Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

#### **Washington, D.C. 20549**

 

----

 

# **Form 10-Q**

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

 

**For the quarterlyperiod ended September 30, 2009**

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

####  

#### **For the transition period from                        to                         **

 

**Commission file number 001-16265**

** **

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** **

**LIMEENERGY CO.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                   | ** ** | **36-4197337**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (I.R.S. Employer Identification No.) |

 

**1280 Landmeier Road, Elk Grove Village, Illinois60007-2410**(Address of principal executive offices, including zip code)

 

**(847) 437-1666**(Registrant’s telephone number, including area code)

 

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(Former name, former address and former fiscal year, if changed sincelast report)

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, everyInteractive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 ofthis chapter) duringthe preceding 12 months (or for suchshorter period that the registrant was required to submit and post such files). Yeso  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act.  (Check one):

 

| Large Accelerated Filer  o |   | Accelerated Filer  o   |
|---------------------------------|--------|-----------------------------|
|                            |   |                        |
| Non-Accelerated Filer o         |   | Smaller reporting company x |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

 

23,492,531 shares ofthe registrant’s common stock, $.0001 par value per share, were outstanding asof November 11, 2009.

 

 

 

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Table of Contents

 

**LIMEENERGY CO.**

**FORM 10-Q**

For The QuarterEnded September 30, 2009

 

#### INDEX

####  

| ** **    | ** **                                                                                                                      | ** ** | **Page**   |
|---------------|---------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **    | ** **                                                                                                                      | ** ** | **Number** |
|          |                                                                                                                            |       |       |
| Part I   | Financial Information                                                                                                           |       |       |
|          |                                                                                                                            |       |       |
| ITEM 1.       | Financial Statements:                                                                                                           |       |       |
|          |                                                                                                                            |       |       |
|          | Condensed Consolidated Balance Sheets  September 30, 2009 (unaudited) and December 31, 2008                           |       | 1          |
|          |                                                                                                                            |       |       |
|          | Unaudited Condensed Consolidated Statements of  Operations Three months and Nine months ended September 30, 2009 and  2008 |       | 3          |
|          |                                                                                                                            |       |       |
|          | Unaudited Condensed Consolidated Statement of  Stockholders’ Equity Nine months ended September 30, 2009              |       | 4          |
|          |                                                                                                                            |       |       |
|          | Unaudited Condensed Consolidated Statements of Cash  Flows Nine months ended September 30, 2009 and 2008                   |       | 5          |
|          |                                                                                                                            |       |       |
|          | Notes to  Condensed Consolidated Financial Statements                                                                           |       | 7          |
|          |                                                                                                                            |       |       |
| ITEM 2.       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                     |       | 21         |
|          |                                                                                                                            |       |       |
| ITEM 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                                     |       | 35         |
|          |                                                                                                                            |       |       |
| ITEM 4.       | Controls and  Procedures                                                                                                        |       | 35         |
|          |                                                                                                                            |       |       |
| Part II. | Other Information                                                                                                               |       |       |
|          |                                                                                                                            |       |       |
| ITEM 1A.      | Risk Factors                                                                                                                    |       | 36         |
|          |                                                                                                                            |       |       |
| ITEM 2.       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                    |       | 42         |
|          |                                                                                                                            |       |       |
| ITEM 6.       | Exhibits                                                                                                                        |       | 43         |
|          |                                                                                                                            |       |       |
|          | Signatures                                                                                                                      |       | 44         |

 

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Table of Contents

 

#### PART I - FINANCIALINFORMATION

####  

ITEM 1. FinancialStatements

 

**Lime Energy Co.**

**Condensed ConsolidatedBalance Sheets**

**(in thousands)**

 
| ** **                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                   | ** ** | **2009**               | ** ** | **2008****(1)**       | ** ** |
| ** **                                                                   | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
|                                                                         |       |                   |       |                  |       |
| **Assets**                                                                   |       |                   |       |                  |       |
|                                                                         |       |                   |       |                  |       |
| **Current assets**                                                           |       |                   |       |                  |       |
| Cash  and cash equivalents                                                   | ** ** | **$**                  | **24,217** | ** **            | **$**      | **3,734** | ** ** |
| Accounts  receivable, net                                                    | ** ** | **23,890**             | ** ** | **24,227**            | ** ** |
| Inventories                                                                  | ** ** | **316**                | ** ** | **665**               | ** ** |
| Costs  and estimated earnings in excess of billings on uncompleted contracts | ** ** | **3,624**              | ** ** | **4,078**             | ** ** |
| Prepaid  expenses and other                                                  | ** ** | **892**                | ** ** | **1,418**             | ** ** |
|                                                                         | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Total Current Assets**                                                     | ** ** | **52,939**             | ** ** | **34,122**            | ** ** |
| ** **                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Net Property and Equipment**                                               | ** ** | **1,962**              | ** ** | **2,081**             | ** ** |
| ** **                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Long Term Receivables**                                                    | ** ** | **633**                | ** ** | **1,031**             | ** ** |
| **Deferred Financing Costs, net**                                            | ** ** | **298**                | ** ** | **4**                 | ** ** |
| **Intangibles, net**                                                         | ** ** | **6,328**              | ** ** | **7,137**             | ** ** |
| **Goodwill**                                                                 | ** ** | **18,627**             | ** ** | **18,513**            | ** ** |
| ** **                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                         | ** ** | **$**                  | **80,787** | ** **            | **$**      | **62,888** | ** ** |

 

1

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**Lime Energy Co.**

**Condensed Consolidated BalanceSheets**

**(in thousands)**

* *
| ** **                                                                                                                                                                                                                                                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                   | ** ** | **2009**               | ** ** | **2008****(1)**       | ** ** |
| ** **                                                                                                                                                                                                                                                   | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
|                                                                                                                                                                                                                                                         |       |                   |       |                  |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                                                |       |                   |       |                  |       |
|                                                                                                                                                                                                                                                         |       |                   |       |                  |       |
| **Current liabilities**                                                                                                                                                                                                                                      |       |                   |       |                  |       |
| Lines  of Credit                                                                                                                                                                                                                                             | ** ** | **$**                  | **—** | ** **            | **$**      | **3,987** | ** ** |
| Current  portion of long-term debt                                                                                                                                                                                                                           | ** ** | **194**                | ** ** | **187**               | ** ** |
| Accounts  payable                                                                                                                                                                                                                                            | ** ** | **13,251**             | ** ** | **15,452**            | ** ** |
| Accrued  expenses                                                                                                                                                                                                                                            | ** ** | **3,112**              | ** ** | **3,855**             | ** ** |
| Billings  in excess of costs and estimated earnings on uncompleted contracts                                                                                                                                                                                 | ** ** | **1,538**              | ** ** | **1,958**             | ** ** |
| Deferred  revenue                                                                                                                                                                                                                                            | ** ** | **—**             | ** ** | **358**               | ** ** |
| Customer  deposits                                                                                                                                                                                                                                           | ** ** | **777**                | ** ** | **1,289**             | ** ** |
|                                                                                                                                                                                                                                                         | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Total Current Liabilities**                                                                                                                                                                                                                                | ** ** | **18,872**             | ** ** | **27,086**            | ** ** |
| ** **                                                                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Deferred Revenue**                                                                                                                                                                                                                                         | ** ** | **6**                  | ** ** | **90**                | ** ** |
| **Long-Term Debt,** less current portion                                                                                                                                                                                                                     | ** ** | **575**                | ** ** | **5,717**             | ** ** |
| **Deferred Tax Liability**                                                                                                                                                                                                                                   | ** ** | **1,034**              | ** ** | **1,034**             | ** ** |
| ** **                                                                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Total Liabilities**                                                                                                                                                                                                                                        | ** ** | **20,487**             | ** ** | **33,927**            | ** ** |
| ** **                                                                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Stockholders’ Equity**                                                                                                                                                                                                                                | ** ** | ** **             | ** ** | ** **            | ** ** |
| Preferred  stock, $0.01 par value; 1,000 authorized, 0 and 359 issued as of  September 30, 2009 and December 31, 2008, respectively (liquidation  value of $0 and $14,707 as of September 30, 2009 and December 31,  2008, respectively) | ** ** | **—**             | ** ** | **4**                 | ** ** |
| Common  stock, $0.0001 par value; 50,000 shares authorized 22,730 and 9,555 issued as  of September 30, 2009 and December 31, 2008, respectively                                                                                                   | ** ** | **2**                  | ** ** | **1**                 | ** ** |
| Additional  paid-in capital                                                                                                                                                                                                                                  | ** ** | **177,286**            | ** ** | **134,390**           | ** ** |
| Accumulated  deficit                                                                                                                                                                                                                                         | ** ** | **(116,988**           | **)**      | **(105,434**          | **)**      |
| ** **                                                                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| **Total Stockholders’ Equity**                                                                                                                                                                                                                          | ** ** | **60,300**             | ** ** | **28,961**            | ** ** |
| ** **                                                                                                                                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                                                                                                         | ** ** | **$**                  | **80,787** | ** **            | **$**      | **62,888** | ** ** |

 

*See accompanying notes to condensed consolidatedfinancial statements*

* *

----

| *(1)* | *Derived  from audited financial statements in the Company’s annual report on  Form 10-K for the year ended December 31, 2008* |
|-------|-----------------------------------------------------------------------------------------------------------------------------------------------|

 

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**Lime Energy Co.**

**Unaudited Condensed ConsolidatedStatements of Operations**

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

 
| ** **                                                          | ** ** | **Three Months**             | ** ** | **Nine Months**              | ** ** |
|---------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                          | ** ** | **Ended September 30,** | ** ** | **Ended September 30,** | ** ** |
| ** **                                                          | ** ** | **2009**                     | ** ** | **2008**                     | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                |       |                         |       |                         |       |   |   |   |   |
| **Revenue**                                                         | ** ** | **$**                        | **21,003** | ** **                   | **$**      | **17,709** | ** ** | **$** | **50,523** | ** ** | **$** | **26,334** | ** ** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost  of sales                                                      | ** ** | **16,524**                   | ** ** | **13,388**                   | ** ** | **40,397** | ** ** | **21,075** | ** ** |
| ** **                                                          | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross Profit**                                                    | ** ** | **4,479**                    | ** ** | **4,321**                    | ** ** | **10,126** | ** ** | **5,259** | ** ** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling,  general and administrative                                | ** ** | **5,731**                    | ** ** | **5,509**                    | ** ** | **16,513** | ** ** | **12,331** | ** ** |
| Amortization  of intangibles                                        | ** ** | **269**                      | ** ** | **602**                      | ** ** | **927** | ** ** | **984** | ** ** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Operating Loss**                                                  | ** ** | **(1,521**                   | **)**      | **(1,790**                   | **)**      | **(7,314** | **)** | **(8,056** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Other  Income (Expense)                                             | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest  income                                                    | ** ** | **30**                       | ** ** | **13**                       | ** ** | **92** | ** ** | **70** | ** ** |
| Interest  expense                                                   | ** ** | **(2,004**                   | **)**      | **(944**                     | **)**      | **(2,907** | **)** | **(1,862** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  other income (expense)                                       | ** ** | **(1,974**                   | **)**      | **(931**                     | **)**      | **(2,815** | **)** | **(1,792** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss  from continuing operations before discontinued operations     | ** ** | **(3,495**                   | **)**      | **(2,721**                   | **)**      | **(10,129** | **)** | **(9,848** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Discontinued Operations:**                                        | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss  from operation of discontinued business                       | ** ** | **(396**                     | **)**      | **(418**                     | **)**      | **(1,425** | **)** | **(2,055** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Loss**                                                        | ** ** | **(3,891**                   | **)**      | **(3,139**                   | **)**      | **(11,554** | **)** | **(11,903** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Preferred  Stock Dividends                                          | ** ** | **(297**                     | **)**      | **—**                   | ** ** | **(1,499** | **)** | **—** | ** ** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net Loss Available to Common Stockholders**                       | ** ** | **$**                        | **(4,188** | **)**                        | **$**      | **(3,139** | **)** | **$** | **(13,053** | **)** | **$** | **(11,903** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic  and diluted loss per common share from Continuing operations | ** ** | **$**                        | **(0.24**  | **)**                        | **$**      | **(0.31** | **)** | **$** | **(0.87** | **)** | **$** | **(1.21** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Discontinued  operations                                            | ** ** | **(0.02**                    | **)**      | **(0.05**                    | **)**      | **(0.11** | **)** | **(0.25** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic  and Diluted Loss Per Common Share                            | ** ** | **$**                        | **(0.26**  | **)**                        | **$**      | **(0.36** | **)** | **$** | **(0.98** | **)** | **$** | **(1.46** | **)** |
|                                                                | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted  Average Common Shares Outstanding (in thousands)          | ** ** | **15,956**                   | ** ** | **8,683**                    | ** ** | **13,365** | ** ** | **8,125** | ** ** |

 

*See accompanying notes to condensed consolidatedfinancial statements*

 

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**Lime Energy Co.**

**Unaudited Condensed ConsolidatedStatement of Stockholders’ Equity**

**(in thousands)**

 
| ** **                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Series A-1** | ** ** | **Series A-1** | ** ** | **Additional** | ** ** | ** **      | ** ** | **Total**              | ** **   |
|--------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|---------------------|------------|----------------|------------|-----------------|------------|------------------------|--------------|
| ** **                                                                           | ** ** | **Common** | ** ** | **Common** | ** ** | **Preferred**       | ** ** | **Preferred**       | ** ** | **Paid-in**    | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** **   |
| ** **                                                                           | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Shares**          | ** ** | **Stock**           | ** ** | **Capital**    | ** ** | **Deficit**     | ** ** | **Equity  (Deficit)**  | ** **   |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| **Balance,** December 31, 2008                                                  | ** ** | **9,555**  | ** ** | **$**      | **1**      | ** **          | **359**    | ** **          | **$**      | **4**          | ** ** | **134,390**     | ** ** | **$**                  | **(105,434** | **)** | **$** | **28,961** | ** ** |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Issuance  of common stock (less issuance costs of $2,057)                            |       | 5,933      |       | 1          |       | —              |       | —              |       | 28,717         |       | —          |       | 28,718                 |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Acquisition  of Advanced Biotherapy, Inc. (less transaction costs of $771)      |       | 2,486      |       | —     |       | —              |       | —              |       | 6,738          |       | —          |       | 6,738                  |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Earn-out  shares paid to former owners of Applied Energy Management, Inc.       |       | 63         |       | —     |       | —              |       | —              |       | 293            |       | —          |       | 293                    |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Preferred  dividends                                                                 |       | —     |       | —     |       | —              |       | —              |       | (1,499         | )          | —          |       | (1,499                 | )            |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Satisfaction  of accrued dividends through the issuance of preferred stock           |       | —     |       | —     |       | 19                  |       | —              |       | 781            |       | —          |       | 781                    |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Satisfaction  of interest obligation through issuance of common stock                |       | 45         |       | —     |       | —              |       | —              |       | 204            |       | —          |       | 204                    |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Conversion  of subordinated notes                                                    |       | 852        |       | —     |       | —              |       | —              |       | 5,000          |       | —          |       | 5,000                  |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Beneficial  conversion value of adjustment in conversion price of subordinated notes |       | —     |       | —     |       | —              |       | —              |       | 938            |       | —          |       | 938                    |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Conversion  of series A-1 preferred stock                                            |       | 3,778      |       | —     |       | (378                | )          | (4                  | )          | 4              |       | —          |       | —                 |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Warrants  issued in connection with bridge line of credit                            |       | —     |       | —     |       | —              |       | —              |       | 309            |       | —          |       | 309                    |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Share  based compensation                                                            |       | —     |       | —     |       | —              |       | —              |       | 1,326          |       | —          |       | 1,326                  |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Shares  issued for benefit plans and option exercises                                |       | 16         |       | —     |       | —              |       | —              |       | 72             |       | —          |       | 72                     |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Shares  issued for services received                                                 |       | 2          |       | —     |       | —              |       | —              |       | 13             |       | —          |       | 13                     |         |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| Net  loss for the nine months ended September 30, 2009                          |       | —     |       | —     |       | —              |       | —              |       | —         |       | (11,554         | )          | (11,554                | )            |
|                                                                                 |       |       |       |       |       |                |       |                |       |           |       |            |       |                   |         |
| **Balance,** September 30, 2009                                                 | ** ** | **22,730** | ** ** | **$**      | **2**      | ** **          | **—** | ** **          | **$**      | **—**     | ** ** | **177,286**     | ** ** | **$**                  | **(116,988** | **)** | **$** | **60,300** | ** ** |

 

*Seeaccompanying notes to condensed consolidated financial statements.*

 

4

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** **

**Lime Energy Co.**

**Condensed ConsolidatedStatements of Cash Flows**

**(in thousands, unaudited)**

** **
| **Nine  Months Ended September 30,**                                                            | ** ** | **2009**   | ** **  | **2008**    | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|-------------|-------------|------------|
|                                                                                                 |       |       |        |        |       |
| **Cash Flows from Operating Activities**                                                             |       |       |        |        |       |
| Net  Loss                                                                                            | ** ** | **$**      | **(11,554** | **)**       | **$**      | **(11,903** | **)** |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| Adjustments  to reconcile net loss to net cash used in operating activities, net of assets  acquired | ** ** | ** ** | ** **  | ** **  | ** ** |
| Provision  for (recovery of) bad debt                                                                | ** ** | **130**    | ** **  | **(24**     | **)**      |
| Share  based compensation                                                                            | ** ** | **1,326**  | ** **  | **2,862**   | ** ** |
| Preferred  stock dividends                                                                           | ** ** | **(1,499** | **)**       | **—**  | ** ** |
| Depreciation  and amortization                                                                       | ** ** | **1,495**  | ** **  | **1,687**   | ** ** |
| Amortization  of deferred financing costs                                                            | ** ** | **15**     | ** **  | **2**       | ** ** |
| Amortization  of issuance discount                                                                   | ** ** | **1,411**  | ** **  | **749**     | ** ** |
| Issuance  of stock and warrants in exchange for services received                                    | ** ** | **13**     | ** **  | **97**      | ** ** |
| Accrued  dividend satisfied through the issuance of preferred stock                                  | ** ** | **781**    | ** **  | **—**  | ** ** |
| Accrued  interest satisfied through the issuance of common stock                                     | ** ** | **204**    | ** **  | **250**     | ** ** |
| Beneficial  value of change in conversion price of suborinated notes                                 | ** ** | **938**    | ** **  | **—**  | ** ** |
| PIK  notes issued for interest                                                                       | ** ** | **21**     | ** **  | **26**      | ** ** |
| Asset  impairment                                                                                    | ** ** | **503**    | ** **  | **—**  | ** ** |
| Loss  on disposition of fixed assets                                                                 | ** ** | **13**     | ** **  | **2**       | ** ** |
| Changes  in assets and liabilities                                                                   | ** ** | ** ** | ** **  | ** **  | ** ** |
| Accounts  receivable                                                                                 | ** ** | **493**    | ** **  | **(8,933**  | **)**      |
| Inventories                                                                                          | ** ** | **(310**   | **)**       | **241**     | ** ** |
| Costs  and estimated earnings in excess of billings on uncompleted contracts                         | ** ** | **454**    | ** **  | **(1,117**  | **)**      |
| Prepaid  expenses and other current assets                                                           | ** ** | **526**    | ** **  | **(513**    | **)**      |
| Accounts  payable                                                                                    | ** ** | **(2,217** | **)**       | **2,526**   | ** ** |
| Accrued  expenses                                                                                    | ** ** | **124**    | ** **  | **661**     | ** ** |
| Billings  in excess of costs and estimated earnings on uncompleted contracts                         | ** ** | **(420**   | **)**       | **1,341**   | ** ** |
| Deferred  revenue                                                                                    | ** ** | **(90**    | **)**       | **(572**    | **)**      |
| Customer  deposits                                                                                   | ** ** | **(440**   | **)**       | **(47**     | **)**      |
|                                                                                                 | ** ** | ** ** | ** **  | ** **  | ** ** |
| Net  cash used in operating activities                                                               | ** ** | **(8,083** | **)**       | **(12,665** | **)**      |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| **Cash Flows Used in Investing Activities**                                                          | ** ** | ** ** | ** **  | ** **  | ** ** |
| Acquisition  costs, net of cash acquired                                                             | ** ** | **(1,047** | **)**       | **(3,789**  | **)**      |
| Expense  related to 2007 acquisitions                                                                | ** ** | **—** | ** **  | **(12**     | **)**      |
| Proceeds  from sale of fixed assets                                                                  | ** ** | **11**     | ** **  | **2**       | ** ** |
| Purchase  of property and equipment                                                                  | ** ** | **(305**   | **)**       | **(357**    | **)**      |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| Net  cash used in investing activities                                                               | ** ** | **(1,341** | **)**       | **(4,156**  | **)**      |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| **Cash Flows Provided by Financing Activities**                                                      | ** ** | ** ** | ** **  | ** **  | ** ** |
| Net  (payments) advances on line of credit                                                           | ** ** | **(3,966** | **)**       | **13,236**  | ** ** |
| Proceeds  from long-term debt                                                                        | ** ** | **27**     | ** **  | **133**     | ** ** |
| Payments  of long-term debt                                                                          | ** ** | **(1,574** | **)**       | **(570**    | **)**      |
| Proceeds  from issuance of common stock                                                              | ** ** | **38,203** | ** **  | **—**  | ** ** |
| Costs  related to stock issuances                                                                    | ** ** | **(2,828** | **)**       | **—**  | ** ** |
| Proceeds  from exercise of options and warrants                                                      | ** ** | **45**     | ** **  | **120**     | ** ** |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| Net  cash provided by financing activities                                                           | ** ** | **29,907** | ** **  | **12,919**  | ** ** |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| **Net Increase (Decrease) in Cash and Cash Equivalents**                                             | ** ** | **20,483** | ** **  | **(3,902**  | **)**      |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| Cash  and Cash Equivalents, at beginning of period                                                   | ** ** | **3,734**  | ** **  | **4,781**   | ** ** |
| ** **                                                                                           | ** ** | ** ** | ** **  | ** **  | ** ** |
| Cash  and Cash Equivalents, at end of period                                                         | ** ** | **$**      | **24,217**  | ** **  | **$**      | **879** | ** ** |

 

*See accompanying notes to condensed consolidatedfinancial statements.*

 

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| **As of  September 30,**                                                                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                    |       |     |       |     |       |
| **Supplemental Disclosure of Cash Flow Information (in  thousands)**                                    |       |     |       |     |       |
|                                                                                                    |       |     |       |     |       |
| Cash  paid during the period for interest - continuing operations                                       |       | $        | 417        |     | $          | 365 |   |
|                                                                                                    |       |     |       |     |       |
| Cash  paid during the period for interest - discontinued operations                                     |       | 1        |       | 1        |       |
|                                                                                                    |       |     |       |     |       |
| Cash  paid for preferred dividends                                                                      |       | 1,006    |       | —   |       |
|                                                                                                    |       |     |       |     |       |
| Subordinated  notes converted to common stock                                                           |       | 5,000    |       | —   |       |
|                                                                                                    |       |     |       |     |       |
| Interest  obligation satisfied through the issuance of common stock                                     |       | 204      |       | 250      |       |
|                                                                                                    |       |     |       |     |       |
| Accrued  earn-out satisfied through the issuance of common stock                                        |       | 293      |       | —   |       |
|                                                                                                    |       |     |       |     |       |
| Satisfaction  of accrued dividend through the issuance of 19 shares of Series A-1  preferred stock |       | 781      |       | —   |       |
|                                                                                                    |       |     |       |     |       |
| Extinguishment  of line of credit                                                                       |       | 21       |       | —   |       |
|                                                                                                    |       |     |       |     |       |
| Issuance  of revolving credit note in satisfaction of interest payable                                  |       | 21       |       | —   |       |
|                                                                                                    |       |     |       |     |       |
| Value  of warrants recorded to deferred financing costs                                                 |       | 309      |       | —   |       |
|                                                                                                         |            |          |            |          |            |  |  |

 

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Lime Energy Co.

Notes to Condensed ConsolidatedFinancial Statements

 

***Note 1 — Basis of Presentation***

 

The accompanyingunaudited condensed consolidated financial statements (the “FinancialStatements”) of Lime Energy Co. (“Lime Energy” and, together with itssubsidiaries, the “Company”, “we”, “us” or “our”) have been prepared inaccordance with Rule 10-01 of Regulation S-X promulgated by the Securitiesand Exchange Commission (the “SEC”) and, therefore, do not include allinformation and footnotes necessary for a fair presentation of financialposition, results of operations and cash flows in conformity with accountingprinciples generally accepted in the United States of America (“GAAP”).  In our opinion, however, the FinancialStatements contain all adjustments, consisting only of normal recurringadjustments, necessary to present fairly our financial position, results ofoperations and cash flows as of and for the interim periods.

 

The results of operationsfor the nine months ended September 30, 2009 and 2008 are not necessarilyindicative of the results to be expected for the full year.

 

For further information,refer to the audited financial statements and the related footnotes included inthe Lime Energy Co. Annual Report on Form 10-K for the year ended December 31,2008.

 

The Company disposed ofthe assets of its Maximum Performance Group, Inc. (“MPG”) subsidiary on August 10,2009 and has reported the operating results for this business as discontinuedoperations.  Please see Note 5 foradditional information regarding the discontinued operations.

 

The Company has evaluatedsubsequent events through November 12, 2009, the date these financialstatements were issued.

 

***Note 2 - Stock-Based Compensation***

 

**StockOptions**

 

TheCompany accounts for employee stock options in accordance with Accounting Standards Codification (ASC) 718. Thispronouncement requires companies to measure the cost of employee servicereceived in exchange for a share based award (typically stock options) based onthe fair value of the award, with expense recognized over the requisite serviceperiod, which is generally equal to the vesting period of the option.  The Company recognized approximately $388,000and $917,000 of share based compensation expense related to stock optionsduring the three-month periods ended September 30, 2009 and 2008,respectively.  The following tablesummarizes the expense for the three-month periods ended September 30,2009 and 2008 (in thousands):

 

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Lime Energy Co.

Notesto Condensed Consolidated Financial Statements

 
| ** **               | ** ** | **Three months ended September 30, 2009** | ** ** | **Three months ended September 30, 2008** | ** ** |
|--------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **               | ** ** | **Cost of**                                    | ** ** | ** **                                     | ** ** | ** ** | ** ** | **Cost of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Sales**                                      | ** ** | **SG&A**                                   | ** ** | **Total** | ** ** | **Sales** | ** ** | **SG&A** | ** ** | **Total** | ** ** |
|                     |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Continuing  operations   |       | $                                              | 24         |                                           | $          | 363 |   | $ | 387 |   | $ | 45 |   | $ | 834 |   | $ | 879 |   |
|                     |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |
| Discontinued  operations |       | 1                                              |       | —                                         |       | 1 |   | 13 |   | 25 |   | 38 |   |
|                     |       |                                           |       |                                           |       |   |   |   |   |   |   |   |   |
|                     |       | $                                              | 25         |                                           | $          | 363 |   | $ | 388 |   | $ | 58 |   | $ | 859 |   | $ | 917 |   |

 

TheCompany recognized $1.255 million and $2.862 million of share basedcompensation expense related to stock options during the nine-month periodsended September 30, 2009 and 2008, respectively.  The following table summarizes the expensefor the nine-month periods ended September 30, 2009 and 2008 (inthousands):

 
| ** **               | ** ** | **Nine months ended September 30, 2009** | ** ** | **Nine months ended September 30, 2008** | ** ** |
|--------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **               | ** ** | **Cost of**                                   | ** ** | ** **                                    | ** ** | ** ** | ** ** | **Cost of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Sales**                                     | ** ** | **SG&A**                                  | ** ** | **Total** | ** ** | **Sales** | ** ** | **SG&A** | ** ** | **Total** | ** ** |
|                     |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Continuing  operations   |       | $                                             | 77         |                                          | $          | 1,169 |   | $ | 1,246 |   | $ | 132 |   | $ | 2,584 |   | $ | 2,716 |   |
|                     |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Discontinued  operations |       | 7                                             |       | 2                                             |       | 9 |   | 41 |   | 105 |   | 146 |   |
|                     |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
|                     |       | $                                             | 84         |                                          | $          | 1,171 |   | $ | 1,255 |   | $ | 173 |   | $ | 2,689 |   | $ | 2,862 |   |

 

TheCompany historically used a modified Black-Scholes option pricing model tovalue its employee options, but on October 1, 2008, it began using anEnhanced Hull-White Trinomial model because it believed that the EnhancedHull-White Trinomial model more accurately reflected the value of theunderlying options.  Theweighted-average, grant-date fair value of stock options granted to employeesand the weighted-average significant assumptions used to determine those fairvalues, using a modified Black-Scholes option pricing model and EnhancedHull-White Trinomial model for stock options under ASC 718 are as follows:

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                      | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                      | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                            |       |                   |       |                   |       |   |   |   |   |
| Weighted  average fair-value per option granted |       | $                      | 2.35       |                   | $          | 4.41 |   | $ | 2.17 |   | $ | 5.08 |   |
|                                            |       |                   |       |                   |       |   |   |   |   |
| Significant  assumptions (weighted average):    |       |                   |       |                   |       |   |   |   |   |
| Risk-free  rate                                 |       | 0.18                   | %          | 1.90                   | %          | 0.13 | % | 2.24 | % |
| Dividend  yield                                 |       | 0.00                   | %          | 0.00                   | %          | 0.00 | % | 0.00 | % |
| Expected  volatility                            |       | 83.0                   | %          | 86.0                   | %          | 83.5 | % | 87.5 | % |
| Expected  life (years) (1)                      |       | 5.4                    |       | 5.9                    |       | 5.1 |   | 5.6 |   |
| Expected  turn-over rate (2)                    |       | 10.60                  | %          | —                 |       | 11.60 | % | — |   |
| Expected  exercise multiple (2)                 |       | 2.20                   |       | —                 |       | 2.20 |   | — |   |
|                                                 |            |                        |            |                        |            |  |  |  |  |  |  |  |  |

 

----

(1)   The company continues to use thesimplified method to estimate expected term due to the historical structuralchanges to its business such that historical exercise data may no longerprovide a reasonable basis on which to estimate expected term.

(2)   These assumptions are used with theEnhanced Hull-White Trinomial model which the Company began using on October 1,2008.

 

Therisk-free interest rate is based on the U.S. Treasury Bill rates at the time ofgrant. The dividend yield reflects the fact that the Company has never paid adividend on its common stock and does not expect to in the foreseeable future.The Company estimated the volatility of its common stock at the date of grantbased on the historical volatility of its stock. The expected term of theoptions is based on the simplified method as described in the Staff AccountingBulletin No. 107, which is the average of the vesting term and theoriginal contract term.  The expectedturn-over rate represents the expected forfeitures due to employee turnover andis based on historical rates experienced by the Company.  The expected exercise multiple represents themean ratio of the stock price to the exercise price at which employees areexpected to exercise their options and is based on an empirical study completedby S. Huddart and M. Lang (1996).

 

OnMarch 3, 2009, the Company completed a value-for-value stock optionexchange program which was approved by the Company’s stockholders on November 26,2008. Pursuant to the option exchange, 238,697 eligible options were canceledand replaced with 109,073 replacement stock options. The exchange ratio wascalculated such that the value of the replacement options would approximate thevalue of the canceled options, determined in accordance with the Black-Scholesoption valuation model.

 

Aspart of the acquisition of Advanced Biotherapy, Inc. (“ADVB”) the Companyagreed to exchange existing ADVB options for options to purchase the number ofshares of its stock each holder would have received had he or she exercised theoption in full prior to the acquisition with the same aggregate price andexpiration date.  ADVB option holders haduntil May 5, 2009 to accept the Company’s exchange offer.  The exchange offer has resulted in theCompany issuing options to acquire 194,150 shares of its stock to formerholders of ADVB options with an average exercise price of $3.62 per share.

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

Optionactivity under the Company’s stock option plans as of September 30, 2009and changes during the three months then ended are presented below:

 

| ** **                                      | ** ** | **Shares** | ** ** | **Exercise Price Per  Share** | ** ** | **Weighted  Average Exercise  Price** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------------------------|------------|---------------------------------------|------------|
|                                            |       |       |       |                          |       |                                  |       |
| Outstanding  at June 30, 2009              |       | 2,539,828  |       | $3.30 -  $1,363.95            |       | $                                     | 16.78      |   |
|                                            |       |       |       |                          |       |                                  |       |
| Granted                                         |       | 29,286     |       | $5.32 - $6.42                 |       | $                                     | 5.88       |   |
| Exercised                                       |       | (6,719     | )          | $3.66 - $7.00                 |       | $                                     | 6.64       |   |
| Forfeited                                       |       | (6,378     | )          | $3.66 - $215.25               |       | $                                     | 17.08      |   |
|                                            |       |       |       |                          |       |                                  |       |
| Outstanding  at September 30, 2009         |       | 2,556,017  |       | $3.30 -  $1,363.95            |       | $                                     | 16.68      |   |
|                                            |       |       |       |                          |       |                                  |       |
| Options  exercisable at September 30, 2009 |       | 1,787,132  |       | $3.30 -  $1,363.95            |       | $                                     | 21.12      |   |

 

Optionactivity under the Company’s stock option plans as of September 30, 2009and changes during the nine months then ended are presented below:

 

| ** **                                      | ** ** | **Shares** | ** ** | **Exercise Price Per  Share** | ** ** | **Weighted  Average Exercise  Price** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------------------------|------------|---------------------------------------|------------|
|                                            |       |       |       |                          |       |                                  |       |
| Outstanding  at December 31, 2008          |       | 2,488,657  |       | $3.50 -  $1,363.95            |       | $                                     | 18.61      |   |
|                                            |       |       |       |                          |       |                                  |       |
| Granted                                         |       | 292,151    |       | $3.30 - $196.88               |       | $                                     | 4.03       |   |
| Exercised                                       |       | (6,719     | )          | $3.66 - $7.00                 |       | $                                     | 6.64       |   |
| Forfeited                                       |       | (88,448    | )          | $3.50 - $215.25               |       | $                                     | 8.24       |   |
| Tendered  for exchange                          |       | (238,697   | )          | $8.26 - $215.25               |       | $                                     | 18.76      |   |
| Replacements  issued                            |       | 109,073    |       | $3.66                         |       | $                                     | 3.66       |   |
|                                            |       |       |       |                          |       |                                  |       |
| Outstanding  at September 30, 2009         |       | 2,556,017  |       | $3.30 -  $1,363.95            |       | $                                     | 16.68      |   |
|                                            |       |       |       |                          |       |                                  |       |
| Options  exercisable at September 30, 2009 |       | 1,787,132  |       | $3.30 -  $1,363.95            |       | $                                     | 21.12      |   |

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

Thefollowing table summarizes information about stock options outstanding at September 30,2009:

 

| ** **          | ** ** | **Options Outstanding**                         | ** ** | **Options Exercisable**                             | ** ** |
|---------------------|------------|-------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Exercise Price**  | ** ** | **Number  Outstanding  at September  30, 2009** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable at  September 30,  2009** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|                |       |                                            |       |                                                |       |   |   |   |   |   |   |
| $3.30  - $4.00      |       | 666,162                                         |       | 8.0 years                                           |       | $ | 3.48 |   | 243,600 |   | $ | 3.37 |   |
| $4.01  - $6.00      |       | 50,001                                          |       | 9.4 years                                           |       | $ | 4.84 |   | 17,860 |   | $ | 4.65 |   |
| $6.01  - $8.00      |       | 1,412,957                                       |       | 6.7 years                                           |       | $ | 7.07 |   | 1,341,291 |   | $ | 7.04 |   |
| $8.01  - $10.00     |       | 22,369                                          |       | 8.4 years                                           |       | $ | 9.07 |   | 14,604 |   | $ | 9.15 |   |
| $10.01  - $20.00    |       | 363,081                                         |       | 8.0 years                                           |       | $ | 11.15 |   | 128,330 |   | $ | 11.16 |   |
| $20.01  - $1,363.95 |       | 41,447                                          |       | 0.9 years                                           |       | $ | 623.37 |   | 41,447 |   | $ | 623.37 |   |
|                |       |                                            |       |                                                |       |   |   |   |   |   |   |
| $3.30  - $1,363.95  |       | 2,556,017                                       |       | 7.2 years                                           |       | $ | 16.68 |   | 1,787,132 |   | $ | 21.12 |   |

 

Theaggregate intrinsic value of the outstanding options (the difference betweenthe closing stock price on the last trading day of the third quarter of 2009 of$5.55 per share and the exercise price, multiplied by the number ofin-the-money options) that would have been received by the option holders hadall option holders exercised their options on September 30, 2009 wasapproximately $1.4 million. The aggregate intrinsic value of exercisableoptions as of September 30, 2009 was approximately $493,000.  These amounts will change based on changes inthe fair market value of the Company’s common stock.

 

Asof September 30, 2009, there was approximately $1.1 million of totalunrecognized compensation cost related to stock options which is expected to berecognized over a weighted-average period of 1.15 years.

 

*Employee Stock Purchase Plan*

 

The Company implemented an Employee Stock PurchasePlan during the first quarter of 2009, with the first offering periodcommencing on March 1, 2009 and ending on May 31, 2009.  A total of 8,959 shares of the Company’scommon stock were purchased under the Employee Stock Purchase Plan at theconclusion of the first offering period. As of September 30, 2009, 291,041 shares remain available forissuance under the 2008 Purchase Plan. The Company recorded compensationexpense related to the Employee Stock Purchase Plan of $29,053 and $70,850 forthe three month and nine month periods ended September 30, 2009,respectively.  As of September 30,2009 there was approximately $50,832 of total unrecognized compensation costrelated to the Employee Stock Purchase Plan which is expected to be recognizedover a 14 month period.

 

***Note 3 — Acquisition of Advanced Biotherapy, Inc.***

 

OnMarch 3, 2009, the Company exchanged 2,252,341 shares of its common stockfor 1,060,421,884 shares of Advanced Biotherapy, Inc. (“ADVB”) held bycertain stockholders of ADVB (the “Sellers”) 

 

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Lime Energy Co.

Notesto Condensed Consolidated Financial Statements

 

representingapproximately 90.8% of ADVB’s issued and outstanding shares pursuant to a StockPurchase Agreement dated November 18, 2008.  The Company then completed a short-formmerger in which it merged ADVB with and into a newly formed merger subsidiary,with the merger subsidiary continuing as the surviving entity.  Upon the closing of the merger the Companyobtained access to ADVB’s assets, including approximately $7.4 million of cashand a revolving credit note issued by the Company that had an outstandingbalance of $42,029 and accrued interest payable of $51,797.  The Company has cancelled the revolvingcredit note and does not plan to continue to operate ADVB as a going concern.

 

TheCompany exchanged the remaining shares of ADVB for 233,808 shares of theCompany’s common stock, pursuant to a Form S-4 registration statement(File No. 333-156924) that was declared effective by the Securities andExchange Commission on February 6, 2009.

 

RichardP. Kiphart, one of the Sellers, was the beneficial owner of more than 80% ofthe shares of ADVB and served as its Chairman. Mr. Kiphart also served andcontinues to serve as Chairman of the Company, and was the beneficial owner ofapproximately 40% of the common shares of the Company.  David Valentine is also a stockholder anddirector of Lime and was a stockholder and director of ADVB.

 

ADVB was formed for the purpose of developing biologictherapeutic antibodies for the treatment of a range of autoimmune diseasesbased on an anti-cytokine platform technology. ADVB’s activities consistedprimarily of research, development and investigational human clinical trials.  During 2006, ADVB completed a debtrestructuring and equity placement at which time Mr. Kiphart became ADVB’schairman and majority owner.  Due to thetime and expense required to commercialize the methods underlying its patentsin combination with the remaining life of the patents, ADVB’s managementdecided to discontinue all research and development work in 2006 and insteadfocus on investment and acquisition opportunities.  As of December 31, 2008, it had onepart-time employee whom Lime Energy did not retain after the stock exchange.

 

ADVB had no revenue generating operations and didnot have employees capable of developing a product that would be considered abusiness. Therefore the Company did not consider ADVB a business as defined byRegulation S-X, Rule 11-01(d) or by generally accepted accountingprinciples. Consequently, the merger was not accounted for as a businesscombination under the guidance of ASC 805, Business Combinations.  The substance of the ADVB acquisitionincludes two distinct events. First, as a result of the transaction, theCompany has settled the amounts due to ADVB under its revolving credit note(see note 9).  In addition, the Companyreceived approximately $7.4 million of cash in exchange for the shares of commonstock it issued in connection with the ADVB acquisition. As a result of themerger, the Company eliminated any debt due to ADVB, recorded the assetsacquired (consisting primarily of cash and cash equivalents) at fair value andcredited equity for the value of its common shares issued in connection withthe ADVB acquisition.

 

***Note 4 — Acquisition of Applied Energy Management, Inc.***

 

On June 11, 2008, the Company acquired all ofthe outstanding capital stock of Applied Energy Management, Inc. (“AEM”)for $4,000,000 in cash and 945,777 shares of the Company’s common stock, ofwhich $3,500,000 in cash and 882,725 shares were paid at the time of closingand $500,000 and 63,052 shares were paid in March 2009 followingdetermination of the amounts owed under an earn-out 

 

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Lime Energy Co.

Notesto Condensed Consolidated Financial Statements

 

provision of the purchase agreement.  For accounting purposes the common stockissued was valued at the fair market value at the time of issuance.  The acquisition was recorded using thepurchase method of accounting, accordingly, the results of operations for AEM have been included in theconsolidated statement of operations since the date of acquisition.

 

***Note 5 — Discontinued Operations***

 

On March 10, 2009, the Company announced itsintention to divest its Energy Technology segment operated by its subsidiaryManagement Performance Group, Inc. (“MPG”).  On August 10, 2009, the Company enteredinto an Asset Purchase Agreement with Elutions, Inc., a Delawarecorporation (“Elutions”) pursuant to which Lime sold certain assets of MPGincluding the eMAC and uMAC systems, accounts receivable, inventory andcustomer monitoring contracts.  The assetsale is structured as an earnout with certain minimum revenue levels that mustbe achieved by Elutions from the sale of the eMAC and uMAC controllers andsystems before any earnout is payable to Lime. The earnout period is for four years and Lime has an opportunity to earnup to $4 million.  The transaction closedon August 10, 2009.  During thequarter ended June 30, 2009, in anticipation of the sale, Lime reduced thecarrying value of MPG’s assets to their expected fair value, incurring animpairment loss of $503,407.  No earnoutpayments have been received to date and the Company does not anticipatereceiving any earnout payment before late 2010, at the earliest.

 

The assets and liabilities of the discontinuedoperations that are included in the Company’s consolidated assets andliabilities are as follows (in thousands):

 

| **As of**                                 | ** ** | **December 31, 2008** | ** **  |
|-------------------------------------------|------------|----------------------------|-------------|
|                                      |       |                       |        |
| Accounts  receivable                      |       | $                          |  413   |   |
| Other  current assets                     |       | 774                        |        |
| Total  current assets                     |       | 1,187                      |        |
|                                      |       |                       |        |
| Net  property, plant & equipment |       | 117                        |        |
| Other  assets                             |       | 327                        |        |
| Total  assets                             |       | $                          |  1,631 |   |
|                                      |       |                       |        |
|                                      |       |                       |        |
| Accounts  payable                         |       | $                          |  107   |   |
| Other  current liabilities                |       | 612                        |        |
| Total  current liabilities                |       | 719                        |        |
|                                      |       |                       |        |
| Long  term liabilities                    |       | 103                        |        |
| Total  liabilities                        |       | $                          |  822   |   |

 

After the impairment charge recorded during the quarterended June 30, 2009, the carrying value of the net assets of thediscontinued operations as of June 30, 2009 approximated $0.

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

The revenue and loss related to the discontinuedoperations were as follows (in thousands):

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **Nine  months ended September 30,** | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                      |       |                   |       |                   |       |   |   |   |   |
| Revenue                                   |       | $                      |  47   |                   | $          |  623 |   | $ |  828 |   | $ |  1,839 |   |
|                                      |       |                   |       |                   |       |   |   |   |   |
| Net  Loss                                 |       | (396                   | )          | (418                   | )          | (1,425 | ) | (2,055 | ) |
|                                           |            |                        |            |                        |            |  |  |  |  |  |  |  |  |

 

***Note 6 — Recent Accounting Pronouncements***

 

The Financial Accounting Standards Board (FASB)issued Accounting Standards Codification (ASC) 105-10, “The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples,” which was effective for fiscal years, and interim periods withinsuch fiscal years, ending after September 15, 2009. ASC 105-10 establishesan authoritative United States GAAP superseding all pre-existing accountingstandards and literature. ASC 105-10 is effective for the Company’s September 30,2009 interim financial reporting, and did not have a material effect on itsfinancial statements upon adoption. All references to specific authoritativeguidance have been updated within this report to reflect the new AccountingStandards Codification structure.

 

InDecember 2007, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 141(R), “BusinessCombinations” (SFAS 141(R)) (codified within ASC Topic 805). SFAS 141(R) establishesprinciples and requirements for how an acquirer recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,the goodwill acquired and any noncontrolling interest in theacquiree.  This statement also establishes disclosure requirements toenable the evaluation of the nature and financial effect of the businesscombination. SFAS 141(R) is effective for fiscal years beginning on orafter December 15, 2008.  The adoption of this statement did nothave a material impact on the Company’s consolidated results of operations andfinancial condition, but will affect future acquisitions.

 

In May 2009, the FASB issued SFAS No. 165,“Subsequent Events” (SFAS 165) (codified within ASC Topic 855). SFAS 165establishes general standards of accounting for and disclosure of events thatoccur after the balance sheet date but before the financial statements areissued or are available to be issued. Specifically, SFAS 165 sets forth theperiod after the balance sheet date during which management of a reportingentity should evaluate events or transactions that may occur for potentialrecognition or disclosure in the financial statements, the circumstances underwhich an entity should recognize events or transactions occurring after thebalance sheet date in its financial statements, and the disclosures that anentity should make about events or transactions that occurred after the balancesheet date. SFAS 165 is effective prospectively for interim and annual periodsending after June 15, 2009. The adoption of this statement did not have amaterial impact on the Company’s consolidated results of operations andfinancial condition as management followed a similar approach prior to theadoption of this standard.

 

InJune 2009, the FASB issued SFAS No. 167, “Amendments to FASBInterpretation No. 46(R)” (SFAS 167) (codified under the ASC 810). SFAS167 amends the consolidation guidance applicable to variable 

 

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Lime Energy Co.

Notesto Condensed Consolidated Financial Statements

 

interestentities and affects the overall consolidation analysis under FASBInterpretation No. 46(R). SFAS 167 is effective for fiscal years beginningafter November 15, 2009. The Company is currently evaluating the impactthat the adoption of SFAS 167 may have on the Company’s consolidated financialstatements.

 

***Note 7 — Net Loss Per Share***

 

The Company computes lossper share under ASC 260 “Earnings Per Share,” which requires presentation oftwo amounts: basic and diluted loss per common share. Basic loss per commonshare is computed by dividing loss available to common stockholders by thenumber of weighted average common shares outstanding, and includes all commonstock issued.  Diluted earnings wouldinclude all common stock equivalents. The Company has not included the outstanding options, warrants or sharesissuable upon conversion of the convertible debt as common stock equivalents inthe computation of diluted loss per share for the nine months ended September 30,2009 and 2008 because the effect would be antidilutive.

 

The following table setsforth the weighted average shares issuable upon exercise of outstanding optionsand warrants and conversion of convertible debt that are not included in thebasic and diluted loss per share available to common stockholders because to doso would be antidilutive:

 
| ** **                                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                      |       |                   |       |                   |       |   |   |   |   |
| Weighted  average shares issuable upon exercise of outstanding options    |       | 2,541,659              |       | 2,167,388              |       | 2,519,161 |   | 2,142,236 |   |
|                                                                      |       |                   |       |                   |       |   |   |   |   |
| Weighted  average shares issuable upon exercise of outstanding warrants   |       | 844,824                |       | 379,890                |       | 776,189 |   | 402,838 |   |
|                                                                      |       |                   |       |                   |       |   |   |   |   |
| Weighted  average shares issuable upon conversion of convertible debt (1) |       | 477,409                |       | 714,286                |       | 637,988 |   | 714,286 |   |
|                                                                      |       |                   |       |                   |       |   |   |   |   |
| Total                                                                     |       | 3,863,892              |       | 3,261,564              |       | 3,933,338 |   | 3,259,360 |   |

 

----

(1) *All of the convertible debtwas converted to common shares during the 3**rd** quarter of 2009.*

 

***Note 8 - Inventories***

 

Inventories consisted ofthe following (in thousands):

 

| ** **                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| **As of**                 | ** ** | **2009**               | ** ** | **2008**              | ** ** |
|                      |       |                   |       |                  |       |
| Raw  materials            |       | $                      |  316  |                  | $          |  667 |   |
|                      |       |                   |       |                  |       |
| Reserve  for obsolescence |       | —                 |       | (2                    | )          |
|                      |       |                   |       |                  |       |
|                      |       | $                      |  316  |                  | $          |  665 |   |

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

***Note 9 — Revolving Line of Credit***

** **

OnMarch 12, 2008, the Company entered into a $3 million revolving line ofcredit note with Advanced Biotherapy, Inc. (“ADVB”) and Richard Kiphart,the Company’s chairman and largest individual investor.  On June 6, 2008 and August 14, 2008the note and related documents were amended to increase the size of the line to$16 million with Mr. Kiphart increasing his commitment under his note to$14.5 million from $1.5 million.  On October 31,2008 the note and related documents with ADVB were amended to increase itscommitment from $1.5 million to $4.5 million. On November 14, 2008, Mr. Kiphart agreed to convert his noteinto shares of the Company’s Series A-1 preferred stock.  On November 18, 2008, the Companyentered an agreement to acquire 90.8% of the shares of ADVB and it completed ashort-form merger on March 3, 2009, whereby it merged ADVB with a newlycreated acquisition subsidiary. Following the merger it canceled the outstanding balance of $42,029 andaccrued interest of $51,797 on the ADVB line of credit.  Please refer to Note 3 for additionalinformation regarding the ADVB acquisition.

 

OnAugust 10, 2009, the Company and Mr. Kiphart entered into a new $2million revolving bridge line to meet any potential liquidity needs the Companymight have prior to the completion of its follow-on public offering of commonstock.  The bridge line note was tomature on February 10, 2010 and carried an interest rate of 17% per annum,with 12% payable quarterly in cash and the remaining 5% to be capitalized andadded to the principal balance on the note. The loan agreement also required that if the Company terminated the notebefore its scheduled maturity it would owe Mr. Kiphart the differencebetween $70,000 and any interest and unused line fees paid.  The Company issued Mr. Kiphart twowarrants in connection with the issuance of the revolving bridge line ofcredit.  The first warrant gives Mr. Kiphartthe right to purchase 75,000 shares of the Company’s common stock at $6.40 pershare any time prior to August 10, 2013. This warrant was valued at $309,338 using a trinomial tree optionpricing model using the following assumptions: risk free rate of 0.19%;expected volatility of 94.6%; expected dividend of $0; and expected life offour years.  The value of the warrant wasbooked to deferred financing costs and which the Company began amortizing overthe term of the bridge line.  The secondwarrant gave Mr. Kiphart the right to purchase 62,500 shares of theCompany’s common stock at $6.40 per share any time prior to February 20,2014, but this right only vested if the Company failed to repay any outstandingbalance on the bridge line at maturity.

 

TheCompany completed its follow-on offering of common stock in September 2009and terminated the bridge line on October 2, 2009.  The line was never utilized.  Upon termination, it paid Mr. Kiphartthe $70,000 fee described above and terminated the warrant to purchase 62,500shares of its common stock.

 

***Note 10 — SubordinatedConvertible Term Notes***

** **

Duringthe second quarter of 2007, eight investors, including Richard Kiphart, the Company’sChairman and largest individual stockholder (collectively the “Investors”), andthe Company entered into a loan agreement under which the Investors lent theCompany $5 million in the form of subordinated convertible term notes (the“Term Notes”).  The Term Notes were tomature on May 31, 2010, and accrued interest at the rate of 10% peryear.  Interest was payable quarterly,50% in cash and 50% in shares of the Company’s common stock valued at themarket price of the Company’s common stock on the interest due date.

 

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Lime Energy Co.

Notes to Condensed Consolidated FinancialStatements

 

Aspart of the transaction, the Company issued the Investors four-year warrants topurchase 206,044 shares of its common stock at $7.28 per share.  These warrants were valued at $1,136,537utilizing a modified Black-Scholes option pricing model utilizing the followingassumptions: risk free rate of 4.846%; expected volatility of 93.3%; expecteddividend of $0; and expected life of four years.

 

Theshares issued as part of the quarterly interest payments and issuable uponconversion of the term loan or exercise of the warrants were not registered forresale, though the Company has granted the Investors the right to demand theCompany use its best efforts to file a registration statement to register acertain minimum number of shares.

 

Inrecording the transaction, the Company allocated the value of the proceeds tothe Term Notes and warrants based on their relative fair values.  In doing so, it determined that the TermNotes contained a beneficial conversion feature since the fair market value ofthe common stock issuable upon conversion of the Term Notes (determined on theTerm Note issuance date) exceeded the value allocated to the Term Notes of$3,863,463.  The Term Notes wereconvertible into 714,286 shares of common stock, which at the market price of$8.02 per share on date of issuance of the Term Notes was worth$5,730,000.  The difference between themarket value of the shares issuable upon conversion and the value allocated tothe Term Notes of $1,866,537 was considered to be the value of the beneficialconversion feature.

 

Thevalue of the beneficial conversion feature and the value of the warrants wererecorded as a discount to the Term Notes which was then amortized over the termof the Term Notes using the effective interest method.  Amortization of the discount of $159,945 and$251,624 was included in interest expense during the three-month periods ended September 30,2009 and 2008, respectively.

 

Inaddition, the Company incurred costs of $8,572 relative to the Term Noteoffering.  These costs were capitalizedand were also being amortized over the term of the Term Notes using theeffective interest method.  Amortizationof the deferred issuance costs of $456 and $719 was included in interestexpense during the three-month periods ended September 30, 2009 and 2008,respectively.

 

OnAugust 10, 2009, the Company and Mr. Kiphart agreed to convert hisTerm Notes, totaling $3.1 million, into 484,375 shares of the Company’s commonstock at the prior day’s closing market price of $6.40 per share.  Also on August 10, 2009, the holders ofthe remaining Term Notes all elected to convert their notes into common stockupon the closing of the underwritten public offering at the lower of theoffering price less the underwriters’ discount and the stated conversion priceof the notes of $7.00 per share.  Thepublic follow-on offering closed on September 25, 2009, at which time the$1.9 million in Term Notes were converted into 367,504 shares of common stock.

 

Uponthe conversion of Mr. Kiphart’s Term Notes on August 10, 2009 and theremaining $1.9 million of Term Notes on September 25, 2009, the Companyexpensed the unamortized discount totaling $756,293 and deferred issuance coststotaling $2,157.  In addition, becausethe Term Notes were converted at less than their stated conversion price of$7.00, the Company was required to record a non-cash interest charge of$938,248 which represented the value of the additional shares issued as aresult of the reduction in the conversion price.

 

Asof September 30, 2009, there were no Term Notes outstanding.

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

***Note 11 — The November 2008 PIPE Transaction***

 

On November 13,2008, the Company entered into Subscription Agreements with 15 investors tosell 1,787,893 units, each comprised of one share of the Company’s common stockand a warrant to purchase an additional quarter share of common stock (the“Units”).  The sale price was $3.51 perUnit, which was equal to 75% of the volume-weighted average price of theCompany’s stock for the ten days prior to closing.  The warrants allow holders to purchase ashare of common stock for $4.10 per share, which was the closing price of theCompany’s common stock on the day prior to the closing, and the warrants areexercisable any time after May 13, 2009 and before November 13,2011.  The total gross proceeds raised inthe offering totaled $6,275,500.

 

The private offeringclosed in two tranches: tranche A, which was comprised of unaffiliatedinvestors; and tranche B which was comprised of affiliated investors, primarilyexecutive officers and directors of the Company.  The Company raised $3,000,500 in tranche A,which closed on November 13, 2008 and $3,275,000 in tranche B, whichclosed on January 30, 2009. The issuance of the Units sold in tranche Brequired approval by holders of a majority of the Company’s outstanding votingstock pursuant to the NASDAQ Marketplace Rules. The Company received the written consent in lieu of a meeting ofstockholders from the holders of shares representing 58.7% of the totaloutstanding shares of its common stock on November 13, 2008, which wassufficient under the General Corporation Law of the State of Delaware, theCompany’s By-Laws and the NASDAQ Marketplace Rules to approve thetransaction.

 

Securities and ExchangeCommission rules require that any corporate actions requiring thestockholder approval that are approved pursuant to a written consent in lieu ofa meeting be communicated to all stockholders via an Information Statement andthat the corporate action so approved cannot take place until at least 20 daysfollowing the mailing or giving of the Information Statement tostockholders.  The Company mailed anInformation Statement to all of its stockholders on December 31, 2008informing them of the November 13, 2008 written consent in lieu of ameeting.

 

***Note 12 — Preferred Stock***

 

OnNovember 14, 2008, Richard Kiphart agreed to convert his $14.5 millionrevolving line of credit note and $207,104 of accrued interest into 358,710shares of Series A-1 preferred stock. Each outstanding share of preferred stock was entitled to cumulativequarterly dividends at a rate of (i) 15% per annum of its stated value(which was $41.00) on or prior to March 31, 2009 (9% in cash and 6% inadditional shares of preferred stock); and (ii) 17% per annum of itsstated value, at any time on or after April 1, 2009 (9% in cash and 8% inadditional shares of preferred stock). The preferred stock was convertible at the holder’s election any timeafter December 31, 2009 into shares of the Company’s common stock at therate of 10 shares of common stock for each share of preferred stock.

 

OnAugust 10, 2009, to facilitate the anticipated public offering of itscommon stock, the Company and Mr. Kiphart converted his Series A-1preferred stock into 3,777,705 shares of the Company’s common stock.  Following this conversion there were noshares of Series A-1 Preferred Stock outstanding.

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

***Note 13 — Sale of Common Stock***

 

OnSeptember 25, 2009, the Company completed an underwritten follow-on publicoffering of its common stock, receiving $27,500,000 in gross proceeds less$1,650,000 in underwriters’ discount and offering costs of $381,830.  On October 2, 2009, the Underwritersexercised their overallotment and purchased an additional 750,000 shares fromthe Company at $5.50 per share, less a discount of 6% for total net proceeds tothe Company of $3,877,500.  Proceeds fromthe offering were used to repay a $2 million line of credit and $1.4 million innotes payable.  The balance of theproceeds will be used for other general corporate purposes.

 

Inconnection with this public offering all board members, the Company’s executivemanagement and former holders of the Company’s subordinated convertible notesentered into a six-month lockup agreement with the Underwriters.  The lock-up agreement prohibits any of theparties from selling any of the shares of the Company’s common stock prior to March 16,2010.  Under certain circumstances thelock-up period may be extended to as late as April 17, 2010.

 

***Note 14 — Business Segment Information***

 

The Company hashistorically segregated its results into three distinct reporting segments: theEnergy Efficiency Services segment; the Energy Technology segment and theFinancial Services segment.  As a resultof the decision to sell the Energy Technology segment, it has reported itsoperating results as discontinued operations. Since the Financial Services segment exists exclusively in support ofthe Energy Efficiency Services segment and does not represent a materialportion of the Company’s revenue or assets, management views the FinancialServices segment to be part of the Energy Efficiency Services segment and, thereforeit considers all of the Company’s continuing operations to be part of oneoperating segment.

 

***Note 15 — Other Equity Issuances***

 

(a)          During the first nine monthsof 2009, the Company issued 45,400 shares of its common stock to the holders ofits subordinated convertible term notes in satisfaction of 50% of the interestowed on the notes.

 

(b)         During thefirst nine months of 2009, the Company issued 19,063 shares of its Series A-1preferred stock in partial satisfaction of dividends owed the holder.

 

(c)          In August 2009, the Company issued2,000 shares to a consultant as partial compensation for servicesreceived.  These shares were valued atthe market on the date of issuance and charged to operations during August.

 

(d)         During thethird quarter of 2009, holders of certain of the Company’s options exercisedtheir rights to purchase 6,719 shares of the Company’s common stock.

 

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Lime Energy Co.

Notes to Condensed Consolidated Financial Statements

 

***Note 16 — Related Party Transactions***

 

OnJanuary 30, 2009, the Company closed on tranche B of the SubscriptionAgreements dated November 13, 2008 between the Company and seven investorsaffiliated with the Company.  Theinvestors in this private transaction included Richard Kiphart, the Company’sChairman, David Asplund, the Company’s Chief Executive Officer, Daniel Parke,the Company’s President, Jeffrey Mistarz, the Company’s Chief FinancialOfficer, and Gregory Barnum and David Valentine, members of the Company’s Boardof Directors.  For additional informationregarding this transaction please refer to Note 11 above.

 

Asis more fully described in Note 3 above, in March 2009, the Companyacquired all of the outstanding shares of Advanced Biotherapy, Inc., acompany in which Mr. Kiphart, the Company’s Chairman and largestindividual stockholder, owned approximately 80% of the common stock and servedas the chairman of its board of directors. Mr. David Valentine, one of the Company’s directors, was also adirector and stockholder of Advanced Biotherapy.

 

OnAugust 10, 2009, Mr. Kiphart, the Company’s Chairman, converted allof his shares of Series A-1 Convertible Preferred Stock into 3,777,705shares of common stock and $3.1 million of Convertible Subordinated Notes into484,375 shares of common stock.  Pleaserefer to Notes 10 and 12 for additional information regarding these conversions.

 

***Note 17 — Subsequent Events***

 

OnOctober 2, 2009, the underwriters for the Company’s public offeringexercised their overallotment option to purchase 750,000 shares of theCompany’s common stock for total net proceeds to the Company of$3,877,500.  For additional informationplease refer to note 13.

 

OnOctober 2, 2009, the Company terminated its $2 million revolving bridgeline of credit.  For additionalinformation regarding the bridge line please refer to note 9.

 

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| **ITEM 2.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS**OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS |
|-------------|----------------------------------------------------------------------------------------------|

** **

You should read thefollowing discussion regarding the Company along with our financial statementsand related notes included in this quarterly report.  This quarterly report, including thefollowing discussion, contains forward-looking statements that are subject torisks, uncertainties and assumptions. Our actual results, performance and achievements in 2009 and beyond maydiffer materially from those expressed in, or implied by, these forward-lookingstatements.  See Cautionary NoteRegarding Forward-Looking Statements.

 

**Overview**

 

We are a leading provider ofintegrated energy engineering, consulting and implementation solutionsspecializing in improving the energy efficiency of our clients’ facilities, reducing their operating costs andcarbon emissions.  We operate in twospecific markets: the commercial and industrial (C&I) market and the publicsector market.    In the C&I marketwe sell directly to commercial and industrial clients and to utilities where weact as energy efficiency program managers. In the public sector market we work with energy service companies(“ESCOs”), but we have also recently begun to act as a prime contractor to thefederal government when they do not need the services of our ESCOpartners.  Our clients include commercialand industrial businesses, property owners and managers, utilities, ESCOsserving U.S. government and educational institutions, and the federalgovernment.  We focus on deployingsolutions to reduce the energy-related expenditures of our client’s facilitiesand the impact of their energy use on the environment, including energyefficient lighting upgrades, energy efficiency mechanical and electricalretrofit and upgrade services, water conservation, weatherization and renewableproject development and implementation. We provide energy efficiency solutions across all of our clients’facilities, ranging from high-rise office buildings to manufacturing plants,retail sites, mixed use complexes and large, government sites to small, localfacilities.

 

Weoffer our clients a full range of services to address the energy efficiencyneeds of their facilities based on our ability to identify and deliversignificant return on our clients’ investments, improve the quality of theirphysical workspaces, maximize their operational savings and reduce theirmaintenance costs. Our turnkey services include**:**

 

**·**                  *Energy Engineering andConsulting*:  We apply our engineering expertise to analyzeeach client’s energy consumption and operational needs and develop customizedenergy efficiency and renewable energy solutions.  Our energy engineering and consulting servicesinclude sustainability consulting, energy master planning, project developmentservices, design engineering and building e-commissioning.  We also provide design review and analysis ofnew construction projects to maximize energy efficiency and sustainability,project management of energy-related construction, and processing andprocurement of incentive and rebate applications.

** **

**·**                  *Implementation:*  Weprovide complete turnkey implementation services for a range of energyefficiency and renewable energy projects, including energy efficient lightingupgrades, energy efficiency mechanical and electrical retrofit and upgradeservices, water conservation, weatherization and renewable project developmentand implementation, including solar, biomass and geothermal.  We consider factors such as current facilityinfrastructure, best available technologies, building environmental conditions,hours of operation, energy costs, available utility rebates and tax incentives,and installation, operation and maintenance costs of various efficiencyalternatives.  Our professionals’extensive knowledge in energy efficiency solutions

 

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**enables us to apply the mostappropriate, effective and proven technologies available in the marketplace.**

** **

We serve a wide range of commercial, industrial,utility and public sector clients.  Ourcommercial and industrial clients include many Fortune 500 companies for whichwe provide our energy efficiency solutions directly, as well as utilities forwhich we manage energy efficiency portfolio projects. Our public sector clientsinclude government agencies and educational institutions, which we serve boththrough our relationships with ESCOs and directly.  ESCOs are awarded project contracts with thepublic sector as prime contractors, and we provide energy efficiency expertiseto develop and implement tailored solutions under these contracts.  In addition, during the third quarter of 2009we became one of three companies qualified to bid under the US Army Corp. ofEngineers’ Facility Repair and Renewal (FRR) program.  As a result, we are now able to bid directlyon federal government projects under the FRR program as a prime contractor.

 

In August 2009 we sold certain assets of our Maximum PerformanceGroup, Inc. subsidiary, which formerly made up our Energy Technologybusiness segment in order to focus on our core Energy Efficiency Servicesbusiness.  The Energy Technology segment,which represented approximately 4% of our 2008 revenue, offered a patented lineof heating, ventilation and air conditioning and lighting controllers under theeMAC and uMAC brand names. The eMAC technology provides remote monitoring,management and control of commercial rooftop HVAC units. The uMAC technology isa version of the eMAC that remotely controls the operation of a facility’slights via wireless communications.

 

**Resultsof Operations**

 

*Revenue*

 

Wegenerate the majority of our revenue from the sale of our services and theproducts that we purchase and resell to our clients.   The substantial majority of our revenue isderived from fixed-price contracts, although we occasionally bill on atime-and-materials basis. Under fixed-price contracts, we bill our clients foreach project once the project is completed or throughout the project asspecified in the contract. Under time-and-materials arrangements, we bill ourclients on an hourly basis with material costs and other reimbursable expensespassed through and recognized as revenue. Our projects take a couple days to ayear or more to complete with projects in our commercial and industrial marketstypically taking less time to complete than the larger projects in our publicsection markets.  We recognize therevenue on smaller, shorter term projects on a completed contract basis and onlarger, longer projects we utilize the percentage of completion method forrevenue recognition. All of our revenue is earned in the United States.

 

*Gross Profit*

 

Gross profit equals our revenue less costs ofsales. The cost of sales for our business consists primarily of materials, ourinternal labor, including engineering, and the cost of subcontracted labor.

 

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Gross profit is a key metric that we use toexamine our performance. Gross profit depends in part on the volume and mix ofproducts and services that we sell during any given period. A portion of ourexpenses, such as the cost of certain salaried project management and engineeringpersonnel, are relatively fixed. Accordingly, an increase in the volume ofsales will generally result in an increase to our margins since these fixedexpenses are not expected to increase proportionately with sales. Our businessis also seasonal, as such, our margins will vary with seasonal changes in ourrevenue due to the fixed nature of some of our costs.

 

*Selling, General andAdministrative Expenses*

 

Selling,general and administrative expenses (“SG&A”) include the followingcomponents:

 

·                  direct labor and commissioncosts related to our employee sales force;

 

·                  costs of our non-productionmanagement, supervisory and staff salaries and employee benefits, including thecosts of stock-based compensation;

 

·                  costs related to insurance,travel and entertainment, office supplies and utilities;

 

·                  costs related to marketingand advertising our products;

 

·                  legal and accountingexpenses; and

 

·                  costs related toadministrative functions that serve to support our existing businesses, as wellas to provide the infrastructure for future growth.

 

*Amortization of Intangibles*

 

Whenwe acquire companies we allocate the purchase price to tangible assets (such asproperty, equipment, accounts receivable, etc.), intangible assets (such ascontract backlogs, customer lists, technology, trade name, etc.), with thebalance recorded as goodwill.  Weamortize the value of certain intangible assets over their estimated usefullives as a non-cash expense.

 

*Other Expense*

 

Otherexpense consists of interest expense, net of interest earned on ourinvestments. Interest expense represents the interest costs and fees associatedwith our subordinated convertible term notes (including amortization of therelated debt discount and issuance costs), our lines of credit, the mortgage onour headquarters building, notes payable and various vehicle loans. Interestincome includes earnings on our invested cash balances and amortization of thediscount on our long term receivables.

 

*DividendExpense*

 

Dividendexpense includes dividends accrued on our Series A-1 preferred stock.

 

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**Three Months Ended September 30, 2009 Compared to ThreeMonths Ended September 30, 2008**

 

***Consolidated Results (in thousands):***

 
| ** **                                 | ** ** | **Three Months Ended** | ** **   | ** ** | ** ** | ** **   | ** ** |
|--------------------------------------------|------------|------------------------|--------------|------------|------------|--------------|------------|
| ** **                                 | ** ** | **September 30,** | ** **   | **Change** | ** ** |
| ** **                                 | ** ** | **2009**               | ** **   | **2008**   | ** ** | **$**        | ** ** | **%** | ** ** |
|                                       |       |                   |         |       |       |         |       |   |   |
| Revenue                                    |       | $                      |  21,003 |       | $          |  17,709 |       | $ |  3,294 |   | 18.6 | % |
| Cost  of sales                             |       | 16,524                 |         | 13,388     |       | 3,136        |       | 23.4 | % |
| Gross  profit                              |       | 4,479                  |         | 4,321      |       | 158          |       | 3.7 | % |
|                                       |       |                   |         |       |       |         |       |   |   |
| Selling,  general and administrative       |       | 5,731                  |         | 5,509      |       | 222          |       | 4.0 | % |
| Amortization  of intangibles               |       | 269                    |         | 602        |       | (333         | )          | -55.3 | % |
| Operating  Loss                            |       | (1,521                 | )            | (1,790     | )          | 269          |       | -15.0 | % |
|                                       |       |                   |         |       |       |         |       |   |   |
| Other  income (expense)                    |       | (1,974                 | )            | (931       | )          | (1,043       | )          | 112.0 | % |
| Loss  from continuing operations           |       | (3,495                 | )            | (2,721     | )          | (774         | )          | 28.4 | % |
|                                       |       |                   |         |       |       |         |       |   |   |
| Loss  from discontinued operations         |       | (396                   | )            | (418       | )          | 22           |       | -5.3 | % |
| Net  loss                                  |       | $                      |  (3,891 | )          | $          |  (3,139 | )          | $ |  (752 | ) | 24.0 | % |
|                                       |       |                   |         |       |       |         |       |   |   |
| Preferred  stock dividends                 |       | (297                   | )            | —     |       | (297         | )          | — |   |
| Net  loss available to common stockholders |       | $                      |  (4,188 | )          | $          |  (3,139 | )          | $ |  (1,049 | ) | 33.4 | % |

 

The following table presents the percentage ofcertain items to revenue:

 

| ** **                                 | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **September 30,** | ** ** |
| ** **                                 | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                       |       |                   |       |   |   |
| Revenue                                    |       | 100.0                  | %          | 100.0 | % |
| Cost  of sales                             |       | 78.7                   | %          | 75.6 | % |
| Gross  profit                              |       | 21.3                   | %          | 24.4 | % |
|                                       |       |                   |       |   |   |
| Selling,  general and administrative       |       | 27.3                   | %          | 31.1 | % |
| Amortization  of intangibles               |       | 1.3                    | %          | 3.4 | % |
| Operating  Loss                            |       | -7.2                   | %          | -10.1 | % |
|                                       |       |                   |       |   |   |
| Other  income (expense)                    |       | -9.4                   | %          | -5.3 | % |
| Loss  from continuing operations           |       | -16.6                  | %          | -15.4 | % |
|                                       |       |                   |       |   |   |
| Loss  from discontinued operations         |       | -1.9                   | %          | -2.4 | % |
| Net  loss                                  |       | -18.5                  | %          | -17.7 | % |
|                                       |       |                   |       |   |   |
| Preferred  stock dividends                 |       | -1.4                   | %          | 0.0 | % |
| Net  loss available to common stockholders |       | -19.9                  | %          | -17.7 | % |

 

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***Revenue.***  Our revenue for the three months ended September 30,2009 was $21.003 million, representing an 18.6%, or $3.294 million increaseover the $17.709 million earned during the three months ended September 30,2008.  Revenue earned in our commercialand industrial markets increased approximately 24% over the prior year thirdquarter while revenue in our public sector markets increased by approximately16%.  The increase in revenue during thecurrent period was due to continued improvement in the productivity of oursalespeople and continued strong customer interest in energy efficiencyservices.  No revenue was earned duringthe quarter from our recently awarded utility program management contract orFRR contract, nor do we expect any material revenue from these contracts until2010.  We expect our fourth quarterrevenue will be lower than the revenue earned during the fourth quarter of 2008,but higher than that of the 3rd quarter of 2009.  We also expect our first quarter 2010 revenueto be lower than our fourth quarter revenue, consistent with the seasonalpattern experience in prior years, but higher than the revenue realized in thefirst quarter of 2009.

 

***Gross Profit. ***Our gross profit for the three-month period ended September 30, 2009was $4.479 million, a $158 thousand or 3.7% increase over the $4.321 millionearned during the same period in 2008. Our gross profit margin for the third quarter of 2009 was 21.3% comparedto 24.4% for the third quarter of 2008. The decline in our gross profit margin was the result of a change in themix of our business with revenue from our public sector representing a slightlylarger portion of our consolidated revenue, and lower margins earned in ourcommercial and industrial business due to the type of work completed during thequarter.  We believe that our fourthquarter gross profit margin will remain largely unchanged from the levelsrealized during the third quarter.

 

***Selling, General and Administrative Expense. ***OurSG&A for the third quarter of 2009 was $5.731 million, an increase of $222thousand, or 4.0%, compared to the $5.509 million for the same period during2008.  Share based compensation expenseincluded in SG&A declined approximately $442 thousand from the expenserecorded during the same period in 2008. This was offset by increases in labor expense resulting from new hiresto support our new initiatives in engineering, utility program 

 

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management and direct federal governmentcontracting, as well as additions to our sales staff added earlier in theyear.  Our SG&A was 27.3% of revenueduring the third quarter of 2009 as compared to 31.1% for the same period in2008.  We expect our quarterly SG&Aexpense to increase slightly during the balance of the year, due primarily tothe costs associated with new hires made during the past 12 months and commissionexpense on projected higher fourth quarter sales in our C&I markets.

 

***Amortization of Intangibles.***  Amortization expense associated with ourintangible assets was $269 thousand during the third quarter of 2009, adecrease of $333 thousand from the $602 thousand recorded during the thirdquarter of 2008.  Our amortizationexpense has declined as intangible assets associated with acquisitions we havemade over the past three years have become fully amortized.  Amortization expense for the fourth quarterof 2009 will be $294 thousand, declining to $163 thousand for the first andsecond quarters of 2010.

 

***Other Non-Operating (Expense) Income.***  Other expense increased $1.043million to $1.974 million during the third quarter of 2009 as compared to $931thousand for the third quarter of 2008. Interest expense for the third quarter of 2009 was $2.004 million, a$1.06 million increase over the $944 thousand recorded for the third quarter of2008.  The components of interest expensefor the three-month periods ended September 30, 2009 and 2008 are asfollows:

 
| **Three  months ended September 30,**                                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                             |       |     |       |     |       |
| Lines  of credit                                                                 |       | $        | —     |     | $          | 517 |   |
| Note  payable                                                                    |       | 22       |       | 30       |       |
| Mortgage                                                                         |       | 5        |       | 7        |       |
| Subordinated  convertible notes                                                  |       | 81       |       | 126      |       |
| Other                                                                            |       | 28       |       | 12       |       |
|                                                                             |       |     |       |     |       |
| Total  contractual interest                                                      |       | $        | 136        |     | $          | 692 |   |
|                                                                             |       |     |       |     |       |
| Amortization  of deferred issuance costs and debt discount                       |       | 930      |       | 252      |       |
|                                                                             |       |     |       |     |       |
| Beneficial  conversion value of change in conversion price of siborindated notes |       | 938      |       | —   |       |
|                                                                             |       |     |       |     |       |
| Total  interest expense                                                          |       | $        | 2,004      |     | $          | 944 |   |

 

Total contractual interest (the interest onoutstanding loan balances) decreased $556 thousand during the third quarter of2009 to $136 thousand when compared to $692 thousand incurred during the thirdquarter of 2008.  The decrease was theresult of the conversion of the line of credit to preferred stock at the end of2008 and the conversion of $3.1 million of subordinated convertible notes intocommon stock on August 10, 2009. Offsetting the decline in contractual interest was an increase of $678thousand in amortization expense, as during the quarter we recognized theremaining unamortized debt discount and deferred financing costs upon theconversion of the subordinated convertible notes.  In addition, during the period we incurred a$938 thousand non-cash charge resulting from the conversion of the subordinatedconvertible notes at a conversion price which was lower than their statedconversion price of $7.00 per share. Please refer to note 10 for additional information regarding theconversion of the subordinated

 

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convertible notes. Our fourth quarter interest expense will include approximately $300thousand of non-cash interest expense resulting from the write off of deferredfinancing costs associated with the bridge line of credit that was terminatedin early October.

 

Interest income increased $17 thousand to $30thousand during the third quarter of 2009, from $13 thousand during the thirdquarter of 2008.  During the fourthquarter of 2007 we began offering certain customers extended paymentterms.  We are required to discount thesereceivables at a market rate of interest and amortize the discount over theterm of the extended payments as interest income.  We significantly scaled back the offering ofextended payment terms in late 2008 in order to conserve cash for other workingcapital needs, buthave recently begun offering such terms to certain customers again.  The average balance of thesereceivables was higher during the third quarter of 2009 than during the yearearlier period, contributing to the increase in interest income for the period.

 

***Discontinued Operations.***  The loss from discontinued operationsdeclined $22 thousand or 5.3% to $396 thousand for the third quarter of 2009from $418 thousand for the third quarter of 2008.  We wound down most of the operations of ourMaximum Performance Group subsidiary during the quarter following the sale ofall of the significant assets of the company in August 2009.  We do not believe we will incur anysignificant expenses related to this subsidiary in future periods.

 

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**Nine Months Ended September 30, 2009 Compared to NineMonths Ended September 30, 2008**

 

***Consolidated Results(thousands)***

 
| ** **                                 | ** ** | **Nine Months Ended September 30,** | ** ** | **Change from Historical** | ** ** | **Change from Pro forma** | ** ** |
|--------------------------------------------|------------|------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                                 | ** ** | ** **                               | ** ** | **2008**                   | ** ** | **2008**                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **2009**                                 | ** ** | **Historical**             | ** ** | **Pro forma (1)**         | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
|                                       |       |                                     |       |                       |       |                      |       |   |   |   |   |   |   |   |   |
| Revenue                                    |       | $                                        | 50,523     |                       | $          | 26,334                    |       | $ | 36,471 |   | $ | 24,189 |   | 91.9 | % | $ | 14,052 |   | 38.5 | % |
| Cost  of sales                             |       | 40,397                                   |       | 21,075                     |       | 29,476                    |       | 19,322 |   | 91.7 | % | 10,921 |   | 37.1 | % |
| Gross  profit                              |       | 10,126                                   |       | 5,259                      |       | 6,995                     |       | 4,867 |   | 92.5 | % | 3,131 |   | 44.8 | % |
|                                       |       |                                     |       |                       |       |                      |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative       |       | 16,513                                   |       | 12,331                     |       | 16,537                    |       | 4,182 |   | 33.9 | % | (24 | ) | -0.1 | % |
| Amortization  of intangibles               |       | 927                                      |       | 984                        |       | 1,866                     |       | (57 | ) | -5.8 | % | (939 | ) | -50.3 | % |
| Operating  Loss                            |       | (7,314                                   | )          | (8,056                     | )          | (11,408                   | )          | 742 |   | -9.2 | % | 4,094 |   | -35.9 | % |
|                                       |       |                                     |       |                       |       |                      |       |   |   |   |   |   |   |   |   |
| Other  income (expense)                    |       | (2,815                                   | )          | (1,792                     | )          | (2,506                    | )          | (1,023 | ) | 57.1 | % | (309 | ) | 12.3 | % |
| Loss  from continuing operations           |       | (10,129                                  | )          | (9,848                     | )          | (13,914                   | )          | (281 | ) | 2.9 | % | 3,785 |   | -27.2 | % |
|                                       |       |                                     |       |                       |       |                      |       |   |   |   |   |   |   |   |   |
| Loss  from discontinued operations         |       | (1,425                                   | )          | (2,055                     | )          | (2,055                    | )          | 630 |   | -30.7 | % | 630 |   | -30.7 | % |
| Net  loss                                  |       | $                                        | (11,554    | )                          | $          | (11,903                   | )          | $ | (15,969 | ) | $ | 349 |   | -2.9 | % | $ | 4,415 |   | -27.6 | % |
|                                       |       |                                     |       |                       |       |                      |       |   |   |   |   |   |   |   |   |
| Preferred  stock dividends                 |       | (1,499                                   | )          | —                     |       | —                    |       | (1,499 | ) | — |   | (1,499 | ) | — |   |
| Net  loss available to common stockholders |       | $                                        | (13,053    | )                          | $          | (11,903                   | )          | $ | (15,969 | ) | $ | (1,150 | ) | 9.7 | % | $ | 2,916 |   | -18.3 | % |

 

----

*(1) Assuming the acquisition of Applied EnergyManagement, Inc. had taken place on January 1, 2008*

 

The following table presents the percentage ofcertain items to revenue:

 
| ** **                                 | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                 | ** ** | ** **                               | ** ** | **2008** | ** ** | **2008** | ** ** |
| ** **                                 | ** ** | **2009**                                 | ** ** | **Historical** | ** ** | **Pro forma (1)** | ** ** |
|                                       |       |                                     |       |   |   |   |   |
| Revenue                                    |       | 100.0                                    | %          | 100.0 | % | 100.0 | % |
| Cost  of sales                             |       | 80.0                                     | %          | 80.0 | % | 80.8 | % |
| Gross  profit                              |       | 20.0                                     | %          | 20.0 | % | 19.2 | % |
|                                       |       |                                     |       |   |   |   |   |
| Selling,  general and administrative       |       | 32.7                                     | %          | 46.8 | % | 45.3 | % |
| Amortization  of intangibles               |       | 1.8                                      | %          | 3.7 | % | 5.1 | % |
| Operating  Loss                            |       | -14.5                                    | %          | -30.6 | % | -31.3 | % |
|                                       |       |                                     |       |   |   |   |   |
| Other  income (expense)                    |       | -5.6                                     | %          | -6.8 | % | -6.9 | % |
| Loss  from continuing operations           |       | -20.0                                    | %          | -37.4 | % | -38.2 | % |
|                                       |       |                                     |       |   |   |   |   |
| Loss  from discontinued operations         |       | -2.8                                     | %          | -7.8 | % | -5.6 | % |
| Net  loss                                  |       | -22.9                                    | %          | -45.2 | % | -43.8 | % |
|                                       |       |                                     |       |   |   |   |   |
| Preferred  stock dividends                 |       | -3.0                                     | %          | 0.0 | % | 0.0 | % |
| Net  loss available to common stockholders |       | -25.8                                    | %          | -45.2 | % | -43.8 | % |

 

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----

*(1) Assuming the acquisition of Applied Energy Management, Inc.had taken place on January 1, 2008*

 

***Revenue.***  Our revenue for the nine months ended September 30,2009 increased $24.189 million, or 91.9%, to $50.523 million as compared to the$26.334 million recorded during the first nine months of 2008.   This increase was in part due to theacquisition of AEM in June 2008. Our revenue increased $14.052 million, or 38.5%, over the pro formarevenue of $36.471 million for the first nine months of 2008.  Through the first nine months of 2009 revenueearned in our commercial and industrial markets increased 26% over the sameperiod in 2008 while revenue from our public sector markets was up 45%.

 

***Gross Profit. ***Our gross profit for the first nine months of 2009 was $10.126 million, a$4.867 million, or 92.5% increase over the gross profit of $5.259 millionearned during the same period in 2008. Our gross profit increased $3.131 million, or 44.8%, over the grossprofit of $6.995 million for the first nine months of 2008 on a pro formabasis.  Our gross margins for the firstnine months of 2009 and 2008 were both 20.0%, compared to 19.2% for the 2008period on a pro forma basis.

 

***Selling, General and Administrative Expense.***  Our SG&A expense was $16.513million for the first nine months of 2009, an increase of $4.182 million, or33.9% compared to the first nine months of 2008 on a historical basis.  This increase was largely due to theinclusion of nine months of AEM’s SG&A expense during the 2009 period.  AEM was acquired in June 2008.  Our SG&A declined $24 thousand, or 0.1%,when compared to the first nine months of 2008 on a pro forma basis.  A $1.3 million decline in share basedcompensation was offset by increases in labor expense, outside consulting fees,including legal, marketing, IT and compensation, and higher franchise taxes.

 

***Amortization of Intangibles.***  Amortization expense declined $57 thousand,or 5.8% to $927 thousand during the first nine months of 2009 compared to $984thousand for the first nine months of 2008 on a historical basis.  On a pro forma basis amortization expensedeclined $939 thousand, or 50.3%. Amortization expense will continue to decline in future periods as theunderlying intangible assets become fully amortized.

 

***Other Non-Operating (Expense) Income.***  Other expense increased $1.023million or 57.1% to $2.815 million during the first nine months of 2009compared to $1.792 million for the year earlier period on a historicalbasis.  Interest expense was $2.907million for the first nine months of 2009, a increase of $1.045 million whencompared to $1.862 million for the first nine months of 2008.  The components of interest expense for thenine-month periods ended September 30, 2009 and 2008 are as follows:

 

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| ** **                                                                       | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                       | ** ** | ** **                               | ** ** | **2008** | ** ** | **2008** | ** ** |
| ** **                                                                       | ** ** | **2009**                                 | ** ** | **Historical** | ** ** | **Pro forma** | ** ** |
|                                                                             |       |                                     |       |   |   |   |   |
| Lines  of credit                                                                 |       | $                                        | 53         |   | $ | 657 |   | $ | 1,246 |   |
| Note  payable                                                                    |       | 75                                       |       | 42 |   | 146 |   |
| Mortgage                                                                         |       | 14                                       |       | 21 |   | 21 |   |
| Subordinated  convertible notes                                                  |       | 329                                      |       | 374 |   | 374 |   |
| Other                                                                            |       | 72                                       |       | 16 |   | 37 |   |
|                                                                             |       |                                     |       |   |   |   |   |
| Total  contractual interest                                                      |       | $                                        | 543        |   | $ | 1,110 |   | $ | 1,824 |   |
|                                                                             |       |                                     |       |   |   |   |   |
| Amortization  of deferred issuance costs and debt discount                       |       | 1,426                                    |       | 752 |   | 752 |   |
|                                                                             |       |                                     |       |   |   |   |   |
| Beneficial  conversion value of change in conversion price of siborindated notes |       | 938                                      |       | — |   | — |   |
|                                                                             |       |                                     |       |   |   |   |   |
| Total  interest expense                                                          |       | $                                        | 2,907      |   | $ | 1,862 |   | $ | 2,576 |   |

 

Ourcontractual interest expense declined $567 thousand during the first ninemonths of 2009 to $543 thousand from $1.11 million for the same period in2008.  Thedecrease was primarily the result of the conversion of the line of credit topreferred stock at the end of 2008 and the conversion of $3.1 million of thesubordinated convertible notes on August 10, 2009.  Offsetting the decline in contractualinterest was an increase in amortization expense of $674 thousand as werecognized the remaining unamortized debt discount and deferred financing costsupon the conversion of the subordinated convertible notes.  In addition during the period we incurred a$938 thousand non-cash charge resulting from the conversion of the subordinatedconvertible notes at a conversion price which was lower than the statedconversion price of $7.00 per share. Please refer to note 10 for additional information regarding theconversion of the subordinated convertible notes.

 

Interestincome increased $22 thousand to $92 thousand during the first nine months of2009 from the $70 thousand earned during the same period in 2008.  The increase was the result of higher averagebalances on our portfolio of extended receivables.

 

***Discontinued Operations.***  The loss from discontinued operationsdeclined $630 thousand or 30.7% to $1.425 million for the first nine months of2009 from $2.055 million for the same period in 2008.  Reductions in research and development costsand labor expense were partially offset by a second quarter impairment chargeof $503,407 we took to reduce the carrying value of certain assets inanticipation of the sale of our Energy Technology business.  The sale of this business closed on August 10,2009, therefore we do not expect to incur any significant further losses fromthis segment in future periods.

 

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**Liquidityand Capital Resources**

 

As of September 30,2009, we had cash and cash equivalents of $24.217 million, compared to $3.734million on December 31, 2008. Our debt obligations as of September 30,2009 consisted of a mortgage of $427 thousand on our facility in Elk GroveVillage Illinois and various vehicle loans totaling $342 thousand.  Subsequent to the end of our third quarter wereceived an additional $3.9 million from the public sale of our common stock.

 

Ourprincipal cash requirements are for operating expenses, the funding ofinventory and accounts receivable, and capital expenditures. We have financedour operations since inception primarily through the sale of our common andpreferred stock, as well as through various forms of secured debt.

 

The following tablesummarizes, for the periods indicated, selected items in our consolidatedstatement of cash flows:

 
| ** **                                            | ** ** | **Nine months ended**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **September 30,** | ** ** |
| ** **                                            | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                                  |       |                   |       |   |   |
| Net  cash used in operating activities                |       | $                      | (8,083     | ) | $ | (12,665 | ) |
| Net  cash used in investing activities                |       | (1,341                 | )          | (4,156 | ) |
| Net  cash provided by financing activities            |       | 29,907                 |       | 12,919 |   |
|                                                  |       |                   |       |   |   |
| Net  Increase (Decrease) in Cash and Cash Equivalents |       | $                      | 20,483     |   | $ | (3,902 | ) |
|                                                  |       |                   |       |   |   |
| Cash  and Cash Equivalents, at beginning of period    |       | 3,734                  |       | 4,781 |   |
|                                                  |       |                   |       |   |   |
| Cash  and Cash Equivalents, at end of period          |       | $                      | 24,217     |   | $ | 879 |   |

 

**Ninemonths Ended September 30, 2009 Compared to Nine months Ended September 30,2008**

 

Net cash increased$20.483 million during the first nine months of 2009 as compared to decreasing$3.902 million during the same period in 2008.

 

*Operating Activities*

 

Operatingactivities consumed cash of $8.083 million during the nine-month period ended September 30,2009 as compared to consuming cash of $12.665 million during the same period of2008.

 

Whethercash is used or generated by operating activities is a function of theprofitability of our operations and changes in working capital.  To get a better understanding of cash sourcesand uses, our management separates the cash used or provided by operatingactivities into two categories: the cash consumed (or generated) by operatingactivities before changes in working capital; and the cash consumed (orgenerated) from changes in working capital.

 

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Thecash consumed by operating activities before changes in working capitaldeclined $49 thousand to $6.203 million during the first nine months of 2009 ascompared to consuming $6.252 million during the first nine months of 2008.  The reduction in the cash consumption was theresult of the reduction in the cash operating loss (excluding depreciation,amortization and share based compensation) and the reduced loss from discontinuedoperations.  We believe that we willcontinue to see improvements in the cash consumed by operating activitiesbefore changes in working capital if our revenue and profitability improve aswe believe they will, such that we expect our operations will generate cashbefore changes in working capital during the fourth quarter of the year.

 

Changesin working capital consumed cash of $1.88 million during the first nine monthsof 2009, a reduction of $4.533 million, or 70.7%, when compared to the $6.413million consumed during the same period in 2008.  The reduced use of cash for working capitalduring 2009 was primarily the result of receivable collections generated fromstrong sales in the fourth quarter of 2008, in combination with improved receivableturnover.  We expect our working capitalrequirements to increase with increases in our sales in future periods, thoughwe hope improvements in our receivables turnover will keep the growth inworking capital to a rate that is lower than the growth of our future sales.

 

*Investing Activities*

 

Cash used in investingactivities decreased $2.815 million, or 67.7% to $1.341 million during thenine-month period ended September 30, 2009 from $4.156 million for thesame period in 2008.  During the firstnine months of 2009 we paid $614 thousand for the AEM earn-out and costsassociated with the acquisition of AEM and $446 thousand to purchase the rightsto the FRR contract.  We also madecapital expenditures of $305 thousand for service vehicles and office equipmentduring the first nine months of 2009. During the first nine months of 2008 we purchased AEM and made capitalpurchases totaling $357 thousand.  We donot expect to make significant expenditures for fixed assets for the balance of2009.

 

*Financing Activities*

 

Financingactivities generated cash of $29.907 million during the first nine months of2009 as compared to generating $12.919 million during the first nine months of2008.  In September 2009, wecompleted a follow-on public offering of our common stock generating grossproceeds of $27.5 million.  In March 2009we closed on the acquisition of ADVB and gained access to its cash balances of$7.4 million.  We have treated thisacquisition as an offering because the primary purpose was to gain access toits cash.  We have not continued to operateADVB as a going concern.  In January 2009we closed on tranche B of the November 2008 PIPE, generating cash proceedsof $3.275 million.  We also received $45thousand from the exercise of options and $27 thousand from new vehicleloans.  The proceeds from thesetransactions were partially offset by $3.966 million used to repay our lines ofcredit; $2.828 million in transaction costs related to the acquisition of ADVBand the follow-on offering; and $1.574 million in other debt repayments.  During the first half of 2008 we drew $3.5million on our line of credit to fund the acquisition of AEM, $2.0 million tofund an equity infusion into AEM to assist with its working capitalrequirements and $7.7 million to fund other operating needs.  We also borrowed $133 thousand to fund thepurchase of a new service vehicles and received $120 thousand from the exerciseof options and warrants.  These sourcesof cash were partially offset by $570 thousand used to repay a portion of ourlong term debt.

 

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**SOURCES OF LIQUIDITY**

 

Ourprimary sources of liquidity are our available cash reserves.

 

Ourability to continue to expand our sales will require the continued commitmentof significant funds. The actual timing and amount of our future fundingrequirements will depend on many factors, including the amount and timing offuture revenues, working capital requirements and the level and amount of oursales and marketing efforts, among other things.

 

Wehave raised a significant amount of capital since our formation through theissuance of shares of our common stock, which has allowed us to acquirecompanies and to continue to execute our business plan.  Most of these funds have been consumed byoperating activities, either to fund our losses or for working capitalrequirements.  In an attempt to move theCompany to a position where it can start to generate positive cash flow ourmanagement has set the following key strategies for cash flow improvement:

 

·                  Focus on increasing thesales and profitability of our products and services while controlling thegrowth in our SG&A expense.  We believe that to a great degree our abilityto generate positive cash flow is dependent on our ability to increase saleswhile controlling the growth of our SG&A and maintaining or improving ourgross margins.  We have built a corporateinfrastructure over the past couple of years to support a large, diversifiednational company.  We believe that thisinfrastructure can support significantly higher revenue without a correspondingincrease in our SG&A.  During thefirst nine months of 2009, on a pro forma basis our revenue has grown 39% withno increase in our total SG&A.   Weare focused on continually reducing our SG&A expense as a percentage ofrevenue with a target of reducing it to 11% to 14% within the next three tofive years, which we believe is asustainable SG&A expense ratio for the business over the longer term andreflects our expectations with respect to our ability to achieve additionaloperating leverage.  If we areable to achieve this goal, while holding or improving our gross margins, webelieve we will begin to generate positive cash flow and earnings within thenext 12 to 24 months.

 

·                  Sell our Energy TechnologyBusiness.  We made thedecision in early 2009 to sell our Energy Technology business segment toeliminate this source of losses and allow us to focus on our growing EnergyEfficiency business.  We began theprocess of seeking a buyer for this business during the first quarter of 2009and closed on the sale on August 10, 2009. The sale has been structured as an earnout in which the buyer mustachieve minimum revenue levels before we would be eligible for anypayment.  We do not anticipate receivingany earnout payments before late 2010 at the earliest and we may never receive any earnout payments.

 

Webelieve that if we are successful in increasing our revenue while controllingthe growth in our operating expenses we should have sufficient liquidity toallow us to operate until our operations turn cash flow positive.

 

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**CautionaryNote Regarding Forward-Looking Statements**

 

Ourdisclosure and analysis in this report, including Management’s Discussion andAnalysis of Financial Condition and Results of Operations contains“forward-looking” information within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, adopted pursuant to the Private SecuritiesLitigation Reform Act of 1995. Statements that are not purely historical may beforward-looking. You can identify these forward-looking statements by the useof words such as “anticipate,” “believe,” “estimate,” “expect,” “hope,”“intend,” “may,” “project,” “plan,” “goal,” “target,’ “should,” and similar expressions, including when usedin the negative.

 

Forward-lookingstatements are subject to various risks and uncertainties. Accordingly, thereare or will be important factors that could cause actual results to differmaterially from those indicated in these statements, including but not limitedto those described in this Report under “Part II, Item 1A—Risk Factors”and the following:

 

·                  we have a limited operatinghistory under our current business model in a rapidly evolving market, whichmay make it difficult to evaluate our business and prospects, and may expose usto increased risks and uncertainties;

·                  we have incurred significantoperating losses since inception and may not achieve or sustain profitabilityin the future;

·                  the current economicdownturn could diminish the demand for our services and products;

·                  it is difficult for us toestimate our future quarterly results;

·                  we operate in a highlycompetitive industry and if we are unable to compete successfully our revenue;and profitability will be adversely affected;

·                  and

·                  we may be unable to obtainsufficient bonding capacity to support certain service offerings.

 

Allforward-looking statements in this report should be considered in the contextof the risk and other factors described above and as detailed from time to timein the Company’s Securities and Exchange Commission filings. Anyforward-looking statements speak only as of the date the statement is made andwe undertake no obligation to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise. It is notpossible to identify all of the risks, uncertainties and other factors that mayaffect future results. In light of these risks and uncertainties, theforward-looking events and circumstances discussed in this report may not occurand actual results could differ materially from those anticipated or implied inthe forward-looking statements. Accordingly, users of this report are cautionednot to place undue reliance on the forward-looking statements.

 

Exceptas otherwise required by federal securities laws, we do not undertake anyobligation to publicly update, review or revise any forward-looking statements,whether as a result of new information, future events, changed circumstances orany other reason.

 

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ITEM3.                                       **Quantitative andQualitative Disclosures About Market Risk**

 

Notapplicable.

 

ITEM4.                                       **Controls and Procedures**

 

**Disclosure Controls andProcedures.**

 

Our management, includingour chief executive officer and our chief financial officer, maintains our“disclosure controls and procedures” (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the“Exchange Act”)) and has evaluated the effectiveness of our disclosure controlsand procedures as of the end of the period covered by this report.  Based on such evaluation, our chief executiveofficer and chief financial officer have concluded that, as of September 30,2009, such disclosure controls and procedures are effective for the purpose ofensuring that material information required to be in the reports that wesubmit, file, furnish or otherwise provide to the Securities and ExchangeCommission is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

**Changes in Internal Controls.**

 

There have not been anychanges in our internal control over financial reporting (as defined in Rule 13a-15(f) underthe Exchange Act) during the quarter ended September 30, 2009 that havematerially affected or are reasonably likely to materially affect our internalcontrol over financial reporting.

 

**Limitationsof the Effectiveness of Internal Control**

A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the internal control system are met.  Because of the inherent limitations of anyinternal control system, no evaluation of controls can provide absoluteassurance that all control issues, if any, within a company have been detected.

 

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**PART II.  OTHER INFORMATION**

 

**ITEM 1A.****                                           ****Risk Factors**

 

We have updated the risk factors appearingunder the captions “Risks Related to Our Financial Condition” and “RisksRelating to our Business” previously disclosed in Part I, Item 1A of ourAnnual Report on Form 10-K for the year ended December 31, 2008,which was filed with the Securities and Exchange Commission on March 11,2009, as set forth below.

 

***We have a limited operating history under our current business model ina rapidly evolving market, which may make it difficult to evaluate our businessand prospects, and may expose us to increased risks and uncertainties.***

 

Our business has evolvedsubstantially over time through organic growth and strategic acquisitions.  Our current business model has only been inoperation since June 2006, when we launched our Energy Efficiency Servicesbusiness. Accordingly, we have only a limited history of generating revenuesunder our current business model, and the future revenue potential of ourcurrent business model in the rapidly evolving energy efficiency solutionsmarket is uncertain. As a result of our short operating history under ourcurrent business model, we have limited financial data that can be used toevaluate our business, strategies, performance and prospects or an investmentin our common stock. Any evaluation of our business and our prospects must beconsidered in light of our limited operating history under our current businessmodel and the risks and uncertainties encountered by companies with newbusiness models. To address these risks and uncertainties, among other things,we must do the following:

 

·                  maintainand expand our current relationships and develop new relationships with commercial andindustrial businesses, property owners and managers and energy servicecompanies, or “ESCOs,” serving government and educational institutions;

·                  maintainand enhance our existing energy efficiency solutions;

·                  executeour business and marketing strategies successfully;

·                  respondto competitive developments; and

·                  attract,integrate, retain and motivate qualified personnel.

 

Wemay be unable to accomplish one or more of these objectives, which could causeour business to suffer and could have a material adverse effect on ourbusiness, results of operations and financial condition. In addition, accomplishing many of these goals might be veryexpensive, which could adversely impact our operating results and financialcondition. Additionally, any predictions about our future operating results maynot be as accurate as they could be if we had a longer operating history underour current business model.

 

***We have incurred significant operating losses since inception and maynot achieve or sustain profitability in the future.***

*** ***

Wehave experienced losses and negative cash flow from operations since ourinception and we currently have an accumulated deficit. We must increase saleswhile maintaining or improving our margins to operate profitably and sustainpositive operating cash flows. We may be required to reduce the prices of ourservices in order to increase sales. If we reduce prices, we may not be able toreduce costs sufficiently to achieve acceptable profit margins. As we strive togrow our business, we have spent and expect to continue to spend significantfunds for: (i) general corporate purposes, including working capital, 

 

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marketing,recruiting and hiring additional personnel; and (ii) acquisitions. To theextent that our revenues do not increase as quickly as these costs andexpenditures, our results of operations and liquidity will be adverselyaffected. If we experience slower than anticipated revenue growth or if thegross margins we earn on our sales are lower than expected or our operatingexpenses exceed our expectations, we may not achieve profitability in thefuture or if we achieve profitability in the future, we may not be able tosustain it.  As we grow, our workingcapital requirements are likely to increase. We may need additional funds in the form of a bank working capital lineto support this increased working capital. If in the future we cannot obtain bank financing it could limit ourability to grow our business to the point that it is profitable on a consistentbasis.

 

In addition, because of our negative cash flow, wehave funded our operations through the issuance of common and preferred stockand debt. Our ability to continue to operate until our cash flow turns positivemay depend on our ability to continue to raise additional funds through theissuance of equity or debt. If we are not successful in raising any neededadditional funds, we might have to significantly scale back or delay our growthplans, or sell or shut down some of our businesses. Any reduction or delay inour growth plans could materially adversely affect our ability to compete inthe marketplace, take advantage of business opportunities and develop orenhance our services and technologies, which could have a material adverseeffect on our business, results of operations and financial condition.

 

***The current widespread economic downturn and uncertainty and turmoil inthe equity and credit markets could adversely impact our clients, diminish thedemand for our services and products, and harm our operations and financialperformance.***

 

The energy efficiency solutions marketplace hasexperienced rapid evolution and growth, but we do not know how sensitive it isto a recession or downturn in the general economy. The current recession couldharm the economic health of our clients and consequently decrease the demandfor our products or services, particularly in the commercial and industrialmarkets. The recession also may cause reductions or elimination of utility orgovernment energy efficiency incentive programs used to partially fund thecosts of customer projects. In addition, increased competition during therecession may result in lower sales, reduced likelihood of profitability, anddiminished cash flow to us.

 

Further, the sales of our energy efficiencysolutions are made on the basis of contracts that permit our customers toterminate the engagement prior to completion rather than long-term purchasecommitments and consequently our clients may cancel, delay or otherwise modifytheir purchase commitments in response to economic pressures with little or noconsequence to them and with little or no notice to us. Whether in response toan economic downturn affecting an industry or a client’s specific businessincluding its bankruptcy or insolvency, any cancellation, delay or othermodification in our clients’ orders could significantly reduce our revenue,impact our working capital, cause our operating results to fluctuate fromperiod to period and make it more difficult for us to predict our revenue.

 

***It is difficult for us toestimate our future quarterly operating results.***

 

Asignificant portion of our revenue is seasonal. Historically, this seasonalityhas caused our revenue, operating income, net income and cash flow fromoperating activities to be lower in the first two quarters and higher in thelast two quarters of each year. The concentration of earnings and cash flow inthe fourth quarter is primarily due to our clients’ budget cycles.  Further, many of our clients purchase ourenergy efficiency solutions on the basis of cancellable short-term agreementsfor projects that can be completed in a matter of weeks rather than long-termpurchase commitments.  Consequently, wedo not have a constant and predictable stream of revenue from thoseclients.  Additionally, because a fewlarge projects 

 

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areoften responsible for a significant portion of our revenue from public sectorclients, the level of activity, initial project delays or gaps between projectshave historically led to significant fluctuations of revenue on an irregularbasis throughout the fiscal year.  As aresult, we may be unable to forecast our revenue accurately, and a failure tomeet our revenue or expense forecasts could have an immediate and negativeimpact on the market price of our common stock.

 

***We operate in a highly competitive industry and if we are unable tocompete successfully our revenue and profitability will be adversely affected.***

 

Theenergy efficiency solutions market is highly competitive, and we expectcompetition to increase and intensify as the energy efficiency solutions marketcontinues to evolve. We face strong competition primarily from lighting andlighting fixture manufacturers, lighting fixture distributors, providers ofenergy efficiency lighting upgrades and maintenance, small regional providersof energy efficiency solutions and local electrical and mechanicalcontractors.  As we extend energyefficiency offerings that are currently available to our public sector clientsto our commercial and industrial clients, we expect to face additionalcompetition from providers of those services in the commercial and industrialmarket. We compete primarily on the basis of client service and support,quality and scope of services and products, cost of services and products,ability to service clients on a national level, name recognition and financialresources and performance track record for services provided.

 

Inaddition to our existing competitors, new competitors such as large national ormultinational engineering and/or construction companies could enter ourmarkets.  Many of these current andpotential competitors are better capitalized than we are, have longer operatinghistories and strong existing client relationships, greater name recognition,and more extensive engineering and sales and marketing capabilities.Competitors could focus their substantial resources on developing a competingbusiness model or energy efficiency solutions that may be potentially more attractiveto clients than our products or services. In addition, we may face competitionfrom other products or technologies that reduce demand for electricity. Ourcompetitors may also offer energy efficiency solutions at reduced prices inorder to improve their competitive positions. If our ESCO clients internallydevelop sufficient energy efficiency expertise they may no longer outsourcework to us.  Any of these competitivefactors could make it more difficult for us to attract and retain clients,require us to lower our prices in order to remain competitive, and reduce ourrevenue and profitability, any of which could have a material adverse effect onour results of operations and financial condition.

 

***We may be unable to obtain sufficientbonding capacity to support certain service offerings.***

 

Asignificant number of our public sector contracts require surety bonds toguarantee our performance and payment to our suppliers and subcontractors.Bonding capacity for construction projects has become increasingly difficult toobtain, and bonding companies are denying or restricting coverage to anincreasing number of contractors.  Somesureties have required us to post collateral, guarantees, agreements ofindemnity and letters of credit to secure the performance and suretybonds.  One of our directors has agreedto provide us with letters of credit for up to an aggregate total of $10.0million, but his obligation expired upon the completion of our recent publicoffering.  We intend to use a portion ofthe proceeds from our recent public offering to replace the collateral providedby these letters of credit.  Thiscollateral may be insufficient to support our continuing need for surety bonds,which could preclude us from being able to bid for certain contracts and successfullycontract with certain customers. If we are unable to obtain surety bonds, ourbusiness, results of operations and financial condition could be materiallyadversely affected.

 

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***Our success is largely dependentupon the skills, experience and efforts of our senior management******andour ability to attract and retain highly qualified engineers and other skilledpersonnel******, and the loss oftheir services or our inability to attract and retain such personnel could havea material adverse effect on our ability to expand our business or to maintainprofitable operations.***

 

Ourfuture success will depend largely on the skills, efforts, and motivation ofour executive officers and other senior managers.  The loss of the service of executive officersand other senior managers or our inability to attract or retain other qualifiedpersonnel could have a material adverse effect on our ability to expand ourbusiness, implement our strategy or maintain profitable operations.

 

Inaddition, to execute our growth strategy and maintain our margins, we mustattract and retain highly qualified engineers, other skilled personnel and aneffective sales force that can accurately price our clients’ energy efficiencysolution contracts. Competition for hiring these individuals is intense,especially with regard to engineers specializing in the energy efficiencysolutions market. If we fail to attract and retain highly qualified engineersand other skilled personnel, our business and growth prospects could bematerially adversely affected.

 

***We depend upon a limited number ofclients in any given period to generate a substantial portion of our revenue.***

 

Historically,we did not have long-term contracts with our clients, and our dependence onindividual key clients varied from period to period as a result of thesignificant size of some of our retrofit and multi-facility roll-out projects.  In 2008, two clients accounted forapproximately 24% of our consolidated revenue. On a pro forma basis, our top 10clients accounted for approximately 60% and 68%, respectively, of our totalrevenue in fiscal 2008 and 2007, and 65% and 46%, respectively, of our fiscal2009 and pro forma 2008 first six-month total revenue.  We expect large retrofit and roll-outprojects to become a greater component of our total revenue in the near term.As a result, we may experience more client concentration in any given futureperiod. The loss of, or substantial reduction in sales to, any of oursignificant clients could have a material adverse effect on our business,results of operations and financial condition in any given future period.

 

***Our public sector business depends on a limited number of ESCOs undercontract by government and other public end-users.***

 

Asignificant portion of our public sector business revenue is generated throughour relationship with a limited number of ESCOs that provide energy efficiencyservices to government and other public end-users.  If for any reason government spending onenergy efficiency services is reduced or postponed or government and otherpublic end-users shift contracts to ESCOs with whom we do not have establishedrelationships, this may have a significant negative impact on our business,results of operations and financial condition. Further, our public sector projects typically have long payment cyclesthat may impact our liquidity and which could have a material adverse effect onour results of operations in any given future period.

 

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***Failure of oursubcontractors to properly and effectively perform their services in a timelymanner could cause delays in the delivery of our energy efficiency solutions.***

 

Our success depends on our ability to provide quality,reliable energy efficiency solutions in a timely manner, which in part requiresthe proper removal and installation of lighting, mechanical and electricalsystems and other products by our contractors and subcontractors upon which wedepend.   A significant portion of ourenergy efficiency solutions are installed by contractors or subcontractors.  Any delays, malfunctions, inefficiencies orinterruptions in our energy efficiency solutions caused by improperinstallation could cause us to have difficulty retaining current clients andattracting new clients.  Such delayscould also result in additional costs that could affect the profit margin ofour projects.  In addition, our brand,reputation and growth could be negatively impacted.

 

***If our information technologysystems fail, or if we experience operation interruptions, then our business,results of operations and financial condition could be materially adverselyaffected.***

 

Theefficient operation of our business is dependent on our information technologysystems. We rely on those systems generally to manage the day-to-day operationof our business, manage relationships with our clients and maintain ourfinancial and accounting records. The failure of our information technologysystems, our inability to successfully maintain and enhance our informationtechnology systems, or any compromise of the integrity or security of the datawe generate from our information technology systems, could have a materialadverse effect on our results of operations, disrupt our business and make usunable, or severely limit our ability, to respond to client demands. Inaddition, our information technology systems are vulnerable to damage orinterruption from:

 

·                  earthquake, fire, flood andother natural disasters;

·                  employee or other theft;

·                  attacks by computer virusesor hackers;

·                  power outages; and

·                  computer systems, Internet,telecommunications or data network failure.

 

Anyinterruption of our information technology systems could result in decreasedrevenue, increased expenses, increased capital expenditures, clientdissatisfaction and potential lawsuits, any of which could have a materialadverse effect on our results of operations or financial condition.

 

***Product liability and personal injury claims could have a materialadverse effect on our business, results of operations and financial condition.***

*** ***

Weface exposure to product liability and personal injury claims in the event thatour energy efficiency solutions fail to perform as expected or cause bodilyinjury or property damage.  Since themajority of our products use electricity, it is possible that the products wesell could result in injury, whether by product malfunctions, defects, improperinstallation or other causes. Particularly because the products we sell oftenincorporate new technologies or designs, we cannot predict whether or notproduct liability claims will be brought against us in the future or result innegative publicity about our business or materially adversely affect our clientrelations. Further, we face exposure to personal injury claims in the eventthat an individual is injured as a result of our negligence.   Moreover, we may not have adequate resourcesin the event of a successful claim against us. A successful product liabilityor personal injury claim against us that is not covered by insurance or is inexcess of our available insurance limits could require us to 

 

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makesignificant payments of damages which could materially adversely affect ourresults of operations and financial condition.

 

***Our retrofitting process frequently involvesresponsibility for the removal and disposal of components containing hazardousmaterials and at times requires that our contractors or subcontractors work inhazardous conditions, either of which could give rise to a claim against us.***

 

Whenwe retrofit a client’s facility, we typically assume responsibility forremoving and disposing of its existing lighting fixtures. Certain components ofthese fixtures typically contain trace amounts of mercury and other hazardousmaterials. Older components may also contain trace amounts of polychlorinatedbiphenyls, or PCBs. We utilize licensed and insured hazardous wastes disposalcompanies to dispose of such components. Failure to properly handle, remove ordispose of the components containing these hazardous materials in a safe,effective and lawful manner could give rise to liability for us, or couldexpose our workers or other persons to these hazardous materials, which couldresult in claims against us.  Further,our workers are sometimes required to work in hazardous environments thatpresent a risk of serious personal injury which could result in claims againstus.  A successful personal injury claimagainst us that is not covered by insurance or is in excess of our availableinsurance limits could require us to make significant payments of damages andcould materially adversely affect our results of operations and financialcondition.

 

***If we are unable to manage our anticipated revenue growth effectively,our operations and profitability could be adversely affected.***

 

***We intend to undertake a number ofstrategies in an effort to grow our revenue. If we are successful, our revenuegrowth may place significant strain on our limited resources. To properlymanage any future revenue growth, we must continue to improve our management,operational, administrative, accounting and financial reporting systems andexpand, train and manage our employee base, which may involve significantexpenditures and increased operating costs. Due to our limited resources andexperience, we may not be able to effectively manage the expansion of ouroperations or recruit and adequately train additional qualified personnel. Ifwe are unable to manage our anticipated revenue growth effectively, the qualityof our client care may suffer, we may experience client dissatisfaction,reduced future revenue or increased warranty claims, and our expenses couldsubstantially and disproportionately increase. Any of these circumstances couldadversely affect our business, results of operations and financial condition.***

*** ***

***Our growth may be impaired and our current business may suffer if we donot successfully address risks associated with any future acquisitions that wemay make.***

*** ***

***Our future growthmay depend, in part, upon our ability to successfully identify, acquire andoperate other complementary businesses.***  Any acquisitioncontemplated or completed by us may result in adverse short term effects on ourreported results of operation; divert management’s attention; introduce risksassociated with unanticipated problems or legal liabilities; cause theincurrence of additional debt; cause the issuance of additional equity; orintroduce contingent liabilities and amortization expenses related tointangible assets, some or all of which could harm our business, results ofoperations and financial condition.

*** ***

In addition, often an acquired company’sperformance is largely dependent on a few key people, particularly in smallercompanies.  If these key people leave thecompany, become less focused on the business or less motivated to make thebusiness successful after the acquisition, the performance of the acquiredcompany and our combined business may suffer.

 

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***Our ability to use our netoperating loss carry forwards will be subject to additional limitation, whichcould potentially result in increased future tax liability.***

 

Generally,a change of more than 50% in the ownership of a company’s stock, by value, overa three-year period constitutes an ownership change for U.S. federal income taxpurposes. An ownership change may limit a company’s ability to use its netoperating loss carry forwards attributable to the period prior to such change.We have sold shares of our common stock in various transactions sufficient toconstitute an ownership change. As a result, if we earn net taxable income, ourability to use our pre-change net operating loss carry forwards, which amountedto $77 million as of December 31, 2008, to offset U.S. federal taxableincome will be subject to limitations, which will likely result in increasedfuture tax liability.  Our recentlycompleted public offering and the conversion of our outstanding preferred stockand the conversion of all of our outstanding convertible notes will constitutea further ownership change that will further limit our ability to use ourpre-change net operating loss carry forwards. In addition, future shifts in our ownership, including transactions inwhich we may engage, may cause additional ownership changes, which could havethe effect of imposing additional limitations on our ability to use ourpre-change net operating loss carry forwards.

 

ITEM 2.                                       **Unregistered Sales ofEquity Securities and Use of Proceeds**

 

(1)          On January 30, 2009, weissued 933,049 unregistered shares of our common stock along with warrants topurchase an additional 233,263 shares of our common stock at $4.10 per share toseven affiliated investors in exchange for gross proceeds of $3,275,000.  Proceeds from this offering will be used forgeneral corporate purposes.

 

(2)          On March 3,2009, we exchanged 2,252,341 unregistered shares of our common stock for1,060,421,884 shares of Advanced Biotherapy, Inc. (“ADVB”) held bystockholders of ADVB (the “Sellers”) representing approximately 90.8% of ADVB’sissued and outstanding shares pursuant to a Stock Purchase Agreement dated November 18,2008. We then completed a short-form merger in which we merged ADVB with andinto a newly formed merger subsidiary, with the merger subsidiary remaining asthe surviving entity.  Upon the closingof the merger we obtained access to ADVB’s assets, including approximately $7.4million of cash and a revolving credit note we issued that had an outstandingbalance of approximately $42,000.  Wecancelled the revolving credit note and do not plan to continue to operate ADVBas a going concern after the closing.  Weplan to use the cash obtained in the acquisition for general corporatepurposes.

 

(3)          During the first quarter of 2009 weissued 63,052 unregistered shares of our common stock to the former owners ofApplied Energy Management, Inc. following determination of the amountsowed under an earn-out provision of the AEM purchase agreement.

 

(4)          In August 2009, we issued 2,000shares to a consultant as partial compensation for services received.  These shares were valued at the market valueon the date of issuance and charged to operations during August.

 

(5)          During thefirst nine months of 2009, we issued 19,063 shares of our Series A-1preferred stock in partial satisfaction of dividends owed the holder.

 

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(6)          During thefirst nine months of 2009, we issued 45,400 unregistered shares of our commonstock to the holders of our subordinated convertible term notes in satisfactionof 50% of the interest owed to them.

 

Nounderwriters were involved in the transaction described above. All of thesecurities issued in these transactions were issued by us in reliance upon theexemption from registration available under Section 4(2) of theSecurities Act, including Regulation D promulgated thereunder, in that thetransactions involved the issuance and sale of our securities to financiallysophisticated individuals or entities that were aware of our activities andbusiness and financial condition and took the securities for investmentpurposes and understood the ramifications of their actions. Certain of thepurchasers also represented that they were “accredited investors” as defined inRegulation D and were acquiring such securities for investment for their ownaccount and not for distribution.

 

ITEM 6.                                       **Exhibits**

 

31.1                           Certificate of Chief Executive Officerpursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) asAdopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

31.2                           Certificate of Chief Financial Officerpursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) asAdopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1                           Certification of the Chief ExecutiveOfficer of the Corporation Pursuant to Section 1350 of Chapter 63 of Title18 of the United States Code Pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

 

32.2                           Certification of the Chief FinancialOfficer of the Corporation Pursuant to Section 1350 of Chapter 63 of Title18 of the United States Code Pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

 

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#### **SIGNATURES**

####  

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                           | LIME ENERGY CO.: |
|--------------------------------|------------------|
|                           |             |
|                           |             |
| Dated:  November 12, 2009 | By:              | /s/ David R. Asplund |
|                           |             | David R. Asplund |
|                           |             | *Chief  Executive Officer (principal* |
|                           |             | *executive  officer)* |
|                           |             |   |
|                           |             |   |
| Dated:  November 12, 2009 | By:              | /s/ Jeffrey R. Mistarz |
|                           |             | Jeffrey R. Mistarz |
|                           |             | *Chief  Financial Officer (principal* |
|                           |             | *financial  and accounting officer)* |

 

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