EnergyConnect Group Inc - FORM 10-Q

Attached files

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EX-31.1 - EXHIBIT 31.1 - EnergyConnect Group Inc	ex31_1.htm
EX-31.2 - EXHIBIT 31.2 - EnergyConnect Group Inc	ex31_2.htm
EX-32.1 - EXHIBIT 32.1 - EnergyConnect Group Inc	ex32_1.htm
EX-32.2 - EXHIBIT 32.2 - EnergyConnect Group Inc	ex32_2.htm

U.S. Securities and Exchange Commission

Washington, D. C. 20549

Form 1O-Q

T QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 3, 2009

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission File Number : 0-26226

ENERGYCONNECT GROUP, INC.

(Name of small business issuer in its charter)

Oregon		93-0935149
(State or other jurisdiction of incorporation or organization)		(I. R. S. Employer Identification No.)

901 Campisi Way, Suite 260

Campbell, CA 95008

(Address of principal executive offices and zip code)

(408) 370-3311

(Issuer’s telephone number)

51 E. Campbell Avenue

Campbell, California 95008

(Former Name and Former Address, if Changed Since Last Report)

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

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

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

Indicate by check mark whether Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). oYes xNo

The number of shares outstanding of the Registrant’s Common Stock as of November 9, 2009 was 95,629,961 shares.

ENERGYCONNECT GROUP, INC.

FORM 10-Q

INDEX

PART I FINANCIAL INFORMATION			Page

	Item 1.	Financial Statements

		Condensed Consolidated Balance Sheets – October 3, 2009 (unaudited) and January 3, 2009	3

		Condensed Consolidated Statements of Operations – three and nine months ended October 3, 2009 and September 27, 2008 (unaudited)	4

		Condensed Consolidated Statement of Cash Flows – nine months ended October 3, 2009 and September 27, 2008 (unaudited)	5

		Notes to Unaudited Condensed Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26

	Item 4.	Controls and Procedures	26



PART II OTHER INFORMATION

	Item 1.	Legal Proceedings	27

	Item 1A.	Risk Factors	27

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27

	Item 3.	Defaults Upon Senior Securities	27

	Item 4.	Submission of Matters to a Vote of Security Holders	27

	Item 5.	Other Information	28

	Item 6.	Exhibits	28

Index

Item 1. Financial Statements

ENERGYCONNECT GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


	October 3,			January 3,
	2009			2009
Current assets:	(Unaudited)
Cash and cash equivalents	$	1,624, 975		$	410,101
Certificates of deposit		100,000			300,000
Accounts receivable		10,711,799			4,373,818
Other current assets		324,285			269,144
Total current assets		12,761,059			5,353,063

Property and equipment, net		286,031			299,263
Intangible assets, net (Note 5)		1,492,609			1,633,622
Other assets		43,579			70,876
	$	14,583,278		$	7,356,824

Current liabilities:
Accounts payable	$	10,241,733		$	5,116,296
Bank line of credit (Note 4)		-			117,257
Other current liabilities		359,426			127,016
Total current liabilities		10,601,159			5,360,569

Long-term liabilities:
Note payable, net of debt discount (Note 4)		1,878,671			-
Total long-term liabilities		1,878,671			-

Commitments and contingencies
Shareholders’ equity :
Common stock, no par value, 225,000,000 shares authorized, 95,629,961 and 95,179,961 shares issued and outstanding, respectively (Note 2)		121,731,000			120,671,694
Common stock warrants (Note 3)		36,098,289			36,098,289
Accumulated deficit		(155,725,841	)		(154,773,728	)
Total shareholders’ equity		2,103,448			1,996,255
	$	14,583,278		$	7,356,824

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

Index

ENERGYCONNECT GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)

	Three months ended						Nine months ended
	October 3,			September 27,			October 3,			September 27,
	2009			2008			2009			2008

Revenues	$	10,337,922		$	11,641,127		$	19,069,889		$	24,082,822
Cost of Revenues		7,221,172			6,458,010			12,160,944			16,944,723
Gross profit		3,116,750			5,183,117			6,908,945			7,138,099

Operating expenses
Sales, general and administrative		2,245,933			3,023,904			7,125,821			9,322,224

Income (loss) from operations		870,817			2,159,213			(216,876	)		(2,184,125	)

Other income (expense)
Interest income (expense), net		(342,406	)		(12,286	)		(735,237	)		7,397
Other income, net		-			16,817			-			43,580

Income (loss) before provision for income taxes		528,411			2,163,744			(952,113	)		(2,133,148	)

Provision for income taxes		-			-			-			-

Income (loss) from continuing operations		528,411			2,163,744			(952,113	)		(2,133,148	)

Discontinued operations:
Gain (loss) on discontinued operations		-			-			-			(146,057	)
Gain on sale of discontinued operations		-			-			-			134,775

Net income (loss)	$	528,411		$	2,163,744		$	(952,113	)	$	(2,144,430	)

Net income (loss) per share from continuing operations:
Basic	$	0.01		$	0.02		$	(0.01	)	$	(0.02	)
Diluted	$	0.01		$	0.02		$	(0.01	)	$	(0.02	)
Net income (loss) per share from discontinued operations:
Basic	$	0.00		$	0.00		$	0.00		$	(0.00	)
Diluted	$	0.00		$	0.00		$	0.00		$	(0.00	)
Net income (loss) per share:
Basic	$	0.01		$	0.02		$	(0.01	)	$	(0.02	)
Diluted	$	0.01		$	0.02		$	(0.01	)	$	(0.02	)

Shares used in per share calculations:
Basic		95,629,961			94,684,424			95,433,808			89,941,134
Diluted		96,839,705			94,697,281			95,433,808			89,941,134

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

Index

ENERGYCONNECT GROUP, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

	Nine Months Ended
	October 3, 2009			September 27, 2008
Cash Flows From Operating Activities:
Net loss	$	(952,113	)	$	(2,144,430	)
Add (deduct):
Loss on discontinued operations		-			11,282

Loss from continuing operations		(952,113	)		(2,133,148	)
Depreciation of equipment		107,709			89,408
Amortization of intangible assets		179,300			179,300
Stock-based compensation		547,225			643,802
Common stock issued for services		54,000			214,883
Amortization and write-off of debt discount		281,052			-

Changes in current assets and liabilities:
Certificates of deposit		200,000			(166,600	)
Accounts receivable		(6,337,981	)		(5,631,745	)
Other current assets		(55,141	)		(412,508	)
Other assets		27,298			(36,212	)
Accounts payable		5,125,437			4,139,864
Other current liabilities		232,410			119,130

Net cash used by continuing operations		(590,804	)		(2,993,827	)

Net cash provided (used) by discontinued operations		-			379,319

Net cash used by operating activities		(590,804	)		(2,614,508	)

Cash flows from investing activities:
Purchases of fixed assets		(94,478	)		(200,360	)
Capitalized patent costs		(38,287	)		-

Net cash used by continuing investing activities		(132,765	)		(200,360	)

Net cash used by discontinued investing activities		-			(534,325	)

Net cash used by investing activities		(132,765	)		(734,685	)

Cash flows from financing activities:
Repayments on line of credit		(117,257	)		(1,198	)
Borrowings from debt facility, net of repayments		2,050,000			-
Exercise of options and warrants		5,700			718,205
Proceeds from private placement, net of direct costs		-			3,476,891

Net cash provided by continuing financing activities		1,938,443			4,193,899

Net cash provided by discontinued financing activities		-			539,163

Net cash provided by financing activities		1,938,443			4,733,062

Net increase (decrease) in cash and cash equivalents		1,214,875			1,383,869

Cash and cash equivalents, beginning of period		410,101			758,299
Cash and cash equivalents, end of period		1,624,975			2,142,168

Supplemental disclosures for cash flow information:

Cash paid during the period for interest	300,796	8,733
Cash paid during the period for income taxes	-	-

Supplemental schedule of non-cash financing and investing activities:
Beneficial conversion feature of advances from debt facility	452,381	-

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

Index

ENERGYCONNECT GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

October 3, 2009

1.	Description of the Business

General

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Accordingly, the results from operations for the three and nine-month periods ended October 3, 2009, are not necessarily indicative of the results that may be expected for the year ended January 2, 2010. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated January 3, 2009 financial statements and footnotes thereto included in the Company's Form 10-K.

The consolidated financial statements as January 3, 2009 have been derived from the audited consolidated financial statements at that date but do not include all disclosures required by the accounting principles generally accepted in the United States of America.

Business and Basis of Presentation

On September 24, 2008, our shareholders voted to change the name of the Company to EnergyConnect Group, Inc. from Microfield Group, Inc. EnergyConnect Group, Inc. (the “Company,” “we,” “us,” or “our”) through its subsidiary EnergyConnect, Inc. (“ECI”) provides a full range of demand response services to the electric power industry. Our customers are the regional grid operators who pay us market rates for reductions in electrical demand during periods of high prices or peak demand and for being available to reduce electric power demand on request at periods of capacity limitations or in response to grid emergencies. Our suppliers are large commercial and industrial consumers of electricity who we pay to shift their demand for electricity from high priced hours in the day to lower priced hours. We also pay these participating energy consumers to be available to curtail electric demand on request.

Through proprietary technology and business processes we automate electric consumer demand response transactions and the associated measurement, verification, and support decisions. These capabilities make it possible and easy for electric consumers, particularly commercial and industrial facilities, to shift load from high priced hours to lower priced periods.

Our services provide market incentives to reduce electric demand during periods of peak demand or high prices. By shifting load from high demand periods our services improve the operating efficiency of the electrical grids and improve grid reliability. By improving grid reliability and efficiency, we also delay the need for construction of new electrical generating plants. Through higher efficiencies on the grid, lower cost of generation and improved reliability, all consumers of electricity benefit from our demand response activities.

Our customers are regional electric grid operators such as PJM, the largest electric grid in the nation, and selected electric utilities who support and sponsor demand response. All of our current operations are in the United States with services provided in more than 25 states. Our revenues in 2008 were $25.9 million. Our participants are commercial and industrial electric energy consumers, who we pay to shift, curtail and in some cases produce electric energy.

Index

In 2003 we acquired a part of Christenson Electric, Inc. (“CEI”), and in 2005, we acquired the remainder of CEI and the stock of ECI. This combined a 60 year old electrical contracting and technology business with a high growth demand response business. In 2007 we determined that ECI had grown to a self sustaining transition point and in November 2007 we agreed to sell the stock of CEI. The sale was completed on April 24, 2008. Our objective is to leverage our unique and proprietary technologies, business processes, and resources and build a viable, profitable demand response business servicing wholesale power markets. Financial statements and accompanying notes included in this report include disclosure of the results of operations for CEI, for all periods presented, as discontinued operations.

All significant inter-company accounts and transactions have been eliminated in consolidation.

The Company was incorporated in October 1986 as an Oregon Corporation, succeeding operations that began in October 1984. The Company’s headquarters are located in Campbell, California.

Going Concern

The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the previously issued consolidated financial statements during the year ended January 3, 2009, the Company incurred net losses of $34,077,050 and generated negative cash flow from operations in the amount of $4,100,473. The Company incurred net losses of $952,113 and generated negative cash flow from operations in the amount of $590,804 for the nine months ended October 3, 2009. The Company’s current liabilities exceeded its current assets by $7,506 as of January 3, 2009. These factors among others may indicate that the Company may be unable to continue as a going concern for a reasonable period of time.

The Company's existence is dependent upon management's ability to develop profitable operations and resolve its liquidity problems. Management anticipates the Company will attain profitable status and improve its liquidity through continued growth, distribution and sale of its products and services, and additional equity investment in the Company. The accompanying unaudited condensed consolidated financial statements do not include any adjustments that might result should the Company be unable to continue as a going concern.

At January 3, 2009, the Company did not have any available credit, bank financing or other external sources of liquidity. Due to our brief history and historical operating losses, our operations have not been a source of liquidity. In February 2009, the Company entered into a secured debt facility that will supplement the Company’s cash needs for 2009. While we believe our cash availability under this debt facility along with cash generated by operations will be adequate for the next twelve months, we may need to obtain additional capital in order to sustain and expand operations and become profitable. In order to obtain capital, we may need to sell additional shares of our common stock or borrow funds from private lenders while remaining in compliance with the terms of our debt facility. There can be no assurance that we will be successful in obtaining additional funding.

We may still need additional investments in order to continue operations to cash flow break even. Additional investments may be sought, but we cannot guarantee that we will be able to obtain such investments. Financing transactions may include the issuance of equity or debt securities, obtaining credit facilities, or other financing mechanisms. However, the trading price of our common stock, the downturn in the U.S. stock and debt markets and the first priority lien on all of our assets granted to our secured lender could make it more difficult to obtain financing through the issuance of equity or debt securities. Even if we are able to raise the funds required, it is possible that we could incur unexpected costs and expenses, fail to collect significant amounts owed to us, or experience unexpected cash requirements that would force us to seek alternative financing. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. If additional financing is not available or is not available on acceptable terms, we may have to curtail our operations.

Index

By adjusting the Company’s operations and development to the level of capitalization, management believes it has sufficient capital resources to meet projected cash flow deficits. However, if during that period or thereafter, the Company is not successful in generating sufficient liquidity from operations or in raising sufficient capital resources on terms acceptable to them, or is no longer in compliance with the terms of our debt facility, this could have a material adverse effect on the Company’s business, results of operations liquidity and financial condition. If operations and cash flows continue to improve through these efforts, management believes that the Company can continue to operate. However, no assurance can be given that management’s actions will result in profitable operations or the resolution of its liquidity problems.

Reclassification

Certain reclassifications have been made to conform to prior periods’ data to the current presentation. These reclassifications had no effect on reported losses.

Fiscal Year

The Company’s fiscal year is the 52- or 53-week period ending on the Saturday closest to the last day of December. The Company’s current fiscal year is the 52-week period ending January 2, 2010. The Company’s last fiscal year was the 53-week period ended January 3, 2009. The Company’s third fiscal quarters in fiscal 2009 and 2008 were the 13-week periods ended October 3, 2009 and September 27, 2008, respectively.

Revenue Recognition

We produce revenue through agreements with both building owners and the power grid operators. Under our agreements with facilities owners, we use electrical and energy related products that help energy consumers control energy use in their buildings. In conjunction with this agreement we are members of the power grid operators and have agreed to provide the grids with energy, capacity, and related ancillary services during specified times and under specified conditions. These transactions are summarized at the end of each monthly period and submitted to the power grids for settlement and approval. While the power grids are our customers, they are primarily a conduit through which these electrical curtailment transactions are processed. The vast majority of our revenues each year are processed through the PJM Interconnection. PJM serves as the market for electrical transactions in a specific region in the United States. Our agreement with PJM is an ongoing one as we are members of PJM. These transactions are initiated by building owners, who are our participants. The transactions form the basis for our revenue. We have little risk, if any, from the concentration of revenue through this power grid as it is a not-for-profit organization that exists to act as the market for electrical transactions.

In 2008, we revised our accounting for reserves for collections of revenues. The revision in our reserve accounting is a result of improvements in our ability to accurately estimate collections, which is based upon historical trends and timely and accurate information. Previously the transactions were recorded as revenue on the settlement date, which typically fall 45-70 days after the transaction date from which the revenue is derived, because management believed that without an established history for this source of revenue, and the potential for disputes, that the settlement date, on which both parties agree to the amount of revenue to recognize, was the most conservative and appropriate date to use. For periods beginning with the first quarter of 2008 and forward, revenue from these settlements were accrued into the prior month instead of recognizing revenue as the settlement amounts were received. The record of these settlement amounts being realized over the prior two years had been extremely accurate so that management believed it was appropriate to accrue the settlement amounts into the prior month. This revision in our reserve accounting resulted in an extra month of revenue being recorded in the first quarter of 2008. This first quarter of 2008 contained the payment received in January of 2008 (which was not accrued into December) and the settlement amounts from the fifth business day in February, March and April of 2008, each of which was accrued into the prior months of January, February and March of 2008. The first quarter of 2009 includes three months of revenue which is comprised of the settlement amounts from the fifth business day in February, March and April of 2009, each of which was accrued into the prior months of January, February and March of 2009. Therefore, the nine month period ended October 3, 2009 is comprised of nine months of settlement amounts and the nine month period ended September 27, 2008 is comprised of ten months of settlement amounts.

Index

An additional source of our revenue is derived from agreements with the power grid operators whereby a monthly reserve fee is paid for our agreement to be available to provide relief in the form of curtailment of energy usage, in times of high energy demand. We record these payments as revenue over the period during which we’re required to perform under these programs. Under certain programs, our obligation to perform may not coincide with the period over which we receive payments under that program. In these cases we record revenue over the mandatory performance obligation period and record a receivable for the amount of payments that will be received after that period has been completed.

New Accounting Requirements and Disclosures

Accounting Standards Codification and GAAP Hierarchy — Effective for interim and annual periods ending after September 15, 2009, the Accounting Standards Codification and related disclosure requirements issued by the FASB became the single official source of authoritative, nongovernmental GAAP. The ASC simplifies GAAP, without change, by consolidating the numerous, predecessor accounting standards and requirements into logically organized topics. All other literature not included in the ASC is non-authoritative. We adopted the ASC as of October 3, 2009, which did not have any impact on our results of operations, financial condition or cash flows as it does not represent new accounting literature or requirements. All references to pre-codified U.S. GAAP have been removed from this Form 10Q.

Determining Fair Value in Inactive Markets — Effective for interim and annual periods beginning after June 15, 2009, GAAP established new accounting standards for determining fair value when the volume and level of activity for the asset or liability have significantly decreased and the identifying transactions are not orderly. The new standards apply to all fair value measurements when appropriate. Among other things, the new standards:

•	affirm that the objective of fair value, when the market for an asset is not active, is the price that would be received in a sale of the asset in an orderly transaction;

•	clarify certain factors and provide additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active;

•

provide that a transaction for an asset or liability may not be presumed to be distressed (not orderly) simply because there has been a significant decrease in the volume and level of activity for the asset or liability, rather, a company must determine whether a transaction is not orderly based on the weight of the evidence, and provide a non-exclusive list of the evidence that may indicate that a transaction is not orderly; and

•	require disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and any change in valuation technique (and the related inputs) resulting from the application of the standard, including quantification of its effects, if practicable.

These new accounting standards must be applied prospectively and retrospective application is not permitted. See Note 9 for disclosure of our fair value measurements.

Financial Instruments — Effective for interim and annual periods ending after June 15, 2009, GAAP established new disclosure requirements for the fair value of financial instruments in both interim and annual financial statements. Previously, the disclosure was only required annually. We adopted the new requirements as of July 4, 2009, which resulted in no change to our accounting policies, and had no effect on our results of operations, cash flows or financial position, but did result in the addition of interim disclosure of the fair values of our financial instruments. See Note 4 for disclosure of the fair value of our debt.

Index

Subsequent Events — Effective for interim and annual periods ending after June 15, 2009, GAAP established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The new requirements do not change the accounting for subsequent events; however, they do require disclosure, on a prospective basis, of the date an entity has evaluated subsequent events. We adopted these new requirements as of July 4, 2009, which had no impact on our results of operations, financial condition or cash flows.

Consolidation— Effective for interim and annual periods beginning after November 15, 2009, with earlier application prohibited, GAAP amends the current accounting standards for determining which enterprise has a controlling financial interest in a VIE and amends guidance for determining whether an entity is a VIE. The new standards will also add reconsideration events for determining whether an entity is a VIE and will require ongoing reassessment of which entity is determined to be the VIE’s primary beneficiary as well as enhanced disclosures about the enterprise’s involvement with a VIE. We are currently assessing the future impact these new standards will have on our results of operations, financial position or cash flows.

Transfers and Servicing -- Effective for interim and annual periods beginning after November 15, 2009, GAAP eliminates the concept of a qualifying special purpose entity, changes the requirements for derecognizing financial assets and requires additional disclosures. We are currently assessing the future impact these new standards will have on our results of operations, financial position or cash flows.

2.	Capital Stock

The Company has authorized 10,000,000 shares of Preferred Stock, no par value. As of October 3, 2009 and January 3, 2009, the Company’s Series 2, Series 3 and Series 4 preferred stock had been completely converted to common shares. The Company has authorized 225,000,000 shares of Common Stock, no par value. As of October 3, 2009 and January 3, 2009, the Company had 95,629,961 and 95,179,961 shares of common stock issued and outstanding, respectively. During the nine month period ended October 3, 2009, the Company issued an aggregate of 450,000 shares of common stock, all of which were issued to directors for their services on the Company’s board.

3.	Stock Options and Warrants

Stock Incentive Plan

The Company has a Stock Incentive Plan (the "Plan"). At October 3, 2009 and September 27, 2008, 556,234 and 6,063,870 shares of common stock were reserved, respectively, for issuance to employees, officers, directors and outside advisors. Under the Plan, the options may be granted to purchase shares of the Company's common stock at fair market value, as determined by the Company's Board of Directors, at the date of grant. The options are exercisable over a period of up to ten years from the date of grant or such shorter term as provided for in the Plan. The options become exercisable over periods from zero to four years.

Also under the Plan during the quarter ended July 4, 2009, the Company granted Restricted Stock Awards to the independent Directors of the Company’s Board of Directors in connection with their services as Directors. These four awards granted the Directors a total of 450,000 shares of the Company’s common stock (Note 2). The shares are restricted from transfer, except as permitted for estate planning purposes, until January 15, 2010.

A total of 11,223,249 options to purchase shares of the Company’s common stock were granted to employees of the Company during the nine months ended October 3, 2009. There were 147,000 options granted to employees, directors and consultants during the nine months ended September 27, 2008. The 11,223,249 options issued to employees during the nine months ended October 3, 2009 are forfeited if not exercised within ten years. Of the options granted during the nine months ended October 3, 2009, 950,000 were granted to certain management employees in exchange for permanent salary reductions instituted in March 2009. The reductions ranged from 7% to 25% of the employees’ annual salary. These options vest monthly over the 12 months after grant, after which they will be fully vested. The remaining 10,273,249 options have a 12-month waiting period during which no vesting occurs. At the end of this 12-month period, the options become 25% vested, and then vest ratably over the remaining thirty six–months of the vesting period. The weighted average per share value of all options granted in the current nine months was $0.08.

Index

The following table summarizes the changes in stock options outstanding and the related prices for the shares of the Company’s common stock issued to employees, officers and directors of the Company under the Plan.

	Options Outstanding							Options Exercisable
Exercise Prices		Number Outstanding		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Number Exercisable		Weighted Average Exercise Price
$	0.05-0.94		15,474,581		5.32	$	0.28		4,114,982	$	0.61
$	1.76-2.70		225,346		1.61	$	2.18		225,346	$	2.21
			15,699,927		5.05	$	0.30		4,310,228	$	0.68

Transactions involving stock options issued are summarized as follows:

	Number of Shares			Weighted Average Price Per Share
Outstanding at December 29, 2007		9,723,750		$	0.54
Granted		162,000			0.42
Exercised		(2,069,331	)		0.34
Cancelled or expired		(1,737,549	)		0.67
Outstanding at January 3, 2009		6,078,870		$	0.81
Granted		11,223,249			0.08
Exercised		-			0.00
Cancelled or expired		(1,602,192	)		0.64
Outstanding at October 3, 2009		15,699,927		$	0.31

The Company has computed the value of all options granted during fiscal 2009 and 2008 using the Black-Scholes pricing model. There were 1,120,000 options granted during the third quarter of 2009. The following assumptions were used to calculate the value of options granted during the third quarter of 2009 and 2008:

	2009			2008
Risk-free interest rate		3.54	%		3.54	%
Expected dividend yield		-			-
Expected life	5 years			5 years
Expected volatility		122	%		122	%

Stock-based compensation expense recognized for the three and nine months ended October 3, 2009 was $186,787 and $601,226, respectively. Employee stock-based compensation expense recognized for the three and nine months ended September 27, 2008 was $172,235 and $643,802, respectively.

Common Stock Warrants

In connection with the August 24, 2004 debt issuance by Destination Capital, LLC, the Company is obligated to issue warrants to purchase the Company’s common stock. According to the terms of the debt issuance, warrants in the amount of 12.5% of the loan balance, outstanding on the first day of each month, will be issued to the debt holders for each calendar month that the debt is outstanding. Each warrant is exercisable into one share of common stock at the lesser of $0.38 per share or the price applicable to any shares, warrants or options issued (other than options issued to employees or directors) while the loan is outstanding, and will expire in 2010. Prior to this debt issuance, the Company exercised an option to convert $1,400,000 of outstanding debt into preferred stock that is convertible into shares of common stock. This exercise, when aggregated with all other outstanding equity arrangements, resulted in the total number of common shares that could be required to be delivered to exceed the number of authorized common shares. The fair value of the 37,500 warrants initially issued in connection with the debt issuance must be recorded as a liability for warrant settlement in the financial statements using the Black-Scholes model, and any subsequent changes in the Company’s stock price to be recorded in earnings. Accordingly, the aggregate fair value of these warrants, issued prior to September 1, 2004, was determined to be $17,513. At September 1, 2004, the Company’s shareholder’s voted to increase the authorized shares available for issuance or conversion, which cured the situation described above. Accordingly, the fair value of the warrants on September 1, 2004 was determined to be $20,776. The warrant liability was reclassified to shareholders’ equity and the increase from the initial warrant value was recorded in earnings in the fiscal year ended January 1, 2005. For the months from August 1, 2004 to July 2, 2005, according to the terms of the warrant provision of the August 24, 2004 debt agreement, the Company was obligated to issue 1,626,042 additional warrants. The value of these warrants of $604,955 was added to shareholders’ equity on the consolidated balance sheet, with a corresponding expense charged to interest expense in the consolidated statement of operations. As of October 3, 2009, the holders of these warrants exercised 1,309,616 warrants in exchange for 1,170,841 shares of the Company’s common stock, and 316,426 warrants remain outstanding.

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On October 13, 2005, the Company issued an aggregate of 19,695,432 warrants in connection with the acquisition of acquired EnergyConnect, Inc. The Company valued the warrants using the Black-Scholes option pricing model, applying a useful life of 5 years, a risk-free rate of 4.06%, an expected dividend yield of 0%, a volatility of 129% and a fair value of the common stock of $2.17. Total value of the warrants issued amounted $36,495,391, which was included in the purchase price of ECI. As of October 3, 2009, the warrant holders have not exercised any of these warrants.

On October 5, 2005, in conjunction with a private placement which resulted in gross proceeds of $3,276,000, the Company sold 5,233,603 shares of common stock at $0.70 per share, and issued warrants to purchase up to 2,944,693 shares of common stock. The warrants have a term of five years and an exercise price of $0.90 per share. As of October 3, 2009, the warrant holders have exercised 192,370 warrants, for 180,409 shares of common stock, and 2,752,323 warrants remain outstanding.

On June 30, 2006, in conjunction with a private placement which resulted in gross proceeds of $15,000,000, the Company sold 7,500,000 shares of common stock at $2.00 per share, and issued warrants to purchase up to 5,625,000 shares of common stock. The warrants have a term of five years and an exercise price of $3.00 per share. As of October 3, 2009, the warrant holders have not exercised any of these warrants.

On May 7, 2008, in conjunction with a private placement which resulted in gross proceeds of $3,615,000, the Company sold 9,051,310 shares of common stock at $0.40 per share, and issued warrants to purchase up to 4,525,655 shares of common stock. The warrants have a term of five years and an exercise price of $0.60 per share. As of October 3, 2009, the warrant holders have not exercised any of these warrants.

No warrants were issued, exercised, cancelled or expired during the nine months ended October 3, 2009.

Debt

Operating Line of Credit

At January 3, 2009, the Company had a loan facility which was an unsecured $120,000 line of credit at prime plus 3 ¾%, due on demand with interest payable monthly. As of January 3, 2009, there was $117,257 outstanding, respectively, under this line. During the second quarter of 2009, the balance was paid and the line was closed.

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Convertible Note

A summary of the Company’s convertible note payable is as follows:

	October 3, 2009			January 3, 2009
Convertible note payable, interest due monthly at 30% with 23% due and payable currently with 7% deferred each month until December 31, 2009, at which time the deferred interest balance will be added to the note balance. The note is due January 1, 2011. The note is convertible into shares of the Company’s common stock at $0.091 per share, in an amount equal to two-thirds of the outstanding balance at conversion with the remaining balance due in cash.	$	2,050,000		$	-
Debt discount – beneficial conversion feature, net of accumulated amortization and write-off of $281,052 and $0 at October 3, 2009 and January 3, 2009.		(171,329	)		-
Note payable, net of debt discount	$	1,878,671		$	-

On February 26, 2009 we entered into a Business Loan Agreement, a Convertible Secured Promissory Note and Commercial Security Agreement (collectively the “Loan Agreements”) with Aequitas Commercial Finance, LLC (“Aequitas”). Aequitas is a commercial finance company that provides loan and lease financing to companies. Aequitas is managed by Aequitas Capital Management, Inc. (“Aequitas Capital”). Aequitas Capital and its affiliates have previously provided the Company with debt and equity financing. William C. McCormick, the Chairman of the Board of Directors of EnergyConnect Group, Inc., is a member of the Advisory Board of Aequitas Capital.

Pursuant to the terms and conditions of the Loan Agreements, Aequitas will provide the Company with a revolving credit facility enabling the Company to borrow money in a maximum principal amount not to exceed $5,000,000. The current interest rate for funds borrowed by the Company in the first twelve (12) month term is twenty-three percent (23%) with an additional seven percent (7%) deferred interest per annum. The accrued deferred interest shall be added to the then current principal balance of the loan at the end of the first twelve (12) month term. The interest rate for funds borrowed in the second twelve (12) month term is thirty percent (30%). The loan matures on January 1, 2011. As security for this loan, the Company granted Aequitas a first priority security interest in the assets of the Company.

The Loan Agreements grant Aequitas the right to convert up to two-thirds (2/3rds) of unpaid principal and interest into shares of ECNG’s common stock at an exercise price of $0.091 anytime after issuance. The Company recognized an imbedded beneficial conversion feature in the amount of $452,381 present in the convertible note equal to the intrinsic value of the imbedded beneficial conversion feature, to additional paid in capital and a discount against the convertible note during the nine months ended October 3, 2009. The debt discount attributed to the beneficial conversion feature is amortized over the convertible note's maturity period (twenty-two months) as interest expense.

During the nine months ended October 3, 2009, total proceeds received from the convertible note was $3,250,000 and the Company repaid $1,200,000 of the loan. The Company amortized and wrote-off the convertible note debt discount attributed to the beneficial conversion feature and recorded non-cash interest expense in the amount of $105,694 and $281,052 for the three and nine month periods ended October 3, 2009, respectively. No debt discount was amortized in 2008.

As of October 3, 2009 the balance owed on the Note was $2,050,000, and is recorded in long term debt. The Company is current with its obligations under this Note and is in compliance with all covenants. Other than this obligation, there was no other interest bearing debt due by the Company at October 3, 2009.

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5.	Intangible Assets and Goodwill

As a result of our acquisition of ECI we recorded an intangible asset of $2,390,667 at the date of acquisition representing developed technology that is currently used within ECI. The intangible asset acquired has an estimated useful life of ten years, and as such is being amortized monthly, over that period. Goodwill of $106,544,871 represented the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. At December 31, 2005 and January 3, 2009, it was determined in independent valuations that the goodwill generated in this transaction was impaired. The Company decided to write off approximately $77,191,344 and $29,353,527 of this goodwill in the years ended December 31, 2005 and January 3, 2009, respectively. The write-off of the goodwill and the amortization of the intangible assets are included in operating expenses in the consolidated statement of operations.

Intangible assets consist of the following:

	October 3, 2009			January 3, 2009

Developed technology (including patents)	$	2,428,954		$	2,390,667

Less accumulated amortization		(936,345	)		(757,045	)

	$	1,492,609		$	1,633,622

Amortization of intangible assets included as a charge to income was $179,300 for both of the nine month periods ended October 3, 2009 and September 27, 2008.

Based on the Company’s current intangible assets, amortization expense for the five succeeding years will be as follows:

	Amortization
Year	Expense
Twelve months ended September 2010	$	239,487
Twelve months ended September 2011		239,487
Twelve months ended September 2012		239,487
Twelve months ended September 2013		239,487
Twelve months ended September 2014 and beyond		534,661
Total	$	1,492,609

6.	Business Concentrations

We produce revenue and therefore accounts receivable through agreements with both building owners and the power grid operators. Under our agreements with facilities owners, we use electrical and energy related products that help energy consumers control energy use in their buildings. In conjunction with this agreement we are members of the power grid operators and have agreed to provide the grids with energy, capacity, and related ancillary services during specified times and under specified conditions. These transactions are summarized at the end of each monthly period and submitted to the power grids for settlement and approval. While the power grids are our customers, they are primarily a conduit through which these electrical curtailment transactions are processed. The vast majority of our revenues each year are processed through the PJM Interconnection. PJM serves as the market for electrical transactions in a specific region in the United States. Our agreement with PJM is an ongoing one as we are members of PJM. These transactions are initiated by building owners, who are our participants. These transactions form the basis for our revenue.

Financial transactions and instruments that potentially subject us to concentrations of credit risk consist primarily of revenue generating transactions and the resultant accounts receivable. During the three months ended October 3, 2009, revenue from one customer, whom is a grid operator, approximated $9,479,000 or 92% of total revenue. This revenue is the result of multiple participating electric consumers that each executed myriad energy transactions in the economic market, or that are registered in capacity programs. These economic transactions and capacity commitments were aggregated and billed to the grid operators. That revenue is dependent on actions taken or commitments made to reduce electricity usage by these third parties in conjunction with ECI, for which the grids, as our customers, remit payments to us. These transactions form the basis for the majority of our annual revenue. We have little risk, if any, from the concentration of revenue through these power grids as they maintain the market for electrical transactions and capacity support for the grids.

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For the three months ended October 3, 2009, there were no participants whose transactions resulted in revenue that totaled more than 10% of our revenue. During the three months ended September 27, 2008, there was one customer who generated 96% of the Company’s revenue and one participant whose transactions generated 13% of the Company’s total revenue.

For the nine month period ended October 3, 2009, one customer generated 91% of the Company’s total revenues. There were no participants whose capacity commitments generated more than 10% of our revenues. For the nine month period ended September 27, 2008, there was one participant whose capacity commitments generated 13% of the Company’s total revenue.

7.	Sale of Discontinued Operations

Divestiture of Christenson Electric, Inc.

On July 20, 2005, the Company acquired Christenson Electric, Inc. (CEI) in exchange for 2,000,000 shares of the Company’s common stock and the assumption of certain liabilities within CEI. CEI provides services to utilities and other energy related companies. On November 29, 2007, our board of directors signed an agreement to sell all of the shares of our wholly-owned subsidiary Christenson Electric, Inc. to a corporation formed by the management of CEI. The agreement was approved by our shareholders in a vote on March 10, 2008. The closing occurred on April 24, 2008.

The following summarizes the actual results of the disposition of the CEI business segment.

Debts assumed by buyer	$	12,653,197
Net assets disposed of		(12,149,018	)
Expenses incurred in connection with the transaction		(369,404	)
Net gain on disposal of CEI	$	134,775

In the three and six months ended June 28, 2008, the Company recorded a gain on discontinued operations of approximately $163,000, and a loss on discontinued operations of approximately $11,000, respectively.

8.	Legal Proceedings

During 2008, we were contacted by the Federal Regulatory Energy Commission (“FERC”) and asked to provide information to them as part of a non-public inquiry on the demand response markets, and our activity in our markets under the FERC tariffs. Over a period of 8 months we provided them with the requested documentation both in paper and electronic form, and voluntarily provided them with access to certain of our employees in an effort to answer all questions put forth to us. Our responses under the inquiry were completed on December 31, 2008.

On April 28, 2009, staff from FERC’s Office of Enforcement informed EnergyConnect that FERC had found our technology and business processes to be in compliance with the tariff and had closed its inquiry, without any proposed enforcement actions or remedies.

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9.	Fair Value Measurement

Fair Value Measurements under GAAP clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements are separately disclosed by level within the fair value hierarchy. It only applies to accounting pronouncements that already require or permit fair value measures, except for standards that relate to share-based payments

Valuation techniques considered are based on observable and unobservable inputs. The Standard classifies these inputs into the following hierarchy:

Level 1 inputs are observable inputs and use quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date and are deemed to be most reliable measure of fair value.

Level 2 inputs are observable inputs and reflect assumptions that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity. Level 2 inputs includes 1) quoted prices for similar assets or liabilities in active markets, 2) quoted prices for identical or similar assets or liabilities in markets that are not active, 3) observable inputs such as interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, credit risks, default rates, and 4) market-corroborated inputs.

Level 3 inputs are unobservable inputs and reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available under the circumstances.

This statement permits us to choose to measure certain financial assets and liabilities at fair value that are not currently required to be measured at fair value (the “Fair Value Option”). Election of the Fair Value Option is made on an instrument-by-instrument basis and is irrevocable. At the adoption date, unrealized gains and losses on financial assets and liabilities for which the Fair Value Option has been elected are reported as a cumulative adjustment to beginning retained earnings. We did not elect the Fair Value Option as we had no financial assets or liabilities that qualified for this treatment. In the future, if we elect the Fair Value Option for certain financial assets and liabilities, we would report unrealized gains and losses due to changes in their fair value in net income at each subsequent reporting date. The adoption of this statement had no impact on our consolidated financial statements.

The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable, borrowings under the revolving credit facility, and other current assets and liabilities approximate fair value because of their short-term maturity. The fair value of the Company’s long-term debt is approximately $2,050,000 as of October 3, 2009.

10.	Subsequent Events

Management has reviewed and evaluated material subsequent events from the balance sheet date of October 3, 2009 through the financial statements issue date of November 12, 2009. All appropriate subsequent disclosures, if any, have been made in the Notes to Unaudited Condensed Consolidated Financial Statements.

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

The following discussion of the financial condition and results of operations of EnergyConnect Group, Inc. should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements and the Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 3, 2009.

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Forward-Looking Statements

Certain statements contained in this Form 10-Q concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements which are other than statements of historical facts are "forward-looking statements" within the meaning of the federal securities laws. Although the Company believes that the expectations and assumptions reflected in these statements are reasonable, there can be no assurance that these expectations will prove to be correct. These forward-looking statements involve a number of risks and uncertainties, and actual results may differ materially from the results discussed in the forward-looking statements. Any such forward-looking statements should be considered in light of such important factors and in conjunction with other documents of the Company on file with the SEC.

New factors that could cause actual results to differ materially from those described in forward-looking statements emerge from time to time, and it is not possible for the Company to predict all of such factors, or the extent to which any such factor or combination of factors may cause actual results to differ from those contained in any forward-looking statement. Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligations to update the information contained in such statement to reflect subsequent developments or information.

Overview

EnergyConnect Group, Inc. (the “Company,” “we,” “us,” or “our”) through its subsidiary EnergyConnect, Inc. (“ECI”) provides a full range of demand response services to the electric power industry. Our customers are the regional grid operators who pay us market rates for reductions in electrical demand during periods of high prices or peak demand and for being available to reduce electric power demand on request at periods of capacity limitations or in response to grid emergencies. Our suppliers are large commercial and industrial consumers of electricity who we pay to shift their demand for electricity from high priced hours in the day to lower priced hours. We also pay these participating energy consumers to be available to curtail electric demand on request.

Our services provide market incentives to reduce electric demand during periods of peak demand or high prices. By shifting load from high demand periods to times of lower electrical demand our services improve the operating efficiency of the electrical grids and improve grid reliability. We also delay the need for construction of new electrical generating plants. Through higher efficiencies on the grid, lower cost of generation and improved reliability all consumers of electricity benefit from our demand response activities on the electrical grid. By providing consumers of electricity an effective means of responding to grid wholesale prices of electricity we complete the supply demand market place for electricity and provide offsetting market forces to electricity generators.

Our customers are regional electric grid operators such as PJM, the largest electric grid in the nation, and selected electric utilities who support and sponsor demand response. All of our current operations are in the United States with services provided in more than 25 states. Following a three year testing and pilot period, we began commercial operations in 2005. Our revenues in 2008 were $25.9 million. Our suppliers are commercial and industrial electric energy consumers who we pay to shift, curtail, bank, and in some cases produce electric energy.

ECI operates on a national footprint currently serving consumers and grid operators in more than 25 states.

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ECI delivers services to wholesale electric markets of regional electric grids. Selected needs of electric grid operators, including energy, capacity, and reserves have been formed into products that can be delivered through ECI systems to the grid. ECI technologies, processes, and services enable buildings and electric consumers to contribute to such wholesale services in direct competition with expensive peaking power plants.

In 2003 we acquired a part of Christenson Electric, Inc. (“CEI”), and in 2005, we acquired the remainder of CEI and the operations of ECI. This combined a 60 year old electrical contracting and technology business with a high growth demand response business. In 2007 we determined that ECI had grown to a self sustaining transition point and in November 2007 we agreed to sell the stock of CEI. Our objective is to leverage our unique and proprietary technologies, business processes, and resources and build a viable, profitable demand response business servicing North American wholesale power markets. Financial statements and accompanying notes included in this report include disclosure of the results of operations for CEI, for all periods presented, as discontinued operations. All significant inter-company accounts and transactions have been eliminated in consolidation.

The Company was incorporated in October 1986 as an Oregon Corporation, succeeding operations that began in October 1984. The Company’s headquarters are located in Campbell, California.

Critical Accounting Policies

The discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continuously evaluate our estimates and judgments, including those related to revenue recognition, sales returns, bad debts, excess inventory, impairment of goodwill and intangible assets, income taxes, contingencies and litigation. Our estimates are based on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors on a quarterly basis, and the Audit Committee has reviewed our related disclosure in this Form 10-Q.

We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue recognition

We produce revenue through agreements with both building owners and the power grid operators. Under our agreements with facilities owners, we use electrical and energy related products that help energy consumers control energy use in their buildings. In conjunction with this agreement we are members of the power grid operators and have agreed to provide the grids with energy, capacity, and related ancillary services during specified times and under specified conditions. These transactions are summarized at the end of each monthly period and submitted to the power grids for settlement and approval. While the power grids are our customers, they are primarily a conduit through which these electrical curtailment transactions are processed. The vast majority of our revenue in 2008 was processed through the PJM Interconnection. PJM serves as the market for electrical transactions in a specific region in the United States. Our agreement with PJM is an ongoing one as we are members of PJM. These transactions are initiated by building owners, who are our participants. The transactions form the basis for our revenue. We have little risk, if any, from the concentration of revenue through this power grid as it’s a not-for-profit organization that exists to act as the market for electrical transactions.

In 2008, we revised our accounting for reserves for collections of revenues. The revision in our reserve accounting was a result of improvements in our ability to accurately estimate collections, which is based upon historical trends and timely and accurate information. Previously the transactions were recorded as revenue on the settlement date, which typically fall 45-70 days after the transaction date from which the revenue is derived, because management believed that without an established history for this source of revenue, and the potential for disputes, that the settlement date, on which both parties agree to the amount of revenue to recognize, was the most conservative and appropriate date to use. For periods beginning with the first quarter of 2008 and forward, revenue from these settlements were accrued into the prior month instead of recognizing revenue as the settlement amounts were received. The record of these settlement amounts being realized over the prior two years had been extremely accurate so that management believed it was appropriate to accrue the settlement amounts into the prior month. This revision in our reserve accounting resulted in an extra month of revenue being recorded in the first quarter of 2008. This first quarter of 2008 contained the payment received in January of 2008 (which was not accrued into December) and the settlement amounts from the fifth business day in February, March and April of 2008, each of which was accrued into the prior months of January, February and March of 2008. The first quarter of 2009 includes three months of revenue which is comprised of the settlement amounts from the fifth business day in February, March and April of 2009, each of which was accrued into the prior months of January, February and March of 2009. Therefore, the nine month period ended September 27, 2008 is comprised of ten months of settlement amounts and the nine month period ended October 3, 2009 is comprised of nine months of settlement amounts.

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An additional source of our revenue is derived from agreements with the power grid operators whereby a monthly reserve fee is paid for our agreement to standby, ready to provide relief in the form of curtailment of energy usage, in times of high energy demand. We record these payments as revenue over the period during which we’re required to perform under these programs. Under certain programs, our obligation to perform may not coincide with the period over which we receive payments under that program. In these cases we record revenue over the mandatory performance obligation period and record a receivable for the amount of payments that will be received after that period has been completed.

Accruals for contingent liabilities

We make estimates of liabilities that arise from various contingencies for which values are not fully known at the date of the accrual. These contingencies may include accruals for reserves for costs and awards involving legal settlements, costs associated with vacating leased premises or abandoning leased equipment, and costs involved with the discontinuance of a segment of a business. Events may occur that are resolved over a period of time or on a specific future date. Management makes estimates of the potential cost of these occurrences, and charges them to expense in the appropriate periods. If the ultimate resolution of any event is different than management’s estimate, compensating entries to earnings may be required.

Purchase price allocation and impairment of intangible and long-lived assets

Intangible and long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset, and its eventual disposition. Measurement of an impairment loss for intangible and long-lived assets that management expects to hold and use is based on the fair value of the asset as estimated using a discounted cash flow model.

We measure the carrying value of goodwill recorded in connection with the acquisitions for potential impairment in accordance with GAAP, a company is divided into separate “reporting units,” each representing groups of products that are separately managed. For this purpose, we have one reporting unit. To determine whether or not goodwill may be impaired, a test is required at least annually, and more often when there is a change in circumstances that could result in an impairment of goodwill. If the trading of our common stock is below book value for a sustained period, or if other negative trends occur in our results of operations, a goodwill impairment test will be performed by comparing book value to estimated market value. To the extent goodwill is determined to be impaired, an impairment charge is recorded in accordance with GAAP.

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We tested our intangibles for impairment as of the end of fiscal years 2005 through 2008. Goodwill of $106,544,871 was recorded upon the acquisition of ECI in October 2005, and represented the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. At December 31, 2005, it was determined in an independent valuation that the goodwill generated in this transaction was impaired. The Company decided to write off approximately $77,191,344 of this goodwill. At January 3, 2009, it was determined that the remaining carrying value of goodwill generated from the 2005 transaction was impaired. The Company decided to write off the remaining carrying value of goodwill of $29,353,527. The amortization of the intangible assets is included in operating expenses in the consolidated statements of operations.

Stock-Based Compensation

In accordance with GAAP regarding “Share-Based Payment,” (which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values), we are using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006.

Stock-based compensation expense recognized for the three months ended October 3, 2009 and September 27, 2008 was approximately $187,000 and $172,000, respectively. Employee stock-based compensation expense recognized for the nine months ended October 3, 2009 and September 27, 2008 was approximately $601,000 and $644,000, respectively.

GAAP requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Consolidated Statement of Operations. Previously, we accounted for stock-based awards to employees and directors using the intrinsic value method. Under the intrinsic value method, no stock-based compensation expense had been recognized in our Consolidated Statement of Operations because the exercise price of our stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in our Consolidated Statements of Operations for the three and nine months ended October 3, 2009 and September 27, 2008 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with pro forma provisions and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated. GAAP requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

We are using the Black-Scholes option-pricing model as its method of valuation for share-based awards granted beginning in fiscal 2006, which was also previously used for our pro forma information required. Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to our expected stock price volatility over the term of the awards, and certain other market variables such as the risk free interest rate.

Computation of Net Income (Loss) per Share

Basic earnings (loss) per common share are computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is computed using the combination of dilutive common share equivalents, which include convertible preferred shares, options and warrants and the weighted-average number of common shares outstanding during the period. During the nine months ended October 3, 2009 and the nine months ended September 27, 2008, common stock equivalents are not considered in the calculation of the weighted average number of common shares outstanding because they would be anti-dilutive, thereby decreasing the net loss per common share.

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Concentrations

At October 3, 2009 and January 3, 2009 there was one customer whose trade accounts receivable balance represented 80% and 94% of our outstanding trade accounts receivable respectively.

We have little risk, if any, from the concentration of revenues and receivables through our power grid customers as they maintain the various markets for electrical transactions and are pass-through entities regulating the payments between purchasers and suppliers of electricity. We perform limited credit evaluations of our power grid customers and do not require collateral on accounts receivable balances. We have not experienced material credit losses for the periods presented.

The level of revenue resulting from any single participant’s transactions may vary and the loss of any one of these participants, or a decrease in the level of revenue from transactions generated by any one of these participants, could have a material adverse impact on our financial condition and results of operations.

Recent Accounting Pronouncements

See Note 1 of the Unaudited Condensed Consolidated Financial Statements for a full description of new accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition.

Results of Operations

The financial information presented is for the three and nine months ended October 3, 2009 and September 27, 2008, represents activity in EnergyConnect Group, Inc. and its wholly-owned subsidiary, ECI.

Revenue.

The Company generates revenue mainly from demand response transactions regulated by a FERC tariff. These transactions include economic or price-based programs and capacity programs.

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Economic or price-based programs entail voluntary, daily opportunities to enter into transactions in the energy markets based on our customers’ responses to fluctuations in hourly energy prices.

Capacity programs allow for payments to partners such as ECI based on energy availability and curtailment when required by an electric grid to stabilize the supply and demand of electricity on the grid. Also included in the FERC tariff are rules under which we recognize revenue in capacity based energy programs.

The FERC tariff also allows for other revenue opportunities in helping to meet various needs of electric grids. We recognize revenue from these programs ratably over the months during which our response is required.

Three months ended October 3, 2009 compared to Three months ended September 27, 2008.

Revenue for the three months ended October 3, 2009 was approximately $10,338,000 compared to $11,641,000 for the three months ended September 27, 2008, a reduction of approximately $1,303,000 or (11%).

The reduction in revenues of approximately $1,303,000 is primarily attributable to a change in the revenue recognition pattern for the PJM ILR capacity program arising from a change in the terms of and administration of the program by PJM. For the three months ended October 3, 2009 approximately 75% of the annual revenue for the program was included in the period, the other 25% being recognized in revenues during the second quarter which ended on July 4, 2009. For the three months ended September 27, 2008, approximately 100% of the annual revenue for the program was included in the period.

For the three months ended October 3, 2009, one customer generated 92% the Company’s total revenue, no other customer generated more than 10% of the Company’s total revenue. For the three months ended September 27, 2008, one customer generated 96% of the Company’s total revenue, no other customer generated more than 10% of the Company’s total revenue.

For the three months ended October 3, 2009, there were no participants whose capacity commitments generated more than 10% of the Company’s total revenue. For the three months ended September 27, 2008, there was one participant whose capacity commitments generated 13% of the Company’s total revenue.

Nine months ended October 3, 2009 compared to Nine months ended September 27, 2008.

Revenue for the nine months ended October 3, 2009 was approximately $19,070,000 compared to approximately $24,083,000 for the nine months ended September 27, 2008, a reduction of $5,013,000 or (21%).

The reduction in revenues of approximately $5,013,000 is primarily attributable to the nine month period ended September 27, 2008, being comprised of ten months settlement amounts and the nine month period ended October 3, 2009, being comprised of nine months of settlement amounts as described in the Critical Accounting Policies.

For the nine months ended October 3, 2009 and the nine months ended September 27, 2008, approximately 100% of the annual revenues for the PJM ILR capacity program are included in the period.

For the nine months ended October 3, 2009, one customer generated 91% the Company’s total revenue, no other customer generated more than 10% of the Company’s total revenue. For the nine months ended September 27, 2008, one customer generated 96% of the Company’s total revenue, no other customer generated more than 10% of the Company’s total revenue.

For the nine months ended October 3, 2009, there were no participants whose capacity commitments generated more than 10% of the Company’s total revenue. For the nine months ended September 27, 2008, there was one participant whose capacity commitments generated 13% of the Company’s total revenue.

Index

Cost of Revenues.

Three months ended October 3, 2009 compared to three months ended September 27, 2008.

Cost of revenues for the three months ended October 3, 2009 was approximately $7,221,000 compared to $6,458,000 for the three months ended September 27, 2008, an increase of approximately $763,000 or (12%).

Nine months ended October 3, 2009 compared to nine months ended September 27, 2008.

Cost of revenues for the nine months ended October 3, 2009 was approximately $12,161,000 compared to $16,945,000 for the nine months ended September 27, 2008, a reduction of approximately $4,784,000 or (28%).

Cost of revenues includes the payments to our participants for capacity commitments made by them, and for transactions initiated by them, and various costs required to do business in the grids in which we operate.

Gross Profit.

Three months ended October 3, 2009 compared to Quarter ended September 27, 2008.

Gross profit for the three months ended October 3, 2009 was approximately $3,117,000 or (30% of revenues) compared to approximately $5,183,000 or (45% of revenues) for the three months ended September 27, 2008, a reduction of $2,066,000 or (40%).

The reduction in gross profit is primarily attributable to lower revenues and to an overall lower gross margin percentage. The reduction in gross margin percentage from 45% to 30% is primarily attributable to the change in the mix of capacity and economic programs.

Nine months ended October 3, 2009 compared to Nine months ended September 27, 2008.

Gross profit for the nine months ended October 3, 2009 was approximately $6,909,000 or (36% of revenues) compared to $7,138,000 or (30% of revenues) for the same period in 2008, representing a reduction in gross profit of $229,000 or (3%).

The reduction in gross profit is primarily attributable to lower revenues which have been partially offset by an overall higher gross margin percentage. The increase in gross margin percentage to 36% of revenues in 2009 from 30% of revenues in 2008 is primarily attributable to the change in the customer mix and the mix of capacity and economic programs.

Future gross profit margins will depend on the Company’s ability to sign contracts with participants for appropriate percentages for the duration of the contract term.

Operating Expenses.

Three months ended October 3, 2009 compared to Three months ended September 27, 2008.

Operating expenses for the three months ended October 3, 2009, were approximately $2,246,000 compared to approximately $3,024,000 for the three months ended September 27, 2008, a reduction of approximately $778,000 or (25.7%)

This reduction in operating expenses was primarily attributable to, lower personnel costs of approximately $700,000, and lower professional services costs of approximately $100,000.

The reduction in personnel costs of approximately $700,000 which was primarily attributable to lower headcount and a decrease in the use of temporary labor.

Included in the reduction of personnel costs was the impact of a increase in the non-cash charge for employee stock-based compensation, which was approximately $187,000 for the three months ended October 3, 2009, compared to $172,000 for the nine months ended September 27, 2008, a increase of approximately $15,000 or (9%).

Index

Nine months ended October 3, 2009 compared to Nine months ended September 27, 2008.

Operating expenses for the nine months ended October 3, 2009 were approximately $7,126,000 for the nine months ended October 3, 2009, compared to approximately $9,322,000 for the nine months ended September 27, 2008, a reduction of approximately $2,196,000 or (23.6%)

This reduction in operating expenses was primarily attributable to, lower personnel costs of approximately $1,600,000, lower advertising and marketing costs of approximately $400,000, lower professional services costs of approximately $100,000 and lower other costs of $100,000.

The reduction in personnel costs of approximately $1,600,000 represented a 27% reduction in these costs, which was primarily attributable to lower headcount and a decrease in the use of temporary labor.

Included in the reduction of personnel costs was the impact of a reduction in the non-cash charge for employee stock-based compensation, which was approximately $601,000 for the nine months ended October 3, 2009, compared to $644,000 for the nine months ended September 27, 2008, a reduction of approximately $43,000 or (7%).

Interest Expense.

Three months ended October 3, 2009 compared to three months ended September 27, 2008.

Net interest expense was $342,000 for the three months ended October 3, 2009 compared to net interest expense $12,000 for the three months ended September 27, 2008.

Nine months ended October 3, 2009 compared to Nine months ended September 27, 2008.

Net interest expense was $735,000 for the nine months ended October 3, 2009, compared to $7,000 of net interest income for the nine months ended September 27, 2008.

Net interest expense in 2009 is comprised mainly of interest expense incurred under the Company’s debt facility and amortization of debt discount associated with the beneficial conversion feature of the debt facility. Interest expense on the debt facility for the three and nine months ended October 3, 2009 was $185,000 and $458,000 respectively. Debt discount amortization for the three and nine months ended October 3, 2009 was $160,000 and $281,000, respectively.

Gain / Loss From Discontinued Operations.

Discontinued operations represents a loss from the operations of the Christenson Electric electrical construction business. On November 29, 2007, our board of directors signed an agreement to sell all of the shares of our wholly-owned subsidiary Christenson Electric, Inc. to a corporation formed by the management of CEI. The agreement was approved by our shareholders in a vote on March 10, 2008. The closing occurred on April 24, 2008. The Company recorded a gain from discontinued operations of $29,000 for the three months ended June 28, 2008. The Company recorded a loss from discontinued operations of $146,000 for the nine months ended September 27, 2008. On April 24, 2008, the sale of discontinued operations was consummated, and the Company recorded a gain on the sale of discontinued operations in the amount of $135,000.

Index

Income Taxes.

No federal tax benefit from loss carryback was recorded in either year as there was no income tax paid in the open loss carryback periods. The Company has provided a full valuation allowance on its net deferred tax asset.

Liquidity and Capital Resources

Since inception, the Company has financed its operations and capital expenditures through public and private sales of equity securities, cash from operations, and borrowings under debt facilities. At October 3, 2009, the Company had positive working capital of approximately $2,160,000 and its primary source of liquidity consisted of cash advances under its debt facility and cash generated from operations. Of the amounts contained in certificates of deposit, $66,800 was restricted at both October 3, 2009 and January 3, 2009.

On February 26, 2009 we entered into a Business Loan Agreement, a Convertible Secured Promissory Note and Commercial Security Agreement (collectively the “Loan Agreements”) with Aequitas Commercial finance, LLC (Aequitas). Pursuant to the terms and conditions of the Loan Agreements, Aequitas will provide the Company with a revolving credit facility enabling the Company to borrow money in a maximum principal amount not to exceed $5,000,000. As security for this loan, the Companies granted Aequitas a first priority security interest in the assets of the Companies. The Loan Agreements grant Aequitas the right to convert up to two-thirds (2/3rds) of unpaid principal and interest into shares of ECNG’s common stock at an exercise price of $0.091.

On May 7, 2008 we closed a private placement in which we issued 9,051,310 shares of common stock resulting in aggregate cash proceeds of $3,512,000 and elimination of accounts payable of $103,000. In conjunction with this private placement, we also issued 4,525,655 five year warrants exercisable at $0.60 per share. The proceeds of this financing were used for general working capital purposes.

Accounts receivable increased to $10,712,000 at October 3, 2009 from $4,374,000 at January 3, 2009. The increase was primarily due to the recognition of revenue and receivables from the 2009-2010 ILR capacity program. Receivables were also affected by collections from the prior year ILR capacity receivable that was outstanding at January 3, 2009. The receivable from the 2008-2009 ILR capacity program which was approximately $6 million as of the end of September 2008, decreased ratably through the end of the second quarter of 2009 and was paid in full as of the end of the current quarter. Our remaining receivables will increase and decrease in accordance with the revenue recognized in each quarter. The large majority of our revenue, and therefore cash and receivables, is generated through the PJM Interconnection. PJM serves as the market for electrical transactions in a specific region in the United States. We are members of PJM, and our relationship with this power grid is perpetual. We have little risk, if any, from the concentration of revenue through this power grid as it is a not-for-profit organization that exists to act as the market for electrical transactions.

Property and equipment, net of depreciation, decreased to $286,000 at October 3, 2009, compared to $299,000 at January 3, 2009. This decrease was due primarily to the capitalization of software costs to produce internally used software, less normal depreciation on fixed assets. The Company does not anticipate spending significant amounts to acquire fixed assets for the foreseeable future.

Accounts payable increased to $10,242,000 at October 3, 2009 from $5,116,000 at January 3, 2009. The increase was primarily due to the accrual of participant payments to match recognition of expenses associated with the PJM ILR capacity program with the recognition of revenue and receivables. At October 3, 2009, other than normal obligations to vendors, payables consist primarily of payment obligations to participants, not currently due, in our capacity programs and to normal monthly obligations in our economic programs.

The Company had no material commitments for capital expenditures at October 3, 2009.

As a result of our history of losses and our experiencing difficulty in generating sufficient cash flow to meet our obligations and sustain our operations, our independent registered public accounting firm, in their report included in our January 3, 2009 Form 10-K, have expressed substantial doubt about our ability to continue as going concern.

Index

In prior periods, we generated cash through our discontinued operating subsidiary, Christenson Electric, Inc. This subsidiary also held a $10 million operating line of credit under which we borrowed funds against eligible accounts receivable. The funds generated from the discontinued operations and their debt facility are no longer available to the continuing entity. All future cash will need to be generated from the operations of EnergyConnect, our debt facility and from funds raised through future debt and equity financings should cash generated from operations and current debt facilities prove insufficient.

Management believes it has sufficient capital resources to meet projected cash flow deficits for the following twelve months. If during that period or thereafter, the Company is not successful in generating sufficient liquidity from operations, cash needs exceed its ability to borrow on its debt facility, or in raising sufficient capital resources, on terms acceptable to them, this could have a material adverse effect on the Company’s business, results of operations liquidity and financial condition.

The Company has reduced costs through two reductions in force, and through management salary reductions in the last two sequential quarters. If operations and cash flows continue to improve through these efforts, management believes that the Company can continue to operate. However, no assurance can be given that management’s actions will result in profitable operations or the resolution of its liquidity problems.

Our registered independent certified public accountants have stated in their report dated March 19, 2009, that we have incurred operating losses in the past years, and that we are dependent upon management's ability to develop profitable operations. These factors among others may raise substantial doubt about our ability to continue as a going concern.

Inflation

In the opinion of management, inflation will not have a significant impact on the Company’s financial condition and results of its operations.

Off-Balance Sheet Arrangements

The Company does not maintain off-balance sheet arrangements nor does it participate in any non-exchange traded contracts requiring fair value accounting treatment.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

The Company does not own or trade any financial instruments about which disclosure of quantitative and qualitative market risks are required to be disclosed.

Item 4. Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

Index

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, our CEO and CFO concluded, as of the end of such period, our disclosure controls and procedures were effective in ensuring that the information required to be filed or submitted under the Exchange Act is recorded, processed, summarized and reported as specified in the Securities and Exchange Commission's rules and forms, and accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in internal controls over financial reporting that occurred during the period covered by this report that have affected, or are reasonably likely to affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

During 2008, we were contacted by FERC and asked to provide information to them as part of a non-public inquiry on the demand response markets, and our activity in our markets under the FERC tariffs. Over a period of 8 months we provided them with the requested documentation both in paper and electronic form, and voluntarily provided them with access to certain of our employees in an effort to answer all questions put forth to us. Our responses under the inquiry were completed on December 31, 2008.

The Company is subject to legal proceedings and claims, which arise in the ordinary course of its business. Although occasional adverse decisions or settlements may occur, the Company believes that the final disposition of such matters should not have a material adverse effect on its financial position, results of operations or liquidity.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Item 7 (Management's Discussion and Analysis of Financial Condition and Plan of Operation) of our Annual Report on Form 10-K for the year ended January 3, 2009 (the "Annual Report"), which could materially affect our business, financial condition or future results. There have been no material changes to the risk factors disclosed in the Annual Report.

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

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

Index

The Company held its annual shareholders’ meeting on July 28, 2009. There were present at the meeting in person or by proxy shareholders of the Corporation who were the holders of 61,092,167 (64.4%), shares of Common Stock entitled to vote thereat constituting a quorum. There were three proposals upon which shareholders were asked to vote.

Election of directors.

To approve the restatement of EnergyConnect’s 2004 Stock Incentive Plan to make amendments and updates as necessary to comply with recent changes in applicable laws and provide flexibility for employee compensation; and

To transact such other business as may properly come before the Annual Meeting and any adjournment or adjournments thereof.

The following nominees were elected by the following vote count.

	Votes For		Votes Withheld
William C. McCormick		46,575,227		14,516,940
Rodney M. Boucher		48,421,809		12,670,358
John P. Metcalf		60,481,744		610,423
Kurt E. Yeager		60,720,026		372,141
Gary D. Conley		60,469,852		622,315
Kevin R. Evans		60,463,190		628,977

On April 1, 2009, Gene Ameduri tendered his resignation from the Company’s board of directors.

The shareholders passed both the second and third proposals listed above.

Item 5. Other Information

None

Item 6. Exhibits

(a) The exhibits filed as part of this report are listed below:

Exhibit No.

31.1 Certification of Chief Executive Officer pursuant to Section 302, of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer pursuant to Section 302, of the Sarbanes-Oxley Act of 2002.

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Index

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: November 12, 2009

	ENERGYCONNECT GROUP, INC.

	By: /s/ Kevin R. Evans
	Kevin R. Evans
	Chief Executive Officer
	(Principal Executive Officer)

Attached files

EnergyConnect Group Inc Reports

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