SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2016

or

For the transition period from                      to                     

Commission file number: 001-35828

 

Silver Spring Networks, Inc.

(Exact name of registrant as specified in its charter)

 

 

230 W. Tasman Drive

San Jose, California 95134

(Address of principal executive offices) (Zip Code)

(669) 770-4000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 3, 2016, there were approximately 51,894,472 shares of the Registrant’s Common Stock outstanding.

 

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TABLE OF CONTENTS

 

 

 

 

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NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements. All statements, other than statements of historical fact, contained in this Quarterly Report on Form 10-Q, including statements regarding our revenue, billings, backlog, and other aspects of our future results of operations, financial position and cash flows, our business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “would,” “could,” “should,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part II, Item 1A “Risk Factors.”  Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of these forward-looking statements after the date of this Quarterly Report on Form 10-Q or to conform these statements to actual results or revised expectations.

 

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SILVER SPRING NETWORKS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except for par value)

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILVER SPRING NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts, unaudited)

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILVER SPRING NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(in thousands, unaudited)

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILVER SPRING NETWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(in thousands, unaudited)

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

 

 

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Silver Spring Networks, Inc. (the “Company”, “we”, “us” and “our”) have been prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, for interim financial information as well as the instructions to Form 10-Q and applicable rules and regulations of the U.S. Securities and Exchange Commission, or SEC. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments, including normal recurring accruals, considered necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2016, are not necessarily indicative of the results that may be expected for the year ending December 31, 2016, or any future period. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors,” “Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015. The preparation of unaudited condensed consolidated financial statements necessarily requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the condensed consolidated balance sheet dates and the reported amounts of revenues and expenses for the periods presented. Actual results could differ materially from those estimates under different assumptions or conditions. As a result, the quarterly results may not be indicative of the full year results.

The condensed consolidated financial statements include the accounts of Silver Spring Networks, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

 

2. Significant Accounting Policies and Estimates

There have been no material changes to our significant accounting policies described in Note 1, Description of Business, Basis of Presentation and Significant Accounting Policies, in Notes to Consolidated Financial Statements in Item 8 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2015 that have had a material impact on our condensed consolidated financial statements and related notes.

Recent Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. This standard is effective for annual reporting periods beginning after December 15, 2016. We are currently evaluating the effect that this new guidance will have on our financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This standard requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to current lease accounting. The guidance also eliminates current real estate-specific provisions for all entities. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. All entities will classify leases to determine how to recognize lease-related revenue and expense. The guidance becomes effective for fiscal years and interim reporting periods beginning after December 15, 2018. We are currently evaluating the effect that this new guidance will have on our financial statements and related disclosures.

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), or ASU 2014-09, which supersedes the revenue recognition requirements in Accounting Standards Codifications, or ASC, 605, Revenue Recognition. Under this new guidance, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The new guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The updated standard will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective and permits the use of either the full retrospective or cumulative effect transition method. In July 2015, the FASB decided to delay the effective date of ASU 2014-09 by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. As such, the updated standard will be effective for us in the first quarter of 2018, with the option to early adopt it in the first quarter of 2017. We have not yet selected a transition method and we are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

 

3. Net (loss) income per share

Basic net (loss) income per share is computed by dividing the net (loss) income by the weighted-average number of shares of common stock outstanding during the period. Diluted net (loss) income per share is computed by dividing the net (loss) income by the weighted-average number of shares of common stock outstanding plus dilutive potential shares of common stock outstanding during the period. Dilutive potential shares of common stock consist of common shares issuable upon exercise of stock options, issuances of shares pursuant to the 2012 Employee Stock Purchase Plan, or ESPP, vesting of restricted stock units, or RSUs, and contingently issuable performance stock units, or PSUs, to the extent dilutive. We include the common shares underlying PSUs in the calculation of diluted net (loss) income per share when they become contingently issuable and exclude such shares when they are not contingently issuable. Certain potential shares of common stock were excluded from the computation of diluted net (loss) income per share because their effect would be anti-dilutive.

The following table sets forth the computation of basic and diluted net (loss) income per share (in thousands, except per share data):

 

 

The following potential common shares outstanding were excluded from the computation of diluted net (loss) income per share because including them would have been anti-dilutive (in thousands):

 

 

 

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

4. Cash, Cash Equivalents and Short-Term Investments

Cash, cash equivalents and short-term investments consisted of the following as of September 30, 2016 (in thousands):

 

 

Cash, cash equivalents and short-term investments consisted of the following as of December 31, 2015 (in thousands):

 

 

As of September 30, 2016, approximately 85% and 9% of our cash, cash equivalents, and short-term investments were held with two financial institutions, respectively. As of December 31, 2015, approximately 84% and 11% of our cash, cash equivalents, and short-term investments were held with two financial institutions, respectively.

Contractual Maturities

The contractual maturities of cash equivalents and short-term investments consisted of the following (in thousands):  

 

 

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table presents gross unrealized losses and fair values for those investments that were in an unrealized loss position as of September 30, 2016 and December 31, 2015, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in thousands):  

 

 

As of September 30, 2016 and December 31, 2015, there were no investments with unrealized losses for a period in excess of 12 months.

We periodically review our marketable debt securities for other-than-temporary impairment. We consider factors such as the duration, severity and the reason for the decline in value, the potential recovery period and our intent to sell. We also consider whether it is more likely than not that we will be required to (i) sell the debt securities before recovery of their amortized cost basis, and (ii) the amortized cost basis cannot be recovered as a result of credit losses. As of September 30, 2016, we anticipate that we will recover the entire amortized cost basis of such available-for-sale debt securities and have determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three and nine months ended September 30, 2016 and 2015. It is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases. There were insignificant gross realized gains or losses from available-for-sale securities during the three and nine months ended September 30, 2016 and 2015.  

 

5. Fair Value Measurements

We determine the fair values of our financial instruments based on a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The classification of a financial asset or liability within the hierarchy is based upon the lowest level input that is significant to the fair value measurement. Under ASC Topic 820, Fair Value Measurement and Disclosures, the fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value. The fair value framework requires the categorization of assets and liabilities into three levels based upon the assumptions (inputs) used to price the assets or liabilities. The guidance for fair value measurements requires that assets and liabilities carried at fair value be classified and disclosed in one of the following categories:

Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3—Unobservable inputs in which there is little or no market data, which requires us to develop our own assumptions.

Level 1 measurements are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 measurements are obtained from readily available pricing sources for comparable instruments, identical instruments in less active markets, or models using market observable inputs. We did not have any transfers of financial instruments between valuation levels during the nine months ended September 30, 2016 and year ended December 31, 2015.

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Assets Measured at Fair Value on a Recurring Basis

As of September 30, 2016, financial assets recorded at fair value on a recurring basis were determined using the following inputs (in thousands):

 

 

As of December 31, 2015, financial assets recorded at fair value on a recurring basis were determined using the following inputs (in thousands):

 

 

As of September 30, 2016 and December 31, 2015, there were no liabilities that are measured and recorded at fair value on a recurring basis.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

As of September 30, 2016, we had no liabilities measured at fair value on a nonrecurring basis.

Our intangible assets are measured at fair value on a nonrecurring basis, if impairment is indicated. During the three and nine months ended September 30, 2016, intangible assets were measured at fair value resulting in an impairment charge of $2.2 million, which was recorded in the condensed consolidated statements of operations. We measured the fair value of the assets primarily using discounted cash flow projections. The discounted cash flow projections require estimates for expected performance such as revenue, gross margin and operating expenses, in order to discount the sum of future independent cash flows using discount rates. Acquired intangible assets are classified as Level 3 assets, due to the absence of quoted market prices. See Note 7, Goodwill and Intangibles Assets, for further information.

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

As of December 31, 2015, there were no assets and liabilities that are measured and recorded at fair value on a nonrecurring basis except for assets and liabilities valued on the date of acquisition for business acquired during 2015.

Assets and Liabilities Not Measured at Fair Value

The carrying amounts of our accounts receivable, accounts payable, and other accrued liabilities approximate fair value due to their short maturities.

 

6. Business Acquisition

On January 16, 2015, we completed the acquisition of Detectent, Inc., or Detectent, a privately held corporation that provides customer intelligence solutions for utilities leveraging its data analytics platform, and paid $7.6 million in cash consideration. The acquisition of Detectent was accounted for under the acquisition method of accounting. Detectent’s SaaS, subscription, and software solutions help improve advanced metering infrastructure and utility grid operations, ensure revenue protection, and deliver enhanced customer engagement programs. We recorded goodwill of $4.5 million and intangible assets of $3.8 million, which consisted primarily of developed technology, customer relationships, non-compete agreements and order backlog, at the time of acquisition. The goodwill arising from the Detectent acquisition was largely attributable to the synergies expected to be realized and was not deductible for U.S. federal income tax purposes.

In addition, we paid and held $4.0 million of deferred cash consideration, or contingent payments, in an escrow account, to be released over a two-year period subject to the retention of key employees of Detectent, or retention period. Contingent payments associated with future employment conditions are being recorded as compensation expense over the retention period. During the nine months ended September 30, 2016, we released $1.0 million from the escrow account in connection with the satisfaction of the retention terms of the acquisition agreement.

7. Goodwill and Intangible Assets

Goodwill:

As of September 30, 2016 and December 31, 2015, the gross amount of goodwill was $8.8 million. In accordance with its accounting policy and ASC 350, we test our goodwill and any other intangibles with indefinite lives annually for impairment and assess whether there are any indicators of impairment on an interim basis. We operate in one reportable segment and we are organized as one reporting unit. We performed our annual impairment test for all reporting units on August 1, 2016 in accordance with its accounting policy and concluded that there was no impairment to goodwill during the nine months period ended September 30, 2016.

Intangible Assets:

The following table summarizes the gross carrying amount and accumulated amortization for the intangible assets resulting from acquisitions (in thousands):

 

 

Intangible assets subject to amortization are amortized over their useful lives as shown in the table above.

During the three months ended September 30, 2016, we determined that there were indicators of impairment for intangible assets which were acquired as part of our acquisition of Streetlight.Vision SAS. These resulted from a change of our monetization plans including a business model shift from on-time, lower-margin, third-party product shipments to higher-margin recurring managed services and SaaS billings. As a result, the impairment analysis for these intangible assets resulted in an impairment charge to

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

operating expense of $2.2 million which was recorded in our consolidated statements of operations for the three and nine months ended September 30, 2016.

The following table illustrates the amortization expense included in the consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 (in thousands):

 

 

The estimated future amortization expense of purchased intangible assets with definite lives for the next five years is as follows (in thousands):

 

 

 

8. Stock-Based Compensation

Equity Incentive Plan and Employee Stock Purchase Plan

Our Board of Directors adopted the 2012 Equity Incentive Plan, or 2012 Plan, which became effective on March 12, 2013 and serves as the successor to our 2003 Stock Option Plan, or 2003 Plan. Pursuant to the 2012 Plan, 3,400,000 shares of our common stock were initially reserved for grant, plus (1) any shares that were reserved and available for issuance under the 2003 Plan at the time the 2012 Plan became effective, and (2) any shares that become available upon forfeiture or repurchase by us under the 2003 Plan and a stock option plan assumed in connection with a previous acquisition, will be reserved for issuance. In addition, the number of shares of our common stock available for grant and issuance shall be increased on January 1 of each calendar year during the term of the Plan by the lesser of (i) four percent (4%) of the number of shares of our common stock issued and outstanding on each December 31 immediately prior to the date of increase, or (ii) such number of shares determined by the Board of Directors. Under the 2012 Plan, we may grant both incentive and non-statutory stock options, restricted stock, restricted stock units, and performance stock units to employees, directors and service providers. We may grant options to purchase shares of common stock to employees, directors and service providers at prices not less than the fair market value on the date of grant for both Incentive Stock Options, or ISOs, and Nonqualified Stock Options. ISOs granted to a person who, at the time of the grant, owns more than 10% of the voting power of all classes of stock must be at no less than 110% of the fair market value and expire five years from the date of grant. All other options generally have a contractual term of 10 years. Options generally vest over four years. RSUs generally vest between two to four years. PSUs generally vest over three years.

Our Board of Directors adopted the ESPP, which became effective on March 12, 2013, pursuant to which 400,000 shares of our common stock have been reserved for future issuance. In addition, on each January 1 for the first ten calendar years after the first Offering Date, the aggregate number of shares of our common stock reserved for issuance under the ESPP shall be increased automatically by the number of shares equal to 1% of the total number of outstanding shares of our common stock on the immediately preceding December 31 subject to restrictions defined in the ESPP. Eligible employees can enroll and elect to contribute up to 15% of their compensation through payroll withholdings in each offering period, subject to certain limitations. Each offering period is six months in duration. The purchase price of the stock is the lower of 85% of the fair market value on (a) the first day of the offering period or (b) the purchase date.

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Inducement Grants

On July 6, 2016, we entered into an employment agreement with Aysegul Ildeniz as our Chief Operating Officer, or COO. In connection with her employment, we granted Ms. Ildeniz a stock option to purchase 120,000 shares of our common stock, and RSUs that may be settled for 80,000 shares of our common stock, as inducement grants made outside of the 2012 Plan in reliance upon NYSE Rule 303A.08. The stock option has an exercise price equal to the closing market value of our common stock on the date of grant, and vests (i) with respect to 25% of the underlying shares on the one-year anniversary of the date of grant, and (ii) with respect to an additional 1/48th of the underlying shares each month thereafter, until such time as the option is fully vested and exercisable. The RSUs vest (i) with respect to 25% of the shares on the one-year anniversary of the date of grant, and (ii) with respect to an additional 1/16th of the shares on each three-month anniversary thereafter, until such time as the RSUs are fully vested.

As of September 30, 2016 and December 31, 2015, there were 5.9 million and 4.9 million shares, respectively, of common stock reserved for future grants under our ESPP and 2012 Plan.

 

Stock Option Activities

The following table summarizes our stock option activity and related information for the nine months ended September 30, 2016 as follows (in thousands, except per share data):

 

 

The aggregate intrinsic value disclosed above represents the total intrinsic value (the difference between the fair value of our common stock as of September 30, 2016 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2016. This amount is subject to change based on changes to the fair value of our common stock.

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Restricted Stock Units Activities

The following table summarizes our restricted stock units activity and related information for the nine months ended September 30, 2016 as follows (in thousands, except per share data):  

 

 

Stock-based Compensation

We recorded stock-based compensation expense as follows (in thousands):

 

Stock-based compensation related to our corporate bonus incentive plan was $3.0 million and $0.8 million for the three months ended September 30, 2016 and 2015, respectively. Stock-based compensation related to our corporate bonus incentive plan was $7.0 million and $6.1 million for the nine months ended September 30, 2016 and 2015, respectively. We recorded these amounts under accrued liabilities in our consolidated balance sheets.

The following table presents unrecognized compensation cost, adjusted for estimated forfeitures, recognized over a weighted-average period related to unvested stock options, ESPP, RSUs, and PSUs as of September 30, 2016 (in thousands, except year data):

 

 

 

9. Income Taxes  

Our income tax provision for the three months ended September 30, 2016 and 2015 reflects an effective tax rate of (8.1%) and (26.2%), respectively. Our income tax provision and benefit for income taxes for the nine months ended September 30, 2016 and 2015 reflects an effective tax rate of (38.8%) and (3.6%), respectively. Our income tax expense for the three and nine months ended September 30, 2016 consists primarily of income tax from state and foreign jurisdictions, and the write off of $0.5 million deferred tax charge associated with the impairment of intangible assets discussed in Note 7. Goodwill and Intangible Assets. Our tax provision and

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

benefit for income taxes for the three and nine months ended September 30, 2015 consists primarily of a net benefit of $0.1 million and $1.1 million, respectively, which was due to the deferred income tax benefits related to the Detectent acquisition.

10. Segment Information

We operate in one reportable segment and we are organized as one reporting unit. Our chief operating decision makers are our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, who review consolidated operating results to make decisions about allocating resources and assessing performance for the entire company. Revenue by geography is based on the billing address of the customer. The following table presents revenue by geographic region (in thousands):

 

 

Substantially all of our long-lived assets are located in the United States.

11. Balance Sheet Details

Inventory

Inventory consisted of the following (in thousands):

 

 

Accrued and Other Liabilities

Accrued and other liabilities consisted of the following (in thousands):  

 

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Other Liabilities, non-current

Other liabilities, non-current consisted of the following (in thousands):  

 

          Product Warranty

Product warranty activity is as follows (in thousands):

 

Accumulated Other Comprehensive (Loss) Income (AOCI), Net of Tax

The components of accumulated other comprehensive (loss) income, net of tax, for the nine months ended September 30, 2016 are as follows (in thousands):

 

 

12. Commitments and contingencies

Operating and Capital Leases

Our primary operating lease commitment as of September 30, 2016, related to our headquarters in San Jose, California, requires monthly lease payments through September 2026.

We recognize rent expense on a straight-line basis over the lease period. Where leases contain escalation clauses, rent abatements, or concessions, such as rent holidays and landlord or tenant incentives or allowances, we apply them in the determination of straight-line rent expense over the lease term. Rent expense for all facility leases was $1.8 million and $1.4 million for the three months ended September 30, 2016 and 2015, respectively, and $6.1 million and $3.9 million for the nine months ended September 30, 2016 and 2015, respectively.

 

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

As of September 30, 2016, the future minimum commitments under our operating leases were as follows (in thousands):  

 

 

Legal Contingencies

EON Patent Litigation.  In June 2011, EON Corp. IP Holdings, LLC, a non-producing entity, or EON, filed suit in United States District Court for the Eastern District of Texas, Tyler Division against us and a number of smart grid providers.  The lawsuit alleges infringement of United States Patent Nos. 5,388,101, 5,481,546, and 5,592,491, or the EON Patents, by certain networking technology and services that we and the other defendants provide.  Other defendants included Landis+Gyr AG (which was acquired by Toshiba Corporation), Aclara Power-Line Systems Inc., Elster Solutions, LLC, Itron, Inc. and Trilliant Networks Inc., all of which settled with EON prior to trial. We filed answers, affirmative defenses and counterclaims denying the plaintiff’s allegations and asserting that the plaintiff’s patents are invalid. A trial was held in June 2014. After the trial, the jury determined that we had infringed certain, but not all, of the claims under the EON Patents, and returned a verdict against us in the amount of $18.8 million.  Following post-trial motions by both parties, the court reduced the damage award to approximately $13.0 million, and in December 2014, entered a final judgment in that amount plus approximately $1.5 million in pre-judgment interest.  The court subsequently revised the final judgment to include additional costs of about $0.2 million and entered an amended final judgment in December 2014.  All of the EON Patents have expired and therefore EON is not seeking, and EON may not recover, any additional sums as royalties for our sales of products going forward.

In December 2014, we filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit in Washington, D.C.  In order to stay the execution of the final judgment pending the appeal, in December 2014 we filed a surety bond in the amount of $17.6 million, which includes an additional 20% of the final judgment for post-judgment interest and expenses expected to be incurred during the appeal process, in accordance with court rules.  The bond was issued by Zurich Insurance and is collateralized with a standby letter of credit in the amount of $13.0 million, the amount of the damage award, as described below in “Customer Performance and Other Commitments.” Upon completion of the appeal process, both the surety bond and standby letter of credit will be released.  In January 2015, the District Court accepted the bond and entered the stay of execution of the judgment.  The appellate hearing took place in November 2015, and in February 2016 the appellate court issued a ruling reversing the District Court’s prior decision and judgment against us, and holding that no reasonable jury could find we infringed the EON patents. In April 2016, EON filed a petition for a rehearing en banc, which the appellate court denied in May 2016.  In June 2016, the appellate court notified the District Court that the prior judgment in favor of EON was vacated and that judgment was in our favor, and the District Court released our appellate bond obligation. In July 2016 the District Court awarded us $0.6 million in costs, which EON appealed in August 2016. EON also filed a petition for certiorari to the Supreme Court in October 2016, seeking review of the appellate court’s reversal of the District Court’s original judgment against us. We intend to continue vigorously pursuing this motion and collection of the cost award, and defending the action as necessary.

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Linex Patent Litigation.  In March 2013, Linex Technologies, Inc., a non-producing entity, or Linex, filed suit against us in United States District Court for the Southern District of Florida. Linex alleged that certain of our networking technology infringes United States Patent Nos. 6,493,377 and 7,167,503. We filed an answer in May 2013. In January 2014, the court granted the plaintiff’s request for a stay of the matter, pending reexamination of the patents at issue by the USPTO. In September 2014, Linex amended certain patent claims and canceled certain other patent claims based upon the USPTO’s completed reexaminations, and in October 2014, the court lifted the stay of the matter.  In January 2015, Linex filed an amended complaint to incorporate facts related to the completed reexaminations, and we filed an answer responding to the complaint and raising additional defenses.  In June 2015, the court stayed the action pending the USPTO’s completion of further ex parte reexaminations of the patents at issue.  We believe that we have meritorious defenses to Linex’s allegations and intend to continue vigorously defending against the action.

Atlas/ComEd, Atlas/PG&E, and Atlas/FP&L Patent Litigation. In November 2015, Atlas IP, LLC filed separate suits against our customers Commonwealth Edison Company, or ComEd, and Pacific Gas and Electric Co., or PG&E, alleging infringement of United States Patent No. 5,371,734 by communications between smart meters and access points over a neighborhood area network using wireless communication modules and networking equipment supplied by us. In May 2016, Atlas filed a similar suit against our customer Florida Power & Light Company, or FP&L. We have agreed to assume the defense in each of these suits.

ComEd.  The suit against ComEd was filed in the Northern District of Illinois in November 2015, and also named Exelon Corp., or Exelon, as a defendant. In January 2016, we filed a motion to dismiss the ComEd complaint and to remove Exelon as a defendant. In February 2016, the court granted our motion to dismiss the complaint, and dismissed Exelon from the case with prejudice. In March 2016, Atlas IP filed an amended complaint against ComEd, which the court dismissed in May 2016, finding the complaint to be legally insufficient. The court awarded us reasonable attorneys’ fees and costs in July 2016. Atlas IP filed a notice of appeal in June 2016, seeking to appeal the dismissal to the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. The parties have filed briefs with the court, and a hearing date has not yet been set.

PG&E.  The suit against PG&E was filed in the Northern District of California. We filed a motion to dismiss the PG&E complaint, which the court granted in March 2016.  Atlas IP filed an amended complaint against PG&E, which the court dismissed in June 2016, determining that Atlas IP is collaterally estopped from re-litigating the sufficiency of its complaint as the sufficiency of Atlas IP’s complaint was already decided against Atlas IP by the court in the ComEd suit.

FP&L.  The suit against FP&L was filed in the Southern District of Florida in May 2016. In June 2016, the court stayed the action until the conclusion of Atlas IP’s appeal in the ComEd case, pursuant to an agreement between the parties that if the appellate court affirms the dismissal of the ComEd case, it will be dispositive of the FP&L action.

We believe that we have meritorious defenses to Atlas IP’s allegations in each of these matters, and intend to continue vigorously defending the actions.

Acoustic Technology Patent Litigation.  In July 2016, Acoustic Technology, Inc., a non-producing entity, filed suit in United States District Court for the Eastern District of Texas, Marshall Division against us. The lawsuit alleges infringement of United States Patent Nos. 5,986,574, and 6,509,841 by certain meters and networking technology and services that we provide. The patents will expire in late 2017 and early 2018. We filed a motion to dismiss, as well as a motion to transfer the matter to the Northern District of California, in September 2016. We believe that we have meritorious defenses to Acoustic’s allegations and intend to vigorously defend ourselves.

GroupChatter/GE Patent Litigation.  In November 2015, GroupChatter, LLC, or GroupChatter, filed suit in United States District Court for the Eastern District of Texas, against General Electric Company, GE Energy Management Services, Inc. and GE Grid Solutions, LLC (collectively, “GE”), alleging infringement of United States Patent Nos. 7,969,959, 8,199,740, 8,588,207, 9,014,659 and 9,294,888, by certain systems that include wireless communication-enabled meters produced by GE, some of which include our wireless modules.  GE has requested that we indemnify them in connection with the GroupChatter suit.  We have denied the request.

 

In addition to the matters described above, from time to time we may be subject to other legal proceedings and claims in the ordinary course of business. We have received, and may in the future continue to receive, claims from third parties asserting infringement of their intellectual property rights. We may, from time to time, also be subject to various legal or government claims, disputes, or investigations. Such matters may include, but not be limited to, claims, disputes, or investigations related to warranty, refund, breach of contract, employment, intellectual property, government regulation, compliance or other matters. Future litigation

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SILVER SPRING NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

may be necessary to defend ourselves and our customers by determining the scope, enforceability and validity of third-party rights or to establish our rights. There can be no assurance with respect to the outcome of any current or future litigation brought against us or pursuant to which we have indemnification obligations and the outcome could have a material adverse impact on our business, operating results and financial condition.

We have not recorded any amounts for contingent losses associated with the matters described above based on our belief that losses, while reasonably possible, are not probable. Unless otherwise stated, we are currently unable to predict the final outcome of these lawsuits and therefore cannot determine the likelihood of loss nor estimate a range of possible loss.

 

We are directly involved with various unresolved legal actions and claims, and are indirectly involved with proceedings by administrative bodies such as public utility commissions, arising in the ordinary course of business. We do not believe that any liability from any reasonably foreseeable disposition of such legal actions and claims, individually or in the aggregate, would have a material effect on our consolidated financial statements. There are many uncertainties associated with any litigation or claim, and we cannot be certain that these actions or other third-party claims will be resolved without costly litigation, fines and/or substantial settlement payments. If that occurs, our business, financial condition and results of operations could be materially and adversely affected. If information becomes available that causes us to determine that a loss in any of our pending litigation matters, claims or settlements is probable, and a reasonable estimate of the loss associated with such events can be made, we will record the estimated loss at that time.

Customer Performance and Other Commitments

Certain customer agreements require us to obtain letters of credit or surety bonds in support of our obligations under such arrangements. These letters of credit or surety bonds typically provide a guarantee to the customer for future performance, which usually covers the deployment phase of a contract and may on occasion cover the operations and maintenance phase of service contracts.

As of September 30, 2016 and December 31, 2015, we had a total of $13.9 million and $22.7 million, respectively, of standby letters of credit issued under a credit facility with a financial institution. As of September 30, 2016 and December 31, 2015, $4.6 million (AUD $6.2 million) and $4.4 million (AUD $6.2 million) of these standby letters of credit were denominated in Australian dollars, respectively.

In accordance with the terms of our credit facility, increases or decreases in the exchange rate between the Australian dollar and the U.S. dollar will increase or decrease the amount available to us under the credit facility. On December 18, 2015, we entered into a senior secured credit facilities credit agreement, or Credit Facility, with Silicon Valley Bank and HSBC Bank USA, National Association, or HSBC, which provides a revolving loan facility in an aggregate amount not to exceed $75.0 million with an available letter of credit sub-facility in the aggregate amount of $75.0 million and an available swingline sub-facility in the aggregate amount of $5.0 million. As of September 30, 2016, there were no borrowings outstanding under the Credit Facility; however, this line of credit is backing $13.9 million of letters of credit, leaving $61.1 million of available capacity for cash borrowings or additional letters of credit or swingline loan, subject to compliance with financial covenants and other customary conditions to borrowings, which varies at each period end. As of September 30, 2016, we were in compliance with the financial covenants in the credit agreement. 

As of September 30, 2016, we had a $20.3 million unsecured surety bond. The surety bond provides a financial guarantee to support performance obligations under certain customer agreements. In the event any such letters of credit or surety bonds are called, we would be obligated to reimburse the issuer of the letters of credit or surety bond. We do not believe there will be any claims against currently outstanding letters of credit or surety bonds.

Indemnification Commitments

Directors, Officers and Employees. In accordance with our bylaws and/or pursuant to indemnification agreements we have entered into with directors, officers and certain employees, we have indemnification obligations to our directors, officers and employees for claims brought against these persons arising out of certain events or occurrences while they are serving at our request in such a capacity. We maintain a director and officer liability insurance coverage to reduce our exposure to such obligations, and payments made under these agreements. To date, there have been no indemnification claims by these directors, officers and employees.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Customers and Third Party Device Manufacturers. Refer to the discussion above under the heading Legal Contingencies for a description of our indemnification obligations.

Our contracts with customers and third party device manufacturers typically provide indemnification for claims filed by third parties alleging that our products and services sold to the customer or manufacturer infringe or misappropriate any patent, copyright, trademark or other intellectual property right.

In our customer contracts, we also typically provide an indemnification for third-party claims resulting from death, personal injury or property damage caused by the negligence or willful misconduct of our employees and agents in connection with the performance of certain contracts.

Under our customer and third party device manufacturer indemnities, we typically agree to defend the utility customer or third party device manufacturer, as the case may be, from such claims, and pay any resulting costs, damages and attorneys’ fees awarded against the indemnified party with respect to such claims, provided that (a) the indemnified party promptly notifies us in writing of the claim, (b) the indemnified party provides reasonable assistance to us at our expense, and (c) we have sole control of the defense and all related settlement negotiations.

 

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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, 2015. 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, or IoT, for critical infrastructure. The IoT 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 platform by applying advanced networking technology and solutions to the power grid. We have broadened our focus beyond the smart grid to other utility networks including gas and water, and other critical infrastructure such as street lights, which enable 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 started 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 has started to yield significant benefits to utilities, consumers and the environment, as the industry begins to realize the potential benefits of increased communication capabilities being deployed in the smart grid. 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 intend to continue to innovate in order to advance our networking platform to support increased performance and a broader range of communications modules, including compact battery-operated solutions and advanced analytics capabilities. We believe this will enable a more powerful smart grid with support for more devices, applications and solutions. We believe these technological advances are also well-suited to provide intelligence to other devices within our core smart grid market, as well as adjacent markets for distribution systems to gas and water utilities.

We believe our technology is also well suited for a range of other solutions across the broader category of the IoT. We are focused on critical infrastructure within the IoT that requires similar networking performance as our smart grid solution. Our first expansion beyond the power grid has been on city infrastructure, specifically networking street lights. We believe that by applying advanced networking technology, we can enable cities to achieve their goals for increasing energy and operating efficiency while improving quality of life. In the long term, we look to expand our reach into an even broader range of IoT markets by working with new and existing customers to open their smart grid networks to third parties and support a wide range of devices, applications and solutions.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or JOBS Act. 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.

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Key Non-GAAP and Other Financial Metrics

We supplement our results of operations presented in accordance with GAAP with certain non-GAAP metrics. We manage our business, make planning decisions, evaluate our performance and allocate resources by assessing non-GAAP metrics such as billings (including product billings, services billings, professional services billings, managed services and SaaS billings, advanced metering infrastructure billings, new solutions billings, and international billings), recurring billings, recurring billings per endpoint, cost of billings (including product cost of billings and services cost of billings), gross profit and gross margin on billings (including gross profit and gross margin on product billings, and gross profit and gross margin on services billings), adjusted EBITDA, and total backlog in addition to other financial metrics presented in accordance with GAAP. We believe that these non-GAAP and other financial metrics 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 and other financial metrics are not intended to be considered in isolation from, as a substitute for, and do not purport to be an alternative to revenue, cost of revenue, gross profit, gross margin, net income (loss), or any other performance measure derived in accordance with GAAP.

Billings

Billings represent 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. Billings exclude amounts for undelivered products, services to be performed in the future, and amounts paid or payable to customers. Billings are initially recorded as deferred revenue and are then recognized as revenue when all revenue recognition criteria have been met under our accounting policies. We reconcile revenue to billings by adding revenue to the change in deferred revenue in a given period. We use the following categories to further analyze and evaluate billings calculating and reconciling each metric as described above:

Product Billings

Product billings represent billings associated with hardware, such as communications modules, access points, relays, and bridges, and various types of software products used in our networking and data platforms, which have been delivered to the customer.

Services Billings

Services billings represent billings associated with services related to the initial deployment and ongoing operation of our networking platform and solutions that have been provided to the customer. This includes professional services billings and managed services & SaaS billings.

Professional Services Billings

Professional services billings represent billings associated with professional services related to the deployment of our networking platform and solutions that have been provided to the customer.

Managed Services & SaaS Billings

Managed services & SaaS billings represent billings associated with managed services and SaaS offerings that have been provided to the customer.  

Advanced Metering Infrastructure Billings

Advanced metering infrastructure billings represent billings associated with products and services for our advanced metering solution.  

 

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New Solutions Billings

New solutions billings represent billings derived from our products and services beyond our advanced metering solution, such as distribution automation, demand side management, demand response, smart cities, street lights, and SilverLink Data Platform. New solutions billings represent incremental opportunities to deliver benefits into our customers’ deployed network or in some cases new stand-alone opportunities to deliver our new solutions.

International Billings

International billings represent billings for products and services that have been provided to customers outside of the United States.

Recurring Billings and Recurring Billings per Endpoint

Recurring billings are our billings from our managed services and SaaS offering, as well as customer support and other services offerings. Recurring billings are primarily recurring in nature and includes managed services, hosting and software maintenance, and support fees, as well as one-time managed services and SaaS setup fees. We do have other sources of revenue that are recurring in nature in both our product and services solutions but we believe revenue from our managed services and SaaS offerings, as well as customer support and other services revenue, best represents our overall recurring billings. We reconcile recurring revenue to recurring billings by adding revenue due to the change in deferred revenue in a given period.

Recurring billings per endpoint represents a trailing twelve months, or TTM, recurring billings from our managed services and SaaS offering divided by cumulative home and business endpoints shipped from inception to date.

Cost of Billings

Cost of billings represents the cost associated with products and services that have been delivered to the customer, excluding stock-based compensation and amortization of intangibles and acquisition-related charges. 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 services are expensed in the period incurred. We reconcile cost of revenue to cost of billings by adding cost of revenue to the change in deferred cost of revenue, less stock-based compensation, amortization of intangibles, and acquisition-related charges included in cost of revenue, in a given period. We use the following categories to further analyze and evaluate cost of billings, calculating and reconciling each metric as described above:

Product Cost of Billings

Product cost of billings represents the cost associated with products that have been delivered to the customer.

Services Cost of Billings

Services cost of billings represents the cost associated with services that have been delivered to the customer. This includes professional services cost of billings and managed services & SaaS cost of billings.

Gross Profit and Gross Margin on Billings

Gross profit on billings is the difference between billings and cost of billings. Gross margin on billings is gross profit on billings as a percentage of billings.

Gross Profit and Gross Margin on Product Billings

Gross profit on product billings is the difference between product billings and product cost of billings. Product gross margin on billings is product gross profit on billings as a percentage of billings.

Gross Profit and Gross Margin on Services Billings

Gross profit on services billings is the difference between services billings and services cost of billings. Services gross margin on billings is services gross profit on billings as a percentage of billings.

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Adjusted EBITDA

Adjusted EBITDA is net income (loss) adjusted for changes in deferred revenue and deferred cost of revenue, other (income) expense, net, provision (benefit) for income taxes, depreciation and amortization, impairment of intangible assets, stock-based compensation, acquisition-related charges, restructuring charges, legal settlements and certain other items management believes affect the comparability of operating results.

Total Backlog

Total backlog represents future product and services billings that we expect to generate pursuant to contracts that we have entered into with our utility customers and meter manufacturers. Total backlog includes order backlog, which represents future billings for open purchase orders and other firm commitments.

 

The non-GAAP financial metrics set forth below for the three and nine months ended September 30, 2016 and 2015 have been derived from our unaudited financial statements. Reconciliations to the comparable GAAP metrics are contained in the notes below.

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Non-GAAP metrics 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:

 

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Key Elements of Operating and Financial Performance

We monitor the key elements of our operating and financial performance set forth below to help us evaluate growth trends, determine investment priorities, establish budgets, measure the effectiveness of our sales efforts and assess operational efficiencies. These key elements of operating and financial performance include financial metrics presented in accordance with GAAP as well as non-GAAP metrics which consist of billings (including product billings, services billings, professional services billings, managed services and SaaS billings, advanced metering infrastructure billings, new solutions billings, and international billings), recurring billings, recurring billings per endpoint, cost of billings (including product cost of billings and services cost of billings), gross profit and gross margin on billings (including gross profit and gross margin on product billings, and gross profit and gross margin on services billings), adjusted EBITDA, and total backlog. For more information regarding our use of non-GAAP metrics, see Key Non-GAAP and Other Financial Metrics above.

Revenue

We derive revenue from sales of products and services that enable customers to deploy our networking platform. For the three and nine months ended September 30, 2016, product revenue represented 68% and 63% of our total revenue, respectively, and services revenue represented 32% and 37% of our total revenue. For the three and nine months ended September 30, 2016, we shipped approximately 569,000 and 2,014,000 endpoints, respectively. We have shipped over 24.9 million cumulative endpoints from inception to September 30, 2016.

Our product revenue is derived from sales of hardware such as communications modules, access points, relays and bridges, and various types of software related to our solutions. 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 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 services revenue includes fees for managed services and SaaS, and professional services. For the three and nine months ended September 30, 2016, revenue from managed services and SaaS represented 19% and 20% of our total revenue, respectively, and revenue from professional services represented 13% and 17% of our total revenue, respectively.

For the three and nine months ended September 30, 2016, our advanced metering solutions represented 89% and 87% of our total revenue, respectively, and our new solutions represented 11% and 13% of our total revenue, respectively. Advanced metering solutions revenue includes hardware and software products along with services primarily related to deployment of the network canopy through our access points and the shipment of our communications modules which are integrated into third-party meters for deployment to homes and businesses supported by our customer base. New solutions revenue includes revenues derived from our products and services beyond our advanced metering solutions, such as distribution automation, demand side management, demand response, smart cities, street lights, and SilverLink Data Platform.

To date, a substantial majority of our revenue is attributable to a limited number of customer deployments. In the three months ended September 30, 2016, the deployments for AusNet Electricity Services, Pty. Ltd. or AusNet, Commonwealth Edison Company, or ComEd, and CPS Energy, or CPS, represented 36%, 30%, and 10% of our total revenue, respectively. In the nine months ended September 30, 2016, the deployments for CPS, ComEd, and AusNet, represented 34%, 28%, 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.

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Billings

For the three and nine months ended September 30, 2016, product billings represented 66% and 65% of our total billings, respectively, and services billings represented 34% and 35% of our total billings, respectively. Our services billings include revenue from managed services and SaaS, and professional services. For the three and nine months ended September 30, 2016, billings from managed services and SaaS represented 20% and 20% of our total billings, respectively, and professional services represented 14% and 15% of our total billings, respectively.

For the three and nine months ended September 30, 2016, billings from our advanced metering solutions represented 84% and 84% of our total billings, respectively, and new solutions represented 16% and 16% of our total billings, respectively. For a description of billings, see Key Non-GAAP and Other Financial Metrics above.

To date, a substantial portion of our billings are attributable to a limited number of customer deployments. In the three months ended September 30, 2016, the billings from ComEd, Consolidated Edison Company of New York, Inc. or ConEd, and Florida Power & Light, or FPL, represented 30%, 20%, and 10% of total billings, respectively. In the nine months ended September 30, 2016, the billings from ComEd, FPL, and CPS represented 32%, 11%, and 10% of total billings, respectively.

Recurring Revenue per Endpoint

Recurring revenue is our revenue from our managed services and SaaS offering, as well as customer support and other services offerings. Recurring revenue is primarily recurring in nature and includes managed services, hosting and software maintenance, and support fees, as well as one-time managed services and SaaS setup fees. We do have other sources of revenue that are recurring in nature in both our product and services solutions but we believe revenue from our managed services and SaaS offerings, as well as customer support and other services revenue, best represents our overall recurring revenue. Recurring revenue per endpoint represents TTM recurring revenue from our managed services and SaaS offering divided by cumulative home and business endpoints shipped from inception to date. Recurring revenue per endpoint as of September 30, 2016 was $3.48. Changes in recurring revenue are primarily driven by the timing of customer acceptances and recognition of revenue subject to contingency provisions.

Recurring Billings and Recurring Billings per Endpoint

Recurring billings are our billings from our managed services and SaaS offering, as well as customer support and other services offerings. Managed services and SaaS billings are primarily recurring in nature and includes some one-time set-up fees related to the business. These one-time set-up fees could cause fluctuations in our recurring billings from period to period. In addition, our managed services and SaaS offerings are subject to regular renewals and renegotiations with our customers, which could contribute to fluctuations or cancellations in the amount of revenue which is deemed to be recurring from period to period, which in turn, could cause fluctuations in the amount of recurring billings and recurring billings per endpoint from period to period.  

Recurring billings per endpoint enables us to measure the amount of incremental revenue we derive from our growing footprint of networked homes and business as a result of sales of our additional solutions and services. Recurring billings per endpoint as of September 30, 2016 was $2.31. For a description of recurring billings and recurring billings per endpoint, see Key Non-GAAP and Other Financial Metrics above. We intend to continue to broaden the scope of our available solutions and services, which should have the effect of increasing the amount of recurring billings per endpoint over time.

Cost of Revenue, Gross Profit, and Gross Margin

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, and 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.

Services cost of revenue includes compensation and related costs for our services delivery, customer operations and customer support personnel, facilities and infrastructure cost and depreciation, and data center costs. In accordance with our accounting policies,

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we recognize services cost of revenue in the period in which it is incurred even though the associated services revenue may be required to be deferred.

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 services 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. In addition, our gross profit will also increase based on revenue generated from sales of third-party devices. If in a given period our mix of revenue generated from third-party devices is higher, our gross profit will be lower as margin on third-party devices is lower as compare to our own products.

Cost of Billings, Gross Profit on Billings, and Gross Margin on Billings

Cost of billings represents the cost associated with products and services that have been delivered to the customer, excluding stock-based compensation and amortization of acquired intangibles and acquisition-related charges as described in Key Non-GAAP and Other Financial Metrics above.

Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses, as well as legal settlement expenses, amortization of acquired intangibles, and restructuring charges. Personnel-related expense represents a significant component of our operating expenses. Our regular full-time employee headcount increased from 652 as of December 31, 2015 to 709 as of September 30, 2016.

Research and Development

We expense our research and development costs as they are incurred. Research and development expense represents the largest component of our operating expenses and consists primarily of:

Sales and Marketing

Sales and marketing expense consists primarily of:

General and Administrative

General and administrative expense consists primarily of:

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Impairment of intangible assets

During the three and nine months ended September 30, 2016, we recorded an impairment charge of $2.2 million related to intangible assets in our consolidated statements of operations. See Part I, Item 1. Financial Statements, Note 7, Goodwill and Intangible Assets, of Notes to Consolidated Financial Statements for more information.

Restructuring

During September 2014, we initiated a restructuring plan to refocus our strategy, optimize our structure, and improve operational efficiencies. This restructuring plan included a worldwide workforce reduction.

Results of Operations and Key Non-GAAP Financial Metrics

The following table sets forth our consolidated results of operations for the periods shown:

 

 

Revenue, net

The following table sets forth our revenue for the periods shown:

 

 

From incorporation through December 31, 2014, we deferred revenue for arrangements that contained customer-specific acceptance criteria until we determined whether acceptance was achieved due to our limited experience with customer deployments during that period. We perform an ongoing evaluation of the sufficiency of historical experience in determining the effect of customer-specific acceptance terms on timing of revenue recognition. During the quarter ended March 31, 2015, following the completion of

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analyses of historical experience, we determined that we have sufficient objective evidence to conclude that (i) network solution testing conducted in prior deployments can be relied upon to demonstrate that products and services delivered for deployments of other customers will meet acceptance testing criteria, provided that such prior deployments have similar characteristics and substantially similar testing criteria, or (ii) in absence of such evidence from prior deployments, network solution testing in the initial service area for a specific customer deployment can be relied upon to demonstrate that products and services delivered for subsequent service areas within that same deployment will meet subsequent acceptance testing criteria, provided that such initial network solution testing is successfully completed, and the testing criteria in the initial service area are substantially similar to the agreed-upon testing criteria for the remaining service areas. Receipt of acceptance from these customers is no longer considered necessary as (i) substantially similar acceptance testing criteria have been met in similar deployments of other customers, or (ii) substantially similar acceptance testing criteria have been met in the initial service area within the customer’s deployment, and all other revenue recognition criteria were met.

 

Total revenue recognized 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. Of our total revenue, revenue from our advanced metering solutions and new solutions represented 89% and 11%, respectively, for the three months ended September 30, 2016, and 87% and 13%, respectively, for the three months ended September 30, 2015. The increase in revenue for the three months ended September 30, 2016 as compared to the same period in 2015 was primarily due to the receipt of customer initial acceptances.

Of our total revenue, revenue from our advanced metering solutions and new solutions represented 87% and 13%, respectively, for the nine months ended September 30, 2016 and 83% and 17%, respectively, for the nine months ended September 30, 2015. The decrease in revenue for the nine months ended September 30, 2016 as compared to the same period in 2015 was due primarily to a one-time cumulative catch up adjustment recorded during the three months ended March 31, 2015 as a result of a change in assessment of the impact of customer-specific acceptance criteria as mentioned above.

For the three months ended September 30, 2016, the deployments for AusNet, ComEd, and CPS, represented 36%, 30%, and 10% of our total revenue, respectively. For three months ended September 30, 2015, the deployments for ComEd, and CHED Services or CHED, represented 45% and 16% of our total revenue, respectively. For the nine months ended September 30, 2016, the deployments for CPS, ComEd, and AusNet represented 34%, 28%, and 11% of our total revenue, respectively. For the nine months ended September 30, 2015, the deployments for ComEd, Virginia Electric and Power Company, or Dominion, FPL, and CHED represented 44%, 11%, 11%, and 10% of our total revenue, respectively.

Product Revenue

The product revenue for the three months ended September 30, 2016, as compared to the same period in 2015, was relatively flat.

The decrease in product revenue for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily due to a one-time cumulative catch up adjustment recorded during the three months ended March 31, 2015 as a result of a change in assessment of the impact of customer-specific acceptance criteria, partially offset by receipt of customer initial acceptances.

Services Revenue

The increase in services revenue for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to the receipt of customer initial acceptances.

The increase in services revenue for the nine months ended September 30, 2016 as compared to the same period in 2015 was primarily due to the receipt of customer initial acceptances, partially offset by a one-time cumulative catch up adjustment recorded during the three months ended March 31, 2015, as a result of a change in assessment of the impact of customer-specific acceptance criteria.

Our revenue from product, managed services and SaaS, and professional services represented 68%, 19%, and 13%, respectively, of our total revenue for the three months ended September 30, 2016, and 72%, 16% and 12%, respectively, of our total revenue for the three months ended September 30, 2015.

Our revenue from product, managed services and SaaS, and professional services represented 63%, 20%, and 17%, respectively, of our total revenue for the nine months ended September 30, 2016, and 72%, 12% and 16%, respectively, of our total revenue for the nine months ended September 30, 2015.

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We anticipate that revenue in 2016 may fluctuate from period to period throughout 2016 primarily due to the timing of when we expect to meet the completion and acceptance criteria in our customer arrangements.

Recurring Revenue per Endpoint

Recurring revenue per endpoint as of September 30, 2016 and 2015 was $3.48 and $2.03, respectively. The increase is due to higher recurring revenue as a result of receipt of customer initial acceptances in the last twelve months.

Billings

The following table sets forth our billings for the periods shown:

 

 

For the three months ended September 30, 2016, billings from product and services represented 66% and 34% of our total billings, respectively, and for the three months ended September 30, 2015, billings from product and services represented 69% and 31% of our total billings, respectively. We delivered approximately 569,000 endpoints during the three months ended September 30, 2016, as compared to approximately 815,000 endpoints during the same period in 2015. The decrease in product billings was driven by fewer endpoints delivered, which was partially offset by an increase in software billings. The increase in services billings was primarily due to an increase in managed services and SaaS billings, driven by an expanded footprint of cumulative endpoints delivered and set up fees for new projects. Billings from international customers represented 15% and 12% of total billings in the three months ended September 30, 2016 and 2015, respectively.

Of our total billings, billings from our advanced metering solutions and new solutions represented 84% and 16%, respectively, for the three months ended September 30, 2016, and 85% and 15%, respectively, for the three months ended September 30, 2015.

Of our total billings, billings from product, managed services and SaaS, and professional services represented 66%, 20%, and 14%, respectively, for the three months ended September 30, 2016, and 69%, 17% and 14%, respectively, for the three months ended September 30, 2015.

 

For the nine months ended September 30, 2016, billings from product and services represented 65% and 35%, of our total billings, respectively, and for the nine months ended September 30, 2015, billings from product and services represented 66% and 34%, of our total billings, respectively. The amount of endpoints delivered during the nine months ended September 30, 2016, as compared to the same period in 2015, was relatively flat. The increase in product billings was primarily driven by an increase in software billings. The increase in services billings was primarily due to an increase in managed services and SaaS billings, driven by an expanded footprint of cumulative endpoints delivered and set up fees for new projects. Billings from international customers represented 17% and 15% of total billings in the nine months ended September 30, 2016 and 2015, respectively.

Of our total billings, billings from our advanced metering solutions and new solutions represented 84% and 16%, respectively, for the nine months ended September 30, 2016, and 81% and 19%, respectively, for the nine months ended September 30, 2015.

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Of our total billings, billings from product, managed services and SaaS, and professional services represented 65%, 20%, and 15%, respectively, for the nine months ended September 30, 2016, and 66%, 19% and 15%, respectively, for the nine months ended September 30, 2015.

To date, a substantial portion of our billings are attributable to a limited number of customer deployments. In the three months ended September 30, 2016, the billings for ComEd, ConEd, and FPL represented 30%, 20%, and 10% of our total billings, respectively. In the three months ended September 30, 2015, the billings for ComEd and CPS represented 42% and 11% of total billings, respectively. In the nine months ended September 30, 2016, the billings for ComEd, FPL, and CPS represented 32%, 11%, and 10% of our total billings, respectively. In the nine months ended September 30, 2015, the billings for ComEd, CPS, and FPL represented 35%, 11%, and 10% of our total billings, respectively.

Recurring Billings per Endpoint

Recurring billings per endpoint as of September 30, 2016 and 2015 was $2.31 and $2.23, respectively.

We anticipate that billings will fluctuate from period to period throughout 2016.

Cost of Revenue, Gross Profit, and Gross Margin

The following table sets forth our cost of revenue, gross profit and gross margin for the periods shown:

 

 

Product Cost of Revenue. The increase in product cost of revenue for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to product and customer mix, and the receipt of customer initial acceptances, partially offset by lower warranty expenses.

The decrease in product cost of revenue for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily due to an one-time cumulative catch up adjustment recorded during the three months ended March 31, 2015 as a result of a change in assessment of the impact of customer-specific acceptance criteria, product and customer mix, and lower warranty expenses during the nine-month period in 2016, partially offset by an increase in the receipt of customer initial acceptances in 2016.

Services Cost of Revenue. The increase in services cost of revenue for three months ended September 30, 2016, as compared to the same periods in 2015, was primarily due to an increase in managed services and SaaS cost of revenue, driven by higher employee compensation due to an increase in headcount.

The services cost of revenue was relatively flat for the nine months ended September 30, 2016, as compared to the same period in 2015, which was primarily due to an increase in the cost of managed services and SaaS revenue, offset by a decrease in the cost of

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professional services revenue. The overall service cost of revenue increased primarily due to higher employee compensation and facilities and infrastructure cost, driven by an increase in headcount, partially offset by a decrease in installation cost.

Product Gross Profit and Product Gross Margin.  Product gross profit decreased during the three months ended September 30, 2016, as compared to the same period in 2015, primarily due to product and customer mix, and the timing of receipt of customer initial acceptances. Product gross profit decreased during the nine months ended September 30, 2016, as compared to the same period in 2015, primarily due to a one-time cumulative catch up adjustment recorded during the three months ended March 31, 2015 as a result of a change in assessment of the impact of customer-specific acceptance criteria as mentioned above, and product and customer mix, partially offset by lower warranty expense.

Product gross margin decreased during the three months ended September 30, 2016, as compared to the same period in 2015, primarily due to the receipt of customer initial acceptances, and product and customer mix, partially offset by lower warranty expenses. The product gross margin was relatively flat for the nine months ended September 30, 2016, as compared to the same period in 2015.

Services Gross Profit and Services Gross Margin. Services gross profit increased during the three and nine months ended September 30, 2016 as compared to the same periods in 2015, primarily due to receipt of customer initial acceptances.  

Services gross margin increased during the three and nine months ended September 30, 2016, as compared to the same periods in 2015, primarily due to the receipt of customer initial acceptances. The service gross margin for the nine months ended September 30, 2015 includes a one-time cumulative catch up adjustment which was recorded during the three months ended March 31, 2015 as a result of a change in assessment of the impact of customer-specific acceptance criteria. The overall increase in services gross margin during the nine months ended September 30, 2016, as compared to the same period in 2015, was partially offset by an one-time cumulative catch up adjustment recorded during the three months ended March 31, 2015.

Changes in our services cost of revenue are disproportionate to changes in our services revenue because we recognize services cost of revenue in the period in which it is incurred even though the associated services revenue may be required to be deferred, as described under “Key Elements of Operating and Financial Performance” 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 Billings, Gross Profit on Billings, and Gross Margin on Billings

The following table sets forth our cost of billings, gross profit on billings and gross margin on billings for the periods shown:

 

 

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The overall cost of billings decreased during the three and nine months ended September 30, 2016, as compared to the same periods in 2015, primarily due to a decrease in cost of product billings. Cost of product billings decreased due to cost savings from manufacturing efficiencies, fewer endpoints delivered, and an improved product mix.    

The total gross profit on billings increased during the three and nine months ended September 30, 2016, as compared to the same periods in 2015, primarily due to an increase in both product and services gross profit on billings. Gross profit on product billings increased due to cost savings from manufacturing efficiencies, higher volume, and favorable product mix. Gross profit on services billings increased due to increases in services billings, and lower third party costs.

For the three and nine months ended September 30, 2016, the gross margin on billings increased as compared to the same periods in 2015, primarily due to changes in product and customer mix, costs savings from manufacturing efficiencies, and lower third party costs.

We expect gross margin on billings to fluctuate from period to period throughout 2016.

Operating Expenses

The following table sets forth our operating expenses for the periods shown:

 

 

Operating expenses consist primarily of employee compensation, including salaries, commissions, bonuses, benefits, and stock-based compensation, which fluctuate 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. Facilities and information technology costs are allocated to each department based on usage and headcount.

Research and Development. We focus the bulk of our research and development activities on the continued development of existing products and the development of new offerings for emerging market opportunities. The increase in research and development expenses for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily driven by increases of $2.2 million in employee compensation due to an increase in headcount and $0.7 million in outside services and facilities and infrastructure cost. These increases were partially offset by a decrease of $0.9 million in non-recurring engineering expenses.

The increase in research and development expenses for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily driven by increases of $1.7 million in employee compensation due to an increase in headcount, $1.1 million in facilities and infrastructure cost, and $0.5 million in software maintenance cost.

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. We focus a significant proportion of our sales and marketing activities on new and emerging market opportunities. Sales and marketing expenses for the three months ended September 30, 2016, as compared to the same period in 2015, increased primarily due to increases of $1.5 million in commission expenses and $0.2 million in outside services expenses.

Sales and marketing expenses for the nine months ended September 30, 2016, as compared to the same period in 2015, increased primarily due to increases of $2.0 million in commission expenses and $1.0 million in outside services, marketing, and facilities and infrastructure costs. These increases were partially offset by a decrease of $1.0 million in employee compensation due to lower stock-based compensation.

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General and Administrative. The increase in general and administrative expenses for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily driven by increases of $1.0 million in employee compensation due to an increase in headcount, $0.3 million in software maintenance cost, $1.0 million in outside service expenses, and $0.3 million in facilities and infrastructure cost.  

The increase in general and administrative expenses for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily driven by increases of $2.1 million in employee compensation due to an increase in headcount, $0.4 million in software maintenance cost, and $0.8 million in facilities and infrastructure cost. These increases were partially offset by decreases of $0.5 million in professional services expense and $0.7 million in other general and administration expenses.

Impairment of Intangible Assets. During the three and nine months ended September 30, 2016, we recorded an impairment charge of $2.2 million related to intangible assets in our consolidated statements of operations. See Part I, Item 1. Financial Statements, Note 7, Goodwill and Intangible Assets, of Notes to Consolidated Financial Statements for more information.

Restructuring. The restructuring expense during the three months ended September 30, 2015 was related to severance costs and professional fees incurred in connection with our restructuring plan initiated in September 2014. We completed our restructuring plan during the first quarter of 2016, and incurred no restructuring costs during the three months ended September 30, 2016.

Other Income, Net

Other income, net, consists primarily of interest income on cash balances, foreign currency-related gains and losses, and interest expense on capital leases. We have historically invested our cash in money market accounts and fixed income securities.

Other income, net, increased for the three and nine months ended September 30, 2016, compared to the three and nine months ended September 30, 2015, is due to foreign currency-related gain.

Provision (Benefit) for Income Taxes

For the three months ended September 30, 2016 and 2015, we recorded a provision for income taxes of $1.1 million and $0.1 million, respectively. Our provision for income taxes for the three months ended September 30, 2016 reflects an effective tax rate of (8.1%). The decrease in effective tax rate, from the three months ended June 30, 2016, is primarily due to the recorded pretax book loss for the period. Our provision for income taxes for the three months ended September 30, 2016 consists primarily of state and foreign taxes, and the write off of $0.5 million deferred tax charge associated with the impairment of intangible assets during the quarter. Our provision for income taxes for the three months ended September 30, 2015, reflects an effective tax rate of (26.2%). The effective tax rate for the three months ended September 30, 2015, reflects our recognition of a discrete tax benefit of approximately $0.1 million due to a release of our valuation allowance attributable to the Detectent acquisition in the period and foreign return to provision adjustments. In connection with the acquisition of Detectent, we recorded deferred tax liabilities of $0.1 million, which were netted against our existing deferred tax assets. As a result, we released valuation allowance of $0.1 million in the third quarter of 2015.

For the nine months ended September 30, 2016 and 2015, we recorded a provision for income taxes of $2.1 million and a benefit for income taxes of $0.6 million, respectively. Our provision for income taxes for the nine months ended September 30, 2016 reflects an effective tax rate of (38.8%). The decrease in effective tax rate, from the three months ended June 30, 2016, is primarily due to the recorded pretax book loss for the nine months ended September 30, 2016. Our provision for income taxes for the nine months ended September 30, 2016 consists primarily of state and foreign taxes, and the write off of $0.5 million deferred tax charge associated with the impairment of intangible assets during the three months ended September 30, 2016. Our benefit for income taxes for the nine months ended September 30, 2015 reflects an effective tax rate of (3.6%). The effective tax rate for the nine months ended September 30, 2015, reflects our recognition of discrete tax benefit of approximately $1.1 million due to release of our valuation allowance attributable to the Detectent acquisition in the period.

We have not reported a provision for federal taxes in the consolidated financial statements as the federal taxable income has been offset by the deferred tax asset arising from net operating losses from prior years. State provision arose from states where there are insufficient net operating losses from prior years to offset state taxable income.

Our effective tax rate differs from the U.S. federal statutory rate primarily due to the valuation allowance on our deferred tax assets, differences between the U.S. federal tax rate and tax rates applicable to our non-U.S. operations, and non-deductible stock-based compensation.

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Liquidity and Capital Resources

As of September 30, 2016, we had $48.0 million in cash and cash equivalents and $65.3 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 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. We believe our existing balances of cash, cash equivalents and short-term investments will be sufficient to satisfy our working capital needs, capital asset purchases, outstanding commitments, and other liquidity requirements associated with our existing operations through the next 12 months.

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. Our cash flows from operating activities have fluctuated since our inception, and we expect cash flows to fluctuate from period to period in 2016 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. 

On December 18, 2015, we entered into a senior secured credit facilities credit agreement. See Part I, Item 1. Financial Statements, Note 12, Commitments and Contingencies, of Notes to Consolidated Financial Statements for more information on the Credit Facility.

Uses of Capital

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. 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. For example, in December 2014, we filed a surety bond in the amount of $17.6 million in connection with a notice of appeal that we filed with the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. in our ongoing patent infringement litigation with EON. In June 2016, the appellate court notified the District Court that the prior judgment in favor of EON was vacated and that judgment was in our favor, and the District Court released our appellate bond obligation. See Part I, Item 1. Financial Statements, Note 12, Commitments and Contingencies, of Notes to Consolidated Financial Statements for more information. 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 and, as a result, to bid or enter into significant long-term agreements could have a material adverse effect on our future revenues and business prospects.

Capital Expenditures

Our capital expenditures were $23.4 million and $3.5 million in the nine months ended September 30, 2016 and 2015, respectively. The increased expenditures were primarily related to investment in our new headquarters in San Jose, and to support increased network operations, hosting data centers, and corporate infrastructure. In 2016, we expect to have increased capital expenditures as we continue to invest in our new headquarters in San Jose, California and other facilities. We will continue to use a portion of our cash for capital expenditures in the development of new products and services and expansion of our infrastructure, including servers and equipment related to managed services, SaaS, and other information systems required to support increased demand for our offerings and the related infrastructure.

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Cash Flows

The following table sets forth the major sources and uses of cash for each of the periods set forth below:

 

 

Cash Flows from Operating Activities

Cash provided by operating activities was relatively flat for the nine months ended September 30, 2016, as compared to the same period in 2015, primarily driven by lower net income, and offset by an increase in cash provided by working capital.

Cash Flows from Investing Activities

Cash used in investing activities decreased during the nine months ended September 30, 2016, as compared to the same period in 2015, primarily due to increase in net cash provided by sales of investments, which were used to fund our capital expenditures driven by our investment in our new San Jose headquarters. In addition, we spent $7.1 million in the acquisition of Detectent in 2015.

Cash Flows from Financing Activities

Cash used in financing activities increased during the nine months ended September 30, 2016, as compared to the same period in 2015, primarily due to a $0.7 million decrease from payments on capital leases.

Concentration of Credit Risk

We typically extend credit to our customers and third-party device 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 September 30, 2016, ComEd and ConEd accounted for 33% and 32%, respectively, of our accounts receivable. As of September 30, 2015, ComEd and CPS accounted for 42%, and 10%, respectively, of our accounts receivable.

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 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 September 30, 2016, our financial guarantees that were not recorded on our balance sheet consisted of $13.9 million of standby letters of credit.

Contractual Obligations and Commitments

The following is a summary of our contractual obligations as of September 30, 2016 (in thousands)

 

 

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Our consolidated balance sheet consists of other long-term liabilities which include gross unrecognized tax benefits, and related gross interest and penalties. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years in connection with these tax liabilities; therefore, such amounts are not included in the contractual obligation table above.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in the condensed consolidated financial statements and the accompanying notes. On an ongoing basis, we evaluate our estimates and assumptions. These estimates and assumptions are based on current facts, historical experience, and various other factors that we believe are reasonable under the circumstances to determine reported amounts of assets, liabilities, revenue and expenses that are not readily apparent from other sources.

An accounting policy is considered to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the effect of the estimates and assumptions on financial condition or operating performance is material. The accounting policies we believe to reflect our more significant estimates, judgments and assumptions and are most critical to understanding and evaluating our reported financial results are as follows:  

During the nine months ended September 30, 2016, there were no significant changes to our critical accounting policies and estimates 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 Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2015.

Recent Accounting Pronouncements

See Note 2, Significant Accounting Policies and Estimates, in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, for a full description of recent accounting pronouncements, including the actual and expected dates of adoption and estimated effects on our consolidated results of operations and financial condition, which is incorporated herein by reference.

 

Interest Rate Risk

Fixed Income Securities

Our exposure to changes in interest rates relates primarily to interest earned and market value of our cash equivalents and short-term fixed income securities.

Our fixed income investment portfolio is denominated in U.S. dollars and consists of various holdings, types, and maturities. Our primary objective for holding fixed income securities is to achieve an appropriate investment return consistent with preserving principal and managing risk. At any time, a sharp rise in interest rates or credit spreads could have a material adverse impact on the fair value of our fixed income investment portfolio. A sensitivity analysis is performed on our investment portfolio each quarter.

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The following table presents the hypothetical changes in the fair value of our short-term investment portfolio as of September 30, 2016, arising from potential changes in interest rates. The modeling technique estimates the change in fair value from immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points, or BPS, and 100 BPS.

 

 

We monitor our interest rate and credit risk, including our credit exposures to specific rating categories and to individual issuers. There were no impairment charges on our cash equivalents and fixed income securities during the quarter. These instruments are not leveraged and we do not enter into speculative securities for trading purposes.

Interest rate risk also reflects our exposure to movements in interest rates associated with our Credit Facility. The interest bearing Credit Facility is denominated in U.S. dollars. The revolving loans and any swingline loans made pursuant to our Credit Facility bear interest at a rate per annum equal to (i) the higher of (a) the prime rate in effect on such day, and (b) the federal funds effective rate plus 0.5%, but in any case at a minimum rate of 0.0% per annum, plus (ii) 0.75%. As of September 30, 2016, we had not drawn on this Credit Facility.

Foreign Currency Exchange Risk

Our sales contracts are denominated primarily in U.S. dollars and, to a lesser extent, Australian dollars, Euro and Brazilian real. Consequently, our customer billings denominated in foreign currencies are subject to foreign currency exchange risk. A portion of our operating expenses are incurred outside the United States and are denominated in foreign currencies, which are also subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Australian dollar, Euro and Brazilian real. Additionally, fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our statement of operations. To date, we have not entered into derivatives or hedging strategies as our exposure to foreign currency exchange risk has not been material to our historical operating results, but we may do so in the future if our exposure to foreign currency exchange risk should become more significant. There were no significant foreign exchange gains or losses in the three and nine months ended September 30, 2016, respectively.

 

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Our management, with the participation of our CEO and CFO, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2016. Based on the evaluation of our disclosure controls and procedures as of September 30, 2016, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were not effective, due to the material weaknesses as a result of insufficient processes and qualified personnel as described below.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

The material weaknesses in internal control over financial reporting identified were as follows:

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We have performed additional analyses and procedures to enable management to conclude that, despite the existence of the material weaknesses discussed above, we believe the condensed consolidated financial statements included in this Form 10-Q present fairly, in all material respects, our financial position, results of operations, comprehensive income (loss) and cash flows for the periods presented in conformity with U.S. GAAP.

 

We are in the process of remediating these material weaknesses in our internal control over financial reporting, including implementing a number of measures designed to address the underlying causes of these material weaknesses. Remediation efforts currently in process or expected to be implemented include the following:

We believe the foregoing efforts will effectively remediate the material weaknesses. We have developed a timetable for the implementation of the foregoing remediation efforts and will monitor the implementation. In addition, under the direction of the Audit Committee, we will continue to review and make necessary changes to the overall design of our internal control environment, as well as to policies and procedures to improve the overall effectiveness of internal control over financial reporting. We believe that these additional procedures and personnel will enable us to broaden the scope and quality of our controls relating to the oversight and review of our financial statements. However, these material weaknesses will not be considered remediated until the applicable remedial controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

Changes in Internal Control over Financial Reporting

Other than with respect to the remediation efforts described above, there were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the third quarter of 2016 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

 

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

EON Patent Litigation. In June 2011, EON Corp. IP Holdings, LLC, a non-producing entity, or EON, filed suit in United States District Court for the Eastern District of Texas, Tyler Division against us and a number of smart grid providers. The lawsuit alleges

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infringement of United States Patent Nos. 5,388,101, 5,481,546, and 5,592,491, or the EON Patents, by certain networking technology and services that we and the other defendants provide. Other defendants included Landis+Gyr AG, Aclara Power-Line Systems Inc., Elster Solutions, LLC, Itron, Inc. and Trilliant Networks Inc., all of which settled with EON prior to trial. We filed answers, affirmative defenses and counterclaims denying the plaintiff’s allegations and asserting that the plaintiff’s patents are invalid.  A trial was held in June 2014. After the trial, the jury determined that we had infringed certain, but not all, of the claims under the EON Patents, and returned a verdict against us in the amount of $18.8 million. Following post-trial motions by both parties, the court reduced the damage award to approximately $13.0 million, and in December 2014, entered a final judgment in that amount plus approximately $1.5 million in pre-judgment interest. The court subsequently revised the final judgment to include additional costs of about $0.2 million and entered an amended final judgment in December 2014. All of the EON Patents have expired and therefore EON is not seeking, and EON may not recover, any additional sums as royalties for our sales of products going forward.

In December 2014, we filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. In order to stay the execution of the final judgment pending the appeal, in December 2014 we filed a surety bond in the amount of $17.6 million, which includes an additional 20% of the final judgment for post-judgment interest and expenses expected to be incurred during the appeal process, in accordance with court rules. The bond was issued by Zurich Insurance and is collateralized with a standby letter of credit in the amount of $13.0 million, the amount of the damage award.  Upon completion of the appeal process, both the surety bond and standby letter of credit will be released. In January 2015, the District Court accepted the bond and entered the stay of execution of the judgment. The appellate hearing took place in November 2015, and in February 2016 the appellate court issued a ruling reversing the District Court’s prior decision and judgment against us, and holding that no reasonable jury could find we infringed the EON patents.  In April 2016, EON filed a petition for a rehearing en banc, which the appellate court denied in May 2016.  In June 2016, the appellate court notified the District Court that the prior judgment in favor of EON was vacated and that judgment was in our favor, and the District Court released our appellate bond obligation.  In July 2016 the District Court awarded us $0.6 million in costs, which EON appealed in August 2016. EON also filed a petition for certiorari to the Supreme Court in October 2016, seeking review of the appellate court’s reversal of the District Court’s original judgment against us. We intend to continue vigorously pursuing this motion and collection of the cost award, and defending the action as necessary.

Linex Patent Litigation.  In March 2013, Linex Technologies, Inc., a non-producing entity, or Linex, filed suit against us in United States District Court for the Southern District of Florida. Linex alleged that certain of our networking technology infringes United States Patent Nos. 6,493,377 and 7,167,503. We filed an answer in May 2013. In January 2014, the court granted the plaintiff’s request for a stay of the matter, pending reexamination of the patents at issue by the USPTO. In September 2014, Linex amended certain patent claims and canceled certain other patent claims based upon the USPTO’s completed reexaminations, and in October 2014, the court lifted the stay of the matter.  In January 2015, Linex filed an amended complaint to incorporate facts related to the completed reexaminations, and we filed an answer responding to the complaint and raising additional defenses.  In June 2015, the court stayed the action pending the USPTO’s completion of further ex parte reexaminations of the patents at issue.  We believe that we have meritorious defenses to Linex’s allegations and intend to continue vigorously defending against the action.

Atlas/ComEd, Atlas/PG&E, and Atlas/FP&L Patent Litigation. In November 2015, Atlas IP, LLC filed separate suits against our customers Commonwealth Edison Company, or ComEd, and Pacific Gas and Electric Co., or PG&E, alleging infringement of United States Patent No. 5,371,734 by communications between smart meters and access points over a neighborhood area network using wireless communication modules and networking equipment supplied by us. In May 2016, Atlas filed a similar suit against our customer Florida Power & Light Company, or FP&L. We have agreed to assume the defense in each of these suits.

ComEd.  The suit against ComEd was filed in the Northern District of Illinois in November 2015, and also named Exelon Corp., or Exelon, as a defendant. In January 2016, we filed a motion to dismiss the ComEd complaint and to remove Exelon as a defendant. In February 2016, the court granted our motion to dismiss the complaint, and dismissed Exelon from the case with prejudice. In March 2016, Atlas IP filed an amended complaint against ComEd, which the court dismissed in May 2016, finding the complaint to be legally insufficient. The court awarded us reasonable attorneys’ fees and costs in July 2016. Atlas IP filed a notice of appeal in June 2016, seeking to appeal the dismissal to the U.S. Court of Appeals for the Federal Circuit in Washington, D.C. The parties have filed briefs with the court, and a hearing date has not yet been set.

PG&E.  The suit against PG&E was filed in the Northern District of California in November 2015. We filed a motion to dismiss the PG&E complaint, which the court granted in March 2016.  Atlas IP filed an amended complaint against PG&E, which the court dismissed in June 2016, determining that Atlas IP is collaterally estopped from re-litigating the sufficiency of its complaint as the sufficiency of Atlas IP’s complaint was already decided against Atlas IP by the court in the ComEd suit.

FP&L.  The suit against FP&L was filed in the Southern District of Florida in May 2016.  In June 2016, the court stayed the action until the conclusion of Atlas IP’s appeal in the ComEd case, pursuant to an agreement between the parties that if the appellate court affirms the dismissal of the ComEd case, it will be dispositive of the FP&L action.

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We believe that we have meritorious defenses to Atlas IP’s allegations in each of these matters, and intend to continue vigorously defending against the actions.

Acoustic Technology Patent Litigation.  In July 2016, Acoustic Technology, Inc., a non-producing entity, filed suit in United States District Court for the Eastern District of Texas, Marshall Division against us. The lawsuit alleges infringement of United States Patent Nos. 5,986,574, and 6,509,841 by certain meters and networking technology and services that we provide. The patents will expire in late 2017 and early 2018. We filed a motion to dismiss, as well as a motion to transfer the matter to the Northern District of California, in September 2016. We believe that we have meritorious defenses to Acoustic’s allegations and intend to vigorously defend ourselves.

In addition to the matters described above, from time to time we may be subject to other legal proceedings and claims in the ordinary course of business. We have received, and may in the future continue to receive, claims from third parties asserting infringement of their intellectual property rights. We may, from time to time, also be subject to various legal or government claims, disputes, or investigations. Such matters may include, but not be limited to, claims, disputes, or investigations related to warranty, refund, breach of contract, employment, intellectual property, government regulation, compliance or other matters. Future litigation may be necessary to defend ourselves and our customers by determining the scope, enforceability and validity of third-party rights or to establish our rights. There can be no assurance with respect to the outcome of any current or future litigation brought against us or pursuant to which we have indemnification obligations and the outcome could have a material adverse impact on our business, operating results and financial condition.

 

Item 1A. Risk Factors

Our business is subject to many risks and uncertainties, which may affect our future performance. If any of the events or circumstances described below occurs, our business and financial performance could be harmed, our actual results could differ materially from our expectations and the market value of our stock could decline. The risks and uncertainties discussed below are not the only ones we face. There may be additional risks and uncertainties not currently known to us or that we currently do not believe are material that may harm our business and financial performance.

We have a prior history of operating losses and we may not sustain profitability on a quarterly or annual basis.

Prior to our year ended December 31, 2015, we incurred significant losses in each annual year to date.  We have an accumulated deficit of $634.1 million as of September 30, 2016. We experienced net loss of ($89.2) million and ($66.8) million for the years ended December 31, 2014 and 2013, respectively, and we achieved profitability for the first time with net income of $80.0 million for the year ended December 31, 2015. Our ability to be profitable for 2016 and beyond will depend on our ability to continue to increase our revenues, and maintain proportional expense levels. We may not achieve profitability again in 2016 or future periods and may incur negative operating cash flow in future periods, as we expect to incur significant costs to sell our products and operating expenses in connection with the continued development and expansion of our business. Our expenses include research and development expenses, general and administrative expenses, selling and marketing expenses and customer service and support expenses. Some of these expenses relate to prospective customers that may never place any orders and products that may not be introduced or generate revenue until later periods, if at all. There can be no assurance that we will be able to sustain profitability on a quarterly or annual basis.

Our quarterly results are inherently unpredictable and subject to substantial fluctuations, and, as a result, we may fail to meet the expectations of securities analysts and investors, which could adversely affect the trading price of our common stock.

Our revenue, billings and other operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control. Our revenue and billings have fluctuated in recent periods, and have in the past decreased on a quarterly basis and on an annual basis. There can be no assurances that our revenue and billings will increase, or will not continue to decrease on a quarterly or annual basis. We expect revenue, billings, gross margin on billings, and adjusted EBITDA to fluctuate from period to period throughout 2016 and beyond. We also expect operating losses in certain future periods. See Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The factors that may affect the unpredictability of our quarterly results and cause our stock price to fluctuate include, but are not limited to:

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As a result, we believe that quarter to quarter comparisons of operating results are not necessarily a good indication of what our future performance will be. In some future quarters our operating results may be below our expectations or the expectations of securities analysts or investors, in which case the price of our common stock may decline.

Sales cycles to our customers can be lengthy and unpredictable and require significant employee time and financial resources with no assurances that a prospective customer will select our products and services.

Sales cycles with our prospective customers, particularly to utilities, which are our primary set of prospective customers, tend to be long and unpredictable. Utilities generally have extensive budgeting, procurement, competitive bidding, technical and performance review, and regulatory approval processes that can take up to several years to complete. Utilities may choose, and many historically have often chosen, to follow industry trends rather than be early adopters of new products or services, which can extend the lead time for or prevent acceptance of more recently introduced products or services such as ours. In addition, in many instances, a utility may require one or more pilot programs to test new products and services before committing to a larger deployment. These pilot programs may be quite lengthy and further delay the sales cycle with no assurance that they will lead to a larger deployment or future sales. Furthermore, to the extent our products are required to be deployed with the products of others, such as meters, delays related to such third-party products will further lengthen the sales cycle.

This extended sales process requires us to dedicate significant time by our senior management, sales and marketing personnel and customer services personnel, and to use significant financial resources without any assurance of success or recovery of our related expenses. Similarly, we are likely to incur these significant operating expenses well ahead of recognizing the related revenue because our ability to recognize revenue is typically dependent on meeting contractual customer acceptance and other requirements.

The lengthy sales cycles of our products and services also make it difficult to forecast new customer deployments, as well as the volume and timing of orders, which in turn makes forecasting our future results of operations challenging. In the event that we publicly disclose any forecasts of our future results of operations or other performance metrics and those forecasts ultimately turn out to be inaccurate, the value of our common stock could significantly decline.

Our revenue is not predictable and recognition of a significant portion of it will be deferred into future periods.

Once a customer decides to move forward with a large-scale deployment of our products and services, the timing of and our ability to recognize related revenue will depend on several factors, some of which may not be under our control. These factors include shipment schedules that may be delayed or subject to modification, the rate at which our customers choose to deploy our solutions, customer acceptance of all or any part of our products and services, our contractual commitments to provide new or enhanced functionality at some point in the future, other contractual provisions such as liquidated damages, our manufacturers’ ability to provide an adequate supply of components, our customers’ requirement to obtain regulatory approval, and our ability to deliver quality

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products according to expected schedules. In light of these factors, the application of complex revenue recognition rules to our products and services has required us to defer, and in the future could continue to require us to defer, a significant amount of revenue until undetermined future periods. As of September 30, 2016 and December 31, 2015, we had $373.9 million and $401.8 million in deferred revenue, respectively. It may be difficult to predict the amount of revenue that we will recognize in any given period, and amounts recognized may fluctuate significantly from one period to the next.

Amounts included in our total backlog and order backlog may not result in actual billings or revenue or translate into profits.

Our total backlog represents future product and services revenue and billings that we expect to generate pursuant to contracts that we have entered into with our customers and third-party device manufacturers. Order backlog represents future revenue and billings for open purchase orders and other firm commitments and is included in our total backlog. We anticipate that our total backlog and order backlog will fluctuate from period to period throughout 2016 and beyond.

We cannot guarantee that our total backlog or order backlog will result in actual billings or revenue in the originally anticipated period, or at all. In addition, the contracts reflected in our total backlog and order backlog may not generate margins equal to or better than our historical operating results. We have a short history of tracking total backlog and order backlog on a consistent basis as performance measures, and as a result, we do not have significant experience in determining the level of realization that we will actually achieve on our total backlog and order backlog. Our customer contracts are typically structured as master purchase and services agreements, or MSAs, under which the customer may place purchase orders over the course of a deployment. These deployments can extend for a number of years. Because our MSAs do not typically require a customer to purchase a minimum amount of product or services, total backlog is an estimate based upon contractual terms, existing purchase orders and other available information regarding the amount and timing of expected future purchase orders to be placed by our customers, including non-binding forecasts. No assurance can be made that firm purchase orders will be placed under these MSAs in the amounts we estimate, within the time period we expect, or at all. Total backlog is subject to adjustments due to the long-term nature of our customer deployments. Adjustments can result from a variety of factors, including changes in the nature or scope of customer deployments, the impact of contingency provisions related to future delivery or performance, customer cancellations, market conditions, delayed regulatory approvals and customer defaults. Delays due to external market factors or delays in deployments and required regulatory approvals have in the past and may in the future cause us to extend the deployment schedule or make modifications under customer contracts. In addition, under our MSAs, our customers generally have the right to terminate the MSA for any reason, including for their sole convenience, a material breach or insolvency on our part or their inability to obtain required regulatory approval. The occurrence of such adjustments or terminations could materially reduce the amount of, or delay the fulfillment of, our total backlog and order backlog. If our total backlog or order backlog fails to materialize as expected, we could experience a material reduction in future billings, revenue, operating results or cash flow.

We are dependent on the utility industry, which has experienced volatility in capital spending. This volatility could cause our results of operations to vary significantly from period to period.

We derive a substantial portion of our revenue and billings from sales of products and services directly and indirectly to utilities. Similar to other industries, the utility industry has been affected by recent economic factors, including continued global economic uncertainty. Purchases of our products and services may be reduced or deferred as a result of many factors including economic downturns and uncertainty, slowdowns in new residential and commercial construction, a utility’s access to capital on acceptable terms, the timing and availability of government grants or incentives, utility specific financial circumstances, mergers and acquisitions, regulatory decisions, weather conditions, consumer opposition and fluctuating interest rates. Even with economic recovery, it may take time for our customers to establish new budgets and return to normal purchasing patterns. We cannot predict the recurrence of any economic slowdown or the strength or sustainability of the economic recovery, worldwide, in the United States or in our industry. We have experienced, and may in the future experience, variability in operating results on an annual and a quarterly basis as a result of these factors. Because a significant portion of our expenses is fixed in the short term or is incurred in advance of anticipated sales, we may not be able to decrease our expenses in a timely manner to offset any shortfall of sales. This could materially and adversely affect our operating results, financial condition and cash flows.

Substantially all of our current products depend on the availability and are subject to the regulation of radio spectrum in the United States and abroad.

Substantially all of our current products are designed to communicate wirelessly via radio frequencies and therefore depend on the availability of adequate radio spectrum in order to operate. While these products are designed to operate in a variety of different frequencies to allow us to adapt our solutions to local market conditions, or by using other technologies such as cellular, in the United States they are primarily designed to form a wireless RF mesh using the unlicensed 902-928 megahertz, or MHz, band. The 902-928 MHz band is available for a wide variety of uses and requires us to manage interference by other users who operate in accordance with the Federal Communications Commission, or FCC, rules. The unlicensed frequencies are also often the subject of proposals to the

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FCC requesting a change in the rules under which such frequencies may be used. In the past, the FCC has re-allocated spectrum for new or additional uses, and has adopted changes to the requirements for equipment using radio spectrum. It is possible that the FCC or the U.S. Congress could adopt additional changes, which may be incompatible with our current or future product offerings, as well as products currently installed in the field, or require them to be modified at significant, or even prohibitive, cost. If the unlicensed frequencies become unacceptably crowded, restrictive or subject to changed laws, regulations or rules governing their use, our business, financial condition and results of operations could be materially and adversely affected.

Our international growth and future success also depend on the availability of radio spectrum that is compatible with our products, and on our ability to develop products that use alternative communications technology as we continue to integrate our products with products from additional device partners. Certain international markets, such as Europe, use and may continue to use different spectrum bands than the United States, which has in the past and may continue to require us to make modifications to our products in order to operate within the designated spectrum. Additionally, we have in the past and may in the future seek rights and seek to certify our products for using a variety of spectrum in various international markets, however we may not be granted such rights or certifications in all countries. In many other countries, there may not be spectrum available or we may be required to obtain a license to operate in a frequency band that is not immediately compatible with our products. Licenses to appropriate spectrum in these countries may be unavailable or only available at unreasonably high prices. Similarly, in the event that we were only able to obtain a license in a different frequency band, the cost of modifying or redesigning our products to make them compatible with available spectrum could be significant or even cost-prohibitive. Alternatively, if we are not able to obtain available spectrum on financially advantageous terms, we may not be able to compete without investing in alternative communication technology. Moreover, interference caused by others who do not comply with regulatory or statutory requirements could further limit the availability of spectrum that is compatible with our products. If limitations on the availability of spectrum or the cost of making necessary modifications or investments in new technology preclude us from selling our products in markets outside of the United States, our growth, prospects, financial condition and results of operations could be materially and adversely affected.

A limited number of our customers are responsible for a significant portion of our revenue, billings and cash flow. A decrease in sales to these customers or delays in customer deployments could have a material adverse effect on our operating results and financial condition.

A substantial majority of our revenue, billings and cash flow depends on relatively large sales to a limited number of customers. The combination of lengthy sales cycles, challenges in securing new customers and relatively large sales to a small number of customers increases the risk of quarterly fluctuations in our billings, revenue and operating results. See Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations for further information regarding customer concentration. Our MSAs do not impose purchase obligations on our customers until we have received a purchase order or agreed to a statement of work. Further, the MSAs are typically subject to termination for any reason, including for convenience following a specified notice period. We expect that a limited number of customers will continue to account for a substantial portion of our revenue and billings in future periods. Changes in the business requirements, vendor selection, or purchasing behavior of our customers could significantly decrease our sales. In addition, our MSAs are complex, often requiring close coordination with our customers over extended preparation and deployment periods and involving large-scale delivery of our products and services. From time to time we have experienced and may in the future experience challenges in satisfying our customers throughout these preparation and deployment periods regarding all aspects of our performance. Additionally, we have in the past received correspondence from customers claiming that there have been deficiencies in our timeliness and coordination regarding hardware, software and services for deployment, and requesting that we remedy the deficiencies noted. If we are unable to address customers’ concerns, we could be required to pay penalties, liquidated damages or other expenses, the customer could terminate our MSA and our reputation could be damaged. Additionally, delays in customer deployments have in the past, and could in the future, affect our results of operations. Any of these factors could materially and adversely affect our business, financial condition, and results of operations.

Our marketing efforts depend significantly on our ability to receive positive references from our existing customers.

Our marketing efforts depend significantly on our ability to call on our current customers to provide positive references to new, potential customers. Given our limited number of customers, the loss or dissatisfaction of any customer could substantially harm our brand and reputation, inhibit the market acceptance of our products and services, and impair our ability to attract new customers and maintain existing customers. Any of these consequences could have a material adverse effect on our business, financial condition and results of operations.

The markets for our products and services, smart grid, smart city, and broader IoT technology in general, are still developing. If the markets develop less extensively or more slowly than we expect, our business could be harmed.

The markets for our products and services, smart grid, smart city and broader IoT technology in general, are still developing, and it is uncertain whether our products and services will achieve and sustain high levels of demand and market acceptance. Our near-

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term and long-term success will depend to a substantial extent on the willingness and ability of utilities to implement smart grid technology. Many utilities lack the financial resources and/or technical expertise required to evaluate, deploy and operate smart grid technology. Utilities’ activities are governed by regulatory agencies, including public utility commissions, which may not create a regulatory environment that is conducive to the implementation of smart grid technologies in a particular jurisdiction. Furthermore, some utilities may be reluctant or unwilling to adopt smart grid technology because they do not perceive the benefits or are unable to develop a business case to justify the up-front and ongoing expenditures. If utilities do not implement smart grid technology or do so in fewer numbers or more slowly than we expect, our business and operating results would be adversely affected. For example, in the past, the rate of smart grid adoption slowed due to uncertainty surrounding the timing and tax treatment of U.S. government stimulus funding, negative publicity and consumer opposition, and regulatory investigations. These uncertainties caused many potential customers that had been considering smart grid programs in the United States to further evaluate their smart grid initiatives and delay their procurement processes or extend their deployment schedules. Smart grid adoption in international markets has trailed adoption in the United States as international markets continue to explore the technology and define the benefits and regulatory requirements for the smart grid.

Our success in the smart grid market also depends on our ability to expand beyond advanced metering sales and sell additional products and services, such as distribution automation, demand-side management, and our data analytics platform. There can be no assurance that these products and services will be accepted by utilities or consumers. Similarly, our future success depends on our ability to expand our business beyond the smart grid into smart city infrastructure, such as with our street light solution, and into the broader IoT markets, such as with our Starfish network service. There can be no assurance that these or other smart city and broader IoT products and services will be accepted by cities or other potential customers. Other competing products and services for the smart grid, smart city and broader IoT markets may emerge and may be more successful.

Adverse publicity about, or consumer or political opposition to, the smart grid could inhibit the growth of the overall market.

The safety and security of the power grid, the accuracy and protection of the data collected by meters and transmitted via the smart grid, concerns about the safety of smart meters following recent meter-related fires, and concerns about the safety and perceived health risks of using radio frequency communications have been the focus of adverse publicity. For example, in Northern California, PG&E’s full-scale deployment of our networking platform and advanced metering solution was subject to scrutiny following allegations of inaccurate bills generated by newly-installed “smart meters” and safety concerns about the levels of radio frequency electromagnetic fields emitted by the wireless communications technology used by the meters. As a result, the California State Senate created a special committee and the California Public Utilities Commission, or CPUC, and hired an independent investigator to review the installation and use of advanced metering products. Negative publicity and consumer opposition in California, Maine and elsewhere have caused other utilities or their regulators to respond by delaying or modifying planned smart grid initiatives, mandating that utilities allow their customers to opt out of smart metering programs, or calling for investigations and/or implementation of unfavorable regulations and legislation. Similarly, outside the United States, public concern over smart grid projects in places such as Victoria, Australia has resulted in increased government scrutiny. Additionally, testing commissioned by the CPUC and other organizations could, in the future, contain negative information regarding the accuracy and safety of smart grid solutions. Finally, smart grid projects by other companies may be, or could be viewed by the public as, unsuccessful. Any of the foregoing factors could directly impact our current or future deployments, as well as inhibit the growth of the overall smart grid market, either of which could cause our business to suffer.

Security breaches involving our products or services, publicized breaches in smart grid or smart city products and services offered by others, or the public perception of security risks or vulnerability created by the deployment of the smart grid or smart city in general, whether or not valid, could harm our business.

The security technologies we have integrated into our networking platform and solutions that are designed to detect unauthorized activity and prevent or minimize security breaches may not function as expected and there can be no assurance that our products and services, those of other companies with whose products our products and services are integrated or interact, or even the products of other smart grid and smart city solutions providers, will not be subject to significant real or perceived security breaches.

Our networking and analytics platforms allows utilities to collect, monitor, store, compile and analyze sensitive information related to consumers’ energy usage, as well as the performance of different parts of the power grid. As part of our data transfer and managed services and SaaS services, we may store and/or come into contact with sensitive consumer information and data when we perform operational, installation or maintenance functions for our customers. If, in handling this information, we, our partners or our customers fail to comply with privacy or security laws, we could face significant legal and financial exposure to claims of government agencies, customers and consumers whose privacy is compromised. Even the perception that we, our partners or our customers have improperly handled sensitive, confidential information could have a negative effect on our business. In addition, third parties may attempt to breach our security measures or inappropriately use or access our network services or the network hardware and software we have in the field through computer viruses, physical or electronic break-ins, and other means. If a breach is successful, sensitive

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information may be improperly obtained, manipulated or corrupted, and we may face legal and financial exposure. A breach could also lead to a loss of confidence in our products and services and our business could suffer.

Our current and anticipated future products and services allow authorized personnel to remotely control equipment at residential and commercial locations, at various points on the power grid, and at various points in a city’s critical infrastructure. For example, our software allows a utility to remotely connect and disconnect electricity at specific customer locations. If an unauthorized third-party were to breach our security measures and disrupt, gain access to or take control of any of our products or services, our business and reputation could be severely harmed.

Our products and services may also be integrated or interface with products and services sold by third parties, and rely on the security of those products and their secure transmission of proprietary data over the internet and cellular networks. Because we do not have control over the security measures implemented by third-parties in their products or in the transmission of data over the internet and cellular networks, we cannot ensure the complete integrity or security of such third-party products and transmissions.

Concerns about security, customer or consumer privacy may result in the adoption of state or federal legislation that restricts the implementation of smart grid and smart city technology or requires us to make modifications to our products, which could significantly limit the deployment of our technologies or result in significant expense to modify our products.

Any real or perceived security breach could seriously harm our reputation and result in significant legal and financial exposure, including increased remediation costs and security protection costs, inhibit market acceptance of our products and services, halt or delay the deployment by customers of our products and services, cause us to lose customers, harm our reputation, trigger unfavorable legislation and regulatory action, and inhibit the growth of the overall market for the smart grid and smart cities. Any of these risks could have a material adverse effect on our business, financial condition and results of operations.

If our products contain defects or otherwise fail to perform as expected, we could be liable for damages and incur unanticipated warranty, recall and other related expenses, our reputation could be damaged, we could lose market share and, as a result, our financial condition or results of operations could suffer.

Our products are complex and may contain defects or experience failures due to any number of issues in design, materials, deployment and/or use. If any of our products contain a defect, compatibility or interoperability issue or other error, we may have to devote significant time and resources to find and correct the issue. Such efforts could divert the attention of our management team and other relevant personnel from other important tasks. A product defect, product recall or a significant number of product returns could be expensive, damage our reputation and relationships with our customers and third-party vendors, result in property damage or physical injury or death, result in the loss of business to competitors, and result in litigation against us. Costs associated with field replacement labor, hardware replacement, re-integration with third-party products, handling charges, correcting defects, errors and bugs, or other issues could be significant and could materially harm our financial results. We have in the past experienced product defects due to faulty components supplied by third-parties, and recorded significant costs associated with warranty claims, write-offs of returned products and customer repair programs implemented as a result.

Estimated future product warranty claims are based on the expected number of field failures over the warranty commitment period, the term of the product warranty period, and the costs for repair, replacement and other associated costs. Our warranty obligations are affected by product failure rates, claims levels, material usage and product re-integration and handling costs. Because our products are relatively new and we do not yet have the benefit of long-term experience observing the products’ performance in the field, our estimates of a product’s lifespan and incidence of claims may be inaccurate. Should actual product failure rates, claims levels, material usage, product re-integration and handling costs, defects, errors, bugs or other issues differ from the original estimates, we could end up incurring materially higher warranty or recall expenses than we anticipate.

Our customer contracts typically contain provisions that could cause us to incur penalties, be liable for damages, and/or incur unanticipated expenses with respect to the functionality, deployment, operation and availability of our products and services, and that provide the customer with the right to terminate the contract for any reason.

In addition to the risk of unanticipated warranty or recall expenses, our customer contracts typically contain provisions that could cause us to incur penalties, be liable for damages, including liquidated damages, or incur other expenses, if we experience difficulties with respect to the functionality, deployment, operation and availability of our products and services. In the event of late deliveries, late or improper installations or operations, failure to meet product or performance specifications or other product defects, interruptions or delays in our managed services offerings, our customer contracts may expose us to penalties, significant damages and other liabilities. For example, we have in the past agreed to reimburse customers for their costs and incurred liquidated damages by failing to timely meet contractual milestones or other contractual requirements. In addition, our customer contracts are typically subject to termination for any reason, including for convenience following a specified notice period, our material breach or

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insolvency, or the failure to obtain required regulatory approval. If a customer terminates its customer contract for any reason, our estimates of total backlog and order backlog will be reduced. Reductions in total backlog and order backlog may have a negative effect on future revenue, billings, profitability and liquidity. In the event we were to incur contractual penalties, such as liquidated damages or other related costs that exceed our expectations, or our customers terminate their contracts with us, our business, financial condition and operating results could be materially and adversely affected.

Our success depends in part on our ability to integrate our technology into devices and our relationship with device manufacturers.

Our business depends on our ability to integrate our communications modules into devices manufactured by third-party vendors. For example, for our advanced metering solution, our communications modules are integrated into electricity meters that are manufactured by third parties such as Aclara Technologies LLC (which acquired GE Energy Management’s Grid Solutions electricity meter business from General Electric Company), Toshiba Corporation (which acquired Landis+Gyr AG), and Secure Meters Limited, among others. A similar structure is used in our street light solution, where fulfillment of our communications modules is often completed by our partners who manufacture lighting fixtures or control modules. In a typical deployment, our customer purchases integrated devices from one or more third-party device manufacturers after integration of our communications modules into the device. Accordingly, even if demand for our products is strong, we have in the past and may in the future be constrained by the production capacity and priorities of the device manufacturers. In addition, several of these device manufacturers offer competing products, partner with other providers or may otherwise choose not to integrate our communications modules with their devices. If for technical or any other reason we were to lose the ability to integrate our communications modules with devices manufactured by third parties, or if our relationships with device manufacturers were to be terminated or renegotiated on unfavorable terms, our business, financial condition, and operating results could suffer. Further, there have been instances where devices with which our technology had been integrated experienced defects or had other problems that were unrelated to our technology. If this occurs in the future and the defects or problems are more significant or occur more frequently, our reputation could suffer and our business could be harmed.

From time to time, we have worked and expect to continue to work with third parties to pursue smart grid, smart city and broader IoT market opportunities. If we are unable to establish and maintain these relationships, or if our initiatives with these third parties are unsuccessful, our business may suffer.

For some of our existing and anticipated future products and services, we expect to maintain and may seek to establish relationships with third parties in order to take advantage of smart grid, smart city and broader IoT market opportunities. For example, we have designed our products to interface with in-home devices and data analytics products, and will need to work with third parties to successfully deploy these products. Before a customer is willing to move forward with a deployment of our products, they may require that we partner with third-party vendors and/or obtain a certification from these vendors that our products will function as intended when integrated with their products. In addition, third-party vendors may offer competing products, partner with other networking providers or otherwise choose not to partner with us. In the event that we are unable to establish or maintain new relationships on favorable terms, or at all, our ability to successfully sell our existing and anticipated future products and services could be jeopardized.

We may not be able to identify adequate strategic relationship opportunities, or form strategic relationships, in the future.

Strategic business relationships may be an important factor in the growth and success of our business. However, there are no assurances that we will be able to identify or secure suitable business relationship opportunities in the future and our competitors may capitalize on such opportunities before we do. Moreover, identifying such opportunities could demand substantial management time and resources and involves significant costs and uncertainties. If we are unable to successfully source and execute on strategic relationship opportunities in the future, our business and results of operations could be significantly harmed.

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As we continue to expand our business and evolve our technology, we may face unexpected challenges in the adoption, deployment and operation of our technology.

The smart grid, smart city, and broader IoT markets are still expanding and involve rapidly changing technology, which requires us to continue to expand our business and evolve our technology. The current generation of our networking platform and solutions has only been developed in the last several years. We announced our next generation networking platform and solutions, Gen5, in January 2015, and announced Starfish, a wireless network service for the IoT, in December 2015. We expect each of these technologies to continue to evolve over time. We may face unexpected problems or challenges in connection with the introduction and deployment of our new Gen5 platform and solutions and Starfish, including in the adoption and acceptance by our existing and potential customers, for a variety of reasons such as:

If Gen5, Starfish, or other new technologies do not achieve adequate acceptance and adoption in the market, we may not realize our investments in their research and development, our competitive position will be impaired, and our results of operations could be adversely affected.

In addition, deploying and operating our technology is a complex endeavor. As the size, complexity and scope of our deployments have expanded, we have been able to test product performance at a greater scale and in a variety of new geographic settings and environmental conditions. These larger deployments have presented a number of unforeseen operational and technical challenges, which in some cases have caused delays and required us to commit significant resources to address these challenges. As the number, size and complexity of our deployments grow, we may continue to encounter unforeseen operational, technical and other challenges, some of which could cause significant delays, trigger contractual penalties, result in unanticipated expenses, and/or damage to our reputation, each of which could materially and adversely affect our business, financial condition and results of operations.

If we fail to respond to evolving technological changes, our products and services could become obsolete or less competitive.

Our industry is highly competitive and characterized by new and rapidly evolving technologies, standards, regulations, customer requirements, and frequent product introductions. Accordingly, our operating results depend upon, among other things, our ability to develop and introduce new products and services, as well as our ability to reduce production costs of our existing products. The process of developing new technologies and products is complex, and if we are unable to develop enhancements to, and new features for, our existing products or acceptable new products that keep pace with technological developments or industry standards, our products may become obsolete, less marketable and less competitive and our business could be significantly harmed.

We depend on our ability to develop new products and to enhance and sustain the quality of existing products.

Most of our current billings and revenue are derived from our networking platform and advanced metering solution, but our growth and future success will depend, in part, on our ability to continue to design and manufacture new competitive products that achieve market acceptance and to enhance and sustain the quality and marketability of our existing products. As such, we have made, and expect to continue to make, substantial investments in technology development. Any new technology or product that we develop may not be introduced in a timely or cost-effective manner, may not be priced appropriately, and may not achieve the broad market acceptance necessary to generate significant revenues. For example, in January 2015 we announced Gen5, our next generation networking platform and solutions, and in December 2015 we announced Starfish, a wireless network service for the IoT. In previous years, we introduced our street light and SilverLink Data Platform solutions. These new products and solutions may not be adopted by prospective or existing customers to the extent we anticipate, or at all. In the future, we may not have the necessary capital, or access to capital on acceptable terms, to fund necessary levels of research and development. Even with adequate capital resources, we may nonetheless experience unforeseen problems in the development or performance of our technologies or products. The markets for smart grid, smart city, and broader IoT technology products are still in their early stages, and we cannot assure you that we will be successful in developing or selling new products in these markets. In addition, we may not meet our product development schedules and, even if we do, we may not develop new products fast enough to provide sufficient differentiation from our competitors’ products, which may be more successful. If we are unable to develop new products or enhance or sustain the quality of our existing products,

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successfully develop and deploy new technology and products or integrate these new technologies into devices manufactured by our third-party devices, our business and operating results could be harmed.

We and our customers operate in a highly regulated business environment and changes in regulation could impose costs on us or make our products less economical.

Our products and our customers are subject to federal, state, local and foreign laws and regulations. Laws and regulations applicable to us and our products govern, among other things, the manner in which our products communicate, and the environmental impact and electrical reliability of our products. Additionally, our U.S. customers are often regulated by national, state and/or local bodies, including public utility commissions, the Department of Energy, the Federal Energy Regulatory Commission and other bodies. International customers are often subject to similar regulatory regimes. Prospective customers may be required to gain approval from any or all of these organizations prior to implementing our products and services, including specific permissions related to the cost recovery of these systems. Regulatory agencies may impose special requirements for implementation and operation of our products. We may incur material costs or liabilities in complying with government regulations applicable to us or our customers. In addition, potentially significant expenditures could be required in order to comply with evolving regulations and requirements that may be adopted or imposed on us or our customers in the future. Such costs could make our products less economical and could impact our customers’ willingness to adopt our products, which could materially and adversely affect our revenue, results of operations and financial condition.

Furthermore, changes in the underlying regulatory conditions that affect utilities could have a potentially adverse effect on a utility’s interest or ability to implement smart grid technologies. For example, ongoing regulatory uncertainties have in the past delayed the timing of some deployments. Many regulatory jurisdictions have implemented rules that provide financial incentives for the implementation of energy efficiency and demand response technologies, often by providing rebates or through the restructuring of utility rates. If these programs were to cease, or if they were restructured in a manner inconsistent with the capabilities enabled by our products and services, our business, financial condition and results of operations could be significantly harmed.

The adoption of industry standards applicable to our products or services could limit our ability to compete in the marketplace.

Standards bodies, which are formal and informal associations that seek to establish voluntary, non-governmental product and technology standards, are influential in the United States and abroad. We participate in voluntary standards organizations in order to both help promote non-proprietary, open standards for interoperability with our products and prevent the adoption of exclusionary standards. However, we are not able to control the content of adopted voluntary standards and do not have the resources to participate in all voluntary standards processes that may affect our markets. Some of the standards bodies and alliances in which we participate may require that we license certain of our patent claims that are necessary or essential to practice a particular standard to other participants, including competitors who elect to produce products compliant with that standard. These obligations to license our necessary patent claims may allow our competitors to use our patents to develop and sell products that compete with our products without spending the time and expense that we incurred to develop the technology covered by the patents, thereby potentially reducing any time to market advantage we might have as a result of these patents. These obligations could also substantially restrict and may eliminate our ability to use our patents as a barrier to entry or as a significant source of revenue. Moreover, because the specifications for these industry standards are generally available to members of the applicable standards bodies and alliances for little or no cost, competitors might be able to more easily create products that compete with our products.

The adoption, or expected adoption, of voluntary standards that are incompatible with our products or technology or that favor our competitors’ products or technology could limit the market opportunity for our products and services or render them obsolete, any of which could materially and adversely affect our revenue, results of operations, and financial condition.

If our products do not interoperate with our customers’ other systems, the purchase or deployment of our products and services may be delayed or cancelled.

Our products are designed to interface with our customers’ back office billing and other systems, each of which may have different specifications and utilize multiple protocol standards and products from other vendors. Our products will be required to interoperate with many or all of these products as well as future products in order to meet our customers’ requirements. If we find errors in the existing software or defects in the hardware used in our customers’ systems, we may need to modify our products or services to fix or overcome these errors so that our products will interoperate with the existing software and hardware, which could be costly and negatively affect our business, financial condition, and results of operations. In addition, if our products and services do not interoperate with our customers’ systems, customers may seek to hold us liable, demand for our products could be adversely affected or orders for our products could be delayed or cancelled. This could hurt our operating results, damage our reputation, and seriously harm our business and prospects.

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Interruptions or delays in services from our third-party data center facilities, or problems with the third-party hardware or software that we employ, could impair the delivery of our services and harm our business.

We currently offer managed services and SaaS, including disaster recovery services, utilizing two data center facilities operated by separate third parties in California and Nevada. These facilities may be vulnerable to damage or interruption from, among other things, fire, natural disaster, power loss, telecommunications failure, war, acts of terrorism, unauthorized entry, human error, and computer viruses or other defects. They may also be subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct. We rely on software and hardware technology provided by third-parties to enable us to provide these services. Any damage to, or failure of, these third-party data centers or the third-party hardware and software we employ, could result in significant and lengthy interruptions in the services we provide to our customers. Such interruptions could reduce our revenue and billings, cause us to issue credits or pay penalties, cause customers to terminate their services, harm our reputation and adversely affect our ability to attract new customers.

We do not control certain critical aspects of the manufacture of our products and depend on a limited number of contract manufacturers.

Our future success will depend significantly on our ability to manufacture our products timely and cost-effectively, in sufficient volumes, and in accordance with quality standards. Currently, our primary manufacturing relationships are with Celestica, Inc. and Flextronics International Ltd. These vendors provide or will provide us with a wide range of operational and manufacturing services, including material procurement, final assembly, test quality control, warranty repair, and shipment to our customers and third-party vendors.

Our reliance on our contract manufacturers reduces our control over the manufacturing process, exposing us to risks, including reduced control over quality assurance, product costs and product supply. Any manufacturing disruption by our contract manufacturers could impair our ability to fulfill orders and warranty repair obligations. We may be unable to manage our relationships with our contract manufacturers effectively as they may experience delays, disruptions, capacity constraints or quality control problems in their manufacturing operations or otherwise fail to meet our future requirements for timely delivery. Similarly, to the extent that our contract manufacturers procure materials on our behalf, we may not benefit from any warranties received by the contract manufacturers from the suppliers or otherwise have recourse against the original supplier of the materials or even the contract manufacturer. In such circumstances, if the original supplier were to provide us or our contract manufacturers with faulty materials, we might not be able to recover the costs of such materials or be compensated for any damages that arise as a result of the inclusion of the faulty components in our products. For example, in the past we discovered that faulty components from third-party suppliers were used in a discrete number of our communications modules.

One or more of our contract manufacturers may suffer an interruption in its business, or experience delays, disruptions or quality control problems in its manufacturing operations, or seek to terminate its relationship with us, or we may choose to change or add additional contract manufacturers for other reasons. Additionally, we do not have long-term supply agreements with our contract manufacturers. As a result, we may be unable to renew or extend our agreement on terms favorable to us, if at all. Although the contract manufacturing services required to manufacture and assemble our products may be readily available from a number of established manufacturers, it is risky, time consuming and costly to qualify and implement contract manufacturer relationships.

We depend on a limited number of key suppliers and if such suppliers fail to provide us with sufficient quantities of components at acceptable levels of quality and at anticipated costs, our revenue and operating results could be materially and adversely affected.

Several of the components used in our products come from sole, limited source or geographically concentrated suppliers, such as Analog Devices and Renesas Electronics America Inc. Additionally, our suppliers are not typically contractually obligated to supply us with components in minimum quantities or at predetermined prices over the long term. Accordingly, we may be vulnerable to price increases, component quality issues, the discontinuance of certain components, and financial, natural disasters, or other difficulties faced by our suppliers, causing shortages or interruptions in supply of components and materials, which could cause us to delay shipments to our customers. For example, some of our key suppliers are located in Japan and their ability to timely provide us with the necessary components used in our products was compromised as a result of the catastrophic earthquake and tsunami in 2011, and we could experience similar disruptions as a result of the recent earthquake in Japan in April 2016. To help address these issues, we may purchase excess quantities of these items to hold in inventory to help ensure adequate available supply. As a result, we could be forced to record excess and obsolete inventory charges to provide for these excess quantities and we may also be subject to pricing risk or carrying charges, which could harm our operating results.

If we experience any shortages due to reliance on a limited number of suppliers, commodity supply constraints, capacity constraints, discontinuance, natural disasters or price fluctuations related to the raw materials used, or if we are not able to identify, test, qualify, and procure components from alternate sources at acceptable prices and within a reasonable period of time, our

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reputation could suffer and our business, financial condition and results of operations could be materially and adversely effected. We may not be able to obtain component replacements on commercially reasonable terms in the event of a natural disaster, act of God or similar catastrophic event. In such circumstances, we could be forced to exhaust our excess on-hand inventory and then face a delay in shipments of our products to our customers. In addition, we may also be subject to contractual penalties if we fail to deliver our products and services on time.

Further, our customers may reschedule or cancel orders on relatively short notice. If our customers cancel orders after we have ordered the corresponding product from our suppliers, we may be forced to incur cancellation fees or to purchase products that we may not be able to resell, which could have a material adverse effect on our business, financial condition and results of operations.

Our business could be severely harmed by natural disasters or other catastrophes.

A significant catastrophic event such as war, acts of terrorism, natural disasters, such as earthquakes, or global threats, including, but not limited to, the outbreak of epidemic disease, could disrupt our operations and impair deployment of our solutions by our customers, interrupt critical functions, cause our suppliers to be unable to meet our demand for parts and equipment, reduce demand for our products, prevent our customers from honoring their contractual obligations to us or otherwise affect our business negatively. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders or the deployment of our products, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

We operate in a highly competitive industry and we compete against many companies with substantially greater financial and other resources, and our market share and results of operations may be reduced if we are unable to respond to our competitors effectively.

Competition in our market is intense and involves quickly changing technologies, evolving industry standards, frequent new product introductions, rapid consolidation, and changes in customer requirements. To maintain and improve our competitive position, we must keep pace with the evolving needs of our customers and continue to develop and introduce new solutions, applications and services in a timely and efficient manner. Our competitors range from small companies to very large and established companies. These competitors offer a variety of products and services related to the smart grid and smart city and come from a number of industries, including traditional meter manufacturers, application developers, telecommunications vendors, street light providers, and other service providers. We compete with traditional meter manufacturers that incorporate various communications technologies that provide some level of connectivity to the utility’s back office. Our key competitors in this segment include Elster Group GmbH (which was acquired by Honeywell International Inc.), Itron Inc., Landis+Gyr AG (which was acquired by Toshiba Corporation), Sensus Metering Systems Inc. (which was acquired by Xylem, Inc.), Aclara Incorporated, and Trilliant Holdings, Inc. Similarly, we compete with traditional providers of distribution automation equipment, such as Cisco Systems, Inc., General Electric Company, S&C Electric Company and Schweitzer Engineering Laboratories, Inc. We also face competition from newer entrants that are providing specific narrowly focused products for the smart grid, including C3 IoT Inc., Grid Net Inc., Opower Inc. (which was acquired by Oracle Corporation), and Tendril Networks Inc. In smart lighting and smart cities, we compete against companies such as Echelon Corporation, Harvard Engineering PLC, Telensa Limited, Sensity Systems Inc. (which was acquired by Verizon Wireless), and proprietary offerings from lighting manufacturers, such as General Electric, Royal Philips Electronics, Schreder Group and others. We expect to face additional competitors as we expand into the broader IoT from companies such as SIGFOX and Ingenu, as well as Semtech Corporation, which is working to build a broad IoT ecosystem within the cellular community through the LoRa Alliance, an open, non-profit association of members with a mission to enable the IoT.  Furthermore, other large companies such as Alcatel-Lucent S.A., AT&T Inc., Cisco Systems, Inc., Enel SpA, Électricité Réseau Distribution France, Fujitsu Limited, General Electric Company, International Business Machines Corporation, Siemens AG, Sprint Nextel Corporation, Vodafone Group Plc, Verizon Communications Inc. and others have announced plans to pursue business opportunities related to the smart grid, smart city, and the broader IoT. As we look to expand into new international markets, we expect to face additional competitors that may be more established in specific geographies. We anticipate that in the future, additional competitors will emerge that offer a broad range of competing products and services related to the smart grid, smart city, and the broader IoT, some of which may be competitive with our offerings.

Several of our competitors enjoy substantial competitive advantages such as:

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Some of these larger competitors have substantially broader product offerings and may be able to leverage the existing relationships they have with customers. In some cases, our larger competitors are also currently vendors of ours, and they could decide in the future to develop their own products instead of working with us. Any inability to effectively manage these relationships could have a material adverse effect on our business, operating results, and financial condition, and accordingly affect our chances of success. In addition, some of our competitors may have larger patent portfolios than we have, which may provide them with a competitive advantage and may require us to engage in costly litigation to protect and defend our freedom to operate and/or intellectual property rights.

Conditions in our market could change rapidly and significantly as a result of technological advancements or market consolidation. The development and market acceptance of alternative technologies could decrease the demand for our products or render them obsolete. Our competitors may introduce products and services that are less costly, provide superior performance or achieve greater market acceptance than our products and services. In order to remain competitive, we may need to lower prices or attempt to add incremental features and functionality, which could negatively impact our revenue, billings, gross margin and financial condition. In addition, our larger competitors often have broader product lines and are in a better position to withstand any significant reduction in capital spending by customers in the smart grid and smart city markets, and will therefore not be as susceptible to downturns in a particular market. If we are unable to compete successfully in the future, our business may be harmed.

We have experienced, and may in the future experience, rapid changes in the pace of our growth. If we fail to manage our growth effectively, our financial performance may suffer.

We have substantially expanded our overall business, customer base, employee headcount and operations both domestically and internationally in the past, and may do so in the future in response to market conditions and opportunities. Our expansion has placed, and any future growth could continue to place, a significant strain on our managerial, customer operations, research and development, sales and marketing, manufacturing, administrative, financial and other resources. If we are unable to manage our growth successfully, our operating results will suffer. Moreover, we have in the past undertaken cost savings initiatives, including a restructuring in 2014 that involved a reduction in force. We may from time to time decide to undertake additional cost savings initiatives, such as restructurings, disposing of, and/or otherwise discontinuing certain products, in an effort to focus our resources on key strategic initiatives and streamline our business. Any decision to take these actions may result in charges to earnings associated with, among other things, inventory or other fixed, intangible or goodwill asset reductions (including, without limitation, impairment charges), workforce and facility reductions and penalties and claims from customers or other third parties. These charges would affect our operating results. In addition to the costs associated with these activities, we may not realize any of the anticipated benefits of the underlying cost savings initiatives.

We rely on our management team and need additional personnel to grow our business, and the loss of one or more key employees or our inability to attract and retain qualified personnel could harm our business.

Our success and future growth depend on the skills, working relationships and continued services of our management team and other key personnel. The loss of any member of our senior management team could adversely affect our business.

In September 2015, Michael Bell was appointed as our new President and Chief Executive Officer, and Scott Lang transitioned to the role of Executive Chairman and remains Chairman of the Board. In July 2016, Aysegul Ilendiz was appointed as our Chief Operating Officer, and we made executive and organization changes in connection with Ms. Ildendiz’s appointment. Leadership transitions can be inherently difficult to manage and may cause operational and administrative inefficiencies, added costs, uncertainty and decreased productivity among our employees and increase the likelihood of turnover, which could result in significant disruptions to our operations. In addition, we must successfully integrate the new CEO and COO within our organization in order to achieve our operating objectives, and changes in key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. The presence of a new CEO and COO may also impact our relationships with customers and vendors, resulting in loss of business and loss of vendor relationships. The uncertainty inherent in our recent management changes could also lead to concerns from current and potential third parties with whom we do business, any of which could damage our business prospects.

Our future success will also depend on our ability to attract, retain and motivate highly skilled management, product development, operations, sales, technical and other personnel in the United States and abroad. We have in the past lost members of our

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senior management team, and the loss of additional members of our senior management team could adversely affect our business. We could also be adversely affected if we fail to adequately plan for the succession of members of our senior management team should we have departures. Even in today’s economic climate, competition for these types of personnel is intense, particularly in the Silicon Valley, where our headquarters are located. All of our employees in the United States work for us on an at-will basis. Given the lengthy sales cycles with customers and deployment periods of our networking platform and solutions, the loss of key personnel could adversely affect our business.

Volatility or lack of performance in our stock price may also affect our ability to attract and retain our senior management, key personnel and other employees. Many of our longest-tenured employees, including members of our senior management and key personnel with deep institutional knowledge, hold significant vested stock options and shares of our common stock. Employees may be more likely to leave us if the shares they own or the shares underlying their vested stock options have significantly appreciated in value relative to the original purchase prices of the shares or the exercise prices of the options, or if the exercise prices of the options that they hold are significantly above the market price of our common stock. As a result of these factors, we may be unable to attract or retain qualified personnel. Our inability to attract and retain the necessary personnel could adversely affect our business.

Our ability to provide bid bonds, performance bonds or letters of credit is limited and could negatively affect our ability to bid on or enter into significant long-term agreements.

We have in the past been, and may in the future be, required to provide bid bonds or performance bonds to secure our performance under customer contracts or, in some cases, as a pre-requisite to submit a bid on a potential project. For example, in connection with the litigation with EON Corp. IP Holdings, LLC, we were required to provide a surety bond that was later released by the district court in order to stay the execution of a judgment pending our appeal. 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 guarantees 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.

We are subject to international business uncertainties.

Our ability to grow our business and our future success will depend to a significant extent on our ability to expand our operations and customer base worldwide. Operating in international markets requires significant resources and management attention, and other than our existing international operations, we have limited experience entering new geographic markets. There can be no assurance that our international efforts will be successful. International sales and operations may be subject to risks such as:

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Fluctuations in the value of the U.S. dollar may impact our ability to compete in international markets. International expansion and market acceptance depend on our ability to modify our business approach and technology to take into account such factors as differing customer business models, product requirements and needs, the applicable regulatory and business environment, labor costs and other economic conditions. In addition, the laws of certain countries do not protect our intellectual property to the same extent as do the laws of the United States. There can be no assurance that these factors will not have a material adverse effect on our future international sales and, consequently, on our business, financial condition and results of operations.

Developments in data protection laws and regulations may affect technology relating to smart grid products and solutions, which could adversely affect the demand for our products and solutions.

Our products and services may be subject to data protection laws and regulations that impose a general framework for the collection, processing and use of personal data. Our networking platform and solutions rely on the transfer of data relating to individual energy use and may be affected by these laws and regulations. It is unclear how the regulations governing the transfer of personal data in connection with privacy requirements will further develop in the United States and internationally, and to what extent this may affect technology relating to smart grid products and solutions. This could have a material adverse effect on our business, financial condition and results of operations.

Adverse changes in general economic or political conditions in any of the major countries in which we do business could adversely affect our operating results.

Our business can be affected by a number of factors that are beyond our control, such as general geopolitical, economic, and business conditions. The continued global economic uncertainty and continued global monetary, financial and sovereign debt crisis could have a negative effect on our business. For example, the worldwide financial and credit crisis reduced the availability of liquidity and credit to fund the continuation and expansion of business operations worldwide. Even with economic recovery, it may take time for our customers or potential customers to establish new budgets and return to normal purchasing patterns. We cannot predict the recurrence of any economic slowdown or the strength or sustainability of the economic recovery, worldwide, in the United States or in our industry. These and other economic factors could adversely affect the demand for our products and services and, consequently, our business, financial condition and results of operations.

There can be no assurance that a deterioration in financial markets will not impair our ability or our customers’ ability to obtain financing in the future, including, but not limited to, our or our customers’ ability to incur indebtedness if necessary. In addition, there could be several residual effects from the credit crisis on our business, including insolvency of certain of our key customers or suppliers, which could result in the inability of our customers to obtain credit to finance purchases of our products.

Our inability to acquire and integrate other businesses, products or technologies could seriously harm our competitive position.

In order to remain competitive, obtain key competencies or accelerate our time to market, we may seek to acquire additional businesses, products or technologies. To date, we have completed only three small acquisitions, and we therefore have limited experience in successfully acquiring and integrating additional businesses, products or technologies. If we identify an appropriate acquisition candidate, we may not be successful in negotiating the terms of the acquisition, financing the acquisition, or effectively integrating the acquired business, product or technology into our existing business and operations. We may have difficulty integrating acquired businesses, technologies or products with our existing products and services. Our due diligence may fail to identify all of the

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problems, liabilities or other shortcomings or challenges of an acquired business, product or technology, including issues related to intellectual property, product quality or product architecture, regulatory compliance practices, revenue recognition or other accounting practices or employee or customer issues. If we finance acquisitions by issuing convertible debt or equity securities, our existing stockholders may be diluted, which could affect the market price of our stock. In addition, any acquisitions we are able to complete may not result in the synergies or any other benefits we had expected to achieve, which could result in substantial write-offs or impairment charges. Further, contemplating or completing an acquisition and integrating an acquired business, product or technology will significantly divert management and employee time and resources.

Our business may suffer if it is alleged or found that our products infringe the intellectual property rights of others.

Our industry is characterized by the existence of a large number of patents and by litigation based on allegations of infringement or other violations of intellectual property rights. Moreover, in recent years, individuals and groups have purchased patents and other intellectual property assets for the purpose of making claims of infringement in order to extract settlements from companies like ours. From time to time, third parties have claimed and may continue to claim that we are infringing upon their patents or other intellectual property rights. For example, we are currently engaged in litigation as further described in Part II, Item 1. Legal Proceedings. In addition, we may be contractually obligated to indemnify our customers or other third parties that use or resell our products in the event our products are alleged to infringe a third-party’s intellectual property rights. Responding to such claims, regardless of their merit, can be time consuming, costly to defend in litigation, divert management’s attention and resources, damage our reputation and brand, and cause us to incur significant expenses. Even if we are indemnified against such costs, the indemnifying party may be unable to uphold its contractual obligations. Further, claims of intellectual property infringement might require us to redesign affected products, delay affected product offerings, enter into costly settlement or license agreements or pay costly damage awards or face a temporary or permanent injunction prohibiting us from marketing, selling or distributing the affected products. If we cannot or do not license alleged infringed technology on reasonable terms or at all, or substitute similar technology from another source, our revenue and earnings could be adversely impacted. Additionally, our customers may not purchase our products if they are concerned that our products infringe third-party intellectual property rights. This could reduce the market opportunity for the sale of our products and services. The occurrence of any of these events may have a material adverse effect on our business, financial condition and results of operations.

The success of our business depends on our ability to protect and enforce our intellectual property rights.

We rely on a combination of patent, trademark, trade dress, copyright, unfair competition and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. These laws, procedures and restrictions provide only limited protection and any of our intellectual property rights may be challenged, invalidated, circumvented, infringed or misappropriated. Further, the laws of certain countries do not protect proprietary rights to the same extent as the laws of the United States and, therefore, in certain jurisdictions, we may be unable to protect our proprietary technology adequately against unauthorized third-party copying, infringement or use, which could adversely affect our competitive position.

As of September 30, 2016, we had 107 issued patents and 62 patent applications pending in the United States. In foreign jurisdictions, we have 170 patents granted and 67 patent applications pending, which are collectively based on 69 U.S. patent applications. Our patents expire at various times between 2017 and 2035. We cannot ensure that any of our pending applications will be granted or that any of our issued patents will adequately protect our intellectual property. In addition, third parties have in the past and could in the future bring infringement, invalidity, co-inventorship, re-examination, or similar claims with respect to any of our currently issued patents or any patents that may be issued to us in the future. Any such claims, whether or not successful, could be extremely costly to defend, divert management’s attention and resources, damage our reputation and brand, and substantially harm our business and results of operations.

In order to protect or enforce our patent rights, protect our trade secrets or know-how, or determine the enforceability, scope and validity of the proprietary rights of others, we may initiate patent litigation or other proceedings against third parties, such as infringement suits or interference proceedings. Any lawsuits or proceedings that we initiate could be expensive, take significant time and divert management’s attention from other business concerns. Litigation and other proceedings also put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third parties to assert claims against us. We may not prevail in any lawsuits or other proceedings that we initiate and the damages or other remedies awarded, if any, may not be commercially valuable. The occurrence of any of these events may have a material adverse effect on our business, financial condition and results of operations.

Some of our products rely on technologies developed or licensed by third-parties. We may seek to license technology from third parties for future products and services. We may not be able to obtain or continue to obtain licenses and technologies from these third parties on commercially reasonable terms or at all. Our inability to retain our current third-party licenses or obtain third-party licenses required to develop new products or product enhancements could require us to obtain alternate technology that may be of lower

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quality or performance standards or at greater cost, or could require that we change our product and design plans, any of which could limit or delay our ability to manufacture and sell our products.

If we are unable to protect the confidentiality of our proprietary information, the value of our technology and products could be adversely affected.

In addition to patented technology, we rely on our unpatented technology and trade secrets. We generally seek to protect this information by confidentiality, non-disclosure and assignment of invention agreements with our employees and contractors and with parties with which we do business. These agreements may be breached and we may not have adequate remedies for any such breach. We cannot be certain that the steps we have taken will prevent unauthorized use or reverse engineering of our technology. Moreover, our trade secrets may be disclosed to or otherwise become known or be independently developed by competitors. To the extent that our employees, contractors, or other third parties with whom we do business use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions. If, for any of the above reasons, our intellectual property is disclosed or misappropriated, it would harm our ability to protect our rights and have a material adverse effect on our business, financial condition, and results of operations.

We use open source software in our products and services that may subject our products and services to general release or require us to re-engineer our products and services, which may cause harm to our business.

We use open source software in connection with our products and services. From time to time, companies that incorporate open source software into their products have faced claims challenging the ownership of open source software and/or compliance with open source license terms. Therefore, we could be subject to suits by parties claiming ownership of what we believe to be open source software or noncompliance with open source licensing terms. Some open source software licenses require users who distribute open source software as part of their software to publicly disclose all or part of the source code to such software and/or make available any derivative works of the open source code on unfavorable terms or at no cost. While we monitor the use of open source software in our products and services and try to ensure that none is used in a manner that would require us to disclose the source code to the related product or that would otherwise breach the terms of an open source agreement, such use could inadvertently occur and we may be required to release our proprietary source code, pay damages for breach of contract, re-engineer our products, discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely basis or take other remedial action that may divert resources away from our development efforts, any of which could adversely affect our business, operating results and financial condition.

Some of our customers and potential customers have applied for government grants and may also seek to participate in other government incentive programs, and if those grants or other incentives are not received or are significantly delayed, our results of operations could suffer.

Many utilities, including some of our customers and potential customers, apply for grants and may seek to participate in other government incentive programs, designed to stimulate the economy and support environmental initiatives, including smart grid technologies. Our customers and potential customers who apply for these government grants or incentives may delay or condition the purchase of our products and services upon receipt of such funds or upon their confidence in the future disbursement of those funds. If our customers and potential customers do not receive these funds or if receipt is significantly delayed, our results of operations could suffer. Similarly, the receipt of government funds or incentives may be conditioned upon utilities meeting milestones and other requirements, some of which may not be known until a future point in time. In addition, if our products and services do not meet the requirements necessary for receipt of government funds or other incentives, or if third parties fail to meet their obligations, our customers and potential customers may delay or condition the purchase of our products and services until they meet these requirements and our results of operations could suffer. Furthermore, there can be no assurance of government funds or incentives in future periods, either in the United States or in other countries where we may pursue business. As a result, our customers and potential customers may not have the resources or incentives to purchase our products and services.

We are an “emerging growth company,” and any decision on our part to comply with certain reduced disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.

We are an “emerging growth company,” or EGC, as defined in the JOBS Act, and, for as long as we continue to be an EGC, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years from our initial public offering date, although if our annual revenue exceeds $1.0 billion in any year or our market value of our common stock that is held by

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non-affiliates exceeds $700 million as of June 30 of any year before the end of that five-year period, we would cease to be an EGC as of December 31 of that year. If we lose our EGC status before the end of that five-year period, we will be required to comply with all the reporting requirements applicable to other public companies including, but not limited to, the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002. We cannot predict if investors will find our common stock less attractive as we continue to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and our stock price may decline or be more volatile.

Under Section 107(b) of the JOBS Act, EGCs 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 EGCs.

We identified material weaknesses in our internal control over financial reporting. We will continue to incur costs to remediate these weaknesses and to maintain effective internal controls over financial reporting. If we are unable to remediate these material weaknesses, and if additional weaknesses are discovered in the future, our business, results of operations and investors’ confidence in us could be materially affected.

In the course of preparing our condensed consolidated financial statements, we identified material weaknesses in internal control over financial reporting. Specifically, we determined that the design and operation of controls related to the classification in the statements of cash flows and the revenue recognition process were inadequate. More specifically our controls over the review of underlying schedules supporting the preparation of our cash flow statement and determination of revenue did not operate at a level of precision to identify errors. For a further discussion of our internal control over financial reporting and a description of the identified material weaknesses, see Part I, Item 4. Controls and Procedures. Although management has implemented a remediation plan to address these material weaknesses, there can be no assurance that such remediation efforts will be successful or that our internal control over financial reporting will be effective as a result of these efforts. In addition, we may in the future identify additional internal control deficiencies that could rise to the level of a material weakness or uncover errors in financial reporting.

 

Our remediation efforts are in process and have not yet been completed. Because of these material weaknesses, there is heightened risk that (1) our management might not be able to certify, and our independent registered public accounting firm might not be able to report on, the adequacy of our internal control over financial reporting, which would cause us to fail to meet our reporting obligations, and (2) a material misstatement of our annual or quarterly financial statements may not be prevented or detected. In addition, the planned remediation steps we expect to take may not effectively remediate the material weaknesses, in which case our internal control over financial reporting would continue to be ineffective. We cannot guarantee that we will be able to complete our remedial actions successfully. In addition, it is possible that we will discover additional material weaknesses in our internal control over financial reporting.

 

Under Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, our management is required to make certain assessments and certifications regarding our disclosure controls and internal controls over financial reporting. In addition, we are required to disclose changes in our internal control and procedures on a quarterly basis. As an EGC, we are not required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002 until the earlier of five years from our initial public offering date or the date we would cease to be an EGC as of December 31 of that year. At such time, our independent registered public accounting firm may issue a report that is adverse in the event that such firm is not satisfied with the level at which our internal control and procedures are documented, designed or operating. As a result, we may need to undertake various actions, such as implementing new internal controls and procedures and hiring additional accounting or internal audit staff. We have dedicated, and expect to continue to dedicate, significant management, financial and other resources in connection with our compliance with Section 404 of the Sarbanes-Oxley Act. The process of maintaining and evaluating the effectiveness of these controls is expensive, time-consuming and requires significant attention from our management and staff. During the course of our evaluation, we may identify areas requiring improvement and may be required to design enhanced processes and controls to address issues identified through this review. This could result in significant delays and costs to us and require us to divert substantial resources, including management time from other activities.

 

In addition, all internal control systems, no matter how well designed and operated, can only provide reasonable assurance that the objectives of the control system are met. Because there are inherent limitations in all control systems, no evaluation of control can provide absolute assurance, that all control issues and instances of fraud, if any, within the company have been or will be detected. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

If we are unable to adequately remediate the foregoing material weaknesses or comply or continue to comply with the foregoing obligations, it could subject us to a variety of administrative sanctions, including the suspension or delisting of our common stock

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from the New York Stock Exchange and the inability of registered broker-dealers to make a market in our common stock, which could reduce the market price of our common stock. In addition, ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of shares of our common stock. In the event that we do not adequately remediate these material weaknesses, or if we fail to maintain proper and effective internal control and procedures in future periods, our business, results of operations and financial condition and our ability to run our business effectively could be adversely affected and investors could lose confidence in our financial reporting.

Our business is subject to changing regulations regarding corporate governance and public disclosure that will increase both our costs and the risk of noncompliance.

As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of the New York Stock Exchange. Achieving and maintaining compliance with these rules and regulations, particularly after we cease to be an emerging growth company, has increased and may further increase our legal, accounting and financial compliance costs, has made and may further make some activities more difficult, time-consuming and costly and may also place undue strain on our personnel, systems and resources.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Any failure to develop or maintain effective controls, or any difficulties encountered in their implementation or improvement, could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our prior period financial statements. Any failure to implement and maintain effective internal controls also could adversely affect the results of periodic management evaluations regarding the effectiveness of our internal control over financial reporting that we are required to include in our periodic reports filed with the SEC under Section 404(a) of the Sarbanes-Oxley Act, or the annual auditor attestation reports regarding effectiveness of our internal controls over financial reporting that we will be required to include in our annual reports filed with the SEC beginning for the year ending December 31, 2018, unless, under the JOBS Act, we meet certain criteria that would require such reports to be included prior to then, under Section 404(b) of the Sarbanes-Oxley Act. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our common stock.

In order to maintain the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we will need to continue to expend significant resources and provide significant management oversight. We are in the process of implementing appropriate business processes, documenting our system of internal control over relevant processes, assessing their design, remediating any deficiencies identified and testing their operation. As a result, management’s attention may be diverted from other business concerns, which could harm our business, operating results and financial condition. These efforts will also involve substantial accounting-related costs. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the New York Stock Exchange.

Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In the event that our internal controls are perceived as inadequate or that we are unable to produce timely or accurate financial statements, investors may lose confidence in our operating results and our stock price could decline.

The Sarbanes-Oxley Act and the rules and regulations of the New York Stock Exchange make it difficult and expensive for us to maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to maintain or increase coverage. If we are unable to maintain adequate directors’ and officers’ insurance, our ability to recruit and retain qualified directors, especially those directors who may be considered independent for purposes of the New York Stock Exchange rules, and officers may be curtailed.

The effects of regulations relating to the source of materials used in the manufacture of our products may adversely affect our business.

The SEC has recently adopted regulations concerning the supply of certain minerals, known as conflict minerals, originating from the conflict zones of the Democratic Republic of Congo, or DRC, and adjoining countries. These regulations require us to determine the origin of certain materials used in our products and disclose whether we use any materials containing conflict minerals originating from the DRC and adjoining countries. Since our supply chain is complex, we may face reputational harm if our customers

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or other stakeholders conclude that we are unable to verify sufficiently the origins of the minerals used in the products we sell. If it is determined that our products do contain or use any conflict minerals from the DRC or adjoining countries, additional requirements will be triggered. Compliance with these regulations may results in increased costs of regulatory compliance, potential risks to our reputation, difficulty satisfying any customers that insist on conflict-free products, and harm to our business.

We may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs.

In the future we may require additional capital to respond to business opportunities, challenges, acquisitions or unforeseen circumstances and may determine to engage in equity or debt financings, replace our current line of credit, or enter into new credit facilities for other reasons. We may not be able to timely secure additional debt or equity financing on favorable terms, or at all. Any debt financing obtained by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to grow or support our business and to respond to business challenges could be significantly limited.

Our investment portfolio may become impaired by deterioration of the capital markets.

Our cash, cash equivalent and short-term investment portfolio as of September 30, 2016 consisted of $113.4 million of money market mutual funds, highly liquid debt instruments of the U.S. government and its agencies, commercial paper, and U.S. and foreign corporate debt securities. Should financial market conditions worsen in the future, investments in some financial instruments may pose risks arising from market liquidity and credit concerns. In addition, any deterioration of the capital markets could cause our other income and expense to vary from expectations. As of September 30, 2016, we had no impairment charges associated with our short-term investment portfolio, and although we believe our current investment portfolio has little risk of material impairment, we cannot predict future market conditions or market liquidity, or credit availability, and can provide no assurance that our investment portfolio will remain materially unimpaired.

We may not be able to utilize a significant portion of our net operating loss or research tax credit carryforwards, which could adversely affect our operating results.

As of September 30, 2016, we had federal and state net operating loss carryforwards due to prior period losses, which if not utilized will begin to expire in 2029 and 2016 for federal and state purposes, respectively. We also have federal research tax credit carryforwards that will begin to expire in 2024, as well as state research tax credit carryforwards that have no expiration date.  Realization of these net operating loss and research tax credit carryforwards is dependent upon future income, and there is a risk that our existing federal and state net operating loss carryforwards and federal research tax credit carryforwards could expire unused and be unavailable to offset future income tax liabilities, which could adversely affect our results.

In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, our ability to utilize net operating loss carryforwards or other tax attributes, such as research tax credits, in any taxable year may be limited if we experience an “ownership change.” A Section 382 “ownership change” generally occurs if one or more stockholders or groups of stockholders who own at least 5% of our stock increase their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. Similar rules may apply under state tax laws. It is possible that an ownership change, or any future ownership change, could have a material effect on the use of our net operating loss carryforwards or other tax attributes, which could adversely affect our operating results.

Our business and financial performance could be negatively impacted by changes in tax laws or regulations.

New income, sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time. Those enactments could adversely affect our domestic and international business operations, and our business and financial performance. Further, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us. These events could require us or our customers to pay additional tax amounts on a prospective or retroactive basis, as well as require us or our customers to pay fines and/or penalties and interest for past amounts deemed to be due. If we raise our prices to offset the costs of these changes, existing and potential future customers may elect not to continue or purchase our products and services in the future. Additionally, new, changed, modified or newly interpreted or applied tax laws could increase our customers’ and our compliance, operating and other costs, as well as the costs of our products. Further, these events could decrease the capital we have available to operate our business. Any or all of these events could adversely impact our business and financial performance.

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Our stock price has been and may continue to be volatile and may decline regardless of our operating performance.

There has not been a long history of a public market for our common stock, and an active or liquid market in our common stock may not be sustainable. The trading prices of the securities of technology companies have been highly volatile, and the trading price of our common stock has been and may continue to be volatile. The market price of our common stock has in the past and may in the future fluctuate significantly in response to numerous factors, many of which are beyond our control, including:

In addition, the stock markets, and in particular the New York Stock Exchange on which our common stock is listed, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. During the three months ended September 30, 2016, the closing price of our common stock on the New York Stock Exchange ranged from $11.61 to $14.22 per share. In the past, stockholders have instituted securities class action litigation against other companies following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business and adversely affect our business, operating results and financial condition.

If there are substantial sales of shares of our common stock, the price of our common stock could decline.

Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales might occur, could depress the market price of our common stock and may make it more difficult for you to sell your common stock at a time and price that you deem appropriate. We are unable to predict the effect that sales may have on the prevailing market price of our common stock. In addition, the holders of an aggregate of 13,732,453 shares of our common stock have rights, subject to some conditions, that require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. Registration of the resale of these shares under the Securities Act would generally result in the shares becoming freely tradable without restriction. Any sales of securities by existing stockholders could adversely affect the trading price of our common stock.

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Our directors, executive officers and their respective affiliates have substantial control over us and could delay or prevent a change in corporate control.

As of September 30, 2016, our directors, executive officers and their respective affiliates beneficially owned in the aggregate 25.7% of our outstanding shares of common stock. As a result, these stockholders, acting together, would likely have the ability to significantly influence the outcome of matters submitted to our stockholders for approval, including the election of directors and other significant matters such as a merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would likely have the ability to significantly influence the management and affairs of our company. Accordingly, this concentration of ownership might harm the market price of our common stock by:

We do not intend to pay dividends for the foreseeable future.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. In addition, the terms of our Credit Facility with Silicon Valley Bank currently restricts our ability to pay dividends. As a result, you may only receive a return on your investment in our common stock if the market price of our common stock increases.

Delaware law and provisions in our amended and restated certificate of incorporation and bylaws could make a merger, tender offer or proxy contest difficult, thereby depressing the trading price of our common stock.

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our restated certificate of incorporation and restated bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our Board of Directors, including the following:

 

 

(a) Sales of Unregistered Securities

Not applicable.

(b) Use of Proceeds

Not applicable.

(c) Issuer Purchases of Equity Securities

Not applicable.

 

 

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Not applicable.

 

 

Not applicable.

 

 

Not applicable.

 

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SIGNATURES

Pursuant to the requirements 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, in the City of San Jose, State of California, on November 9, 2016.

 

 

 

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