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EX-31.2 - SECTION 302 CFO CERTIFICATION - COMVERGE, INC.ex312-2011930.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - COMVERGE, INC.ex321-2011930.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - COMVERGE, INC.ex311-2011930.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - COMVERGE, INC.ex322-2011930.htm
EX-10.1 - EMPLOYMENT AGREEMENT - COMVERGE, INC.ex101-2011930.htm
EXCEL - IDEA: XBRL DOCUMENT - COMVERGE, INC.Financial_Report.xls
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2011
 
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  ý    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 ý       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   ý    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  ý
 
There were 25,430,700 shares of the Registrant’s common stock, $0.001 par value per share, outstanding on November 2, 2011. 

Comverge, Inc.
Index to Form 10-Q
 
 
 
 
 
 
  
Page
Part I - Financial Information
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
Part II - Other Information
  
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 
 
 


 





COMVERGE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited) 
 
September 30,
2011
 
December 31,
2010
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
25,505

 
$
7,800

Restricted cash
4,755

 
1,736

Marketable securities

 
27,792

Billed accounts receivable, net
18,709

 
14,433

Unbilled accounts receivable
16,691

 
17,992

Inventory, net
9,968

 
9,181

Deferred costs
4,871

 
1,712

Other current assets
1,251

 
2,056

Total current assets
81,750

 
82,702

Restricted cash
719

 
3,733

Property and equipment, net
26,460

 
22,480

Intangible assets, net
3,570

 
3,816

Goodwill
499

 
499

Other assets
464

 
927

Total assets
$
113,462

 
$
114,157

Liabilities and Shareholders' Equity
 

 
 

Current liabilities
 

 
 

Accounts payable
$
3,131

 
$
8,455

Accrued expenses
27,808

 
17,375

Deferred revenue
14,040

 
5,821

Current portion of long-term debt
3,000

 
3,000

Other current liabilities
8,282

 
7,962

Total current liabilities
56,261

 
42,613

Long-term liabilities
 

 
 

Deferred revenue
421

 
1,662

Long-term debt
24,000

 
21,750

Other liabilities
1,659

 
2,074

Total long-term liabilities
26,080

 
25,486

Shareholders' equity
 

 
 

Common stock, $0.001 par value per share, authorized 150,000,000
shares;  issued 25,476,115 and outstanding 25,430,700, shares as of
September 30, 2011 and issued 25,355,223 and outstanding 25,329,118
shares as of December 31, 2010
25

 
25

Additional paid-in capital
265,101

 
262,226

Common stock held in treasury, at cost, 45,415 and 26,105 shares as of
September 30, 2011 and December 31, 2010, respectively
(325
)
 
(257
)
Accumulated deficit
(233,654
)
 
(215,947
)
Accumulated other comprehensive income (loss)
(26
)
 
11

Total shareholders' equity
31,121

 
46,058

Total liabilities and shareholders' equity
$
113,462

 
$
114,157

 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
COMVERGE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Revenue
 
 
 
 
 
 
 
Product
$
5,414

 
$
5,798

 
$
17,768

 
$
16,553

Service
43,189

 
45,937

 
81,915

 
65,610

Total revenue
48,603

 
51,735

 
99,683

 
82,163

Cost of revenue
 

 
 

 
 

 
 
Product
4,397

 
4,588

 
14,214

 
12,594

Service
27,612

 
30,928

 
49,767

 
43,278

Total cost of revenue
32,009

 
35,516

 
63,981

 
55,872

Gross profit
16,594

 
16,219

 
35,702

 
26,291

Operating expenses
 
 
 
 
 

 
 
General and administrative expenses
10,410

 
10,496

 
31,803

 
27,808

Marketing and selling expenses
5,107

 
4,634

 
15,395

 
13,478

Research and development expenses
1,216

 
1,664

 
3,317

 
4,572

Amortization of intangible assets
106

 
536

 
579

 
1,608

Operating loss
(245
)
 
(1,111
)
 
(15,392
)
 
(21,175
)
Interest and other expense, net
612

 
214

 
2,264

 
567

Loss before income taxes
(857
)
 
(1,325
)
 
(17,656
)
 
(21,742
)
Provision for income taxes
18

 
55

 
51

 
170

Net loss
$
(875
)
 
$
(1,380
)
 
$
(17,707
)
 
$
(21,912
)
Net loss per share (basic and diluted)
$
(0.04
)
 
$
(0.06
)
 
$
(0.71
)
 
$
(0.89
)
Weighted average shares used in computation
24,914,085

 
24,718,710

 
24,861,031

 
24,638,815

 
 
 
 
 
 

 

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




COMVERGE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Nine Months Ended
 
September 30,
 
2011
 
2010
Cash flows from operating activities
 
 
 
Net loss
$
(17,707
)
 
$
(21,912
)
Adjustments to reconcile net loss to net cash from operating activities:
 

 
 

Depreciation
1,821

 
966

Amortization of intangible assets and capitalized software
1,268

 
2,121

Stock-based compensation
2,763

 
2,335

Other
1,232

 
1,022

Changes in operating assets and liabilities:
 

 
 
Billed and unbilled accounts receivable, net
(2,932
)
 
(23,278
)
Inventory, net
(1,820
)
 
(1,911
)
Deferred costs and other assets
52

 
(1,406
)
Accounts payable
(5,324
)
 
(1,851
)
Accrued expenses and other liabilities
10,539

 
16,902

Deferred revenue
6,978

 
17,109

Net cash used in operating activities
(3,130
)
 
(9,903
)
Cash flows from investing activities
 

 
 

Changes in restricted cash
(5
)
 
362

Purchases of marketable securities

 
(13,948
)
Maturities/sales of marketable securities
27,724

 
26,262

Purchases of property and equipment
(9,152
)
 
(5,765
)
Net cash provided by investing activities
18,567

 
6,911

Cash flows from financing activities
 
 
 

Borrowings under debt facility
12,500

 
18,000

Repayment of debt facility
(10,250
)
 
(20,250
)
Other
44

 
(431
)
Net cash provided by (used) in financing activities
2,294

 
(2,681
)
Effect of exchange rate changes on cash and cash equivalents
(26
)
 

Net change in cash and cash equivalents
17,705

 
(5,673
)
Cash and cash equivalents at beginning of period
7,800

 
16,069

Cash and cash equivalents at end of period
$
25,505

 
$
10,396

Cash paid for interest
$
1,355

 
$
723

Supplemental disclosure of noncash investing and financing activities
 

 
 

Recording of asset retirement obligation
$
(214
)
 
$
(201
)

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

 
 


1


COMVERGE, INC. AND SUBSIDIARIES
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 two reportable segments: the Residential Business segment and the Commercial & Industrial, or C&I, 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, 2011 and the results of operations for the three and nine months ended September 30, 2011 and 2010, and cash flows for the nine months ended September 30, 2011 and 2010, consisting only of normal and recurring adjustments. All significant intercompany transactions have been eliminated in consolidation. Operating results for the nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011. 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, 2010 on Form 10-K filed on March 9, 2011.

The condensed consolidated balance sheet as of
December 31, 2010 was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States.

Liquidity

The Company has incurred losses since inception, resulting in an accumulated deficit of $233,654 and stockholders' equity of $31,121 as of September 30, 2011. Working capital as of September 30, 2011 was $25,489, consisting of $81,750 in current assets and $56,261 in current liabilities, including $3,000 of long-term debt due within one year.   The total long-term debt as of September 30, 2011 was $24,000, excluding the $3,000 included in current liabilities. Further, the Company anticipates spending approximately $2,000 on capital expenditures during the fourth quarter of fiscal 2011.

The Company is required to meet certain financial covenants for both Silicon Valley Bank, or SVB, and Partners for Growth III, L.P., or PFG, lender agreements, specifically a minimum tangible net worth and an adjusted quick ratio. The Company reports compliance with the adjusted quick ratio covenant on a monthly basis and the tangible net worth covenant on a quarterly basis. For the period ended September 30, 2011, the minimum tangible net worth requirement was $40,000. For the fourth quarter of 2011, the minimum tangible net worth requirement is $42,000. For September and the remaining months of 2011, the minimum ratio of current assets to current liabilities is 1.25:1.00. The Company met the covenant requirements for the period ended September 30, 2011; however, management believes it is possible that the Company will not meet the covenant requirements during the fourth quarter of 2011 if additional capitalization of the Company is not achieved. The Company's failure to comply with these covenants may result in the declaration of an event of default and cause the Company to be unable to borrow under its loan agreement with SVB. See "Part II, Item 1A - Risk Factors - Our failure to meet various covenants and financial tests contained in our loan and security agreements could have a material adverse effect on our financial condition." below.

The Company had aggregate available borrowing capacity under its SVB loan agreement of $4,019 as of September 30, 2011; however, to the extent that it does not maintain at least $20,000 of unrestricted cash at all times, then this additional capacity is not available to the Company and could cause other potential defaults in its borrowing arrangements such that all outstanding debt could become due.  Even with its anticipated revenue growth or cash expenditure reductions, it is possible that the

2


Company's cash balance may fall below $20,000. Should the Company's unrestricted cash balance fall below $20,000 and the Company's borrowing capacity be consequently reduced, any amounts the Company owes to SVB in excess of the Company's reduced borrowing capacity will become immediately due and payable under its SVB loan agreement. Further, if the Company does not achieve certain year-to-date revenue growth targets, which are $99,658 in revenue for the nine months ending September 30, 2011 and $139,838 in revenue for the year ending December 31, 2011, PFG has the right, but not the obligation, to begin requiring quarterly repayments of the loan balance over the remaining term of the PFG loan. Such payments would be front-loaded, such that 45% of the loan balance (approximately $6,750 as of September 30, 2011) would be due over the first twelve months after PFG's election. If PFG exercises its Amortization Right (as defined in the loan agreement) and the Company subsequently complies with succeeding measurements periods, the Company may prospectively cease monthly amortization of the loan, provided however, PFG may again exercise its Amortization Right under the loan agreement if the Company fails to meet future minimum revenue targets. Also, any failure by the Company to pay any obligations that become due and payable may constitute an event of default under the SVB loan agreement or PFG loan. Such event of default could enable SVB or PFG to accelerate all amounts due under their respective loans or exercise other remedies available to them under the respective loan agreements. Further, any payment of such immediately due and payable obligations under the SVB loan agreement may cause the Company to breach certain financial covenants of either the SVB or PFG loan agreements. Any such breach of financial covenants would constitute an event of default under such agreements, enabling SVB or PFG to exercise their remedies under their respective agreements, including acceleration of all amounts due thereunder.

Management believes that there are various options available for the effective and reasonable capitalization of the Company that will allow for sufficient cash on hand to continue operations for the next 12 months. Management will continue to actively explore all such financing options, including restructuring of its current credit facilities in the near term. The Company's ability to secure additional capital or modify its existing debt terms to meet its projected revenue growth or cash expenditure reductions cannot be assured. In addition, certain financing options may require the consent of our current debt holders and we may not be able to obtain such consent or the terms of such consent may be cost-prohibitive. In such event, this could have a material adverse impact on its liquidity, financial position and results of operations and its ability to continue as a going concern.

2.    Significant Accounting Policies and Recent Accounting Pronouncements

Revenue Recognition - Residential Business
 
The Company sells intelligent energy management solutions 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: persuasive evidence of an arrangement exists, the price is fixed or determinable, delivery has occurred and collection is probable.  
 
The Company has certain contracts which are multiple element arrangements and provide for several deliverables to the customer that may include hardware, software and services, such as installation of the hardware, marketing, program management and hosting. The Company evaluates each deliverable to determine whether it represents a separate unit of accounting.   A deliverable constitutes a separate unit of accounting when it has stand-alone value and there are no customer-negotiated refunds or return rights for the delivered elements.  The separate deliverables in these arrangements meet the separation criteria.  The contract consideration for these multiple element arrangements is allocated to the units of accounting based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy of Vendor Specific Objective Evidence (VSOE), Third Party Evidence (TPE) or Estimated Selling Price (ESP).  VSOE of fair value is based on the price charged when the element is sold separately.  TPE of selling price is established by evaluating largely interchangeable competitor products or services in stand-alone sales to similarly situated customers. ESP is established considering multiple factors including, but not limited to list price, gross margin analysis and internal costs.  Allocation of the consideration is determined at arrangement inception on the basis of each unit’s relative selling price.  Once an allocated fair value is established for each unit of accounting, the contract deliverables are scoped into the appropriate accounting guidance for revenue recognition.    

The Company enters into long-term contracts with utilities in which the Company typically owns the underlying intelligent energy management network and provides its customer with electric capacity during the peak season. The Company invoices Virtual Peaking Capacity, or VPC, customers on a monthly or quarterly basis throughout the 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. 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 certain VPC contracts, the results of the measurement and verification process are applied retrospectively to the program year. For these contracts, the Company defers revenue and the associated cost of revenue related to these until such time as the annual contract payment is fixed or determinable.   Once a utility’s customer, or program participant, enrolls in one of the Company’s VPC programs, the Company installs 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, 2011 and December 31, 2010 are provided below:  
 
 
September 30,
2011
 
December 31,
2010
Deferred revenue:
 
 
 
VPC contract related
$
9,668

 
$
2,502

Other
4,372

 
3,319

Current deferred revenue
$
14,040

 
$
5,821

Deferred cost of revenue:
 

 
 

VPC contract related
$
3,922

 
$
1,041

Other
949

 
671

Current deferred cost of revenue
$
4,871

 
$
1,712



Revenue Recognition - Commercial & Industrial Business
 
The Company enters into agreements to provide 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 end users’ 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 or determinable. 
 
The Company bids into forward auctions for open market programs with independent system operators. The program year, which spans from June 1st to May 31st annually for the Company's primary program, is three years from the date of the initial auction. 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. For participation, the Company receives cash payments on a monthly basis in the program year. The Company may utilize the incremental auctions held within the three-year period prior to the commencement of the program year or may enter into bilateral agreements with other market demand or supply-side providers to fulfill a portion of the megawatts awarded in the initial auction. For the remaining megawatts, the Company enrolls C&I participants in order to fulfill its megawatt commitment with the independent system operator. If the Company remains the primary obligor for the megawatt commitment, the Company recognizes revenue and cost of revenue on a gross basis for those megawatts ratably over the performance period, once the revenue is fixed or determinable. If the Company is released from its obligations to fulfill those megawatts through an incremental auction or a bilateral agreement, the Company recognizes revenue, net of the cost of revenue, at the time that megawatts are accepted and the financial assurance is released.

The Company enters into agreements to provide base load reduction. Energy efficiency revenues are earned based on the Company’s ability to achieve committed capacity through base load reduction. In order to provide this reduction, 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 or determinable. Once the reduction 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.
 
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 as well as the effect of exchange rate changes.
 
The components of comprehensive loss are as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Net loss
$
(875
)
 
$
(1,380
)
 
$
(17,707
)
 
$
(21,912
)
Unrealized loss on marketable securities

 
27

 

 
17

Unrealized loss due to effect of exchange rates
(26
)
 

 
(26
)
 

Comprehensive loss
$
(901
)
 
$
(1,353
)
 
$
(17,733
)
 
$
(21,895
)
 
 
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, 2011, the Company had one customer which accounted for 39% of the Company’s revenue. During the nine months ended September 30, 2011, the Company had three customers which accounted for 26%, 15% and 11% of the Company's revenue. The total billed and unbilled accounts receivable from these customers was $22,833, in the aggregate, as of September 30, 2011. The total billed and unbilled accounts receivable from these customers was $19,352, in the aggregate, as of December 31, 2010. 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 39% and 13% of the Company's revenue. No other customer accounted for more than 10% of the Company’s total revenue during the three and nine months ended September 30, 2011 and 2010.
 
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.
 
Recent Accounting Pronouncements
 
In October 2009, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2009-13, “Multiple-Deliverable Revenue Arrangements” (ASU 2009-13). ASU 2009-13 changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable to be based on the relative selling price. Concurrently with issuing ASU 2009-13, the FASB also issued ASU No. 2009-14, “Certain Revenue Arrangements That Include Software Elements” (ASU 2009-14). ASU 2009-14 excludes software that is contained on a tangible product from the scope of software revenue guidance if the software component and the non-software component function together to deliver the tangible products’ essential functionality.  The Company adopted these standards on a prospective basis for new and materially modified arrangements originating after December 31, 2010.  The adoption of these amendments did not have a material effect on the Company’s financial statements.

In May 2011, the FASB issued new guidance for the measurement and disclosure of fair value. The primary objective of the standard is to ensure that fair value has the same meaning under GAAP and International Financial Reporting Standards and to establish common fair value measurement guidance in the two sets of standards. The standard does not change the overall fair value model in GAAP, but it amends various fair value principles and establishes additional disclosure requirements. This new guidance will be effective for interim and annual periods beginning after December 15, 2011, with amendments applied prospectively. The Company is currently evaluating the impact of this guidance.

In June 2011, the FASB issued authoritative guidance related to comprehensive income. The guidance eliminates the option to present other comprehensive income in the Statement of Shareholders' Equity, but instead allows companies to elect to present net income and other comprehensive income in one continuous statement (Statement of Comprehensive Income) or in two consecutive statements. This guidance does not change any of the components of net income or other comprehensive income and earnings per share will still be calculated based on net income. The Company plans to adopt this guidance on January 1, 2012.

In September 2011, the FASB issued new accounting guidance which allows a company the option to make a qualitative evaluation about the likelihood of goodwill impairment. A company will be required to perform the two-step impairment test only if it concludes, based on a qualitative assessment, the fair value of a reporting unit is more likely than not to be less than its carrying value. The guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. Adoption is not expected to have a material impact on the Company's financial condition or results of operations.

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 nine months ended September 30, 2011 and 2010, 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:
 
 
Nine Months Ended
 
September 30,
 
2011
 
2010
Subordinated debt convertible to common stock
2,747,252

 

Unvested restricted stock awards
499,988

 
567,696

Outstanding options
2,632,348

 
2,619,234

Total
5,879,588

 
3,186,930

 
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, 2011 and December 31, 2010, respectively, is presented below.
 
 
September 30, 2011
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
Cash and
Equivalents
 
Restricted
Cash
 
Marketable
Securities
Money market funds
$
10,602

 
$

 
$

 
$
10,602

 
$
10,602

 
$

 
$

Corporate debentures/bonds
702

 

 

 
702

 
702

 

 

Total marketable securities
11,304

 

 

 
11,304

 
11,304

 

 

Cash in operating accounts
19,675

 

 

 
19,675

 
14,201

 
5,474

 

Total
$
30,979

 
$

 
$

 
$
30,979

 
$
25,505

 
$
5,474

 
$

 
 
December 31, 2010
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
 
Cash and
Equivalents
 
Restricted
Cash
 
Marketable
Securities
Money market funds
$
1,657

 
$

 
$

 
$
1,657

 
$
1,657

 
$

 
$

Commercial paper
9,395

 

 

 
9,395

 
3,598

 

 
5,797

Corporate debentures/bonds
23,982

 
24

 
(13
)
 
23,993

 
1,998

 

 
21,995

Total marketable securities
35,034

 
24

 
(13
)
 
35,045

 
7,253

 

 
27,792

Cash in operating accounts
6,016

 

 

 
6,016

 
547

 
5,469

 

Total
$
41,050

 
$
24

 
$
(13
)
 
$
41,061

 
$
7,800

 
$
5,469

 
$
27,792

 
Realized gains and losses to date have not been material. Interest income for the nine months ended September 30, 2011 and 2010 was $109 and $723, 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, 2011 and December 31, 2010.
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
September 30, 2011
 
Quoted Prices 
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
 Observable
Inputs
(Level 2)
 
 Significant
 Unobservable
Inputs
(Level 3)
Money market funds
$
10,602

 
$
10,602

 
$

 
$

Corporate debentures/bonds
702

 

 
702

 

Total
$
11,304

 
$
10,602

 
$
702

 
$

 
 
 
 
Fair Value Measurements at Reporting Date Using
 
December 31,
2010
 
Quoted Prices 
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
 Observable
Inputs
(Level 2)
 
 Significant
 Unobservable
Inputs
(Level 3)
Money market funds
$
1,657

 
$
1,657

 
$

 
$

Commercial paper
9,395

 

 
9,395

 

Corporate debentures/bonds
23,993

 

 
23,993

 

Total
$
35,045

 
$
1,657

 
$
33,388

 
$

 
5.
Long-Term Debt

The Company entered into Modification No. 1 of the subordinated convertible loan agreement with PFG effective March 31, 2011.  The original agreement, dated November 5, 2010, sets forth quarterly revenue targets to be maintained by the Company on a consolidated basis.  The modification revised these revenue targets for fiscal year 2011.   If the revenue targets are not maintained, the lender has the right, but not the obligation, to begin requiring repayments of the loan balance over the remaining term of the loan.  Such payments would be front-loaded, such that 45% of the loan balance would be due over the first twelve months after the lender’s election.  If PFG exercises its Amortization Right (as defined in the loan agreement) and the Company subsequently complies with succeeding measurements periods, the Company may prospectively cease monthly amortization of the loan, provided however, PFG may again exercise its Amortization Right under the loan agreement if the Company fails to meet future minimum revenue targets. Any failure by the Company to maintain such minimum revenues does not, by itself, constitute an event of default.  The modification of the subordinated convertible loan agreement also revised the price at which the note may be converted into the Company’s common stock from $9.41 to $5.46 per share of common stock.  As a result of the modification, the Company recognized a charge of $523 in interest expense to write off the debt issuance costs related to the original agreement during the nine months ended September 30, 2011. Modification No. 1 is included as Exhibit 10.1 with the Company's Quarterly Report on Form 10-Q for the three months ended March 31, 2011 as filed with the SEC on May 5, 2011.

Long-term debt as of September 30, 2011 and December 31, 2010 consisted of the following:
 
 
September 30,
2011
 
December 31,
2010
Security and loan agreement with SVB, collateralized by all assets of Comverge, Inc. and its subsidiaries, maturing in December 2013, interest payable at a variable rate (3.22% as of September 30, 2011 and 3.26% as of December 31, 2010)
$
12,000

 
$
9,750

Subordinated convertible loan agreement with PFG, secured by all assets of Comverge, Inc. and its subsidiaries, maturing in November 2015, interest payable at a variable rate (6.50% as of September 30, 2011 and 5.75% December 31, 2010)
15,000

 
15,000

Total debt
27,000

 
24,750

Less: Current portion of long-term debt
(3,000
)
 
(3,000
)
Total long-term debt
$
24,000

 
$
21,750



6.
Legal Proceedings

The Company assesses the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses.  A determination of the amount of the liability required, if any, for these contingencies is made after an analysis of each known issue.  In accordance with applicable accounting guidance, a liability is recorded when the Company determines that a loss is probable and the amount can be reasonably estimated.  Additionally, the Company discloses contingencies for which a material loss is reasonably possible, but not probable. As a litigation or regulatory matter develops, the Company monitors the matter for further developments that could affect the amount previously accrued, if any, and updates such amount accrued or disclosures previously provided as appropriate. As of September 30, 2011, there were no material contingencies requiring accrual.
 
On October 12, 2010, a civil action complaint was filed against the Company in the United States District Court for the Western District of Kentucky (Case No. 3:10-CV-00638) by Louisville Gas & Electric Company and Kentucky Utilities Company (“Plaintiffs”).  The Plaintiffs alleged a breach of warranty claim relating to certain thermostats manufactured by White-Rodgers that they claim are defective.  The relief sought by Plaintiffs included an unspecified amount of damages, pre and post judgment interest and costs. On July 25, 2011, the Parties settled the lawsuit. The settlement did not have a material impact on our results of operations or financial condition.
 
On November 22, 2010, a civil action complaint was filed against the Company in the United States District Court for the Eastern District of Kentucky (Case No. 5:10-CV-00398) by East Kentucky Power Cooperative, Inc. (“EKPC”).  EKPC alleged a breach of warranty claim relating to certain thermostats manufactured by White-Rodgers that it claims are defective.  The relief sought by EKPC includes an unspecified amount of damages, pre- and post-judgment interest and costs.  The parties are attempting to resolve the dispute.

On May 9, 2011, a civil action complaint was filed against the Company and White-Rodgers, a division of Emerson Electric, in the Ontario Superior Court of Justice (Case No. CV-11-16275) by Enwin Utilities Ltd.  Enwin alleged breach of contract and tort claims for approximately 2,000 thermostats, manufactured by White-Rodgers, and purchased from Comverge.  The relief sought by Enwin includes $1,000,000 in damages plus costs.  The Company intends to defend this claim vigorously. 
 
At this time, the Company's management cannot estimate with reasonable certainty the ultimate disposition of any of the unresolved lawsuits and, while the Company does not believe it will sustain material liability in relation to any of the two active disputes described above, there can be no assurance that the Company will not sustain material liability as a result of, or related to, these lawsuits.

On December 1, 2010, NV Energy initiated a claim against the Company with the American Arbitration Association for a contract dispute arising out of the Company's delivered demand response program and in relation to the White-Rodgers thermostat in Nevada.  The relief sought by NV Energy included compensatory damages, attorney's fees, costs and interest. On December 1, 2010, NV Energy also filed a lawsuit in the U.S. District Court of Nevada (2:10-cv-02094-GMN-RJJ) against the Company seeking a declaration that NV Energy did not violate a Non-Disclosure Agreement with the Company by disclosing confidential and/or trade secret information in connection with the Company's work on NV Energy's Advanced Service Delivery (ASD) project.  NV Energy further contended that it did not owe the Company for service performed on the ASD project.  The Company counter-sued in the proceedings to recover damages stemming from NV Energy's tortious conduct breach of contract, conversion, and misappropriation of trade secrets, among other claims.  On October 26, 2011, the Parties settled both the arbitration and the litigation. The settlements did not have a material negative impact on the Company's results of operations or financial condition.

7.
Stock-Based Compensation

The Company’s Amended and Restated 2006 Long-Term Incentive Plan  (“2006 LTIP”) was approved by the Company’s stockholders 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 seven 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, 2011, 1,606,443 shares were available for grant under the 2006 LTIP. The expense related to stock-based incentive awards recognized for the three months ended September 30, 2011 and 2010 was $605 and $1,010, respectively. The expense related to stock-based incentive awards recognized for the nine months ended September 30, 2011 and 2010 was $2,763 and $2,335, respectively.
 
A summary of the Company’s stock option activity for the nine months ended September 30, 2011 is presented below:
 
 
September 30, 2011
 
Number of
Options
(in Shares)
 
Weighted
Average
Exercise
Price
 
Range of
Exercise Prices
Outstanding at beginning of period
2,533,947

 
$
11.82

 
$0.58-$34.23
Granted
505,923

 
5.11

 
$2.19-$6.20
Exercised
(82,678
)
 
1.36

 
$0.58-$4.30
Cancelled
(109,349
)
 
16.79

 
$0.58-$34.23
Forfeited
(215,495
)
 
7.21

 
$4.30-$13.90
Outstanding at end of period
2,632,348

 
$
11.03

 
$0.58-$34.23
Exercisable at end of period
1,554,555

 
$
13.22

 
$0.58-$34.23

 
 
 
Outstanding as of September 30, 2011
 
Exercisable as of September 30, 2011
Exercise Prices

 
Number Outstanding
 
Average
Remaining
Contractual Life
 
Weighted
Average
Exercise
Price per Share
 
Number Exercisable
 
Average
Remaining
Contractual Life
 
Weighted
Average
Exercise
Price per Share
 
 
(In Shares)
 
(In Years)
 
 
 
(In Shares)
 
(In Years)
 
 
$0.58 - $2.39

 
134,624

 
1.2

 
$
0.87

 
122,124

 
0.7

 
$
0.74

$2.40 - $3.99

 
111,473

 
6.0

 
3.47

 
17,162

 
2.4

 
3.04

$4.00 - $7.99

 
547,470

 
5.2

 
5.22

 
202,773

 
3.9

 
4.68

$8.00-$10.33

 
785,813

 
5.3

 
9.65

 
308,993

 
4.9

 
9.71

$10.34 - $14.09

 
504,041

 
3.6

 
11.53

 
355,113

 
2.9

 
11.80

$14.10 - $17.99

 
1,000

 
1.0

 
14.10

 
1,000

 
1.0

 
14.10

$18.00 - $23.53

 
376,555

 
2.1

 
18.05

 
376,018

 
2.1

 
18.05

23.54

 
14,047

 
2.0

 
23.54

 
14,047

 
2.0

 
23.54

$23.55 - $36.00

 
157,325

 
2.1

 
32.67

 
157,325

 
2.1

 
32.67

 

 
2,632,348

 
4.1

 
$
11.03

 
1,554,555

 
2.9

 
$
13.22

 
 
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):

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Risk-free interest rate
2.29
%
 
1.70
%
 
2.21
%
 
2.05
%
Expected term of options, in years
4.6

 
4.6

 
4.5

 
4.6

Expected annual volatility
93
%
 
70
%
 
71
%
 
70
%
Expected dividend yield
%
 
%
 
%
 
%
 
The weighted average grant-date fair value of options granted during the nine months ended September 30, 2011 and 2010 was $2.93 and $5.54, respectively.

A summary of the Company’s restricted stock award activity for the nine months ended September 30, 2011 is presented below:
 
 
September 30, 2011
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Per Share
Unvested at beginning of period
557,776

 
$
8.91

Granted
263,417

 
4.25

Vested
(96,001
)
 
12.73

Forfeited
(225,204
)
 
8.60

Unvested at end of period
499,988

 
$
5.86


8.
Segment Information

As of September 30, 2011, the Company had two reportable segments: the Residential Business segment and the C&I Business segment. Management has three primary measures of segment performance: revenue, gross profit and operating income. The Company does not allocate assets and liabilities to its operating segments. All inter-operating segment revenues were eliminated in consolidation. Substantially all of our revenues are generated with domestic customers.

The Residential Business segment sells intelligent energy management solutions to utility customers for use in programs with residential and small commercial end-use participants.  These solutions include intelligent hardware, our IntelliSOURCE software and services, such as installation, customer acquisition marketing and program management.  If the Company enters into a fully-outsourced pay-for-performance agreement providing capacity or energy, in which it typically owns the intelligent energy management system, the Company refers to the program as a VPC program.  The VPC programs are pay-for-performance in that the Company is only paid for capacity that it provides as determined by a measurement and verification process with its customers. For VPC programs, cost of revenue is based on operating costs of the demand response system, primarily telecommunications costs related to the system and depreciation of the assets capitalized in building the demand response system. If the customer elects to own the intelligent energy management system, the Company refers to the program as a turnkey program. For turnkey programs and other sales, product and service cost of revenue includes materials, labor and overhead.    

The C&I Business segment provides intelligent energy management solutions to utilities and independent system operators that are managing programs or auctions for large C&I consumers.  These solutions are delivered through the management of C&I megawatts in open markets and VPC programs as well as through the completion of energy efficiency projects. Cost of revenue includes participant payments for the VPC and open market programs as well as materials, labor and overhead for the energy efficiency programs.  

Operating expenses directly associated with each operating segment include sales, marketing, product development, amortization of intangible assets and certain administrative expenses.  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.
 
For the three and nine months ended September 30, 2010, the Company previously reported the results of operations in three segments: the Utility Products & Services segment, the Residential Business segment and the C&I Business segment. For the three and nine months ended September 30, 2011, the former Utility Products & Services segment is presented as part of the Residential Business segment. The results of our energy efficiency programs were previously reported in the Residential Business segment. For the three and nine months ended September 30, 2011, the energy efficiency programs are reported as part of the C&I Business segment.  Accordingly, the results of operations have been reclassified for the three and nine months ended September 30, 2010 to conform to the presentation for the three and nine months ended September 30, 2011.
 
The following tables show operating results for each of the Company’s reportable segments:


3


 
Three Months Ended
September 30, 2011
 
Residential
Business
 
C&I
Business
 
Corporate
Unallocated
Costs
 
Total
Revenue
 
 
 
 
 
 
 
Product
$
5,414

 
$

 
$

 
$
5,414

Service
11,350

 
31,839

 

 
43,189

Total revenue
16,764

 
31,839

 

 
48,603

Cost of revenue
 

 
 

 
 

 
 

Product
4,397

 

 

 
4,397

Service
5,980

 
21,632

 

 
27,612

Total cost of revenue
10,377

 
21,632

 

 
32,009

Gross profit
6,387

 
10,207

 

 
16,594

Operating expenses
 

 
 

 
 

 
 

General and administrative expenses
4,044

 
1,356

 
5,010

 
10,410

Marketing and selling expenses
2,009

 
2,203

 
895

 
5,107

Research and development expenses
1,216

 

 

 
1,216

Amortization of intangible assets

 
103

 
3

 
106

Operating income (loss)
(882
)
 
6,545

 
(5,908
)
 
(245
)
Interest and other expense, net
1

 
1

 
610

 
612

Income (loss) before income taxes
$
(883
)
 
$
6,544

 
$
(6,518
)
 
$
(857
)


 
Three Months Ended
September 30, 2010
 
Residential
Business
 
C&I
Business
 
Corporate
Unallocated
Costs
 
Total
Revenue
 
 
 
 
 
 
 
Product
$
5,798

 
$

 
$

 
$
5,798

Service
7,061

 
38,876

 

 
45,937

Total revenue
12,859

 
38,876

 

 
51,735

Cost of revenue
 

 
 

 
 

 
 

Product
4,588

 

 

 
4,588

Service
4,345

 
26,583

 

 
30,928

Total cost of revenue
8,933

 
26,583

 

 
35,516

Gross profit
3,926

 
12,293

 

 
16,219

Operating expenses
 

 
 

 
 

 
 

General and administrative expenses
4,240

 
1,275

 
4,981

 
10,496

Marketing and selling expenses
1,690

 
1,860

 
1,084

 
4,634

Research and development expenses
1,664

 

 

 
1,664

Amortization of intangible assets

 
532

 
4

 
536

Operating income (loss)
(3,668
)
 
8,626

 
(6,069
)
 
(1,111
)
Interest and other expense (income), net
(21
)
 

 
235

 
214

Income (loss) before income taxes
$
(3,647
)
 
$
8,626

 
$
(6,304
)
 
$
(1,325
)


4


 
Nine Months Ended
September 30, 2011
 
Residential
Business

 
C&I
Business
 
Corporate
Unallocated
Costs
 
Total
Revenue
 
 
 
 
 
 
 
Product
$
17,768

 
$

 
$

 
$
17,768

Service
33,082

 
48,833

 

 
81,915

Total revenue
50,850

 
48,833

 

 
99,683

Cost of revenue
 
 


 


 
 

Product
14,214

 

 

 
14,214

Service
16,699

 
33,068

 

 
49,767

Total cost of revenue
30,913

 
33,068

 

 
63,981

Gross profit
19,937

 
15,765

 

 
35,702

Operating expenses
 
 
 
 


 
 

General and administrative expenses
11,457

 
3,739

 
16,607

 
31,803

Marketing and selling expenses
5,795

 
6,013

 
3,587

 
15,395

Research and development expenses
3,317

 

 

 
3,317

Amortization of intangible assets

 
570

 
9

 
579

Operating income (loss)
(632
)
 
5,443

 
(20,203
)
 
(15,392
)
Interest and other expense (income), net
6

 
(8
)
 
2,266

 
2,264

Income (loss) before income taxes
$
(638
)
 
$
5,451

 
$
(22,469
)
 
$
(17,656
)


 
Nine Months Ended
September 30, 2010
 
Residential
Business

 
C&I
Business
 
Corporate
Unallocated
Costs
 
Total
Revenue
 
 
 
 
 
 
 
Product
$
16,553

 
$

 
$

 
$
16,553

Service
18,242

 
47,368

 

 
65,610

Total revenue
34,795

 
47,368

 

 
82,163

Cost of revenue


 


 
 
 
 

Product
12,594

 

 

 
12,594

Service
10,844

 
32,434

 

 
43,278

Total cost of revenue
23,438

 
32,434

 

 
55,872

Gross profit
11,357

 
14,934

 


 
26,291

Operating expenses
 
 
 
 


 
 

General and administrative expenses
12,262

 
3,682

 
11,864

 
27,808

Marketing and selling expenses
5,223

 
5,732

 
2,523

 
13,478

Research and development expenses
4,572

 

 

 
4,572

Amortization of intangible assets

 
1,596

 
12

 
1,608

Operating income (loss)
(10,700
)
 
3,924

 
(14,399
)
 
(21,175
)
Interest and other expense (income), net
(16
)
 
(5
)
 
588

 
567

Income (loss) before income taxes
$
(10,684
)
 
$
3,929

 
$
(14,987
)
 
$
(21,742
)
 

5



Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
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 9, 2011, 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 our other Quarterly Reports on Form 10-Q filed in 2011. 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 9, 2011 and the financial 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, or IEM, solutions that empower utilities, commercial and industrial customers, and residential consumers to use energy in a more effective and efficient manner.  IEM 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 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 IEM solutions through our two reportable segments: the Residential Business segment and the Commercial & Industrial, or C&I, Business segment.  The Residential Business segment sells IEM solutions to utility customers for use in programs with residential and small commercial end-use participants.  These solutions include hardware, our IntelliSOURCE software and services, such as installation, participant marketing and program management.  If the utility customer elects to own the IEM system, we refer to the program as a turnkey program. If we provide capacity through fully-outsourced programs, in which we typically own the underlying system, we refer to the program as a Virtual Peaking Capacity, or VPC, program.  Our VPC programs are pay-for-performance in that we are only paid for capacity that we provide as determined by a measurement and verification process with our customers.  The C&I Business segment provides IEM solutions to utilities and independent system operators that are managing programs or auctions for large C&I consumers.  These solutions are delivered through the management of C&I megawatts in open markets and VPC programs as well as through the completion of energy efficiency projects.

Recent Developments
Annual Guidance
We expect 2011 annual revenues to range from $136 to $141 million. We plan to provide full year 2012 guidance when we report our fourth quarter and full year 2011 results.
Megawatts
 
We evaluate the megawatts of capacity that we own, manage or provide to the electric utility industry according to operating segment.  For VPC, energy efficiency and turnkey contracts, we include the maximum contracted capacity at contract

6


inception. For open market programs, we include megawatts when we have enrolled a participant to fulfill the megawatt awarded to us in the open market program.  The following table summarizes megawatts owned, managed or provided as of September 30, 2011.
 
 
As of September 30, 2011
(Megawatts)
Residential
Business
 
C&I
Business
 
Total
Comverge
VPC and energy efficiency contracts
442

 
294

 
736

Open market programs

 
1,868

 
1,868

Turnkey contracts
690

 

 
690

Managed for a fee

 
437

 
437

Owned, managed or provided
1,132

 
2,599

 
3,731

 
The table below presents the activity in megawatts owned or managed during the nine months ended September 30, 2011.
 
 
 
Megawatts Owned or Managed
As of December 31, 2010
 
3,732

VPC and energy efficiency contracts (1)
 
(155
)
Open market programs
 
154

Turnkey contracts
 
-

As of September 30, 2011
 
3,731

 
(1)
Our VPC contract with NV Energy for 155 megawatts of contracted capacity is no longer in effect for 2011.

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, turnkey contracts and open market programs. As of September 30, 2011, we estimated that our total payments to be received through 2024 are approximately $541 million. The long-term contracts that relate to these anticipated payments provide for such anticipated payments as follows: $39 million in the fourth quarter of 2011 (a portion of which has already been reflected in revenue for the period ended September 30, 2011), $138 million in 2012, $152 million in 2013, $91 million in 2014 and the remaining $121 million thereafter.
 
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 filing 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 significantly differing from management’s current estimates of payments allowed under the long-term contracts and our actual experiences may result in actual payments collected being significantly lower than current estimates. See “Part II, Item 1A - Risk Factors—We may not receive the payments anticipated by our long-term contracts and recognize revenues or the anticipated margins from our backlog or expected business, and comparisons of period-to-period estimates are not necessarily meaningful and may not be indicative of actual payments.” below.  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.
 
VPC Programs
 
In calculating an estimated $214 million of payments from our VPC contracts, 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

7


achieved during build-out.
 
The amount our utility customers pay to us at the end of each contract year may vary due to 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 in future periods.
 
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.

Energy Efficiency Programs
 
In calculating an estimated $6 million in payments from these contracts through 2013, we have included expectations for build-out through contract end based on our historical experience. 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, 2011, we expect to receive $193 million in long-term payments through the year 2015 in open market programs in which we have been awarded megawatts.  In estimating the long-term payments, we have assumed that we will retain our commercial and industrial participants that we have currently enrolled in the auctions and that we will be able to fulfill additional capacity.
 
Turnkey Programs
 
Our turnkey contracts as of September 30, 2011 represent $107 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 anticipated order volumes, forecasted installations and other services applied over the term of the contract.
 
Other Contracts
 
We expect to receive an estimated $21 million in payments through 2014 pursuant to currently executed contracts for our IEM 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 2010, 2009 and 2008 was $31.4 million, $31.7 million and $94.1 million, respectively. We may continue to generate annual net losses in the future, including through the term of our long-term contracts. See “Part II, Item 1A - Risk Factors—We have incurred annual net losses since our inception, and we may continue to incur annual net losses in the future.” below.
 
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 filing.
 
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, operational deficiencies, 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, 2011, we had contractual backlog of $123 million through September 30, 2012.



8



Results of Operations
 
Three and Nine Months Ended September 30, 2011 Compared to Three and Nine Months Ended September 30, 2010
 
Revenue
 
The following table summarizes our revenue for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands):
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2011
 
2010
 
Percent
Change
 
2011
 
2010
 
Percent
Change
Segment Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
Residential Business
 
$
16,764

 
$
12,859

 
30
 %
 
$
50,850

 
$
34,795

 
46
%
C&I Business
 
31,839

 
38,876

 
(18
)%
 
48,833

 
47,368

 
3
%
Total
 
$
48,603

 
$
51,735

 
(6
)%
 
$
99,683

 
$
82,163

 
21
%

As of December 31, 2010, we reported the results of operations in two segments: our Residential Business segment and our C&I Business segment. In prior periods, including the three and nine months ended September 30, 2010, we reported the results of operations in three segments: the Utility Products & Services segment, the Residential Business segment and the C&I Business segment.  For the three and nine months ended September 30, 2011, the former Utility Products & Services segment is presented as part of the Residential Business segment.  Accordingly, revenue of $12.5 million and $32.7 million has been reclassified for the three and nine months ended September 30, 2010, respectively, to reflect this change in reportable segments.  The results of our energy efficiency programs were previously reported in the Residential Business segment.  For the three and nine months ended September 30, 2011, the energy efficiency programs are reported as part of the C&I Business segment.  Accordingly, revenue of $1.9 million and $4.5 million has been reclassified for the three and nine months ended September 30, 2010, respectively, to reflect this change in reportable segments.
 
Residential Business
 
Our Residential Business segment had revenue of $16.8 million for the three months ended September 30, 2011 compared to $12.9 million for the three months ended September 30, 2010, an increase of $3.9 million or 30%. The increase in revenue is due to a $2.3 million increase from our turnkey programs as we continued to build out these programs during the three months ended September 30, 2011. We also recognized an increase of $2.4 million in revenue from our New Mexico and Pennsylvania VPC programs. For our New Mexico program, the measurement and verification results completed in late 2010 are contractually applied to the current program year. In prior periods, the measurement and verifications results were retrospectively applied; thus, we did not recognize revenue for the program until the fourth quarter. For our Pennsylvania program, we recognized revenue based on program build-out that is not subject to measurement and verification of delivered capacity. We continue to defer the revenue and cost of revenue for our remaining three residential VPC programs until the measurement and verification results are determined during the fourth quarter.  The increase in revenue from turnkey and VPC programs was partially offset by a $0.8 million decrease in other products and services, mainly due to a decrease in stand-alone product sales.
 
During the three months ended September 30, 2011, we sold 58,000 digital control units and thermostats compared to 65,000 digital control units and thermostats during the three months ended September 30, 2010, a decrease of 7,000 units mainly due to the decrease in stand-alone product sales.  For the three months ended September 30, 2011, our turnkey programs comprised 47% of total units sold compared to 42% during the three months ended September 30, 2010.

Our Residential Business segment had revenue of $50.9 million for the nine months ended September 30, 2011 compared to $34.8 million for the nine months ended September 30, 2010, an increase of $16.1 million or 46%. The increase in revenue is due to a $13.1 million increase from our turnkey programs as we continued to build out these programs during the nine months ended September 30, 2011. We also recognized an increase of $5.8 million from our New Mexico and Pennsylvania VPC programs. For our New Mexico program, the measurement and verification results completed in late 2010 are contractually applied to the current program year. In prior periods, the measurement and verifications results were retrospectively applied; thus, we did not recognize revenue for the program until the fourth quarter. For our Pennsylvania program, we recognized

9


revenue based on program build-out that is not subject to measurement and verification of delivered capacity.  We continue to defer the revenue and cost of revenue for our remaining three residential VPC programs until the measurement and verification results are determined during the fourth quarter. The increase in revenue from turnkey and VPC programs was partially offset by a $2.8 million decrease in other products and services, partially attributable to a decrease in stand-alone product sales.
 
During the nine months ended September 30, 2011, we sold 204,000 digital control units and thermostats compared to 150,000 digital control units and thermostats during the nine months ended September 30, 2010, an increase of 54,000 units mainly due to the build-out of digital control units in our turnkey programs.  For the nine months ended September 30, 2011, our turnkey programs comprised 50% of total units sold compared to 39% during the nine months ended September 30, 2010.

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 did not concede that the thermostats contained a defect or posed a substantial product hazard, but voluntarily proposed a corrective action plan to address thermostats in inventory and thermostats installed in the field.  In January 2011, the CPSC approved the corrective action plan.  White-Rodgers stated that it will provide compensation for our work in implementing the corrective action plan and, to date, we received a non-recurring payment during the first and third quarters of 2011 for the majority of our field work.  After the corrective action plan was approved and any needed remediation work was completed for our inventory, we resumed installing thermostats in certain turnkey programs during the first quarter of 2011.  Please also see Part II, Item 1 “Legal Proceedings” and Note 6 to the consolidated financial statements included in this report for additional information related to the White-Rodgers thermostats.
 
We defer revenue and direct costs under three of our residential 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 cost of revenue increased as of September 30, 2011 compared to December 31, 2010 due to our continued deployment and operation of the existing VPC programs. Deferred revenue and cost of revenue related to residential VPC contracts are presented below (dollars in thousands).
 
 
As of
 
 
September 30,
2011
 
December 31,
2010
 
VPC Contract Related:
 
 
 
 
Deferred revenue
$
9,668

 
$
2,502

 
Deferred cost of revenue
$
3,922

 
$
1,041

 
 
C&I Business
 
Our C&I Business segment had revenue of $31.8 million for the three months ended September 30, 2011 compared to $38.9 million for the three months ended September 30, 2010, a decrease of $7.0 million or 18%.  The decrease in revenue is due to a decrease of $11.9 million in PJM Interconnection, or PJM, capacity program revenue. Of the $11.9 million, a decrease of $5.8 million in PJM capacity revenue is due to timing of revenue recognition. We receive cash payments on a monthly basis in the capacity year and are required to curtail energy usage during the mandatory performance period of June through September, which is the peak demand season. In prior periods, we recognized the full program year revenue in September at the end of the mandatory performance period. In the current year, we determined that we have sufficient historical data to recognize the capacity program revenue ratably over the mandatory performance period. As such, we recognized $5.8 million of PJM capacity revenue in the second quarter of 2011. The remaining decrease of $6.1 million in PJM capacity revenue is due to a decrease of approximately 40% in the current program auction price compared to the prior program year. The decrease in PJM capacity revenue was partially offset by a $1.8 million increase in revenue in the other open markets in which we participate, such as ISO New England, as well as an increase of $3.3 million in VPC program revenue as we committed and fulfilled increased megawatts compared to the prior year's control season. The remaining $0.2 million decrease is due to the energy efficiency programs partially offset by revenue from other energy services.

Our C&I Business segment had revenue of $48.8 million for the nine months ended September 30, 2011 compared to $47.4 million for the nine months ended September 30, 2010, an increase of $1.5 million or 3%.  The increase in revenue is due to an increase of $3.2 million in VPC program revenue as we committed and fulfilled increased megawatts compared to the prior year's control season, an increase of $1.1 million in energy efficiency program revenue due to the increase in annual payments that we received for maintaining the lighting upgrades originally installed as well as increased build-out and an increase of $1.3 million in revenue from other energy services. These increases were partially offset by a decrease of $4.1 million in open

10


market revenue. The decrease of $4.1 million in open market revenue consisted of a decrease of $6.1 million in PJM capacity revenue due to a decrease of approximately 40% in the current program auction price compared to the prior program year partially offset by an increase of $2.0 million in the other open markets in which we participate.

Gross Profit and Gross Margin
 
The following table summarizes our gross profit and gross margin for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands):

 
 
Three Months Ended
 
 
Nine Months Ended
 
 
September 30,
 
 
September 30,
 
 
2011
 
2010
 
 
2011
 
2010
 
 
Gross
Profit
 
Gross
Margin
 
Gross
Profit
 
Gross
Margin
 
 
Gross
Profit
 
Gross
Margin
 
Gross
Profit
 
Gross
Margin
Segment Gross Profit:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential Business
 
$
6,387

 
38
%
 
$
3,926

 
31
%
 
 
$
19,937

 
39
%
 
$
11,357

 
33
%
C&I Business
 
10,207

 
32
%
 
12,293

 
32
%
 
 
15,765

 
32
%
 
14,934

 
32
%
Total
 
$
16,594

 
34
%
 
$
16,219

 
31
%
 
 
$
35,702

 
36
%
 
$
26,291

 
32
%
 
As of December 31, 2010, we reported the results of operations in two segments: our Residential Business segment and our C&I Business segment. In prior periods, including the three and nine months ended September 30, 2010, we reported the results of operations in three segments: the Utility Products & Services segment, the Residential Business segment and the C&I Business segment.  For the three and nine months ended September 30, 2011, the former Utility Products & Services segment is presented as part of the Residential Business segment to reflect this change in reportable segments.  Accordingly, gross profit of $3.6 million and $9.7 million has been reclassified for the three and nine months ended September 30, 2010, respectively.  The results of our energy efficiency programs were previously reported in the Residential Business segment.  For the three and nine months ended September 30, 2011, the energy efficiency programs are reported as part of the C&I Business segment.  Accordingly, gross profit has been reclassified for the three and nine months ended September 30, 2010 to reflect this change in reportable segments.
 
Residential Business
 
Gross profit for our Residential Business segment was $6.4 million for the three months ended September 30, 2011 compared to $3.9 million for the three months ended September 30, 2010, an increase of $2.5 million or 63%. The increase in gross profit is due to an increase of $1.4 million from our turnkey programs and $1.8 million from our New Mexico and Pennsylvania VPC programs partially offset by a decrease of $0.7 million from our other product and service sales.  The increase in gross profit from our turnkey programs is due to the increased revenue during the three months ended September 30, 2011. The increase in gross profit from our VPC programs is a result of the recognition of revenue and cost of revenue in the New Mexico program as the measurement and verification results completed in late 2010 are contractually applied to the current program year as well as the build-out in our Pennsylvania program during 2011.  The gross profit from other product and service sales decreased, in part, due to the decrease in stand-alone product sales.
 
Gross margin for our Residential Business segment was 38% for the three months ended September 30, 2011 compared to 31% for the three months ended September 30, 2010. The increase of seven percentage points is due mainly to the higher gross margin contributed by the New Mexico and Pennsylvania VPC programs.

Gross profit for our Residential Business segment was $19.9 million for the nine months ended September 30, 2011 compared to $11.4 million for the nine months ended September 30, 2010, an increase of $8.6 million or 76%. The increase in gross profit is due to an increase of $5.1 million from our turnkey programs and $4.9 million from our New Mexico and Pennsylvania VPC programs partially offset by a decrease of $1.4 million from our other product and service sales.  The increase in gross profit from our turnkey programs is due to the increased revenue during the nine months ended September 30, 2011. The increase in gross profit from our VPC programs is a result of the recognition of revenue and cost of revenue in the New Mexico program as the measurement and verification results completed in late 2010 are contractually applied to the current program year as well as the build-out in our Pennsylvania program during 2011.  The gross profit from other product and service sales decreased, in part, due to the decrease in stand-alone product sales.
 
Gross margin for our Residential Business segment was 39% for the nine months ended September 30, 2011 compared to 33%

11


for the nine months ended September 30, 2010. The increase of six percentage points is due to the higher gross margin contributed by the New Mexico and Pennsylvania VPC programs as well as the non-recurring payments received from White-Rodgers during the first quarter of 2011 for a portion of our field work to implement the corrective action plan, as previously discussed.
 
C&I Business
 
Gross profit for our C&I Business segment was $10.2 million for the three months ended September 30, 2011 compared to $12.3 million for the three months ended September 30, 2010, a decrease of $2.1 million or 17%. The decrease in gross profit is due to a decrease of $3.3 million from our open market programs due to decreased revenue in the PJM capacity program and $0.3 million from our energy efficiency programs and other energy services partially offset by an increase of $1.5 million from our VPC programs as we committed and fulfilled increased megawatts compared to the prior year's control season.
 
Gross margin for the three months ended September 30, 2011 and 2010 was consistent at 32% due to the margins contributed from our open market programs.  

Gross profit for our C&I Business segment was $15.8 million for the nine months ended September 30, 2011 compared to $14.9 million for the nine months ended September 30, 2010, an increase of $0.8 million or 6%. The increase in gross profit is due to an increase of $1.2 million from our VPC programs, $1.7 million from our energy efficiency programs due to the increase in annual payments that we received for maintaining the lighting upgrades originally installed and $0.4 million from other energy services. These increases were partially offset by a decrease of $2.5 million in gross profit from open market programs due to decreased revenue in the PJM capacity program.

Gross margin for the nine months ended September 30, 2011 and 2010 was consistent at 32% due to the margins contributed from our open market programs.
 
Operating Expenses
 
The following table summarizes our operating expenses for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands):

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2011
 
2010
 
Percent
Change
 
2011
 
2010
 
Percent
Change
Operating Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
General and administrative expenses
 
$
10,410

 
$
10,496

 
(1
)%
 
$
31,803

 
$
27,808

 
14
 %
Marketing and selling expenses
 
5,107

 
4,634

 
10
 %
 
15,395

 
13,478

 
14
 %
Research and development expenses
 
1,216

 
1,664

 
(27
)%
 
3,317

 
4,572

 
(27
)%
Amortization of intangible assets
 
106

 
536

 
(80
)%
 
579

 
1,608

 
(64
)%
Total
 
$
16,839

 
$
17,330

 
(3
)%
 
$
51,094

 
$
47,466

 
8
 %
 
General and Administrative Expenses
 
General and administrative expenses were $10.4 million for the three months ended September 30, 2011 compared to $10.5 million for the three months ended September 30, 2010, a decrease of $0.1 million or 1%. The decrease in general and administrative expenses is due to a decrease of $0.9 million in costs related to the centralization of staff to our corporate headquarters that were recorded during the third quarter of 2010 partially offset by an increase of $0.8 million in compensation and benefits, which included $0.2 million in severance expense related to the current cost initiative as discussed below.

General and administrative expenses were $31.8 million for the nine months ended September 30, 2011 compared to $27.8 million for the nine months ended September 30, 2010, an increase of $4.0 million or 14%. The increase in general and administrative expenses is due to an increase of $2.6 million in compensation and benefits as a result of increased headcount, $0.5 million in stock-based compensation as we recorded a full nine months of expense in 2011 for certain awards granted in mid to late 2010, $0.3 million in professional and consulting fees due to financial and legal advisers to the Board of Directors for strategic initiatives, $0.5 million in travel and entertainment, $0.5 million in depreciation expense, $0.3 million in insurance expense and $0.2 million in other expenses partially offset by a decrease of $0.9 million in centralization costs that were

12


recorded during the nine months ended September 30, 2010.
On July 25, 2011, we announced a cost initiative, which is focused on streamlining and simplifying operations to assist in accelerating our path to profitability. This initiative is expected to reduce annual expenses by $4.0 million to $4.5 million, which will result in a reduction in headcount and efficiencies gained from improved management of our supply chain, warehousing and corporate procurement functions. The cost of this initiative is anticipated to be approximately $1.0 million to $1.5 million. During the three months ended September 30, 2011, we incurred $0.2 million in such costs and expect to incur the majority of the remaining costs in the fourth quarter.

 Marketing and Selling Expenses
 
Marketing and selling expenses were $5.1 million for the three months ended September 30, 2011 compared to $4.6 million for the three months ended September 30, 2010, an increase of $0.5 million or 10%. The increase in marketing and selling expenses was mainly due to an increase of $0.2 million in compensation and benefits, $0.1 million in commissions expense and $0.2 million in other expenses.

Marketing and selling expenses were $15.4 million for the nine months ended September 30, 2011 compared to $13.5 million for the nine months ended September 30, 2010, an increase of $1.9 million or 14%. The increase in marketing and selling expenses was mainly due to an increase of $0.6 million in compensation and benefits, $0.8 million in commissions expense, $0.4 million in consulting expense and $0.1 million in other expenses.
 
Research and Development Expenses
 
Research and development expenses are incurred primarily in connection with the identification, testing and development of new products and software. Research and development expenses were $1.2 million for the three months ended September 30, 2011 and $1.7 million for the three months ended September 30, 2010, a decrease of $0.4 million or 27%. The decrease in research and development expenses is mainly due to our capitalization of certain labor costs related to the development of IntelliSOURCE version 3.0 during the third quarter of 2011. The amortization of these capitalized software costs will be recorded to cost of revenue.

Research and development expenses were $3.3 million for the nine months ended September 30, 2011 and $4.6 million for the nine months ended September 30, 2010, a decrease of $1.3 million or 27%. The decrease in research and development expenses is mainly due to our capitalizing certain labor costs related to the development of IntelliSOURCE version 2.0 and version 3.0 during the period.

Intangible Assets
 
Amortization of intangible assets was $0.1 million for the three months ended September 30, 2011 compared to $0.5 million for the three months ended September 30, 2010, a decrease of $0.4 million or 80%. The decrease in amortization expense is due to the decrease in intangible assets as a result of our impairment assessment during the fourth quarter of 2010 as well as the amortization period fully lapsing during the third quarter for a certain acquired technology.

Amortization of intangible assets was $0.6 million for the nine months ended September 30, 2011 compared to $1.6 million for the nine months ended September 30, 2010, a decrease of $1.0 million or 64%. The decrease in amortization expense is primarily due to the decrease in intangible assets as a result of our impairment assessment during the fourth quarter of 2010.  

In addition to the amortization presented in operating expenses, we also recorded $0.3 million and $0.2 million in amortization expense for the three months ended September 30, 2011 and 2010, respectively, and $0.7 million and $0.5 million for the nine months ended September 30, 2011 and 2010, respectively, in cost of revenue.
 
Interest and Other Expense, Net
 
We recorded net interest and other expense of $0.6 million during the three months ended September 30, 2011 compared to $0.2 million during the three months ended September 30, 2010, an increase of $0.4 million. The increase in net interest and other expense is primarily due to the increased interest expense associated with our subordinated convertible loan agreement with PFG entered into on November 5, 2010 and amended effective March 31, 2011.

We recorded net interest and other expense of $2.3 million during the nine months ended September 30, 2011 compared to $0.6 million during the nine months ended September 30, 2010, an increase of $1.7 million. The increase in net interest and other

13


expense is primarily due to the increased interest expense associated with our subordinated convertible loan agreement with PFG entered into on November 5, 2010 and amended effective March 31, 2011, as well as a $0.5 million charge to write off unamortized debt issuance costs during the first quarter of 2011 related to the modification of the PFG agreement.
 
Income Taxes
 
A provision of $18,000 and $55,000 was recorded for the three months ended September 30, 2011 and 2010, respectively, related to taxable income in one state. A provision of $51,000 and $170,000 was recorded for the nine months ended September 30, 2011 and September 30, 2010, respectively, related to taxable income in one state. We provided a full valuation allowance for our deferred tax assets because the realization of any future tax benefits could not be sufficiently assured as of September 30, 2011 and 2010.

14



 Liquidity and Capital Resources
 
The Company has incurred losses since inception, resulting in an accumulated deficit of $233.7 million and stockholders' equity of $31.1 million as of September 30, 2011. Working capital as of September 30, 2011 was $25.5 million, consisting of $81.8 million in current assets and $56.3 million in current liabilities, including $3.0 million of long-term debt due within one year.   The total long-term debt as of September 30, 2011 was $24.0 million, excluding the $3.0 million included in current liabilities. Further, we anticipate spending approximately $2.0 million on capital expenditures during the fourth quarter of fiscal 2011.

We are required to meet certain financial covenants for both Silicon Valley Bank, or SVB, and Partners for Growth III, L.P., or PFG, lender agreements, specifically a minimum tangible net worth and an adjusted quick ratio. We report compliance with the adjusted quick ratio covenant on a monthly basis and the tangible net worth covenant on a quarterly basis. For the period ended September 30, 2011, the minimum tangible net worth requirement was $40.0 million. For the fourth quarter of 2011, the minimum tangible net worth requirement is $42.0 million. For September and the remaining months of 2011, the minimum ratio of current assets to current liabilities is 1.25:1.00. We met the covenant requirements for the period ended September 30, 2011; however, management believes it is possible that we will not meet the covenant requirements during the fourth quarter of 2011 if additional capitalization of the Company is not achieved. Our failure to comply with these covenants may result in the declaration of an event of default and cause us to be unable to borrow under our loan agreement with SVB. See "Part II, Item 1A - Risk Factors - Our failure to meet various covenants and financial tests contained in our loan and security agreements could have a material adverse effect on our financial condition." below.

We had aggregate available borrowing capacity under our SVB loan agreement of $4.0 million as of September 30, 2011; however, to the extent that we do not maintain at least $20.0 million of unrestricted cash at all times, then this additional capacity is not available to us and could cause other potential defaults in our borrowing arrangements such that all outstanding debt could become due.  Even with our anticipated revenue growth or cash expenditure reductions, it is possible that the Company's cash balance may fall below $20.0 million. Should the Company's unrestricted cash balance fall below $20.0 million and the Company's borrowing capacity be consequently reduced, any amounts the Company owes to SVB in excess of the Company's reduced borrowing capacity will become immediately due and payable under our SVB loan agreement. Further, if we do not achieve certain year-to-date revenue growth targets, which are $99.7 million in revenue for the nine months ending September 30, 2011 and $139.8 million in revenue for the year ending December 31, 2011, PFG has the right, but not the obligation, to begin requiring quarterly repayments of the loan balance over the remaining term of the PFG loan. Such payments would be front-loaded, such that 45% of the loan balance (approximately $6.8 million as of September 30, 2011) would be due over the first twelve months after PFG's election. If PFG exercises its Amortization Right (as defined in the loan agreement) and the Company subsequently complies with succeeding measurements periods, the Company may prospectively cease monthly amortization of the loan, provided however, PFG may again exercise its Amortization Right under the loan agreement if the Company fails to meet future minimum revenue targets. Also, any failure by the Company to pay any obligations that become due and payable may constitute an event of default under the SVB loan agreement or PFG loan. Such event of default could enable SVB or PFG to accelerate all amounts due under their respective loans or exercise other remedies available to them under the respective loan agreements. Further, any payment of such immediately due and payable obligations under the SVB loan agreement may cause us to breach certain financial covenants of either the SVB or PFG loan agreements. Any such breach of financial covenants would constitute an event of default under such agreements, enabling SVB or PFG to exercise their remedies under their respective agreements, including acceleration of all amounts due thereunder.

Management believes that there are various options available for the effective and reasonable capitalization of the Company that will allow for sufficient cash on hand to continue operations for the next 12 months. Management will continue to actively explore all such financing options, including restructuring of our current credit facilities in the near term. Our ability to secure additional capital or modify our existing debt terms to meet our projected revenue growth or cash expenditure reductions cannot be assured. In addition, certain financing options may require the consent of our current debt holders and we may not be able to obtain such consent or the terms of such consent may be cost-prohibitive. In such event, this could have a material adverse impact on our liquidity, financial position and results of operations and our ability to continue as a going concern.
 
The following table summarizes our cash flows for the nine months ended September 30, 2011 and 2010 (dollars in thousands):
 

15


 
Nine Months Ended
 
September 30,
 
2011
 
2010
Operating activities
$
(3,130
)
 
$
(9,903
)
Investing activities
18,567

 
6,911

Financing activities
2,294

 
(2,681
)
Net change in cash and cash equivalents, excluding effect of foreign exchange
$
17,731

 
$
(5,673
)
 
Cash Flows Used in Operating Activities
 
Cash used in operating activities was $3.1 million for the nine months ended September 30, 2011 compared to $9.9 million for the nine months ended September 30, 2010, a decrease of $6.8 million.  The change in cash flows from operating activities included a decrease in net loss of $4.8 million, after adjusting for non-cash items including depreciation, amortization and stock-based compensation.  The remaining change of $2.0 million in cash flows from operating activities is a result of the change in operating assets and liabilities, primarily in accounts receivable, accounts payable and other liabilities and deferred revenue. The change in deferred revenue decreases as a result of the recognition of revenue from the New Mexico residential VPC program and the expiration of our Nevada VPC contract.
 
Cash Flows Provided by Investing Activities
 
Cash provided by investing activities was $18.6 million for the nine months ended September 30, 2011 compared to $6.9 million during the nine months ended September 30, 2010, an increase of $11.7 million.  The increase was due to an increase in the change in marketable securities of $15.4 million as we sold certain marketable securities and allowed others to mature in order to reinvest those funds in more liquid cash and cash equivalents.  Additionally, we incurred increased capital expenditures during the nine months ended September 30, 2011 as we invested in our network operations and data center, capitalized certain software development costs, and continued to build out our IEM networks in existing VPC programs.
 
Cash Flows Provided by (Used in) Financing Activities
 
Cash flows provided by financing activities were $2.3 million for the nine months ended September 30, 2011 and cash flows used in financing activities were $2.7 million for the nine months ended September 30, 2010. The cash flows provided by financing activities mainly consisted of $2.3 million in borrowings, net of payments, from our SVB debt facility. The cash flows used in financing activities mainly consisted of $2.3 million in payments, net of borrowings, of our SVB debt facility.

 Indebtedness
 
As of September 30, 2011, $3.0 million of our outstanding debt was due within the next twelve months and $0.8 million of our outstanding debt is due during the fourth quarter of 2011.  As of September 30, 2011, we were in compliance with the financial and restrictive debt covenants of our outstanding debt facilities.
 
Letters of Credit
 
Our facility with SVB provides for the issuance of up to $30.0 million of letters of credit. As of September 30, 2011, we had $21.5 million face value of irrevocable letters of credit outstanding from the facility.  Additionally, we have $1.2 million of cash collateralized letters of credit outstanding, which are presented as a portion of the restricted cash in our financial statements.
 
Capital Spending
 
Our residential VPC programs require a significant amount of capital spending to build out our demand response systems. We expect to incur approximately $8 million in capital expenditures, primarily over the next three years, to continue building out our existing VPC programs, of which approximately $1.4 million is anticipated to be incurred through December 31, 2011. If we are successful in being awarded additional VPC contracts, we would incur additional amounts to build out these new VPC programs.
 
Over the last few months, we have significantly upgraded the technology infrastructure that supports our solutions, for the purpose of providing our clients with the reliability as well as increased flexibility to run the demand management solutions, including testing and deploying our IntelliSOURCE platform.  We expect to incur approximately $0.6 million in additional

16


capital expenditures through December 31, 2011 as we complete the upgrade to our infrastructure.
 
Non-GAAP Financial Measures
 
Earnings Before Interest, Taxes, Depreciation and Amortization, or EBITDA, is defined as net loss before net interest expense, income tax expense, and depreciation and amortization. EBITDA is a non-GAAP financial measure and is not a substitute for other GAAP financial measures such as net loss, operating loss or cash flows from operating activities as calculated and presented in accordance with accounting principles generally accepted in the U.S., or GAAP. In addition, our calculation of EBITDA may or may not be consistent with that of other companies. We urge you to review the GAAP financial measures included in this filing and our consolidated financial statements, including the notes thereto, and the other financial information contained in this filing, and to not rely on any single financial measure to evaluate our business.
 
EBITDA is a common alternative measure of performance used by investors, financial analysts and rating agencies to assess operating performance for companies in our industry. Depreciation is a necessary element of our costs and our ability to generate revenue. We do not believe that this expense is indicative of our core operating performance because the depreciable lives of assets vary greatly depending on the maturity terms of our VPC contracts. The clean energy sector has experienced recent trends of increased growth and new company development, which have led to significant variations among companies with respect to capital structures and cost of capital (which affect interest expense). Management views interest expense as a by-product of capital structure decisions and, therefore, it is not indicative of our core operating performance.
 
We define Adjusted EBITDA as EBITDA before stock-based compensation expense. Management does not believe that stock-based compensation is indicative of our core operating performance because the stock-based compensation is fixed at the grant date, then expensed over a period of several years after the grant date, and generally cannot be changed or influenced by management after the grant date.
 
A reconciliation of net loss, the most directly comparable GAAP measure, to EBITDA and Adjusted EBITDA for each of the periods indicated is as follows (dollars in thousands):

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2011
 
2010
 
2011
 
2010
Net loss
$
(875
)
 
$
(1,380
)
 
$
(17,707
)
 
$
(21,912
)
Depreciation and amortization
1,166

 
1,099

 
3,089

 
3,087

Interest expense, net
711

 
235

 
2,300

 
592

Provision for income taxes
18

 
55

 
51

 
170

EBITDA
1,020

 
9

 
(12,267
)
 
(18,063
)
Non-cash stock compensation expense
605

 
1,010

 
2,763

 
2,335

Adjusted EBITDA
$
1,625

 
$
1,019

 
$
(9,504
)
 
$
(15,728
)
 
Non-GAAP Net Loss and Net Loss per Share (Basic and Diluted)
 
We believe that the presentation of non-GAAP net loss, which is a measure that adjusts for the impact of stock-based compensation expense and amortization expense for acquisition-related assets, provides investors and financial analysts with a consistent basis for comparison across accounting periods and, therefore, is useful to investors and financial analysts in helping them to better understand our operating results and underlying operational trends.
 
Although stock-based compensation is an important aspect of the compensation of our employees and executives, stock-based compensation expense is generally fixed at the time of grant, then expensed over a period of several years after the grant of the stock-based award, and generally cannot be changed or influenced by management after the grant.

We do not acquire intangible assets on a predictable cycle.  Amortization costs are fixed at the time of an acquisition, are then amortized over a period of several years after the acquisition, and in some cases, the remaining value of acquired intangibles and goodwill is decreased due to impairment charges.  In addition to amortization expense, we record tax expense related to tax deductible goodwill, arising from certain prior acquisitions.  These expenses generally cannot be changed or influenced by management after the acquisition.
 

17


A reconciliation of net loss, the most directly comparable GAAP measure, to non-GAAP net loss for each of the fiscal periods indicated is as follows (dollars in thousands):

 
Three Months Ended