Item 1B.
Unresolved Staff Comments
None.
Our corporate headquarters and principal office is located in Boston, Massachusetts, where we lease approximately 110,000 square feet of office space under a lease agreement, or the 2012 Lease, expiring in July 2020 with a right to first offer, subject to the rights of existing tenants in the building, whereby we may lease certain additional space in the building during the lease term and the right to extend the lease term for one period of five years upon the expiration of the initial term. The average monthly rent over the initial term of the 2012 Lease is $0.4 million, exclusive of operating expenses. We were required to provide a security deposit in the form of an unconditional and irrevocable letter of credit of approximately $1.8 million, which was reduced to $1.5 million and will continue to be reduced on an annual basis through the lease term. We are required to pay our pro rata share of any building operating expenses and real estate taxes over and above a base year, as well as certain utility costs. Additionally, we also have certain rights to sublease the leased space.
We also lease a number of offices under various other lease agreements in the United States, Australia, Canada, New Zealand, Ireland, the United Kingdom, Germany, Switzerland, Brazil, India, Japan, and South Korea. We do not own any real property. We believe that we have adequate space for our anticipated needs and that suitable additional space will be available at commercially reasonable prices as needed.
Item 3.
Item 3.
Legal Proceedings
We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. We do not expect the ultimate costs to resolve these matters to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.
Item 4.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price Range of Our Common Stock
Our common stock is currently traded on The NASDAQ Global Market under the symbol “ENOC”. The following table sets forth the high and low sales prices per share of our common stock as reported on The NASDAQ Global Market for the periods indicated.
Stockholders
As of March 4, 2016, we had approximately 720 stockholders of record. This number does not include stockholders for whom shares are held in a “nominee” or “street” name.
Dividend Policy
We have never paid or declared any cash dividends on our common stock. Except for opportunistic repurchases of outstanding debt and/or equity securities, we currently intend to retain all available funds and any future earnings to fund the development and expansion of our business, and we do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, and other factors that our board of directors deem relevant. Additionally, the terms of the 2014 credit facility preclude us, and the terms of any future debt or credit facility may preclude us, from paying dividends.
Unregistered Sales of Equity Securities
As previously disclosed in our Current Report on Form 8-K on November 26, 2014, we issued 583,218 shares of our common stock as partial consideration to the stockholders of Pulse Energy Inc., or Pulse Energy, upon the closing of our acquisition of Pulse Energy. In addition, we may issue up to an additional 699,855 shares of common stock to Pulse Energy’s stockholders if and to the extent that certain earn-out provisions are met.
The issuance of our common stock is exempt from the registration requirements pursuant to Section 4(a)(2) of the Securities Act of 1933, as amended, or the Securities Act, Rule 506 of Regulation D promulgated under the Securities Act, or Regulation D, and/or Regulation S promulgated under the Securities Act, or Regulation S, based upon representations we have obtained from each Pulse Energy stockholder receiving such shares that, among other things, the Pulse Energy stockholder is either (a) an “accredited investor” as that term is defined in Rule 501(a) of Regulation D or (b) not a “U.S. Person” as that term is defined in Rule 902(k) of Regulation S.
Issuer Purchases of Equity Securities
The following table provides information about our purchases of our common stock during the fourth quarter of the year ended December 31, 2015, or fiscal 2015:
(1)
We repurchased a total of 70,686 shares of our common stock in the fourth quarter of fiscal 2015, consisting of 34,652, 10,379 and 25,655 shares in October, November and December 2015, respectively, to cover employee minimum statutory income tax withholding obligations in connection with the vesting of restricted stock under our equity incentive plans, which we pay in cash to the appropriate taxing authorities on behalf of our employees.
(2)
Average price paid per share is calculated based on the average price per share paid for the repurchase of shares under our publicly announced share repurchase program and the average price per share related to repurchases of our common stock to cover employee minimum statutory income tax withholding obligations in connection with the vesting of restricted stock under our equity incentive plans which we pay in cash to the appropriate taxing authorities on behalf of our employees. Amounts disclosed are rounded to the nearest two decimal places.
Item 6.
Item 6.
Selected Financial Data
The selected financial data presented below is derived from our audited consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Item 7
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our “Selected Financial Data” and consolidated financial statements and accompanying notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to the historical information, the discussion contains certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those expressed or implied by the forward-looking statements due to applications of our critical accounting policies and factors including, but not limited to, those set forth under the caption “Risk Factors” in Item 1A of Part I of this Annual Report on Form 10-K.
Overview
We are a leading provider of energy intelligence software, or EIS, and demand response solutions to enterprises, utilities, and electric power grid operators.
Our EIS provides our enterprise customers with a suite of Software-as-a-Service, or SaaS, offerings that improve how enterprises manage and control energy costs for their organizations. We continually enhance and expand our EIS to meet the evolving needs of our enterprise customers by providing SaaS solutions to manage:
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energy cost visualization, budgets, forecasts, and accruals;
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utility bill validation and payment;
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facility optimization, including benchmarking facilities and identifying cost savings opportunities;
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energy project tracking;
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reporting for energy and sustainability disclosure and compliance; and
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peak energy demand and the related cost impacts.
Our EIS helps our enterprise customers quickly analyze data, achieve real-time visibility and intelligence about their organization’s energy usage, reduce operational costs, comply and report on sustainability requirements, and drive better business decisions. We offer our EIS to our enterprise customers at four subscription levels: basic, standard, professional, and industrial.
Our EIS provides our utility customers with a SaaS-based customer engagement platform that allows utilities to:
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increase customer satisfaction;
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meet energy efficiency mandates;
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reduce cost through lower call volume; and
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increase revenue through more effective targeting of existing utility-sponsored programs.
We deliver shared value for both the utility and its customers by combining our deep expertise with commercial, institutional and industrial end-users of energy, or C&I end-users, with energy data analytics, machine learning, and predictive algorithms to deliver segmentation and targeting capabilities that enable utilities to serve their most complex market segments, including C&I end-users, and small and medium-sized enterprises.
Our EIS also provides our enterprise and utility customers located in restructured or deregulated markets with the ability to more effectively manage energy supplier selection and the energy procurement process by providing highly-structured auction events designed to yield transparent and competitive energy pricing. Our energy procurement application consists of an online auction platform that enables our enterprise and utility customers to get the best price for electricity, natural gas and other energy resources by having energy suppliers compete for their business, as well as supplier contract management and price alert tools. Our energy procurement solutions also include supply procurement advisory services that assist our enterprise customers in developing and implementing risk management and purchasing strategies that provide maximum price transparency and structural savings.
Our demand response solutions provide our utility customers and electric power grid operators with a managed service demand response resource where we match obligation, in the form of megawatts, or MW, that we agree to deliver to our utility customers and electric power grid operators, with supply, in the form of MW, that we are able to curtail from the electric power grid through our arrangements with C&I end-users. When we are called upon by our utility customers and electric power grid operators to deliver our contracted capacity, we use our Network Operations Center, or NOC, to remotely manage and reduce electricity consumption across our network of C&I end-user sites, making demand response capacity available to our utility customers and electric power grid operators on demand while helping C&I end-users achieve energy savings, improve financial results and realize environmental benefits. We receive periodic payments from our utility customers and electric power grid operators for providing our demand response solutions, and we share these periodic payments with C&I end-users in exchange for those C&I end-users reducing their power consumption when called upon by us to do so. Our demand response solutions are
also capable of providing our utility customers with the underlying technology to manage their own utility-sponsored demand response programs and secure reliable demand-side resources. This product consists of long-term contracts with our utility customers for a technology-enabled managed service that provides our utility customers with real-time load monitoring, dispatching applications, customizable reports, and measurement and verification tools.
In addition, we offer premium professional services that support the implementation of our EIS and help our enterprise customers set their energy management strategy, as well as provide energy audits and retro-commissioning. Professional services are offered to our customers as a means to further implement and extend our technology across their organizations.
Use of Non-Financial Business and Operational Data
We utilize certain non-financial business and operational data to provide additional insight into factors and opportunities relevant to our business. This non-financial business and operational data does not necessarily have any direct correlation to our financial performance. However, the non-financial business and operational data may provide observations as to the scope of and trends related to our operations and therefore, we believe the utilization of such data can provide insights into certain aspects of our business, such as market share and penetration, and customer composition and depth.
The following table outlines certain non-financial business and operational data utilized as of and for the years ended December 31, 2015 and December 31, 2014:
(1)
The term “Enterprise Customers,” describes the number of our customers that purchase our EIS for enterprises. By extension, the term “Enterprise Sites,” describes the number of sites across our Enterprise Customer base that purchase our EIS for enterprises.
(2)
The term “Enterprise ARR” describes the annual recurring revenue from our contracts with Enterprise Customers, defined as all contracted subscription revenue, exclusive of non-recurring or one-time fees, from Enterprise Customers under active (non-expired or terminated) contracts at period end, normalized for a one year period regardless of payment mechanism or timing. Non-recurring or one-time fees include fees related to site installation or set-up, discrete consulting or project based fees, and non-recurring professional services fees. By extension, the term “Enterprise ARR Gross Churn Rate” describes the Enterprise ARR lost over the trailing four quarter period for any reason including, but not limited to non-renewal, early termination, or ongoing non-payment, as a percentage of the starting Enterprise ARR value over the trailing four quarter period. The term “Enterprise ARR Net Churn Rate” describes the (gain) loss of Enterprise ARR from Enterprise Customers that were purchasing our EIS at the start of the trailing four quarter period, inclusive of changes to Enterprise ARR from renewal or upsell activity to these Enterprise Customers, as a percentage of the starting Enterprise ARR value over the trailing four quarter period.
(3)
The term “Utility Customers” describes the number of our customers that purchase our EIS and demand response solutions for utilities.
(4)
The term “Utility ARR” describes the annual recurring revenue from our contracts with Utility Customers, defined as all contracted subscription revenue, exclusive of non-recurring or one-time fees, from Utility Customers under active (non-expired or terminated) contracts at period end, normalized for a one year period regardless of payment mechanism or timing. Non-recurring or one-time fees include fees related to product set-up, discrete consulting or project based fees, variable demand response energy payments, and non-recurring professional services fees. By extension, the term “Utility ARR Gross Churn Rate” describes the Utility ARR lost over the trailing four quarter period for any reason including, but not limited to non-renewal, early termination, demand response customer attrition, or ongoing non-payment, as a percentage of the starting Utility ARR value over the trailing four quarter period. The term “Utility ARR Net Churn Rate” describes the loss of Utility ARR from Utility Customers that were purchasing our EIS and demand response solutions at the start of the trailing four quarter period, inclusive of changes to ARR from renewal or upsell activity to these customers, as a percentage of the starting Utility ARR value over the trailing four quarter period.
(5)
The term “Grid Operators,” describes the number of operators of competitive wholesale electricity markets that rely on our demand response programs to manage load on their grid. We enter into contractual commitments with these grid operators through participation in open market auctions, as well as negotiated contractual arrangements for the express purpose of optimizing load on their grid when called upon, or dispatched, to do so.
(6)
The term “Demand Response Customers,” describes the number of our C&I end-users under contract to participate in our demand response programs. By extension, the term “Demand Response Sites,” describes the number of sites across our Demand Response Customer base under contract to participate in our demand response programs. Certain of these customers and sites may additionally purchase our EIS.
(7)
Amounts rounded to nearest hundred.
The number of our enterprise customers at December 31, 2015 was approximately 4,100 compared to approximately 1,300 at December 31, 2014. This increase primarily reflects the addition of new enterprise customers from our acquisition of World Energy Solutions, Inc., or World Energy. This increase also reflects the results of our ongoing efforts to develop our enterprise sales team, the relative success that our enterprise sales team has had in penetrating the market, and the growing need for our solutions with enterprise customers who are increasingly turning to our EIS to make strategic decisions about how and when they consume or procure energy. The number of enterprise sites at December 31, 2015 was approximately 81,500 compared to approximately 35,700 at December 31, 2014. The number of enterprise sites has typically increased in tandem with the increase in enterprise customers, with most of the increase in sites coming from our acquisition of World Energy and new sales of our EIS. Enterprise ARR at December 31, 2015 was approximately $61 million compared to approximately $20 million at December 31, 2014. Enterprise ARR has typically increased in tandem with the increase in enterprise sites, with the increase coming from our acquisition of World Energy as well as organic growth. We expect that the number of enterprise customers, the number of enterprise sites, and enterprise ARR will generally increase over time, but enterprise customers and sites may decrease in the near term as we opt not to renew certain smaller or unprofitable customers acquired through our acquisition of World Energy. Our enterprise ARR gross churn rate was 18% at December 31, 2015 and December 31, 2014. Our enterprise ARR net churn rate was negative 1% at December 31, 2015 compared to 15% at December 31, 2014, which reflects the addition of ARR through upsells to existing enterprise customers.
The number of utility customers that we served at December 31, 2015 was 52, consistent with the number of utility customers as of December 31, 2014. This primarily reflects the non-renewal of certain utility contracts for our demand response offerings offset by an increase in customers contracting for our utility EIS. Utility ARR at December 31, 2015 was approximately $65 million compared to approximately $67 million at December 31, 2014. This decrease primarily reflects a reduction in size or non-renewal of certain utility demand response programs, partially offset by added utility software contracts. Our utility ARR gross churn rate was 16% at December 31, 2015 compared to 13% at December 31, 2014. Our utility ARR net churn rate was 12% at December 31, 2015 compared to 10% at December 31, 2014. In general, we expect that the number of utility customers and utility ARR will increase over time and that our utility ARR gross churn rate and utility ARR net churn rate will fluctuate in future periods depending on the timing and terms of our utility contracts.
The number of grid operators to which we delivered demand response at December 31, 2015 was 14, consistent with the number of grid operators at December 31, 2014. In general, we expect that the number of grid operators will remain the same or moderately increase over time.
The number of demand response customers was approximately 6,500 for both December 31, 2015 and December 31, 2014. The number of demand response sites at December 31, 2015 was approximately 15,200 compared to approximately 15,000 at December 31, 2014. The number of demand response customers and the number of demand response sites are not necessarily correlated and may increase or decrease in future periods if we choose to participate in additional or different markets.
We continually evaluate the non-financial business and operational data that we review and the relevance of this data as our business continues to evolve and, as a result, such data and information may change over time.
Significant Recent Developments
In December 2015, in privately negotiated transactions, we completed repurchases, in cash, of $33.2 million in aggregate principal amount of our outstanding 2.25% convertible senior notes due 2019, or the Notes, at a weighted average price of 59.2% of principal for a total purchase price of $19.7 million plus accrued interest. We recorded a gain on the extinguishment of the Notes of $9.2 million based on the difference between the carrying amount of the repurchased Notes and the cash consideration. The gain is classified as gain on early extinguishment of debt within the consolidated statements of operations.
On January 25, 2016, the United States Supreme Court reversed the D.C. Circuit Court’s May 2014 ruling in FERC v. Electric Power Supply Association thereby upholding FERC Order No. 745 and affirming FERC’s jurisdiction over the participation of demand response in U.S. wholesale electricity markets. The Supreme Court’s landmark ruling preserved the structure of a key market for our grid operator demand response operations.
Effective January 1, 2016, we began operating as two distinct business units: Software and Demand Response, each with dedicated sales, marketing and operations functions. We are evaluating the impact of this change in organizational structure on our future reportable segment information, which will be provided in future periodic filings. Prior periods will be reclassified and presented consistent with the revised current period presentation.
Revenues and Expense Components
Revenues
We derive revenues primarily from the sale of our EIS and demand response solutions. We recognize revenues when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and we deem collection to be reasonably assured. Our customers include enterprises, utilities and electric power grid operators. During the years ended December 31, 2015, 2014 and 2013, revenues from grid operators and utilities were comprised of $314.3 million, $424.5 million and $342.1 million, respectively, of demand response revenues.
Revenues from the sale of our EIS to our enterprise and utility customers generally represent ongoing software or service arrangements under which the revenues are recognized ratably over the same period commencing upon delivery of the EIS to the enterprise or utility customer. Under certain of our arrangements, a portion of the fees received may be subject to adjustment or refund based on the validation of the energy savings delivered after the implementation is complete. As a result, we defer the portion of the fees that are subject to adjustment or refund until such time as the right of adjustment or refund lapses, which is generally upon completion and validation of the implementation.
Revenues associated with the provision of our demand response solutions to our utility customers and electric power grid operators primarily consist of capacity and energy payments, including ancillary services payments, as well as payments derived from the effective management of our portfolio of demand response capacity, including our participation in capacity auctions and third-party contracts and ongoing fixed fees for the overall management of utility-sponsored demand response programs. We earn revenues from our demand response solutions by making demand response capacity available in open market programs and pursuant to contracts that we enter into with our utility customers, which generally range from three to ten years in duration, to deploy our demand response solutions.
We also earn revenues from the provision of our demand response solutions in the form of ongoing fees from utility customers for overall management of utility-sponsored demand response programs. These fees are typically based on enrolled capacity or enrolled C&I end-users, and are not subject to adjustment based on performance during demand response dispatches. We recognize revenues from these fees ratably over the applicable service delivery period commencing upon when the C&I end-users have been enrolled and the contracted services have been delivered. In addition, we may receive additional fees for program start-up and for C&I end-user installations. We have determined that these fees do not have stand-alone value due to the fact that such services do not have value without the ongoing services related to the overall management of the utility demand response program and therefore, we recognize these fees over the estimated customer relationship period, which is generally the greater of three years or the contract period, commencing upon the enrollment of the C&I end-users and delivery of the contracted services.
Cost of Revenues
Cost of revenues primarily consists of amounts owed to our C&I end-users for their participation in our demand response network and are generally recognized over the same performance period as the corresponding revenue. We enter into contracts with our C&I end-users under which we deliver recurring cash payments to them for the capacity they commit to make available on demand. We also generally make an energy payment when a C&I end-user reduces consumption of energy from the electric power grid during a demand response event.
The equipment and installation costs for our devices located at our enterprise customer and C&I end-user sites, which monitor energy usage, communicate with the NOC and, in certain instances, remotely control energy usage to achieve committed capacity, are capitalized and depreciated over the lesser of the remaining estimated customer relationship period or the estimated useful life of the equipment, and this depreciation is reflected in cost of revenues. We also include in cost of revenues our amortization of acquired developed technology, amortization of capitalized internal-use software costs related to our EIS and demand response solutions, the monthly telecommunications and data costs we incur as a result of being connected to enterprise customer and C&I end-user sites, services and products, third-party services, equipment costs, equipment depreciation, our internal payroll and related costs allocated to an enterprise customer or C&I end-user site, the wages and associated benefits that we pay to our project managers for the performance of their services, and related costs of revenue related to the delivery of services of our utility bill management solution. Certain costs, such as equipment depreciation and telecommunications and data costs, are fixed and do not vary based on revenues recognized. These fixed costs could impact our gross margin trends during interim periods as described elsewhere in this Annual Report on Form 10-K.
We capitalize and defer incremental direct costs incurred related to customer contracts where the associated revenues have been deferred as long as the deferred incremental direct costs are deemed realizable. During the years ended December 31, 2015, 2014 and 2013, we capitalized $52.8 million, $38.8 million and $25.1 million, respectively, of incremental direct costs associated with customer contracts. These deferred expenses would not have been incurred without our participation in a certain open market program and will be expensed in proportion to when the related revenue is recognized. Certain of these incremental direct payments are recorded as a reduction of revenues when the associated revenues are recognized as they relate
to third-party demand response arrangements where the third party has become the primary obligor of the demand response obligation. During the years ended December 31, 2015, 2014 and 2013, we expensed $14.5 million, $30.6 million and $26.1 million, respectively, of capitalized incremental direct costs to cost of revenues and recorded $12.6 million, $11.1 million, and $0.4 million, respectively, as a reduction to revenues. As of December 31, 2015, there have been no material recoverability issues related to capitalized incremental direct costs.
We also capitalize the costs of our production and generation equipment utilized in the delivery of our demand response solutions and expense this equipment over the lesser of its estimated useful life or the term of the contractual arrangement. During the years ended December 31, 2015, 2014 and 2013, we capitalized $7.8 million, $10.1 million and $8.7 million, respectively, of production and generation equipment costs. We believe that the above accounting treatments appropriately match expenses with the associated revenues.
Gross Profit and Gross Margin
Gross profit consists of our total revenues less our cost of revenues. Gross margin is calculated as the ratio of gross profit to total revenues. Our gross profit has been, and will continue to be, affected by many factors, including (a) the demand for our EIS and demand response solutions, (b) the selling price of our EIS and demand response solutions, (c) our cost of revenues, (d) the way in which we manage, or are permitted to manage by the relevant electric power grid operator or utility, our portfolio of demand response capacity, including our outcomes in negotiating favorable contracts with our customers and our participation in capacity auctions and third-party contracts, (e) the introduction of new EIS and demand response solutions, (f) our demand response event performance and (g) our ability to open and enter new markets and regions and expand deeper into markets we already serve.
Operating Expenses
Operating expenses consist of selling and marketing, general and administrative, and research and development expenses. Personnel-related costs are the most significant component of each of these expense categories. We grew from 928 full-time employees at December 31, 2014 to 1,088 full-time employees at December 31, 2015, primarily as a result of our fiscal 2014 and 2015 acquisitions. Full time employees in operating expenses exclude 197 and 278 employees included in cost of revenues at December 31, 2014 and 2015, respectively. As noted above under “Cost of Revenues,” a portion of our headcount and associated payroll and related expenses are included within cost of revenues. In addition, we incur up-front costs associated with the enablement of new MW in the demand response programs in which we participate. We expect to keep headcount relatively flat for the foreseeable future as we manage a more consistent MW volume and transfer existing resources to support expected expansion in EIS. In addition, our operating expenses include the expenses related to the operation and oversight of our NOC. We expect our overall operating expenses to slightly decrease in absolute dollar terms for the foreseeable future, as we leverage the investments we have made over the last several years and drive efficiencies across our general and administrative functions.
In certain forward capacity markets in which we choose to participate, such as PJM, we may install our equipment at a C&I end-user site to allow for the curtailment of MW from the electric power grid up to twelve months in advance of enrolling the C&I end-user in a particular program (i.e., we enable the C&I end-user). As a result, there has been a trend of incurring operating expenses at the time of enablement, including salaries and related personnel costs, associated with enabling certain of our C&I end-users, in advance of recognizing the corresponding revenues.
Selling and Marketing
Selling and marketing expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards made to our sales and marketing personnel, (b) commissions, (c) travel and other out-of-pocket expenses, (d) marketing programs such as trade shows and (e) other related overhead. Full-time employees associated with selling and marketing grew from 306 at December 31, 2014 to 325 at December 31, 2015. Commissions are recorded as an expense when earned by the employee.
General and Administrative
General and administrative expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards and bonuses made to our executive, finance, human resource, information technology and operations organizations, (b) facilities expenses, (c) external accounting and legal professional fees, (d) depreciation and amortization and (e) other related overhead. Full-time employees associated with general and administrative costs grew from 461 at December 31, 2014 to 553 at December 31, 2015.
Research and Development
Research and development expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards made to our research and development personnel, (b) payments to suppliers for design and consulting services, (c) costs relating to the design and development of new EIS and demand response solutions and
enhancement of existing EIS and demand response solutions, (d) quality assurance and testing, and (e) other related overhead. Full-time employees associated with research and development grew from 161 at December 31, 2014 to 210 at December 31, 2015. During the years ended December 31, 2015, 2014 and 2013, we capitalized software development costs of $5.3 million, $6.0 million and $7.9 million, respectively, which are included in property and equipment.
Stock-Based Compensation
We grant share-based awards to employees, non-employees, members of the board and advisory board members. We account for grants of stock-based compensation in accordance with ASC 718, Stock Compensation (ASC 718). We account for share-based awards granted to non-employees in accordance with ASC 505-50, Equity Based Payments to Non-Employees, which results in continuous fair value measurements of the non-employee share-based awards until such time as the awards vest. All share-based awards granted, including grants of stock options, restricted stock and restricted stock units, are recognized in the statement of operations based on their fair value as of the date of grant. As of December 31, 2015 the Company had two stock-based compensation plans, which are more fully described in Appendix A to this Annual Report on Form 10-K.
All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest. Restricted stock typically vests ratably over a four-year period from the date of issuance, with certain exceptions. The fair value of restricted stock upon which vesting is solely service-based is expensed ratably over the vesting period. With respect to restricted stock where vesting contains certain performance-based vesting conditions, the fair value is expensed based on the accelerated attribution method as prescribed by ASC 718, over the vesting period. With the exception of certain executives whose employment agreements provide for continued vesting in certain circumstances upon departure, if the employee who received the restricted stock leaves the Company prior to the vesting date for any reason, the shares of restricted stock will be forfeited and returned to the Company.
Interest Expense; Other Expense, Net; and Gain on Early Extinguishment of Debt
Interest expense primarily consists of interest expense related to the Notes, as well as fees associated with our 2014 credit facility. Interest expense also consists of interest expense associated with letters of credit and other financial assurances. Other expense, net consists primarily of gains or losses on transactions denominated in currencies other than our or our subsidiaries’ functional currency and other non-operating income and expenses. Gain on early extinguishment of debt represents the gain we recorded as a result of the repurchase in cash of $33.2 million in aggregate principal amount of the Notes at a weighted average price of 59.2% of principal for a total purchase price of $19.7 million plus accrued interest.
Consolidated Results of Operations
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Revenues
The following table summarizes our revenues for the years ended December 31, 2015 and 2014 (dollars in thousands):
Grid Operator Revenues
The decrease in our revenues from grid operators was primarily attributable to changes in the following operating areas (dollars in thousands):
(1)
The amounts included in ‘other’ relate to various demand response programs, none of which have individually material changes.
The decrease in revenues from grid operators for the year ended December 31, 2015, as compared to 2014, was primarily due to our increased participation in PJM’s extended program in the 2015/2016 delivery year, which resulted in the deferral of revenue recognition to the second quarter of 2016, lower revenue associated with capacity auctions and bilateral contracts in the PJM and ISO-NE demand response programs, and a change during the fourth quarter of 2014 to ratable revenue recognition and decreased pricing in the AEMO program. The decrease in PJM revenues for the year ended December 31, 2015 as compared to 2014 was also attributed to significantly lower energy payments resulting from fewer demand response event dispatches during 2015. The decrease in revenues was also due to lower pricing and fewer enrolled MWs in our Canadian demand response programs in AESO and OPA, and foreign currency exchange losses due to relative weakness of the Canadian and Australian dollars against the US dollar. This decrease in revenue was partially offset by revenue associated with our demand response program in South Korea. We currently expect our revenue from grid operators to be flat to 10% lower during fiscal 2016 as compared to fiscal 2015.
Utility Revenues
(1)
The amounts included in ‘other’ relate to various demand response programs, none of which have individually material changes.
The increase in revenues from utility customers during the year ended December 31, 2015, as compared to 2014, was primarily due to an increase in utility software revenues related to our acquisition of Pulse Energy Inc., or Pulse Energy, which we acquired in the fourth quarter of 2014, and improved performance during demand response events in our SCE demand response program. This increase was offset by reduced revenue from the conclusion of two domestic demand response programs and a decrease in participation in our PG&E demand response program. We currently expect our demand response revenues from utility customers to be flat to 10% lower during fiscal 2016 as compared to fiscal 2015. We currently expect our software revenues from utility customers to increase during fiscal 2016, as compared to fiscal 2015.
Enterprise Revenue
The increase in enterprise revenues during the year December 31, 2015, as compared to 2014, was primarily related to the expansion of our procurement solutions resulting from our acquisition of World Energy in the first quarter of 2015 and an increase in our subscription software packages. This increase in revenue was partially offset by a decrease in enterprise revenue resulting from our December 30, 2014 sale of a component of our business related to our automated demand response offering for agricultural sites, the completion of our 2010 agreement with the MA DOER in August 2014, and a reduction of energy efficiency professional services revenues.
We currently expect software revenues from enterprise customers to increase in fiscal 2016, compared to fiscal 2015. This increase is expected to be partially offset by lower professional services revenues due to the divesture of the World Energy efficiency business in the fourth quarter of fiscal 2015.
Gross Profit and Gross Margin
The following table summarizes our gross profit and gross margin percentages for our EIS and demand response solutions for the years ended December 31, 2015 and 2014 (dollars in thousands):
The decrease in gross profit during the year ended December 31, 2015 as compared to 2014 was primarily due to lower revenue associated with capacity auctions and bilateral contracts in the PJM and ISO-NE demand response programs, lower pricing and fewer MWs enrolled in our Canadian demand response programs in AESO and OPA, and foreign currency exchange losses due to relative weakness of the Canadian and Australian dollars against the US dollar. The decrease was also due to our increased participation in PJM’s extended program in the 2015/2016 delivery year, which resulted in the deferral of profits to the second quarter of 2016, and a change during the fourth quarter of 2014 to ratable revenue recognition and decreased pricing in the AEMO program. The decrease in gross margin during the year ended December 31, 2015, as compared to 2014, was primarily due to a decrease in high-margin revenue associated with capacity auctions and bilateral contracts in the PJM and ISO-NE demand response programs. We currently expect that both our gross profit and gross margin percentage will decrease in 2016 primarily resulting from decreased participation in incremental auctions, although we expect this decrease to be partially offset by higher-margin revenue associated with the growth of our EIS solutions.
Operating Expenses
The following table summarizes our operating expenses for the years ended December 31, 2015 and 2014 (dollars in thousands):
Selling and Marketing Expenses
The following table summarizes our selling and marketing expenses for the years ended December 31, 2015 and 2014 (dollars in thousands):
The increase in payroll and related costs for the year ended December 31, 2015 as compared to 2014 was primarily due to the full-time employees added as a result of the December 2014 and January 2015 acquisitions of Pulse Energy and World Energy, respectively, as well as an increase in salary rates for full time employees. The number of selling and marketing full-time employees was 306 at December 31, 2014 and 325 at December 31, 2015. In addition, we experienced an increase in commission expense during the year ended December 31, 2015 due to an increase in enterprise revenues. During 2015, we changed our U.S. paid time off program from a capped program based on service and employment status to an unlimited time off program. This policy change reduced vacation expense related to our sales and marketing employees by approximately $0.6 million compared to the prior year.
The decrease in stock-based compensation for the year ended December 31, 2015, as compared to 2014 was primarily due to the reversal of $0.8 million of stock-based compensation expense related to the cancellation of awards upon the execution of a separation agreement with a former executive officer and the decrease in grant date fair value of stock-based awards. This decrease was partially offset by an increase in the number of stock-based awards granted during the year ended December 31, 2015, as well as the recognition of stock-based compensation for replacement awards issued to certain employees in connection with the acquisition of World Energy.
Other selling and marketing expenses include advertising, marketing, third party commissions, professional services, and a company-wide overhead cost allocation. The increase in other selling and marketing expenses for the year ended December 31, 2015 as compared to 2014 was primarily attributable to third party commissions associated with the World Energy business and higher overhead allocations due to increases in facility costs. Selling and marketing expenses also increased due to higher amortization expense of acquired intangible assets as a result of acquisitions that we completed during fiscal 2014 and our acquisition of World Energy in January 2015. We currently expect a modest increase in sales and marketing expense in fiscal 2016, compared to fiscal 2015, as we invest to support our continued growth and ongoing market expansion.
General and Administrative Expenses
The following table summarizes our general and administrative expenses for the years ended December 31, 2015 and 2014 (dollars in thousands):
The increase in payroll and related costs for the year ended December 31, 2015, as compared to 2014, was primarily attributable to a full year of expenses related to acquisitions completed during 2014, an increase in the number of general and administrative full-time employees from 461 at December 31, 2014 to 553 at December 31, 2015, the majority of which resulted from the expansion of our global services function, hiring into open positions in our finance and operations organizations, and our acquisition of World Energy in January 2015, which included general and administrative operations personnel. The increase in salaries and wages was partially offset by an increase in reclassifications of payroll costs to cost of revenue for the wages and associated benefits that we pay to our project managers for the performance of their services, and costs related to the delivery of services of our utility bill management solution. Also partially offsetting this increase was the change in our U.S. vacation policy, which reduced vacation expense related to our general and administrative employees by approximately $0.8 million compared to the prior year.
The decrease in stock-based compensation for the year ended December 31, 2015, as compared 2014, was primarily due to a decrease in the number and grant date fair value of stock-based awards granted during the period, partially offset by stock-based compensation expense related to awards settled and replaced in connection with our acquisition of World Energy.
Other general and administrative expenses include third party software fees, professional services such as consulting, audit, and external legal, rent and facility-related expenses, and depreciation. The increase in other general and administrative expenses for the year ended December 31, 2015, as compared to 2014, was primarily due to an increase in rent and facility-related expenses related to the expansion of our corporate lease and the acquisition of World Energy leased facilities, an increase in third-party software fees, and increased depreciation expense, primarily related to leasehold improvements. We currently expect a modest decrease in general and administrative expenses in fiscal 2016, compared to fiscal 2015.
Research and Development Expenses
The following table summarizes our research and development expenses for the years ended December 31, 2015 and 2014 (dollars in thousands):
During the years ended December 31, 2015 and 2014, total research and development payroll and related costs totaled $16.8 million and $12.1 million, respectively, which are net of $5.3 million and $6.0 million, respectively, of capitalized internal-use software development costs. These capitalized costs are typically amortized over a three-year period in cost of revenues. The increase in payroll and related costs was primarily driven by an increase in the number of research and development full-time employees from 161 at December 31, 2014 to 210 at December 31, 2015, which was due to our increased software development efforts related to features and functionality of our EIS offerings.
Other research and development expenses include technology expenses, professional services, facilities and a company-wide overhead cost allocation. The increase in other research and development expenses for the year ended December 31, 2015, as compared to 2014, was primarily attributable to increases in data storage costs and external software costs. We currently expect research and development expenses in fiscal 2016 to be comparable to fiscal 2015 as we develop new technologies and enhance existing technologies to support our continued growth.
Gain on Sale of Service Lines
During the three months ended June 30, 2014, we sold Utility Solutions Consulting for $4.8 million, a component of the business that we acquired in connection with our acquisition of Global Energy related to consulting and engineering support services. We recognized a gain from the sale of Utility Solutions Consulting totaling $3.7 million, net of direct transaction costs totaling $0.3 million during the year ended December 31, 2014. In addition, during 2014, we sold Valley Tracker for $1.6 million, a component of our business that we acquired in connection with our acquisition of M2M related to our automated demand response offering designed to ensure demand response customers can connect their equipment remotely and access meter data securely. We recognized a gain from the sale of Valley Tracker totaling $1.1 million during the year ended December 31, 2014. These gains did not recur in 2015.
Gain on Sale of Assets
During 2014, we entered into an agreement with a third party enterprise customer to sell two contractual demand response capacity resources related to an open market demand response program to that third party allowing the third party the ability to enroll directly with the applicable grid operator. The third party fully paid the purchase price for the first demand response capacity resource during 2014 and as a result, the sale of this resource was completed resulting in the recognition of a gain on the sale of this asset equal to the purchase price of $2.2 million. During the year ended December 31, 2015, we received payment in full from the third party for the second demand response capacity resource and completed the sale resulting in the recognition of a gain on the sale of this asset of $3.0 million.
Goodwill Impairment
As a result of our annual goodwill impairment test conducted as of November 30, 2015, we recognized a $108.8 million goodwill impairment charge for the year ended December 31, 2015. See Critical Accounting Policies in this Item 7 and Note 4 contained in Appendix A to this Annual Report on Form 10-K for further information regarding the impairment charge.
Interest and Other Expense, Net
Interest expense was $8.9 million for the year ended December 31, 2015 compared to $4.7 million in 2014. This increase was due to interest expense recorded on our convertible notes that were issued in August 2014 and were outstanding for the full year in 2015.
Other expense, net for the year ended December 31, 2015 was $7.4 million, which primarily includes foreign currency losses, offset partially by other income. The increase in foreign currency losses as compared to 2014 was primarily due to the weakening of the Canadian dollar, the Euro and Australian dollar against the U.S. Dollar by 16%, 10% and 11%, respectively, which resulted in foreign currency unrealized and realized losses of $8.0 million for 2015 compared to $4.4 million for the prior year.
Gain on Early Extinguishment of Debt
In December 2015, in privately negotiated transactions, we completed repurchases, in cash, of $33.2 million in aggregate principal amount of the Notes at a weighted average price of 59.2% of principal for a total purchase price of $19.7 million plus accrued interest. We recorded a gain on the extinguishment of the Notes of $9.2 million based on the difference between the carrying amount of the repurchased Notes and the cash consideration.
Income Taxes
We recorded a benefit for income taxes of $10.0 million for the year ended December 31, 2015 that includes approximately $7.9 million related to the impairment of tax-deductible goodwill and a $2.0 million benefit from income taxes due to the release of a portion of the U.S. valuation allowance in connection with our acquisition of World Energy. We recorded a provision for income taxes of $5.9 million for the year ended December 31, 2014 that included a $1.1 million benefit from income taxes due to the release of a portion of the U.S. valuation allowance in connection with the EnTech acquisition during the year ended December 31, 2014 and a $1.1 million expense for deferred income taxes in connection with the sale of Utility Solutions Consulting during the year ended December 31, 2014.
ASC 740, Income Taxes (ASC 740), provides criteria for the recognition, measurement, presentation and disclosures of uncertain tax positions. A tax benefit from an uncertain tax position may be recognized if it is “more likely than not” that the position is sustainable based solely on its technical merits. During the year ended December 31, 2015, there were no material changes in our uncertain tax positions.
Deferred tax assets are reduced by a valuation allowance if, based on the weight of available positive and negative evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2015, we have a valuation allowance recorded against certain net domestic and foreign deferred tax assets. Based on our analysis, we have concluded that it is not more likely than not that the majority of our deferred tax assets can be realized and therefore a valuation allowance has been assigned to these deferred tax assets. If we are subsequently able to utilize all or a
portion of the deferred tax assets for which a valuation allowance has been established, then we may be required to recognize these deferred tax assets through the reduction of the valuation allowance which could result in a material benefit to our results of operations in the period in which the benefit is determined.
Our effective tax rate for the year ended December 31, 2015 was 5.1% compared to an effective tax rate of 32.9% for the year ended December 31, 2014.
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Revenues
The following table summarizes our revenues for the years ended December 31, 2014 and 2013 (dollars in thousands):
Grid Operator Revenues
The overall increase in our revenues from grid operators was primarily attributable to changes in the following existing operating areas (dollars in thousands):
(1)
The amounts included in ‘other’ relate to net decreases in various demand response programs, domestic and international, none of which are individually material.
The increase in revenues from grid operators was primarily due to an increase in pricing and enrolled MW in our PJM and AEMO demand response programs. The increase in AEMO revenue was further driven by our ability to recognize revenues in Western Australia ratably over the delivery period of October 1 through September 30, commencing on October 1, 2014. The increase in revenues from grid operators was also due to revenues recognized from our SEMO demand response program in Ireland, for which revenues were recognized for the first time during the year ended December 31, 2014 as a result of our acquisition of Activation Energy. The increase in revenues from grid operators was also a result of an increase in enrolled MW in certain demand response programs in Alberta, Canada, including ancillary services demand response programs that we did not start participating in until the three month period ended September 30, 2013.
Utility Revenues
The overall decrease in our revenues from utilities was primarily attributable to changes in the following existing operating areas (dollars in thousands):
(1)
The amounts included in ‘other’ relate to net decreases in various demand response programs, none of which are individually material.
The decrease in utility revenues was primarily due to a decrease of revenues from SCE and PG&E as a result of underperformance penalties and a decrease in enrolled MW.
Enterprise Revenues
The increase in revenues from enterprise customers was primarily due to revenues recognized during the year ended December 31, 2014 related to our utility bill management services, which were acquired as part of our acquisition of EnTech, as well as an increase in the number of enterprise customers and consulting engagements. The increase in enterprise revenue was partially offset by the end of certain energy efficiency incentive based programs, from which we derived revenues in 2013, and the completion of our 2010 agreement with the Massachusetts Department of Energy Resources in August 2014.
Gross Profit and Gross Margin
The following table summarizes our gross profit and gross margin percentages for our EIS and demand response solutions for the years ended December 31, 2014 and 2013 (dollars in thousands):
The increase in gross profit was primarily due to an increase in grid operator revenues. Our gross margin percentage decreased primarily due to an increase in PJM revenues from delivering demand response which historically yield a lower gross margin than our other programs and solutions, as well as changes to our overall enterprise customer composition. In addition, our gross margin percentage declined due to a decrease in revenues from our SCE demand response program as a result of a decrease in event performance without associated decreases in costs. These decreases in our gross margin were partially offset by an increase in gross margin in our PG&E demand response program, as revenues related to this program were deferred in 2013 with the associated program costs being expensed.
Operating Expenses and Income
The following table summarizes our operating expenses and income for the years ended December 31, 2014 and 2013 (dollars in thousands):
Selling and Marketing Expenses
The following table summarizes our selling and marketing expenses for the years ended December 31, 2014 and 2013 (dollars in thousands):
The increase in payroll and related costs was primarily due to an increase in the number of selling and marketing full-time employees from 231 at December 31, 2013 to 306 at December 31, 2014, most of which resulted from acquisitions that we completed during 2014. Payroll and other employee related costs were also impacted by a higher cash bonus expense for the year ended December 31, 2014, as a portion of the bonuses earned for the year ended December 31, 2013, or fiscal 2013, were settled in shares of our common stock and recorded in stock-based compensation expense during fiscal 2013. In addition, we experienced an increase in commission expense during 2014 related to our increase in revenues and enterprise customers.
The decrease in stock-based compensation was primarily due to the settlement of a portion of the fiscal 2013 bonuses in shares of our common stock.
Other selling and marketing expenses include advertising, marketing, professional services, amortization and a company-wide overhead cost allocation. The increase in other selling and marketing expenses was primarily attributable to a $1.2 million increase in various marketing initiatives, a $0.8 million increase in amortization expense, and a $0.4 million increase in overhead.
General and Administrative Expenses
The following table summarizes our general and administrative expenses for the years ended December 31, 2014 and 2013 (dollars in thousands):
The increase in payroll and related costs was primarily attributable to an increase in the number of general and administrative full-time employees from 386 at December 31, 2013 to 461 at December 31, 2014, most of which resulted from acquisitions that we completed during 2014. The increase also resulted from higher overall salary rates and higher bonus expense in 2014 due to a portion of the fiscal 2013 bonuses that were settled in shares of our common stock and recorded in stock-based compensation expense.
The increase in stock-based compensation was primarily due to an increase in the overall grant-date fair value of stock-based awards granted as a result of the increase in our stock price.
Other general and administrative expenses include professional services, rent, depreciation and a company-wide overhead cost allocation. The increase in other general and administrative expenses was primarily attributable to higher professional fees of $6.2 million due to increased accounting, consulting and legal fees incurred related to our recent acquisitions and other matters, including the derivative and class action complaint, and our international tax planning. Other factors that contributed to the increase: $1.2 million of higher software license fees which were partially the result of our increase in headcount, $0.9 million of higher depreciation costs primarily due to a full year of depreciation expense relative to our corporate headquarters, and higher dues, subscriptions and conference costs of approximately $0.5 million. The increase in other general and administrative expenses was partially offset by a $0.5 million decrease in rent expense, as during the first half of 2013 we incurred rent expense for both our prior and current corporate headquarters.
Research and Development Expenses
The following table summarizes our research and development expenses for the years ended December 31, 2014 and 2013 (dollars in thousands):
The increase in payroll and related costs was primarily driven by an increase in the number of research and development full-time employees from 99 at December 31, 2013 to 161 at December 31, 2014 and an increase in salary rates per full-time employee. The increase was also attributable to a portion of the fiscal 2013 bonuses that were settled in shares of our common stock and recorded in stock-based compensation expense. Additionally, overall capitalized development internal labor costs increased as we conducted more development activities by leveraging our employee base instead of utilizing third parties. This increase in capitalized internal labor development costs partially offset the increase in payroll and payroll related costs for the year ended December 31, 2014.
Other research and development expenses include technology expenses, professional services, facilities and a company-wide overhead cost allocation. The increase in other research and development expenses was primarily attributable to an
increase of $0.8 million in the allocation of company-wide overhead costs, which is based on headcount, higher information technology and communication costs of $0.7 million, and higher consulting and professional fees of $0.3 million, partially offset by decreased software and license costs.
Gain on Sale of Service Lines
During 2014, we sold Utility Solutions Consulting, a component of the business that we acquired in connection with our acquisition of Global Energy related to consulting and engineering support services. We recognized a gain from the sale of Utility Solutions Consulting totaling $3.7 million, net of direct transaction costs totaling $0.3 million during the year ended December 31, 2014.
Also during 2014, we sold Valley Tracker, a component of the business that we acquired in connection with our acquisition of M2M for $1.6 million. We recognized a gain of $1.1 million during the year ended December 31, 2014.
Gain on Sale of Assets
During 2014, we entered into an agreement with a third party enterprise customer to sell two contractual demand response capacity resources related to an open market demand response program, to that third party allowing the third party the ability to enroll directly with the applicable grid operator. The third party paid the purchase price for the first demand response capacity resource during 2014 and as a result, the sale of this resource was completed resulting in a gain on the sale of this asset equal to the purchase price of $2.2 million.
Interest and Other Expense, Net
Interest expense was $4.7 million for the year ended December 31, 2014 compared to $1.6 million for the year ended December 31, 2013. This increase was largely due to interest expense recorded on the Notes, which was $3.0 million for the year ended December 31, 2014.
Other expense, net for the year ended December 31, 2014 was $3.7 million, which primarily included foreign currency losses offset partially by other income. The $2.4 million increase as compared to the year ended December 31, 2013 was primarily due to the weakening of the Euro and Australian dollar against the U.S. dollar, which resulted in a loss of $4.4 million for the year ended December 31, 2014, as compared to a $1.7 million loss for the year ended December 31, 2013.
Income Taxes
We recorded a provision for income taxes of $5.9 million and $2.6 million for the years ended December 31, 2014 and 2013, respectively. The key components of our provision for income taxes include estimated foreign taxes on profits earned by our foreign subsidiaries who have no available net operating loss carryforwards; certain state taxes for jurisdictions where we have utilized all available net operating loss carryforwards; and amortization of tax deductible goodwill, which generates a deferred tax liability that cannot be offset by net operating losses or other deferred tax assets since its reversal is considered indefinite in nature. Additionally, the provision for income taxes for the year ended December 31, 2014 includes a $1.1 million benefit from deferred income taxes due to the release of a portion of the U.S. valuation allowance in connection with the EnTech acquisition and a $1.1 million provision for deferred income taxes in connection with the sale of Utility Solutions Consulting.
Our effective tax rate for the year ended December 31, 2014 was 32.9% compared to an effective tax rate of 10.7% for the year ended December 31, 2013.
Liquidity and Capital Resources
Overview
We have generated significant cumulative losses since inception. As of December 31, 2015, we had an accumulated deficit of $254.3 million. As of December 31, 2015, our principal sources of liquidity were cash and cash equivalents totaling $138.1 million, and our $30 million senior secured revolving credit facility. During 2015, our cash decreased by $116.3 million from the December 31, 2014 balance of $254.4 million. The reduction of cash during 2015 was principally driven by the $77.2 million of cash used to acquire World Energy, net of cash acquired, $23.6 million of cash used for the purchase of property and equipment, including $8.4 million of capitalized internal-use software development costs, $19.7 million of cash used to retire $33.2 million of principal of the Notes; partially offset by $3.5 million of cash generated from operating activities.
Cash Flows
The following table summarizes our cash flows for the years ended December 31, 2015, 2014 and 2013 (dollars in thousands):
The following table presents our net cash from operating activities (dollars in thousands):
(1) Other non-cash items in 2015, 2014 and 2013 primarily consist of depreciation and amortization, impairment charges on long lived assets, unrealized foreign exchange translation losses, deferred taxes and non-cash interest expense.
Net cash provided by operating activities was $3.5 million in 2015 as compared to net cash provided by operating activities in 2014 of $60.4 million. The decrease in net cash provided by operating activities was due to increased net losses in 2015 as compared to net income in 2014, partially offset by higher non-cash items and a $35.7 million decrease in working capital in 2015 as compared to 2014.
Cash flows from working capital for the year ended December 31, 2015 were primarily due to an increase in deferred revenue of $39.8 million, a decrease in unbilled revenue of $27.3 million, partially offset by an increase in capitalized incremental direct customer contract costs of $25.8 million. These changes were primarily driven by our increased participation in the PJM extended program, which impacted the timing of revenue recognition compared to the prior year. In addition, cash flows from working capital are due to an increase in accrued capacity payments of $13.1 million, partially offset by a decrease of $19.8 million in accounts payable, accrued expenses and other current liabilities.
Cash provided by operating activities for the year ended December 31, 2014 was approximately $60.4 million and was driven by net income plus stock-based compensation and other non-cash items. Cash used by working capital consisted of an increase of $31.1 million in unbilled revenues, primarily related to the PJM demand response market, a decrease of $8.1 million in deferred revenue, and an increase in accounts receivable of $3.0 million. This activity was partially offset by an increase of $20.3 million in accounts payable, accrued expenses and other current liabilities, an increase in accrued capacity payments of $16.3 million, an increase of $3.6 million in accrued payroll and related expenses, and a decrease in capitalized incremental direct customer contract costs of $2.5 million.
Cash provided by operating activities for the year ended December 31, 2013 was approximately $79.5 million and was driven by net income plus stock-based compensation and other non-cash items and $9.9 million of net cash provided by working capital. Cash provided by working capital consisted primarily of an increase in accrued capacity payments of $28.5 million, partially offset by an increase of $21.4 million in unbilled revenues primarily related to the PJM demand response program.
The following table presents our net cash from investing activities (dollars in thousands):
Cash used in investing activities was $93.9 million for the year ended December 31, 2015. During the year ended December 31, 2015, we made payments, net of cash acquired of $77.5 million for acquisitions (primarily World Energy). We made $23.6 million of capital expenditures, primarily related to software additions, including capitalized software development costs, to further expand the functionality of our software and solutions, as well as production equipment expenditures due to an increase in our installed customer base. We also made capital expenditures for office equipment, furniture and fixtures, and leasehold improvements associated with the expansion of our corporate office space. Cash used in investing activities for the year ended December 31, 2015 was partially offset by $3.9 million in cash proceeds from the sale of two contractual demand response capacity resources related to an open market demand response program, and the sale of the energy efficiency services business acquired as part of our acquisition of World Energy.
Cash used in investing activities was $74.4 million for the year ended December 31, 2014. During the year ended December 31, 2014, we made payments, net of cash acquired of $54.2 million for business acquisitions and investments. We made $25.6 million of capital expenditures, primarily related to software additions, production equipment, office equipment, furniture and fixtures, and leasehold improvements associated with leasing new office space. Cash used in investing activities for the year ended December 31, 2014 was partially offset by $5.9 million and $2.2 million in cash proceeds from our sale of service lines and our sale of assets, respectively.
Cash used in investing activities was $37.9 million for the year ended December 31, 2013. During the year ended December 31, 2013, we incurred $36.7 million in capital expenditures primarily related to the build-out of our corporate headquarters, purchases of production equipment and capitalized internal use software costs.
The following table presents our cash flows (used in) provide by financing activities (dollars in thousands):
Cash (used in) provided by financing activities was $(22.5) million, $120.9 million and $(6.8) million for the years ended December 31, 2015, 2014 and 2013, respectively. For the year ended December 31, 2015, cash used in financing activities includes payments of $19.7 million for open-market purchases of the Notes. We also acquired $4.3 million of common stock related to employee restricted stock minimum tax withholdings and received $1.1 million of cash for the exercise of stock options.
For the year ended December 31, 2014, cash provided by financing activities primarily consisted of the net proceeds from the sale and issuance of the Notes in August 2014 totaling $155.3 million, less $30.0 million of the net proceeds which were used to repurchase shares of our common stock. We realized $1.6 million of cash from the exercise of stock options, recognized an excess tax benefit related to the exercise of stock options, restricted stock and restricted stock units of $0.6 million, and made payments of approximately $6.6 million for employee restricted stock minimum tax withholdings.
During the year ended December 31, 2013, cash used in financing activities primarily consisted of payments made to repurchase shares of our common stock of $9.5 million, as well as employee restricted stock minimum tax withholding
payments of $0.3 million, partially offset by proceeds that we received from exercises of options to purchase shares of our common stock of $2.4 million.
Borrowings and Credit Arrangements
Credit Agreement
On August 11, 2014, we entered into a $30 million senior secured revolving credit facility, or the 2014 credit facility, the full amount of which may be available for issuances of letters of credit, pursuant to a loan and security agreement with Silicon Valley Bank, or SVB. The 2014 credit facility was subsequently amended on October 23, 2014. On August 6, 2015, we and SVB entered into a second amendment to the 2014 credit facility to extend the termination date to August 9, 2016. The 2014 credit facility is subject to continued covenant compliance and borrowing base requirements. As of December 31, 2015, we had no outstanding borrowings and had outstanding letters of credit totaling $22.4 million under the 2014 credit facility. For further discussion of the 2014 credit facility, please refer to Note 9 contained in Appendix A to this Annual Report on Form 10-K.
Convertible Notes
On August 12, 2014, we entered into a purchase agreement with Morgan Stanley & Co. LLC relating to the sale of $160.0 million aggregate principal amount of the Notes, due August 15, 2019 in an offering exempt from registration under the Securities Act of 1933, as amended. The Notes include customary terms and covenants, including certain events of default after which the Notes may be declared or become due and payable immediately. The Notes are convertible at an initial conversion rate of 36.0933 shares of the common stock per $1,000 principal amount of the Notes. However, because we received approval at the annual meeting of stockholders held on May 27, 2015, we may elect to settle conversions of the Notes by paying or delivering, as the case may be, cash, shares of our common stock or a combination of cash and shares of common stock. The conversion rate will be subject to adjustment in some events, but will not be adjusted for any accrued and unpaid interest.
Upon issuance of the Notes, we accounted for the liability and equity components of the Notes separately to reflect their nonconvertible debt borrowing rate. The estimated fair value of the liability component of $137.4 million was determined using a discounted cash flow technique. The excess of the gross proceeds received over the estimated fair value of the liability component totaling $22.6 million has been allocated to the conversion feature (equity component) with a corresponding offset recognized as a discount to reduce the net carrying value of the Notes. The discount is being amortized to interest expense over a five year period ending August 15, 2019 using the effective interest method. In addition, transaction costs were allocated to the liability and equity components based on their relative percentages. The applicable transaction costs allocated to the liability and equity components at issuance were $4.1 million and $0.7 million, respectively. In addition, during 2015 we were reimbursed for $0.4 million of transaction costs, which were allocated to the liability component. The transaction costs allocated to the liability are being amortized to interest expense on a straight-line basis over a five year period. As discussed in Note 9, we adopted ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, as of December 31, 2015. As a result of adopting this accounting standard, we reclassified $687 and $3,131 of unamortized deferred issuance costs from current assets and other assets, respectively, to a direct reduction of the debt obligation for December 31, 2014. As a result, the adjusted carrying amount of the Notes on the balance sheet, net of unamortized discounts and offering expenses, were $111,254 and $135,090 as of December 31, 2015 and December 31, 2014, respectively.
As noted above, in December 2015, in privately negotiated transactions, we completed repurchases in cash of $33.2 million in aggregate principal amount of the outstanding Notes, at a weighted average price of 59.2% of principal for a total purchase price of $19.7 million plus accrued interest. We recorded a gain on the extinguishment of the Notes of $9.2 million based on the difference between the carrying amount of the repurchased Notes and the cash consideration.
We may from time to time seek to retire or purchase additional outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
For further discussion of the Notes, please refer to Note 9 contained in Appendix A to this Annual Report on Form 10-K.
Interest expense under the Notes is as follows (dollars in thousands):
Contingent Earn-Out Payments
In connection with our acquisitions of Entelios AG, or Entelios, Activation Energy DSU Limited, or Activation Energy, Universal Load Center Co. Ltd., or ULC, and Pulse Energy, we agreed to pay additional purchase price consideration, or earn-out payments, on the achievement of certain milestones. See Note 2 to our consolidated financial statements contained in Appendix A to this Annual Report on Form 10-K.
The earn-out payment for Entelios was based on the achievement of certain minimum defined profit metrics for the years ended December 31, 2014 and 2015. We did not achieve the 2015 or 2014 milestones resulting in no additional payouts.
The earn-out payment for Activation Energy was based on the achievement of certain minimum defined MW enrollment as well as profit metrics for the years ended December 31, 2014 and 2015. The earn-out provided a maximum payment of 1.0 million Euros ($1.4 million), including up to 0.3 million Euros and up to 0.7 million Euros related to the achievement of the defined profit metrics for the years ended December 31, 2014 and 2015, respectively. In January 2015, following the full achievement of Activation Energy's milestone for 2014, we disbursed 0.3 million Euros ($0.3 million) to the former Activation Energy shareholders. In February 2016, following the full achievement of Activation Energy’s milestone for 2015, we disbursed 0.7 million Euros ($0.8 million) to the former Activation Energy shareholders.
In connection with our acquisition of ULC in April 2014, we agreed to pay a maximum of $1.8 million in earn-out payments. The earn-out payments, if any, are be based on the achievement of certain defined market legislation and certain operational metrics. The market legislation metric was achieved in May 2014, with $0.3 million paid out over 2014 and 2015. The remaining $1.5 million is payable to those former ULC stockholders who remain employed as of the time of payment, if such operational metrics are achieved. We concluded these payments should be accounted for as compensation arrangements and expensed ratably over the applicable service period, if achievement is deemed probable. Through January 2016 we have paid $0.3 million for the achievement of certain operational metrics.
The earn-out payment for Pulse Energy, if any, will be based on the achievement of sales targets for the years ended December 31, 2015, 2016 and 2017, and would be paid in the form of our common stock, except for a small portion of the payment that would be paid in cash, if such targets are reached. We recorded our estimate of the fair value of the contingent consideration based on the evaluation of the likelihood of the achievement of the contractual conditions and weighted probability assumptions of these outcomes. Because the contingent consideration is expected to be primarily settled in our own shares and the criteria in ASC 815, Contracts in Entity’s Own Equity, was met, the fair value of the earn-out was recorded in equity as additional paid-in capital. The fair value of the earn-out has been estimated to equal $1.6 million and will not be re-measured subsequent to the acquisition date due to equity classification.
Capital Spending
We have made capital expenditures primarily for general corporate purposes to support our growth and for equipment installations related to our business. Our capital expenditures totaled $23.6 million, $25.6 million and $36.7 million during the years ended December 31, 2015, 2014 and 2013, respectively. We expect our capital expenditures for 2016 to modestly increase over our capital expenditures for 2015 due primarily to increased site implementations.
Off-Balance Sheet Arrangements
As of December 31, 2015, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. We have issued letters of credit in the ordinary course of our business in order to participate in certain demand response programs. As of December 31, 2015, we had outstanding letters of credit totaling $22.4 million. For information on these commitments and contingent obligations, see “Liquidity and Capital Resources-Borrowings and Credit Arrangements” above and Note 9 to our consolidated financial statements contained herein.
Contractual Obligations
Information regarding our significant contractual obligations is set forth in the following table and includes the operating lease arrangement described above. Payments due by period have been presented based on payments due subsequent to December 31, 2015 (in millions):
The future payments related to uncertain tax positions have not been presented in the table above due to the uncertainty of the amounts and timing of cash settlement with the taxing authorities. See Note 12 to our consolidated financial statements contained in Appendix A to this Annual Report on Form 10-K.
Our fixed interest payments at 2.25% relating to the Notes, which mature on August 19, 2019, are presented in the table above.
Our operating lease obligations relate primarily to the leases of our corporate headquarters in Boston, Massachusetts and our offices in Worcester, San Francisco, California; Baltimore, Maryland; Boise, Idaho, Vancouver, Canada; Australia, United Kingdom, Germany, Switzerland, Ireland, South Korea, Brazil and India.
In connection with our acquisition of M2M, we are required to pay additional consideration that was deferred at the date of the acquisition. This deferred purchase price consideration of $7.0 million will be paid upon the earlier of the satisfaction of certain conditions contained in the definitive agreement or seven years after the acquisition date of January 25, 2011. The deferred purchase price consideration is not subject to adjustment or forfeiture. We recorded our estimate of the fair value of the deferred purchase price consideration based on the evaluation of the likelihood of the achievement of the contractual conditions that would result in the payment of the deferred purchase price consideration prior to seven years from the acquisition date and weighted probability assumptions of these outcomes. The cash portion of the deferred purchase price consideration has been recorded as a liability, initially estimated to be less than $0.5 million, discounted to reflect the time value of money. As the milestone payment date approaches, the fair value of this liability will increase. The fair value of the deferred purchase price consideration of $3.4 million, related to the 254,654 shares of common stock to be issued upon the milestone payment date, has been classified as additional paid-in capital within stockholders’ equity. With respect to the cash portion of the deferred purchase price consideration, the increase in fair value is recorded as an expense in our accompanying consolidated statements of operations. At December 31, 2015, the liability was recorded at $0.6 million. The deferred purchase price consideration to be paid in shares meets the requirements of an equity instrument and, accordingly, will not be remeasured at fair value each reporting period. This acquisition had no contingent consideration or earn-out payments.
As of December 31, 2015, we had no borrowings, but had outstanding letters of credit totaling $22.4 million under the 2014 credit facility. As of December 31, 2015, we had $7.6 million available under the 2014 credit facility for future borrowings or issuances of additional letters of credit.
We typically grant certain customers a limited warranty that guarantees that our hardware products will substantially conform to current specifications for one year from the delivery date. Based on our operating history, the liability associated with product warranties has been determined to be nominal. We also indemnify our customers from third-party claims relating to the intended use of our products. Pursuant to these clauses, we indemnify and agree to pay any judgment or settlement relating to a claim.
We guarantee the electric capacity we have committed to deliver pursuant to certain long-term contracts. Such guarantees may be secured by cash or letters of credit. Performance guarantees as of December 31, 2015 and 2014 were $20.2 million and $23.7 million, respectively. For the year ended December 31, 2015, these performance guarantees included deposits held by certain customers of $0.1 million.
Additional Information
Non-GAAP Financial Measures
To supplement our consolidated financial statements presented on a GAAP basis, we disclose certain non-GAAP measures that exclude certain amounts, including non-GAAP net (loss) income attributable to EnerNOC, non-GAAP net (loss) income per share attributable to EnerNOC, adjusted EBITDA and free cash flow. These non-GAAP measures are not in accordance with, or an alternative for, generally accepted accounting principles in the United States.
The GAAP measure most comparable to non-GAAP net (loss) income attributable to EnerNOC is GAAP net (loss) income attributable to EnerNOC; the GAAP measure most comparable to non-GAAP net (loss) income per share attributable to EnerNOC is GAAP net (loss) income per share attributable to EnerNOC; the GAAP measure most comparable to adjusted EBITDA is GAAP net (loss) income attributable to EnerNOC; and the GAAP measure most comparable to free cash flow is cash flows provided by operating activities. Reconciliations of each of these non-GAAP financial measures to the corresponding GAAP measures are included below.
Use and Economic Substance of Non-GAAP Financial Measures
Management uses these non-GAAP measures when evaluating our operating performance and for internal planning and forecasting purposes. Management believes that such measures help indicate underlying trends in our business, are important in comparing current results with prior period results, and are useful to investors and financial analysts in assessing our operating performance. For example, management considers non-GAAP net (loss) income attributable to EnerNOC to be an important indicator of the overall performance because it eliminates the effects of events that are either not part of our core operations or are non-cash compensation expenses. In addition, management considers adjusted EBITDA to be an important indicator of our operational strength and the performance of our business and a good measure of our historical operating trend. Moreover, management considers free cash flow to be an important indicator of our operating trend and the performance of our business.
The following is an explanation of the non-GAAP measures that we utilize, including the adjustments that management excluded as part of the non-GAAP measures:
•
Management defines non-GAAP net (loss) income attributable to EnerNOC as net (loss) income attributable to EnerNOC before accretion expense related to the debt-discount portion of interest expense associated with the convertible note issuance, stock-based compensation, direct and incremental expenses related to acquisitions, divestitures, or restructuring activities, impairment of goodwill, gains on early extinguishment of debt, and amortization expenses related to acquisition-related intangible assets, net of related tax effects.
•
Management defines adjusted EBITDA as net (loss) income attributable to EnerNOC excluding depreciation, amortization, asset impairments, stock-based compensation, direct and incremental expenses related to acquisitions, divestitures and restructuring activities, impairment of goodwill, gains on early extinguishment of debt, interest expense, income taxes and other expense, net.
•
Management defines free cash flow as net cash provided by operating activities, less capital expenditures, plus net cash provided by the sale of assets or disposals of components of an entity. Management defines capital expenditures as purchases of property and equipment, which includes capitalization of internal-use software development costs.
Material Limitations Associated with the Use of Non-GAAP Financial Measures
Non-GAAP net (loss) income attributable to EnerNOC, non-GAAP net (loss) income per share attributable to EnerNOC, adjusted EBITDA and free cash flow may have limitations as analytical tools. The non-GAAP financial information presented here should be considered in conjunction with, and not as a substitute for or superior to the financial information presented in accordance with GAAP and should not be considered measures of our liquidity. There are significant limitations associated with the use of non-GAAP financial measures. Further, these measures may differ from the non-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.
Non-GAAP Net (Loss) Income Attributable to EnerNOC and Non-GAAP Net (Loss) Income per Share Attributable to EnerNOC
Net loss for the year ended December 31, 2015 was $(185.1) million, or $(6.51) per both basic and per diluted share, compared to net income of $12.1 million, or $0.43 per basic share and $0.42 per diluted share for the year ended December 31, 2014, and net income of $22.1 million, or $0.80 per basic share and $0.76 per diluted share for the year ended December 31, 2013. Non-GAAP net loss for the year ended December 31, 2015 was $(56.3) million, or $(1.98) per diluted share, compared to non-GAAP net income of $39.9 million, or $1.39 per diluted share for the year ended December 31, 2014, and non-GAAP net income of $45.0 million or $1.55 per diluted share for the year ended December 31, 2013.
The reconciliation of GAAP net (loss) income attributable to EnerNOC to non-GAAP net (loss) income attributable to EnerNOC is set forth below (dollars in thousands, except share and per share data):
(1) Includes costs for third party professional services (legal, accounting, valuation) and severance.
Adjusted EBITDA
Adjusted EBITDA was $(21.1) million, $76.4 million and $71.4 million for the years ended December 31, 2015, 2014 and 2013, respectively.
The reconciliation of net (loss) income to adjusted EBITDA is set forth below (dollars in thousands):
(1)
Includes impairments to fixed assets and other long term assets recorded during the year ended December 31, 2015.
(2)
Includes costs for third party professional services (legal, accounting, valuation) and severance.
(3)
Other expense, net primarily relates to foreign currency (gains) losses.
(4)
Excludes discrete tax provision of $985 recorded during the year ended December 31, 2014 related to the sale of the USC business component.
Free Cash Flow
Cash flows from operating activities were $3.5 million, $60.4 million and $79.5 million for the years ended December 31, 2015, 2014 and 2013, respectively. We had $(16.2) million, $42.9 million and $42.8 million of free cash flow for the years ended December 31, 2015, 2014 and 2013, respectively. The reconciliation of cash flows from operating activities to free cash flow is set forth below (dollars in thousands):
Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition for multiple element arrangements, allowance for doubtful accounts, valuations and purchase price allocations related to business combinations, expected future cash flows including growth rates, discount rates, terminal values and other assumptions and estimates used to evaluate the recoverability of long-lived assets and goodwill, estimated fair values of intangible assets and goodwill, amortization methods and periods, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, tax reserves and recoverability of our deferred tax assets and related valuation allowance. We base our estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates if past experience or other assumptions do not turn out to be substantially accurate. Any differences could have a material impact on our financial condition and results of operations.
Of our significant accounting policies, which are described in Note 1 to our consolidated financial statements contained in Appendix A to this Annual Report on Form 10-K, we believe that the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations.
Revenue Recognition
We recognize revenues in accordance with ASC 605, Revenue Recognition (ASC 605). Our customers include enterprises, grid operators, and utilities. We derive revenues from the sale of our EIS and demand response solutions. We recognize revenues when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and we deem collection to be reasonably assured.
We maintain a reserve for customer adjustments and allowances as a reduction in revenues. In determining our revenue reserve estimate, we rely on historical data and known performance adjustments. These factors, and unanticipated changes in the economic and industry environment, could cause our reserve estimates to differ from actual results. We record a provision for estimated customer adjustments and allowances in the same period as the related revenues are recorded. These estimates are based on the specific facts and circumstances of a particular program, analysis of credit memo data, historical customer adjustments, and other known factors. If the data we use to calculate these estimates do not properly reflect reserve requirements, then a change in the allowances would be made in the period in which such a determination was made and revenues in that period could be affected.
Revenues from grid operators and revenues from utilities principally represent demand response revenues. During the years ended December 31, 2015, 2014 and 2013, revenues from grid operators and utilities were comprised of $314.3 million, $424.5 million and $342.1 million, respectively, of demand response revenues.
Our revenues from the sales of our EIS to our enterprise and utility customers generally represent ongoing software or service arrangements under which the revenues are recognized ratably over the same period commencing upon delivery of the EIS to the enterprise and utility customer. Under certain of our arrangements, a portion of the fees received may be subject to adjustment or refund based on the validation of the energy savings delivered after the implementation is complete. As a result, we defer the portion of the fees that are subject to adjustment or refund until such time as the right of adjustment or refund lapses, which is generally upon completion and validation of the implementation.
Our demand response revenues from the sales of our demand response solutions to our utility customers and grid operators primarily consist of capacity and energy payments, including ancillary services payments, as well as payments derived from the effective management of our portfolio of demand response capacity, including our participation in capacity auctions and third-party contracts, and ongoing fixed fees for the overall management of utility-sponsored demand response programs. In addition, we also earn revenues from the provision of our demand response solutions in the form of ongoing fees from utility customers for overall management of utility-sponsored demand response programs. These fees are typically based on enrolled capacity or enrolled C&I end-users, and are not subject to adjustment based on performance during demand response dispatches. We recognize revenues from these fees ratably over the applicable service delivery period commencing upon when the C&I end-users have been enrolled and the contracted services have been delivered. In addition, under this offering we may receive additional fees for program start-up, as well as for C&I end-user installations. We have determined that these fees do not have stand-alone value due to the fact that such services do not have value without the ongoing services related to the overall management of the utility demand response program and therefore, we recognize these fees over the estimated customer relationship period, which is generally the greater of three years or the contract period, commencing upon the enrollment of the C&I end-users and delivery of the contracted services.
For further discussion of revenue recognition, please refer to Note 1 contained in Appendix A to this Annual Report on Form 10-K.
Business Combinations
We record tangible and intangible assets acquired and liabilities assumed in business combinations under the purchase method of accounting. Amounts paid for each acquisition are allocated to the assets acquired and liabilities assumed based on their fair values at the dates of acquisition. The fair value of identifiable intangible assets is based on valuations that use information and assumptions provided by us. We estimate the fair value of contingent consideration at the time of the acquisition using all pertinent information known to us at the time to assess the probability of payment of contingent amounts. We allocate any excess purchase price over the fair value of the net tangible and intangible assets acquired and liabilities assumed to goodwill.
We primarily use the income approach to determine the estimated fair value of identifiable intangible assets, including customer relationships, non-compete agreements and trade names. This approach determines fair value by estimating the after-tax cash flows attributable to an in-process project over its useful life and then discounting these after-tax cash flows back to a present value. We base our revenue assumptions on estimates of relevant market sizes, expected market growth rates and expected trends, including introductions by competitors of new EIS and demand response solutions, services and products. We base the discount rate used to arrive at a present value as of the date of acquisition on the time value of money and market participant investment risk factors. The use of different assumptions could materially impact the purchase price allocation and our financial condition and results of operations.
Intangible Assets
We amortize our intangible assets that have finite lives using either the straight-line method or, if reliably determinable, based on the pattern in which the economic benefit of the asset is expected to be consumed utilizing expected undiscounted future cash flows. Amortization is recorded over the estimated useful lives ranging from one to fourteen years. We review our intangible assets subject to amortization to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life. If the carrying value of an asset exceeds its undiscounted cash flows, we will write-down the carrying value of the intangible asset to its fair value in the period identified. In assessing recoverability, we must make assumptions regarding estimated future cash flows. If these estimates or related assumptions change in the future, we may be required to record impairment charges. To the extent fair value estimates are required, we generally calculate fair value as the present value of estimated future cash flows to be generated by the asset using a risk-adjusted discount rate. If the estimate of an intangible asset’s remaining useful life is changed, we will amortize the remaining carrying value of the intangible asset prospectively over the revised remaining useful life.
In estimating the useful life of the acquired assets, we consider ASC 350-30-35, General Intangibles Other Than Goodwill (ASC 350-30-35), which lists the pertinent factors to be considered when estimating the useful life of an intangible asset. These factors include a review of the expected use by the combined Company of the assets acquired, the expected useful life of another asset (or group of assets) related to the acquired assets, legal, regulatory or other contractual provisions that may limit the useful life of an acquired asset or may enable the extension of the useful life of an acquired asset without substantial cost, the effects of obsolescence, demand, competition and other economic factors, and the level of maintenance expenditures required to obtain the expected future cash flows from the asset.
Goodwill
Goodwill represents the amount of the purchase price in excess of the fair values assigned to the underlying identifiable net assets of acquired businesses. Goodwill is assessed annually for potential impairment on November 30 or when management
determines that the carrying value of goodwill may not be recoverable based upon the existence of certain indicators of impairment, such as a loss of a significant customer, a significant change in the Company’s regulatory environment that hinders the ability to conduct business, or a significant downturn in the economy. Goodwill is tested for impairment at the reporting unit level using a two-step process. The first step compares the fair value of the reporting unit to its carrying value. If the carrying value exceeds the fair value, the second step of the test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of reporting unit goodwill with the carrying value of that goodwill. To calculate the implied fair value of goodwill in this second step, the Company allocates the fair value of the reporting unit to all of the assets and liabilities of that reporting unit (including any previously unrecognized intangible assets) as if the reporting unit had been acquired in a current business combination and the fair value was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amount assigned to the assets and liabilities of the reporting unit represents the implied fair value of goodwill. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized for the difference.
In order to determine the fair values of our reporting units, we utilize both a market approach based on the quoted market price of our common stock and the number of shares outstanding and a DCF model under the income approach. The key assumptions that drive the fair value in the DCF model are the discount rates, terminal values, growth rates, and the amount and timing of expected future cash flows. The annual impairment testing process is subjective and requires judgment at many points throughout the analysis. If these estimates or their related assumptions change in the future, we may be required to record additional impairment charges for these assets not previously recorded.
As a result of our annual goodwill impairment test conducted as of November 30, 2015, we recognized a $108.8 million goodwill impairment charge. See Note 4 contained in Appendix A to this Annual Report on Form 10-K for additional information.
Impairment of Long-Lived Assets
We review long-lived assets, including property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable over their remaining estimated useful life. If these assets are considered to be impaired, the long-lived assets are measured for impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets or liabilities. Impairment is recognized in earnings and equals the amount by which the carrying value of the assets exceeds their fair value determined by either a quoted market price, if any, or a value determined by utilizing a DCF technique. If these assets are not impaired, but their useful lives have decreased, the remaining net book value is amortized over the revised useful life.
During the years ended December 31, 2015, 2014 and 2013, we identified impairment indicators related to certain production equipment as a result of the removal of such equipment from operational sites during each of these respective years. As such, the equipment had no remaining useful life and no fair value. The remaining net carrying value was written off, resulting in the recognition of impairment charges of $0.5 million, $1.1 million, and $0.7 million, respectively, which is included in cost of revenues in the accompanying consolidated statements of operations.
Software Development Costs
We capitalize eligible costs associated with software developed or obtained for internal use. We capitalize the payroll and payroll-related costs of employees and applicable third party costs that devote time to the development of internal-use computer software. We amortize these costs on a straight-line basis over the estimated useful life of the software, which is generally two to five years. Our judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value and impairment of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. Internal use software development costs of $8.4 million, $6.0 million and $7.9 million for the years ended December 31, 2015, 2014 and 2013, respectively, have been capitalized.
The costs for the development of new software and substantial enhancements to existing software that is intended to be sold or marketed (external use software) are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. We determine that technological feasibility of external use software is established at the time a working model of software is completed. Because we believe our current process for developing external use software will be essentially completed concurrently with the establishment of technological feasibility, no such costs have been capitalized to date.
Stock-Based Compensation
We issue various types of stock-based awards to employees, non-employees, board members and advisory board members under stockholder-approved plans. When applicable, we measure compensation cost at fair value on the grant date and recognize this cost as stock-based compensation expense over the requisite service period. We make estimates and assumptions which impact the amounts of expense recognized in our consolidated statement of operations, including estimated forfeiture rates. Also, for awards which include performance conditions, we make estimates as to the probability that the underlying
performance conditions will be met. Changes to these estimates and assumptions may have a significant impact on the value and timing of stock-based compensation expense, which could have a material impact on our consolidated financial statements.
For stock option awards, determining the amount of stock-based compensation to be recorded requires us to develop estimates to be used in calculating the grant-date fair value. We use a lattice model to determine the fair value of our stock option awards. We consider a number of factors to determine the fair value of stock option awards. The model requires us to make estimates of the following assumptions:
Risk-free interest rate-The yield on zero-coupon U.S. Treasury securities, for a period that is commensurate with the award’s expected life, is used as the risk-free interest rate.
Vesting term-We use the weighted average vesting term of our stock option awards.
Expected volatility-We are responsible for estimating volatility and have considered a number of factors, including third-party estimates, when estimating volatility. We currently use a combination of historical and implied volatility, which is weighted based on a number of factors.
Expected dividend yield-We use a zero percent dividend yield because we have not paid dividends on our common stock in the past and do not plan to pay any dividends in the foreseeable future.
Exit rate pre-vesting and post-vesting-We use a forfeiture rate that is estimated based upon actual forfeitures one quarter in arrears for certain demographic employee pools. We believe that this historical data is currently the best estimate of the expected pre- and post-vesting forfeiture rates.
The fair value of stock awards where vesting is solely based on service vesting conditions is expensed ratably over the vesting period. With respect to certain awards of restricted stock where vesting contains certain performance-based vesting conditions, the fair value is expensed based on the accelerated attribution method as prescribed by ASC 718, Stock Compensation (ASC 718) over the vesting period.
Accounting for Income Taxes
We use the asset and liability method for accounting for income taxes. Under this method, we determine deferred tax assets and liabilities based on the difference between financial reporting and tax bases of our assets and liabilities. We measure deferred tax assets and liabilities using enacted tax rates and laws that will be in effect when we expect the differences to reverse.
Our deferred tax assets relate primarily to net operating losses and tax credit carryforwards, intangible assets, deferred revenue, and stock-based compensation. We have accumulated consolidated net losses since our inception and as a result, we have recorded a valuation allowance against certain of our deferred tax assets. Our deferred tax liabilities primarily relate to our acquisitions, depreciation of property and equipment, and the convertible debt issued in 2014.
ASC 740, Income Taxes (ASC 740), prescribes a recognition threshold and measurement criteria for tax positions taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition and defines the criteria that must be met for the benefits of a tax position to be recognized.
In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Judgment is required in determining our worldwide income tax provision. Although we believe our estimates are reasonable, no assurance can be given that the final outcome of tax matters will be consistent with our historical income tax accruals, and the differences could have a material impact on our income tax provision and operating results in the period in which such determination is made.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, please refer to Note 1, "Description of Business, Basis of Presentation and Summary of Significant Accounting Policies" to our consolidated financial statements included in Appendix A to this Annual Report on Form 10-K.
Selected Quarterly Financial Data
The table below sets forth selected unaudited quarterly financial information. The information is derived from our unaudited consolidated financial statements and includes, in the opinion of management, all normal and recurring adjustments that management considers necessary for a fair statement of results for such periods. The operating results for any quarter are not necessarily indicative of results for any future period (in thousands, except share and per share data).
(1) The three month period ended June 30, 2015 includes an adjustment in the consolidated statement of operations to increase cost of revenue by approximately $610 related to the recognition of payments owed to enterprise customers enrolled in demand response programs related to the year ended December 31, 2014.
(2) The three month period ended December 31, 2015 includes an increase to revenue and a decrease to cost of revenue of $592 in the consolidated statement of operations to reflect the 2015 year-to-date impact related to the presentation of consideration from a customer who is also a C&I end-user. In addition, the three month period ended December 31, 2015 includes a goodwill impairment charge of $108.8 million, net of a $7.9 million tax benefit, as well as a $9.2 million gain on the extinguishment of debt.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosure About Market Risk
Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments
ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments. Financial instruments principally consist of cash equivalents, marketable securities, accounts receivable, and debt obligations. The fair value of these financial instruments approximates their carrying amount.
Foreign Currency Exchange Risk
Our international business is subject to risks, including, but not limited to unique economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.
A majority of our foreign expense and revenue activities are transacted in local currencies, including Australian dollars, Euros, Brazilian real, British pounds, Canadian dollars, Indian rupee, Japanese yen, South Korean won and New Zealand dollars. Fluctuations in foreign currency rates could affect our sales, cost of revenues and profit margins and could result in exchange losses. In addition, currency devaluations can result in a loss if we maintain deposits or receivables (third party or intercompany) in a foreign currency. During each of the years ended December 31, 2015, 2014 and 2013, our revenues generated outside the United States were 22%, 21% and 19%, respectively. We anticipate that revenues generated outside the United States will continue to represent greater than 10% of our consolidated revenues and will continue to grow in subsequent fiscal years.
The operating expenses of our international subsidiaries that are incurred in local currencies did not have a material adverse effect on our business, results of operations or financial condition for fiscal 2015 and 2014. Our operating results and certain assets and liabilities that are denominated in foreign currencies are affected by changes in the relative strength of the U.S. dollar against the applicable foreign currency. Our operating expenses denominated in foreign currencies are positively affected when the U.S. dollar strengthens against the applicable foreign currency and adversely affected when the U.S. dollar weakens.
During the years ended December 31, 2015, 2014 and 2013, we recognized foreign exchange losses of $8.0 million, $4.4 million and $1.7 million, respectively. This primarily relates to inter-company receivables denominated in foreign currencies, largely driven by fluctuations to the U.S. dollar in the Canadian Dollar, the EURO, and Australian dollar, which weakened by 16%, 10% and 11%, respectively against the U.S. Dollar.
We currently do not have a program in place that is designed to mitigate our exposure to changes in foreign currency exchange rates. We are evaluating certain potential programs, including the use of derivative financial instruments, to reduce our exposure to foreign exchange gains and losses, and the volatility of future cash flows caused by changes in currency
exchange rates. The utilization of forward foreign currency contracts would reduce, but would not eliminate, the impact of currency exchange rate movements.
Interest Rate Risk
We incur interest expense on borrowings outstanding under the Notes and 2014 credit facility. The Notes have fixed interest rates. Borrowings under our 2014 credit facility bear interest at a rate per annum, at our option, initially. The interest on revolving loans under the 2014 credit facility will accrue, at our election, at either (i) the LIBOR (determined based on the per annum rate of interest at which deposits in United States Dollars are offered to SVB in the London interbank market) plus 2.00%, or (ii) the “prime rate” as quoted in the Wall Street Journal with respect to the relevant interest period plus 1.00%.
As of December 31, 2015, we had no aggregate principal amount outstanding under the 2014 credit facility and had outstanding letters of credit totaling $22.4 million under the 2014 credit facility.
The return from cash and cash equivalents will vary as short-term interest rates change. A hypothetical 10% increase or decrease in interest rates, however, would not have a material adverse effect on our financial condition.
Item 8.
Item 8.
Financial Statements and Supplementary Data
All financial statements and schedules required to be filed hereunder are included as Appendix A hereto and incorporated into this Annual Report on Form 10-K by reference.
Item 9.
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Disclosure Controls and Procedures.
Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K, have concluded that, based on such evaluation, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework), or the COSO criteria.
Based on this assessment, management believes that, as of December 31, 2015, our internal control over financial reporting was effective based on these criteria.
Ernst & Young LLP, the independent registered public accounting firm that audited our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, has issued an attestation report on our internal control over financial reporting. That report appears below in this Item 9A under the heading “Report of Independent Registered Public Accounting Firm.”
Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
EnerNOC, Inc.
We have audited EnerNOC, Inc.’s internal control over financial reporting as of December 31, 2015 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). EnerNOC, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, EnerNOC, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of EnerNOC, Inc. as of December 31, 2015 and December 31, 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015 of EnerNOC, Inc. and our report dated March 10, 2016 expressed an unqualified opinion thereon.
Boston, Massachusetts /s/ Ernst & Young LLP
March 10, 2016
Item 9B.
Item 9B.
Other Information
Not applicable.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this Item will be contained in our definitive proxy statement for our 2016 Annual Meeting of Stockholders under the captions “Directors and Executive Officers,” “Corporate Governance and Board Matters-Corporate Code of Conduct and Ethics,” “Corporate Governance and Board Matters-Procedures for Recommending Nominees for Our Board of Directors,” “Corporate Governance and Board Matters-Committees of the Board of Directors-Audit Committee,” and “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated by reference herein.
The information required by this Item will be contained in our definitive proxy statement for our 2016 Annual Meeting of Stockholders under the captions “Information About Executive and Director Compensation,” “Corporate Governance and Board Matters-Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” and is incorporated by reference herein.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item will be contained in our definitive proxy statement for our 2016 Annual Meeting of Stockholders under the captions “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management” and is incorporated by reference herein.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by this Item will be contained in our definitive proxy statement for our 2016 Annual Meeting of Stockholders under the captions “Certain Relationships and Related Transactions” and “Corporate Governance and Board Matters-Board Determination of Independence” and is incorporated by reference herein.
Item 14.
Item 14.
Principal Accounting Fees and Services
The information required by this Item will be contained in our definitive proxy statement for our 2016 Annual Meeting of Stockholders under the proposal captioned “Ratification of Appointment of Independent Registered Public Accounting Firm” and is incorporated by reference herein.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules
(a)
The following are filed as part of this Annual Report on Form 10-K:
1.
Financial Statements
The following consolidated financial statements beginning on page of Appendix A are included in this Annual Report on Form 10-K:
•Report of Independent Registered Public Accounting Firm
•Consolidated Balance Sheets as of December 31, 2015 and 2014
•Consolidated Statements of Operations for the Years ended December 31, 2015, 2014 and 2013
•Consolidated Statements of Comprehensive (Loss) Income for the Years ended December 31, 2015, 2014 and 2013
•Consolidated Statements of Changes in Stockholders’ Equity for the Years ended December 31, 2015, 2014 and 2013
•Consolidated Statements of Cash Flows for the Years ended December 31, 2015, 2014 and 2013
•Notes to Consolidated Financial Statements
(b)
Exhibits
The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed with or incorporated by reference in this Annual Report on Form 10-K.
(c)
Financial Statement Schedules
All other schedules have been omitted since the required information is not present, or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
APPENDIX A
EnerNOC, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
EnerNOC, Inc.
We have audited the accompanying consolidated balance sheets of EnerNOC, Inc. as of December 31, 2015 and December 31, 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of EnerNOC, Inc. at December 31, 2015 and December 31, 2014, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in 2015 the Company changed the manner in which it accounts for the classification of deferred taxes in the consolidated balance sheets due to the adoption of the amendments to the FASB Accounting Standards Codification resulting from Accounting Standards Update 2015-17, Balance Sheet Classification of Deferred Taxes, effective December 31, 2015 and the manner in which it accounts for the classification of debt issuance costs as a result of the adoption of Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, effective December 31, 2015.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), EnerNOC, Inc.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 10, 2016 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Boston, Massachusetts
March 10, 2016
EnerNOC, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share data)
EnerNOC, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
EnerNOC, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
EnerNOC, Inc.
CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS’ EQUITY
(in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
EnerNOC, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
EnerNOC, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
1. Description of Business, Basis of Presentation and Summary of Significant Accounting Policies
Description of Business
EnerNOC, Inc. (the Company) is a leading provider of energy intelligence software (EIS) and demand response solutions to enterprises, utilities, and electric power grid operators.
The Company’s enterprise customers use the Company's Software-as-a-Service (SaaS) solutions to improve how they manage and control energy costs for their organizations, while utilities leverage the Company's SaaS solutions to better engage their customers, deliver savings and consumption reductions to help achieve energy efficiency mandates, manage system peaks and grid constraints, and increase demand for utility-provided products and services.
In addition, the Company’s demand response solutions provide its utility customers and electric power grid operators with a managed service demand response resource that matches obligation, in the form of megawatts (MWs) that the Company agrees to deliver to the Company’s utility customers and electric power grid operators, with supply, in the form of MWs that are curtailed from the electric power grid through its arrangements with commercial, institution and industrial end-users of energy (C&I end-users). The Company’s demand response solutions are also capable of providing its utility customers with the underlying technology to manage their own utility-sponsored demand response programs and secure reliable demand-side resources.
In addition, the Company offers premium professional services that support the implementation of its EIS and help its enterprise customers set their energy management strategy, as well as provide energy audits and retro-commissioning.
Recently Adopted Accounting Standards
The Company has reclassified certain amounts on its consolidated balance sheet for the year ended December 31, 2014 to conform to the 2015 presentation.
In November 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred income taxes. ASU 2015-17 requires that deferred tax assets and liabilities be classified as non-current in a classified statement of financial position. ASU 2015-17 is effective for financial statements issued for fiscal years beginning after December 15, 2016 (and interim periods within those fiscal years) with early adoption permitted. ASU 2015-17 may be either applied prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. The Company has elected to early-adopt ASU 2015-17 prospectively effective for the December 31, 2015 balance sheet. As a result, the Company has presented all deferred tax assets and liabilities as non-current on its consolidated balance sheet as of December 31, 2015, and has not reclassified current deferred tax assets and liabilities on its consolidated balance sheet as of December 31, 2014. There was no impact on the Company's consolidated results of operations or cash flows as a result of the adoption of ASU 2015-17.
In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this update require that debt issuance costs related to a recognized debt liability (other than revolving credit facilities) be presented on the consolidated balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015 (and interim periods within those fiscal years) with early adoption permitted. ASU 2015-03 must be applied retrospectively to all periods presented. The Company elected to early-adopt ASU 2015-03 retrospectively as of December 31, 2015, as permitted. In accordance with ASU 2015-03, prior period deferred financing costs of $3,818 as of December 31, 2014, consisting of $687 of current and $3,131 of non-current assets, were reclassified to long term liabilities as a direct reduction to the associated debt in conformity with current year presentation.
Reclassifications and Presentational Changes
In addition to the reclassifications noted above, the Company condensed presentation of certain balances in its consolidated balance sheet as of December 31, 2014 to conform with December 31, 2015. Specifically, the Company condensed presentation of (i) the noncurrent portion of capitalized incremental direct customer costs, which is currently included in Deposits and other assets and (ii) Accrued acquisition consideration, which is currently included in Other liabilities.
Basis of Presentation
The accompanying consolidated financial statements of the Company include the accounts of its wholly-owned subsidiaries and have been prepared in conformity with accounting principles generally accepted in the United States. Inter-
company transactions and balances are eliminated upon consolidation. The Company owns 60% of EnerNOC Japan K.K., for which it consolidates the operations in accordance with Accounting Standards Codification (ASC) 810, Consolidation. The remaining 40% is accounted for as a non-controlling interest in the accompanying consolidated balance sheet and statements of operations.
Summary of Significant Accounting Policies
Use of Estimates in the Preparation of Financial Statements
The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant estimates made by management relate to revenue recognition reserves, allowance for doubtful accounts, valuations and purchase price allocations related to business combinations and goodwill impairment analysis, including the fair value of intangible assets, expected future cash flows used to evaluate the recoverability of long-lived assets, long-lived asset amortization method and periods, valuation of cost-method investments, certain accrued expenses and other related charges, stock-based compensation, contingent liabilities, tax reserves and recoverability of the Company's net deferred tax assets and related valuation allowance. While the Company believes that such estimates are fair when considered in conjunction with the consolidated financial statements taken as a whole, the actual amounts of such items, when known, could differ from these estimates.
Cash and Cash Equivalents and Restricted Cash
Cash equivalents are comprised of highly liquid investments with insignificant interest rate risk and maturities of three months or less at the time of acquisition. Restricted cash as of December 31, 2015 and 2014 primarily represents cash used to fund certain health insurance commitments. The Company held no marketable securities as of December 31, 2015 or 2014.
Fair Value of Financial Instruments
The Company measures the fair value of financial instruments pursuant to the guidelines of ASC Topic (820) Fair Value Measurement, which establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to quoted market prices in active markets for identical assets and liabilities (Level 1), then to 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 2), and then to model-based techniques that use significant assumptions not observable in the market (Level 3). See Note 6 for further fair value disclosures.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk principally consist of cash and cash equivalents, accounts receivable and unbilled revenue. The Company maintains its cash and cash equivalent balances with highly rated financial institutions and as a result, such funds are subject to minimal credit risk.
The Company’s significant customers consist of PJM Interconnection (PJM) and the Australian Independent Market Operator Wholesale Electricity Market (AEMO), which was formerly known as Independent Market Operator. PJM is an electric power grid operator customer in the mid-Atlantic region of the United States that is comprised of multiple utilities and was formed to control the operation of the regional power system, coordinate the supply of electricity, and establish fair and efficient markets. AEMO is an entity that was established to administer and operate the Western Australia (WA) wholesale electricity market. No other customers accounted for more than 10% of the Company’s consolidated revenues for the years ended December 31, 2015, 2014 or 2013.
The following table presents the Company’s significant customers.
The following table presents customers who comprised 10% or more of the Company’s accounts receivable balance.
Unbilled revenue related to PJM was $68,859 and $96,404 at December 31, 2015 and 2014, respectively. There was no significant unbilled revenue for any other customers at December 31, 2015 and 2014.
Deposits consist of funds to secure performance under certain contracts and open market bidding programs with electric power grid operator and utility customers. Deposits held by customers were $102 and $3,142 as of December 31, 2015 and 2014, respectively.
Property and Equipment
Property and equipment, which includes computer equipment, office equipment, capitalized software, furniture and fixtures, and leasehold improvements, is stated at cost and depreciated using the straight-line method over the estimated useful lives of the respective assets, ranging from three to ten years. Production equipment is depreciated over the lesser of its useful life or the estimated enterprise customer relationship period, which historically has been approximately three years. Leasehold improvements are amortized over their useful life or the remaining lease term, whichever is shorter. Expenditures that improve or extend the life of an asset are capitalized while repairs and maintenance expenditures are expensed as incurred. The estimated useful lives, by asset classification, are as follows:
Software Development Costs
The Company delivers its software as a service to its customers. As a result, certain internal use software development costs qualify for capitalization under the provisions of ASC 350-40, Internal-Use Software (ASC 350-40). ASC 350-40 requires internal use software development costs to be expensed as incurred unless certain capitalization criteria are met and defines which types of costs should be capitalized and which should be expensed. The Company capitalizes the payroll, payroll-related costs and external fees of its employees and external consultants who devote time to the application development stage of internal-use software projects. The Company amortizes these costs on a straight-line basis over the estimated useful life of the software, which is generally two to five years. The Company’s judgment is required in determining 1) software projects that qualify for capitalization, 2) the point at which various projects enter the stages at which costs may be capitalized, 3) the ongoing value and potential impairment of the capitalized costs, and 4) the estimated useful lives over which the costs are amortized. Internal use software development costs of $8,371, $5,955, and $7,947 during the years ended December 31, 2015, 2014, and 2013, respectively, have been capitalized. Amortization of capitalized software costs was $6,980, $6,162, and $5,732 for the years ended December 31, 2015, 2014, and 2013, respectively. Accumulated amortization of capitalized software costs was $34,583, $27,603 and $21,441 as of December 31, 2015, 2014 and 2013, respectively.
Impairment of Property and Equipment
The Company reviews long-lived assets, including property and equipment and intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable over its remaining estimated useful life. Long-lived assets are measured for impairment at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets or liabilities. Impairment expense is recognized in the consolidated statement of operations as the amount by which the carrying value of the asset exceeds its fair value. The fair value is determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow (DCF) technique. If these assets are not impaired, but their useful lives have decreased, the remaining net book value is amortized over the revised useful life.
The Company periodically impairs equipment deployed at third party locations as a result of the removal of such equipment from these sites prior to the end of the originally estimated life of the arrangement. Impairment charges of $523,
$1,071, and $706, were included in cost of revenues in the accompanying consolidated statements of operations, for the years ended 2015, 2014, and 2013, respectively.
Cost-Method Investments
The Company accounts for certain investments according to ASC 325-20, Cost Method Investments (ASC 325-20), whereby the investments are initially recorded at historical cost as long-term assets and are periodically assessed for indicators of a reduction to fair value that is other-than-temporary under the provisions of ASC 320, Investments-Debt and Equity Securities. As of December 31, 2015, the carrying amount of cost-basis investments was $2,500.
Based on the Company’s assessment as of December 31, 2015, the Company did not identify other-than-temporary impairment indicators related to its investments. The Company evaluated all available information, including current financial forecasts and recent or pending capital investments and financings related to its cost-method investments. The Company's investment in these cost-method investments is subject to risk given the future financial condition and results of operations of the entities. Should an adjustment to fair value be required as a result of the Company's analysis and conclusions, the resulting charge will be recorded in other expense, net on the consolidated statement of operations.
Business Combinations
The Company records tangible and intangible assets acquired and liabilities assumed in business combinations under the purchase method of accounting. Amounts paid for each acquisition are allocated to the assets acquired and liabilities assumed based on their fair values at the dates of acquisition. The fair value of identifiable intangible assets is based on valuations that use information and assumptions provided by the Company. The Company primarily uses the income approach to determine the estimated fair value of identifiable intangible assets, including customer relationships, non-compete agreements and trade names. The Company estimates the fair value of contingent consideration, if applicable, at the time of the acquisition based on its estimated probability of payment using all pertinent information known to the Company at the time. The Company allocates any excess purchase price over the fair value of the net tangible and intangible assets acquired and liabilities assumed to goodwill.
Intangible Assets
The Company amortizes its intangible assets that have finite lives using either the straight-line method or, if reliably determinable, based on the pattern in which the economic benefit of the asset is expected to be consumed utilizing expected undiscounted future cash flows. Amortization is recorded over the estimated useful lives ranging from one to fourteen years. The Company reviews its intangible assets subject to amortization to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life. If the carrying value of an asset exceeds its undiscounted cash flows, the Company adjusts the carrying value of the intangible asset to its fair value in the period identified. In assessing recoverability, the Company must make assumptions regarding estimated future cash flows. To the extent a fair value estimate is required, the Company generally calculates fair value as the present value of estimated future cash flows to be generated by the asset using a risk-adjusted discount rate. If the estimate of an intangible asset’s remaining useful life is changed, the Company amortizes the remaining carrying value of the intangible asset prospectively over the revised remaining useful life. During the years ended December 31, 2015 and 2014, the Company has not recorded any impairment charges adverse conditions or made significant changes in the useful lives of its definite-lived intangible assets. The Company had no indefinite-lived intangible assets as of December 31, 2015 and 2014.
Goodwill
Goodwill represents the amount of purchase price in excess of the fair values assigned to the underlying identifiable net assets of acquired businesses. In accordance with ASC 350, Intangibles-Goodwill and Other (ASC 350), the Company tests goodwill at the reporting unit level for impairment on an annual basis and between annual tests if events and circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying value. Events that would indicate impairment and trigger an interim impairment assessment include, but are not limited to, current economic and market conditions, including a decline in market capitalization, a significant adverse change in legal factors, business climate or operational performance of the business, an adverse action or assessment by a regulator, or the realignment of the Company's organization and management structure.
The Company has determined that it has two reporting units for the purpose of the annual goodwill impairment test: (1) North America Software and Services and (2) International. In determining its reporting units for purposes of the annual goodwill test, the Company considers how the components of its business are managed, whether the components have discrete financial information and how these components may be aggregated based on economic similarity and other factors. The Company’s annual impairment test date is November 30.
In performing the goodwill impairment test, the Company utilizes the two-step approach prescribed under ASC 350. The first step compares the carrying value of the reporting unit to its fair value. If the carrying value exceeds the fair value, the
second step of the test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of a reporting unit’s goodwill to its carrying value. To calculate the implied fair value of goodwill in the second step, the Company allocates the fair value of the reporting unit to all of the assets and liabilities of that reporting unit (including any previously unrecognized intangible assets) as if the reporting unit had been acquired in a current business combination and the fair value was the price paid to acquire the reporting unit. The excess of the fair value of the reporting unit over the amount assigned to the assets and liabilities of the reporting unit represents the implied fair value of goodwill. If the carrying value of goodwill exceeds the implied fair value of goodwill, an impairment loss is recognized for the difference.
In order to determine the fair value of its reporting units, the Company utilizes a DCF model under the income approach. The key assumptions that drive the fair value in the DCF model are the discount rates, terminal values, growth rates and profitability rates, and the amount and timing of expected future cash flows based on management's projected financial information, which is based on the Company's strategic plan. The other significant factor that management considers in determining the fair value of the Company's reporting units is the Company's overall market capitalization. The Company ensures that the collective fair value of its reporting units, taking into consideration excess cash and enterprise-level debt, reconciles to its market capitalization, which is calculated as the market price per share of the Company's common stock multiplied by common shares outstanding, while taking into consideration a reasonable premium that a market participant would pay to obtain control of the reporting unit (i.e. the control premium). Please refer to Note 4 for further discussion of the Company's current year impairment charge.
Income Taxes
The Company uses the asset and liability method for accounting for income taxes. Under this method, the Company determines deferred tax assets and liabilities based on the difference between financial reporting and tax bases of its assets and liabilities. The Company measures deferred tax assets and liabilities using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company’s deferred tax assets relate primarily to net operating losses and tax credit carryforwards, intangible assets, deferred revenue, and stock-based compensation. The Company has accumulated consolidated net losses since its inception and, as a result, recorded a valuation allowance against certain of its deferred tax assets. Deferred tax liabilities primarily relate to acquisitions, depreciation of property and equipment, and the convertible debt issued in 2014.
ASC 740, Income Taxes (ASC 740), prescribes a recognition threshold and measurement criteria for tax positions taken or expected to be taken in a tax return. ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition and defines the criteria that must be met for the benefits of a tax position to be recognized.
In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Judgment is required in determining the Company’s worldwide income tax provision. Although the Company believes its estimates are reasonable, no assurance can be given that the final outcome of tax matters will be consistent with its historical income tax accruals, and the differences could have a material impact on the Company’s income tax provision and operating results in the period in which such determination is made.
Revenue Recognition
The Company recognizes revenues in accordance with ASC 605, Revenue Recognition (ASC 605). The Company's customers include enterprises, utilities and grid operators. The Company derives recurring revenues from the sale of EIS and demand response solutions. The Company recognizes revenue when it is earned and all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and the Company deems collection to be reasonably assured.
The Company's grid operator revenues and utility revenues primarily reflect the sale of demand response solutions. During the years ended December 31, 2015, 2014 and 2013, revenues from grid operators and utilities were comprised of $314,305, $424,537 and $342,093, respectively, of demand response revenues.
The Company maintains a reserve for customer adjustments and allowances as a reduction in revenues. In determining the revenue reserve estimate, the Company relies on historical data and known performance adjustments. These factors, and unanticipated changes in the economic and industry environment, could cause the Company’s reserve estimates to differ from actual results. The Company records a provision for estimated customer adjustments and allowances in the same period as the related revenues are recorded. These estimates are based on the specific facts and circumstances of a particular program, analysis of credit memo data, historical customer adjustments, and other known factors. If the data the Company uses to calculate these estimates does not properly reflect reserve requirements, then a change in the allowances would be made in the period in which such a determination was made and revenues in that period could be affected. The company's revenue reserves were $975 and $475 as of December 31, 2015 and 2014, respectively.
The Company’s revenues from the sale of its EIS to its enterprise and utility customers generally represent ongoing software or service arrangements under which the revenues are recognized ratably over the same period commencing upon delivery of EIS to the enterprise or utility customer. Under certain of its arrangements, a portion of the fees received may be subject to adjustment or refund based on the validation of the energy savings delivered after the implementation is complete. As a result, the Company defers the portion of the fees that are subject to adjustment or refund until such time as the right of adjustment or refund lapses, which is generally upon completion and validation of the implementation.
Demand response revenues primarily consist of capacity and energy payments, including ancillary services payments, as well as payments derived from the effective management of its portfolio of demand response capacity, including its participation in capacity auctions and third-party contracts and ongoing fixed fees for the overall management of utility-sponsored demand response programs. The Company derives revenues from its demand response managed services by making demand response capacity available in open market programs and pursuant to contracts that the Company enters into with electric power grid operators and utilities.
The Company recognizes demand response capacity revenue when it has provided verification to the electric power grid operator or utility of its ability to deliver the committed capacity, which entitles the Company to payments under the contract or open market program. Committed capacity is generally verified through the results of an actual demand response event or a measurement and verification test. Once the capacity amount has been verified, the revenue is recognized and future revenue becomes fixed or determinable and is recognized monthly until the next demand response event or test. In subsequent verification events, if the Company’s verified capacity is below the previously verified amount, the electric power grid operator or utility customer may reduce future payments based on the adjusted verified capacity amounts. Ongoing demand response revenue recognized between demand response events or tests that are not subject to penalty or customer refund are recognized in revenue. If the revenue is subject to refund and the amount of refund cannot be reliably estimated, the revenue is deferred until the right of refund lapses.
The Company recognizes demand response energy revenues when earned. Energy event revenue is deemed to be substantive and represents the culmination of a separate earnings process and is recognized when the energy event is initiated by the electric power grid operator or utility customer and the Company has responded under terms of the contract or open market program. During the years ended December 31, 2015, 2014 and 2013 the Company recognized $1,642, $26,460, and $25,061, respectively, of energy event revenues.
Two new demand response programs, which the Company refers to as the PJM Extended program and the PJM Annual program, were introduced in the PJM market beginning in the 2014/2015 delivery year (June 1, 2014-May 31, 2015). Under the PJM Extended program, the delivery period is from June through October and then May in the subsequent calendar year. The revenues and any associated penalties, if any, for underperformance related to participation in the PJM Extended program are separate and distinct from the Company’s participation in other offerings within the PJM open market program. Consistent with the PJM Limited demand response program, the fees paid under this program could potentially be subject to adjustment or refund based on performance during the applicable performance period. Due to the lack of historical performance experience with the PJM Extended program, the Company is unable to reliably estimate the amount of fees potentially subject to adjustment or refund as of the end of September and therefore, revenue from the PJM Extended program is deferred and recognized at the end of the delivery period (i.e., May). Under the PJM Annual program, the delivery period is from June through May of the following year. Consistent with the PJM Limited and PJM Extended programs, to the extent the Company has MW obligation in the PJM Annual program, until the Company is able to reliably estimate the amount of fees potentially subject to adjustment or refund, revenue from the PJM Annual program will be deferred and recognized at the end of the delivery period (i.e., May). However, in the event the Company reduces its MW obligation for a given program to zero through the effective management of its portfolio, including the Company’s participation in PJM incremental auctions, the Company recognizes revenue from such products at the beginning of the delivery year.
As a result of the billing period not coinciding with the revenue recognition period, the Company had $68,859 and $96,404 in unbilled revenues from PJM at December 31, 2015 and December 31, 2014, respectively.
Historically, all capacity revenues related to the Company's participation in the Western Australia open market have been deferred and recognized upon an emergency event dispatch or the end of the program period on September 30th as the Company was not able to reliably estimate the amount of fees potentially subject to adjustment or refund. As of September 30, 2014, the Company determined that the amount of fees potentially subject to adjustment or refund were reliably estimable and began recognizing revenue ratably over the twelve month program period beginning with the new program year in Western Australia commencing on October 1, 2014.
With respect to demand response managed services for utility customers, the Company generally receives an ongoing fee for overall management of the utility demand response program based on enrolled capacity or enrolled C&I end-users, which is not subject to adjustment based on performance during a demand response dispatch. The Company recognizes revenues from these fees ratably over the applicable service delivery period commencing upon when the C&I end users have been enrolled
and the contracted services have been delivered. In addition, under this offering, the Company may receive additional fees for program start-up, as well as for C&I end-user installations. The Company has determined that these fees do not have stand- alone value due to the fact that such services do not have value without the ongoing services related to the overall management of the utility demand response program and therefore, the Company recognizes these fees over the estimated customer relationship period, which is generally the greater of three years or the contract period, commencing upon the enrollment of the C&I end-user and delivery of the contracted services.
Cost of Revenues
Cost of revenues primarily consist of amounts owed to C&I end-users for their participation in the Company’s demand response network and are generally recognized over the same performance period as the corresponding revenue. The Company enters into contracts with its enterprise customers under which it delivers recurring cash payments to them for the capacity they commit to make available on demand. The Company also generally makes energy payments when an enterprise customer reduces consumption of energy from the electric power grid during a demand response event. The demand response equipment and installation costs for the Company’s devices located at its enterprise customer and third party sites, which monitor energy usage, communicate with enterprise customer sites and, in certain instances, remotely control energy usage to achieve committed capacity, are capitalized and depreciated over the lesser of the remaining estimated customer relationship period or the estimated useful life of the equipment, and this depreciation is reflected in cost of revenues. The Company also includes in cost of revenues its amortization of acquired developed technology, amortization of capitalized internal-use software costs related to its EIS and demand response solutions, the monthly telecommunications and data costs it incurs as a result of being connected to enterprise customer sites, services and products, third-party services, equipment costs, equipment depreciation, its internal payroll and related costs allocated to an enterprise customer site, the wages and associated benefits that it pays to its project managers for the performance of their services, and related costs of revenue related to the delivery of services of its utility bill management solution. Certain costs, such as equipment depreciation and telecommunications and data costs, are fixed and do not vary based on revenues recognized.
Research and Development Expenses
Research and development expenses consist primarily of (a) salaries and related personnel costs, including costs associated with share-based payment awards, related to the Company’s research and development personnel, (b) payments to suppliers for design and consulting services, (c) costs relating to the design and development of new EIS and demand response solutions and enhancement of existing EIS and demand response solutions, (d) quality assurance and testing and (e) other related overhead. Costs incurred in research and development are expensed as incurred.
Stock-Based Compensation
The Company grants share-based awards to employees, non-employees, members of the board and advisory board members. The Company accounts for grants of stock-based compensation in accordance with ASC 718, Stock Compensation (ASC 718). The Company accounts for share-based awards granted to non-employees in accordance with ASC 505-50, Equity Based Payments to Non-Employees, which results in the Company continuing to re-measure the fair value of the non-employee share-based awards until such time as the awards vest. All share-based awards granted, including grants of stock options, restricted stock and restricted stock units, are recognized in the statement of operations based on their fair value as of the date of grant. As of December 31, 2015, the Company had two stock-based compensation plans, which are more fully described in Note 11.
All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest. Restricted stock typically vests ratably over a four years period from the date of issuance, with certain exceptions. The fair value of restricted stock upon which vesting is solely service-based is expensed ratably over the vesting period. With respect to restricted stock where vesting contains certain performance-based vesting conditions, the fair value is expensed based on the accelerated attribution method as prescribed by ASC 718, over the vesting period. With the exception of certain executives whose employment agreements provide for continued vesting in certain circumstances upon departure, if the employee who received the restricted stock leaves the Company prior to the vesting date for any reason, the shares of restricted stock will be forfeited and returned to the Company.
The fair value of stock options is estimated on the date of grant using a lattice valuation model. The lattice model considers characteristics of fair value option pricing that are not available under the Black-Scholes model. Similar to the Black-Scholes model, the lattice model takes into account variables such as expected volatility, dividend yield rate, and risk free interest rate. However, in addition, the lattice model considers the probability that the option will be exercised prior to the end of its contractual life and the probability of termination or retirement of the option holder in computing the value of the option. For these reasons, the Company believes that the lattice model provides a fair value that is more representative of actual experience and future expected experience than that value calculated using the Black-Scholes model.
A summary of significant assumptions used to estimate the fair value of stock options granted to employees were as follows:
The risk-free interest rate is the rate available as of the option date on zero-coupon U.S. Treasury securities with a term equal to the expected life of the option. Volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company calculates volatility using a component of implied volatility and historical volatility to determine the value of share-based payments. The Company has not paid dividends on its common stock in the past and does not plan to pay any dividends in the foreseeable future. In addition, the terms of the 2014 credit facility preclude the Company from paying dividends. The Company periodically evaluates its employee demographics and historical forfeiture experience to determine if its estimated pre-vesting and post-vesting exit rates need to be revised. During the years ended December 31, 2015 and 2014, the Company did not change its estimated pre-vesting and post-vesting exit rates.
Stock-based compensation expense recorded in the consolidated statements of operations was as follows:
(1) Stock-based compensation expense for the year ended December 31, 2015 includes $499 related to the acquisition of World Energy that was settled with the equivalent cash payments.
Stock-based compensation expense related to share-based awards granted to non-employees was not material for the years ended December 31, 2015, 2014 and 2013. The Company recognized no income tax benefits from share-based compensation arrangements during the year ended December 31, 2015 as compared to $625 and $595, respectively, during the years ended December 31, 2014 and 2013. No material compensation expense was capitalized during the years ended December 31, 2015, 2014 and 2013.
Beginning in 2014, the Company’s chief executive officer is required to receive his performance based bonus, if achieved, in shares of common stock. The Company recorded this amount as stock-based compensation expense ratably over the applicable performance and service period in accordance with ASC 718. During the years ended December 31, 2015 and 2014, the Company recorded $265 and $476, respectively, of stock-based compensation expense related to this performance based bonus. In accordance with ASC 718, the offsetting credit is recorded to accrued bonus during the year in which the bonus is earned. The accrued bonus is reduced with an offsetting credit to additional paid-in capital when the shares are issued.
Foreign Currency Translation
The financial statements of the Company’s international subsidiaries are translated in accordance with ASC 830, Foreign Currency Matters (ASC 830), into the Company’s reporting currency, which is the United States dollar. The functional currencies of the Company’s subsidiaries are the local currencies.
Assets and liabilities are translated to the United States dollar from the local functional currency at the exchange rate in effect at each balance sheet date. Before translation, the Company re-measures foreign currency denominated assets and liabilities, including certain inter-company accounts receivable and payable which have not been deemed a “long-term investment,” as defined by ASC 830, into the functional currency of the respective entity, resulting in unrealized gains or losses recorded in the consolidated statements of operations. Revenues and expenses are translated using average exchange rates during the respective periods.
Foreign currency translation adjustments are recorded as a component of stockholders’ equity within accumulated other comprehensive loss. Realized and unrealized losses of $8,040, and $4,417, and $1,732 arising from transactions denominated in
foreign currencies and the remeasurement of certain intercompany receivables and payables are included in Other expense, net on the consolidated statements of operations for the years ended December 31, 2015, 2014 and 2013, respectively.
Comprehensive (Loss) Income
Comprehensive (loss) income is defined as the change in equity of a business enterprise during a period resulting from transactions and other events and circumstances from non-owner sources. The Company’s comprehensive (loss) income is composed of net (loss) income and foreign currency translation adjustments. As of December 31, 2015 and 2014, accumulated other comprehensive loss was comprised solely of cumulative foreign currency translation adjustments. The Company presents its components of other comprehensive (loss) income, net of related tax effects, which have not been material to date.
Related Party Transactions
Transactions with related parties that are material to the consolidated financial statements, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business, are disclosed. A related party is an entity that can control or significantly influence the management or operating policies of another entity to the extent one of the entities may be prevented from pursuing their own interests. The Company has determined that there were no material related party transactions requiring disclosure in these consolidated financial statements.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-9). ASU 2014-09 provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. As amended, the new guidance is effective for annual and interim periods beginning after December 15, 2017, with early adoption permitted no earlier than the original effective date of the standard, which is the first quarter of fiscal 2017 for the Company. Unless the Company decides to early adopt the standard, ASU 2014-09 will be effective for the Company beginning in the first quarter of fiscal year 2018. ASU 2014-09 allows for full retrospective adoption applied to all periods presented or retrospective adoption with the cumulative effect of initially applying this update recognized at the date of initial application. The Company has not yet determined the method of adoption. The Company is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial position and results of operations and related disclosures.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014-15). The standard requires that the Company evaluates, at each interim and annual reporting period, whether there are conditions or events that raise substantial doubt about its ability to continue as a going concern within one year after the date the financial statements are issued, and provide related disclosures. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and for annual and interim periods thereafter, and early adoption is permitted. The Company does not expect to early adopt ASU 2014-15, which will be effective for its fiscal year ending December 31, 2016. The Company does not believe the standard will have a material impact on its consolidated financial position and results of operations.
In April 2015, the FASB issued ASU 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (ASU 2015-05). This amendment provides guidance to help entities determine whether a cloud computing arrangement contains a software license that should be accounted for as internal-use software or as a service contract. ASU 2015-05 is effective for interim and annual reporting periods beginning after December 15, 2015, with early adoption permitted. Upon adoption, an entity has the option to apply the provisions of ASU 2015-05 either prospectively to all arrangements entered into or materially modified, or retrospectively. The Company does not believe the standard will have a material impact on its consolidated financial position and results of operations.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments (ASU 2015-16). The standard requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standard update is effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. The standard update is to be applied prospectively to adjustments of provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. The Company does not believe the standard will have a material impact on its consolidated financial position and results of operations.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01), which provides new guidance on recognition and measurement of financial assets and financial liabilities. ASU 2016-01 will impact the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. All equity investments in unconsolidated entities (other than those accounted for under the equity method of accounting) will generally be measured at fair value with changes in fair
value recognized through earnings. There will no longer be an available-for-sale classification for equity securities with readily determinable fair values. In addition, the FASB clarified the need for a valuation allowance on deferred tax assets resulting from unrealized losses on available-for-sale debt securities. In general, the new guidance will require modified retrospective application to all outstanding instruments, with a cumulative effect adjustment recorded to opening retained earnings. This guidance will be effective January 1, 2018. The Company is currently evaluating the effect of the standard on its consolidated statements and related disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (ASU 2016-02). ASU 2016-02 requires lessees to recognize the assets and liabilities on their balance sheet for the rights and obligations created by most leases and continue to recognize expenses on their income statements over the lease term. The standard will also require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. The guidance is effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years, with early adoption permitted. The standard will be effective for the Company in fiscal 2019, unless the Company decides to early-adopt the standard. The Company is currently evaluating the effect of the standard on its consolidated financial statements.
2. Acquisitions
World Energy Solutions, Inc.
On January 5, 2015, the Company completed the acquisition of World Energy Solutions, Inc. (World Energy), an energy management software and services firm that helps enterprises simplify the energy procurement process through a suite of SaaS tools, including on-line energy procurement auctions. World Energy's headquarters is located in Worcester, Massachusetts. The Company believes that the acquisition and integration of World Energy's software into its EIS platform will help deliver more value to its enterprise customers through enhanced technology-enabled capabilities allowing customers to better manage the energy procurement process.
The Company concluded that this acquisition represented a business combination under the provisions of ASC 805, Business Combinations (ASC 805), but has concluded that it did not represent a material business combination, and therefore, no pro forma financial information is required to be presented. Subsequent to the acquisition date, the Company’s results of operations include World Energy operations.
The Company acquired World Energy for a purchase price of $79,913, consisting of $68,538 in cash paid at closing (which represented $5.50 per share of World Energy's outstanding common stock), the retirement of $9,468 of outstanding debt, $58 for the settlement of outstanding warrants, and $1,849 deemed to be purchase price related to the fair value of settled or exchanged outstanding equity awards, which were required to be settled or exchanged. The Company cash-settled the outstanding restricted stock awards and vested stock options for which the per share exercise price was equal to or less than $5.50 per share, and issued replacement awards for vested, out-of-the-money stock options and non-vested options for total value of $3,027. Of this amount, $1,849 was determined to represent purchase price consideration and $1,178 was determined to be post combination stock-based compensation expense. The Company recognized $443 as stock based compensation on the acquisition date as there was no remaining service period and will recognize the remaining $735 over the remaining service period, which is anticipated to expire 2.3 years following the acquisition date.
Transaction costs of $367 related to the acquisition of World Energy were expensed as incurred and are included in general and administrative expenses in the Company’s consolidated statements of operations.
The following table summarizes the purchase consideration for World Energy:
Purchase consideration:
The components and allocation of the purchase price consist of the following amounts:
(1)
During the period following the acquisition of World Energy, the Company adjusted the preliminary purchase price allocation to net deferred income tax liabilities which reduced the liability by $281 based on information obtained during the period subsequent to the acquisition date that was not available on the acquisition date, including tax return filing information.
The goodwill is not deductible for tax purposes. The deferred income tax liability recorded in connection with the allocation of the purchase price relates to the book and tax basis difference of the acquired definite-lived intangible assets where the book amortization expense for such assets will not be deductible for tax purposes. As noted above, the Company allocated purchase price of $41,400 to identifiable intangible assets, including developed technology, customer relationships and backlog. As of the acquisition, the Company determined that there was no in-process research and development as the ongoing activity related to the developed technology were more related to routine, ongoing maintenance efforts. The Company amortizes the acquired intangible assets of World Energy over their estimated useful lives based on estimated future cash flows, which the Company believes best matches the pattern in which the economic benefits provided by the intangible assets are realized. As of December 31, 2015, the acquired intangible assets have remaining lives as follows: developed technology (9 years), customer relationships (14 years), and contract backlog of (5 years).
Net tangible assets acquired in the acquisition of World Energy primarily related to the following:
(1) During the period following the acquisition of World Energy, the Company adjusted the preliminary purchase price allocation to accounts receivable by ($692) and accrued expenses and other current liabilities by ($300) based on information obtained during the period subsequent to the acquisition date as the information provided insight as to the fair value of these assets and liabilities as of the acquisition date.
The acquisition of World Energy included the World Energy Efficiency Services business (WEES), which provides comprehensive energy efficiency services in New England. As of the acquisition date of January 5, 2015, the Company committed to a plan to sell WEES. Based on the Company’s evaluation of the assets held for sale criteria under ASC 360-10, Impairment and Disposal of Long-Lived Assets, the Company concluded all of the criteria were met and that the assets and liabilities of WEES that were expected to be sold should be classified as held for sale as of January 5, 2015. A definitive asset purchase agreement was executed on July 31, 2015 and the sale of WEES subsequently closed on October 16, 2015.
The Company received $946 in cash for the sale of the business, which included $196 for working capital, including costs incurred on in-process contracts, and an allocation of goodwill of $750 from the World Energy acquisition. No gain or loss was recorded on the sale.
Pulse Energy
On December 1, 2014, the Company completed an acquisition of all of the outstanding stock of Pulse Energy Inc. (Pulse Energy), a privately-held company headquartered in Vancouver, Canada, and a global leader in energy intelligence for utilities’ commercial customers. The Company believes that the acquisition of Pulse Energy will expand and accelerate its EIS and demand response solutions by extending its ability to serve its utility and retail customers through deep segmentation and energy analytics for the small and medium-sized enterprises, as well as C&I end-users.
The Company concluded that this acquisition represented a business combination under the provisions of ASC 805, but has concluded that it did not represent a material business combination, and therefore, no pro forma financial information is required to be presented. Subsequent to the acquisition date, the Company’s results of operations include Pulse Energy operations.
The Company acquired Pulse Energy for an aggregate purchase price of $24,811, consisting of $15,519 in cash paid at closing ($17,000 base price, less $1,566 in working capital adjustments, plus $85 of cash paid in lieu of shares), $7,692 representing the fair value of 583,218 shares of Company common stock issued as of the acquisition date and $1,587 representing the fair value of contingent consideration (earn-out). The earn-out is based on the achievement of sales targets during the years ending December 31, 2015, 2016 and 2017, to be paid in the form of EnerNOC common stock, except for a small portion of the payment that would be paid in cash, if such targets are achieved. If the minimum defined sales targets are not achieved, there will be no partial payment. The Company recorded its estimate of the fair value of the contingent consideration based on the evaluation of the likelihood of the achievement of the contractual conditions and weighed probability assumptions of these outcomes. The fair value measurement was determined based on significant inputs not observable in the market and therefore, represented a Level 3 measurement as defined in ASC 820.
Because the contingent consideration is expected to be settled in the Company’s own shares, the Company evaluated whether equity or liability classification was appropriate. The Company concluded that the criteria in ASC 815, Contracts in Entity’s Own Equity, were met and as a result the fair value of the earn-out was recorded as additional paid-in capital. The fair value of the earn-out will not be re-measured subsequent to the acquisition date due its equity classification.
Transaction costs of $364 related to Pulse Energy were expensed as incurred and are included in general and administrative expenses in the Company’s consolidated statements of operations.
The components and allocation of the purchase price consist of the following amounts:
(1) The preliminary purchase price allocation related to goodwill and deferred income taxes was adjusted based new information obtained as a result of finalization of the 2014 tax return.
The deferred income tax liability recorded in connection with the allocation of the purchase price relates to the book and tax basis difference of the acquired definite-lived intangible assets where the book amortization expense for such assets will not be deductible for tax purposes.
Net tangible assets acquired in the acquisition of Pulse Energy primarily related to the following:
As part of the allocation of the purchase price, the Company determined that Pulse Energy’s separately identifiable intangible assets were its developed technology (5 year useful life), customer relationships (2 year useful life), non-compete agreements (3 year useful life), and trade name (2 year useful life). Developed technology represented internally developed software that provides analytical capabilities to utility customers. As of the date of acquisition, the Company determined that there was no in-process research and development as the ongoing research and development efforts were nominal and related to routine, on-going maintenance efforts.
EnTech
On April 17, 2014, the Company and two of its subsidiaries completed acquisitions of all of the outstanding stock of EnTech Utility Service Bureau, Inc. (EnTech US), and EnTech Utility Service Bureau Ltd. (EnTech UK), privately-held companies headquartered in the United States and the United Kingdom, respectively, that are leading providers of global utility bill management (UBM) software, which is currently deployed in over 100 countries, including many of the world’s fastest growing economies, such as China, India, and Brazil. In connection with the acquisition of EnTech US, the Company acquired EnTech US’s 50% ownership in of EnTech USB Private Limited (EnTech India), a joint venture entity in India, which performed development and data processing services principally for EnTech US. On May 9, 2014, the Company completed the acquisition of the remaining 50% ownership of EnTech India. The Company collectively refers to the entities acquired as EnTech. The Company believes that the combination of EnTech’s software and technology, including real-time energy data, tariffs, and monthly utility bill data on the Company’s EIS platform will now enable real-time visibility and forecasting of energy costs and empower better energy management across global enterprises.
The Company concluded that these acquisitions represented business combinations under ASC 805 but has concluded that they did not represent material business combinations and therefore, no pro forma financial information is required to be presented. Subsequent to the acquisition dates, the Company’s results of operations include EnTech operations.
EnTech US and EnTech UK were not entities under common control, however, the overall acquisitions were negotiated in contemplation of acquiring all entities, including EnTech India, and closing was contingent upon acquiring all entities. The Company separately negotiated the allocation of the overall purchase price with the stockholders of each entity. The Company acquired EnTech US for an aggregate purchase price of $6,796, all of which was paid in cash at closing. There were no earn-out or other additional contingent purchase price arrangements related to the acquisition of EnTech US. The Company acquired EnTech UK for an aggregate purchase price of $3,154, all of which was paid in cash at closing. There were no earn-out or other additional contingent purchase price arrangements related to the acquisition of EnTech UK. However, in accordance with the stock purchase agreements, there were post-closing working capital adjustments of $1,323 and $73 recorded as additional purchase price for EnTech US and EnTech UK, respectively. These amounts were paid to the selling shareholders in August 2014.
The Company acquired the remaining 50% ownership interest in EnTech India for an aggregate purchase price of $1,201, all of which was paid in cash at closing. There were no contingent consideration arrangements or working capital adjustments.
Transaction costs related to this business combination have been expensed as incurred and are included in general and administrative expenses in the Company’s consolidated statements of operations. Transaction costs incurred related to this transaction were approximately $311.
The total purchase price related to the Company’s acquisition of EnTech was $12,547. Because these were business combinations of related businesses that were based on acquiring all related entities, the Company is presenting the purchase price allocation on an overall combined basis.
The components and allocation of the purchase price consist of the following amounts:
Included in net tangible assets acquired was EnTech UK’s equity interest in a China joint venture. The fair value of this asset was not material given the nominal amount of net assets in this joint venture and its ongoing activities. The investment was subsequently written off in 2015.
Net tangible assets acquired in the acquisition of EnTech primarily related to the following:
As part of the allocation of the purchase price, the Company determined that EnTech’s separately identifiable intangible assets were its customer relationships (9 year useful life), non-compete agreements (3 year useful life), developed technology (5 year useful life), and trade name (2 year useful life). Developed technology represented internally developed software that supports utility bill management services. As of the date of acquisition, the Company determined that there was no in-process research and development as the ongoing research and development efforts were nominal and related to routine, on-going maintenance efforts.
The factors contributing to the recognition of goodwill were based upon the Company’s determination that several strategic and synergistic benefits are expected to be realized from the combination. None of the goodwill is deductible for tax purposes.
Entelios AG
On February 13, 2014, the Company and one of its subsidiaries completed an acquisition of all of the outstanding stock of Entelios AG (Entelios) a privately-held company headquartered in Germany that is a leading provider of demand response in Europe. The Company believes this acquisition accelerates its entry into continental Europe with Entelios’ strong team and existing relationships with leading grid operators, utilities, retailers, as well as commercial, institutional, and industrial customers.
The Company concluded that this acquisition represented a business combination under ASC 805 and has also concluded that it did not represent a material business combination, and therefore, no pro forma financial information is required to be presented. Subsequent to the acquisition date, the Company’s results of operations include the Entelios operations.
The Company acquired Entelios for an aggregate purchase price, exclusive of potential contingent consideration, of $21,784 (16,000 Euros based on the exchange rate on the closing date of the acquisition), all of which was paid in cash. Of the consideration paid at closing, $6,884 (5,056 Euros) was paid as consideration to allow Entelios to settle its outstanding debt and related tax obligations. In addition to the amounts paid at closing, the agreement provided additional consideration related to an earn-out amount up to a maximum of $2,042 (1,500 Euros) if certain financial metrics were achieved in 2014 and 2015. The Company determined that the fair value of the earn-out as of the acquisition date was $95 (70 Euros). This fair value was included as a component of the purchase price resulting in an aggregate purchase price of $21,879. None of the earn-out measures were achieved and the Company reversed the liability in December 2015.
Transaction costs related to this business combination have been expensed as incurred and are included in general and administrative expenses in the Company’s consolidated statements of operations. Transaction costs incurred related to this transaction were approximately $511.
The components and allocation of the purchase price consist of the following approximate amounts:
The deferred income tax liability recorded in connection with the allocation of purchase price relates to the book and tax basis difference of the acquired definite-lived intangible assets for which the book amortization expense for such assets will not be deductible for tax purposes. Due to the fact that this deferred income tax liability represents a potential source of income as defined in ASC 740, the Company determined that it was more likely than not that a portion of the deferred tax assets acquired in the business combination, which relate to tax net operating loss carry forwards, were realizable. As a result, the Company recorded a corresponding deferred income tax asset that would be utilized to offset this potential source of taxable income. As the deferred income tax liability and deferred income tax asset are both long-term and relate to the same jurisdiction, these amounts are netted in the Company’s consolidated balance sheet.
Net tangible liabilities assumed in the acquisition of Entelios primarily related to the following:
As part of the allocation of the purchase price, the Company determined that Entelios’ separately identifiable intangible assets were its customer relationships (7.5 year useful life), non-compete agreements (3.9 year useful life), developed technology (2 year useful life), and trade name (2 year useful life). Developed technology represented internally developed software that supports the management of demand response dispatches, including fast-response dispatches, as well as assists with the performance calculations and related settlements. As of the date of acquisition, the Company determined that there was no in-process research and development as the ongoing research and development efforts were nominal and related to routine, on-going maintenance efforts.
The factors contributing to the recognition of goodwill were based upon the Company’s determination that several strategic and synergistic benefits are expected to be realized from the combination. None of the goodwill is deductible for tax purposes.
Activation Energy DSU Limited
On February 13, 2014, the Company and one of its subsidiaries completed an acquisition of all of the outstanding stock of Activation Energy DSU Limited (Activation Energy), a privately-held company headquartered in Ireland that is the leading provider of demand response software and services in Ireland. The Company believes this acquisition gives it an immediate presence in the Irish capacity market and further strengthens its ability to deliver its full suite of EIS and demand response solutions throughout Europe.
The Company concluded that this acquisition represented a business combination under ASC 805 and has also concluded that it did not represent a material business combination, and therefore, no pro forma financial information is required to be presented. Subsequent to the acquisition date, the Company’s results of operations include Activation Energy operations.
The Company acquired Activation Energy for an aggregate purchase price of $3,844 (2,823 Euros translated based on the exchange rate on the date of the acquisition close), plus an additional $717 (527 Euros) paid as working capital and other adjustments, all of which was paid in cash. In addition to the amounts paid at closing, the agreement provided additional consideration related to an earn-out amount up to a maximum of $1,398 (1,027 Euros). The earn-out payment was based on the achievement of certain minimum defined MW enrollment as well as profit metrics for the year ended December 31, 2014 and year ending December 31, 2015, respectively. The Company determined that the initial fair value of the earn-out payment as of the acquisition date was $300 (220 Euros). This fair value was included as a component of the purchase price resulting in an aggregate purchase price of $4,861 (3,570 Euros). At December 31, 2014, the liability was $546 (450 Euros). In January 2015, the Company disbursed $277 (257 Euros) to former stockholders of Activation Energy, which reflected payment for the maximum milestones achieved for the year ended December 31, 2014. As of December 31, 2015, the liability was $840 (770 Euros), reflecting the maximum amount due upon achievement of the 2015 performance criteria. This amount was subsequently paid in February 2016.
Transaction costs related to this business combination have been expensed as incurred and are included in general and administrative expenses in the Company’s consolidated statements of operations. Transaction costs incurred related to this transaction were approximately $159.
The components and allocation of the purchase price consist of the following approximate amounts:
The deferred income tax liability recorded in connection with the allocation of the purchase price relates to the book and tax basis difference of the acquired definite-lived intangible assets where the book amortization expense for such assets will not be deductible for tax purposes.
Net tangible assets acquired in the acquisition of Activation Energy primarily related to the following:
As part of the allocation of the purchase price, the Company determined that Activation Energy’s separately identifiable intangible assets were its customer relationships (7.3 year useful life), non-compete agreements (3.7 year useful life), developed technology (2 year useful life), and trade name (2 year useful life). Developed technology represented internally developed software that facilitates customer transactions and provides analytical capabilities. As of the date of acquisition, the Company determined that there was no in-process research and development as the ongoing research and development efforts were nominal and related to routine, on-going maintenance efforts.
The factors contributing to the recognition of goodwill were based upon the Company’s determination that several strategic and synergistic benefits are expected to be realized from the combination. None of the goodwill is deductible for tax purposes.
Universal Load Center Co., Ltd.
On April 2, 2014, one of the Company’s subsidiaries completed the acquisition of all of the outstanding stock of United Load Center Co., Ltd. (ULC) a privately-held company headquartered in South Korea that provides demand response software and services in that market. The Company concluded that this acquisition represented a business combination and, therefore, has accounted for it as such. The Company believes that this acquisition gives it an immediate presence in South Korea and further strengthens its ability to deliver its full suite of EIS and demand response solutions throughout the region.
The Company concluded that this acquisition represented a business combination under ASC 805 but also concluded that it did not represent a material business combination and therefore, no pro forma financial information is required. Subsequent to the acquisition date, the Company’s results of operations include ULC operations.
The Company acquired ULC for an aggregate initial purchase price of $250, plus an additional $464 paid as working capital and other adjustments, all of which was paid in cash.
In addition to the amounts paid at closing, the agreement provided additional contingent purchase price consideration related to certain earn-out amounts up to a maximum of $1,750. The earn-out payments were based on the achievement of certain defined market legislation and certain operational metrics. With respect to the potential earn-out payment of $250 that was based on defined market legislation, the Company concluded that this was probable of achievement and determined that the fair value as of the acquisition date of $175 represented a component of purchase price. The defined market legislation was finalized in May 2014 and the earn-out payment was deemed achieved; however, payment was retained to cover general business representations and warranties and recorded in accrued acquisition consideration. This amount was released in the fourth quarter of 2015. The remaining $1,500 is payable to those stockholders of the acquired entity who remain employed as of the time of payment, if certain operational metrics are achieved. The Company concluded these payments should be accounted for as compensation arrangements and not as a component of purchase price. The Company evaluates the probability of achievement and records the expense ratably over the applicable service period as compensation expense for the amount, if any, deemed probable of achievement.
The final purchase price was determined to be $889. Based on the Company’s evaluation of the assets and liabilities acquired, the Company determined that there were no separately identifiable intangible assets and as a result, $476 was ascribed to the fair value of net tangible assets acquired with the remaining $413 being recorded to goodwill.
The factors contributing to the recognition of goodwill were based upon the Company’s determination that several strategic and synergistic benefits are expected to be realized from the combination. None of the goodwill is deductible for tax purposes.
3. Segment and Entity-Wide Disclosures
The Company views its operations and manages its business as one operating segment. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. The Company’s chief operating decision maker is considered to be its Chief Executive Officer.
The Company operates in the major geographic areas noted in the chart below. The “All other” designation includes revenues from other international locations, primarily consisting of Canada, Germany, Japan, Ireland, New Zealand, South Korea and the United Kingdom. Revenues are based upon customer location and internationally totaled $86,983, $98,214 and $73,738 for the years ended December 31, 2015, 2014 and 2013, respectively.
As of December 31, 2015 and 2014, the long-lived tangible assets related to the Company’s international subsidiaries were less than 10% of the Company’s long-lived tangible assets and were deemed not material.
Effective January 1, 2016, the Company began managing its operations as two distinct business units: Software and Demand Response, each with dedicated sales, marketing and operations functions. The Company is evaluating the impact of this change in organizational structure on its future reportable segment information, which will be provided in the Company's periodic filing for the period ended March 31, 2016. Prior periods will be reclassified and presented consistent with the revised presentation.
4. Goodwill and Intangible Assets
Goodwill
The changes in the gross carrying amount and accumulated impairment loss are as follows:
(1) The current period purchase price adjustment relates to the December 2014 acquisition of Pulse Energy, for which the Company adjusted certain estimates associated with the acquired deferred taxes.
The Company performed its annual goodwill impairment test as of November 30, 2015. The Company determined that it has two reporting units for the purpose of the annual goodwill impairment test: (1) North America (NA) Software and Services and (2) International. The NA Software and Services reporting unit reflects the North American demand response operations as well as the Company’s software, procurement and professional services operations. The International reporting unit reflects the Company’s demand response operations throughout Europe, Asia, and Australia/New Zealand.
The Company used an income approach to measure the fair value of each reporting unit. The income approach utilizes a DCF, which requires the use of significant estimates and assumptions, including projected future cash flows, terminal growth rates, and a discount rate.
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The projected cash flows include revenue and costs from demand response programs and software sales, operating expenses and capital expenditures. Significant assumptions used to estimate these cash flows include: megawatt commitments and pricing, new market opportunities, expected annual recurring revenue contracts, and planned capital investments. To the extent the forecast cash flows decline or are deferred, the DCF will yield a lower fair value.
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The terminal (or long-term) growth rate captures the value of the business beyond the forecast period by projecting stable growth into perpetuity. The Company assumed a 2.5% and 2.0% terminal growth rate for NA Software and Services, and International Reporting Units, respectively, which is consistent with industry averages and historical inflation. To the extent this rate increases or decreases, the DCF will yield a higher or lower fair value, respectively.
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The discount rate accounts for the time value of money and the inherent risk in the Company’s cash flow and terminal growth rate assumptions. The discount rates are derived from each reporting unit's weighted-average costs of capital (WACC), which includes a specific premium above the risk free rate. The Company applied a 21.5% and 17.5% WACC for the NA Software and Services and International reporting units, respectively. To the extent this rate decreases or increases, the DCF will yield a higher or lower fair value, respectively.
The fair value derived from the discounted cash flow analysis using these assumptions was subsequently corroborated by the Company’s market capitalization, which implied a control premium of 24.0%. Management believes this is a reasonable premium given recent acquisitions within the industry.
Challenging conditions in demand response markets and more gradual than anticipated acceleration of software sales impacted the Company’s 2015 operating results and contributed to lower projected cash flows for the NA Software and Services reporting unit. As a result, the fair value for such reporting unit was less than its carrying value as of November 30, 2015. The required Step II test, which compares the implied fair value of a reporting unit’s goodwill to its carrying value, generated a pre-tax goodwill impairment charge of $108,763 for the year-ending December 31, 2015. A Step II test was not required for the International reporting unit as the estimated fair value exceed its carrying value.
The Step II impairment test utilized significant unobservable inputs that caused the determination of the implied fair value of goodwill to fall within level three of the GAAP fair value hierarchy. There is no assurance that the actual future cash flows of
the reporting units will not be materially different from the projections used in the impairment analysis. Additional goodwill impairment charges may be recognized in future periods to the extent changes in factors or circumstances occur, including deterioration in the economy, the Company’s industry, or the Company’s performance.
These non-cash impairment charges do not impact the Company’s liquidity, compliance with any covenants under its debt agreements, or potential future results of operations. The Company has undertaken actions to improve its operating performance, including an organizational re-alignment that will more clearly delineate the resources allocated to the Company’s Demand Response operations and Software operations. The re-alignment will ultimately yield new reporting units (effective January 1, 2016) to which the Company will ascribe goodwill using the relative fair value approach provided in ASC 350. Immediately following the re-alignment, the Company will test the goodwill in the new reporting units for impairment. Any resulting impairment charge would be recognized in the first quarter of 2016.
Intangible Assets
The following table provides the gross carrying amount and related accumulated amortization of the Company’s definite-lived intangible assets as of December 31, 2015 and December 31, 2014:
Amortization expense related to definite-lived intangible assets amounted to $15,252, $9,252 and $7,029 for the years ended December 31, 2015, 2014 and 2013, respectively. Amortization expense for acquired developed technology was $3,943, $1,760 and $555 for the years ended December 31, 2015, 2014 and 2013, respectively, and is included in cost of revenues in the accompanying consolidated statements of operations. Amortization expense for all other intangible assets is included as a component of operating expenses in the accompanying consolidated statements of operations. Amortization expense is estimated to be approximately $12,284, $9,457, $6,989, $6,176 and $19,446 for 2016, 2017, 2018, 2019 and 2020 and beyond, respectively. During the year ended December 31, 2015, the Company recorded $118 of accelerated the amortization expense for a trade name intangible asset that was discontinued during year ended December 31, 2015.
5. Net (Loss) Income Per Share
Computation of basic and diluted net (loss) income per share is as follows (in thousands, except per share information):
In the reporting period in which the Company reports a net loss, anti-dilutive shares comprise the impact of those number of shares that would have been dilutive had the Company had net income plus the number of common stock equivalents that would be anti-dilutive had the Company had net income. In the reporting periods in which the Company reports net income, anti-dilutive shares comprise those common stock equivalents that have either an exercise price above the average stock price for the year or the common stock equivalent’s related average unrecognized stock compensation expense is sufficient to “buy back” the entire amount of shares.
On May 27, 2015, the Company received stockholder approval at its annual meeting of stockholders to elect to settle conversions of $160,000 aggregate principal amount of its 2.25% convertible senior notes due August 15, 2019 (the Notes) by paying or delivering, as the case may be, cash, shares of common stock or a combination of cash and shares of common stock. Under the applicable accounting standards, if an entity controls the means of settlement and past experience or a stated policy provides a reasonable basis to believe that the Notes will be partially or wholly settled in cash, the shares issuable upon conversion of convertible debt instruments may be excluded from the calculation of diluted earnings per share. For the years ended December 31, 2015 and 2014 the convertible debt is not assumed to be converted as the impact is anti-dilutive. See Note 9 for further information regarding the Company's convertible debt.
The Company excludes the shares issued in connection with restricted stock awards from the calculation of basic weighted average common shares outstanding until such time as those shares vest. In addition, with respect to restricted stock awards that vest based on achievement of performance conditions, because performance conditions are considered contingencies under ASC 260, Earnings Per Share, the criteria for contingent shares must first be applied before determining the dilutive effect of these types of share-based payments. Prior to the end of the contingency period (i.e., before the performance conditions have been satisfied), the number of contingently issuable common shares to be included in diluted weighted average common shares outstanding should be based on the number of common shares, if any, that would be issuable under the terms of the arrangement if the end of the reporting period were the end of the contingency period (e.g., the number of shares that would be issuable based on current performance criteria) assuming the result would be dilutive.
The Company includes the 254,654 shares related to a component of the deferred purchase price consideration from the acquisition of M2M Communications Corporation (M2M) in both the basic and diluted weighted average common shares outstanding amounts as the shares are not subject to adjustment and the issuance of such shares is not subject to any contingency.
In connection with certain of the Company’s business combinations, the Company issued common shares that were held in escrow upon closing of the applicable business combination. The Company excludes shares held in escrow from the calculation of basic weighted average common shares outstanding where the release of such shares is contingent upon an event and not solely subject to the passage of time. As of both December 31, 2015 and 2014 the Company had 87,483 shares of common stock held in escrow related to the Pulse Energy acquisition.
6. Fair Value Measurements
The Company's financial instruments mainly consist of cash and cash equivalents, restricted cash, accounts receivable, and accounts payable. The fair value of such instruments approximates their carrying value because of their short-term nature. The
Company had $126,800 and $160,000 of convertible debt outstanding at December 31, 2015 and December 31, 2014, respectively. The fair value of the convertible debt was approximately $73,624 and $133,392 as of December 31, 2015 and December 31, 2014, respectively and was determined based on the quoted market price as of those dates. The fair value of the convertible debt is classified as a Level 1 measurement.
The following table below presents the balances of assets and liabilities measured at fair value on a recurring basis at December 31, 2015 and December 31, 2014
(1)
The money market funds balance included in cash and cash equivalents represents the only asset that the Company measures and records at fair value on a recurring basis. These money market funds represent excess operating cash that is invested daily into an overnight investment account.
(2)
Contingent purchase price consideration relates to the Company’s acquisitions of Activation Energy and Entelios in 2014. As of December 31, 2015, the entire $840 related to the Activation Energy acquisition is reflected in accrued expense and other current liabilities in the consolidated balance sheet and was paid in full in February 2016. There are no amounts reflected on the consolidated balance sheet as of December 31, 2015 for the Entelios earn-out due to the performance of the entity. The liability as of December 31, 2014 includes $546 related to Activation Energy and $103 related to Entelios.
The following is a rollforward of the Level 3 assets and liabilities from January 1, 2014 through December 31, 2015:
7. Allowance for Doubtful Accounts
The Company reduces gross trade accounts receivable by an allowance for doubtful accounts based on the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts on a regular basis and all past due balances are reviewed individually for collectibility. Account balances are charged against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Provisions for allowance for doubtful accounts are recorded in general and administrative expenses. Below is a summary of the changes in the Company’s allowance for doubtful accounts for the years ended December 31, 2015, 2014 and 2013.
8. Property and Equipment
Property and equipment as of December 31, 2015 and December 31, 2014 consisted of the following:
(1) Includes capitalized internal-use software development costs. See Note 1.
Depreciation expense was $24,322, $22,165 and $20,815 for the years ended December 31, 2015, 2014 and 2013, respectively. For the years ended December 31, 2015, 2014 and 2013, $14,317, $13,223 and $12,821, respectively, were included in cost of revenues, and $10,005, $8,942 and $7,994, respectively, were included in general and administrative expenses.
9. Borrowings and Credit Arrangements
Credit Agreement
On August 11, 2014, the Company entered into a $30,000 senior secured revolving credit facility, the full amount of which may be available for issuances of letters of credit and revolving loans, pursuant to a loan and security agreement (the 2014 credit facility) with Silicon Valley Bank (SVB), which was subsequently amended on October 23, 2014. On August 6, 2015, the Company and SVB entered into a second amendment to the 2014 credit facility to extend the termination date from August 11, 2015 to August 9, 2016. The letter of credit fee charged under the 2014 credit facility is 1.50% per annum on the face amount of any letters of credit, plus customary fronting fees. The interest on revolving loans under the 2014 credit facility will accrue, at the Company’s election, at either (i) the LIBOR (determined based on the per annum rate of interest at which deposits in United States Dollars are offered to SVB in the London interbank market) plus 2.00%, or (ii) the “prime rate” as quoted in the Wall Street Journal with respect to the relevant interest period plus 1.00%. The revolving loans also bear a fee of 0.25% applied to the unused portion of the revolving loans and the fee is payable quarterly.
The 2014 credit facility is subject to continued covenant compliance and borrowing base requirements. As of December 31, 2015, the Company was in compliance with all of its covenants under the 2014 credit facility. The Company believes that it is reasonably assured that it will comply with the covenants of the 2014 credit facility through its expiration date of August 9, 2016. The obligations under the 2014 credit facility and any related bank services provided by SVB are guaranteed by several of the Company’s domestic subsidiaries and are secured by substantially all of the Company’s and several of its domestic subsidiaries’ domestic assets, other than intellectual property and other customarily excluded collateral.
The 2014 credit facility contains customary terms and conditions for credit facilities of this type, including restrictions on the ability of the Company and its subsidiaries to incur additional indebtedness, create liens, enter into transactions with affiliates, transfer assets, pay dividends or make distributions on capital stock of the Company (other than certain permitted distributions set forth therein), consolidate or merge with other entities, or suffer a change in control. In addition, the Company is required to meet certain financial covenants customary with this type of agreement, including maintaining minimum unrestricted cash and a minimum specified ratio of current assets to current liabilities.
The 2014 credit facility contains customary events of default, including for payment defaults, breaches of representations, breaches of affirmative or negative covenants, cross defaults to other material indebtedness, bankruptcy and failure to discharge certain judgments. Upon an event of default under the 2014 credit facility, SVB will have the right to accelerate the Company’s obligations under the 2014 credit facility and require the Company to cash collateralize any outstanding letters of credit. In addition, upon an event of default relating to certain insolvency events involving the Company and its subsidiaries, the obligations under the 2014 credit facility will be automatically accelerated. In the event of a termination or an event of default, the Company may be required to cash collateralize any outstanding letters of credit up to 105% of their face amount.
As of December 31, 2015, the Company had no outstanding borrowings and had outstanding letters of credit totaling $22,422, under the 2014 credit facility. As of December 31, 2015, the Company had $7,578 available under the 2014 credit facility for future borrowings or issuances of additional letters of credit.
Convertible Notes
The following table shows the gross and net carrying amount of the Notes (in thousands):
(1) As discussed in Note 1, the Company retrospectively adopted ASU 2015-03 as of December 31, 2015. As a result of adopting this accounting standard, the Company reclassified $687 and $3,131 of unamortized deferred issuance costs from current assets and other assets, respectively, to a direct reduction of the debt obligation.
On August 12, 2014, the Company sold $160,000 aggregate principal amount of 2.25% convertible senior notes due 2019 (the Notes). The net proceeds from the offering were approximately $155,278, after deducting the initial purchasers’ discounts (debit issuance costs) of $4,000 and offering expenses of approximately $722 paid by the Company. During the year ended December 31, 2015, the Company was reimbursed for transaction costs totaling $400. These transaction and debt issuance costs were allocated between the liability and equity components based on their relative values. The transaction costs allocated to the liability and equity components were $3,656 and $666, respectively.
The Company accounted for the liability and equity components of its Notes separately to reflect its nonconvertible debt borrowing rate. The estimated fair value of the liability component at issuance of $137,430 was determined using a discounted cash flow technique, which considered debt issuances with similar features of the Company’s debt, excluding the conversion feature. The resulting effective interest rate for the Notes was 6.14%. The excess of the gross proceeds received over the estimated fair value of the liability component totaling $22,566 was allocated to the conversion feature (equity component, recorded as additional paid-in capital) with a corresponding offset recognized as a discount to reduce the net carrying value of the Notes. The discount is being amortized to interest expense over a five-year period ending August 15, 2019 (the expected life of the liability component) using the effective interest method. At the time of issuance, the Company evaluated the Notes in accordance with ASC 815-40, Contracts in Entity’s Own Equity, and determined that the Notes contain a single embedded derivative, comprising both the contingent interest feature related to timely filing failure, requiring bifurcation as the features is not clearly and closely related to the host instrument. The Company determined that the value of this embedded derivative was nominal as of the date of issuance.
The Notes are the Company’s senior unsecured obligations and rank equally with all of the Company’s future senior unsecured debt and prior to all future subordinated debt. The Notes are effectively subordinated to any future secured indebtedness to the extent of the collateral securing such indebtedness, and structurally subordinated to all indebtedness and other liabilities (including trade payables) of the Company’s subsidiaries. Interest on the Notes is payable semi-annually in cash in arrears on February 15 and August 15 of each year at a rate of 2.25% per year. The Notes will mature on August 15, 2019 unless earlier converted or repurchased.
The Notes are convertible at an initial conversion rate, subject to adjustment in some events, of 36.0933 shares of the common stock per $1,000 principal amount of the Notes (equivalent to an initial conversion price of approximately $27.71 per share of Common Stock). The Company may settle conversions of Notes by paying or delivering, as the case may be, cash, shares of common stock or a combination of cash and shares of common stock, at its election.
Prior to February 15, 2019, holders may convert all or any portion of their Notes at their option only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ended on September 30, 2014 (and only during such fiscal quarter), if the last reported sale price of the common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price for the Notes on each applicable trading day; (2) during the five business day period after any five consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of the Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after February 15, 2019 holders may convert all or any portion of their Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date regardless of the foregoing conditions. The Company may not redeem the Notes prior to maturity and no sinking fund is provided for the Notes.
If certain events occur prior to maturity, holders may require the Company to repurchase for cash all or any portion of their Notes at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid
interest to, but excluding, the repurchase date. The Notes includes customary terms and covenants, including certain events of default after which the Notes may be declared or become due and payable immediately.
In December, 2015, the Company completed repurchases, in cash, of $33,200 in aggregate principal amount of the outstanding Notes at a weighted average price of 59.2% of principal for a total purchase price of $19,733 plus accrued and unpaid interest in privately-negotiated transactions. The cash consideration was allocated to the fair value of the liability component of the repurchased Notes immediately before extinguishment. The fair value of the liability component, which is classified as a Level 3 measurement, was determined by comparing the effective yield-to-maturity of the repurchased Notes as of the extinguishment date to the market yield for non-convertible debt with similar characteristics. The Company recorded a gain on the extinguishment of the Notes of $9,230 based on the difference between the carrying amount of the repurchased Notes and the cash consideration. The gain is classified as gain on early extinguishment of debt within the consolidated statements of operations. Following the repurchases, the remaining principal amount outstanding was $126,800.
Interest expense under the Notes is as follows:
10. Stockholder's Equity
2014 Long-Term Incentive Plan
On May 29, 2014, the Company’s stockholders approved the EnerNOC, Inc. 2014 Long-Term Incentive Plan (the 2014 Plan), which was amended by the Company's stockholders at the Annual Meeting held on May 27, 2015 to increase the number of shares of common stock authorized for issuance under the 2014 Plan by 1,700,000 shares. As of December 31, 2015, 2,496,411 shares were available for future grant under the 2014 Plan.
World Energy Solutions, Inc. 2006 Stock Incentive Plan
In connection with the Company’s acquisition of World Energy in January 2015, the Company assumed the World Energy Solutions, Inc. 2006 Stock Incentive Plan (the World Energy Plan). As a result of the assumption, incentive and nonstatutory stock options or stock purchase rights may be granted under the World Energy Plan to employees of the Company who were employees of World Energy prior to January 5, 2015 or were hired by the Company after January 5, 2015. At December 31, 2015, 94,517 stock-based awards were available for future grants under the World Energy Plan. No awards may be granted under the World Energy Plan after the completion of ten years from August 25, 2006, which is the date on which the World Energy Plan was adopted by the World Energy Board, but awards previously granted may extend beyond that date.
Share Repurchase Program
On August 6, 2015, the Company’s Board of Directors approved a new share repurchase program, effective upon the expiration of the Company's 2014 Repurchase Program on August 8, 2015, that will enable the Company to repurchase up to $50,000 of the Company’s common stock during the period from August 9, 2015 through August 9, 2016 (the 2015 Repurchase Program). Repurchases under the Company’s 2015 Repurchase Program are expected to be made periodically on the open market as market and business conditions warrant, or under a Rule 10b5-1 plan. During the year ended December 31, 2015, the Company did not make any repurchases of its common stock under the 2014 Repurchase Program or the 2015 Repurchase Program.
The Company withheld 381,930, 329,377 and 18,553 shares of its common stock during the years ended December 31, 2015, 2014, and 2013, respectively, to satisfy employee minimum statutory income tax withholding obligations in connection with the vesting of restricted stock and restricted stock units under its equity incentive plans, which the Company pays in cash to the appropriate taxing authorities on behalf of its employees. All withheld shares became immediately available for future issuance under the 2014 Plan and the World Energy Plan.
11. Stock-Based Compensation
The EnerNOC, Inc. Amended and Restated 2003 Stock Option and Incentive Plan, the EnerNOC, Inc. Amended and Restated 2007 Stock Option and Incentive Plan and the 2014 Plan (collectively the Plans) provide for the grant of incentive stock options, nonqualified stock options, restricted and unrestricted stock awards and other stock-based awards to eligible employees, directors and consultants of the Company. Options granted under the Plans are exercisable for a period determined by the Company, but in no event longer than ten years from the date of the grant. Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock on the date of grant. Stock option awards, restricted stock awards and restricted stock unit awards generally vest ratably over four years, with certain exceptions. In addition, during the years ended December 31, 2015, 2014, and 2013, the Company issued 72,926, 6,632 and 8,920 shares of its common stock, respectively, to certain executives to satisfy a portion of the Company’s bonus obligations to those individuals.
Stock Options
The following is a summary of the Company’s stock option activity during the year ended December 31, 2015:
The aggregate intrinsic value as of December 31, 2015 in the preceding table represents the total pre-tax intrinsic value, based on the Company's closing stock price of $3.85 on December 31, 2015, that would have been received by the option holders had all options holders exercised their "in-the-money" options as of that date. The total number of shares issuable upon the exercise of "in-the-money" options exercisable as of December 31, 2015 was approximately 117,122.
The weighted average fair value per share of options granted during the year ended December 31, 2015 was $9.92
The total intrinsic value of options exercised during the years ended December 31, 2015, 2014, and 2013 was $795, $1,457, and $2,014, respectively.
As of December 31, 2015, 610.572 options were held by employees and directors of the Company and 283 options were held by a consultant. As of December 31, 2015, the Company had $263 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 1.4 years.
Restricted Stock
The following table summarizes the Company’s restricted stock activity during the year ended December 31, 2015:
During the year ended December 31, 2015, 20,500 shares of restricted stock were granted to certain non-executive employees and 67,870 shares of restricted stock were granted to members of the Company’s board of directors, all of which were immediately vested. During the years ended December 31, 2015 and 2014, the Company recorded stock-based compensation expense related to these awards of $29 and $185, respectively. As of December 31, 2015, 8,250 shares were unvested and had a fair value of $32.
The Company's chief executive officer is required to receive his performance-based bonus, if achieved, in shares of the Company's common stock. The Company recorded this amount as stock-based compensation expensed ratably over the
applicable performance and service period in accordance with ASC 718. During the years ended December 31, 2015 and 2014, the Company recorded $265 and $476, respectively, of stock-based compensation expense related to this performance based bonus.
In June 2015, the company entered into a separation agreement with a former employee. The Company recorded a reversal of previously recognized stock-based compensation expense during the year ended December 31, 2015 in the amount of $834 related to the cancellation of non-vested awards upon termination.
No material stock-based compensation expense was capitalized during the year ended December 31, 2015. Stock based compensation expense related to share-based awards granted to non-employees was not material for the years ended December 31, 2015 and 2014.
For non-vested restricted stock subject to service-based vesting conditions outstanding as of December 31, 2015, the Company had $20,883 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 2.5 years. For non-vested restricted stock subject to performance-based vesting conditions outstanding and that were probable of vesting as of December 31, 2015, which represents all of the outstanding non-vested restricted stock subject to performance-based vesting conditions, the Company had $1,582 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 1.3 years.
In February 2015, The Company entered into a separation agreement with a former employee, which changed the employee's status to non-employee consultant as of July 1, 2015 and provided for the vesting of 12,514 shares of previously non-vested restricted stock, to continue to vest through January 2, 2016, as long as the individual continues to serve as a consultant through the date of the applicable vesting. Through the non-employee consultation period, the restricted stock will valued at the end of each reporting period, with changes in fair value being recorded to the consolidated statement of operations.
Restricted Stock Units
The following table summarizes the Company’s restricted stock unit activity during the year ended December 31, 2015:
During the year ended December 31, 2014, the Company granted 250,382 shares of non-vested restricted stock units that contain performance-based vesting conditions to certain non-executive German employees in connection with its acquisition of Entelios. Vesting would be triggered for these shares if the employee remained employed with the Company and if certain earnings targets were met in 2014, 2015, and 2016. For the years ended December 31, 2015 and 2014, the performance criteria were not met and as a result 58,531 shares were forfeited. If the performance criteria related to certain 2016 operating results are not achieved, 100% of the remaining 153,520 shares granted will be forfeited. As of December 31, 2015, the awards have not been deemed probable of vesting.
For non-vested restricted stock units subject to service-based vesting conditions outstanding as of December 31, 2015, the Company had $729 of unrecognized stock-based compensation expense, which is expected to be recognized over a weighted average period of 2.9 years. For non-vested restricted stock units subject to outstanding performance-based vesting conditions that were not probable of vesting at December 31, 2015, the Company had $3,087 of unrecognized stock-based compensation expense. If and when any additional portion of these non-vested restricted stock units are deemed probable to vest, the Company will reflect the effect of the change in estimate in the period of change by recording a cumulative catch-up adjustment to retroactively apply the new estimate.
12. Income Taxes
The Company accounts for income taxes in accordance with the asset and liability method of ASC 740. Under ASC 740, deferred tax assets and liabilities are recognized based on the differences between the financial reporting and income tax bases of assets and liabilities using statutory rates. In addition, ASC 740 requires a valuation allowance against deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
The sources of (loss) income before the benefit from or provision for income tax are as follows:
The provision for income tax consists of the following:
The Company has provided for non-income based taxes in general and administrative expenses as of December 31, 2015, 2014, and 2013.
A reconciliation of income tax expense in the consolidated financial statements to the statutory tax rate is as follows:
The Company’s effective tax rate in 2015 differs from the U.S. federal statutory rate of 34.0% principally as a result of a non-deductible goodwill impairment and domestic and certain foreign losses that cannot be benefitted, partially offset by the release of domestic valuation allowance as a result of tax benefits recorded in connection with the Company's acquisition during the period for which a deferred tax liability was established in purchase accounting.
Deferred income tax assets (liabilities) consisted of the following:
The Company has provided a valuation allowance against certain U.S. and foreign deferred tax assets. The valuation allowance increased $38,789 during the year ended December 31, 2015, due to losses not being benefitted, inclusive of deductible goodwill impairment.
As of December 31, 2015, the Company has U.S. federal and state net operating loss carryforwards of $75,931 and $47,016, respectively. The losses expire at various times through 2032. The Company’s U.S. net operating loss carryforwards at December 31, 2015 include $28,335 in income tax deductions, the benefit of which will be reflected as a credit to additional paid-in capital as realized. The Company has U.S. tax credits of $2,116, which begin to expire in 2020. The Company has Canadian SRED credits of $597, which begin to expire in 2031. As of December 31, 2015, the Company has foreign net operating loss carryforwards of $38,396, of which $6,483 will expire various times through 2035 and $31,913 will never expire.
Activity related to unrecognized tax benefits was as follows:
Substantially all of the Company’s unrecognized tax benefits, if recognized, would have no impact on the effective tax rate as the benefit would be offset with a valuation allowance. The Company has adopted a policy that it will recognize both accrued interest and penalties related to unrecognized benefits in income tax expense, when and if recorded. The Company's policy is to account for interest and penalties of $103 and $94 as of December 31, 2015 and 2014, respectively.
The Company files federal and state income tax returns in the United States, as well as income tax returns in Australia, Brazil, Canada, Germany, India, Ireland, Japan, South Korea, New Zealand, and the United Kingdom. Tax years 2010 and forward are open in the material jurisdictions in which the Company operates. However, the Company is not under examination in any jurisdiction.
The Company provides for income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested. Income taxes have not been provided on certain outside basis differences of foreign subsidiaries of approximately $2,311 because such outside basis differences are considered to be indefinitely reinvested in the business. A determination of the amount of the unrecognized deferred tax liability related to the undistributed earnings is not practicable.
13. Employee Savings and Retirement Plan
The Company has established a savings program for its employees that is designated to be qualified under Section 401(k) of the Internal Revenue Code. At the discretion of the Company’s board of directors, the Company may make matching contributions to the 401(k) Plan, which may vest ratably over periods ranging from one to three years. Commencing in fiscal 2013, the Company has matched 50% of an employee’s contribution to the 401(k) Plan up to 6% and a maximum annual contribution by the Company of $2.5 per employee. The Company contributed $1,549 of cash to the savings plan for the year ended December 31, 2015 under the savings program.
14. Commitments and Contingencies
Operating Leases
The Company leases certain office space under various operating leases. In addition to rent, the leases require the Company to pay for taxes, insurance, maintenance and other operating expenses. Certain of these leases contain stated escalation clauses. The Company recognizes rent expense on a straight-line basis over the term of the lease, excluding renewal periods, unless renewal of the lease is reasonably assured. The Company's corporate head quarter lease contains certain provisions requiring the Company to restore certain aspects of the leased space to its initial condition. The Company recorded the estimated fair value of these asset retirement obligations as the related leasehold improvements were incurred and is accreting the liability to fair value over the life of the lease as a component of operating expenses. As of December 31, 2015, the Company’s asset retirement obligation totaled $431.
On October 9, 2014, the Company entered into an amendment to its corporate headquarters lease in order to lease additional space. The lease term for this additional space commenced on January 1, 2015. The lease amendment contained a rent holiday, under which lease payments did commence until June 2015, and contains escalating rental payments. As a result, the Company recorded rent on a straight-line basis in accordance with ASC 840, Leases (ASC 840) beginning upon the lease commencement date. In accordance with the lease amendment, the landlord provided lease incentives with respect to the leasehold improvements. The Company recorded the incentives as deferred rent and will reflect these amounts as reductions of lease expense over the lease term. During the year ended December 31, 2015, the Company recorded $1,500 as deferred rent related to landlord lease incentives.
In connection with the Company’s acquisition of World Energy, which was completed during the year ended December 31, 2015, the Company acquired certain facility operating lease arrangements which were all considered to contain current market terms and rates. These leases have original lease terms between one and ten years and expire through September 2022.
As of December 31, 2015 and 2014, the Company had a deferred rent liability representing rent expense recorded on a straight-line basis in excess of contractual lease payments of $8,037 and $7,296, respectively, of which $4,177 and $3,584 relate to landlord lease incentives. These amounts are included in other liabilities in the accompanying consolidated balance sheets.
At December 31, 2015, future minimum lease payments for operating leases with non-cancelable terms of more than one year were as follows:
Rent expense under operating leases amounted to $8,526, $6,728 and $7,192 for the years ended December 31, 2015, 2014 and 2013, respectively.
Letters of Credit
As of December 31, 2015, the Company was contingently liable under outstanding letters of credit for $22,422.
Performance Guarantees
The Company is subject to performance guarantee requirements under certain utility and electric power grid operator customer contracts and open market bidding program participation rules, which may be secured by cash or letters of credit. Performance guarantees as of December 31, 2015 were $20,223 and included deposits held by certain customers of $102. These amounts primarily represent up-front payments required by utility and electric power grid operator customers as a condition of participation in certain demand response programs and to ensure that the Company will deliver its committed capacity amounts in those programs. If the Company fails to meet its minimum committed capacity requirements, a portion or all of the deposits may be forfeited. The Company assessed the probability of default under these customer contracts and open market bidding programs and has determined the likelihood of default and loss of deposits to be remote. In addition, under certain utility and electric power grid operator customer contracts, if the Company does not achieve the required performance guarantee requirements, the customer can terminate the arrangement and the Company would potentially be subject to termination penalties. Under these arrangements, the Company defers all fees received up to the amount of the potential termination penalty until the Company has concluded that it can reliably determine that the potential termination penalty will not be incurred or the termination penalty lapses. As of December 31, 2015, the Company had $600 in deferred fees for these arrangements, which were included in deferred revenues as of December 31, 2015. As of December 31, 2015, the maximum termination penalty to which the Company could be subject under these arrangements, which the Company has deemed not probable of being incurred, was approximately $7,190.
As of December 31, 2015 and December 31, 2014, the Company accrued in the accompanying consolidated balance sheets $647 and $344, respectively, of performance adjustments related to fees received for its contractual commitments and participation in certain demand response programs. The Company believes that it is probable that these performance adjustments will need to be re-paid to the utility or electric power grid operator and since the utility or electric power grid operator has the right to require repayment at any point at its discretion, the amounts have been classified as a current liability.
Limited Warranties
The Company typically grants customers a limited warranty that guarantees that its hardware will substantially conform to current specifications for 1 year from the delivery date. Based on the Company’s operating history, the potential liability associated with product warranties has been determined to be nominal.
Health Insurance Arrangement
In connection with the Company’s agreement for its employee health insurance plan, the Company could be subject to an additional payment if the agreement is terminated. The Company has not elected to terminate this agreement nor does the Company believe that termination is probable for the foreseeable future. As a result, the Company has determined that it is not probable that a loss is likely to occur and no amounts have been accrued related to this potential payment upon termination. As of December 31, 2015, the payment due upon termination would be $626.
FERC 745 Decision
On May 23, 2014, the United States Court of Appeals for the District of Columbia Circuit held in EPSA v. FERC that FERC did not have jurisdiction under the Federal Power Act to issue FERC Order 745, an order that required, among other things, that economic demand response resources participating in the wholesale energy markets administered by electric power grid operators, such as PJM, be paid the locational marginal price of energy. FERC, the Company, and a number of other
parties filed petitions for a writ of certiorari in the U.S. Supreme Court on January 15, 2015. On May 4, 2015, the U.S. Supreme Court granted petitioners’ writs of certiorari and oral arguments were heard on October 14, 2015. On January 25, 2016, the U.S. Supreme Court reversed the District of Columbia Circuit decision, ruled that FERC has jurisdiction over demand response under the Federal Power Act, and upheld Order 745 as a valid exercise of FERC’s jurisdiction.
Subsequent to May 23, 2014 and prior to the Supreme Court ruling discussed above, the Company had determined that due to the potential risk of refund, all fees received prospectively from continued participation, if any, in wholesale energy market demand response programs implemented pursuant to Order 745 and administered by a Regional Transmission Organization (RTO) or Independent System Operator (ISO) should be deferred until such time as the fees are either refunded or become no longer subject to refund or adjustment. Between May 23, 2014 through December 31, 2015, the Company received and deferred $2,772 of fees related to these programs. As a result of the Supreme Court ruling and the resolution to the matter, beginning in the first quarter of 2016 the Company will no longer defer fees related to these demand response programs.
Enterprise Customer Matter
The Company is currently involved in an ongoing matter related to a review of certain services provided under a contractual arrangement with an enterprise customer. This matter is in initial stages and no lawsuit has currently been filed. The Company does not currently believe it is probable that a loss has been incurred and therefore, no amounts have been accrued related to this matter. However, the Company has determined that it is reasonably possible that it may incur a loss related to this matter. The potential amount of such a loss is not currently estimable because the matter is at an early stage and involves unresolved questions of fact.
Indemnification
The Company includes indemnification provisions in certain of its contracts. These indemnification provisions include provisions indemnifying the customer against losses, expenses, and liabilities from damages that could be awarded against the customer in the event that the Company’s services and related enterprise software platforms are found to infringe upon a patent or copyright of a third party. The Company believes that its internal business practices and policies and the ownership of information limits the Company’s risk in paying out any claims under these indemnification provisions.
The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business. The Company does not expect the ultimate costs to resolve these matters to have a material adverse effect on Company’s consolidated financial condition, results of operations or cash flows.
15. Gain on Sale of Service Lines
Utility Solutions Consulting
On April 16, 2014, the Company entered into an agreement with a third party to sell a component of the business, Utility Solutions Consulting, that the Company acquired in connection with its acquisition of Global Energy Partners, Inc. (Global Energy) related to consulting and engineering support services to the global electric utility industry, with a particular focus on providing consulting services to utilities.
On May 30, 2014, the Company sold the component for $4,750. The Company concluded that Utility Solutions Consulting met the definition of a business in accordance with ASC 805. The following table summarizes the assets sold in connection with this transaction:
The amount of goodwill allocated to the component was based on the relative fair values of this business and the portion of the reporting unit that will be retained. In accordance with the agreement, the Company received $4,750 at closing and $475 was held in escrow to cover general representations and warranties, as well as potential purchase price adjustments for fees that could have been earned related to contracts that were not assigned, which were determined to be $364. The Company recognized a gain from the sale of Utility Solutions Consulting totaling $3,737, net of direct transaction costs totaling $327 during the year ended December 31, 2014.
The Company concluded that the Utility Solutions Consulting disposal group met the criteria of discontinued operations under ASC 205-20, Discontinued Operations (ASC 205-20). However, the Company determined that the operations of Utility Solutions Consulting were neither quantitatively or qualitatively material to the Company’s current or historical consolidated operations and therefore, the results of operations of Utility Solutions Consulting were not presented as discontinued operations
in the Company’s accompanying consolidated statements of operations for the years ended December 31, 2014 and 2013. As a result, the gain has been reflected as a separate component within income from operations with the corresponding discrete tax charge of $1,135 related to the increase in the deferred tax liability as a result of the increased book and tax basis difference in goodwill being recorded as a component of the Company’s provision for income taxes during the year ended December 31, 2014.
Valley Tracker
On December 30, 2014, the Company sold Valley Tracker, a component of the business that the Company acquired in connection with its acquisition of M2M for $1,600 relating to its automated demand response offering designed to ensure demand response customers can connect their equipment remotely and access meter data securely. Customer agreements and customer data were included in the sale of the business. The Company concluded that Valley Tracker met the definition of a business in accordance with ASC 805.
The following table summarizes the assets sold in connection with this transaction:
The amount of goodwill allocated to Valley Tracker was based on the relative fair values of this business and the portion of the reporting unit that will be retained. In accordance with the agreement, the Company received $1,600 at closing. The Company recognized a gain from the sale of Valley Tracker totaling $1,062, net of direct transaction costs totaling $26 during the year ended December 31, 2014.
The Company concluded that the Valley Tracker disposal group does not meet the criteria of discontinued operations under ASC 205-20, Discontinued Operations (ASC 205-20) due to the Company’s conclusion that the operations of Valley Tracker do not represent a strategic shift that will have a major effect on its operations and financial results. As a result, the gain has been reflected as a separate component within income from operations with the corresponding discrete tax benefit of $117 related to the decrease in deferred tax liability as a result of the decreased book and tax basis difference in goodwill being recorded as a component of the Company’s provision for income taxes during the year ended December 31, 2014.
16. Gain on Sale of Assets
On April 22, 2014, the Company entered into an agreement with a third party enterprise customer to sell its remaining two contractual demand response capacity resources related to an open market demand response program, which allowed the buyer to enroll directly with the applicable grid operator. Under the terms of the agreement, the Company agreed to sell each of these two demand response capacity resources with such sale and transfer being effective as of the date that each resource has been paid for in full. The aggregate payment of $5,740 was allocated between each demand response capacity resource based on each resource’s relative fair value as determined by the potential future cash flows from each resource with $2,171 being allocated to the first demand response capacity resource and $3,569 being allocated to the second demand response capacity resource, of which guaranteed fees of $517 were recognized ratably through the end of the contractual period of March 31, 2015. During the year ended December 31, 2014, the third party fully paid the $2,171 purchase price for the first demand response capacity resource resulting in the recognition of a gain on the sale of this asset equal to the purchase price of $2,171. During the year ended December 31, 2015, the Company received the remaining balance in the amount of $2,991 from the third party for the second demand response resource and completed the sale resulting in the recognition of a gain on the sale of this asset equal to the purchase price of $2,991.
17. Subsequent Events
The Company considers events or transactions that occur after the balance sheet date but prior to the issuance of the financial statements to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated as required.
Exhibit Index