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SSNI > SEC Filings for SSNI > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for SILVER SPRING NETWORKS INC

Form 10-K for SILVER SPRING NETWORKS INC


27-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with the information set forth under Item 6, Selected Consolidated Financial Data, and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The statements in this discussion regarding our expectations of our future performance, liquidity and capital resources, and other non-historical statements in this discussion, are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under "Risk Factors" and elsewhere in this Annual Report on Form 10-K. Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Overview

We have over ten years of experience creating, building and successfully deploying large scale networks and solutions enabling the "internet of things" for critical infrastructure. The "internet of things" refers to a system where a diversity of physical devices has the capacity to communicate using internet technologies. Our first area of focus was in energy, creating a leading smart grid network by applying advanced networking technology and solutions to the power grid. We have recently broadened beyond the smart grid to networking other critical infrastructure such as street lights, which 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 the potential to transform the energy industry through better communication just as the application of networking technology to the computing industry enabled the Internet.

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

We believe our technology is particularly well suited for a range of other solutions across the broad category of the "internet of things." We are focused on critical infrastructure that requires similar networking performance as the current market we serve. Our first expansion beyond the power grid has been 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. We expect to expand our offerings in this area as the market opportunity evolves.

For the years ended December 31, 2013, 2012 and 2011 our total revenue was $326.9 million, $196.7 million and $237.1 million, respectively. In the same periods, our total non-GAAP revenue was $344.1 million, $304.3 million and $236.1 million, respectively. In addition, for the years ended December 31, 2013, 2012 and 2011, we earned gross profit of $115.4 million, $31.7 million and $23.0 million, respectively, and incurred net loss of $(66.8) million, $(89.7) million and $(92.4) million, respectively. To date, a substantial majority of our revenue and non-GAAP revenue has been attributable to a limited number of customer deployments of our networking platform and advanced metering solution. Our distribution automation, demand


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side management and street light solutions are being piloted and deployed by some of our customers and, to date, we have recognized limited revenue and non-GAAP revenue on these solutions as compared with those of our advanced metering solution. Please see Item 6. Selected Consolidated Financial Data, Key Non-GAAP and Other Financial Measures and Factors Affecting Our Performance, Key Elements of Operating and Financial Performance for more information on non-GAAP revenue.

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

Factors Affecting Our Performance

The Pace of Smart Grid Adoption

Our financial performance is correlated to the pace of adoption of the smart grid in the utility industry. The adoption of the smart grid in the United States is evolving and is impacted by multiple factors including the business needs and priorities for utilities, cost benefit analysis, technology testing, rate case timing, regulatory or government reviews and approvals and consumer sentiment. 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. Although we believe the adoption of the smart grid will continue to expand globally, the future pace and degree of adoption cannot be determined with certainty.

Long and Unpredictable Sales Cycles and Customer Concentration

Sales cycles with our prospective customers, particularly to utilities, which are our primary set of prospective customers, tend to be long and unpredictable. Sales cycles can be subject to multiple trial deployments, or pilots, before a full deployment contract is awarded, with no assurance that our networking platform and solutions will be selected. Our customers also typically need to obtain regulatory approval for these deployments. In addition, a substantial majority of our revenue, non-GAAP revenue and cash flows depend on relatively large sales to a limited number of customers. As a result of our lengthy sales cycle and relatively large sales to a small number of customers, our revenue, non-GAAP revenue and operating results can fluctuate significantly from period to period.

Customer Acceptance Provisions Impact Timing of Revenue Recognition

Our sales are generally made pursuant to MSAs. Our customer arrangements provide that we may bill and collect for products when ownership has transferred and for services when they have been provided. Our MSAs for each customer include initial acceptance provisions, followed by subsequent acceptances as the deployment progresses. The time to achieve these specific performance levels varies based on several factors, which may include the size and density of a customer's service territory and the complexity of a customer's deployment plan. Considering our limited historical experience to date, we have concluded for our current customers that the acceptance provisions are substantive, and defer revenue until we determine acceptance is achieved. Accordingly, we manage our business, make planning decisions, and evaluate our performance by assessing non-GAAP revenue, which are closely aligned with our sales volume and trends, and cash flow characteristics of our business.

Reliance on Third-Party Manufacturers

We outsource the manufacturing of our hardware products to third-party contract manufacturers. Accordingly, a significant portion of our cost of revenues and substantially all of our deferred costs consist of


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payments to our contract manufacturers. Our contract manufacturers generally secure capacity and procure component inventory on our behalf based on a rolling forecast. To protect against component shortages and to provide replacement parts for our service teams, we manage our supply chain with third-party contract manufacturers to establish adequate quantities of key components. As part of our design review process, we also attempt to identify alternative or substitute parts for single-source components to further mitigate the risk of shortages.

Although we gain significant benefits from outsourcing manufacturing, it results in less control over the manufacturing process, exposing us to risks, including reduced control over quality assurance, product costs and product supply.

Product Costs

Our objective is to continue decreasing product costs and improving product gross margins through engineering design cost reductions, higher volume purchasing of our hardware, elimination of single-source parts and additional economies of scale. We leverage the production capacity of our third-party contract manufacturers to maintain production volume capacity and benefit from their volume component buying power. This allows us to preserve flexibility over our supply chain, while committing to minimum production volumes. See Item 6. Selected Consolidated Financial Data, Key Non-GAAP and Other Financial Measures" for more information on cost of non-GAAP revenue and gross profit (loss) on non-GAAP revenue. Through 2012, we have experienced significant increases in our non-GAAP gross margins, but do not expect the rate of increase to continue in future periods.

Innovation of New Products and Services Expansion

An important aspect of our strategy depends on our ability to expand beyond advanced metering sales and sell additional solutions to our existing and prospective customers. 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. We have only recently introduced our street light solution. There can be no assurance that this or other future smart city products and services will be accepted by potential customers. Other competing products and services for both the smart grid and smart city infrastructure may emerge and may be more successful.

International Expansion

Our future growth will depend, in part, on our ability to increase sales of our networking platform internationally. Historically, the majority of our revenue and non-GAAP revenue have been generated from the United States. In 2013, international customers accounted for 13% of revenue and 16% of our non-GAAP revenue. We intend to aggressively pursue new customers internationally, which may increase operating expenses in the near term and may not result in revenues or non-GAAP revenues until future periods, if at all.

Investments in Growth

We believe the smart grid and smart city markets are still in their infancy and our objective is to continue to invest for long-term growth. We expect to continue to invest heavily in our research and development initiatives to expand the capabilities of our networking platform. In addition, we expect to continue to aggressively expand our sales organization and partnerships to market our solutions both in the United States and internationally. We may incur losses in future periods as we continue to invest in our growth.


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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 certain non-GAAP measures which consist of non-GAAP revenue, cost of non-GAAP revenue and gross profit (loss) on non-GAAP revenue. For more information regarding our use of non-GAAP measures, see Item 6, Selected Consolidated Financial Data, Key Non-GAAP and Other Financial Measures.

Revenue

We derive revenue from sales of products and services that enable customers to deploy our networking platform. In 2013, product revenue represented 69% and service revenue represented 31% of our total revenue.

Our product revenue is derived from sales of hardware such as communications modules, access points, relays and bridges, and software. To date, in our typical customer deployments, we have sold our communications modules to third party device manufacturers and our other hardware and software products directly to our customers. However, when requested by our customers, we have sold third-party devices such as meters integrated with our communications modules directly to our customers.

Our service revenue includes fees for professional services, managed services and SaaS, and ongoing customer support.

To date, a substantial majority of our revenue is attributable to a limited number of customer deployments of our advanced metering solution. In 2013, the deployments for PG&E and FPL represented 39% and 20% 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.

Non-GAAP Revenue

Non-GAAP revenue 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. Non-GAAP revenue exclude amounts for undelivered products, services to be performed in the future, and amounts paid or payable to customers. Non-GAAP revenue are initially recorded as deferred revenue and are recognized as revenue when all revenue recognition criteria have been met under our accounting policies as described in "-Critical Accounting Policies and Estimates-Revenue Recognition." We reconcile revenue to non-GAAP revenue by adding revenue to the change in deferred revenue in a given period.

To date, a substantial portion of our non-GAAP revenue is attributable to a limited number of customer deployments of our advanced metering solution. In 2013, the deployments for BG&E and Commonwealth Edison Company represented 27% and 11% of total non-GAAP revenue, respectively.

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

Cost of Revenue and Gross Profit (Loss)

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,


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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.

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

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

Cost of Non-GAAP Revenue and Gross Profit on Non-GAAP Revenue

Cost of non-GAAP revenue represents the cost associated with products and services that have been delivered to the customer, excluding stock-based compensation and amortization of acquired intangibles. Cost of product shipments for which revenue is not recognized in the period incurred is recorded as deferred cost of revenue. Deferred cost of revenue is expensed in the statement of operations as cost of revenue when the corresponding revenue is recognized. Costs related to invoiced services are expensed in the period incurred. We reconcile cost of revenue to cost of non-GAAP revenue by adding cost of revenue and the change in deferred cost of revenue, less stock-based compensation and amortization of intangibles, included in cost of revenue in a given period.

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

Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses, as well as legal settlement expenses and amortization of acquired intangibles. Personnel-related expense represents a significant component of our operating expenses. Our regular full-time employee headcount grew from 567 as of December 31, 2011 to 602 as of December 31, 2013.

Research and Development

Research and development expense represents the largest component of our operating expenses and consists primarily of:

compensation, benefits and stock-based compensation provided to our hardware and software engineering personnel, as well as facility costs and other related overhead;

cost of prototypes and test equipment relating to the development of new products and the enhancement of existing products; and

fees for design, testing, consulting, legal and other related services.


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

Sales and Marketing

Sales and marketing expense consists primarily of:

compensation, benefits, sales commissions and stock-based compensation provided to our sales, marketing and business development personnel, as well as facility costs and other related overhead;

marketing programs, including expenses associated with industry events and trade shows; and

travel costs.

General and Administrative

General and administrative expense consists primarily of:

compensation, benefits and stock-based compensation provided to our executive, finance, legal, human resource and administrative personnel, as well as facility costs and other related overhead; and

fees paid for professional services, including legal, tax and accounting services.

Results of Operations and Key Non-GAAP Financial Measures

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



                                                              Year Ended December 31,
                                                       2013            2012            2011
                                                                  (in thousands)
Consolidated Statements of Operations Data:
Revenue, net                                         $ 326,858       $ 196,737       $ 237,050
Cost of revenue                                        211,504         165,018         214,099

Gross profit                                           115,354          31,719          22,951

Operating expenses:
Research and development                                77,018          61,998          57,510
Sales and marketing                                     34,931          29,104          25,221
General and administrative                              45,160          29,261          34,353
Legal settlements and amortization of acquired
intangibles                                                 -               -            1,097

Total operating expenses                               157,109         120,363         118,181

Operating loss                                         (41,755 )       (88,644 )       (95,230 )
Other income (expense), net                            (24,828 )          (683 )         3,234

Loss before income taxes                               (66,583 )       (89,327 )       (91,996 )
Provision for income taxes                                 224             390             363

Net loss                                             $ (66,807 )     $ (89,717 )     $ (92,359 )


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                  Years Ended December 31, 2013, 2012 and 2011

Revenue

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



                               Year Ended December 31,            Change in      Change in
                          2013          2012          2011           2013           2012
                                                  (in thousands)
      Product revenue   $ 224,310     $ 162,623     $ 212,317     $   61,687     $  (49,694 )
      Service revenue     102,548        34,114        24,733         68,434          9,381

      Revenue, net      $ 326,858     $ 196,737     $ 237,050     $  130,121     $  (40,313 )

Of the $326.9 million total revenue recognized in 2013, 84%, or $273.5 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from customers for which acceptance of initial phases of deployment was achieved prior to 2013, and 16%, or $53.4 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during 2013. Revenue from our advanced metering solution and demand-side management and distribution automation solutions represented 92% and 8%, respectively, of total revenue for the year ended December 31, 2013. Revenue from international customers represented 13% of total revenue in 2013.

Of the $196.7 million total revenue recognized in 2012, 95%, or $186.9 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from customers for which acceptance of initial phases of deployment was achieved prior to 2012, and 5%, or $9.8 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during 2012. Revenue from our advanced metering, and demand-side management and distribution automation solutions represented 89% and 11%, respectively, of total revenue for 2012. Revenue from international customers represented 8% of total revenue in 2012.

Of the $237.1 million total revenue recognized in 2011, 71%, or $167.7 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and advanced metering solution from customers for which acceptance of initial phases of deployment was achieved prior to 2011, and 29%, or $69.4 million, was due to the receipt of customer acceptances of initial phases of deployment during 2011. Revenue from our advanced metering, and demand-side management and distribution automation solutions represented 97% and 3% respectively, of total revenue for the year ended December 31, 2011. Revenue from international customers represented 5% of total revenue in 2011.

Product Revenue

The $61.7 million increase in product revenue for the year ended December 31, 2013 as compared to the year ended December 31, 2012 was due to an increase of $30.3 million resulting from changes in product mix, an increase of $20.5 million resulting from the recognition of product revenue that was previously deferred subject to contingency provisions with a customer that has now completed its network deployment and optimization, and an increase of $10.9 million due to higher acceptance volumes during 2013.

The $49.7 million decrease in product revenue in 2012 as compared to 2011 was due to lower acceptance volumes and changes in product mix.


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Service Revenue

The $68.4 million increase in service revenue for the year ended December 31, 2013 as compared to the year ended December 31, 2012 was primarily due to an increase of $46.0 million from the recognition of services revenue that was previously deferred subject to contingency provisions with a customer that has now completed its network deployment and optimization, an increase of $22.4 million for services associated with the receipt of customer acceptances.

The $9.4 million increase in service revenue in 2012 as compared to 2011 was primarily due to higher revenue of $8.8 million from professional services for follow-on phases of deployment.

Revenue from managed services and SaaS, and professional services represented 18% and 13%, respectively, of total revenue for the year ended December 31, 2013, 8% and 9%, respectively, of total revenue for the year ended December 31, 2012, and 7% and 4%, respectively, of total revenue for the year ended December 31, 2011.

In 2013, the deployments for PG&E and FPL represented 39% and 20% of our revenue, respectively. In 2012, the deployments for FPL, PG&E and OG&E represented 31%, 30% and 18% of our revenue, respectively. In 2011, the deployments for PG&E, FPL and SMUD represented 34%, 26% and 12% of our revenue, respectively.

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