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EX-32.1 - SECTION 906 CEO CERTIFICATION - COMVERGE, INC.exhibit32_1.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - COMVERGE, INC.exhibit31_2.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - COMVERGE, INC.exhibit32_2.htm
EX-10.2 - MATERIAL AGREEMENT - COMVERGE, INC.exhibit10_2.htm
EX-10.6 - MATERIAL AGREEMENT - COMVERGE, INC.exhibit10_6.htm
EX-10.9 - EMPLOYMENT AGREEMENT - COMVERGE, INC.exhibit10_9.htm
EX-10.5 - MATERIAL AGREEMENT - COMVERGE, INC.exhibit10_5.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - COMVERGE, INC.exhibit31_1.htm
EX-10.7 - EMPLOYMENT AGREEMENT - COMVERGE, INC.exhibit10_7.htm
EX-10.1 - MATERIAL AGREEMENT - COMVERGE, INC.exhibit10_1.htm
EX-10.4 - MATERIAL AGREEMENT - COMVERGE, INC.exhibit10_4.htm
EX-10.8 - EMPLOYMENT AGREEMENT - COMVERGE, INC.exhibit10_8.htm
EX-10.3 - MATERIAL AGREEMENT - COMVERGE, INC.exhibit10_3.htm
EX-10.10 - EMPLOYMENT AGREEMENT - COMVERGE, INC.exhibit10_10.htm



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
x
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2010
 
or
 
¨
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from              to             
 
Commission File Number:  001-33399
 
Comverge, Inc.
(Exact name of Registrant as specified in its charter)
  
     
Delaware
 
22-3543611
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification No.)
     
     
5390 Triangle Parkway, Suite 300
Norcross, Georgia
 
30092
(Address of principal executive offices)
 
(Zip Code)
 
(678) 392-4954
 (Registrant’s telephone number including area code)
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨       No   ¨
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check one):
 
Large accelerated filer    ¨    Accelerated filer   x    Non-accelerated filer   ¨    (Do not check if a smaller reporting company)    Smaller Reporting Company   ¨
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes   ¨     No   x
 
There were 25,314,127 shares of the Registrant’s common stock, $0.001 par value per share, outstanding on November 2, 2010. 
 
 



 
 
 
Comverge, Inc.
 
         
     
  
Page
Part I - Financial Information
 
     
Item 1.
   
     
   
1
     
   
2
     
   
3
     
   
4
     
Item 2.
 
16
     
Item 3.
 
28
     
Item 4.
 
28
   
Part II - Other Information
  
     
Item 1.
 
29
     
Item 1A.
 
29
     
Item 2.
 
33
     
Item 6.
 
33
     
       
       


 
 
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
Assets
           
Current assets
           
Cash and cash equivalents
  $ 10,396     $ 16,069  
Restricted cash
    1,735       3,000  
Marketable securities
    21,543       34,409  
Billed accounts receivable, net
    14,853       8,119  
Unbilled accounts receivable
    28,300       11,873  
Inventory, net
    8,124       6,605  
Deferred costs
    5,785       1,715  
Other current assets
    1,579       938  
Total current assets
    92,315       82,728  
                 
Restricted cash
    3,539       2,636  
Property and equipment, net
    19,914       18,340  
Intangible assets, net
    6,698       8,779  
Goodwill
    8,179       8,179  
Other assets
    254       235  
Total assets
  $ 130,899     $ 120,897  
Liabilities and Shareholders' Equity
               
Current liabilities
               
Accounts payable
  $ 4,688     $ 6,874  
Accrued expenses
    27,296       11,574  
Deferred revenue
    22,032       5,890  
Current portion of long-term debt
    3,000       3,000  
Other current liabilities
    6,994       5,648  
Total current liabilities
    64,010       32,986  
Long-term liabilities
               
Deferred revenue
    2,170       1,203  
Long-term debt
    7,500       9,750  
Other liabilities
    2,717       2,914  
Total long-term liabilities
    12,387       13,867  
                 
Shareholders' equity
               
Common stock, $0.001 par value per share, authorized 150,000,000
               
shares;  issued 25,316,460 and outstanding 25,295,323 shares as of
               
September 30, 2010 and issued 25,072,764 and outstanding 25,067,102
               
shares as of December 31, 2009
    25       25  
Additional paid-in capital
    261,174       258,660  
Common stock held in treasury, at cost, 21,137 and 5,662 shares as of
               
September 30, 2010 and December 31, 2009, respectively
    (224 )     (63 )
Accumulated deficit
    (206,508 )     (184,596 )
Accumulated other comprehensive income
    35       18  
Total shareholders' equity
    54,502       74,044  
Total liabilities and shareholders' equity
  $ 130,899     $ 120,897  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenue
                       
Product
  $ 5,798     $ 6,263     $ 16,553     $ 16,176  
Service
    45,937       26,932       65,610       41,864  
Total revenue
    51,735       33,195       82,163       58,040  
Cost of revenue
                               
Product
    4,588       3,793       12,594       9,879  
Service
    30,928       19,948       43,278       28,451  
Total cost of revenue
    35,516       23,741       55,872       38,330  
Gross profit
    16,219       9,454       26,291       19,710  
Operating expenses
                               
General and administrative expenses
    10,496       12,419       27,808       28,409  
Marketing and selling expenses
    4,634       4,340       13,478       12,782  
Research and development expenses
    1,664       1,158       4,572       3,483  
Amortization of intangible assets
    536       553       1,608       1,657  
Operating loss
    (1,111 )     (9,016 )     (21,175 )     (26,621 )
Interest and other expense, net
    214       376       567       940  
Loss before income taxes
    (1,325 )     (9,392 )     (21,742 )     (27,561 )
Provision for income taxes
    55       52       170       159  
Net loss
  $ (1,380 )   $ (9,444 )   $ (21,912 )   $ (27,720 )
                                 
Net loss per share (basic and diluted)
  $ (0.06 )   $ (0.44 )   $ (0.89 )   $ (1.29 )
                                 
Weighted average shares used in computation     24,718,710        21,551,171        24,638,815        21,442,715   


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

 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
   
Nine Months Ended September 30,
 
   
2010
   
2009
 
Cash flows from operating activities
           
Net loss
  $ (21,912 )   $ (27,720 )
Adjustments to reconcile net loss to net cash from operating activities:
         
Depreciation
    966       810  
Amortization of intangible assets
    2,121       2,089  
Stock-based compensation
    2,335       6,803  
Other
    1,022       780  
Changes in operating assets and liabilities:
               
Billed and unbilled accounts receivable, net
    (23,278 )     (6,185 )
Inventory, net
    (1,911 )     (1,340 )
Deferred costs and other assets
    (1,406 )     (555 )
Accounts payable
    (1,851 )     (1,161 )
Accrued expenses and other liabilities
    16,902       12,163  
Deferred revenue
    17,109       20,938  
Net cash (used in) provided by operating activities
    (9,903 )     6,622  
                 
Cash flows from investing activities
               
Changes in restricted cash
    362       (39 )
Purchases of marketable securities
    (13,948 )     (24,777 )
Maturities of marketable securities
    26,262       25,750  
Purchases of property and equipment
    (5,765 )     (13,011 )
Net cash provided by (used in) investing activities
    6,911       (12,077 )
                 
Cash flows from financing activities
               
Borrowings under debt facility
    18,000       10,900  
Repayment of debt facility
    (20,250 )     (1,758 )
Payment of subordinated convertible notes
    -       (590 )
Other
    (431 )     131  
Net cash (used in) provided by financing activities
    (2,681 )     8,683  
                 
Net change in cash and cash equivalents
    (5,673 )     3,228  
Cash and cash equivalents at beginning of period
    16,069       19,571  
Cash and cash equivalents at end of period
  $ 10,396     $ 22,799  
                 
Cash paid for interest
  $ 723     $ 1,063  
Supplemental disclosure of noncash investing and financing activities
         
Recording of (reduction in) asset retirement obligation
  $ (201 )   $ 336  
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
 
1.
 
Description of Business and Basis of Presentation
 
Description of Business
 
Comverge, Inc., a Delaware corporation, and its subsidiaries (collectively, the “Company”), provide intelligent energy management solutions that enable energy providers and consumers to optimize their power usage and meet peak demand.  The Company delivers its intelligent energy management solutions through a portfolio of hardware, software and services.  The Company has three operating segments: the Utility Products & Services segment, the Residential Business segment, and the Commercial & Industrial Business segment.
 
Basis of Presentation
 
The condensed consolidated financial statements of the Company include the accounts of its subsidiaries. These unaudited condensed consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X.

In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments considered necessary for a fair statement of the Company’s financial position as of September 30, 2010 and the results of operations for the three and nine months ended September 30, 2010 and 2009, and cash flows for the nine months ended September 30, 2010 and 2009, consisting only of normal and recurring adjustments. All significant intercompany transactions have been eliminated in consolidation. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010. The interim condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the Company’s consolidated financial statements and footnotes thereto for the year ended December 31, 2009 on Form 10-K filed on March 8, 2010.

The condensed consolidated balance sheet as of December 31, 2009 was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States.

2.
 
Significant Accounting Policies and Recent Accounting Pronouncements
 
Revenue Recognition – Utility Products & Services
 
The Company sells hardware products and services directly to utilities for use and deployment by the utility. The Company recognizes revenue for such sales when delivery has occurred or services have been rendered and the following criteria have been met: delivery has occurred, the price is fixed and determinable, collection is probable, and persuasive evidence of an arrangement exists.  The Company reports shipping and handling revenue and its associated costs in revenue and cost of revenue, respectively.
 
 

The Company has certain contracts which are multiple element arrangements and provide for several deliverables to the customer that may include installation services, marketing services, program management services, software, hardware and hosting services. These contracts require no significant production, modification or customization of the software and the software is incidental to the products and services as a whole. The Company evaluates each deliverable to determine whether it represents a separate unit of accounting. If objective and reliable evidence of fair value exists for all units of accounting in the arrangement, revenue is allocated to each unit of accounting based on relative fair values. Each unit of accounting is then accounted for under the applicable revenue recognition guidance.

 Revenue Recognition - Residential Business
 
The Company defers revenue and the associated cost of revenue related to certain long-term Virtual Peaking Capacity, or VPC, contracts until such time as the annual contract payment is fixed and determinable. The Company invoices VPC customers on a monthly or quarterly basis throughout the contract year. The VPC contracts require the Company to provide electric capacity through demand reduction to utility customers, and require a measurement and verification of such capacity on an annual basis in order to determine final contract consideration for a given contract year. Contract years typically begin at the end of a control season (generally, at the end of a utility’s summer cooling season that correlates to the end of the utility’s peak demand for electricity) and continue for twelve months thereafter.  Once a participant enrolls in one of the Company’s VPC programs, the Company installs intelligent hardware at the participant’s location. The cost of the installation and the hardware are capitalized and depreciated as cost of revenue over the remaining term of the contract with the utility, which is shorter than the operating life of the equipment.  The Company also records telecommunications costs related to the network as cost of revenue.  The cost of revenue is recognized contemporaneously with revenue.
 
The current deferred revenue and deferred cost of revenue as of September 30, 2010 and December 31, 2009 are provided below:  
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
Deferred revenue:
           
VPC contract related
  $ 18,830     $ 3,443  
Other
    3,202       2,447  
Current deferred revenue
  $ 22,032     $ 5,890  
                 
Deferred cost of revenue:
               
VPC contract related
  $ 5,027     $ 1,072  
Other
    758       643  
Current deferred cost of revenue
  $ 5,785     $ 1,715  
 
 
 
 
The Company enters into agreements to provide base load capacity. Energy efficiency revenues are earned based on the Company’s ability to achieve committed capacity through base load reduction. In order to provide capacity, the Company delivers and installs energy efficiency management solutions. The base load capacity contracts require the Company to provide electric capacity to utility customers, and include a measurement and verification of such capacity in order to determine contract consideration. The Company defers revenue and associated cost of revenue until such time as the capacity amount, and therefore the related revenue, is fixed and determinable. Once the capacity amount has been verified, the revenue is recognized. If the revenue is subject to penalty, refund or an ongoing obligation, the revenue is deferred until the contingency is resolved and/or the Company has met its performance obligation. Certain contracts contain multiple deliverables, or elements, which require the Company to assess whether the different elements qualify for separate accounting. The separate deliverables in these arrangements meet the separation criteria. Accordingly, revenue is recognized for each element by applying the residual method, since there is objective evidence of fair value of only the undelivered item. The amount allocated to the delivered item is limited to the amount that is not contingent upon delivery of the additional element.
 
Revenue Recognition - Commercial & Industrial Business
 
The Company enters into agreements to provide commercial and industrial demand response services. The demand response programs require the Company to provide electric capacity through demand reduction when the utility or independent system operator calls a demand response event to curtail electrical usage. Demand response revenues are earned based on the Company’s ability to deliver capacity. In order to provide capacity, the Company manages a portfolio of commercial and industrial participants’ electric loads. Capacity amounts are verified through the results of an actual demand response event or a demand response test.  The Company recognizes revenue and associated cost of revenue in its demand response services at such time as the capacity amount is fixed and determinable.
 
The Company records revenue from capacity programs with independent system operators. The capacity year for its primary capacity program spans from June 1st to May 31st annually. For participation, the Company receives cash payments on a monthly basis in the capacity year. Participation in the capacity program requires the Company to respond to requests from the system operator to curtail energy usage during the mandatory performance period of June through September, which is the peak demand season. The annual payments for a capacity year are recognized at the end of the mandatory performance period, once the revenue is fixed and determinable.  As of September 30, 2010, there was $20,279 of unbilled accounts receivable and $19,130 of accrued expenses recorded related to the capacity program.  These balances are not indicative of the gross margin associated with this capacity program due to the timing of cash receipts differing from the timing of cash payments to end-use participants.  These balances will be reduced as the Company receives payment from the independent system operator and pays the end-use participants throughout the capacity year.
 
Revenue from time-and-materials service contracts and other services are recognized as services are provided. Revenue from certain fixed price contracts are recognized on a percentage-of-completion basis, which involves the use of estimates. If the Company does not have a sufficient basis to measure the progress towards completion, revenue is recognized when the project is completed or when final acceptance is received from the customer. The Company also enters into agreements to provide hosting services that allow customers to monitor and analyze their electrical usage. Revenue from hosting contracts is recognized as the services are provided, generally on a recurring monthly basis.
 
 

Comprehensive Loss
 
The Company reports total changes in equity resulting from revenues, expenses, and gains and losses, including those that do not affect the accumulated deficit. Accordingly, other comprehensive loss includes those amounts relating to unrealized gains and losses on investment securities classified as available for sale.
 
The components of comprehensive loss are as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net loss
  $ (1,380 )   $ (9,444 )   $ (21,912 )   $ (27,720 )
Unrealized gain (loss) on marketable securities
    27       (3 )     17       16  
Comprehensive loss
  $ (1,353 )   $ (9,447 )   $ (21,895 )   $ (27,704 )
 
Concentration of Credit Risk
 
The Company derives a significant portion of its revenue from products and services that it supplies to electricity providers, such as utilities and independent service operators. Changes in economic conditions and unforeseen events could occur and could have the effect of reducing use of electricity by our customers’ consumers. The Company’s business success depends in part on its relationships with a limited number of large customers.  During the three months ended September 30, 2010, the Company had one customer which accounted for 59% of the Company’s revenue. During the nine months ended September 30, 2010, the Company had two customers which accounted for 52%, in the aggregate, of the Company’s revenue. The total accounts receivable from these customers was $26,119 as of September 30, 2010, or 61% of net accounts receivable outstanding. The Company had one customer which accounted for 57% of the Company’s revenue during the three months ended September 30, 2009 and 33% of the Company’s revenue during the nine months ended September 30, 2009.  No other customer accounted for more than 10% of the Company’s total revenue during the three and nine months ended September 30, 2010 and 2009.
 
The Company is subject to concentrations of credit risk from its cash and cash equivalents and short term investments. The Company limits its exposure to credit risk associated with cash and cash equivalents and short term investments by placing its cash and cash equivalents with a number of domestic financial institutions and by investing in investment grade securities.
 
Goodwill
 
The Company performs its annual impairment test of goodwill as of December 31st. Goodwill is tested for impairment using the two-step approach. Step 1 of the goodwill impairment test compares the fair value of the reporting unit with its carrying amount, including goodwill.  The Company bases its fair value estimates on projected financial information which it believes to be reasonable.  If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test would be performed to measure the amount of impairment, if any. As of September 30, 2010, goodwill in the amount of $7,680 is related to the Energy Efficiency reporting unit in the Residential Business segment.
 
This reporting unit is experiencing a decline in installations in its service territories, resulting in revenue from the reporting unit being less than expected.  As of September 30, 2010, the Company does not believe an event or change in circumstance has occurred that would more likely than not reduce the fair value of the reporting unit below its carrying amount.  If the decline in revenue and associated cash flows continues, it may impact the fair value of the reporting unit, causing its carrying value to exceed its fair value.  Also, materially different assumptions regarding future performance of the reporting unit or a change in the strategic direction of the reporting unit could result in significant impairment losses.
 
 
 
Recent Accounting Pronouncements
 
In October 2009, the Financial Accounting Standards Board, or FASB, issued amendments to the accounting and disclosure for revenue recognition. These amendments, effective for fiscal years beginning on or after June 15, 2010 (early adoption is permitted), modify the criteria for recognizing revenue in multiple element arrangements and the scope of what constitutes a non-software deliverable. The Company is currently assessing the impact of the adoption on its consolidated financial position and results of operations.
 
In January 2010, the FASB issued Accounting Standards Update, or ASU, No. 2010-06 Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements.  The guidance requires previous fair value hierarchy disclosures to be further disaggregated by class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. In addition, significant transfers between Levels 1 and 2 of the fair value hierarchy are required to be disclosed. These additional requirements became effective January 1, 2010 for quarterly and annual reporting. These amendments did not have an impact on the consolidated financial results as this guidance relates only to additional disclosures.
 
In February 2010, the FASB issued ASU No. 2010-09 Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements.  The update removes the requirement to disclose a date through which subsequent events have been evaluated.   The update is effective for interim or annual periods ending after June 15, 2010.  The change in disclosure did not have a material impact on the Company’s financial position, results of operation or cash flows.
 

3.
 
Net Loss Per Share
 
Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed using the weighted average number of common shares outstanding and, when dilutive, potential common shares from options and warrants using the treasury stock method and from convertible securities using the if-converted method. Because the Company reported a net loss for the three and nine months ended September 30, 2010 and 2009, all potential common shares have been excluded from the computation of the dilutive net loss per share for all periods presented because the effect would have been anti-dilutive. Such potential common shares consist of the following:
 
   
 September 30,
   
2010
 
2009
Unvested restricted stock awards
 
              567,696
 
             527,356
Outstanding options
 
           2,619,234
 
          2,239,840
Total
 
3,186,930
 
2,767,196
 
 
 

4.
 
Marketable Securities
 
The amortized cost and fair value of marketable securities, with gross unrealized gains and losses, as well as the balance sheet classification as of September 30, 2010 and December 31, 2009 is presented below.
 
   
September 30, 2010
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
   
Cash and
   
Restricted
   
Marketable
 
   
Cost
   
Gains
   
Losses
   
Value
   
Equivalents
   
Cash
   
Securities
 
Money market funds
  $ 13,316     $ -     $ -     $ 13,316     $ 8,042     $ 5,274     $ -  
Commercial paper
    1,899       -       -       1,899       -       -       1,899  
Corporate debentures/bonds
    19,609       37       (2 )     19,644       -       -       19,644  
Total marketable securities
    34,824       37       (2 )     34,859       8,042       5,274       21,543  
Cash in operating accounts
    2,354       -       -       2,354       2,354       -       -  
Total
  $ 37,178     $ 37     $ (2 )   $ 37,213     $ 10,396     $ 5,274     $ 21,543  
 
   
December 31, 2009
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
   
Cash and
   
Restricted
   
Marketable
 
   
Cost
   
Gains
   
Losses
   
Value
   
Equivalents
   
Cash
   
Securities
 
Money market funds
  $ 15,622     $ -     $ -     $ 15,622     $ 10,406     $ 2,216     $ 3,000  
Commercial paper
    6,142       -       -       6,142       -       -       6,142  
Corporate debentures/bonds
    26,249       45       (27 )     26,267       1,000       -       25,267  
Total marketable securities
    48,013       45       (27 )     48,031       11,406       2,216       34,409  
Cash in operating accounts
    8,083       -       -       8,083       4,663       3,420       -  
Total
  $ 56,096     $ 45     $ (27 )   $ 56,114     $ 16,069     $ 5,636     $ 34,409  
 
Realized gains and losses to date have not been material. Interest income for the three and nine months ended September 30, 2010 was $213 and $723, respectively.  Interest income for the three and nine months ended September 30, 2009 was $154 and $570, respectively.

The Company applies a fair value hierarchy that requires the use of observable market data, when available, and prioritizes the inputs to valuation techniques used to measure fair value in the following categories:
 
 
·
Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.
 
 
·
Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
 
 
·
Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions market participants would use in pricing the asset or liability.

The Company’s assets that are measured at fair value on a recurring basis are generally classified within Level 1 or Level 2 of the fair value hierarchy. The types of instruments valued based on quoted market prices in active markets include most money market securities, U.S. Treasury securities and equity investments. Such instruments are generally classified within Level 1 of the fair value hierarchy. The Company invests in money market funds that are traded daily and does not adjust the quoted price for such instruments.

The types of instruments valued based on quoted prices in less active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include the Company’s U.S. Agency securities, Commercial Paper, U.S. Corporate Bonds and certificates of deposit. Such instruments are generally classified within Level 2 of the fair value hierarchy. The Company uses consensus pricing, which is based on multiple pricing sources, to value its fixed income investments.
 
 

The table below presents marketable securities, grouped by fair value levels, as of September 30, 2010 and December 31, 2009.
 
         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices in Active
   
Significant Other
   
Significant
 
         
Markets for Identical
   
Observable
   
Unobservable
 
   
September 30,
   
Assets
   
Inputs
   
Inputs
 
   
2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Money market funds
  $ 13,316     $ 13,316     $     $ -  
Commercial paper
    1,899       -       1,899       -  
Corporate debentures/bonds
    19,644       -       19,644       -  
Total
  $ 34,859     $ 13,316     $ 21,543     $ -  
 
         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices in Active
   
Significant Other
   
Significant
 
         
Markets for Identical
   
Observable
   
Unobservable
 
   
December 31,
   
Assets
   
Inputs
   
Inputs
 
   
2009
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Money market funds
  $ 15,622     $ 12,622     $ 3,000     $ -  
Commercial paper
    6,142       -       6,142       -  
Corporate debentures/bonds
    26,267       -       26,267       -  
Total
  $ 48,031     $ 12,622     $ 35,409     $ -  

5.
 
Long-Term Debt

On February 5, 2010, Comverge, Inc. and its wholly owned subsidiaries Enerwise Global Technologies, Inc, Comverge Giants, LLC, Public Energy Solutions, LLC, Public Energy Solutions NY, LLC, Clean Power Markets, Inc., and Alternative Energy Resources, Inc., entered into a second amendment to its existing credit and term loan facility with Silicon Valley Bank. The second amendment increased the revolver loan by an additional $20,000 bringing the total revolver loan to $30,000 for borrowings to fund general working capital and other corporate purposes and issuances of letters of credit.  The second amendment also added Alternative Energy Resources, Inc., a wholly owned subsidiary of Comverge, as a borrower and extended the term of the revolver facility by one year to December 2012.  In connection with the extension of the term of the credit facility, a commitment fee of $100 was paid on February 5, 2010, and additional commitment fees of $75 are payable on each of February 5, 2011 and February 5, 2012.  As of September 30, 2010, the Company had $18,145 of outstanding letters of credit and $11,855 of borrowing availability from the revolver loan.
 
The interest on revolving loans under the amended facility accrues at either (a) a rate per annum equal to the greater of the Prime Rate or 4% plus the Prime Rate Advance Margin, or (b) a rate per annum equal to the LIBOR Advance Rate plus the LIBOR Rate Advance Margin, as such terms are defined in the amended facility agreement.  The second amendment also sets forth certain financial ratios to be maintained by the borrowers on a consolidated basis.  The obligations under the amended facility are secured by all assets of Comverge and its other borrower subsidiaries, including Alternative Energy Resources, Inc. All other terms and conditions of the credit facility remain the same and in full force and effect.





Long-term debt as of September 30, 2010 and December 31, 2009 consisted of the following:
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
Security and loan agreement with a U.S. bank, collateralized by
           
substantially all of the Company's assets, maturing in
           
December 2013, interest payable at a variable rate (3.26% and 3.28%
       
as of September 30, 2010 and December 31, 2009)
  $ 10,500     $ 12,750  
Total debt
    10,500       12,750  
Less: Current portion of long-term debt
    (3,000 )     (3,000 )
Total long-term debt
  $ 7,500     $ 9,750  
 
 
6.
 
Stock-Based Compensation
 
The Company’s Amended and Restated 2006 Long-Term Incentive Plan, or 2006 LTIP, was approved by the Company’s shareholders in May 2010 and provides for the granting of stock-based incentive awards to eligible Company employees and directors and to other non-employee service providers, including options to purchase the Company’s common stock and restricted stock awards at not less than the fair value of the Company’s common stock on the grant date and for a term of not greater than seven years. Awards are granted with service vesting requirements, performance vesting conditions, market vesting conditions, or a combination thereof. Subject to adjustment as defined in the 2006 LTIP, the aggregate number of shares available for issuance is 7,556,036. Stock-based incentive awards expire between five and ten years from the date of grant and generally vest over a one to four-year period from the date of grant.  As of September 30, 2010, 1,963,444 shares were available for grant under the 2006 LTIP. The expense related to stock-based incentive awards recognized for the three and nine months ended September 30, 2010 was $1,010 and $2,335, respectively.  The expense related to stock-based incentive awards recognized for the three and nine months ended September 30, 2009 was $3,986 and $6,803, respectively.
 
A summary of the Company’s stock option activity for the nine months ended September 30, 2010 is presented below:
 
   
September 30, 2010
 
         
Weighted
       
   
Number of
   
Average
       
   
Options
   
Exercise
   
Range of
 
   
(in Shares)
   
Price
   
Exercise Prices
 
Outstanding at beginning of period
    1,988,400     $ 12.63       $0.58 to $34.23  
Granted
    990,793       9.77       $6.80 to $11.52  
Exercised
    (111,966 )     1.60       $0.58 to $7.56  
Cancelled
    (81,913 )     21.78       $2.40 to $34.23  
Forfeited
    (166,080 )     7.84       $3.76 to $18.00  
Outstanding at end of period
    2,619,234     $ 12.04       $0.58 to $34.23  
Exercisable at end of period
    1,438,163     $ 14.22       $0.58 to $34.23  
 
 
 
   
Outstanding as of September 30, 2010
   
Exercisable as of September 30, 2010
 
               
Weighted
               
Weighted
 
         
Average
   
Average
         
Average
   
Average
 
         
Remaining
   
Exercise
         
Remaining
   
Exercise
 
   
Number
   
Contractual
   
Price per
   
Number
   
Contractual
   
Price per
 
Exercise Prices
 
Outstanding
   
Life
   
Share
   
Exercisable
   
Life
   
Share
 
   
(In Shares)
   
(In Years)
         
(In Shares)
   
(In Years)
       
  $0.58 - $0.82     200,601       1.4     $ 0.73       200,601       1.4     $ 0.74  
  $2.40 - $3.99     31,538       1.5       2.84       31,538       1.5       2.84  
  $4.00 - $7.99     292,568       5.0       4.66       127,409       4.1       4.33  
  $8.00-$10.33     837,024       6.3       9.67       123,499       5.3       9.65  
  $10.34 - $14.09     582,271       4.8       11.57       284,105       3.5       12.11  
  $14.10 - $17.99     11,250       0.5       14.10       11,250       0.5       14.10  
  $18.00 - $23.53     451,421       3.0       18.08       447,200       3.0       18.08  
  $23.54     15,547       3.4       23.54       15,547       3.4       23.54  
  $23.55 - $36.00     197,014       3.3       32.59       197,014       3.3       32.59  
        2,619,234       4.5     $ 12.04       1,438,163       3.1     $ 14.22  

For awards with performance and/or service conditions only, the Company utilized the Black-Scholes option pricing model to estimate fair value of options issued, with the following assumptions (weighted averages based on grants during the period):

   
Nine Months Ended September 30,
 
   
2010
 
2009
 
Risk-free interest rate
 
2.05
%
1.88
%
Expected term of options, in years
 
4.6
 
4.6
 
Expected annual volatility
 
70
%
70
%
Expected dividend yield
 
0
%
0
%
 
The weighted average grant-date fair value of options granted during the nine months ended September 30, 2010 and 2009 was $5.54 and $3.30, respectively.

A summary of the Company’s restricted stock award activity for the nine months ended September 30, 2010 is presented below:
 
   
September 30, 2010
 
         
Weighted
 
         
Average
 
         
Grant Date
 
   
Number of
   
Fair Value
 
   
Shares
   
Per Share
 
Unvested at beginning of period
    496,589     $ 9.28  
Granted
    248,093       10.06  
Vested
    (60,623 )     14.64  
Cancelled
    -    
NA
 
Forfeited
    (116,363 )     9.18  
Unvested at end of period
    567,696     $ 9.07  
 
 
 
7.
 
Segment Information
 
As of September 30, 2010, the Company had three reportable segments: the Utility Products & Services segment, the Residential Business segment, and the Commercial & Industrial Business segment. The Utility Products & Services segment sells hardware, software and services, such as installation and/or marketing, to utilities that elect to own and operate demand management networks for their own benefit. The Residential Business segment sells electric capacity to utilities under long-term contracts, either through demand response or energy efficiency, primarily through marketing and installing our devices on residential and small commercial end-use participants.  The Commercial & Industrial Business segment provides demand response and energy management services that enable commercial and industrial customers to reduce energy consumption and make informed decisions on energy and renewable energy purchases and programs.
 
Management has three primary measures of segment performance: revenue, gross profit and operating income. Substantially all of our revenues are generated with domestic customers. The Utility Products & Services segment product and service cost of revenue includes materials, labor and overhead. Within the Residential Business segment, cost of revenue is based on operating costs of the demand response networks, primarily telecommunications costs related to the network and depreciation of the assets capitalized in building the demand response network, and build-out costs of the base load energy efficiency networks, primarily lighting costs and installation services related to energy efficiency upgrades. The Commercial & Industrial Business segment’s cost of revenue includes participant payments for the demand response services as well as materials, labor and overhead for the energy management services. Operating expenses directly associated with each operating segment include sales, marketing, product development, amortization of intangible assets and certain administrative expenses. 
 
The Company does not allocate assets and liabilities to its operating segments. Operating expenses not directly associated with an operating segment are classified as “Corporate Unallocated Costs.” Corporate Unallocated Costs include support group compensation, travel, professional fees and marketing activities.
 
The following tables show operating results for each of the Company’s operating segments:
 
 
   
Three Months Ended September 30, 2010
 
   
Utility
         
Commercial
             
   
Products
         
&
   
Corporate
       
   
&
   
Residential
   
Industrial
   
Unallocated
       
   
Services
   
Business
   
Business
   
Costs
   
Total
 
Revenue
                             
Product
  $ 5,798     $ -     $ -     $ -     $ 5,798  
Service
    6,728       2,332       36,877       -       45,937  
Total revenue
    12,526       2,332       36,877       -       51,735  
Cost of revenue
                                       
Product
    4,588       -       -       -       4,588  
Service
    4,348       1,335       25,245       -       30,928  
Total cost of revenue
    8,936       1,335       25,245       -       35,516  
Gross profit
    3,590       997       11,632       -       16,219  
Operating expenses
                                       
General and administrative expenses
    2,512       2,112       891       4,981       10,496  
Marketing and selling expenses
    762       1,237       1,551       1,084       4,634  
Research and development expenses
    1,664       -       -       -       1,664  
Amortization of intangible assets
    -       299       233       4       536  
Operating income (loss)
    (1,348 )     (2,651 )     8,957       (6,069 )     (1,111 )
Interest and other expense (income), net
    (21 )     -       1       234       214  
Income (loss) before income taxes
  $ (1,327 )   $ (2,651 )   $ 8,956     $ (6,303 )   $ (1,325 )
 
 

 
 
 
   
Three Months Ended September 30, 2009
 
   
Utility
         
Commercial
             
   
Products
         
&
   
Corporate
       
   
&
   
Residential
   
Industrial
   
Unallocated
       
   
Services
   
Business
   
Business
   
Costs
   
Total
 
Revenue
                             
Product
  $ 6,263     $ -     $ -     $ -     $ 6,263  
Service
    2,922       2,285       21,725          -       26,932  
Total revenue
    9,185       2,285       21,725       -       33,195  
Cost of revenue
                                       
Product
    3,793       -       -       -       3,793  
Service
    1,713       1,272       16,963       -       19,948  
Total cost of revenue
    5,506       1,272       16,963       -       23,741  
Gross profit
    3,679       1,013       4,762       -       9,454  
Operating expenses
                                       
General and administrative expenses
    1,352       2,434       930       7,703       12,419  
Marketing and selling expenses
    942       1,600       1,178       620       4,340  
Research and development expenses
    1,158       -       -       -       1,158  
Amortization of intangible assets
    -       315       233       5       553  
Operating income (loss)
    227       (3,336 )     2,421       (8,328 )     (9,016 )
Interest and other expense, net
    (20 )     255       (3 )     144       376  
Income (loss) before income taxes
  $ 247     $ (3,591 )   $ 2,424     $ (8,472 )   $ (9,392 )


 
   
Nine Months Ended September 30, 2010
 
   
Utility
         
Commercial
             
   
Products
         
&
   
Corporate
       
   
&
   
Residential
   
Industrial
   
Unallocated
       
   
Services
   
Business
   
Business
   
Costs
   
Total
 
Revenue
                             
Product
  $ 16,553     $ -     $ -     $ -     $ 16,553  
Service
    16,159       6,700       42,751       -       65,610  
Total revenue
    32,712       6,700       42,751       -       82,163  
Cost of revenue
                                       
Product
    12,594       -       -       -       12,594  
Service
    10,450       3,939       28,889       -       43,278  
Total cost of revenue
    23,044       3,939       28,889       -       55,872  
Gross profit
    9,668       2,761       13,862       -       26,291  
Operating expenses
                                       
General and administrative expenses
    6,544       6,891       2,509       11,864       27,808  
Marketing and selling expenses
    2,120       4,377       4,458       2,523       13,478  
Research and development expenses
    4,572       -       -       -       4,572  
Amortization of intangible assets
    -       897       699       12       1,608  
Operating income (loss)
    (3,568 )     (9,404 )     6,196       (14,399 )     (21,175 )
Interest and other expense (income), net
    (15 )     1       (6 )     587       567  
Income (loss) before income taxes
  $ (3,553 )   $ (9,405 )   $ 6,202     $ (14,986 )   $ (21,742 )




 
   
Nine Months Ended September 30, 2009
 
   
Utility
         
Commercial
             
   
Products
         
&
   
Corporate
       
   
&
   
Residential
   
Industrial
   
Unallocated
       
   
Services
   
Business
   
Business
   
Costs
   
Total
 
Revenue
                             
Product
  $ 16,176     $ -     $ -     $ -     $ 16,176  
Service
    7,609       9,256       24,999       -       41,864  
Total revenue
    23,785       9,256       24,999       -       58,040  
Cost of revenue
                                       
Product
    9,879       -       -       -       9,879  
Service
    3,866       5,605       18,980       -       28,451  
Total cost of revenue
    13,745       5,605       18,980       -       38,330  
Gross profit
    10,040       3,651       6,019       -       19,710  
Operating expenses
                                       
General and administrative expenses
    3,798       7,510       2,530       14,571       28,409  
Marketing and selling expenses
    2,556       4,756       3,054       2,416       12,782  
Research and development expenses
    3,483       -       -       -       3,483  
Amortization of intangible assets
    -       944       699       14       1,657  
Operating income (loss)
    203       (9,559 )     (264 )     (17,001 )     (26,621 )
Interest and other expense, net
    (11 )     691       -       260       940  
Income (loss) before income taxes
  $ 214     $ (10,250 )   $ (264 )   $ (17,261 )   $ (27,561 )
 
 
8.
 
Subsequent Events

On November 5, 2010, Comverge, Inc. and its wholly owned subsidiaries entered into a five-year $15,000 subordinated convertible loan agreement with Partners For Growth III, L.P.  The loan will be used to fund general working capital and other corporate purposes.  

The loan is interest only, payable monthly, and accrues at a rate per annum equal to the floating Prime Rate plus 2.50%, currently 6.50% in total, as such terms are defined in the loan agreement.  The agreement also sets forth certain financial covenants and certain pro forma revenue targets to be maintained by the borrowers on a consolidated basis.  The obligations under the loan agreement are secured by all assets of Comverge and its subsidiaries.  The lender may convert the note into up to 1,594,048 shares of Comverge common stock at $9.41 per share.

The loan provides, at the borrowers' option, the ability to borrow up to an additional $5,000 in the first 36 months convertible into common stock at a conversion price based upon the stock price at the time of the additional borrowing; however, at no time may the amount of existing unconverted borrowings exceed $15,000.  In connection with the loan, a commitment fee of $300 was paid on November 5, 2010.  There are no additional commitment fees.









 
Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents incorporated into this Quarterly Report on Form 10-Q by reference contain forward-looking statements. These forward-looking statements include statements with respect to our financial condition, results of operations and business. The words “assumes,” “believes,” “expects,” “budgets,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or similar terminology identify forward-looking statements. These forward-looking statements reflect our current expectations regarding future events, results or outcomes. These expectations may not be realized. Some of these expectations may be based upon assumptions or judgments that prove to be incorrect. In addition, our business and operations involve numerous risks and uncertainties, many of which are beyond our control, which could result in our expectations not being realized, cause actual results to differ materially from our forward-looking statements and/or otherwise materially affect our financial condition, results of operations and cash flows. Please see the section below entitled “Risk Factors,” the section entitled “Risk Factors” in our Annual Report on Form 10-K (File No. 001-33399) filed with the Securities and Exchange Commission, or SEC, on March 8, 2010, and elsewhere in this filing for a discussion of examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should carefully review the risks described herein and in other documents we file from time to time with the SEC, including the other Quarterly Reports on Form 10-Q filed in 2010. We caution readers not to place undue reliance on any forward-looking statements, which only speak as of the date hereof. Except as provided by law, we undertake no obligation to update any forward-looking statement based on changing circumstances or otherwise.
 
You should read the following discussion together with management’s discussion and analysis, financial statements and the notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 8, 2010 and the financials statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q.
 
Overview
 
Comverge is a leading provider of intelligent energy management solutions that empower utilities, commercial and industrial customers, and residential consumers to use energy in a more effective and efficient manner.  Intelligent energy management solutions build upon demand response, enabling two-way communication between providers and consumers—giving all customer classes the insight and control needed to optimize energy usage and meet peak demand.  Beyond just reducing the energy load, this new approach reduces cost for the utility or grid operator, integrates other systems and allows for the informed decision-making that will power the smart grid.
 
We provide our intelligent energy management solutions through our three reporting segments: the Utility Products & Services segment, the Residential Business segment, and the Commercial & Industrial, or C&I, Business segment.  The Utility Products & Services segment sells solutions comprising intelligent hardware, our IntelliSOURCE software and services, such as installation, marketing and program management, to utilities that elect to own and operate intelligent energy management networks for their own benefit.  The Residential Business segment sells electric capacity to utilities under long-term contracts, either through demand response or energy efficiency, primarily through marketing and installing our devices on residential and small commercial end-use participants.  The C&I Business segment provides demand response and energy management services to utilities and associated electricity markets that enable commercial and industrial consumers to reduce energy consumption costs and make informed decisions on energy and renewable energy purchases and programs.  
 
 
 
As of September 30, 2010, we owned or managed 3,541 megawatts, an increase of 642 megawatts or 22% from December 31, 2009. For capacity and turnkey contracts, we include megawatts as owned or managed if there is a contract in place that provides for a certain capacity target or maximum.  For open markets, we include megawatts as owned or managed if we have enrolled a participant’s megawatt in the open market and have the right to curtail that participant’s energy usage if called upon.  The table below summarizes the megawatts we own or manage by segment.
 
 
As of  September 30, 2010
         
Commercial &
   
 
Utility Products
 
Residential
 
Industrial
 
Total
 
& Services
 
Business
 
Business
 
Comverge
Megawatts owned/managed under capacity contracts
                          -
 
                    640
 
                       270
 
                910
Megawatts owned for sale in open market programs
                          -
 
                      10
 
                    1,494
 
             1,504
Megawatts managed under turnkey contracts
                        690
 
                       -
 
                         -
 
                690
Megawatts managed for a fee on a pay-for-performance basis
                          -
 
                       -
 
                       437
 
                437
Megawatts owned or managed
                        690
 
                    650
 
                    2,201
 
             3,541
 
 
The table below presents the activity in megawatts owned or managed during the nine months ended September 30, 2010.
 
 
Megawatts
 
Owned or Managed
As of December 31, 2009
                                   2,899
Capacity contracts
12
Open market programs
310
Turnkey contracts
320
As of September 30, 2010
                                   3,541
 
Megawatts owned/ managed under capacity contracts
 
As of September 30, 2010, we owned or managed 910 megawatts of contracted capacity from Virtual Peaking Capacity, or VPC, and energy efficiency contracts, an increase of 12 megawatts from December 31, 2009. Our existing VPC contracts represented contracted capacity of 817 megawatts and our energy efficiency contracts represented contracted capacity of 93 megawatts.
 
Cumulatively, we have installed capacity of 558 megawatts under our VPC and energy efficiency capacity contracts as of September 30, 2010 compared to 462 megawatts as of December 31, 2009, an increase of 96 megawatts. The main components of the change are an increase of 92 megawatts installed during the nine months ended September 30, 2010 in our existing VPC programs and an increase of 4 megawatts from the energy efficiency program during the nine months ended September 30, 2010. The table below presents contracted, installed and available capacity as of September 30, 2010 and December 31, 2009, respectively.
 
(Megawatts)
September 30, 2010
 
December 31, 2009
Contracted capacity
910
 
898
Installed capacity (1)
558
 
462
Available capacity (2)
517
 
421

 
 
(1)
For residential VPC programs, installed capacity generally refers to the number of devices installed multiplied by the historically highest demonstrated available capacity provided per device for the applicable service territory.  For C&I VPC programs, installed capacity generally refers to the megawatts that our participants have committed to shed.
 
(2)  
Available capacity represents the amount of electric capacity that we have made available to our customers during each contract year based on the results of our measurement and verification process. For residential VPC programs, we have used the most recently settled measurement and verification results to present available capacity for each period, which is typically measured during the fourth quarter of each year.  For C&I VPC programs, we have assumed that our participants will shed the committed capacity as included in installed capacity.
 

 

Megawatts owned for sale in open markets
 
As of September 30, 2010, we had 1,504 megawatts enrolled in open market programs, an increase of 310 megawatts from December 31, 2009.  We consider capacity enrolled when a participant has agreed to shed a committed capacity in an open market program in which we participate.

Megawatts managed under turnkey contracts
 
As of September 30, 2010, we managed 690 megawatts under turnkey contracts, an increase of 320 megawatts from December 31, 2009. The increase of 320 megawatts consists of 40 megawatts from an expansion of our program with Pepco Holdings, Inc. in January 2010 and 280 megawatts from executed agreements with three other customers during the year.  Under these agreements, we will provide a full turnkey program, including hardware, installation, marketing and call center services.  We calculate megawatts managed under turnkey contracts by using a pre-determined factor of anticipated load reduction for each unit deployed, in relation to the type of end-use participant, whether residential or commercial and industrial, and our customer’s service territory.

Recent Developments
 
In July 2010, we were selected by American Electric Power (AEP) to deliver a comprehensive energy management pilot program to be serviced by Public Service Company of Oklahoma (PSO), a unit of AEP. The smart grid ready demand response program will be built on our IntelliSOURCE software. Under a three-year agreement, we will provide full turnkey services for both PSO’s residential and commercial and industrial customers.
 
On July 30, 2010, we entered into an amendment to our current agreement with TXU in which we will provide intelligent hardware and energy management services through December 2012.  The TXU agreement is renewable for successive one year terms thereafter. We estimate receiving in excess of $30 million in payments over the initial contract term.  

In August 2010, we were notified by the supplier of our thermostats, White-Rodgers, that White-Rodgers had filed with the Consumer Product Safety Commission, or CPSC, to address a product issue with the thermostats that White-Rodgers had shipped to Comverge.  White-Rodgers reported to the CPSC that it was aware of incidents of battery leakage in the model of thermostat sold to Comverge, in which battery leakage led to an overheating of the device.  White-Rodgers informed us that in the event of battery leakage, electrolyte can contact the printed circuit board, which may result in the circuit board overheating.  White-Rodgers has communicated to us that it has not conceded that the thermostats contain a defect or pose a substantial product hazard, but has nevertheless voluntarily proposed a corrective action plan to address thermostats in inventory and thermostats installed in the field.  We are not aware of any reports of personal injury associated with these incidents, but we are aware of one claim for minor property damage.   White-Rodgers has stated that it will cover reasonable costs associated with implementing the corrective action plan after that plan is approved by the CPSC.
 
On October 26, 2010, the board of directors (the "Board") of Comverge, Inc. appointed John McCarter and John Rego as independent directors to the Board effectively immediately, in accordance with Comverge's Bylaws and Certificate of Incorporation.  The Board determined that Mr. McCarter will be a Class II director and Mr. Rego a Class III director, and as such, each will serve until the next election of their respective classes, subject to the election and qualification of a successor or successors, or until his earlier death, resignation or removal. In addition, the Board appointed Mr. McCarter to serve on the compensation committee, and Mr. Rego to serve on the audit committee of the Board.
 
New Loan Agreement

On November 5, 2010, Comverge, Inc. and its wholly owned subsidiaries entered into a five-year $15 million subordinated convertible loan agreement with Partners For Growth III, L.P.  The loan will be used to fund general working capital and other corporate purposes.  

The loan is interest only, payable monthly, and accrues at a rate per annum equal to the floating Prime Rate plus 2.50%, currently 6.50% in total, as such terms are defined in the loan agreement.  The agreement also sets forth certain financial covenants and certain pro forma revenue targets to be maintained by the borrowers on a consolidated basis.  The obligations under the loan agreement are secured by all assets of Comverge and its subsidiaries.  The lender may convert the note into up to 1,594,048 shares of Comverge common stock at $9.41 per share.

The loan provides, at the borrowers' option, the ability to borrow up to an additional $5 million in the first 36 months convertible into common stock at a conversion price based upon the stock price at the time of the additional borrowing; however, at no time may the amount of existing unconverted borrowings exceed $15 million.  In connection with the loan, a commitment fee of $300,000 was paid on November 5, 2010.  There are no additional commitment fees.

Current Outlook
 
We are revising our revenue outlook for full year 2010 and expect revenues to be in the range of $118 million to $125 million.  We also expect to grow total megawatts under management by 800 megawatts.
 
 
Payments from Long-Term Contracts
 
Payments from long-term contracts represent our estimate of total payments that we expect to receive under long-term agreements with our customers. The information presented below with respect to payments from long-term contracts includes payments related to our VPC contracts, energy efficiency contracts, and open market programs. As of September 30, 2010, we estimated that our total payments to be received through 2024 will be approximately $615 million.
 
These estimates of payments from long-term contracts are forward-looking statements based on the contractual terms and conditions. In management’s view, such information was prepared on a reasonable basis, reflects the best currently available estimates and judgments, and, to management’s knowledge and belief, presents the assumptions and considerations on which we base our belief that we can receive such payments. However, this information should not be relied upon as being necessarily indicative of actual future results, and readers of this report should not place undue reliance on this information. Any differences among these assumptions, other factors and our actual experiences may result in actual payments in future periods differing significantly from management’s current estimates. See “Risk Factors—We may not receive the payments anticipated by our long-term contracts and recognize revenues or the anticipated margins from our backlog, and comparisons of period-to-period estimates are not necessarily meaningful and may not be indicative of actual payments” as contained in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 8, 2010.  The information in this section is designed to summarize the financial terms of our long-term contracts and is not intended to provide guidance on our future operating results, including revenue or profitability.
 
Our estimated payments from long-term contracts have been prepared by management based on the following assumptions:

VPC Contract
 
Our existing VPC contracts as of September 30, 2010 represented contracted capacity of 817 megawatts. In calculating an estimated $225 million of payments from our VPC contracts as of September 30, 2010, we have included expectations regarding build-out based on our historical experience as well as future expectations of participant enrollment in each contract’s service territory.

We have assumed that once our build-out phase is completed, we will operate our VPC contracts at the capacity achieved during build-out, which generally will be the contracted capacity.

The amount our utility customers pay to us at the end of each contract year may vary based upon the results of measurement and verification tests performed each contract year based on the electric capacity that we made available to the utility during the contract year. The payments from VPC contracts reflect our most reasonable currently available estimates and judgments regarding the capacity that we believe we will provide our utility customer.

The amount of available capacity we are able to provide, and therefore the amount of payments we receive, is dependent upon the number of participants in our VPC programs. For purposes of estimating our payments under long-term contracts, we have assumed the rate of replacement of participant terminations under our VPC contracts will remain consistent with our historical average.

Payments from long-term contracts include $7.4 million that we expect to recognize as revenue over the remainder of this year, which we include in backlog. Payments from long-term contracts exclude $14.2 million of payments which we have already received but have been deferred in accordance with our revenue recognition policy. We expect to also recognize these payments as revenue over the course of the next twelve months.
 
 

Energy Efficiency Contracts
 
Our existing energy efficiency contracts as of September 30, 2010 represent potential base load contracted capacity of 93 megawatts. In calculating the estimated $51 million in payments from these contracts, while the build-out rate has slowed, we have assumed we will complete full build-out of the entire remaining megawatts under contract by the end of 2012 or, if the contract is extended, the end of the extension date. We have assumed that once our build-out is complete, the permanent base load reduction will remain installed and will continue to provide the installed capacity for the remainder of the contract term.
 
Open Market Programs
 
As of September 30, 2010, we had up to 997 megawatts bid into various capacity open market programs with PJM Interconnection, LLC. We currently expect to receive approximately $139 million in long term payments through the year 2014. We also have megawatts bid into open market programs in other geographical service territories from which we currently expect to receive $7 million through the year 2012.  In estimating the long term payments, we have assumed that we will have limited churn among our commercial and industrial participants that we have currently enrolled in the auctions and that we will be able to fulfill incremental capacity in certain programs with new enrollments.
 
Turnkey Contracts
 
Our turnkey contracts as of September 30, 2010 represent $163 million in payments expected to be received through the year 2014 with seven utility customers to provide products, software, and services, including program management, installation, and/or marketing. Payments from turnkey contracts are based on contractual minimum order volumes, forecasted installations and other services applied over the term of the contract.
 
Other Contracts
 
We expect to receive an estimated $30 million in payments through 2014 pursuant to currently executed contracts for our intelligent energy management solutions.
 
In addition to the foregoing assumptions, our estimated payments from long-term contracts assume that we will be able to meet on a timely basis all of our obligations under these contracts and that our customers will not terminate the contracts for convenience or other reasons. Our annual net loss in 2009, 2008 and 2007 was $31.7 million, $94.1 million and $6.6 million, respectively. We may continue to generate annual net losses in the future, including through the term of our long-term contracts. See “Risk Factors—We have incurred annual net losses since our inception, and we may continue to incur annual net losses in the future.” in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 8, 2010.
 
Although we currently intend to release quarterly updates of future revisions that we may make to our estimated payments from long-term contracts, we do not undertake any obligation to release the results of any future revisions that we may make to these estimated payments from long-term contracts to reflect events or circumstances occurring after the date of this report.
 
Backlog
Our backlog represents our estimate of revenues from commitments, including purchase orders and long-term contracts, that we expect to recognize over the course of the next twelve months.  The inaccuracy of any of our estimates and other factors may result in actual results being significantly lower than estimated under our reported backlog.  Material delays, market conditions, cancellations or payment defaults could materially affect our financial condition, results of operation and cash flow.  Accordingly, a comparison of backlog from period to period is not necessarily meaningful and may not be indicative of actual revenues.  As of September 30, 2010, we had contractual backlog of $122 million through September 30, 2011.
 
 

 

Results of Operations
 
Three and Nine Months Ended September 30, 2010 Compared to Three and Nine Months Ended September 30, 2009
 
Revenue
 
The following table summarizes our revenue for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):

   
Three Months Ended September 30,
         
Nine Months Ended September 30,
       
               
Percent
               
Percent
 
   
2010
   
2009
   
Change
   
2010
   
2009
   
Change
 
Segment Revenue:
                                   
Utility Products & Services
  $ 12,526     $ 9,185       36 %   $ 32,712     $ 23,785       38 %
Residential Business
    2,332       2,285       2       6,700       9,256       (28 )
Commercial & Industrial Business
    36,877       21,725       70       42,751       24,999       71  
Total
  $ 51,735     $ 33,195       56 %   $ 82,163     $ 58,040       42 %
 
Utility Products & Services Revenue
 
Our Utility Products & Services segment had revenue of $12.5 million for the three months ended September 30, 2010 compared to $9.2 million for the three months ended September 30, 2009, an increase of $3.3 million or 36%. Our three largest turnkey programs provided the increase in revenue during the three months ended September 30, 2010, mainly due to the services provided as a part of these long-term turnkey solutions.  During the three months ended September 30, 2010, we sold 65,000 units of intelligent hardware compared to 59,000 units of intelligent hardware during the three months ended September 30, 2009.  For the three months ended September 30, 2010, our three largest turnkey programs comprised 42% of the units sold compared to 2% during the three months ended September 30, 2009.
 
Our Utility Products & Services segment had revenue of $32.7 million for the nine months ended September 30, 2010 compared to $23.8 million for the nine months ended September 30, 2009, an increase of $8.9 million or 38%.  Our three largest turnkey programs provided the increase in revenue for the nine months ended September 30, 2010, mainly due to the services provided as a part of these long-term turnkey solutions. Volume remained consistent for both nine-month periods at approximately 150,000 units of intelligent hardware, with turnkey intelligent hardware sales comprising 34% and 1% of units sold during 2010 and 2009, respectively.
 
Residential Business Revenue
 
Our Residential Business segment had revenue of $2.3 million for both the three months ended September 30, 2010 and 2009. The energy efficiency programs contributed an increase of $0.2 million offset by a $0.2 million decrease in revenue from our marketing and other services.
 
Our Residential Business segment had revenue of $6.7 million for the nine months ended September 30, 2010 compared to $9.3 million for the nine months ended September 30, 2009, a decrease of $2.6 million or 28%. The decrease is primarily due to a decline in the number of installations we performed as well as the rate per megawatt that we received during 2010 in the energy efficiency programs.  If the decline in revenue and associated cash flows continues, it may impact the fair value of the reporting unit, causing its carrying value to exceed its fair value.  Also, materially different assumptions regarding future performance of the reporting unit or a change in the strategic direction of the reporting unit could result in significant impairment losses.  The related goodwill balance is currently $7.7 million.
 
We defer revenues and direct costs under our VPC contracts until such revenue can be made fixed and determinable through a measurement and verification test, generally in our fourth quarter. Deferred revenue and deferred charges related to VPC contracts are presented below:
   
As of
 
   
September 30,
   
December 31,
   
Percent
   
September 30,
   
December 31,
   
Percent
 
   
2010
   
2009
   
Change
   
2009
   
2008
   
Change
 
VPC Contract Related:
                                   
Deferred revenue
  $ 18,830     $ 3,443       447 %     24,953     $ 4,271       484 %
Deferred cost of revenue
    5,027       1,072       369 %     11,843       791       1397 %
 
 
 
Deferred revenue as of September 30, 2010 increased by $15.4 million from December 31, 2009 as compared to a $20.7 million increase in deferred revenue from December 31, 2008 to September 30, 2009. During 2010, deferred revenue increased by a lesser amount due to our Nevada VPC program, which has transitioned from an aggressive growth phase to primarily maintenance of the megawatts previously deployed.  Payments for maintenance in the Nevada VPC program during 2010 are less than those received during the original build out of the program.
 
Commercial & Industrial Business Revenue
 
Our Commercial & Industrial Business segment had revenue of $36.9 million for the three months ended September 30, 2010 compared to $21.7 million for the three months ended September 30, 2009, an increase of $15.2 million or 70%. Of the increase, $11.6 million is due to the increased megawatts and their associated performance during the summer in the PJM capacity program.  We recognize the capacity program revenue at the end of the mandatory performance period, which is the peak demand season between June and September.  An increase of $0.8 million is due to providing increased megawatts in open market programs in geographic service territories other than the PJM market.  In addition, the Commercial & Industrial Business had an increase of $3.2 million in revenue due to increased megawatt commitments in our C&I VPC programs compared to the prior three-month period.  The increase in revenue from open market and VPC programs was partially offset by a decrease of $0.4 million in our energy management services for the three months ended September 30, 2010 as compared to the prior period due to the decline in our engineering projects.
 
Our Commercial & Industrial Business segment had revenue of $42.8 million for the nine months ended September 30, 2010 compared to $25.0 million for the nine months ended September 30, 2009, an increase of $17.8 million or 71%. Of the increase, $11.6 million is due to increased megawatts in the PJM capacity program as well as energy payments for their performance during the summer.  An increase of $3.0 million is due to providing increased megawatts in open market programs in geographic service territories other than the PJM market.  In addition, the Commercial & Industrial Business had an increase of $4.0 million in revenue due to increased megawatt commitments in our C&I VPC programs compared to the prior nine-month period.  The increase in revenue from open market and VPC programs was partially offset by a decrease of $0.8 million in our energy management services for the three months ended September 30, 2010 as compared to prior period due to the decline in our engineering projects.
 
Gross Profit and Gross Margin
 
The following table summarizes our gross profit and gross margin for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,