuationtechniques used to measure fair value in the following categories:

 

·                  Level 1—Valuation isbased upon quoted prices for identical instruments traded in active markets.Level 1 instruments include securities traded on active exchange markets,such as the New York Stock Exchange.

 

·                  Level 2—Valuation isbased upon quoted prices for similar instruments in active markets, quotedprices for identical or similar instruments in markets that are not active andmodel-based valuation techniques for which all significant assumptions areobservable in the market.

 

·                  Level 3—Valuation isgenerated from model-based techniques that use significant assumptions notobservable in the market. These unobservable assumptions reflect the Company’sown estimates of assumptions market participants would use in pricing the assetor liability.

 

The table below presents the balances of assets and liabilitiesmeasured at fair value on a recurring basis at September 30, 2010:

 
| ** **              | ** ** | **Fair Value Measurement at September 30, 2010 Using** | ** ** |
|-------------------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **              | ** ** | **Totals**                                                                                | ** ** | **Quoted Prices in  Active Markets  for Identical  Assets (Level 1)** | ** ** | **Significant  Other  Observable  Inputs (Level 2)** | ** ** | **Unobservable  Inputs (Level 3)** | ** ** |
| Money market funds (1)  |       | $                                                                                         | 108,225    |   | $ | 108,225 |   | $ | — |   | $ | — |   |
| Certificates of deposit |       | 177                                                                                       |       | 177 |   |   |   |   |   |
|                    |       | $                                                                                         | 108,402    |   | $ | 108,402 |   | $ | — |   | $ | — |   |

 

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(1)                                  Included in cash and cashequivalents in the accompanying unaudited condensed consolidated balancesheets.

 

At September 30, 2010, the Company had restricted cash ofapproximately $177 invested in certificates of deposit. All certificates ofdeposit have contractual maturities of twelve months or less. The Company’sinvestments in certificates of deposit have a fair value that approximates costbased on current market rates for similar instruments.

 

With respect to assets measured at fair value on a non-recurring basis,which would be impaired long-lived assets, as a result of an indicator ofimpairment related to certain demand response equipment, the Company wasrequired to perform an impairment test during the three months endedSeptember 30, 2010 and measure the fair value of these assets.  Refer to Note 1 for a discussion of the

 

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measurementof fair value of these assets.  Therewere no indicators of impairment related to any of the Company’s otherlong-lived assets during the three and nine months ended September 30,2010 requiring a fair value measurement of these assets.  Accordingly, these other long-lived assetswere not measured at fair value.  Withrespect to liabilities measured at fair value on a non-recurring basis, whichwould be contingent consideration liability, refer to Note 2 for adiscussion of the determination of fair value of this liability.

 

**7. Financing Arrangements**

 

Pursuant to the terms of the Credit Facility, SVB will, among otherthings, make revolving credit and term loan advances and issue letters ofcredit for the Company’s account. The interest on loans under the Company’srevolving credit loan accrues at interest rates based upon either SVB’s primerate or the 30, 60 or 90-day LIBOR plus 2.25%, at the Company’s election. The intereston term loans accrues at SVB’s prime rate plus 0.50% or the 30, 60 or 90-dayLIBOR plus 2.75%, at the Company’s election. The term advance is payable inthirty-six consecutive equal monthly installments of principal, calculated bySVB, based upon the amount of the term advance and an amortization scheduleequal to thirty-six months. All unpaid principal and accrued interest is dueand payable in full on February 4, 2011, which is the maturity date. Inconnection with the issuance or renewal of letters of credit for the Company’saccount, the Company is charged a letter of credit fee of 1.25%. The Companyexpenses the interest and letter of credit fees, as applicable, in the periodincurred.

 

The Company’s obligations under the Credit Facility are secured by allof the assets of the Company and its subsidiaries, excluding any intellectualproperty. The Credit Facility contains customary terms and conditions forcredit facilities of this type, including restrictions on the Company’s abilityto incur additional indebtedness, create liens, enter into transactions withaffiliates, transfer assets, pay dividends or make distributions on, orrepurchase, the Company’s stock, consolidate or merge with other entities, orsuffer a change in control. In addition, the Company is required to meetcertain financial covenants customary with this type of credit facility,including maintaining a minimum specified tangible net worth and a minimumspecified ratio of current assets to current liabilities. The Credit Facilitycontains customary events of default, including payment defaults, breaches ofrepresentations, breaches of affirmative or negative covenants, cross defaultsto other material indebtedness, bankruptcy and failure to discharge certainjudgments. If a default occurs and is not cured within any applicable cureperiod or is not waived, the Company’s obligations under the Credit Facilitymay be accelerated. The Company was in compliance with all financial covenantsunder the Credit Facility at September 30, 2010 and December 31,2009.

 

In October 2009, the Company repaid the outstanding borrowings of$4,442 under the Credit Facility. The Company incurred financing costs of $120in connection with the Credit Facility, which were deferred and are beingamortized to interest expense over the life of the Credit Facility, whichmatures on February 4, 2011. At September 30, 2010, the Company hadno borrowings and letters of credit totaling $35,586 outstanding under theCredit Facility.

 

InApril 2010, the Company and one of its subsidiaries entered into a secondloan modification agreement to the Credit Facility, which increased the Company’sborrowing limit from $35,000 to $50,000, as well as modified certain of theCompany’s financial covenant compliance requirements.  In July 2010,the Company and one of its subsidiaries entered into a third loan modificationagreement to the Credit Facility, which extended the revolving credit linematurity date of the Credit Facility from August 5, 2010 to February 4,2011, as well as modified certain of the Company’s financial covenantcompliance requirements.  Upon termination of the Credit Facility, if theCompany still has letters of credit issued and outstanding under the CreditFacility, the Company would be required to post 105% of the value of theletters of credit in cash with SVB to collateralize those letters of credit.

 

**8. Commitments and Contingencies**

 

The Company is contingently liable under outstanding letters of credit.Restricted cash balances in the amount of $177 and $7,874 collateralize certainoutstanding letters of credit and cover financial assurance requirements incertain of the programs in which the Company participated at September 30,2010 and December 31, 2009, respectively. Based on the Company’s demand response event performance in July 2010under a certain open market demand response program in which the Companyparticipates, approximately $7,697 of restricted cash that collateralized theCompany’s performance obligations became unrestricted in July 2010.

 

TheCompany is subject to performance guarantee requirements under certain utilityand grid operator customer contracts and open market bidding programparticipation rules. The Company had deposits held by certain utility and gridoperator customers of $4,026 and $3,024, respectively, at September 30,2010 and December 31, 2009. These amounts primarily represent up-frontpayments required by utility and grid operator customers as a condition ofparticipation in certain demand response programs and to ensure that theCompany will deliver its committed capacity amounts in those programs. If theCompany fails to meet its minimum committed capacity requirements, a portion orall of the deposit may be forfeited. The Company assessed the probability of defaultunder these customer contracts and open market bidding programs and hasdetermined the likelihood of default and loss of deposits to be remote. In addition, under certain utility and grid operator customer contracts, if theCompany does not achieve the required performance guarantee requirements, thecustomer can terminate the arrangement and the Company would potentially besubject to

 

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terminationpenalties.  Under these arrangements, the Company defers all fees receivedup to the amount of the potential termination penalty until the Company hasconcluded that it can reliably determine that the potential termination penaltywill not be incurred or the termination penalty lapses.   As ofSeptember 30, 2010, the Company has deferred fees totaling approximately$3,109, which are included in deferred revenue, long-term in the accompanyingunaudited condensed consolidated balance sheets.  As of September 30,2010, the maximum termination penalty that the Company is subject to underthese arrangements, which the Company has not deemed probable of incurring, isapproximately $4,800.

 

In connection with the Company’s participation in an open marketbidding program, the Company entered into an arrangement with a third partyduring the three months ended June 30, 2009 to bid capacity into theprogram and provide the corresponding financial assurance required in connectionwith the bid. The arrangement included an up-front payment by the Company equalto $2,000, of which $1,100 was expensed as interest expense during the threemonths ended June 30, 2009 and $900 was deferred and will be recognizedratably as a charge to cost of revenues as revenue is recognized over the2012/2013 delivery year. In addition, the Company will be required to pay thethird party an additional contingent fee, up to a maximum of $3,000, based onthe revenue that the Company expects to earn in 2012 in connection with thebid. This additional fee will be recognized as a reduction of revenue asearned.

 

The Company includes indemnification provisions in certain of itscontracts. These indemnification provisions include provisions indemnifying thecustomer against losses, expenses, and liabilities from damages that could beawarded against the customer in the event that the Company’s services andrelated enterprise software platforms are found to infringe upon a patent orcopyright of a third party. The Company believes that its internal businesspractices and policies and the ownership of information limits the Company’srisk in paying out any claims under these indemnification provisions.

 

**9. Stock-Based Compensation**

 

The Company’s Amended and Restated 2003 Stock Option and Incentive Plan(2003 Plan) and the Amended and Restated 2007 Employee, Director and ConsultantStock Plan (the 2007 Plan, and collectively with the 2003 Plan, the Plans)provide for the grant of incentive stock options, nonqualified stock options,restricted and unrestricted stock awards and other stock-based awards toeligible employees, directors and consultants of the Company. Options grantedunder the Plans are exercisable for a period determined by the Company, but inno event longer than ten years from the date of the grant. Option awards aregenerally granted with an exercise price equal to the market price of theCompany’s common stock on the date of grant. Options, restricted stock awards and restricted stock unit awards generallyvest ratably over four years, with certain exceptions. The 2003 Plan expiredupon the Company’s initial public offering (IPO) in May 2007. Anyforfeitures under the 2003 Plan that occurred after the effective date of theIPO are available for future grant under the 2007 Plan up to a maximum of1,000,000 shares. During the nine months ended September 30, 2010 and2009, the Company issued 24,681 shares of its common stock and 45,085 shares ofits common stock, respectively, to certain executives to satisfy a portion ofthe Company’s compensation obligations to those individuals. As ofSeptember 30, 2010, 2,109,926 shares were available for future grant underthe 2007 Plan.

 

For stock options granted prior to January 1, 2009, the fair valueof each option was estimated at the date of grant using a Black-Scholesoption-pricing model. For stock options granted on or after January 1,2009, the fair value of each option has been and will be estimated on the dateof grant using a lattice valuation model. The lattice model considerscharacteristics of fair value option pricing that are not available under theBlack-Scholes model. Similar to the Black-Scholes model, the lattice modeltakes into account variables such as expected volatility, dividend yield rate,and risk free interest rate. However, in addition, the lattice model considersthe probability that the option will be exercised prior to the end of itscontractual life and the probability of termination or retirement of the optionholder in computing the value of the option. For these reasons, the Companybelieves that the lattice model provides a fair value that is morerepresentative of actual experience and future expected experience than thatvalue calculated using the Black-Scholes model.

 

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

 
| ** **                 | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| Risk-free interest rate    |       | 3.5                                                     | %          | 3.2 | % |
| Vesting term, in years     |       | 2.16                                                    |       | 2.16 |   |
| Expected annual volatility |       | 85                                                      | %          | 86 | % |
| Expected dividend yield    |       | —                                                  | %          | — | % |
| Exit rate pre-vesting      |       | 5.98                                                    | %          | 4.88 | % |
| Exit rate post-vesting     |       | 11.29                                                   | %          | 10.89 | % |

 

Volatility measures the amount that a stock price has fluctuated or isexpected to fluctuate during a period. As there was no public market for the Company’s common stock prior tothe effective date of the IPO, the Company determined the volatility based on

 

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ananalysis of reported data for a peer group of companies that issued optionswith substantially similar terms.  Theexpected volatility of options granted has been determined using an average ofthe historical volatility measures of this peer group of companies, as well asthe historical volatility of the Company’s common stock beginning January 1,2008.  During the three months ended September 30,2010, the Company determined that it had sufficient history to utilizeCompany-specific volatility in accordance with ASC 718, *StockCompensation*(ASC 718) and is now calculating volatility using acomponent of implied volatility and historical volatility to determine thevalue of share-based payments.  Therisk-free interest rate is the rate available as of the option date onzero-coupon United States government issues with a term equal to the expectedlife of the option. The Company has not paid dividends on its common stock inthe past and does not plan to pay any dividends in the foreseeable future. Inaddition, the terms of the Credit Facility preclude the Company from payingdividends.  During the nine months endedSeptember 30, 2010, the Company updated its estimated exit ratepre-vesting and post-vesting applied to options, restricted stock andrestricted stock units based on an evaluation of demographics of its employeegroups and historical forfeitures for these groups in order to determine itsoption valuations as well as its stock-based compensation expense.  The changes in estimate of the volatility,exit rate pre-vesting and exit rate post-vesting did not have a material impacton the Company’s stock-based compensation expense recorded in the accompanyingunaudited condensed consolidated statements of income for the three or ninemonths ended September 30, 2010, and the impact is not expected to bematerial for the fiscal year ending December 31, 2010.

 

The Company accounts for transactions in which services are receivedfrom non-employees in exchange for equity instruments based on the fair valueof such services received or of the equity instruments issued, whichever ismore reliably measured.

 

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

 
| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Stock option expense                        |       | $                                                    | 2,433      |                                                | $          | 2,669 |   | $ | 7,109 |   | $ | 7,477 |   |
| Restricted stock and restricted stock units |       | 1,231                                                |       | 1,253                                               |       | 4,559 |   | 2,519 |   |
| Total                                       |       | $                                                    | 3,664      |                                                | $          | 3,922 |   | $ | 11,668 |   | $ | 9,996 |   |

 

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

 
| ** **                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Selling and marketing expenses      |       | $                                                    | 1,222      |                                                | $          | 1,181 |   | $ | 3,403 |   | $ | 3,001 |   |
| General and administrative expenses |       | 2,218                                                |       | 2,567                                               |       | 7,676 |   | 6,494 |   |
| Research and development expenses   |       | 224                                                  |       | 174                                                 |       | 589 |   | 501 |   |
| Total                               |       | $                                                    | 3,664      |                                                | $          | 3,922 |   | $ | 11,668 |   | $ | 9,996 |   |

 

The Company recognized no income tax benefit from stock-basedcompensation arrangements during the three and nine months endedSeptember 30, 2010 and 2009. In addition, no material compensation costwas capitalized during the three and nine months ended September 30, 2010and 2009.

 

The following is a summary of the Company’s stock option activity forall stock option plans during the nine months ended September 30, 2010:

 

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| ** **                                                 | ** ** | **Nine Months Ended September 30, 2010** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **Number of  Shares  Underlying  Options**                   | ** ** | **Exercise Price  Per Share** | ** ** | **Weighted-  Average  Exercise Price  Per Share** | ** ** | **Aggregate  Intrinsic  Value(1)** | ** ** |
| Outstanding at beginning of period                         |       | 2,503,975                                                         |       | $0.17 - $48.06 |   | $ | 10.84 |   | $ | 49,599 |   |
| Granted                                                    |       | 290,568                                                           |       |   |   | 29.82 |   |   |   |
| Exercised                                                  |       | (517,840                                                          | )          |   |   | 6.73 |   | $ | 12,392 |   |
| Cancelled                                                  |       | (103,940                                                          | )          |   |   | 16.36 |   |   |   |
| Outstanding at end of period                               |       | 2,172,763                                                         |       | $0.17 - $48.06 |   | 14.10 |   | $ | 38,104 |   |
| Weighted average remaining contractual life in  years: 6.3 |       |                                                              |       |   |   |   |   |   |   |
| Exercisable at end of period                               |       | 1,234,640                                                         |       | $0.17 - $48.06 |   | $ | 9.40 |   | $ | 27,463 |   |
| Weighted average remaining contractual life in  years: 5.9 |       |                                                              |       |   |   |   |   |   |   |
| Vested or expected to vest at September 30,  2010 (2) |       | 2,117,566                                                         |       | $0.17 - $48.06 |   | $ | 13.80 |   | $ | 37,763 |   |

 

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(1)                                  The aggregateintrinsic value was calculated based on the positive difference between theestimated fair value of the Company’s common stock on September 30, 2010of $31.37 and the exercise price of the underlying options.

 

(2)                                  This representsthe number of vested options as of September 30, 2010 plus the number ofunvested options expected to vest subsequent to September 30, 2010 basedon the unvested options outstanding at September 30, 2010, adjusted forthe weighted average estimated forfeiture rate of 5.98%.

 

In December 2008, the Company’s board of directors approved aone-time offer to the Company’s employees, including its executive officers,and directors to exchange option grants that had an exercise price per sharethat was equal to or greater than the higher of $12.00 or the closing price ofthe Company’s common stock as reported on NASDAQ on January 21, 2009 (theExchange). The Exchange closed on January 21, 2009, and the Companyexchanged options that had exercise prices equal to or greater than $12.00 pershare. As a result, an aggregate of 744,401 options, with exercise pricesranging from $12.27 to $48.54 per share, were exchanged for 424,722 optionswith an exercise price per share of $8.63 for employees who were not alsoexecutive officers of the Company, 142,179 options with an exercise price pershare of $11.47 for executive officers who were not also directors of theCompany and 45,653 options with an exercise price per share of $12.94 for theCompany’s directors. On the date of the Exchange, the estimated fair value ofthe new options did not exceed the fair value of the exchanged stock optionscalculated immediately prior to the Exchange. As such, there was no incrementalfair value of the new options, and the Company will not record additionalcompensation expense related to the Exchange. The Company will continue torecognize the remaining compensation expense related to the exchanged optionsover the remaining vesting period of the original options.

 

*Additional Information About Stock Options*

* *
| ** **                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Total number of options granted during the period         |       | 39,293                                               |       | 178,100                                             |       | 290,568 |   | 1,093,454 |   |
| Weighted average fair value per share of options  granted |       | $                                                    | 20.98      |                                                | $          | 17.76 |   | $ | 18.98 |   | $ | 18.12 |   |
| Total intrinsic value of options exercised (1)            |       | $                                                    | 2,431      |                                                | $          | 3,240 |   | $ | 12,392 |   | $ | 5,855 |   |

 

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

 

Ofthe stock options outstanding as of September 30, 2010, 2,158,277 optionswere held by employees and directors of the Company and 14,486 options wereheld by non-employees.  For outstandingunvested options related to employees as of September 30, 2010, the

 

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Companyhad $13,022 of unrecognized stock-based compensation expense, which is expectedto be recognized over a weighted average period of 2.3 years. There were nomaterial unvested non-employee options as of September 30, 2010.

 

*RestrictedStock and Restricted Stock Units*

 

Fornon-vested restricted stock and restricted stock units outstanding as ofSeptember 30, 2010, the Company had $11,587 of unrecognized stock-basedcompensation expense, which is expected to be recognized over a weightedaverage period of 3.0 years.

 

*RestrictedStock*

 

Thefollowing table summarizes the Company’s restricted stock activity during thenine months ended September 30, 2010:

 
| ** **                           | ** ** | **Number of  Shares** | ** ** | **Weighted Grant  Date Fair Value  Per Share** | ** ** |
|--------------------------------------|------------|----------------------------|------------|--------------------------------------------------------------------|------------|
| Nonvested at December 31, 2009  |       | 188,618                    |       | $                                                                  | 23.42      |   |
| Granted                              |       | 86,375                     |       | 29.67                                                              |       |
| Vested                               |       | (130,809                   | )          | 22.48                                                              |       |
| Cancelled                            |       | (18,779                    | )          | 27.75                                                              |       |
| Nonvested at September 30, 2010 |       | 125,405                    |       | $                                                                  | 28.05      |   |

 

All shares underlying awards of restricted stock are restricted in thatthey are not transferable until they vest. Restricted stock typically vestsratably over a four-year period from the date of issuance, with certainexceptions. Included in the above table are 1,750 shares of restricted stockgranted to certain non-executive employees during the nine months endedSeptember 30, 2010 that were immediately vested.  The fair value of the restricted stock isexpensed ratably over the vesting period. The shares of restricted stock havebeen issued at no cost to the recipients, except for 152,460 shares ofrestricted stock granted in 2006 that were purchased for $0.51 per share. TheCompany records any proceeds received for unvested shares of restricted stockin accrued expenses and the amount is amortized into additional paid-in capitalas the shares vest. If the employee who received the restricted stock leavesthe Company prior to the vesting date for any reason, the shares of restrictedstock will be forfeited and returned to the Company.

 

*Additional Information About Restricted Stock*

 
| ** **                                                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                                             | ** ** | **2009**                                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Total number of shares of restricted stock granted  during the period    |       | 1,583                                                |       | 22,000                                              |       | 86,375 |   | 40,000 |   |
| Weighted average fair value per share of  restricted stock granted       |       | $                                                    | 33.99      |                                                | $          | 24.38 |   | $ | 29.67 |   | $ | 25.17 |   |
| Total number of shares of restricted stock vested  during the period     |       | 43,482                                               |       | 23,617                                              |       | 130,809 |   | 129,899 |   |
| Total fair value of shares of restricted stock  vested during the period |       | $                                                    | 1,387      |                                                | $          | 644 |   | $ | 3,938 |   | $ | 2,219 |   |

 

*Restricted Stock Units*

 

The following table summarizes the Company’s restricted stock unitactivity during the nine months ended September 30, 2010:

 

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| ** **                           | ** ** | **Number of  Shares** | ** ** | **Weighted Grant  Date Fair Value  Per Share** | ** ** |
|--------------------------------------|------------|----------------------------|------------|--------------------------------------------------------------------|------------|
| Nonvested at December 31, 2009  |       | 114,000                    |       | $                                                                  | 11.55      |   |
| Granted                              |       | 326,000                    |       | 28.99                                                              |       |
| Vested                               |       | (44,083                    | )          | 12.07                                                              |       |
| Cancelled                            |       | —                     |       | —                                                             |       |
| Nonvested at September 30, 2010 |       | 395,917                    |       | $                                                                  | 25.85      |   |

 

Priorto 2009, the Company had not granted any restricted stock units and there wereno restricted stock units that vested in 2009.

 

Theweighted average grant date fair value of restricted stock units granted duringthe nine months ended September 30, 2009 was $11.55 per share.  The total fair value of restricted stockunits that vested during the nine months ended September 30, 2010 was$1,440.

 

**10.Income Taxes**

 

TheCompany accounts for income taxes in accordance with ASC 740, *Income Taxes* (ASC 740), which is the asset and liabilitymethod for accounting and reporting income taxes. Under ASC 740, deferred taxassets and liabilities are recognized based on temporary differences betweenthe financial reporting and income tax bases of assets and liabilities usingstatutory rates. In addition, ASC 740 requires a valuation allowance againstnet deferred tax assets if, based upon the available evidence, it is morelikely than not that some or all of the deferred tax assets will not berealized.

 

ASC740 also provides criteria for the recognition, measurement, presentation anddisclosures of uncertain tax positions. A tax benefit from an uncertain taxposition may be recognized if it is “more likely than not” that the position issustainable based solely on its technical merits. As of September 30, 2010and December 31, 2009, the Company had no material unrecognized taxbenefits.

 

Inaccordance with ASC 740, each interim period is considered an integral part ofthe annual period and tax expense is measured using an estimated annualeffective tax rate. The Company is required, at the end of each interimreporting period, to make its best estimate of the annual effective tax ratefor the full fiscal year and use that rate to provide for income taxes on acurrent year-to-date basis.  If anenterprise has an ordinary loss for the year to date at the end of an interimperiod and anticipates ordinary income for the fiscal year, which was the casewith the Company through the six months ended June 30, 2010, theenterprise will record an interim period tax benefit based on applying theestimated annual effective tax rate to the ordinary loss as long as the taxbenefits are realized during the year or recognizable as a deferred tax assetas of the end of the year.  The Companyrecorded an income tax provision of $3,779 and $2,869 for the three and nine monthsended September 30, 2010, respectively, which included consideration ofthe tax benefit recognized by the Company from stock option deductionsgenerated during the three and nine months ended September 30, 2010.  Even though the Company’s federal and statenet operating loss carryforwards exceed the Company’s estimated taxable incomefor the fiscal year ending December 31, 2010 (fiscal 2010), the Company’sestimated annual effective tax rate is greater than zero due to the following:

 

·                  estimatedforeign taxes resulting from guaranteed profit allocable to the Company’s foreignsubsidiaries, which have been determined to be limited-risk service providersacting on behalf of the U.S. parent for tax purposes, for which there are notax net operating loss carryforwards;

 

·                  certain statetaxes for jurisdictions where the Company does not have sufficient netoperating loss carryforwards; and

 

·                  amortization oftax deductible goodwill, which generates a deferred tax liability that cannotbe offset by net operating losses or other deferred tax assets since itsreversal is considered indefinite in nature.

 

TheCompany’s effective tax rate for the three and nine months endedSeptember 30, 2010 was 7.9% and 8.5%, respectively.  The Company’s estimated annual effective taxrate for fiscal 2010 is 8.5%.  However,the estimated annual effective tax rate could be reduced in the fourth quarterof fiscal 2010 as a result of a tax benefit from stock options which are notrecognized in the determination of the estimated annual effective rate untilthey occur.  In addition, the estimatedannual effective tax rate could increase in the fourth quarter of fiscal 2010if certain proposed state legislation is passed that would limit the Company’sability to utilize its net operating loss carryforwards to offset state taxableincome for fiscal 2010.  The Company’sestimated annual effective tax rate is 

 

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lowerthan the statutory rate as a result of the Company’s federal and state netoperating loss carryforwards to offset future federal and state taxable income.

 

The Company recorded a deferred tax benefit of $786 and $438 for thethree and nine months ended September 30, 2009, respectively, due to taxamortization for indefinite lived intangibles.

 

The Company reviews all available evidence to evaluate the recovery ofdeferred tax assets, including the recent history of accumulated losses in alltax jurisdictions over the last three years, as well as its ability to generateincome in future periods. As of September 30, 2010 and December 31,2009, due to the uncertainty related to the ultimate use of the Company’sdeferred income tax assets, the Company has provided a full valuation allowanceon all of its U.S. deferred tax assets.

 

**11.  Concentrations of CreditRisk**

 

Financialinstruments that potentially subject the Company to significant concentrationsof credit risk principally consist of cash and cash equivalents, restrictedcash and accounts receivable. The Company maintains its cash and cashequivalent balances with highly rated financial institutions and, consequently,such funds are subject to minimal credit risk.

 

TheCompany’s customers are principally located in the northeastern and PJMInterconnection (PJM) regions of the United States. The Company performsongoing credit evaluations of the financial condition of its customers andgenerally does not require collateral. Although the Company is directlyaffected by the overall financial condition of the energy industry, as well asglobal economic conditions, management does not believe significant credit riskexisted as of September 30, 2010. The Company generally has notexperienced any material losses related to receivables from individualcustomers or groups of customers in the energy industry. The Company maintainsan allowance for doubtful accounts based on accounts past due and historicalcollection experience. The Company’s losses related to collection of tradereceivables have consistently been within management’s expectations. Due tothese factors, no additional credit risk beyond amounts provided for collectionlosses is believed by management to be probable.

 

Thefollowing table sets forth the Company’s significant customers. PJM and ISO-NewEngland, Inc. (ISO-NE) are regional grid operator customers comprised ofmultiple utilities and were formed to control the operation of a regional powersystem, coordinate the supply of electricity, and establish fair and efficientmarkets.

 
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|
| ** **                 | ** ** | **2010**                                                 | ** ** | **2009** | ** ** |
| ** **                 | ** ** | **Revenues**                                             | ** ** | **% of Total  Revenues** | ** ** | **Revenues** | ** ** | **% of Total  Revenues** | ** ** |
| PJM Interconnection        |       | $                                                        | 127,609    |   | 78 | % | $ | 75,029 |   | 73 | % |
| ISO-New England, Inc. |       | 9,216                                                    |       | 6 | % | 12,390 |   | 12 | % |
| Total                      |       | $                                                        | 136,825    |   | 84 | % | $ | 87,419 |   | 85 | % |

 
| ** **                 | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| ** **                 | ** ** | **Revenues**                                            | ** ** | **% of Total  Revenues** | ** ** | **Revenues** | ** ** | **% of Total  Revenues** | ** ** |
| PJM Interconnection        |       | $                                                       | 166,806    |   | 65 | % | $ | 98,216 |   | 60 | % |
| ISO-New England, Inc. |       | 41,466                                                  |       | 16 | % | 39,290 |   | 24 | % |
| Total                      |       | $                                                       | 208,272    |   | 81 | % | $ | 137,506 |   | 84 | % |

 

Accountsreceivable from these customers was approximately $13,322 and $9,788 atSeptember 30, 2010 and December 31, 2009, respectively.  No other customers represented 10% or greaterof accounts receivable at September 30, 2010 and December 31, 2009.  Unbilled revenue related to PJM was $114,221and $40,388 at September 30, 2010 and December 31, 2009,respectively.  There was no unbilledrevenue for any other customers at September 30, 2010 andDecember 31, 2009.

 

Depositsand restricted cash consist of funds to secure performance under certainutility and grid operator customer contracts and open market bidding programs.Deposits held by utility and grid operator customers were $4,026 and $3,024 atSeptember 30, 2010 and December 31, 2009, respectively.

 

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**12.Legal Proceedings**

 

TheCompany is subject to legal proceedings, claims and litigation arising in theordinary course of business. The Company does not expect the ultimate costs toresolve these matters to have a material adverse effect on the Company’sconsolidated financial condition, results of operations or cash flows.

 

**13.  Recent AccountingPronouncements**

 

In September 2009, the Financial Accounting Standards Board (FASB)ratified ASC Update No. 2009-13, *Multiple-DeliverableRevenue Arrangements* (ASU 2009-13). ASU 2009-13 amends existing revenue recognition accountingpronouncements that are currently within the scope of FASB ASC Subtopic 605-25.ASU 2009-13 provides for two significant changes to the existing multipleelement revenue recognition guidance. First, ASU 2009-13 deletes therequirement to have objective and reliable evidence of fair value forundelivered elements in an arrangement and will result in more deliverablesbeing treated as separate units of accounting. The second change in ASU 2009-13modifies the manner in which the transaction consideration is allocated acrossthe separately identified deliverables. These changes may result in entitiesrecognizing more revenue up-front, and entities will no longer be able to applythe residual method and defer the fair value of undelivered elements. Uponadoption of ASU 2009-13, each separate unit of accounting must have a sellingprice, which can be based on management’s estimate when there is no other meansto determine the fair value of that undelivered item, and the arrangementconsideration is allocated based on the elements’ relative selling price. ASU2009-13 is effective no later than fiscal years beginning on or afterJune 15, 2010, but may be adopted early as of the first quarter of anentity’s fiscal year. Entities may elect to adopt ASU 2009-13 either throughprospective application to all revenue arrangements entered into or materiallymodified after the date of adoption or through a retrospective application toall revenue arrangements for all periods presented in the financial statements.The Company is currently evaluating the impact of ASU 2009-13, including theperiod in which the Company will adopt ASU 2009-13.

 

InJanuary 2010, the FASB issued ASU 2010-06, *ImprovingDisclosure about Fair Value Measurements*(ASU 2010-06).  ASU 2010-06 requires additional disclosuresregarding fair value measurements, amends disclosures about post-retirementbenefit plan assets and provides clarification regarding the level ofdisaggregation of fair value disclosures by investment class. ASU 2010-06 iseffective for interim and annual reporting periods beginning afterDecember 15, 2009, except for certain Level 3 activity disclosurerequirements that will be effective for reporting periods beginning afterDecember 15, 2010. The adoption of ASU 2010-06 did not have a materialimpact on the Company’s consolidated financial position or results ofoperations.

 

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

 

*Thefollowing discussion should be read in conjunction with our unaudited condensedconsolidated financial statements and related notes thereto included elsewherein this Quarterly Report on Form 10-Q, as well as our audited financialstatements and notes thereto and Management’s Discussion and Analysis ofFinancial Condition and Results of Operations included in our Annual Report onForm 10-K for the fiscal year ended December 31, 2009, as filed withthe Securities and Exchange Commission, or the SEC, on March 12, 2010.This Quarterly Report on Form 10-Q contains forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended, or the Securities Act, and Section 21E of the Securities ExchangeAct 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” andvariations of those terms or the negatives of those terms and similarexpressions are intended to identify forward-looking statements. Allforward-looking statements included in this Quarterly Report on Form 10-Qare based on current expectations, estimates, forecasts and projections and thebeliefs and assumptions of our management including, without limitation, ourexpectations regarding our results of operations, operating expenses and thesufficiency of our cash for future operations. We assume no obligation torevise or update any such forward-looking statements. Our actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of certain important factors, including those set forth below underthis Item 2 — “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” Part II, Item 1A — “Risk Factors”and elsewhere in this Quarterly Report on Form 10-Q, as well as in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2009. You should carefully review those factors and also carefully review therisks outlined in other documents that we file from time to time with the SEC.*

 

**Overview**

 

Weare a leading provider of clean and intelligent energy management applicationsand services, which include comprehensive demand response services, data-drivenenergy efficiency services, energy price and risk management services andenterprise carbon management services. Our customers are commercial, institutional and industrial end-users ofenergy, or C&I customers, as well as electric power grid operators andutilities.

 

Webelieve that we are the largest demand response service provider to C&Icustomers in the United States. As of September 30, 2010, we managed over5,100 megawatts, or MW, of demand response capacity across a C&I customerbase of approximately 3,500 accounts and 8,200 sites throughout multipleelectric power grids. Demand response is an alternative to traditional powergeneration and transmission infrastructure projects that enables grid operatorsand utilities to reduce the likelihood of service disruptions, such asbrownouts and blackouts, during periods of peak electricity demand, andotherwise manage the electric power grid during short-term imbalances of supplyand demand. We use our Network Operations Center, or NOC, and comprehensivedemand response application, DemandSMART, to remotely manage and reduceelectricity consumption across a growing network of C&I customer sites,making demand response capacity available to grid operators and utilities ondemand while helping end-users of electricity achieve energy savings,environmental benefits and improved financial results. To date, we havereceived substantially all of our revenues from grid operators and utilities,who make recurring payments to us for managing demand response capacity that weshare with our C&I customers in exchange for those customers reducing theirpower consumption when called upon.

 

Inproviding our demand response services, we match obligation, in the form of MWthat we agree to deliver to our utility and grid operator customers, withsupply, in the form of MW that we are able to curtail from the electric powergrid through our C&I customers. We occasionally reallocate our obligationthrough open market bidding programs, supplemental demand response programs,auctions or other similar capacity arrangements, open program registrations andbilateral contracts to account for changes in supply and demand forecasts inorder to achieve more favorable pricing opportunities. We increase our ability tocurtail demand from the electric power grid by deploying a sales team tocontract with our C&I customers and by installing our equipment at thesecustomers’ sites to connect them to our network. When we are called upon by ourutility or grid operator customers to deliver MW, we use our DemandSMARTapplication to dispatch this network to meet the demands of these utility andgrid operator customers. We refer to the above activities as managing ourportfolio of demand response capacity.

 

Webuild upon our position as a leading demand response services provider by usingour NOC and energy management application platform to deliver a portfolio ofadditional energy management applications to our customers.  These additional energy managementapplications include our SiteSMART, SupplySMART and CarbonSMARTapplications.  SiteSMART is ourdata-driven energy efficiency application that has multiple features, includingmonitoring-based commissioning tools, commissioning and retro-commissioningauthority services, energy consulting and engineering services, distributedgeneration services and owner-engineer services.  SupplySMART is our energy price and riskmanagement application that provides our C&I customers located inrestructured or deregulated markets throughout the United States with theability to more effectively manage the energy supplier selection process,including energy supply product procurement and implementation.  CarbonSMART is our enterprise carbonmanagement application that supports the measurement, tracking, analysis,reporting and management of greenhouse gas emissions.

 

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Wecontinue to devote substantially all of our efforts toward the sale of ourenergy management applications and services. Our net income was $43.9 millionand $30.7 million, respectively, for the three and nine months endedSeptember 30, 2010.  Our net incomewas $26.6 million and $8.4 million, respectively, for the three and nine monthsended September 30, 2009.  As ofSeptember 30, 2010, our accumulated deficit was $46.6 million.

 

**Revenues and Expense Components**

 

***Revenues***

 

Wederive recurring revenues from the sale of our energy management applicationsand services. Our revenues from our demand response services primarily consistof capacity and energy payments, including ancillary services payments. Wederive revenues from demand response capacity that we make available in openmarket programs and pursuant to contracts that we enter into with gridoperators and utilities. In open market programs, grid operators and utilitiesgenerally seek bids from companies such as ours to provide demand responsecapacity based on prices offered in competitive bidding. These opportunitiesare generally characterized by flexible capacity commitments and prices thatvary by hour, day, month, bidding period or supplemental, new or modifiedprograms. In certain markets, we enter into contracts with grid operators andutilities, generally ranging from three to 10 years in duration, to deployour demand response services. We refer to these contracts as utility contracts.

 

Wherewe operate in open market programs, our revenues from demand response capacitypayments may vary month-to-month based upon our enrolled capacity and themarket payment rate. Where we have a utility contract, we receive periodiccapacity payments, which may vary monthly or seasonally, based upon enrolledcapacity and predetermined payment rates. Under both open market programs andutility contracts, we receive capacity payments regardless of whether we arecalled upon to reduce demand for electricity from the electric power grid, andwe recognize revenue over the applicable delivery period, even where paymentsare made over a different period. We generally demonstrate our capacity eitherthrough a demand response event or a measurement and verification test. Thisdemonstrated capacity is typically used to calculate the continuing periodiccapacity payments to be made to us until the next demand response event ormeasurement and verification test establishes a new demonstrated capacity amount.In most cases, we also receive an additional payment for the amount of energyusage that we actually curtail from the grid during a demand response event; wecall this an energy payment.

 

Wedo not recognize any revenues until we can determine that persuasive evidenceof an arrangement exists, delivery has occurred, the fee is fixed ordeterminable, and we deem collection to be reasonably assured. As programrules may differ for each open market program in which we participate orutility contract, we assess whether or not we have met the specific servicerequirements under the program rules and recognize or defer revenues asnecessary. We recognize demand response capacity revenues when we have providedverification to the grid operator or utility of our ability to deliver thecommitted capacity under the open market program or utility contract. Committedcapacity is verified through the results of an actual demand response event ora measurement and verification test. Once the capacity amount has beenverified, the revenues are recognized and future revenues become fixed ordeterminable and are recognized monthly over the performance period until thenext demand response event or measurement and verification test. In subsequentdemand response events or measurement and verification tests, if our verifiedcapacity is below the previously verified amount, the grid operator or utilitycustomer will reduce future payments based on the adjusted verified capacityamounts.  Under certain utility contractsand open market program participation rules, our performance and related feesare measured and determined over a period of time.  If we can reliablyestimate our performance for the applicable performance period, we will reservethe entire amount of estimated penalties that will be incurred, if any, as aresult of estimated underperformance prior to the commencement of revenuerecognition.  If we are unable to reliably estimate the performance andany related penalties, we will defer the recognition of revenues until the feeis fixed or determinable.  Any changes toour original estimates of net revenues are recognized as a change in accountingestimate in the earliest reporting period that such a change is determined.

 

Wedefer incremental direct costs incurred related to the acquisition ororigination of a utility contract or open market program in a transaction thatresults in the deferral or delay of revenue recognition. As ofSeptember 30, 2010 and December 31, 2009, the incremental directcosts deferred were approximately $0.9 million and $0.9 million,respectively. These deferred expenses would not have been incurred without ourparticipation in a certain open market program and will be expensed inproportion to the related revenue being recognized. During the three and ninemonths ended September 30, 2010 and 2009, we did not defer any utilitycontract or open market program origination costs. In addition, we capitalizethe costs of our production and generation equipment utilized in the deliveryof our demand response services and expense this equipment over the lesser ofits useful life or the term of the contractual arrangement. These capitalizedcosts are included in property and equipment in our consolidated balancesheets. We believe that this accounting treatment appropriately matchesexpenses with the associated revenue.

 

Asof September 30, 2010, we had over 5,100 MW under management in our demandresponse network, meaning that we had entered into definitive contracts withour C&I customers representing over 5,100 MW of demand response capacity.We generally begin earning revenues from our MW under management withinapproximately one month from the date on which we “enable” the MW, or the dateon which we can reduce the MW from the electricity grid if called upon to doso. The most significant exception is the PJM Interconnection, or PJM, forwardcapacity market, which is a market in which we expect to continue toparticipate and derive 

 

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revenuesfor the foreseeable future. Because PJM operates on a June toMay program-year basis, a MW that we enable after June of each yearmay not begin earning revenue until June of the following year. Thisresults in a longer average revenue recognition lag time in our C&Icustomer portfolio from the point in time when we consider a MW to be undermanagement to when we earn revenues from the MW. Certain other markets in whichwe currently participate, such as ISO New England, Inc., or ISO-NE, orchoose to participate in the future operate or may operate in a manner thatcould create a delay in recognizing revenue from the MW that we enable in thosemarkets. Additionally, not all of our MW under management may be enrolled in ademand response program or may earn revenue in a given program period or yearbased on the way that we manage our portfolio of demand response capacity.

 

Revenuesgenerated from open market sales to PJM, a grid operator customer, accountedfor 78% and 73%, respectively, of our total revenues for the three months endedSeptember 30, 2010 and 2009 and 65% and 60%, respectively, of our totalrevenues for the nine months ended September 30, 2010 and 2009. Undercertain utility contracts and open market programs, such as PJM’s EmergencyLoad Response Program, the period during which we are required to perform maybe shorter than the period over which we receive payments under that contractor program. In these cases, we record revenue, net of reserves for estimatedpenalties related to potential delivered capacity shortfalls, over themandatory performance obligation period, and a portion of the revenues thathave been earned is recorded and accrued as unbilled revenue. Our unbilledrevenue of $114.2 million at September 30, 2010 will be billed andcollected through May 31, 2011.

 

Revenuesgenerated from open market sales to ISO-NE, a grid operator customer, accountedfor 6% and 12%, respectively, of our total revenues for the three months endedSeptember 30, 2010 and 2009 and 16% and 24%, respectively, of our totalrevenues for the nine months ended September 30, 2010 and 2009.

 

Inaddition to demand response revenues, we generally receive either asubscription-based fee, consulting fee or a percentage savings fee forarrangements under which we provide our other energy management applicationsand services.  Revenues derived from ourother energy management applications and services were $4.0 million and$1.9 million, respectively, for the three months ended September 30,2010 and 2009 and $10.5 million and $5.0 million, respectively, for the ninemonths ended September 30, 2010 and 2009.

 

Ourrevenues have historically been higher in our second and third fiscal quarterscompared to other quarters in our fiscal year due to seasonal demand related tothe demand response market.

 

***Cost of Revenues***

 

Costof revenues for our demand response services consists primarily of amounts owedto our C&I customers for their participation in our demand response networkand are generally recognized over the same performance period as thecorresponding revenue. We enter into contracts with our C&I customers underwhich we deliver recurring cash payments to them for the capacity they committo make available on demand. We also generally make an additional payment whena C&I customer reduces consumption of energy from the electric power gridduring a demand response event. The equipment and installation costs for ourdevices located at our C&I customer sites, which monitor energy usage,communicate with C&I customer sites and, in certain instances, remotelycontrol energy usage to achieve committed capacity are capitalized anddepreciated over the lesser of the remaining estimated customer relationshipperiod or the estimated useful life of the equipment, and this depreciation isreflected in cost of revenues. We also include in cost of revenues ouramortization of capitalized internal-use software costs related to our energymanagement applications, the monthly telecommunications and data costs we incuras a result of being connected to C&I customer sites and our internalpayroll and related costs allocated to a C&I customer site. Certain costssuch as equipment depreciation and telecommunications and data costs are fixedand do not vary based on revenues recognized. These fixed costs could impact our gross margin trends described belowduring interim periods.  Cost of revenuesfor our other energy management applications and services include third partyservices, equipment depreciation and the wages and associated benefits that wepay 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 and services,(b) the selling price of our energy management applications and services, (c) ourcost of revenues, (d) the way in which we manage, or are permitted tomanage by the relevant grid operator or utility, our portfolio of demandresponse capacity, (e) the introduction of new clean and intelligentenergy management applications and services, (f) our demand response eventperformance and (g) our ability to open and enter new markets and regionsand expand deeper into markets we already serve. Our outcomes in negotiatingfavorable contracts with our C&I customers, as well as with our utility andgrid operator customers, the effective management of our portfolio of demandresponse capacity and our demand response event performance are the primarydeterminants of our gross profit and gross margin.

 

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***Operating Expenses***

 

Operating expenses consist of selling and marketing, general andadministrative, and research and development expenses. Personnel-related costsare the most significant component of each of these expense categories. We grewfrom 370 full-time employees at September 30, 2009 to 465 full-timeemployees at September 30, 2010. We expect to continue to hire employeesto support our growth for the foreseeable future. In addition, we incursignificant up-front costs associated with the expansion of the number of MWunder our management, which we expect to continue for the foreseeable future.Although we expect our overall operating expenses to increase in absolutedollar terms for the foreseeable future as we grow our MW under management andfurther increase our headcount, we expect our overall annual operating expensesto decrease as a percentage of total annual revenues as we leverage our existingemployee base and continue generating revenues from our MW under management.

 

*Selling and Marketing*

 

Selling and marketing expenses consist primarily of (a) salariesand related personnel costs, including costs associated with share-basedpayment awards, related to our sales and marketing organization,(b) commissions, (c) travel, lodging and other out-of-pocketexpenses, (d) marketing programs such as trade shows and (e) otherrelated overhead. Commissions are recorded as an expense when earned by theemployee. We expect increases in selling and marketing expenses in absolutedollar terms for the foreseeable future as we further increase the number ofsales professionals and, to a lesser extent, increase our marketing activities.We expect annual selling and marketing expenses to decrease as a percentage oftotal annual revenues as we leverage our current sales and marketing personnel.

 

*General and Administrative*

 

General and administrative expenses consist primarily of(a) salaries and related personnel costs, including costs associated withshare-based payment awards, related to our executive, finance, human resource,information technology and operations organizations, (b) facilitiesexpenses, (c) accounting and legal professional fees, (d) depreciationand amortization and (e) other related overhead. We expect general andadministrative expenses to continue to increase in absolute dollar terms forthe foreseeable future as we invest in infrastructure to support our continuedgrowth. We expect general and administrative expenses to decrease as apercentage of total annual revenues as we leverage our current infrastructureand employee base.  However, amortizationexpense from intangible assets acquired in future acquisitions couldpotentially increase our general and administrative expenses in future periods.

 

*Research and Development*

 

Research and development expenses consist primarily of(a) salaries and related personnel costs, including costs associated withshare-based payment awards, related to our research and developmentorganization, (b) payments to suppliers for design and consultingservices, (c) costs relating to the design and development of new energymanagement applications and services and enhancement of existing energy managementapplications and services, (d) quality assurance and testing and(e) other related overhead. During the three and nine months endedSeptember 30, 2010, we capitalized payroll and benefits-related internaluse software costs of $0.4 million and $1.2 million, respectively, and theamounts are included as software in property and equipment. We expect researchand development expenses to increase in absolute dollar terms for theforeseeable future as we develop new technologies and to decrease as apercentage of total revenues in the long term as we leverage our existingtechnology.

 

***Stock-Based Compensation***

 

We account for stock-based compensation in accordance with AccountingStandards Codification, or ASC, 718, *Stock Compensation*.  As such, all share-based payments toemployees, including grants of stock options, restricted stock and restrictedstock units, are recognized in the statement of income based on their fairvalues as of the date of grant. For stock options granted prior toJanuary 1, 2009, the fair value for these options was estimated at thedate of grant using a Black-Scholes option-pricing model, and for stock optionsgranted on or after January 1, 2009, the fair value of each award is andwill be estimated on the date of grant using a lattice valuation model. For thethree and nine months ended September 30, 2010, we recorded expenses ofapproximately $3.7 million and $11.7 million, respectively, in connectionwith share-based payment awards to employees and non-employees.  For the three and nine months endedSeptember 30, 2009, we recorded expenses of approximately$3.9 million and $10.0 million, respectively, in connection withshare-based payment awards to employees and non-employees.  With respect to grants throughSeptember 30, 2010, a future expense of non-vested options ofapproximately $13.0 million is expected to be recognized over a weightedaverage period of 2.3 years and a future expense of restricted stock andrestricted stock unit awards of approximately $11.6 million is expected tobe recognized over a weighted average period of 3.0 years.

 

***Other Income and Expense, Net***

 

Other income and expense consist primarily of interest income earned oncash balances, gain or loss on transactions designated in currencies other thanour or our subsidiaries’ functional currency and other non-operating income. Wehistorically have

 

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investedour cash in money market funds, treasury funds, commercial paper, municipalbonds and auction rate securities. We do not currently hold any auction rate securities.

 

***Interest Expense***

 

Interest expense consists of interest on our capital lease obligations,fees associated with our credit facility with Silicon Valley Bank, or the SVBcredit facility, and fees associated with issuing letters of credit and otherfinancial assurances.

 

**Consolidated Results of Operations**

 

***Three and Nine Months Ended September 30, 2010Compared to the Three and Nine Months Ended September 30, 2009***

 

***Revenues***

 

The following table summarizes our revenues for the three and ninemonths ended September 30, 2010 and 2009 (dollars in thousands):

 
| ** **                       | ** ** | **Three Months Ended September 30,** | ** ** | **Dollar** | ** ** | **Percentage** | ** ** |
|----------------------------------|------------|----------------------------------------------------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | **2010**                                                 | ** ** | **2009**   | ** ** | **Change**     | ** ** | **Change** | ** ** |
| Revenues:                        |       |                                                     |       |       |       |           |       |   |   |
| Demand response                  |       | $                                                        | 158,836    |       | $          | 101,227        |       | $ | 57,609 |   | 56.9 | % |
| Other energy management services |       | 3,962                                                    |       | 1,890      |       | 2,072          |       | 109.6 | % |
| Total revenues                   |       | $                                                        | 162,798    |       | $          | 103,117        |       | $ | 59,681 |   | 57.9 | % |

 
| ** **                       | ** ** | **Nine Months Ended September 30,** | ** ** | **Dollar** | ** ** | **Percentage** | ** ** |
|----------------------------------|------------|---------------------------------------------------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | **2010**                                                | ** ** | **2009**   | ** ** | **Change**     | ** ** | **Change** | ** ** |
| Revenues:                        |       |                                                    |       |       |       |           |       |   |   |
| Demand response                  |       | $                                                       | 246,983    |       | $          | 158,931        |       | $ | 88,052 |   | 55.4 | % |
| Other energy management services |       | 10,484                                                  |       | 5,011      |       | 5,473          |       | 109.2 | % |
| Total revenues                   |       | $                                                       | 257,467    |       | $          | 163,942        |       | $ | 93,525 |   | 57.0 | % |

 

For the three and nine months ended September 30, 2010, our demandresponse revenues increased by $57.6 million and $88.1 million, respectively,as compared to the same periods in 2009. The increase in our demand response revenues was primarily attributableto an increase in our MW under management in the following existing operatingareas (dollars in thousands):

 
| ** **                               | ** ** | **Revenue Increase (Decrease):**                                                           | ** ** | **Revenue Increase:**                                                                          | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                               | ** ** | **Three months ended  September 30, 2009 to  September 30, 2010** | ** ** | **Nine months ended  September 30, 2009 to  September 30, 2010** | ** ** |
| PJM                                      |       | $                                                                                                    | 52,580     |                                                                                                | $          | 68,590 |   |
| Tennessee Valley Authority               |       | 1,053                                                                                                |       | 5,289                                                                                               |       |
| New England                              |       | (3,174                                                                                               | )          | 2,176                                                                                               |       |
| New York                                 |       | 1,152                                                                                                |       | 2,368                                                                                               |       |
| California                               |       | 1,694                                                                                                |       | 2,113                                                                                               |       |
| Other (1)                                |       | 4,304                                                                                                |       | 7,516                                                                                               |       |
| Total increased demand response revenues |       | $                                                                                                    | 57,609     |                                                                                                | $          | 88,052 |   |

 

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(1)         The amounts included in thiscategory relate to increases in various demand response programs, none of whichare individually material.

 

In addition to an increase in our MW under management, the increase inour demand response revenues for the three and nine months endedSeptember 30, 2010 compared to the same periods in 2009 was alsoattributable to the effective management of our

 

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portfolioof demand response capacity and more favorable pricing in certain operatingareas.  These increases were offset bythe commencement of an ISO-NE program in which we currently participate, whichstarted on June 1, 2010, under which we enrolled fewer MW with lowerpricing compared to a prior, similar ISO-NE program in which we participated.

 

For the three months ended September 30, 2010, our other energymanagement services revenues increased by $2.1 million as compared to the threemonths ended September 30, 2009. For the nine months ended September 30, 2010, our other energy managementservices revenues increased by $5.5 million as compared to the nine monthsended September 30, 2009.  Theseincreases were primarily due to our acquisition of Cogent Energy, Inc., orCogent, a company specializing in comprehensive energy consulting, engineeringand building commissioning solutions to C&I customers, which occurred inDecember 2009.

 

We currently expect our revenues to increase in 2010 compared to 2009as we further increase our MW under management in all operating regions, enrollnew C&I customers in our demand response programs, expand the sales of ourother energy management applications and services to our new and existingC&I customers and pursue more favorable pricing opportunities with ourC&I customers.  Although we expect asignificant increase in our MW under management in the PJM market in 2011 ascompared to 2010, until PJM prices return in 2013 to more historical levels, weexpect our revenues derived from the PJM market to decrease as a percentage oftotal annual revenues in 2011 and 2012 as significantly lower capacity pricesin this market take effect for those years. These lower prices in PJM will negatively impact our ability to grow ouroverall revenues in 2011 and 2012 at levels consistent with prior years.

 

***Gross Profit and Gross Margin***

 

The following table summarizes our gross profit and gross marginpercentages for our demand response and other energy management services forthe three and nine months ended September 30, 2010 and 2009 (dollars inthousands):

 
| **Three Months Ended September 30,** | ** **   |
|----------------------------------------------------------|--------------|
| **2010**                                                 | ** **   | **2009** | ** ** |
| **Gross Profit**                                    | ** **   | **Gross Margin** | ** ** | **Gross Profit** | ** ** | **Gross Margin** | ** ** |
| $                                                        |  77,736 |   | 47.7 | % | $ | 51,677 |   | 50.1 | % |
|                                                          |              |  |  |  |  |  |  |  |  |

 
| **Nine Months Ended September 30,** | ** **    |
|------------------------------------------|---------------|
| **2010**                                 | ** **    | **2009** | ** ** |
| **Gross Profit**                    | ** **    | **Gross Margin** | ** ** | **Gross Profit** | ** ** | **Gross Margin** | ** ** |
| $                                        |  116,303 |   | 45.2 | % | $ | 77,710 |   | 47.4 | % |
|                                          |               |  |  |  |  |  |  |  |  |

 

Our gross profit increased during the three and nine months endedSeptember 30, 2010 as compared to the same periods in 2009 primarily dueto the substantial increase in our revenues, as well as the effectivemanagement of our portfolio of demand response capacity and strong demandresponse event performance, particularly in the PJM region from which wecurrently derive a substantial portion of our revenues.

 

Ourgross margin decreased during the three and nine months endedSeptember 30, 2010 as compared to the same periods in 2009 primarily dueto lower prices in the ISO-NE region, an increase in cost of revenues in acertain demand response program where the associated revenues were deferred andrecognition of certain project start-up costs related to an enterprise energymanagement arrangement pursuant to which revenue recognition has not yetcommenced.  Additionally, our grossmargin decreased during the three and nine months ended September 30, 2010as compared to the same periods in 2009 due to increased depreciation andamortization of capitalized costs and an impairment charge of $0.6 million and$1.3 million, respectively, recognized during the three and nine months ended September 30,2010 related to certain demand response and back-up generator equipment.

 

We currently expect that our gross margin for the year endingDecember 31, 2010 will be slightly lower as compared to the year endedDecember 31, 2009, and that our gross margin for the three months ended September 30,2010 will be the highest gross margin among our four quarterly reportingperiods in 2010, consistent with our gross margin pattern in 2009, due toseasonal demand related to the demand response market.  Further, for the year ended December 31,2009 and nine months ended September 30, 2010, we were able to derivesignificant gross profits from managing our portfolio of demand responsecapacity in the PJM incremental auctions, which may not occur at similar levelsbeyond 2010.  Until the prices in the PJMmarket improve in 2013, we expect the lower capacity prices that will takeeffect in the PJM market in 2011 and 2012 to negatively impact our ability togrow our overall gross profits and gross margins in 2011 and 2012 at levelsconsistent with prior years.

 

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***Operating Expenses***

 

The following table summarizes our operating expenses for the three andnine months ended September 30, 2010 and 2009 (dollars in thousands):

 
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|----------------|------------|
| ** **                 | ** ** | **2010**                                                 | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Operating Expenses:        |       |                                                     |       |           |       |   |   |
| Selling and marketing      |       | $                                                        | 12,893     |           | $          | 11,602 |   | 11.1 | % |
| General and administrative |       | 13,848                                                   |       | 12,155         |       | 13.9 | % |
| Research and development   |       | 3,197                                                    |       | 2,111          |       | 51.4 | % |
| Total                      |       | $                                                        | 29,938     |           | $          | 25,868 |   | 15.7 | % |

 
| ** **                 | ** ** | **Nine Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|----------------|------------|
| ** **                 | ** ** | **2010**                                                | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Operating Expenses:        |       |                                                    |       |           |       |   |   |
| Selling and marketing      |       | $                                                       | 34,173     |           | $          | 29,481 |   | 15.9 | % |
| General and administrative |       | 40,114                                                  |       | 33,252         |       | 20.6 | % |
| Research and development   |       | 7,748                                                   |       | 5,524          |       | 40.3 | % |
| Total                      |       | $                                                       | 82,035     |           | $          | 68,257 |   | 20.2 | % |

 

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 ourequipment at a C&I customer site to allow for the curtailment of MW fromthe electric power grid, up to twelve months in advance of enrolling theC&I customer in a particular program. This market feature creates a longeraverage revenue recognition lag time across our C&I customer portfolio fromthe point in time when we consider MW to be under management to when we earnrevenues from those MW. Because we incur operational expenses, includingsalaries and related personnel costs, at the time of enablement, we believethere may be a trend of incurring operating expenses associated with enablingour C&I customers in advance of recognizing the corresponding revenues.

 

*Selling and Marketing Expenses*

 
| ** **                | ** ** | **Three Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                                 | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Payroll and related costs |       | $                                                        | 8,983      |           | $          | 7,938 |   | 13.2 | % |
| Stock-based compensation  |       | 1,222                                                    |       | 1,181          |       | 3.5 | % |
| Other                     |       | 2,688                                                    |       | 2,483          |       | 8.3 | % |
| Total                     |       | $                                                        | 12,893     |           | $          | 11,602 |   | 11.1 | % |

 
| ** **                | ** ** | **Nine Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|---------------------------|------------|---------------------------------------------------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                                | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Payroll and related costs |       | $                                                       | 22,951     |           | $          | 19,872 |   | 15.5 | % |
| Stock-based compensation  |       | 3,403                                                   |       | 3,001          |       | 13.4 | % |
| Other                     |       | 7,819                                                   |       | 6,608          |       | 18.3 | % |
| Total                     |       | $                                                       | 34,173     |           | $          | 29,481 |   | 15.9 | % |

 

The increase in selling and marketing expenses for the three and ninemonths ended September 30, 2010 compared to the same periods in 2009 wasprimarily driven by the payroll and related costs associated with an increasein the number of selling and marketing full-time employees from 138 atSeptember 30, 2009 to 176 at September 30, 2010. The increase inpayroll and related costs for the nine months ended September 30, 2010compared to the same period in 2009 was also attributable to an increase insales commissions of $0.9 million due to the growth in our business.  The increase in stock-based compensation forthe nine months ended September 30, 2010 compared to the same period in2009 was primarily due to

 

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additionalstock-based awards to existing and new employees.  The increase in other selling and marketingexpenses for the nine months ended September 30, 2010 as compared to thesame period in 2009 was attributable to increases in professional services andmarketing costs of $0.6 million due to our rebranding efforts and attendance atconferences and seminars, increases in facility costs of $0.2 million due tothe expansion of our existing office space, and technology and communicationcosts of $0.4 million due to the increased utilization in our data servicecenters.

 

*General and Administrative Expenses*

 
| ** **                | ** ** | **Three Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                                 | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Payroll and related costs |       | $                                                        | 7,814      |           | $          | 6,561 |   | 19.1 | % |
| Stock-based compensation  |       | 2,218                                                    |       | 2,567          |       | (13.6 | )% |
| Other                     |       | 3,816                                                    |       | 3,027          |       | 26.1 | % |
| Total                     |       | $                                                        | 13,848     |           | $          | 12,155 |   | 13.9 | % |

 
| ** **                | ** ** | **Nine Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|---------------------------|------------|---------------------------------------------------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                                | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Payroll and related costs |       | $                                                       | 21,750     |           | $          | 17,199 |   | 26.5 | % |
| Stock-based compensation  |       | 7,676                                                   |       | 6,494          |       | 18.2 | % |
| Other                     |       | 10,688                                                  |       | 9,559          |       | 11.8 | % |
| Total                     |       | $                                                       | 40,114     |           | $          | 33,252 |   | 20.6 | % |

 

Theincrease in general and administrative expenses for the three and nine monthsended September 30, 2010 compared to the same periods in 2009 wasprimarily driven by an increase in the number of general and administrativefull-time employees from 184 at September 30, 2009 to 232 at September 30,2010.  The decrease in stock-basedcompensation for the three months ended September 30, 2010 compared to thesame period in 2009 was primarily due to the acceleration of the vesting of acertain portion of our former chief financial officer’s options to purchaseshares of our common stock during the three months ended September 30,2009.  The increase in stock-basedcompensation for the nine months ended September 30, 2010 compared to thesame period in 2009 was primarily due to annual stock-based awards granted toour officers and directors.  The increasein other general and administrative expenses for the three months endedSeptember 30, 2010 compared to the same period in 2009 was primarilyattributable to an increase in professional services costs of $0.5 million, anincrease in other tax expense of $0.2 million and an increase in bad debtexpense of $0.1 million.  The increase inother general and administrative expenses for the nine months endedSeptember 30, 2010 compared to the same period in 2009 was attributable toan increase in professional services of $0.5 million, facility costs of $0.4million primarily related to increased rent expense due to the expansion of ouroffice space and $0.2 million of other miscellaneous expenses associated withthe growth of our business.

 

*Research and Development Expenses*

 
| ** **                | ** ** | **Three Months Ended September 30,** | ** ** | **Percentage** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|----------------|------------|
| ** **                | ** ** | **2010**                                                 | ** ** | **2009**       | ** ** | **Change** | ** ** |
| Payroll and related costs |       | $                                                        | 1,664      |           | $          | 1,205 |   | 38.1 | % |
| Stock-based compensation  |       | 224                                                      |       | 174            |       | 28.7 | % |
| Other                     |       | 1,309                                                    |       | 732            |       | 78.8 | % |
| Total                     |       | $                                                        | 3,197      |           | $          | 2,111 |   | 51.4 | % |

 
| ** **                | ** ** | **Nine Months Ended September 30,** | ** ** | **Percentage ** | ** ** |
|---------------------------|------------|---------------------------------------------------------|------------|----------------------|------------|
| ** **                | ** ** | **2010**                                                | ** ** | **2009**             | ** ** | **Change** | ** ** |
| Payroll and related costs |       | $                                                       | 4,437      |                 | $          | 3,051 |   | 45.4 | % |
| Stock-based compensation  |       | 589                                                     |       | 501                  |       | 17.6 | % |
| Other                     |       | 2,722                                                   |       | 1,972                |       | 38.0 | % |
| Total                     |       | $                                                       | 7,748      |                 | $          | 5,524 |   | 40.3 | % |

 

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The increase in research and development expenses for the three andnine months ended September 30, 2010 compared to the same periods in 2009was primarily driven by the costs associated with an increase in the number ofresearch and development full-time employees from 48 at September 30, 2009to 57 at September 30, 2010, as well as higher average salary rates peremployee.  The increase in research anddevelopment expenses for the nine months ended September 30, 2010 compared tothe same period in 2009 was also attributable to lower capitalized internalpayroll and related costs of $0.5 million.  The increase in stock-based compensation forthe three and nine months ended September 30, 2010 compared to the sameperiods in 2009 was primarily attributable to stock-based awards granted tocertain employees in connection with our acquisition of SmallFoot LLC, orSmallfoot, and ZOX, LLC, or Zox, in March 2010.  The increase in other research anddevelopment expenses for the three months ended September 30, 2010 ascompared to the same period in 2009 was primarily related to a $0.3 millionincrease in technology and communications costs related to software licensesand fees used in the development of our various energy management applicationsand $0.3 million related to professional services for consulting servicesassociated with the development of our various energy management applications.The increase in other research and development expenses for the nine monthsended September 30, 2010 as compared to the same period in 2009 wasprimarily related to a $0.4 million increase in technology and communicationsrelated to software licenses and fees used in the development of our variousenergy management applications and $0.4 million related to professionalservices costs for consulting services associated with the development of ourvarious energy management applications.

 

***Other Income (Expense), Net***

 

Other income, net for the three and nine months ended September 30,2010 was primarily comprised of a nominal amount of interest income and anominal amount of foreign currency gains related to certain receivablesdenominated in foreign currencies.  Otherincome, net for the three months ended September 30, 2009 and otherexpense, net for the nine months ended September 30, 2009 was primarilycomprised of a nominal amount of interest income, as well as a nominal amountof foreign currency gains, for the three months ended September 30, 2009and a nominal amount of foreign currency losses for the nine months ended September 30,2009 related to certain receivables dominated in foreign currencies.

 

***Interest Expense***

 

Theincrease in interest expense for the three months ended September 30, 2010compared to the same period in 2009 was primarily due to increased letters ofcredit origination fees related to certain markets in which weparticipate.  The decrease in interestexpense for the nine months ended September 30, 2010 compared to the sameperiod in 2009 was due to our repayment of outstanding borrowings under the SVBcredit facility of $4.4 million during the three months ended December 31,2009, resulting in no interest expense related to any borrowings under the SVBcredit facility during the nine months ended September 30, 2010.  Additionally, the decrease in interestexpense for the nine months ended September 30, 2010 compared to the sameperiod in 2009 was due to $1.1 million in fees incurred during the nine monthsended September 30, 2009 associated with outstanding letters of credit,primarily attributable to the arrangement we entered into with a third party inMay 2009 in connection with bidding capacity into a certain open market program.  Interest expense for the three and ninemonths ended September 30, 2010 includes interest on our outstandingcapital leases and letters of credit origination fees.

 

***Income Taxes***

 

Werecorded a provision for income taxes of $3.8 million and $2.9 million for thethree and nine months ended September 30, 2010, respectively, whichincluded consideration of the tax benefit recognized by us from stock optiondeductions generated during the three and nine months ended September 30,2010.  Even though our federal and statenet operating loss carryforwards exceed our estimated taxable income for thefiscal year ending December 31, 2010, or fiscal 2010, our estimated annualeffective tax rate is greater than zero due to the following:

 

·                  estimatedforeign taxes resulting from guaranteed profit allocable to our foreignsubsidiaries, which have been determined to be limited-risk service providersacting on behalf of the U.S. parent for tax purposes, for which there are notax net operating loss carryforwards;

 

·                  certain statetaxes for jurisdictions where we do not have sufficient net operating losscarryforwards; and

 

·                  amortization oftax deductible goodwill, which generates a deferred tax liability that cannotbe offset by net operating losses or other deferred tax assets since itsreversal is considered indefinite in nature.

 

Oureffective tax rate for the three and nine months ended September 30, 2010was 7.9% and 8.5%, respectively.  Ourestimated annual effective tax rate for fiscal 2010 is 8.5%.  However, the estimated annual effective taxrate could be reduced in the fourth quarter of fiscal 2010 as a result of a taxbenefit from stock options which are not recognized in the determination of the

 

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estimatedannual effective rate until they occur. In addition, the estimated annual effective tax rate could increase inthe fourth quarter of fiscal 2010 if certain proposed state legislation ispassed that would limit our ability to utilize our net operating losscarryforwards to offset state taxable income for fiscal 2010.

 

Werecorded an income tax benefit of $0.8 million and $0.4 million for the threeand nine months ended September 30, 2009, respectively.  This tax provision was primarily related tothe amortization of tax deductible goodwill, which generated a deferred taxliability that cannot be offset by net operating losses or other deferred taxassets since its reversal is considered indefinite in nature.

 

Wereview all available evidence to evaluate the recovery of our deferred taxassets, including the recent history of accumulated losses in all taxjurisdictions over the last three years as well as our ability to generateincome in future periods. As of September 30, 2010 and December 31,2009, due to the uncertainty related to the ultimate use of our deferred incometax assets, we have provided a full valuation allowance against our U.S. deferredtax assets.

 

***Net Income***

 

Net income for the three months ended September 30, 2010 was $43.9million, or $1.76 per basic share and $1.67 per diluted share, compared to anet income of $26.6 million, or $1.21 per basic share and $1.12 perdiluted share, for the three months ended September 30, 2009.  Net income for the nine months endedSeptember 30, 2010 was $30.7 million, or $1.25 per basic share and $1.18per diluted share, compared to a net income of $8.4 million, or $0.40 perbasic share and $0.38 per diluted share, for the nine months endedSeptember 30, 2009. Excluding stock-based compensation charges andamortization of expenses related to acquisition-related assets, net of taxeffects, non-GAAP net income for the three months ended September 30, 2010was $47.6 million, or $1.91 per basic share and $1.81 per diluted share,compared to a non-GAAP net income of $30.7 million, or $1.40 per basicshare and $1.30 per diluted share, for the three months endedSeptember 30, 2009. Excluding stock-based compensation charges andamortization of expenses related to acquisition-related assets, net of taxeffects, non-GAAP net income for the nine months ended September 30, 2010was $42.4 million, or $1.72 per basic share and $1.63 per diluted share,compared to a non-GAAP net income of $18.9 million, or $0.90 per basicshare and $0.85 per diluted share, for the nine months ended September 30,2009. Please refer to the section below entitled “Use of Non-GAAP FinancialMeasures” for a reconciliation of non-GAAP measures to the most directlycomparable measure calculated and presented in accordance with GAAP.

 

**Use of Non-GAAP Financial Measures**

 

In this Quarterly Report on Form 10-Q, we provide certain “non-GAAPfinancial measures.” A non-GAAP financial measure refers to a numericalfinancial measure that excludes (or includes) amounts that are included in (orexcluded from) the most directly comparable financial measure calculated andpresented in accordance with GAAP in our financial statements. In thisQuarterly Report on Form 10-Q, we provide non-GAAP net income and non-GAAPnet income per share data as additional information relating to our operatingresults. These non-GAAP measures exclude expenses related to stock-based compensationand amortization expense related to acquisition-related assets. Management usesthese non-GAAP measures for internal reporting and forecasting purposes. Wehave provided these non-GAAP financial measures in addition to GAAP financialresults because we believe that these non-GAAP financial measures provideuseful information to certain investors and financial analysts in assessing ouroperating performance due to the following factors:

 

·                  we believe that thepresentation of non-GAAP measures that adjust for the impact of stock-basedcompensation expense and amortization expense related to acquisition-relatedassets provides investors and financial analysts with a consistent basis forcomparison across accounting periods and, therefore, are useful to investorsand financial analysts in helping them to better understand our operatingresults and underlying operational trends;

 

·                  although stock-basedcompensation is an important aspect of the compensation of our employees andexecutives, stock-based compensation expense is generally fixed at the time ofgrant, then amortized over a period of several years after the grant of thestock-based instrument, and generally cannot be changed or influenced bymanagement after the grant; and

 

·                  we do not acquire intangibleassets on a predictable cycle. Our intangible assets relate solely to businessacquisitions. Amortization costs are fixed at the time of an acquisition, arethen amortized over a period of several years after the acquisition andgenerally cannot be changed or influenced by management after the acquisition.

 

Pursuant to the requirements of the SEC, we have provided below areconciliation of each non-GAAP financial measure used to the most directlycomparable financial measure prepared in accordance with GAAP. These non-GAAPfinancial measures are not prepared in accordance with GAAP. These measures maydiffer from the non-GAAP information, even where similarly titled, used byother companies and therefore should not be used to compare our performance tothat of other companies. The presentation of this

 

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additionalinformation is not meant to be considered in isolation or as a substitute fornet income or net income per share prepared in accordance with GAAP.

 
| ** **                                               | ** ** | **Three Months Ended September 30,**                               | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2010**                                                                               | ** ** | **2009** | ** ** |
| ** **                                               | ** ** | **(In thousands, except share and per share data)** | ** ** |
| GAAP net income                                          |       | $                                                                                      | 43,866     |   | $ | 26,637 |   |
| ADD: Stock-based compensation                            |       | 3,664                                                                                  |       | 3,922 |   |
| ADD: Amortization expense of acquired intangible  assets |       | 353                                                                                    |       | 182 |   |
| LESS: Income tax effect of Non-GAAP adjustments  (1)     |       | (319                                                                                   | )          | — |   |
| Non-GAAP net income                                      |       | $                                                                                      | 47,564     |   | $ | 30,741 |   |
| GAAP net income per basic share                          |       | $                                                                                      | 1.76       |   | $ | 1.21 |   |
| ADD: Stock-based compensation                            |       | 0.15                                                                                   |       | 0.18 |   |
| ADD: Amortization expense of acquired intangible  assets |       | 0.01                                                                                   |       | 0.01 |   |
| LESS: Income tax effect of Non-GAAP adjustments  (1)     |       | (0.01                                                                                  | )          | — |   |
| Non-GAAP net income per basic share                      |       | $                                                                                      | 1.91       |   | $ | 1.40 |   |
| GAAP net income per diluted share                        |       | $                                                                                      | 1.67       |   | $ | 1.12 |   |
| ADD: Stock-based compensation                            |       | 0.14                                                                                   |       | 0.17 |   |
| ADD: Amortization expense of acquired intangible  assets |       | 0.01                                                                                   |       | 0.01 |   |
| LESS: Income tax effect of Non-GAAP adjustments  (1)     |       | (0.01                                                                                  | )          | — |   |
| Non-GAAP net income per diluted share                    |       | $                                                                                      | 1.81       |   | $ | 1.30 |   |
| Weighted average number of common shares  outstanding    |       |                                                                                   |       |   |   |
| Basic                                                    |       | 24,864,755                                                                             |       | 21,938,427 |   |
| Diluted                                                  |       | 26,215,766                                                                             |       | 23,689,477 |   |

 
| ** **                                               | ** ** | **Nine Months Ended September 30,**                                | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2010**                                                                               | ** ** | **2009** | ** ** |
| ** **                                               | ** ** | **(In thousands, except share and per share data)** | ** ** |
| GAAP net income                                          |       | $                                                                                      | 30,744     |   | $ | 8,374 |   |
| ADD: Stock-based compensation                            |       | 11,668                                                                                 |       | 9,996 |   |
| ADD: Amortization expense of acquired intangible  assets |       | 1,109                                                                                  |       | 514 |   |
| LESS: Income tax effect of Non-GAAP adjustments  (1)     |       | (1,091                                                                                 | )          | — |   |
| Non-GAAP net income                                      |       | $                                                                                      | 42,430     |   | $ | 18,884 |   |
| GAAP net income per basic share                          |       | $                                                                                      | 1.25       |   | $ | 0.40 |   |
| ADD: Stock-based compensation                            |       | 0.47                                                                                   |       | 0.48 |   |
| ADD: Amortization expense of acquired intangible  assets |       | 0.04                                                                                   |       | 0.02 |   |
| LESS: Income tax effect of Non-GAAP adjustments  (1)     |       | (0.04                                                                                  | )          | — |   |
| Non-GAAP net income per basic share                      |       | $                                                                                      | 1.72       |   | $ | 0.90 |   |
| GAAP net income per diluted share                        |       | $                                                                                      | 1.18       |   | $ | 0.38 |   |
| ADD: Stock-based compensation                            |       | 0.45                                                                                   |       | 0.45 |   |
| ADD: Amortization expense of acquired intangible  assets |       | 0.04                                                                                   |       | 0.02 |   |
| LESS: Income tax effect of Non-GAAP adjustments  (1)     |       | (0.04                                                                                  | )          | — |   |
| Non-GAAP net income per diluted share                    |       | $                                                                                      | 1.63       |   | $ | 0.85 |   |
| Weighted average number of common shares  outstanding    |       |                                                                                   |       |   |   |
| Basic                                                    |       | 24,650,453                                                                             |       | 20,703,779 |   |
| Diluted                                                  |       | 26,013,402                                                                             |       | 22,154,745 |   |

 

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(1)          Represents the increase in the income tax provisionrecorded for the three and nine months ended September 30, 2010 based onour effective tax rate for the three and nine months ended September 30,2010, respectively.

 

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**Liquidity and Capital Resources**

 

**Overview**

 

Since inception, we have generated significant cumulative losses. As ofSeptember 30, 2010, we had an accumulated deficit of $46.6 million.As of September 30, 2010, our principal sources of liquidity were cash andcash equivalents totaling $141.3 million, an increase of$21.6 million from the December 31, 2009 balance of$119.7 million. As of September 30, 2010, we were contingently liablefor $35.6 million in connection with outstanding letters of credit underthe SVB credit facility. As of September 30, 2010 and December 31,2009, we had restricted cash balances of $0.2 million and $7.9 million,respectively, which relate to amounts to collateralize unused outstandingletters of credit and cover financial assurance requirements in certain of theprograms in which we participate.

 

At September 30, 2010 and December 31, 2009, our excess cashwas primarily invested in money market funds.

 

We believe our existing cash and cash equivalents at September 30,2010 and our anticipated net cash flows from operating activities will besufficient to meet our anticipated cash needs, including investing activities,for at least the next 12 months. Our future working capital requirementswill depend on many factors, including, without limitation, the rate at whichwe sell certain of our energy management applications and services to utilitiesand grid operators and the increasing rate at which letters of credit orsecurity deposits are required by those utilities and grid operators, theintroduction and market acceptance of new energy management applications andservices, the expansion of our sales and marketing and research and developmentactivities, and the geographic expansion of our business operations. To theextent that our cash and cash equivalents and our anticipated cash flows fromoperating activities are insufficient to fund our future activities or plannedfuture acquisitions, we may be required to raise additional funds through bankcredit arrangements, including the potential expansion, renewal or replacementof the SVB credit facility, or public or private equity or debt financings. Wealso may raise additional funds in the event we determine in the future toeffect one or more acquisitions of businesses, technologies or products. Inaddition, we may elect to raise additional funds even before we need them ifthe conditions for raising capital are favorable. Accordingly, we have filed ashelf registration statement with the SEC to register shares of our commonstock and other securities for sale, giving us the opportunity to raise fundingwhen needed or otherwise considered appropriate at prices and on terms to bedetermined at the time of any such offerings. We currently have the ability tosell approximately $62.1 million of our securities under the shelfregistration statement. Any equity or equity-linked financing could be dilutiveto existing stockholders. In the event we require additional cash resources, wemay not be able to obtain bank credit arrangements or effect any equity or debtfinancing on terms acceptable to us or at all.

 

Ifwe fail to extend or renew the SVB credit facility and we still have letters ofcredit issued and outstanding under the SVB credit facility when it matures on February 4,2011, we will be required to post 105% of the value of the letters of credit incash with SVB to collateralize those letters of credit.

 

**Cash Flows**

 

The following table summarizes our cash flows for the nine months endedSeptember 30, 2010 and 2009 (dollars in thousands):

 
| ** **                                  | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                  | ** ** | **2010**                                                | ** ** | **2009** | ** ** |
| Cash flows provided by operating activities |       | $                                                       | 28,662     |   | $ | 3,042 |   |
| Cash flows used in investing activities     |       | (10,544                                                 | )          | (18,166 | ) |
| Cash flows provided by financing activities |       | 3,473                                                   |       | 84,243 |   |
| Effects of exchange rate changes on cash    |       | (9                                                      | )          | 25 |   |
| Net increase in cash and cash equivalents   |       | $                                                       | 21,582     |   | $ | 69,144 |   |

 

*Cash Flows Provided by Operating Activities*

 

Cash provided by operating activities primarily consists of net incomeadjusted for certain non-cash items including depreciation and amortization,stock-based compensation expenses, and the effect of changes in working capitaland other activities.

 

Cash provided by operating activities for the nine months endedSeptember 30, 2010 was $28.7 million and consisted of net income of $30.7 millionand $26.2 million of non-cash items, primarily consisting of depreciation andamortization, deferred taxes, stock-based compensation charges and impairmentof property and equipment, offset by $28.2 million of net cash used inworking capital and other activities. Cash used in working capital and otheractivities consisted of an increase of $73.8 million in unbilled revenuesrelating to the PJM demand response market and an increase of $16.6 million inaccounts receivable due to the timing of cash receipts under the demandresponse programs in which we participate. These amounts were partially offset by cash provided by working capitaland other activities which reflected an increase of $2.8 million inaccrued payroll and related expenses, an increase in other non-currentliabilities of $1.9 million, an increase of $7.6 million in accounts payableand accrued expenses due to the timing

 

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payments,an increase in accrued capacity payments of $48.6 million, the majority ofwhich was related to the PJM demand response market, an increase of $0.3 indeferred revenue and a decrease in prepaid expenses and other assets of $1.0million.

 

Cash provided by operating activities for the nine months endedSeptember 30, 2009 was $3.0 million and consisted of $8.4 million of netincome and $18.9 million of non-cash items, primarily consisting ofdepreciation and amortization, unrealized foreign exchange transaction loss,deferred tax provision, stock-based compensation charges and othermiscellaneous items, offset by $24.3 million of net cash used for workingcapital and other activities.  Cash used for working capital and otheractivities consisted of an increase of $53.3 million in unbilled revenuesrelating to the PJM demand response market, an increase in accounts receivableof $9.1 million due to the timing of cash receipts under the demand responseprograms in which we participate, an increase in other assets of $3.4 milliondue to increases in prepaid expenses, and a decrease of $1.6 million inaccounts payable and accrued expenses due to the timing of payments. Theseamounts were partially offset by cash provided by working capital and otheractivities, which reflected a $1.4 million increase in deferred revenue, a$35.8 million increase in accrued capacity payments, the majority of which wasrelated to the PJM demand response market, a $5.7 million increase in accruedpayroll and related expenses and an increase of $0.2 million in other noncurrentliabilities.

 

*Cash Flows Used in Investing Activities*

 

Cash used in investing activities was $10.5 million for the ninemonths ended September 30, 2010. Our principal cash investments during thenine months ended September 30, 2010 related to capitalizing internal usesoftware costs used to build out and expand our demand response and otherenergy management applications and services and purchases of property andequipment. During the nine months ended September 30, 2010, we acquiredSmallfoot and Zox for a purchase price of $1.4 million, of which $1.1 millionwas paid in cash.  Additionally, our cashinvestments included the cash portion of the earn-out payment due in connectionwith our acquisition of South River Consulting, LLC, or SRC, of $0.9 million.  We had a decrease in restricted cash anddeposits of $6.7 million primarily as a result of demand response eventperformance in July 2010 under a certain open market program in which weparticipate, resulting in our restricted cash becoming unrestricted in July 2010.  During the nine months endedSeptember 30, 2010, we also incurred $15.3 million in capitalexpenditures primarily related to the purchase of office equipment and demandresponse equipment and other miscellaneous expenditures.

 

Cashused in investing activities for the nine months ended September 30, 2009was $18.1 million. Our principal cash investments during this period related toinstallation services used to build out and expand our demand response andother energy management applications and services and purchases of property andequipment. Cash provided by the sales of available-for-sale securities duringthis period was $2.0 million, and we had an increase in restricted cash anddeposits for customer programs resulting in a reduction of cash of $5.9million, primarily as a result of our cash deposits made in connection withdemand response programs in which we participate. During the nine months endedSeptember 30, 2009, we also incurred $13.2 million in capital expendituresprimarily related to the purchase of office equipment, demand responseequipment and other miscellaneous expenditures. Additionally, our cashinvestments included the cash portion of the earn-out payment due in connectionwith our acquisition of SRC of $0.7 million and $0.3 million of cash used forour acquisition of eQuilibrium Solutions Corporation, or eQ.

 

*Cash Flows Provided by Financing Activities*

 

Cash provided by financing activities was $3.5 million for thenine months ended September 30, 2010 and consisted primarily of proceedsthat we received from exercises of options to purchase shares of our commonstock during the nine months ended September 30, 2010.

 

Cash provided by financing activities was $84.2 million for the ninemonths ended September 30, 2009.  InAugust 2009, we completed an underwritten public offering of 3,963,889shares of our common stock at an offering price of $27.00 per share, whichincluded the exercise of the underwriters’ over-allotment option to purchase213,889 shares and the sale of 709,026 shares by certain of our stockholders.Net proceeds to us from the offering were approximately$83.5 million.  Additionally, wereceived approximately $0.8 million from exercises of options to purchaseshares of our common stock during the nine months ended September 30,2009.

 

*Credit Facility Borrowings*

 

Pursuant to the terms of the SVB credit facility, SVB will, among otherthings, make revolving credit and term loan advances and issue letters ofcredit for our account.  All unpaidprincipal and accrued interest is due and payable in full on February 4,2011, which is the maturity date. Our obligations under the SVB credit facilityare secured by all of our assets and the assets of our subsidiaries, excludingany intellectual property. The SVB credit facility contains customary terms andconditions for credit facilities of this type. In addition, we are required tomeet certain financial covenants customary with this type of facility,including maintaining a minimum specified tangible net worth and a minimummodified quick ratio. The SVB credit facility contains customary events ofdefault. If a default occurs and is not cured within any applicable cure periodor is not waived, our obligations under the SVB credit facility may beaccelerated. We were in compliance with all financial covenants under the SVBcredit facility at September 30, 2010. As of September 30, 2010, wecontinue to have an aggregate of $35.6 million in letters of credit issuedfor our account under the SVB credit facility.

 

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InApril 2010, we and one of our subsidiaries entered into a second loanmodification agreement to the SVB credit facility, which increased ourborrowing limit from $35.0 million to $50.0 million, as well as modifiedcertain of our financial covenant compliance requirements.  In July 2010,we and one of our subsidiaries entered into a third loan modification agreementto the SVB credit facility, which extended the revolving credit line maturitydate of the SVB credit facility from August 5, 2010 to February 4,2011, as well as modified certain of our financial covenant compliancerequirements.  If we fail to extend orrenew the SVB credit facility and we still have letters of credit issued andoutstanding under the SVB credit facility when it matures on February 4,2011, we will be required to post 105% of the value of the letters of credit incash with SVB to collateralize those letters of credit.

 

In July 2010, based on our demandresponse event performance in connection with an open market program in which weparticipate, approximately $7.7 million of restricted cash that collateralizedour performance obligations became unrestricted.

 

**Contingent Earn-Out Payments**

 

In connection with our acquisition of Cogent, we agreed to make asingle contingent earn-out payment of $1.5 million in cash, to be paidbased on the achievement of a certain minimum revenue-based milestone and acertain earnings-based milestone of Cogent for the year endingDecember 31, 2010. Both of these milestones need to be achieved in orderfor the earn-out payment to occur, and there will be no partial payment if themilestones are not fully achieved. As we believe that it is remote that theearn-out payment will not be made, we determined the fair value of the earn-outpayment based on the present value of the $1.5 million, which will be paid inDecember 2010.

 

In connection with our acquisition of SRC, in addition to the amountspaid at closing, we incurred a contingent obligation to pay to the formerholders of SRC membership interests an earn-out amount equal to 50% to 60% ofthe revenues of SRC’s business during each twelve-month period from May 1,2008 through April 30, 2010, which would be recognized as additionalpurchase price when earned. The earn-out payments were based on the achievementof certain minimum revenue-based milestones of SRC and paid in a combination ofcash and shares of our common stock.  Theadditional purchase price recorded in the three months ended June 30,2009, which was related to the May 1, 2008 to April 30, 2009 earn-outperiod, totaled $1.5 million, of which $0.7 million was paid in cash during thethree months ended June 30, 2009 and the remainder of which was paid bythe issuance of 44,776 shares of our common stock during the three months endedSeptember 30, 2009.  The additionalpurchase price recorded in the six months ended June 30, 2010, which wasrelated to the May 1, 2009 to April 30, 2010 earn-out period, totaled$1.8 million, of which $0.9 million was paid in cash during the three monthsended June 30, 2010, $39,000 was settled through a reduction of areceivable due to us from the former holders of SRC membership interests andthe remainder of which was paid by the issuance of 30,879 shares of our commonstock with a fair value of $0.9 million.

** **

**CapitalSpending**

 

We have made capital expenditures primarily for general corporatepurposes to support our growth and for equipment installation related to ourbusiness. Our capital expenditures totaled $15.3 million and$13.2 million during the nine months ended September 30, 2010 and2009, respectively. As we continue to grow, we expect our capital expendituresfor 2010 to increase as compared to 2009.

 

**Contractual Obligations**

 

Asof September 30, 2010, the contractual obligations disclosure contained inour Annual Report on Form 10-K for the fiscal year ended December 31,2009, which we filed with the SEC on March 12, 2010, has not materiallychanged.

 

**Off-Balance Sheet Arrangements**

 

As of September 30, 2010, we did not have any off-balance sheetarrangements, 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 ourfinancial condition, changes in our financial condition, revenues or expenses,results of operations, liquidity, capital expenditures or capital resourcesthat is material to investors. We have issued letters of credit in the ordinarycourse of our business in order to participate in certain demand responseprograms. As of September 30, 2010, we had outstanding letters of credittotaling $35.6 million. For information on these commitments andcontingent obligations, see Note 8 to our unaudited condensed consolidatedfinancial statements contained herein.

 

**Critical Accounting Policies and Use of Estimates**

 

The discussion and analysis of our financial condition and results ofoperations are based upon our interim condensed consolidated financialstatements, which have been prepared in accordance with GAAP. The preparationof these consolidated

 

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financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, we evaluate ourestimates, including those related to revenue recognition for multiple elementarrangements, allowance for doubtful accounts, valuations and purchase priceallocations related to business combinations, expected future cash flowsincluding growth rates, discount rates, terminal values and other assumptionsand estimates used to evaluate the recoverability of long-lived assets andgoodwill, estimated fair values of intangible assets and goodwill, amortizationmethods and periods, certain accrued expenses and other related charges,stock-based compensation, contingent liabilities, tax reserves andrecoverability of our net deferred tax assets and related valuation allowance.We base our estimates on historical experience and various other assumptionsthat are believed to be reasonable under the circumstances. Actual resultscould differ from these estimates if past experience or other assumptions donot turn out to be substantially accurate. Any differences may have a materialimpact on our financial condition and results of operations.

 

The critical accounting estimates used in the preparation of ourfinancial statements that we believe affect our more significant judgments andestimates used in the preparation of our interim condensed consolidatedfinancial statements presented in this Quarterly Report on Form 10-Q aredescribed in “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and in the notes to the consolidated financialstatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2009, which we filed with the SEC on March 12,2010.  Except as disclosed herein, therehave been no material changes to our critical accounting policies or estimatesduring the three and nine months ended September 30, 2010.

 

**Recent Accounting Pronouncements**

 

In September 2009, the FASB ratified ASC Update No. 2009-13, *Multiple-Deliverable Revenue Arrangements*, or ASU2009-13.  ASU 2009-13 amends existingrevenue recognition accounting pronouncements that are currently within thescope of FASB ASC Subtopic 605-25. ASU 2009-13 provides for two significantchanges to the existing multiple element revenue recognition guidance. First,ASU 2009-13 deletes the requirement to have objective and reliable evidence offair value for undelivered elements in an arrangement and will result in moredeliverables being treated as separate units of accounting. The second changein ASU 2009-13 modifies the manner in which the transaction consideration isallocated across the separately identified deliverables. These changes mayresult in entities recognizing more revenue up-front, and entities will nolonger be able to apply the residual method and defer the fair value ofundelivered elements. Upon adoption of ASU 2009-13, each separate unit ofaccounting must have a selling price, which can be based on management’sestimate when there is no other means to determine the fair value of thatundelivered item, and the arrangement consideration is allocated based on theelements’ relative selling price. ASU 2009-13 is effective no later than fiscalyears beginning on or after June 15, 2010 but may be adopted early as ofthe first quarter of an entity’s fiscal year. Entities may elect to adopt ASU2009-13 either through prospective application to all revenue arrangementsentered into or materially modified after the date of adoption or through aretrospective application to all revenue arrangements for all periods presentedin the financial statements. We are currently evaluating the impact of ASU2009-13, including the period in which we will adopt ASU 2009-13.

 

InJanuary 2010, the FASB issued ASU 2010-06, *ImprovingDisclosure about Fair Value Measurements*, or ASU 2010-06.  ASU 2010-06 requires additional disclosuresregarding fair value measurements, amends disclosures about post-retirementbenefit plan assets and provides clarification regarding the level ofdisaggregation of fair value disclosures by investment class. ASU 2010-06 iseffective for interim and annual reporting periods beginning afterDecember 15, 2009, except for certain Level 3 activity disclosurerequirements that will be effective for reporting periods beginning afterDecember 15, 2010. The adoption of ASU 2010-06 did not have a materialimpact on our consolidated financial position or results of operations.

 

**Item 3.  Quantitative and Qualitative Disclosures About MarketRisk.**

 

AtSeptember 30, 2010, there had not been a material change in the interestrate risk information and foreign exchange risk information disclosed in the “Quantitativeand Qualitative Disclosures About Market Risk” subsection of the sectionentitled “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in our Annual Report on Form 10-K for the fiscalyear ended December 31, 2009, which we filed with the SEC onMarch 12, 2010.

 

**Item 4.  Controls and Procedures.**

 

***Disclosure Controls and Procedures***

 

Our principal executive officer and principal financial officer, afterevaluating the effectiveness of our disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the endof the period covered by this Quarterly Report on Form 10-Q, have concludedthat, based on such evaluation, our disclosure controls and procedures wereeffective to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported, within the time periods specified in the SEC’srules and forms, and is accumulated and communicated to 

 

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ourmanagement, including our principal executive and principal financial officers,or persons performing similar functions, as appropriate to allow timelydecisions regarding required disclosure.

 

***Internal Control over Financial Reporting***

 

No change in our internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act)occurred during the fiscal quarter ended September 30, 2010 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II — OTHER INFORMATION**

 

**Item 1.    Legal Proceedings.**

 

Weare subject to legal proceedings, claims and litigation arising in the ordinarycourse of business. We do not expect the ultimate costs to resolve thesematters to have a material adverse effect on our consolidated financialcondition, results of operations or cash flows.

 

**Item 1A.  Risk Factors.**

 

We operate in a rapidly changing environmentthat involves a number of risks that could materially affect our business,financial condition or future results, some of which are beyond ourcontrol.  In addition to the other information set forth in this QuarterlyReport on Form 10-Q, the risks and uncertainties that we believe are mostimportant for you to consider are discussed in Part I — Item 1A under theheading “Risk Factors” in our Annual Report on Form 10-K for the fiscalyear ended December 31, 2009, or our 2009 Form 10-K, which we filedwith the SEC on March 12, 2010.   During the three months endedSeptember 30, 2010, there were no material changes to the risk factorsthat were disclosed in Part I — Item 1A under the heading “Risk Factors”in our 2009 Form 10-K, other than as set forth below:

 

The following risk factors replace andsupersede the corresponding risk factors set forth in our 2009 Form 10-K:

*** ***

***A substantial majority of our revenues areand have been generated from contracts with, and open market program sales to,a limited number of grid operator and utility customers, and the modificationor termination of these open market programs or sales relationships couldmaterially adversely affect our business.***

 

Duringthe years ended December 31, 2007, 2008 and 2009 and the nine months endedSeptember 30, 2010, revenues generated from open market sales to PJM, agrid operator customer, accounted for 4%, 28%, 52% and 65%, respectively, ofour total revenues. The PJM forward capacity market is a market in which we expectto continue to increase our participation and derive revenues for theforeseeable future. The modification or termination of our sales relationshipwith PJM, or the modification or termination of any of PJM’s open marketprograms in which we participate, could significantly reduce our futurerevenues and profit margins and have a material adverse effect on our resultsof operations and financial condition. For example, beginning in June 2012,PJM will discontinue its Interruptible Load for Reliability program, or the ILRprogram, which is a program in which we have historically been an activeparticipant. The discontinuance of the ILR program by PJM will reduce theflexibility that we currently have to manage our portfolio of demand responsecapacity in the PJM market and will likely negatively impact our futurerevenues and profit margins. PJM may also adopt other open market program rule changes,some of which may have a material adverse effect on our results of operationsand financial condition, such as changes to the measurement and verificationcriteria used to establish a baseline of capacity for each C&I customersite in our portfolio, changes restricting our ability to achieve committedcapacity thresholds by aggregating performance from C&I customer sites inour portfolio, and other similar changes affecting the way in which we manageour portfolio of demand response capacity in the PJM market.

 

Revenuesgenerated from two fixed price contracts with, and open market sales to ISO-NE,a grid operator customer, accounted for 60%, 36%, 29% and 16%, respectively, ofour total revenues for the years ended December 31, 2007, 2008 and 2009and the nine months ended September 30, 2010. The modification ortermination of our sales relationship with ISO-NE, or the modification ortermination of any of ISO-NE’s open market programs in which we participate,could significantly reduce our future revenues and profit margins and have amaterial adverse effect on our results of operations and financial condition.

 

***If we fail to obtain favorable prices inthe open market programs in which we currently participate or choose toparticipate in the future, specifically in the PJM or ISO-NE market, ourrevenues, gross profits and profit margins will be negatively impacted.***

 

Inopen market programs, grid operators and utilities generally seek bids fromcompanies such as ours to provide demand response capacity based on pricesoffered in competitive bidding. These prices may be subject to volatility dueto certain market conditions or other events, and as a result the pricesoffered to us for this demand response capacity may be significantly lower thanhistorical prices. For example, open market auctions of capacity in the PJM andISO-NE markets in which we currently participate have resulted in prices thatare significantly lower than those achieved in prior periods. Accordingly, ourrevenues, gross profits and profit margins will be adversely affected in 2011and 2012 as the lower capacity prices in the PJM market take effect for thoseyears. To the extent we are subject to other similar price reductions, ourrevenues, gross profits and profit margins could be negatively impacted. Wealso may be subject to reduced capacity prices or be unable to participate incertain open market programs for a period of time to the extent that ourbidding strategy fails to produce favorable results. In addition, adversechanges in the general economic and market conditions in the United States mayresult in a reduced demand for electricity, resulting in lower prices forcapacity, both demand-side and supply-side, for the foreseeable future, whichcould materially and adversely affect our results of operations and financialcondition.

 

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**Item 6.  Exhibits.**

 
| 10.1@* |   | EnerNOC, Inc.  Amended and Restated 2007 Employee, Director and Consultant Stock Plan and  HMRC Sub-Plan for UK Employees, and forms of agreement thereunder.                                                                                                                                                     |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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 Financial 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 Financial 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. |

 

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| @ | Management  contract, compensatory plan or arrangement. |
|---|---------------------------------------------------------|
| * | Filed  herewith.                                        |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                         | EnerNOC, Inc. |
|------------------------------|--------------------|
|                         |               |   |
| Date:  November 9, 2010 | By:                | /s/  Timothy G. Healy |
|                         |               | Timothy  G. Healy |
|                         |               | Chief  Executive Officer |
|                         |               | (principal  executive officer) |
|                         |               |   |
| Date:  November 9, 2010 | By:                | /s/  Timothy Weller |
|                         |               | Timothy  Weller |
|                         |               | Chief  Financial Officer and Treasurer |
|                         |               | (principal  financial officer) |

 

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**Exhibit Index**

 
| **Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                                 |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                   |
| 10.1@*     |       | EnerNOC, Inc.  Amended and Restated 2007 Employee, Director and Consultant Stock Plan and  HMRC Sub-Plan for UK Employees, and forms of agreement thereunder.                                                                                                                                                     |
| 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 Financial 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 Financial 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. |

 

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| @ | Management  contract, compensatory plan or arrangement. |
|---|---------------------------------------------------------|
| * | Filed  herewith.                                        |

 

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