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WORLD ENERGY SOLUTIONS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This quarterly report on Form 10-Q including this Item 2, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties. Readers can identify these statements by forward-looking words such as "may," "could," "should," "would," "intend," "will," "expect," "anticipate," "believe," "estimate," "continue" or similar words. Our actual results and the timing of certain events may differ significantly from the results and timing discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed or referred to in this report and in the "Risk Factors" section of our Annual Report on Form 10-K and any later publicly available filing with the Securities and Exchange Commission ("SEC"). The following discussion and analysis of our financial condition and results of operations should be read in light of those factors and in conjunction with our accompanying condensed consolidated financial statements and notes thereto. Overview World Energy (the "Company") offers a range of energy management solutions to commercial and industrial businesses, institutions, utilities, and governments to reduce their overall energy costs. We come to market with a holistic approach to energy management helping customers a) contract for a competitive price for energy, b) engage in energy efficiency projects to minimize quantity used and c) pursue available rebate and incentive programs. We made our mark on the industry with an innovative approach to procurement via our online auction platform, the World Energy Exchange®. With recent investments and acquisitions, we are building out our energy efficiency practice by engaging new customers while also pursuing more cross-selling opportunities for our procurement services. We provide energy management services utilizing state-of-the-art technology and the experience of a seasoned management team to bring lower energy costs to its customers. We use a simple equation E = P · Q - i to help customers to understand the holistic nature of the energy management problem. Total energy cost (E) is a function of Energy Price (P) times the Quantity of Energy Consumed (Q), minus any rebates or incentives (i) the customer can earn. This approach not only makes energy management more approachable for customers, simplifying what has become an increasingly dynamic and complex problem, it also highlights the inter-related nature of the energy management challenge. We assert that point solution vendors may optimize one of the three elements, but we believe it takes looking at the problem holistically to unlock the most savings. Acquisitions are an important component of our business strategy. Our focus is on both our core procurement business as well as new product lines within the energy management services industry such as energy efficiency services. During the fourth quarter of 2012, we acquired substantially all of the assets and assumed certain obligations of Northeast Energy Partners, LLC ("NEP") pursuant to an Asset Purchase Agreement (the "Asset Purchase Agreement") between us, NEP, and its members. NEP was a Connecticut based energy management and procurement company. During the third and fourth quarters of 2011 we acquired the energy procurement business of Co-eXprise, Inc. ("Co-eXprise"), Northeast Energy Solutions, LLC ("NES") and GSE Consulting, LP ("GSE"). These acquisitions expanded our capabilities in the Energy efficiency services segment, enabled us to enter the growing small- and medium-sized customer Energy procurement marketplaces, and consolidate the large commercial, industrial and government auction space. With the acquisition of NES, we are managing the business as two business segments: Energy procurement and Energy efficiency services. On November 4, 2014, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with EnerNOC, Inc. ("Parent") and Wolf Merger Sub Corporation, a wholly owned subsidiary of Parent ("Merger Sub"), pursuant to which Parent and Merger Sub will commence an offer (the "Offer") to acquire all of the outstanding shares of our common stock (the "Shares"), at a price of $5.50 per share in cash (the "Offer Price"). The Merger Sub is required to commence the Offer no later than 10 business days after the date of the Merger Agreement. If the Offer is consummated, Shares not tendered will be acquired by Merger Sub in a second step merger (the "Merger") for the Offer Price. Completion of the Offer is subject to a number of conditions, including (i) that a majority of the Shares outstanding be validly tendered and not validly withdrawn prior to the expiration of the Offer; (ii) completion of a 55-day "go-shop" period during which time we will solicit alternative proposals to the Offer and Merger and (iii) certain other customary conditions. The Offer and the Merger are not subject to any financing conditions. The Board has approved the Merger Agreement and unanimously recommends that our stockholders tender their Shares in the Offer. We will file a Schedule 14D-9 with the SEC containing the recommendation of the Board on the same day that the Offer is commenced. 14 -------------------------------------------------------------------------------- Parent and the Company have made customary representations, warranties and covenants in the Merger Agreement, including covenants (i) to promptly make all filings required by the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and other applicable laws with respect to the Offer and the Merger; and (ii) to use their reasonable best efforts to take all appropriate action to consummate and effectuate the Offer, the Merger and the other transactions contemplated by the Merger Agreement. Additionally, prior to consummation of the Merger, we have agreed to conduct our business in all material respects in the ordinary and usual course and to comply with certain other operating covenants through the consummation of the Merger. Prior to the closing of the Offer, the Board may, subject to compliance with certain obligations, (i) terminate the Merger Agreement to enter into a definitive agreement with respect to a Takeover Proposal; or (ii) change its recommendation to our stockholders regarding tendering into the Offer and approving the Merger and related transactions and the Board determines in good faith, after consultation with its legal advisors, that failure to take such action would be inconsistent with the directors' fiduciary duties under applicable law. Upon termination of the Merger Agreement under specified circumstances, the Company and the Parent will be required to pay termination and reverse termination fees, respectively. Our business model is heavily dependent on our people. We have significantly grown our employee base from 20 at the time of our initial public offering in November 2006 to 130 at September 30, 2014. This planned investment in staffing has been, and will continue to be, a key component of our strategic initiatives and revenue growth. These infrastructure investments will result in increased operating costs in the short-term, but in the long-term we expect them to generate cash flow and profitability as we build incremental revenue. To date we have funded our acquisitions and strategic investments primarily with cash on-hand, notes payable, cash from operations and long-term debt. We have also deferred portions of the purchase prices through the use of earnouts that are tied to the ongoing performance of the acquired entity. Through the utilization of seller notes and earnouts, we have been able to finance a portion of the cost of the acquisitions over time with the targets' ongoing cash flow. These acquisition activities will increase our operating costs both in the short and long-term and may require us to borrow against our current credit facility and/or raise funds through additional capital raises. Operations Revenue Retail Electricity Transactions We earn a monthly commission on energy sales contracted through our online auction platform from each bidder or energy supplier based on the energy usage transacted between the bidder and lister or energy consumer. Our commissions are not based on the retail price for electricity; rather on the amount of energy consumed. Commissions are calculated based on the volume of energy usage transacted between the energy supplier and energy consumer multiplied by our contractual commission rate. Our contractual commission rate is negotiated with the energy consumer on a procurement-by-procurement basis based on energy consumer specific circumstances, including the size of auction, the effort required to organize and run the respective auction and competitive factors, among others. Once the contractual commission is agreed to with the energy consumer, all energy suppliers participating in the auction agree to that rate. That commission rate remains fixed for the duration of the contractual term regardless of energy usage. Energy consumers provide us with a letter of authorization to request their usage history from the local utility. We then use this data to compile a usage profile for that energy consumer that will become the basis for the auction. This data may also be used to estimate revenue on a going forward basis, as noted below. Historically, our revenue and operating results have varied from quarter-to-quarter and are expected to continue to fluctuate in the future. These fluctuations are primarily due to the buying patterns of our wholesale and natural gas customers, which tend to have large, seasonal purchases during the fourth and first quarters and electricity usage having higher demand in our second and third quarters. In addition, the activity levels on the World Energy Exchange® can fluctuate due to a number of factors, including market prices, weather conditions, energy consumers' credit ratings, the ability of suppliers to obtain financing in credit markets, and economic and geopolitical events. To the extent these factors affect the purchasing decisions of energy consumers, our future results of operations may be affected. Contracts between energy suppliers and energy consumers are signed for a variety of term lengths, with a one to two year contract term being typical for commercial and industrial energy consumers, and government contracts typically having two to three year terms. We do not invoice our electricity energy suppliers for monthly commissions earned and, therefore, we report a substantial portion of our receivables as "unbilled." Unbilled accounts receivable is based on management's best estimate of energy provided by the energy suppliers to the energy consumers for a specific completed time period at contracted commission rates and is made up of two components. The first component represents energy usage for which we have received actual data from the supplier and/or the utility, but for which payment has not been received at the balance sheet date. The majority of our contractual relationships with energy suppliers require them to supply actual usage data to us on a monthly basis and remit payment to us based on that usage. The second component represents energy usage for which we have not received actual data, but for which we have estimated usage. 15 -------------------------------------------------------------------------------- Commissions paid in advance by certain bidders are recorded as deferred revenue and amortized to commission revenue on a monthly basis on the energy exchanged that month. Retail Natural Gas Transactions There are two primary fee components to our retail natural gas services: transaction fees and management fees. Transaction fees are billed to and paid by the energy supplier awarded business on the platform. These fees are established prior to award and are the same for each supplier. For the majority of our natural gas transactions, we bill the supplier upon the conclusion of the transaction based on the estimated energy volume transacted for the entire award term multiplied by the transaction fee. Management fees are paid by our energy consumers and are generally billed on a monthly basis for services rendered based on terms and conditions included in contractual arrangements. While substantially all of our retail natural gas transactions are accounted for in accordance with this policy, a significant percentage is accounted for as the natural gas is consumed by the energy consumer and recognized as revenue in accordance with the retail electricity transaction revenue recognition methodology described above. Mid-Market Transactions We earn a monthly commission on energy sales from each energy supplier based on the energy usage transacted between the energy supplier and energy consumer. The commissions are not based on the retail price for electricity but rather on the amount of energy consumed. Commissions are calculated based on the energy usage transacted between the energy supplier and energy consumer multiplied by our contractual commission rate. Revenue from commissions is recognized as earned over the life of each contract as energy is consumed, provided there is persuasive evidence of an arrangement, the sales price is fixed or determinable, collection of the fee is reasonably assured, and customer acceptance criteria, if any, has been successfully demonstrated. We generally recognize revenue on these transactions when we have received verification from the energy supplier of the end-users energy usage and energy supplier's subsequent collection of the fees billed to the end user. The verification is generally accompanied with payment of the agreed upon fee to us, at which time the revenue is recognized. Commissions paid in advance are recorded as customer advances and are recognized monthly as commission revenue based on the energy exchanged that month. To the extent we do not receive verification of actual energy usage or we cannot reliably estimate what actual energy usage was for a given period, revenue is deferred until usage and collection data is received from the energy supplier. To the extent that we do not receive actual usage data from the energy supplier, we will recognize revenue at the end of the contract flow date. Demand Response Transactions Demand response transaction fees are recognized when we have received confirmation from the demand response provider ("DRP") that the energy consumer has performed under the applicable Regional Transmission Organization ("RTO") or Independent System Operator ("ISO") program requirements. The energy consumer is either called to perform during an actual curtailment event or is required to demonstrate its ability to perform in a test event during the performance period. For the PJM Interconnection ("PJM"), an RTO that coordinates the movement of wholesale electricity in all or parts of 13 states and the District of Columbia, the performance period is June through September in a calendar year. Test results are submitted to the PJM by the DRPs and we receive confirmation of the energy consumer's performance in the fourth quarter. DRPs typically pay us ratably on a quarterly basis throughout the demand response fiscal (June to May) year. As a result, a portion of the revenue we recognize is reflected as unbilled accounts receivable. Wholesale and Environmental Commodity Transactions Wholesale transaction fees are invoiced upon the conclusion of the auction based on a fixed fee. These revenues are not tied to future energy usage and are recognized upon the completion of the online auction. For reverse auctions where our customers bid for a consumer's business, the fees are paid by the bidder. For forward auctions where a lister is selling energy products, the fees are typically paid by the lister. Environmental commodity transaction fees are accounted for utilizing two primary methods. For regulated allowance programs like Regional Greenhouse Gas Initiative, Inc. ("RGGI"), fees are paid by the lister and are recognized quarterly as revenue as auctions are completed and approved. For most other environmental commodity transactions both the lister and the bidder pay the transaction fee and revenue is recognized upon the consummation of the underlying transaction as credits are delivered by the lister and payment is made by the bidder. Energy Efficiency Services Our Energy efficiency services segment is primarily project driven where we identify efficiency measures that energy consumers can implement to reduce their energy usage. We present retrofit opportunities to customers, get approval from them to proceed and submit the proposal to the local utility for cost reimbursement. Once the utility approves funding for the project, we 16 -------------------------------------------------------------------------------- install the equipment, typically new heating, ventilation or air conditioning equipment, or replace lighting fixtures to more efficient models. We recognize revenue for Energy efficiency services when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured. Due to the short-term nature of projects (typically two to three weeks), we utilize the completed-contract method. We also assess multiple contracts entered into by the same customer in close proximity to determine if the contracts should be combined for revenue recognition purposes. Revenues are recognized based upon factors such as passage of title, installation, payments and customer acceptance. Cost of revenue Cost of revenue consists primarily of: - salaries, bonus and commissions, employee benefits and share-based compensation associated with our auction management and efficiency services, which are directly related to the development and production of the online auction and maintenance of market-related data on our auction platform and monthly management fees (our supply desk function); - project costs including direct labor equipment and materials directly associated with efficiency projects; and - rent, depreciation and other related overhead and facility-related costs. Sales and marketing Sales and marketing expenses consist primarily of: - salaries, bonus and commissions, employee benefits and share-based compensation related to sales and marketing personnel; - third party commission expenses to our channel partners; - travel and related expenses; - amortization related to customer relationships and contracts; - rent, depreciation and other related overhead and facility-related costs; and - general marketing costs such as trade shows, marketing materials and outsourced services. General and administrative General and administrative expenses consist primarily of: - salaries, bonus and commissions, employee benefits and share-based compensation related to general and administrative personnel; - accounting, legal, investor relations, information technology, insurance and other professional fees; and - rent, depreciation and other related overhead and facility-related costs. Interest expense, net Interest expense, net consists primarily of: - interest income earned on cash held in the bank; and - interest expense related to bank term loans, notes payable and contingent consideration. Income tax benefit (expense) Income tax benefit (expense) is based on projected annualized taxable income or loss when this can be reliably estimated. In the event that we cannot reliably estimate due to the fact that a relatively small change in projected annualized taxable income or loss produces a significant variance in our annual effective tax rate then we utilize the actual effective rate for the year to date period. 17 -------------------------------------------------------------------------------- Under both scenarios, the benefit (expense) also reflects our deferred tax provision, federal alternative minimum liability, if applicable, and state income taxes. For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Revenue 100% 100% 100% 100% Cost of revenue 27 26 25 26 Gross profit 73 74 75 74 Operating expenses: Sales and marketing 48 56 49 58 General and administrative 24 20 25 24 Operating income (loss) 1 (2) 1 (8) Other expense, net (2) (3) (2) (3) Income tax benefit (expense) 0 (2) 0 (2) Net income (loss) (1%) (7%) (1%) (13%) Results of Operations The following table sets forth certain items as a percent of revenue for the periods presented: Comparison of the Three Months Ended September 30, 2014 and 2013 Revenue For the Three Months Ended September 30, 2014 2013 Increase Energy procurement $ 7,762,852 $ 7,295,276 $ 467,576 6% Energy efficiency services 2,154,787 1,443,281 711,506 49 Total revenue $ 9,917,639 $ 8,738,557 $ 1,179,082 13% Revenue increased 13% for the three months ended September 30, 2014 as revenue from both segments increased as compared to the same period in 2013. Energy procurement segment revenue increased 6% due to increased transaction activity from our auction, mid-market and wholesale customers as well as increased revenue recognized from previously deferred items. These increases were partially offset by a decrease of in-period natural gas transaction activity. Energy efficiency services segment revenue increased 49% as the rebuilt Massachusetts sales team continued to deliver an increase in the number of projects as well as an increase in the average project size compared to the third quarter of 2013. Cost of revenue For the Three Months Ended September 30, 2014 2013 $ % of Revenue $ % of Revenue Increase (Decrease) Energy procurement $ 959,069 12% $ 1,141,432 16% $ (182,363 ) (16 %) Energy efficiency services 1,709,997 79 1,102,443 76 607,554 55 Total cost of revenue $ 2,669,066 27% $ 2,243,875 26% $ 425,191 19 % Cost of revenue increased 19% for the three months ended September 30, 2014 as compared to the same period in 2013. Cost of revenue for our Energy procurement segment decreased 16% due to decreases in payroll reflecting our integration, automation and reorganization efforts. Cost of revenue associated with our Energy procurement segment as a percent of revenue decreased by 4% primarily due to the cost decreases described above and, to a lesser extent, the 6% increase in Energy procurement revenue. Cost of revenue associated with our Energy efficiency services segment increased 55% primarily due to an increase in project costs associated with the 49% increase in revenue. Cost of revenue associated with our Energy efficiency services segment as a percent of revenue increased by 3% primarily due to a lower contribution margin on one large project completed in the third quarter of 2014. 18 -------------------------------------------------------------------------------- Operating expenses For the Three Months Ended September 30, 2014 2013 $ % of Revenue $ % of Revenue Increase (Decrease) Sales and marketing $ 4,767,475 48% $ 4,875,985 56% $ (108,510 ) (2 %) General and administrative 2,399,892 24 1,817,996 20 581,896 32 Total operating expenses $ 7,167,367 72% $ 6,693,981 76% $ 473,386 7 % Sales and marketing expenses decreased 2% for the three months ended September 30, 2014 as compared to the same period in 2013 primarily due to decreases in internal commissions, marketing expenses and amortization of intangible assets. Internal commissions decreased due to the change in commission policy for our mid-market group that we implemented in the second quarter of 2013. Under the revised policy, we continued to pay commissions based on cash received from mid-market transactions that were deferred for revenue purposes and also provided for a bookings bonus to offset the impact of the change in our policy. We converted the bookings bonus to a draw program in 2014, eliminating that component of commission expense. The decrease resulting from this change in policy was substantially offset by increases in efficiency and energy procurement commissions. Amortization expense related to intangible assets decreased as certain intangible assets related to our acquisitions became fully amortized in 2014. These decreases were partially offset by an increase in share-based compensation and third party commission expense. Sales and marketing expense as a percentage of revenue decreased 8% primarily due to the 13% increase in total revenue. The 32% increase in general and administrative expenses for the three months ended September 30, 2014 as compared to the same period in 2013 was primarily due to merger related costs associated with the proposed sale of the Company to EnerNOC as well as an increase in payroll costs. In addition, the third quarter of last year benefitted from a decrease in contingent consideration. Payroll costs increased primarily due to investments in our product development team. General and administrative expenses as a percent of revenue increased 4% due to the transaction costs described above. Other income (expense), net We recorded net interest expense of approximately $0.2 million for the three months ended September 30, 2014 compared to net interest expense of approximately $0.3 for the three months ended September 30, 2013. The decrease in net interest expense in 2014 was primarily due to a reduction in the interest rate charged on our long-term debt resulting from the replacement of our credit facility in the fourth quarter of 2013. Income tax benefit (expense) We recorded an income tax expense of approximately $37,000 for the three months ended September 30, 2014 and an income tax expense of approximately $0.1 million for the three months ended September 30, 2013. For the three months ended September 30, 2014, we utilized our actual effective tax rate as the basis for the income tax expense as we were unable to make a reliable estimate of our annual effective tax rate. For the three months ended September 30, 2013, the effective tax rate was based on our estimated annual effective tax rate. The income tax expense for the three months ended September 30, 2014 reflects a deferred tax benefit and state income taxes. The income tax expense for the three months ended September 30, 2013 reflects a deferred tax provision, federal alternative minimum tax liability and state income taxes. Net loss We reported a net loss of approximately $0.1 million for the three months ended September 30, 2014 and approximately $0.6 million for the three months ended September 30, 2013. The $0.5 million decrease in net loss was primarily due to the increase in revenue, improved gross margin and the decrease in sales and marketing expenses. These increases were partially offset by an increase in general and administrative costs associated with our proposed merger with EnerNOC. 19 --------------------------------------------------------------------------------Comparison of the Nine Months Ended September 30, 2014 and 2013 Revenue For the Nine Months Ended September 30, 2014 2013 Increase Energy procurement $ 23,686,849 $ 21,673,273 $ 2,013,576 9% Energy efficiency services 5,144,180 3,658,423 1,485,757 41 Total revenue $ 28,831,029 $ 25,331,696 $ 3,499,333 14% Revenue increased 14% for the nine months ended September 30, 2014 as revenue from both segments increased as compared to the same period in 2013. Energy procurement segment revenue increased 9% due to increased transaction activity from our auction and mid-market customers as well as increased revenue recognized from previously deferred items. These increases were partially offset by a decrease in gas transaction activity in the nine months ended September 30, 2014 as increased commodity prices during the first quarter resulted in delayed contracting decisions by listers. Energy efficiency services segment revenue increased 41% as the rebuilt Massachusetts sales team continued to deliver increased revenue in the NSTAR territory in Massachusetts during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. Cost of revenue For the Nine Months Ended September 30, 2014 2013 $ % of Revenue $ % of Revenue Increase (Decrease) Energy procurement $ 2,979,002 13% $ 3,639,116 17% $ (660,114 ) (18 %) Energy efficiency services 4,122,183 80 2,982,365 82 1,139,818 38 Total cost of revenue $ 7,101,185 25% $ 6,621,481 26% $ 479,704 7 % Cost of revenue increased 7% for the nine months ended September 30, 2014 as compared to the same period in 2013. Cost of revenue for our Energy procurement segment decreased 18% due to decreases in payroll reflecting our integration, automation and reorganization efforts. Cost of revenue associated with our Energy procurement segment as a percent of revenue decreased by 4% primarily due to the cost decreases described above and, to a lesser extent, the 9% increase in Energy procurement revenue. Cost of revenue associated with our Energy efficiency services segment increased 38% primarily due to an increase in project costs associated with the 41% increase in revenue. Cost of revenue associated with our Energy efficiency services segment as a percent of revenue decreased by 2% primarily due to improved contribution margins on projects completed in the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. Operating expenses For the Nine Months Ended September 30, 2014 2013 $ % of Revenue $ % of Revenue Increase (Decrease) Sales and marketing $ 14,163,226 49% $ 14,744,413 58% $ (581,187 ) (4 %) General and administrative 7,313,006 25 6,046,690 24 1,266,316 21 Total operating expenses $ 21,476,232 75% $ 20,791,103 82% $ 685,129 3 % Sales and marketing expenses decreased 4% for the nine months ended September 30, 2014 as compared to the same period in 2013 primarily due to decreases in internal commissions and amortization of intangible assets. Internal commissions decreased due to the change in commission policy for our mid-market group that we implemented in the second quarter of 2013. Under the revised policy, we continued to pay commissions based on cash received from mid-market transactions that were deferred for revenue purposes and provided for a bookings bonus to offset the impact of the change in our policy. We converted the bookings bonus to a draw program in 2014, eliminating that component of commission expense. This decrease in mid-market commissions was offset by increased commission expense for our auction and efficiency groups. Amortization expense related to intangible assets decreased as certain intangible assets related to our acquisitions became fully amortized in 2014. These decreases were partially offset by an increase in third party commission expense as we continued to expand our channel partner network. Sales and marketing expense as a percentage of revenue decreased 9% primarily due to the 14% increase in revenue. 20 -------------------------------------------------------------------------------- The 21% increase in general and administrative expenses for the nine months ended September 30, 2014 as compared to the same period in 2013 was due to an increase in legal, transaction, and payroll costs. Legal and transaction costs increased primarily due to a shareholder action during the first quarter of 2014 and the proposed sale of the Company to EnerNOC. Payroll costs increased due to investments in our product development team. In addition, 2013 benefitted from a decrease in contingent consideration. General and administrative expenses as a percent of revenue was substantially consistent with the prior year period as the 14% increase in revenue offset the above noted cost increases. Other income (expense), net We recorded net interest expense of approximately $0.6 million for the nine months ended September 30, 2014 compared to net interest expense of approximately $0.7 million for the nine months ended September 30, 2013. The decrease in net interest expense in 2014 was primarily due to a reduction in the interest rate charged on our long-term debt resulting from the replacement of our credit facility in the fourth quarter of 2013. Income tax benefit (expense) We recorded an income tax expense of approximately $12,000 for the nine months ended September 30, 2014 and an income tax expense of approximately $0.4 million for the nine months ended September 30, 2013. For the nine months ended September 30, 2014, we utilized our actual year-to-date effective tax rate as the basis for the income tax expense as we were unable to rely on our annual effective tax rate. For the nine months ended September 30, 2013, the effective tax rate was based on our estimated annual effective tax rate. The income tax expense for the nine months ended September 30, 2014 reflects a deferred tax benefit and state income taxes. The income tax expense for the nine months ended September 30, 2013 reflects a deferred tax provision, federal alternative minimum tax liability and state income taxes. Net loss Net loss improved approximately $2.9 million for the nine months ended September 30, 2014 compared to the same period in 2013, primarily due the increase in revenue, improved gross margin and the decrease in sales and marketing expenses. These decreases in net loss were partially offset by the increase in general and administrative expenses. Liquidity and Capital Resources At September 30, 2014, we had no commitments for material capital expenditures. We have identified and executed against a number of strategic initiatives that we believe are key components of our future growth, including: making strategic acquisitions; entering into other energy-related markets including energy efficiency; expanding our community of listers, bidders and channel partners on our exchanges; strengthening and extending our long-term relationships with government agencies; and growing our direct and inside sales force. As of September 30, 2014 our workforce numbered 130, an increase of four from the number that we employed at December 31, 2013. At September 30, 2014, we had 62 professionals in our sales and marketing and account management groups, 41 in our supply desk group and 27 in our general and administrative group. We paid $10.4 million to acquire three businesses in 2011 through the use of cash on hand, cash flow from ongoing operations as well as cash flow generated by the acquisitions. In addition, we have paid $6.7 million in seller notes and contingent consideration bringing the total cash paid for the 2011 acquisitions to $17.1 million. In October 2012, we acquired NEP for $11.3 million. We funded this acquisition through the issuance of $8.0 million in long-term bank debt, a $2.0 million seller note and $1.3 million in contingent consideration. While the expansion/addition of these debt instruments significantly increased our commitments, we believe we have the resources to meet both our short- and long-term obligations under these arrangements based on cash on-hand, operating cash flows from our base business and cash expected to be generated from all of our acquired businesses. We subsequently retired the seller note and contingent consideration payments and commenced repayment of the long-term bank debt. In addition, in 2014 we settled all outstanding earnout claims with GSE by issuing 200,000 shares of common stock, which had a fair value of approximately $0.9 million. As of September 30, 2014 we have retired all of our seller-note and earnout obligations related to all of our acquisitions. During the nine months ended September 30, 2014 we generated cash flow from operations of $2.0 million and ended the quarter with $2.8 million in cash and cash equivalents. 21 --------------------------------------------------------------------------------Comparison of September 30, 2014 to December 31, 2013 September 30, December 31, 2014 2013 Increase (Decrease) Cash and cash equivalents $ 2,756,332 $ 1,725,136 $ 1,031,196 60 % Trade accounts receivable, net 7,995,230 7,738,141 257,089 3 Days sales outstanding 74 76 (2 ) (3 ) Working capital (deficit) 423,263 (893,984 ) 1,317,247 147 Stockholders' equity 26,914,075 25,480,584 1,433,491 6 Cash and cash equivalents increased 60% primarily due to cash flows from operations of approximately $2.0 million. Trade accounts receivable at September 30, 2014 increased 3% as compared to the fourth quarter of 2013 as days sales outstanding (representing accounts receivable outstanding at September 30, 2014 divided by the average sales per day during the three months ended September 30, 2014, as adjusted) decreased 3%. Days sales outstanding decreased 3% due to the timing of in-period revenue recognized and cash receipts within the nine months ended September 30, 2014 as compared to the same period in 2013. Revenue from bidders representing 10% or more of our revenue decreased to 26% from two bidders during the nine months ended September 30, 2014, from an aggregate 28% for two bidders in the same period of the previous year. Two bidders merged at the end of 2013 and have been combined to determine the percentages above in both periods. The working capital balance at September 30, 2014 (consisting of current assets less current liabilities) improved $1.3 million from December 31, 2013. Current assets increased $1.7 million primarily due to the increase in cash and cash equivalents. Current liabilities increased $0.4 million due to increases in short-term deferred revenue and long-term debt. These increases were partially offset by the settlement of our contingent consideration obligations and the $0.5 million payment against the short-term related party note. Stockholders' equity increased 6% for the nine months ended September 30, 2014 primarily due to the issuance of shares under the GSE settlement and share-based compensation. Cash provided by operating activities for the nine months ended September 30, 2014 and 2013 was approximately $2.0 million and $2.2 million, respectively. Cash used in investing activities for the nine months ended September 30, 2014 was approximately $0.4 million primarily due to capitalized software cost. Cash used in financing activities for the nine months ended September 30, 2014 and 2013 was approximately $0.6 million and $2.9 million, respectively. Cash used in financing activities for the nine months ended September 30, 2014 primarily resulted from the final $0.5 million payment of the NEP seller note and repayment of long-term debt, both partially offset by proceeds from the exercise of stock options. Cash used in financing activities for the nine months ended September 30, 2013 was primarily due to a contingent consideration payment of $1.4 million and $1.5 million of principal payments on long term debt. Adjusted EBITDA, representing net loss adjusted for non-recurring transaction costs before interest, income taxes, depreciation and amortization for the nine months ended September 30, 2014 was $3.6 million as compared to $1.1 million for the same period in the prior year. Please refer to the section below discussing non-GAAP financial measures for a reconciliation of non-GAAP measures to the most directly comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In this Quarterly Report on Form 10-Q, we provide certain "non-GAAP financial measures". A non-GAAP financial measure refers to a numerical financial measure that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable financial measure calculated and presented in accordance with GAAP in our financial statements. In this Quarterly Report on Form 10-Q, we provide Non-GAAP adjusted net income (loss) and adjusted EBITDA as additional information relating to our operating results. These non-GAAP measures exclude expenses related to the proposed sale of the Company to EnerNOC, depreciation related to our fixed assets, amortization expense related to acquisition-related assets and other assets, interest expense on bank borrowings, notes payable to sellers and contingent consideration, interest income on invested funds, and income taxes. Management uses these non-GAAP measures for internal reporting and bank reporting purposes. We have provided these non-GAAP financial measures in addition to GAAP financial results because we believe that these non-GAAP financial measures provide useful information to certain investors and financial analysts in assessing our operating performance due to the following factors: - We believe that the presentation of a non-GAAP measure that adjusts for depreciation of fixed assets, amortization expense related to acquisition-related assets and other assets, interest expense on bank borrowings, seller notes and contingent consideration, interest income on invested funds, and income taxes, 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; 22 --------------------------------------------------------------------------------- We do not regularly incur costs relating to an evaluation of strategic alternatives and costs associated with entering into an Agreement and Plan of Merger. We identify these costs as non-recurring and, once incurred, generally cannot be changed or influenced by management; - We do not acquire intangible assets on a predictable cycle. Our intangible assets relate solely to business acquisitions. Amortization costs are fixed at the time of an acquisition, are then amortized over a period of several years after the acquisition and generally cannot be changed or influenced by management after the acquisition; - We do not regularly incur capitalized software and website costs. Our capitalized software costs relate primarily to the build-out of our exchanges. Amortization costs are fixed at the time the costs are incurred and are then amortized over a period of several years and generally cannot be changed or influenced by management after the initial costs are incurred; - We do not regularly invest in fixed assets. Our fixed assets relate primarily to computer and office equipment and furniture and fixtures. Depreciation costs are fixed at the time of purchase and are then depreciated over several years and generally cannot be changed or influenced by management after the purchase; - We do not regularly enter into bank debt, seller notes and/or pay interest on contingent consideration. Our seller notes and contingent consideration relate to acquisition activities. Interest expense is fixed at the time of purchase and recorded over the life of the lease and generally cannot be changed or influenced by management after the purchase; - We do not regularly earn interest on our cash accounts. Our cash has not yielded material returns to date and these returns generally cannot be changed or influenced by management; and - We do not regularly pay federal or state income taxes due to our net operating loss carryforwards. Our income tax expense reflects the release of our deferred tax assets to apply to projected annualized taxable income, and an anticipated alternative minimum tax liability based on statutory rates that generally cannot be changed or influenced by management. Pursuant to the requirements of the SEC, we have provided below a reconciliation of the non-GAAP financial measures used to the most directly comparable financial measures prepared in accordance with GAAP. These non-GAAP financial measures are not prepared in accordance with GAAP. These measures may differ from the GAAP information, even where similarly titled used by other companies, and therefore should not be used to compare our performance to that of other companies. The presentation of this additional information is not meant to be considered in isolation or as a substitute for net income (loss) prepared in accordance with GAAP. Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 GAAP net loss $ (149,339 ) $ (592,298 ) $ (341,514 ) $ (3,203,338 ) Add: Non-recurring transaction costs 405,807 - 488,807 - Non-GAAP adjusted net income (loss) $ 256,468 $ (592,298 ) $ 147,293 $ (3,203,338 ) Add: Interest expense, net 196,010 253,822 594,306 733,956 Add: Income taxes 36,844 142,555 11,844 405,165 Add: Amortization of intangibles 844,701 974,759 2,616,046 2,924,275 Add: Amortization of other assets 11,947 8,507 37,959 25,520 Add: Depreciation 48,927 56,373 153,923 167,112 Non-GAAP adjusted EBITDA $ 1,394,897 $ 843,718 $ 3,561,371 $ 1,052,690 Critical Accounting Policies The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Accordingly, actual results could differ from these estimates. The most judgmental estimates affecting our consolidated financial statements are those relating to revenue recognition and the estimate of actual energy delivered from the bidder to the lister of such energy; stock-based compensation; the valuation of intangible assets and goodwill; the valuation of contingent consideration; impairment of long-lived assets; and estimates of future taxable income as it relates to the realization of our net deferred tax assets. We regularly evaluate our estimates and assumptions based upon historical 23 -------------------------------------------------------------------------------- experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent actual results differ from those estimates; future results of operations may be affected. Refer to Note 2 of our consolidated financial statements within our Annual Report on Form 10-K as filed with the SEC on March 31, 2014 for a description of our accounting policies. Off-Balance Sheet Arrangements We currently have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. |