TMCNet:  SILVER SPRING NETWORKS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

[August 12, 2014]

SILVER SPRING NETWORKS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013.


In addition, the following discussion contains forward-looking statements that are based on our management's beliefs and assumptions and on information currently available to our management. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly the section entitled "Risk Factors." Overview We have over ten years of experience creating, building and successfully deploying large scale networks and solutions enabling the "internet of things" for critical infrastructure. The "internet of things" refers to a system where a diversity of physical devices has the capacity to communicate using internet technologies. Our first area of focus was in energy, creating a leading smart grid network by applying advanced networking technology and solutions to the power grid. We have recently broadened beyond the smart grid to networking other critical infrastructure such as street lights, which enables smarter and more efficient cities.

For the smart grid, we provide a leading networking platform and solutions that enable utilities to transform the power grid infrastructure into the smart grid.

The smart grid intelligently connects millions of devices that generate, control, monitor and consume power, providing timely information and control to both utilities and consumers. We believe that the application of networking technology to the power grid has the potential to transform the energy industry through better communication just as the application of networking technology to the computing industry enabled the Internet.

We believe the power grid is one of the most significant elements of contemporary industrial infrastructure that has yet to be extensively networked with modern technology. To address this challenge, we pioneered a fundamentally new approach to connect utilities with millions of devices on the power grid. We believe our technology will yield significant benefits to utilities, consumers and the environment, both in the near term and the future. These benefits include more efficient management of energy, improved grid reliability, capital and operational savings, integration with renewable-generation sources, consumer empowerment, and assistance in complying with evolving regulatory mandates through reduced carbon emissions. We believe networking the power grid will fundamentally transform the world's relationship with energy.

We believe our technology is particularly well suited for a range of other solutions across the broad category of the "internet of things." We are focused on critical infrastructure that requires similar networking performance as the current market we serve. Our first expansion beyond the power grid has been in city infrastructure, specifically networking street lights. We believe that by applying advanced networking technology, we can enable cities to achieve their goals of increasing energy and operating efficiency while improving quality of life. We expect to expand our offerings in this area as the market opportunity evolves.

We are an "emerging growth company," as defined in the Jumpstart Our Business Startups Act ("JOBS Act") enacted in April 2012. Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail our company of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

23 -------------------------------------------------------------------------------- Financial Overview Revenue We derive revenue from sales of products and services that enable customers to deploy our networking platform. For the six months ended June 30, 2014, product revenue represented 62% and service revenue represented 38% of our total revenue. For the six months ended June 30, 2014 and 2013, we shipped 0.9 million and 0.5 million endpoints, respectively. We have shipped 19.1 million cumulative endpoints since inception.

Our product revenue is derived from sales of hardware such as communications modules, access points, relays and bridges, and software. To date, in our typical customer deployments, we have sold our communications modules to third party device manufacturers and our other hardware and software products directly to our customers. In such sales of communications modules to third party device manufacturers, we only record revenue related to the communications modules which is pursuant to a contractual relationship between us and the third party device manufacturer. However, in some cases, we have sold third-party devices such as meters integrated with our communications modules directly to our customers. In those circumstances where we sell third party devices directly to our customers, we recognize the sale on a gross basis as we are acting as principal. Whether our customer purchases the third party device from us or the third party device manufacturer is dependent on the nature and extent of the business relationship our customer has with the third party device manufacturer and how our customer prefers to manage their deployment.

Our service revenue includes fees for professional services, managed services and SaaS, and ongoing customer support. Our professional services revenue for the six months ended June 30, 2014 and 2013 was $16.8 million and $25.4 million, respectively. Our managed and SaaS services revenue for the six months ended June 30, 2014 and 2013 were $16.1 million and $42.1 million, respectively.

To date, a substantial majority of our revenue is attributable to a limited number of customer deployments of our advanced metering solution. In the six months ended June 30, 2014, the deployments for Progress Energy, Singapore PowerAssets Ltd, Pacific Gas and Electric Company ("PG&E"), and OG&E represented 26%, 14%, 11%, and 11% of our revenue, respectively.

Each of these total revenue percentages includes amounts related to the customers' deployments that were invoiced directly to our third party device manufacturers, as well as direct revenue from our customers. We expect that a limited number of customers will continue to account for a substantial portion of our revenue in future periods although these customers have varied and are likely to vary from period to period.

Cost of Revenue and Gross Profit Product cost of revenue consists of contract manufacturing costs, including raw materials, component parts and associated freight, and normal yield loss in the period in which we recognize the related revenue. In addition, product cost of revenue includes compensation, benefits and stock-based compensation provided to our supply chain management personnel, overhead and other direct costs, which are recognized in the period in which we recognize the related revenue. Further, we recognize certain costs, including logistics costs, manufacturing ramp-up costs, expenses for inventory obsolescence, warranty obligations, lower of cost or market adjustments to inventory, and amortization of intangibles, in the period in which they are incurred or can be reasonably estimated. We record a lower of cost or market adjustment in instances where the selling price of the products delivered or expected to be delivered is less than cost. We also include the cost of third-party devices in cost of revenue in instances when our customers contract with us directly for such devices. In accordance with our accounting policies, we recognize product cost of revenue in the periods we recognize the related revenue.

Service cost of revenue includes compensation and related costs for our service delivery, customer operations and customer support personnel, facilities and infrastructure cost and depreciation, and data center costs. In accordance with our accounting policies, we recognize service cost of revenue in the period in which it is incurred even though the associated service revenue may be required to be deferred.

24 -------------------------------------------------------------------------------- Our gross profit varies from period to period based on the volume, average selling prices, and mix of products and services recognized as revenue, as well as product and service costs, expense for warranty obligations, and inventory write-downs. The timing of revenue recognition and related costs, which depends primarily on customer acceptance, can fluctuate significantly from period to period and have a material impact on our gross profit and gross margin results.

Operating Expenses Operating expenses consist of research and development, sales and marketing, and general and administrative expenses, as well as amortization of acquired intangibles. Personnel-related expense represents a significant component of our operating expenses. Our regular full-time employee headcount was 639 as of June 30, 2014.

Research and Development Research and development expense represents the largest component of our operating expenses and consists primarily of: · compensation, benefits and stock-based compensation provided to our hardware and software engineering personnel, as well as facility costs and other related overhead; · cost of prototypes and test equipment relating to the development of new products and the enhancement of existing products; and · fees for design, testing, consulting, legal and other related services.

We expense our research and development costs as they are incurred.

Sales and Marketing Sales and marketing expense consists primarily of: · compensation, benefits, sales commissions and stock-based compensation provided to our sales, marketing and business development personnel, as well as facility costs and other related overhead; · marketing programs, including expenses associated with industry events, trade shows; and · travel costs.

General and Administrative General and administrative expense consists primarily of: · compensation, benefits and stock-based compensation provided to our executive, finance, legal, human resource and administrative personnel, as well as facility costs and other related overhead; and · fees paid for professional services, including legal, tax and accounting services.

Key Non-GAAP Financial Measures We believe that our results of operations under GAAP, when considered in isolation, may only provide limited insight into the performance of our business in any given period. As a result, we manage our business, make planning decisions, evaluate our performance and allocate resources by assessing non-GAAP measures such as non-GAAP revenue, cost of non-GAAP revenue, gross profit on non-GAAP revenue, and adjusted EBITDA, in addition to other financial measures presented in accordance with GAAP. We believe that these non-GAAP measures offer valuable supplemental information regarding the performance of our business, and will help investors better understand the sales volumes, and gross margin and profitability trends, as well as the cash flow characteristics, of our business.

These non-GAAP measures should not be considered in isolation from, are not a substitute for, and do not purport to be an alternative to revenue, cost of revenue, gross profit (loss), net income (loss) or any other performance measure derived in accordance with GAAP.

25 -------------------------------------------------------------------------------- Non-GAAP revenue represents amounts invoiced for products for which ownership, typically evidenced by title and risk of loss, has transferred or services that have been provided to the customer, and for which payment is expected to be made in accordance with normal payment terms. Non-GAAP revenue excludes amounts for undelivered products, services to be performed in the future, and amounts paid or payable to customers. Non-GAAP revenue is initially recorded as deferred revenue and is recognized as revenue when all revenue recognition criteria have been met under our accounting policies. We reconcile revenue to non-GAAP revenue by adding revenue to the change in deferred revenue in a given period.

To date, a substantial portion of our non-GAAP revenue is attributable to a limited number of customer deployments of our advanced metering solution. In the six months ended June 30, 2014, the deployments for Baltimore Gas and Electric Company and Commonwealth Edison Company represented 18% and 14% of our non-GAAP revenue, respectively.

Each of these total non-GAAP revenue percentages includes amounts related to the customers' deployments that were invoiced directly to our third party device manufacturers, as well as direct invoices to our customers.

Recurring non-GAAP revenue per endpoint on a trailing twelve month basis as of June 30, 2014 and 2013 was $2.07 per endpoint and $2.14 per endpoint, respectively.

Cost of Non-GAAP Revenue and Gross Profit on Non-GAAP Revenue Cost of non-GAAP revenue represents the cost associated with products and services that have been delivered to the customer, excluding stock-based compensation and amortization of acquired intangibles. Cost of product shipments for which revenue is not recognized in the period incurred is recorded as deferred cost of revenue. Deferred cost of revenue is expensed in the statement of operations as cost of revenue when the corresponding revenue is recognized.

Costs related to invoiced services are expensed in the period incurred. We reconcile cost of revenue to cost of non-GAAP revenue by adding cost of revenue to the change in deferred cost of revenue, less stock-based compensation and amortization of intangibles, included in cost of revenue in a given period.

Gross profit on non-GAAP revenue is the difference between non-GAAP revenue and cost of non-GAAP revenue.

Adjusted EBITDA is net income (loss) adjusted for changes in deferred revenue and deferred cost of revenue, other (income) expense, net, provision for income taxes, depreciation and amortization, stock-based compensation and certain other items management believes affect the comparability of operating results.

The non-GAAP financial measures set forth below for the three and six months ended June 30, 2014 and 2013 have been derived from our condensed consolidated financial statements. Reconciliations to the comparable GAAP measures are contained in the notes below.

Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (unaudited, in thousands, except for percentages) Non-GAAP revenue(1) $ 63,604 $ 86,451 $ 135,454 $ 160,222 Cost of non-GAAP revenue(2) 43,018 60,444 93,320 112,664 Gross profit on non-GAAP revenue(3) $ 20,586 $ 26,007 $ 42,134 $ 47,558 Gross margin on non-GAAP revenue 32% 30% 31% 30% Adjusted EBITDA(4) $ (8,547) $ (2,306) $ (15,456) $ (8,890) 26 --------------------------------------------------------------------------------(1)The following table reconciles revenue to non-GAAP revenue: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (unaudited, in thousands) Revenue, net $ 41,607 $ 103,510 $ 85,836 $ 157,213 Change in deferred revenue, net of foreign currency translation 21,997 (17,059) 49,618 3,009 Non-GAAP revenue $ 63,604 $ 86,451 $ 135,454 $ 160,222 (2)The following table reconciles cost of revenue to cost of non-GAAP revenue: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (unaudited, in thousands) Cost of revenue $ 28,195 $ 55,260 $ 60,980 $ 98,829 Change in deferred cost of revenue, net of foreign currency translation 16,801 7,763 37,058 23,186 Less: Stock-based compensation included in cost of revenue (1,930) (2,531) (4,622) (9,255) Less: Amortization of intangibles included in cost of revenue (48) (48) (96) (96) Cost of non-GAAP revenue $ 43,018 $ 60,444 $ 93,320 $ 112,664 (3)The following table reconciles gross profit to gross profit on non-GAAP revenue: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (unaudited, in thousands, except for percentages) Gross profit $ 13,412 $ 48,250 $ 24,856 $ 58,384 Change in deferred revenue, net of foreign currency translation 21,997 (17,059) 49,618 3,009 Change in deferred cost of revenue, net of foreign currency translation (16,801) (7,763) (37,058) (23,186) Stock-based compensation included in cost of revenue 1,930 2,531 4,622 9,255 Amortization of intangibles included in cost of revenue 48 48 96 96 Gross profit on non-GAAP revenue $ 20,586 $ 26,007 $ 42,134 $ 47,558 Gross margin on non-GAAP revenue 32% 30% 31% 30% (4)The following table reconciles net income (loss) to adjusted EBITDA: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (unaudited, in thousands) Net income (loss) $ (24,591) $ 9,470 $ (52,398) $ (54,896) Change in deferred revenue, net of foreign currency translation 21,997 (17,059) 49,618 3,009 Change in deferred cost of revenue, net of foreign currency translation (16,801) (7,763) (37,058) (23,186) Other (income) expense, net (85) 184 (48) 24,912 Provision for income taxes 4 328 603 392 Depreciation and amortization 1,467 1,689 2,933 3,366 Legal settlements (100) - (100) - Stock-based compensation 9,562 10,845 20,994 37,513 Adjusted EBITDA $ (8,547) $ (2,306) $ (15,456) $ (8,890) 27 -------------------------------------------------------------------------------- Non-GAAP measures have limitations and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. The most significant of these limitations include: · our non-GAAP measures do not reflect the effect of customer acceptance provisions as required under GAAP; · our non-GAAP measures do not reflect the effect of contingent revenue recognition limits due to potential refunds and penalty provisions related to future delivery or performance as required under GAAP; · our non-GAAP measures are based on contractual invoiced amounts and therefore do not reflect the effect of relative selling price allocations between separate units of accounting as required under GAAP; · our non-GAAP measures do not reflect the impact of issuing equity-based compensation to our management team and employees or in connection with acquisitions; · our non-GAAP measures do not reflect the impact of the amortization of acquired intangibles arising from acquisitions; · our non-GAAP measures do not reflect other (income) expense primarily related to gains and losses from the remeasurement of embedded derivative and preferred stock warrant liabilities, and interest expense or loss on conversion from our promissory notes; · our non-GAAP measures do not reflect income tax expense or legal settlement costs; · although depreciation and amortization are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditures; · our non-GAAP measures do not reflect changes in, or cash requirements for, our working capital needs; and · other companies, including companies in our industry, may not use such measures, may calculate non-GAAP measures differently or may use other financial measures to evaluate their performance, all of which reduce the usefulness of our non-GAAP measures as comparative measures.

Results of Operations and Other Financial Measures The following table sets forth our condensed consolidated results of operations for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (unaudited, in thousands) Revenue, net $ 41,607 $ 103,510 $ 85,836 $ 157,213 Cost of revenue 28,195 55,260 60,980 98,829 Gross profit 13,412 48,250 24,856 58,384 Operating expenses: Research and development 17,342 18,752 35,067 43,871 Sales and marketing 8,854 8,637 18,077 19,090 General and administrative 11,888 10,879 23,555 25,015 Total operating expenses 38,084 38,268 76,699 87,976 Operating income (loss) (24,672) 9,982 (51,843) (29,592) Other income (expense), net: 85 (184) 48 (24,912) Loss before income taxes (24,587) 9,798 (51,795) (54,504) Provision for income taxes 4 328 603 392 28 -------------------------------------------------------------------------------- Net income (loss) $ (24,591) $ 9,470 $ (52,398) $ (54,896) Revenue The following table sets forth our revenue for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands) Product revenue $ 24,751 $ 47,996 $ (23,245) $ 52,978 $ 89,716 $ (36,738) Service revenue 16,856 55,514 (38,658) 32,858 67,497 (34,639) Revenue, net $ 41,607 $ 103,510 $ (61,903) $ 85,836 $ 157,213 $ (71,377) Of the $41.6 million total revenue recognized in the three months ended June 30, 2014, 97%, or $40.5 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from customers for which acceptance of initial phases of deployment was achieved prior to the three months ended June 30, 2014, and 3%, or $1.1 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during the three months ended June 30, 2014. Revenue from our advanced metering solution and demand-side management and distribution automation solutions represented 81% and 19%, respectively, of total revenue for the three months ended June 30, 2014.

Of the $103.5 million total revenue recognized in the three months ended June 30, 2013, 89%, or $92.6 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from utility customers for which acceptance of initial phases of deployment was achieved prior to the three months ended June 30, 2013, and 11%, or $10.9 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during the three months ended June 30, 2013. Revenue from our advanced metering solution and demand-side management and distribution automation solutions represented 94% and 6%, respectively, of total revenue for the three months ended June 30, 2013.

Of the $85.8 million total revenue recognized in the six months ended June 30, 2014, 80%, or $69.0 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from customers for which acceptance of initial phases of deployment was achieved prior to the six months ended June 30, 2014, and 20%, or $16.8 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during the six months ended June 30, 2014. Revenue from our advanced metering solution and demand-side management and distribution automation solutions represented 86% and 14%, respectively, of total revenue for the six months ended June 30, 2014.

Of the $157.2 million total revenue recognized in the six months ended June 30, 2013, 93%, or $146.3 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from utility customers for which acceptance of initial phases of deployment was achieved prior to the six months ended June 30, 2013, and 7%, or $10.9 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during the six months ended June 30, 2013. Revenue from our advanced metering solution and demand-side management and distribution automation solutions represented 91% and 9%, respectively, of total revenue for the six months ended June 30, 2013.

Product Revenue. The $23.2 million decrease in product revenue for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to a decrease of $29.3 million related to lower volume, offset by increases related to product mix.

29 -------------------------------------------------------------------------------- The $36.7 million decrease in product revenue for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was primarily due to a decrease of $50.5 million related to lower volume, offset by increases related to product mix.

Service Revenue. The $38.7 million decrease in service revenue for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to $41.6 million resulting from the recognition of services revenue during the three months ended June 30, 2013 that was previously deferred subject to contingency provisions for a customer. Revenue from managed and SaaS services and professional services represented 20% and 21%, respectively, of total revenue for the three months ended June 30, 2014 and 19% and 20%, respectively, of total revenue for the three months ended June 30, 2013.

The $34.6 million decrease in service revenue for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was primarily due to $41.6 resulting from the recognition of services revenue during the six months ended June 30, 2013 that was previously deferred subject to contingency provisions for a customer, partially offset by an increase of $7.0 million for services associated with the receipt of customer acceptances for follow-on phases of deployment of our networking platform and solutions. Revenues from managed and SaaS services and professional services represented 20% and 21%, respectively, of total revenue for the six months ended June 30, 2014, and 19% and 20%, respectively, of total revenue for the six months ended June 30, 2013.

We anticipate that revenue will be lower sequentially in the three months ended September 30, 2014 and year-over-year for the three and nine months ended September 30, 2014, and will fluctuate from period to period for the remainder of 2014 and beyond, and may lead to gross losses primarily due to the timing of when we expect to meet the completion and acceptance criteria in our customer arrangements.

Non-GAAP Revenue The following table sets forth our non-GAAP revenue for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands)Non-GAAP revenue $ 63,604 $ 86,451 $ (22,847) $ 135,454 $ 160,222 $ (24,768) The $22.8 million decrease in non-GAAP revenue for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was due to decreases of $19.2 million and $5.1 million related to changes in product mix and lower volumes, respectively, partially offset by an increase of $0.8 million in service billings.

Non-GAAP revenue from our advance metering solution and demand-side management and distribution automation solutions represented 81% and 19%, respectively, for the three months ended June 30, 2014, and 88% and 12%, respectively, for the three months ended June 30, 2013.

Non-GAAP revenue from product, managed services and SaaS, and professional services represented 67%, 17%, and 16%, respectively, of total non-GAAP revenue for the three months ended June 30, 2014, and 76%, 11% and 13%, respectively, for the three months ended June 30, 2013.

The $24.8 decrease in non-GAAP revenue for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was due to decreases of $17.3 million and $11.2 million related to changes in mix and lower volumes, respectively, partially offset by an increase of $3.1 million in service billings.

Non-GAAP revenue from our advance metering solution and demand-side management and distribution automation solutions represented 84% and 16%, respectively, for the six months ended June 30, 2014, and 90% and 10%, respectively, for the six months ended June 30, 2013.

30 -------------------------------------------------------------------------------- Non-GAAP revenue from product, managed services and SaaS, and professional services represented 70%, 15%, and 15%, respectively, of total non-GAAP revenue for the six months ended June 30, 2014, and 76%, 11% and 13%, respectively, for the six months ended June 30, 2013.

We anticipate that non-GAAP revenue will be lower year-over-year for the three and nine months ended September 30, 2014 primarily due to continued effect of the long and unpredictable sales cycles of our existing and potential customers.

Cost of Revenue and Gross Profit The following table sets forth our cost of revenue and gross profit for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands) Product cost of revenue $ 13,414 $ 39,565 $ (26,151) $ 31,329 $ 65,308 $ (33,979) Service cost of revenue 14,781 15,695 (914) 29,651 33,521 (3,870) Cost of revenue $ 28,195 $ 55,260 $ (27,065) $ 60,980 $ 98,829 $ (37,849) Product gross profit (loss) $ 11,337 $ 8,431 $ 2,906 $ 21,649 $ 24,408 $ (2,759) Service gross profit (loss) 2,075 39,819 (37,744) 3,207 33,976 (30,769) Gross profit $ 13,412 $ 48,250 $ (34,838) $ 24,856 $ 58,384 $ (33,528) Product Cost of Revenue. The $26.2 million decrease in product cost of revenue for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to a decrease of $24.3 million from lower volumes.

The $34.0 million decrease in product cost of revenue for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was due to a decrease of $42.0 million related to a decrease in volumes, partially offset by an increase related to higher costs and product mix.

Service Cost of Revenue. The $0.9 million decrease in service cost of revenue for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to a $0.5 million decrease in stock-based compensation related to our IPO.

The $3.9 million decrease in service cost of revenue for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was primarily due to a decrease of $3.5 million in stock-based compensation related to our IPO.

Changes in our service cost of revenue are disproportionate to changes in our service revenue because we recognize service cost of revenue in the period in which it is incurred even though the associated service revenue may be required to be deferred, as described under "Financial Overview-Cost of Revenue and Gross Profit (Loss)" above. In addition, we may incur gross losses primarily due to the timing of when we expect to meet the completion and acceptance criteria in our customer arrangements.

Cost of Non-GAAP Revenue and Gross Profit on Non-GAAP Revenue The following table sets forth our cost of non-GAAP revenue for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands)Cost of non-GAAP revenue $ 43,018 $ 60,444 $ (17,426) $ 93,320 $ 112,664 $ (19,344) 31 -------------------------------------------------------------------------------- Cost of non-GAAP revenue decreased by $17.4 million during the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 due to decreases of $15.3 million and $5.5 million related to lower volumes and product mix, respectively, partially offset by an increase of $3.4 million related to higher costs.

Cost of non-GAAP revenue decreased by $19.3 million during the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 due to decreases of $16.4 million and $5.8 million related to product mix and lower volumes, respectively, partially offset by an increase of $2.9 million related to higher costs.

The following table sets forth our gross profit and gross margin on non-GAAP revenue for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands, except for percentages) Gross profit on non-GAAP revenue $ 20,586 $ 26,007 $ (5,421) $ 42,134 $ 47,558 $ (5,424) Gross margin on non-GAAP revenue 32 % 30 % 31 % 30 % Gross profit on non-GAAP revenue decreased by $5.4 million during the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 primarily due to a decrease of $5.4 million due to lower volumes.

Gross profit on non-GAAP revenue decreased by $5.4 million during the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 primarily due to a decrease of $14.1 million related to changes in product mix, partially offset by an increase of $10.1 million related to higher volumes.

Operating Expenses The following table sets forth our operating expenses for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands)Research and development $ 17,342 $ 18,752 $ (1,410) $ 35,067 $ 43,871 $ (8,804) Sales and marketing 8,854 8,637 217 18,077 19,090 (1,013) General and administrative 11,888 10,879 1,009 23,555 25,015 (1,460) Operating expenses $ 38,084 $ 38,268 $ (184) $ 76,699 $ 87,976 $ (11,277) Personnel-related expenses represent the most significant component of our operating expenses and decreased from period to period. We intend to continue to manage our operating expenses in line with our existing cash and available financial resources and anticipate continued spending in future periods in order to execute our long-term business plan. In addition, the timing of additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.

Stock-based compensation in operating expenses was lower by $0.7 million during the three months ended June 30, 2014 due to higher stock-based compensation during the three months ended June 30, 2013 as a result of our IPO. Stock-based compensation in operating expenses was lower by $11.9 million during the six months ended June 30, 2014 due to higher stock-based compensation for equity instruments vested upon our IPO during the six months ended June 30, 2013.

Research and Development. The $1.4 million decrease in research and development expense for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to decrease of $0.9 million and $0.4 million in stock-based compensation and payroll compensation expense, respectively.

32 --------------------------------------------------------------------------------The $8.8 million decrease in research and development expense for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was primarily due to decreases of $7.3 million and $0.7 million in stock-based compensation and outside services, respectively.

We intend to continue to invest significantly in our research and development efforts, which we believe are essential to enhancing our competitive position and developing new products.

Sales and Marketing. The $0.2 million increase in sales and marketing expense for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to an increase of $0.2 million in stock-based compensation.

The $1.0 million decrease in sales and marketing expense for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 is primarily due to a decrease of $1.1 million in stock-based compensation.

General and Administrative. The $1.0 million increase in general and administrative expense for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was due to increases of $0.9 million in legal expenses and acquisition costs for the acquisition of SLV and $0.4 million in cash compensation, partially offset by a decrease of $0.3 million in travel expenses.

The $1.5 million decrease in general and administrative expense for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was primarily due to a $3.5 million decrease in stock-based compensation, partially offset by increases of $1.4 million and $0.5 million in outside services and payroll compensation, respectively.

Operating Income (Loss) The following table sets forth our operating loss for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands)Operating income (loss) $ (24,672) $ 9,982 $ (34,654) $ (51,843) $ (29,592) $ (22,251) The approximately $34.7 million increase in operating loss for the three months ended June 30, 2014 as compared to the operating income for the three months ended June 30, 2013 was due to a decrease of $34.8 million in gross profit, offset by a decrease of $0.2 million in operating expenses.

The approximately $22.3 million increase in operating loss for the six months ended June 30, 2014 as compared to the six months ended June 30, 2014 was due to a decrease of $33.5 million in gross profit, offset by a decrease of $11.3 million in operating expenses.

Other Income (Expense), Net 33 -------------------------------------------------------------------------------- The following table sets forth our other income (expense), net, for the periods shown: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands)Interest income (expense), net $ 85 $ (184) $ 269 $ 48 $ (1,236) $ 1,284 Conversion of promissory notes and remeasurement of warrants and derivatives - - - - (23,676) 23,676 Other income (expense), net $ 85 $ (184) $ 269 $ 48 $ (24,912) $ 24,960 Other income (expense), net, was higher for the six months ended June 30, 2014 primarily due to the $22.9 million loss on conversion of convertible promissory notes, $0.9 million of interest expense on our convertible promissory notes, and $0.8 million loss on termination of warrants, all of which were related to our IPO and were recorded during the six months ended June 30, 2013.

Net Income (Loss) Three Months Ended Six Months Ended June 30, June 30, 2014 2013 Change 2014 2013 Change (unaudited, in thousands)Net income (loss) $ (24,591) $ 9,470 $ (34,061) $ (52,398) $ (54,896) $ 2,498 The approximately $34.1 million decrease in net income (loss) for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 was primarily due to a decrease of $34.7 million in operating loss, offset by a increase of $0.3 million in other income, net.

The approximately $2.5 million increase in net loss for the six months ended June 30, 2014 as compared to the six months ended June 30, 2014 was due to a decrease of $22.3 million in operating loss, offset by an increase of $25.0 million in other income, net.

Provision for Income Taxes Since inception, we have incurred net losses and have not recorded provisions for U.S. federal and state income taxes, except state minimum taxes. We have not reported a benefit for federal and state income taxes in the condensed consolidated financial statements as the deferred tax asset arising from our net operating losses has been offset by a valuation allowance because it was more likely than not that the tax benefit of the net operating losses may not be realized. We have recorded a provision for foreign taxes associated with our foreign subsidiaries.

Liquidity and Capital Resources As of June 30, 2014 we had $64.8 million in cash and cash equivalents and $60.5 million in short-term investments. Our investment portfolio consisted of money market funds and fixed income securities. Our fixed income securities were denominated in U.S. dollars and consisted of highly liquid debt instruments of the U.S. government and its agencies, foreign government and agency securities, and U.S. and foreign corporate debt securities. We limit the amount of our domestic and international investments with any single issuer and any single financial institution, and also monitor the diversity of the portfolio, thereby diversifying the credit risk. Within our portfolio, we held $4.1 million of foreign government and agencies securities as of June 30, 2014. These sovereign debt securities had an average credit rating of AAA and were predominantly from Canada. None of the securities deemed sovereign debt was from Greece, Ireland, Italy, Portugal or Spain.

34 -------------------------------------------------------------------------------- We expect that operating expenses will constitute a material use of our cash balances. In the near term, we intend to continue to manage our operating expenses in line with our existing cash and available financial resources and anticipate increased spending in future periods in order to execute our long-term business plan. In addition, we may use cash to fund acquisitions or invest in other businesses, technologies or product lines. We have incurred net losses and negative cash flows from operating activities since our inception, and we expect we will continue to incur operating and net losses and cash flows to fluctuate from period to period in 2014 and beyond. We believe that our available cash balances and credit facilities will be sufficient to meet our presently anticipated working capital, capital expenditure and business expansion requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of customer wins and related billings and the expansion of our production capacity, as well as sales and marketing activities, timing and extent of spending on research and development efforts and the continuing market acceptance of our networking platform and solutions.

Prior to fiscal 2013, we funded our operations primarily through private sales of equity securities and debt financing. In March 2013, we completed our IPO in which we issued and sold 5,462,500 shares of common stock at a public offering price of $17.00 per share. We received net proceeds of $84.5 million after deducting underwriting discounts and commissions of $6.5 million and paid offering costs of $1.9 million, but before deducting previously paid and unpaid offering expenses of approximately $4.5 million. Our convertible notes converted into 3,764,954 shares of common stock. We paid $12.0 million in consideration for the termination of certain preferred stock warrants of a related party.

Concurrently with our IPO, we issued and sold in a private placement with a related party 705,881 shares of common stock at the IPO price of $17.00 per share and we received net proceeds of $12.0 million.

We have available a line of credit with a bank, which provides for advances and the issuance of letters of credit of up to $50 million. As of June 30, 2014, there were no borrowings outstanding under the credit agreement; however, $6.0 million of letters of credit were outstanding, leaving $44.0 million of available capacity for cash borrowings or additional letters of credit, subject to compliance with financial covenants and other customary conditions to borrowings. As of June 30, 2014 we were in compliance with the financial covenants in the credit agreement.

We are occasionally required to provide performance bonds to secure our performance under customer contracts. Our ability to obtain such bonds primarily depends upon our capitalization, working capital, past performance, management expertise and reputation and external factors beyond our control, including the overall capacity of the surety market. Surety companies consider those factors in relation to the amount of our tangible net worth and other underwriting standards that may change from time to time. Surety companies may require that we collateralize a percentage of the bond with our cash or other form of credit enhancement. Events that affect surety markets generally may result in bonding becoming more difficult to obtain in the future, or being available only at a significantly greater cost. In addition, some of our customers also require collateral in the form of letters of credit to secure performance or to fund possible damages as the result of an event of default under our contracts with them. If we enter into significant long-term agreements that require the issuance of letters of credit, our liquidity could be negatively impacted. Our inability to obtain adequate bonding or letters of credit to meet bid requirements or enter into significant long-term agreements could have a material adverse effect on our future revenues and business prospects.

Cash Flows The following table sets forth the major sources and uses of cash for each of the periods set forth below: Six Months Ended June 30, 2014 2013 Change (unaudited, in thousands) Cash used in operating activities $ (6,655) $ (22,961) $ 16,306 Cash used in investing activities (9,891) (2,462) (7,429) Cash (used in) provided by financing activities (1,264) 77,747 (79,011) 35 --------------------------------------------------------------------------------Cash Flows from Operating Activities Cash flows used in operating activities totaled $6.7 million during the six months ended June 30, 2014, primarily as a result of a net loss of $52.4 million, which was partially offset by the change in our operating assets and liabilities of $21.9 million, non-cash stock-based compensation of $21.0 million, and depreciation and amortization of $2.9 million.

Cash flows used in operating activities totaled $23.0 million during the six months ended June 30, 2013, primarily as a result of a net loss of $54.9 million and the change in our operating assets and liabilities of $34.1 million, which were partially offset by non-cash stock-based compensation expense of $37.5 million, non-cash loss on conversion of convertible promissory notes and termination of warrants of $23.7 million, and depreciation and amortization of $3.4 million.

Cash Flows from Investing Activities Cash flows used in investing activities totaled $9.9 million during the six months ended June 30, 2014, primarily as a result of $ $39.5 million in purchases of short-term investments, $8.8 million for the acquisition of Streetlight.Vision, and $3.7 million in purchases of property and equipment, partially offset by $42.1 million in proceeds from sales and maturities of short-term investments.

Cash flows used in investing activities totaled $2.5 million during the six months ended June 30, 2013, primarily as a result of purchases of property and equipment.

Cash Flows from Financing Activities Cash flows used in financing activities totaled $1.3 million during the six months ended June 30, 2014 primarily as a result of $5.3 million for taxes paid related to the net share settlement of equity awards, partially offset by $4.7 million in proceeds from our employee stock purchase program and the exercise of stock options.

Cash provided by financing activities totaled $77.8 million during the six months ended June 30, 2013 and consisted primarily of $84.7 million in net proceeds from the sale of 5,462,500 shares of common stock in our IPO, $12.0 million proceeds from the sale of 705,881 shares of common stock in a private placement, partially offset by the payment of $12.0 million payment for the termination of certain Series A and Series C preferred stock warrants, and $6.2 million for taxes paid related to the net share settlement of equity awards.

Concentration of Credit Risk We typically extend credit to our customers and meter manufacturers and do not require collateral or other security in support of accounts receivable. We attempt to mitigate the credit risk in our trade receivables through our credit evaluation process and payment terms. We analyze the need to reserve for potential credit losses and record allowances for doubtful accounts when necessary. As of June 30, 2014, Commonwealth Edison Company and PG&E accounted for 14% and 12%, respectively, of our accounts receivable. As of December 31, 2013, Baltimore Gas and Electric Company, Landis+Gyr AG (acquired by Toshiba Corporation), Commonwealth Edison Company, and Virginia Electric and Power Company accounted for 26%, 11%, 10%, and 10%, respectively, of our accounts receivable.

To date, we have not had any significant write-offs of uncollectable accounts receivable, and there was no allowance for doubtful accounts as of June 30, 2014 and December 31, 2013.

Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of 36 --------------------------------------------------------------------------------facilitating off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limited purposes.

During the ordinary course of business, we provide standby letters of credit or other guarantee instruments to third parties as required for certain transactions initiated either by us or our subsidiaries. As of June 30, 2014, our financial guarantees that were not recorded on our balance sheet consisted of $44.0 million of standby letters of credit and $15.0 million of surety bonds related to performance guarantees, facility leases, and workers compensation insurance.

Contractual Obligations There were no material changes in our commitments under contractual obligations, as disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K.

Critical Accounting Policies and Estimates Our 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. GAAP requires us to make certain estimates and judgments that affect the amounts reported in our consolidated financial statements. We base our estimates on historical experience, anticipated future trends and other assumptions we believe to be reasonable under the circumstances. Because these accounting policies require significant judgment, our actual results may differ materially from our estimates.

There have been no material changes in our critical accounting policies and estimates during the six months ended June 30, 2014 as compared to the critical accounting policies and estimates disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Annual Report on Form 10-K.

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