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ELON > SEC Filings for ELON > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for ECHELON CORP

Form 10-Q for ECHELON CORP


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Quarterly Report. The following discussion contains predictions, estimates, and other forward-looking statements that involve a number of risks and uncertainties about our business. These statements may be identified by the use of words such as "we believe," "expect," "anticipate," "intend," "plan," "goal," "continues," "may" and similar expressions. Forward-looking statements include statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances. In particular, these statements include statements such as: our projections of Systems revenues; estimates of our future gross margins; statements regarding reinvesting a portion of our earnings from foreign operations; plans to use our cash reserves to strategically acquire other companies, products, or technologies; our projections of our combined cash, cash equivalent and short term investment balance; the sufficiency of our cash reserves to meet cash requirements; our expectations that our Sub-systems revenues will not fluctuate significantly from foreign currency sales; our forecasts regarding our sales and marketing expenses; and estimates of our interest income. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in the "Factors That May Affect Future Results of Operations" section. Therefore, our actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to review or update publicly any forward-looking statements for any reason.

EXECUTIVE OVERVIEW
Echelon Corporation was incorporated in California in February 1988 and reincorporated in Delaware in January 1989. We are based in San Jose, California, and maintain offices in eleven foreign countries throughout Europe and Asia. We develop, market, and sell energy control networking solutions, a critical element of incorporating action-oriented intelligence into the utility grid, buildings, streetlights, and other energy devices - all components of the evolving smart grid, which encompasses everything from the power plant to the plug. Echelon's products can be used to make the management of electricity over the smart grid cost effective, reliable, survivable and instantaneous. Our products enable everyday devices - such as air conditioners, appliances, electricity meters, light switches, thermostats, and valves - to be made "smart" and inter-connected.

Our proven, open standard, multi-application energy control networking platform powers energy-savings applications for smart grid, smart cities and smart buildings that help customers save on their energy usage, reduce outage duration or prevent them from happening entirely, reduce carbon footprint and more. Today, we offer, directly and through our partners worldwide, a wide range of innovative, fully integrated products and services. We classify these products and services into two primary categories: Systems, such as our smart metering solutions, which are targeted for use by utilities and that we previously referred to as our Utility products and services; and Sub-systems that include our components, control nodes and development software, which are sold typically to OEMs who build them into their smart grid, smart cities and smart buildings solutions. Revenues from our Sub-systems products and services were previously referred to as Commercial and Enel Project revenues.

Our total revenues decreased by 33.7% during the third quarter of 2012 as compared to the same period in 2011, driven principally by decreased sales of our Systems products. Gross margins remained constant between the two periods, while overall operating expenses decreased by 8.3%. The net effect was a third quarter loss attributable to Echelon Corporation stockholders in 2012 that increased by $4.9 million as compared to the third quarter of 2011. For the nine months ended September 30, 2012, total revenues decreased by 4.9% as compared to the same period in 2011. Gross margins decreased by 3.1 percentage points between the two periods, while overall operating expenses decreased by 10.0%. The net effect was a loss attributable to Echelon Corporation stockholders for the first nine months in 2012 that decreased by $92,000 as compared to the first nine months of 2011.

The following tables provide an overview of key financial metrics for the three and nine months ended September 30, 2012 and 2011 that our management team focuses on in evaluating our financial condition and operating performance (in thousands, except percentages).


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                                     Three Months Ended
                                       September 30,
                                   2012              2011            $ Change         % Change
Net revenues                 $       29,064     $      43,827     $    (14,763 )         (33.7 )%
Gross margin                           40.9 %            40.9 %            ---         0.0 ppt
Operating expenses           $       15,742     $      17,165     $     (1,423 )          (8.3 )%
Net income (loss)
attributable to Echelon
Corporation Stockholders     $       (4,264 )   $         655     $     (4,919 )        (751.0 )%
                                     Nine months Ended
                                       September 30,
                                   2012              2011            $ Change         % Change
Net revenues                 $      110,219     $     115,952     $     (5,733 )          (4.9 )%
Gross margin                           41.1 %            44.2 %            ---       (3.1) ppt
Operating expenses           $       52,762     $      58,596     $     (5,834 )         (10.0 )%
Net loss attributable to
Echelon Corporation
Stockholders                 $       (8,713 )   $      (8,805 )   $         92            (1.0 )%
                                       Balance as of
                              September 30,      December 31,
                                   2012              2011            $ Change         % Change
Cash, cash equivalents, and
short-term investments       $       62,667     $      58,656     $      4,011             6.8  %

Net revenues: Our total revenues decreased by 33.7% during the third quarter of 2012 as compared to the same period in 2011, driven primarily by a $11.4 million, or 39%, decrease in sales of our Systems products and services and a $3.4 million or 23% decrease in net revenues from our Sub-systems products. The decrease in our Systems revenues was primarily due to an overall decrease in the level of large-scale deployments in the United States of our NES system products. With respect to our Sub-systems product line, the decrease in revenues during the third quarter of 2012 was due to decrease in sales to our American and European Sub-system customers other than Enel, reflecting depressed economic conditions and ongoing market share loss. Many of our Sub-systems customers produce products used in commercial or industrial buildings. The markets for these products were adversely affected by the recession that started in 2008. These markets have yet to recover to their pre-recession levels. Our total revenues decreased during the nine months ended September 30, 2012 as compared to the same period in 2011 by 4.9%. This was due mainly to decreased sales of Sub-systems products to European customers, including Enel, partially offset by increased shipments of our Systems products for projects in Finland and increases due to a change in the timing of revenue recognition for certain of our Systems products. These increases were partially offset by a reduction in Systems products shipped for our projects in United States.

Gross margin: Our gross margin remained constant for the three months ended September 30, 2012 as compared to the same period in 2011, and decreased by 3.1 percentage points during the nine month period ended September 30, 2012 as compared to the same period in 2011. The decrease during the nine month period was primarily due to increased manufacturing costs for our Systems products, as well as a change in the mix of products sold. This decline in gross margins was partially offset by reductions in indirect manufacturing expenses mainly due to reduced compensation expenses.

Operating expenses: Our operating expenses decreased by 8.3% and 10.0% during the three and nine month periods ended September 30, 2012, respectively, as compared to the same periods in 2011. The decreases in the three month period ended September 30, 2012, compared to the same period in 2011, were driven primarily by decreases in compensation costs (primarily due to reduced headcount and other employee related costs) as well as reduced travel costs. Along with the reasons noted above, also contributing to the decrease in operating expenses for the nine month period ended September 30, 2012, compared to the same period in 2011, was the impact of the reduction of stock compensation expense of $800,000 reflecting the retirement of our former CFO as well as the restructuring action during the second quarter of 2012 and the related restructuring charge of approximately $1.2 million that we took during 2012. This was partially offset by reduced stock compensation expense of $1 million resulting from the passing of our former Executive Chairman, Ken Oshman, in 2011. Also contributing to the decrease in operating expenses for the nine month period were the reduced fees paid to third party service providers.


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Net loss attributable to Echelon Corporation Stockholders: We generated a net loss of $4.3 million during the third quarter of 2012 compared to net income of $655,000 during the same period in 2011. This reduction in net income was directly attributable to the $14.8 million quarter-over-quarter decrease in net revenues, partly offset by reduced operating expenses. Excluding the impact of non-cash stock-compensation charges, our net income decreased by approximately $4.3 million in the third quarter of 2012 as compared to the same period in 2011. Our net loss decreased by $92,000 during the nine months ended September 30, 2012 as compared to the same period in 2011. This marginal decrease was attributable to the reduced operating expenses offset by the reduction in revenues. Excluding the impact of non-cash stock-compensation charges and restructuring charges incurred in the first half of 2012, our net loss decreased by approximately $89,000 in the first nine months of 2012 as compared to the same period in 2011.

Cash, cash equivalents, and short-term investments: During the first nine months of 2012, our cash, cash equivalents, and short-term investment balance increased by 6.8%, from $58.7 million at December 31, 2011 to $62.7 million at September 30, 2012. This increase was primarily the result of cash provided by operations of $7.2 million due mainly to reduction in working capital (increased A/R collections of $18.2 million being the primary driver), partly offset by cash used for taxes paid on stock awards released during the year and principal payments on our lease financing obligations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 1, "Significant Accounting Policies" of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2011, which we filed with the Securities and Exchange Commission in March 2012, describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to our revenues, stock-based compensation, allowance for doubtful accounts, inventories, and commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.

During the three and nine months ended September 30, 2012, there were no material changes to our critical accounting policies or in the matters for which we make critical accounting estimates in the preparation of our condensed consolidated financial statements as compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.


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                             RESULTS OF OPERATIONS
The following table reflects the percentage of total revenues represented by
each item in our Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 2012 and 2011:
                                          Three Months Ended              Nine months Ended
                                             September 30,                  September 30,
                                         2012             2011           2012            2011
Revenues:
Product                                   96.5  %          98.1  %        97.4  %         97.6  %
Service                                    3.5              1.9            2.6             2.4
Total revenues                           100.0            100.0          100.0           100.0
Cost of revenues:
Cost of product                           57.4             58.0           57.4            54.4
Cost of service                            1.7              1.1            1.5             1.4
Total cost of revenues                    59.1             59.1           58.9            55.8
Gross profit                              40.9             40.9           41.1            44.2
Operating expenses:
Product development                       25.0             17.2           21.3            22.4
Sales and marketing                       16.5             13.4           15.0            16.5
General and administrative                12.6              8.6           10.5            11.6
Restructuring charges                        -                -            1.1               -
Total operating expenses                  54.1             39.2           47.9            50.5
Income (loss) from operations            (13.2 )            1.7           (6.8 )          (6.3 )
Interest and other income (expense),
net                                       (0.6 )            0.9           (0.2 )          (0.1 )
Interest expense on lease financing
obligations                               (1.2 )           (0.8 )         (0.9 )          (1.0 )
Income (loss) before provision for
income taxes                             (15.0 )            1.8           (7.9 )          (7.4 )
Income tax expense                         0.2              0.3            0.1             0.2
Net income (loss)                        (15.2 )%           1.5  %        (8.0 )%         (7.6 )%
Net loss attributable to non
controlling interest                       0.5  %             -  %         0.1  %            -  %
Net income (loss) attributable to
Echelon Corporation stockholders         (14.7 )%           1.5  %        (7.9 )%         (7.6 )%



Revenues
Total revenues
                                 Three Months Ended
                         September 30,      September 30,     2012 over 2011    2012 over 2011
(Dollars in thousands)        2012              2011             $ Change          % Change

Total revenues           $     29,064     $        43,827     $   (14,763 )       (33.7 )%
                                 Nine Months Ended
                         September 30,      September 30,     2012 over 2011    2012 over 2011
(Dollars in thousands)        2012              2011             $ Change          % Change

Total revenues           $    110,219     $       115,952     $    (5,733 )        (4.9 )%

The $14.8 million decrease in total revenues for the quarter ended September 30, 2012 as compared to the same period in 2011 was primarily due to an $11.4 million, or 39.0%, decrease in sales of our Systems products and services and a $3.4 million, or 23.2%, decrease in net revenues from our Sub-systems products. The $5.7 million decrease in total revenues for the


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nine months ended September 30, 2012 as compared to the same period in 2011 was primarily the result of a $7.2 million decrease in Sub-systems revenues, which was partially offset by a $1.5 million increase in Systems revenues.

As we look forward to the remainder of 2012, the smart energy market continues to be in the midst of a challenging time. Macro conditions remain tentative amidst the European financial crisis, and competition is heightened as the industry faces slow growth and ongoing consolidation. New tender activity for smart-metering deployments is down and pricing pressures are increasing. In addition, the Sub-system business is still being negatively impacted by worldwide macro economic conditions, as well as ongoing market share loss, particularly in the buildings market. In this challenging environment, we expect our revenues in the fourth quarter of 2012 will be lower than those generated in the first three quarters of the year.

Systems revenues
                                 Three Months Ended
                          September 30,      September 30,     2012 over 2011    2012 over 2011
(Dollars in thousands)        2012               2011             $ Change          % Change

Systems revenues         $      17,806     $        29,171     $   (11,365 )       (39.0 )%

Nine Months Ended September 30, September 30, 2012 over 2012 over 2011 (Dollars in thousands) 2012 2011 2011 $ Change % Change

Systems revenues $ 74,526 $ 73,053 $ 1,473 2.0 %

During the three and nine months ended September 30, 2012 and 2011, our Systems revenues were derived primarily from a relatively small number of customers who have undertaken large-scale deployments of our NES System products. These deployments generally come to fruition after an extended and complex sales process, and each is relatively substantial in terms of its revenue potential. They vary significantly from one another in terms of, among other things, the overall size of the deployment, the duration of time over which the products will be sold, the mix of products being sold, the timing of delivery of those products, and the ability to modify the timing or size of those projects. This relative uniqueness among each deployment results in significant variability and unpredictability in our Systems revenues.
Systems revenues decreased during the quarter ended September 30, 2012 as compared to the same period in 2011. This was primarily due to an overall decrease in the level of large-scale deployments in the United States of our NES system products, partly offset by a one time price increase for products sold in the first half of 2012 to one of our customers. Systems revenues increased during the nine months ended September 30, 2012 as compared to the same period in 2011. This was due to increased shipments of our Systems products for projects in Finland. These increases were partially offset by a reduction in products shipped for our projects in Denmark and the United States. Our ability to recognize revenue for our Systems products depends on several factors, including, but not limited to, the impact on delivery dates of any modifications to existing shipment schedules included in the contracts that have been awarded to us thus far, and in some cases, certain contractual provisions, such as customer acceptance. For arrangements that contain contractual acceptance provisions, revenue recognition may be delayed until acceptance by the customer or the acceptance provisions lapse unless we can objectively demonstrate that the contractual acceptance criteria have been satisfied, which is generally accomplished by establishing a history of acceptance for the same or similar products. In the future, we will continue to evaluate historical acceptance rates for our Systems products and, when the data supports it, will recognize revenue at the point of delivery to the customer's carrier for those particular products (once all other revenue recognition criteria have been met), which could increase our Systems revenue in the period in which this determination is made. In addition, the revenue recognition rules relating to products such as our NES System may require us to defer some or all of the revenue associated with NES product shipments until certain conditions are met in a future period.

Our Systems revenues have historically been concentrated with a relatively few customers. During the years ended December 31, 2011, 2010, and 2009, approximately 94.2%, 85.4%, and 82.5%, respectively, of our Systems revenues were attributable to four customers. While our Systems customers will change over time, given the nature of the Systems market, we expect our future Systems revenues will continue to be concentrated among a limited number of customers.


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Sub-systems revenues
                                       Three Months Ended
                                                                           2012 over 2011   2012 over 2011
(Dollars in thousands)     September 30, 2012       September 30, 2011        $ Change         % Change

Sub-systems revenues     $             11,258     $             14,656     $   (3,398 )       (23.2 )%



                                       Nine Months Ended
                                                                          2012 over 2011   2012 over 2011
(Dollars in thousands)    September 30, 2012       September 30, 2011        $ Change         % Change

Sub-systems revenues     $            35,693     $             42,899     $   (7,206 )       (16.8 )%

Our Sub-systems revenues are primarily comprised of sales of our hardware products, and to a lesser extent, revenues we generate from sales of our software products and from our customer support and training offerings. Included in these totals are products and services sold to Enel.
Excluding sales of products and services to Enel, which are discussed more fully below, our Sub-systems revenues decreased by $3.2 million, or 25.0% during the three months ended September 30, 2012, and by $5.8 million, or 15.2% during the nine months ended September 30, 2012, as compared to the same periods in 2011. For the three month period, this decrease was primarily due to a decrease in revenues in the EMEA and Americas regions and ongoing market share loss. For the nine month period, this decrease was primarily due to a decrease in revenues in the EMEA region. These decreases were attributable, we believe, to generally poor macroeconomic conditions in Europe and the depressed Sub-systems market in Americas during 2012 and ongoing market share loss. Within the Sub-systems family of products, the year-over-year decrease was driven primarily from decreased sales of our control and connectivity products, partially offset by an increase in sales of our SmartServer products.

Our future Sub-systems revenues will also be subject to further fluctuations in the exchange rates between the United States dollar and the foreign currencies in which we sell these products and services. In general, if the dollar were to weaken against these currencies, our revenues from those foreign currency sales, when translated into United States dollars, would increase. Conversely, if the dollar were to strengthen against these currencies, our revenues from those foreign currency sales, when translated into United States dollars, would decrease. The extent of this exchange rate fluctuation increase or decrease will depend on the amount of sales conducted in these currencies and the magnitude of the exchange rate fluctuation from year to year. The portion of our Sub-systems revenues conducted in currencies other than the United States dollar, principally the Japanese Yen, was about 8.3% for the nine months ended September 30, 2012 and 6.9% for the same period in 2011. To date, we have not hedged any of these foreign currency risks. We do not currently expect that, during 2012, the amount of our Sub-systems revenues conducted in these foreign currencies will fluctuate significantly from prior year levels. Given the historical and expected future level of sales made in foreign currencies, we do not currently plan to hedge against these currency rate fluctuations. However, if the portion of our revenues conducted in foreign currencies were to grow significantly, we would re-evaluate these exposures and, if necessary, enter into hedging arrangements to help minimize these risks. Enel project revenues (included in Sub-systems)

                                 Three Months Ended
                          September 30,      September 30,     2012 over 2011 $   2012 over 2011
(Dollars in thousands)        2012               2011               Change           % Change

Enel project revenues    $       1,768     $         2,001     $      (233 )        (11.6 )%


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                                     Nine Months Ended
                                                   September 30,     2012 over 2011   2012 over 2011
(Dollars in thousands)    September 30, 2012           2011             $ Change         % Change

Enel project revenues    $        3,527          $         4,969     $   (1,442 )       (29.0 )%

In October 2006, we entered into two agreements with Enel, a development and supply agreement and a software enhancement agreement. Under the development and supply agreement, Enel is purchasing additional metering kit and data concentrator products from us. Under the software enhancement agreement, we are providing software enhancements to Enel for use in its Contatore Elettronico system. Enel Project revenues recognized during the three and nine month periods ended September 30, 2012 and 2011, respectively, related primarily to shipments under the development and supply agreement, and to a lesser extent, from revenues attributable to the software enhancement agreement. The software enhancement agreement expires in December 2012 and the development and supply agreement expires in December 2013.

We sell our products to Enel and its designated manufacturers in U.S. dollars. Therefore, the associated revenues are not subject to foreign currency risks.

Gross Profit and Gross Margin

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